One-On-One: Exec: AA Capacity Cuts Are Temporary

American Airlines is one of only two Big Six legacy U.S. carriers, along with Continental, not in or recently clear of bankruptcy reorganization. BTN editors last week spoke with AA executive vice president Dan Garton about the carrier's competition against bankrupt and low-cost competitors, adjustments to flight schedules, business travel demand and international developments.

BTN: Industry capacity finally is starting to come out of the system. Beyond previously announced schedule reductions, what is American's strategy?

Dan Garton: Considering fuel prices, the routes that used to be on the edge have fallen off. It is responsible management to look through the route structure to see which are cash-negative. Fuel is now our biggest expense. I have been here 20 years and it had never been so. It had always been salaries. These fuel adjustments are probably temporary in nature, but changes by airlines that are restructuring are probably permanent. I do expect Northwest and Delta to make capacity adjustments that are permanent.

BTN: Will additional cuts generally come from reducing frequencies or suspending routes?

Garton: It will be driven by economic evaluation. If you are in a high-frequency market, you can recapture a substantial amount of the revenue that you would otherwise lose by canceling a flight on your other frequencies. Obviously, there is a competitive issue. If you are in a dogfight, you would be wary of reducing frequencies too much. The international phenomenon is different. Some of those services are at risk because they are incredibly fuel-intensive.

BTN: Will business travel demand remain strong?

Garton: As long as the economy stays strong, the volume of corporate traffic will be strong. We still are seeing that strong demand in part because the airline industry has not done a slick job in passing on the increase in fuel costs. To completely pass along fuel cost increases in the last two years, our average fare would have had to been up $75, when in fact it has been up $15.

BTN: Speaking of fares, how would you describe the elasticity in the business travel market?

Garton: There has been generally a pretty positive response to fare simplification on the business side. It did eliminate those pretty frustrating situations where a businessperson on a tight budget was forced to stay over on a Saturday or not travel. By lowering the full-Y walk-up fare, it eliminated some of those really high fares compared with the guy sitting next to you. I do not know if it is elasticity or share shift, because some of those people were finding ways to fly either one-stop or on a low-cost competitor. It certainly has been stimulative to us, as we have been able to steal share. Other than fare restructuring, I still believe that elasticity can result in a favorable revenue outcome for slightly increased fares. Average fare levels in general are still quite a bargain. We still believe that small fare increases would be revenue-positive.

BTN: Can AA cut costs quickly enough to keep pace with competitors now in bankruptcy court?

Garton: That is the plan. It is a different plan than other airlines have followed. Some of our earlier successes give us confidence that we can continue down this path. It is a more difficult process because changes being pursued by our competitors are aided by having a judge on their side, but it is clearly favored by our creditors, shareholders and employees. Until you are at the point of saying, 'My God, I cannot go on,' this is the path we have to follow, as a fiduciary responsibility. We are confident in our ability to make strides, but fast enough? We certainly hope so.

BTN: Considering the carriers that are in bankruptcy, is consolidation a strong possibility?

Garton: I am not one of those pundits who sees consolidation. Maybe it makes sense for some folks, and maybe it comes out of the chaos of 2006, but I would not bet my bottom dollar on that. The issue is the ability to compete in a cost sense, not in terms of network size. No one says the problem with American or Delta is that the network is too small. It does not seem consolidation would address the real issue.

BTN: What would the the repeal of the Wright Amendment impact beyond Dallas?

Garton: Hubs work by combining local traffic and connecting traffic. On most of our flights, two-thirds of our passengers are connecting to another flight. As we begin to pull apart those strings of flights, we lose connecting traffic. That weakens the downline flight. If we need to move flights to Love Field to compete against Southwest, the issue is not the local customer; the issue is the connecting customers who would be lost as they connect over Houston, Denver, Minneapolis, etc. Eventually, those routes that had connecting customers on them will begin to not make sense.

BTN: Is that not simply a decision for American, to either move service to Love or focus on maintaining the integrity of the DFW hub?

Garton: Yes, but it is almost an inevitable decision. The local customer is what makes a route work, and we cannot afford to have local customers siphoned off by Southwest. We would have to compete for local customers.

BTN: The United States and European Union this week are again discussing new air service agreements (see Inside Track, page 4). Are there any likely first steps that you expect?

Garton: We do see a 50/50 chance that something will happen, although sometimes we feel a little like Charlie Brown with Lucy holding the football. We have been down this path before, but there does appear to be interest in moving forward.

BTN: Short of a full replacement agreement between U.S. and E.U. regulators, what is the next step in the British Airways relationship?

Garton: We are obviously confined by the laws. If we can make greater connectivity between our networks, greater beyond-hub codesharing, greater frequent flyer promotions, etc., it would be helpful for us. There is room to move, even within the current construct. If the 50/50 turns out positive, more doors would be opened, but in the absence of antitrust immunity, you cannot talk about routes or pricing.

BTN: Antitrust immunity without a new Open Skies agreement would have been granted in 2002, had American and British Airways agreed to concessions at London Heathrow.

Garton: Exactly. But in that case, we were told that we could coordinate if we spun off something bigger than American Airlines. We could have done that deal, but it would have been ridiculous.

BTN: Was the sticking point the size of concessions requested, or the concept in principle?

Garton: That depends on what we would get in return. Basically, at this point, because of the strength of SkyTeam and others, we do not think there should be any penalty.

BTN: What is your view on India and China as American prepares to expand service there?

Garton: India historically has not had a lot of front-of-the-airplane traffic. In evaluating the route, we had conversations with some of our biggest corporate customers and they gave us a little confidence that historical yield data and passenger mix may not be reflective of the future. It encourages us that we might achieve better results. These guys are saying, 'We have to one-stop over Frankfurt. If you added direct service, it would be very helpful.' In China, the only question is whether or not we all flood the market to such an extent that the opportunity becomes diluted. The traffic opportunity, though, is clear.

BTN: American recently announced plans for a new international business-class seat. What is the importance of product in attracting business traffic?

Garton: It remains important on longer flights. One answer does not fit all situations and we try to make decisions to reflect the balancing act. On a short-haul flight, we have to be careful not to handle that balance improperly and raise costs. On long-haul flights, we have to make sure we do not become noncompetitive in a product sense and lose premium customers. It is a juggling act that varies by length of haul, market and competitor base.