The Stengel Angle

I grew up in Bethlehem, Pennsylvania, somewhere that probably does not ring a bell to most people. However, if you’re at all familiar with the steel industry, you might recognize the name Bethlehem Steel, once the second-largest steelmaker in the United States. Founded in 1857, Bethlehem was a titan that had large influences on the steel industry, like shipbuilding during World War II and the mass production of the ubiquitous I-Beam (which placed the company as the leading supplier to the construction industry and led to the skyscraper era).

Unfortunately, if you know the story of Bethlehem Steel, you also know about their demise. Plagued by the increasing market share of cheaper foreign steel in the U.S., mismanagement, and labor issues, the company closed its iconic Bethlehem plant in 1995, declared Chapter 11 bankruptcy in 2001, and finally sold all remaining assets to the International Steel Group in 2003. According to this CNN Money article, written in the aftermath of the sale to ISG, “The truth is that Bethlehem did itself in. It was not fit enough to deal with the new competition nor perceptive enough to sense its need for radical treatment.” 

The authors continue to point out that, “Bethlehem, typically joining in industry-wide bargaining, grimly settled into triennial negotiations in which the union worked unbendingly at keeping the maximum number of its members employed at the highest possible pay. That vault in wages shows how well the union succeeded.” Furthermore, and more to the point, the authors note that, “Written into the contracts as offsets, though, were a long string of benefit improvements. These took up their role as company killers.”

By now you’re likely wondering why I’m writing about a steel company and what the connection is to the aerospace industry. Well, it turns out that there is a modern-day case of Bethlehem Steel-itis in American Airlines.

It’s no secret that U.S. airlines have endured a difficult decade following September 11 with the spike in oil prices, a deep recession, and other factors. American, however, was the last to take the action necessary to continue competing with the other “legacy” carriers (i.e. United, Delta, US Airways). While much of the industry entered Chapter 11 bankruptcy protection, during which they were free to cut the contracts with their labor unions to lower costs, American settled for union concessions in 2003 that were simply not enough (American did enter Chapter 11 on November 29, 2011, however). Just take one look below at the disadvantage American has had in labor since 2002 compared to their peers (prepare yourself for graphs!!):

While American decided against bankruptcy in 2003, Chapter 11 helped all the competing carriers trim their labor costs more extensively

You may have astutely noticed that American does not have the highest labor costs anymore, and is now actually behind United and Delta. However, please read the note I added on, indicating that Delta merged with Northwest in 2008 and United joined hands with Continental in 2010, thereby naturally increasing their labor costs. So, American is in good shape then, right? Well…

American currently leads the legacy carriers with as high as a 7% margin for labor costs as a percentage of revenue

…not exactly. Although American doesn’t have the highest labor costs, labor still takes the biggest chunk compared to the competition. Just in case you haven’t seen enough graphs, I’m going to throw one more piece of evidence out there to prove my point:

For every available seat-mile, American pays 4.20 cents towards labor, or 28% of its 2011 cost per available seat-mile, the highest percentage and payment among the legacies

Surprisingly, even with a large and older fleet, American does not have the highest fuel cost per ASM. However, we see once again that labor is just beating the company into the ground.

It’s not uncommon for labor unions and airline management to be at each other’s throats, but this has been especially true since 2003 as employees have been trying to recover the concessions they made that year, while management is trying to continue to cut costs in order to compete. Through Chapter 11, Delta, United, and US Airways were able to reorganize themselves, cancel pensions, impose paycuts, and more. Upon emerging from bankruptcy, each carrier was leaner and more efficient, and in the case of United and Delta, were also good candidates for mergers, which offer even more valuable synergies and growth opportunities.

So we know that labor is an issue at American, but what about operations? How does AA perform compared to everyone else? More specifically, are they as disciplined with capacity and are they extracting the same amount of revenues? Let the graphs speak for themselves:

This data certainly paints a different and rosier picture for AA. For the non-airline-geek readers out there, yield is defined as passenger revenue divided by the total revenue passenger-miles and is measured in cents (forgive the odd parameters, it’s an airline thing). In other words, it’s a measure of how much money the company is squeezing out of all its customers. Load factor, on the other hand, simply measures how full the planes are (revenue passenger-miles divided by available seat-miles). This information is telling us that American has adopted the same capacity control discipline as its peers (as evidenced by the load factor) and actually gains more from fares than the other legacies (see yield).

The bottom line: American actually operates pretty well, but their labor liabilities are the biggest factor in keeping them from competing with other carriers effectively. Perhaps it was an unfair comparison to place American in the same boat as Bethlehem Steel, since American is still around and still has plenty of options. American has also taken in the same operating practices as their competition, whereas Bethlehem Steel didn’t. However, the labor issue is really the key theme, and illustrates how destructive it can be to a company if not managed adequately.

Some things to look out for in the future: since AA is now in Chapter 11, it has the opportunity to finally get rid of its albatross of labor costs. Furthermore, as of April 2012, American has a large number of new aircraft on order which will lower its fleet age along with its fuel costs. These aircraft include Boeing 777-300ERs, 737 MAXs, and Airbus A320 NEOs. By this time next year, American plans to be out of bankruptcy and to be effectively competing again.

Sources: AirlineFinancials.com, individual company annual reports