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ANALYSIS: Exploring Progress Made in the American Airlines-US Airways Merger

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ANALYSIS: Exploring Progress Made in the American Airlines-US Airways Merger

ANALYSIS: Exploring Progress Made in the American Airlines-US Airways Merger
December 10
15:33 2014

MIAMI — Just one year after American Airlines and US Airways won approval from the U.S. Department of Justice to merge and form the world’s largest airline, the new American Airlines has made remarkable and substantial progress in combining operations. Led by a management team primarily sourced from pre-merger US Airways, American Airlines Group (AAG) has already met several key milestones.

Already over the course of 2014, AAG has co-located operations at more than 60 airports, combined major cabin service elements (food and beverage), and consolidated cargo operations. American combined cargo operations in May, blending investment in facilities at hubs of both pre-merger carriers as part of a combined $800 million operation flying exclusively belly cargo.

American Airlines Chief Integration Officer Beverly Goulet.

American Airlines Chief Integration Officer Beverly Goulet.

Earlier this fall, AirwaysNews.com conducted an exclusive interview with Beverly Goulet, AAG’s Chief Integration Officer, discussing the pace and scope of the merger integration. Goulet oversees the day-to-day minutiae of the integration process, and previously served as the Chief Restructuring Officer of AMR Corp, the parent of pre-merger American Airlines during its sojourn through Chapter 11 bankruptcy protection.

Under the Shadow of Delta and United


The path that American and US Airways must take is fraught with complications, ranging from potentially devastating battles with labor to poorly communicated customer service policy changes that anger high value frequent flyers. Consolidation in the U.S. airline industry since 2005 has certainly been beneficial for the US airline industry in aggregate. But on an individual, case-by-case basis, these mergers have been far more uneven. Since 2005, there have been five major US airline mergers: US Airways–America West, Delta–Northwest, United–Continental, Southwest–AirTran, and Frontier–Midwest.

Of the five, Delta–Northwest was an unqualified success and Frontier–Midwest an unqualified failure. The other three mergers fall somewhere in between. US Airways-America West begat a financially successful airline, but the combined carrier struggled to integrate its labor workgroups (primarily pilots) and may have suffered in the long run as a standalone carrier.

Southwest–AirTran was reasonably successful, but the elimination of the Boeing 717 fleet, the drawdown of the Atlanta and (partially) Milwaukee operation, and the exceedingly slow pace of consolidation all point to a relatively uneven result. And of course United-Continental, for the moment, was largely a failure (the airline is profitable yes, but largely due to factors beyond their control and cyclicality – most merger synergies have not yet been realized).

Indeed for American, the two best comparisons for its present state are United and Delta, and to that extent, American clearly wants to execute its merger in the same manner as Delta and avoid a meltdown on the scale of United’s summer of 2012.

Goulet noted that American had taken some lessons from these prior mergers. “We looked at other mergers and learned from them. It has guided what we do. First and foremost, we are focused on the integration and getting it right.” The prioritization of integration is a marked contrast with United, which rushed to combine networks without properly addressing the underlying systems.

Doug Parker, Robert Crandall, Tom Horton, and the new American Airlines leadership on stage after the merger and NASDAQ event on Dec 9, 2013.

Doug Parker, Robert Crandall, Tom Horton, and the new American Airlines leadership on stage after the merger and NASDAQ event on Dec 9, 2013.

Indeed, combining operating and IT systems was cited by Goulet as perhaps the greatest challenge faced by the combined carrier, who must switch its reservation system from Shares to Sabre and combine its customer-facing reservation elements into a single website. Mrs. Goulet pointed out that in contrast to United, which attempted to shoehorn the larger pre-merger United operation onto the Shares platform used by Continental Airlines, American has been utilizing what Goulet tabs an “Adopt and Go” principle for operational combination.

“If you move to one system, [you] go to the bigger system of the larger [pre-merger] carrier,” explains Goulet, “but we don’t always follow the principle every time–it’s a rule of thumb.” In sum, the new American must combine 712 pre-merger American (pmAA) systems and 660 pre-merger US Airways (pmUS) systems into just 600 for the combined airline.

American Airlines Airbus A319 at DFW.

American Airlines Airbus A319 at DFW.

American CEO Doug Parker re-iterated Goulet’s comments in a separate interview conducted this fall. “We have a 24-hour business that you can’t ever shut down, so you have to do this in real time,” opined Parker, “So systems integration is certainly a challenge and remains a challenge. The team behind the scenes has been knocking them off one at a time and doing a fantastic job, so that gives us a lot of confidence about what lies ahead.”

Of these systems, American’s primary focus and challenge is IT. “We are hugely focused on IT,” reveals Goulet, opining that, “Systems can work well but if our employees don’t have the right level of training, then they stumble. It’s more than technology. It’s what we ask them to take on and at what pace.” Her remark on training is perhaps a veiled jab at United’s struggle with Shares, which was driven primarily by inadequate training of employees expected to use the system.

Of course the integration has been anything but a cakewalk for American. “The integration of two airlines is very complex, driven by fact we are heavily reliant on technology,” Goulet stated. “I am mostly focused on the tension between making the right decisions [for the long run] and the need to provide our employees [in the near term] with tools they need [to do their jobs]. Another challenge is communicating what’s happening and what isn’t to our customers.”

A view from American’s DFW operations tower.

A view from American’s DFW operations tower.

The nascent combined communications operation for American was repeatedly tested in the first four months of the year due to inclement weather, and then again in late September and early October due to the fire at Aurora Center, which snarled operations at the carrier’s Chicago O’Hare hub. Goulet notes that, “Our operations haven’t been quite where we wanted them to be, largely due to weather. Our folks have had to go above and beyond under lots of trying circumstances.”

And despite her optimistic outlook on incorporating lessons learned, Goulet remains keenly aware of the complexity that lies ahead, concluding “I always touch wood when I say that things are going well. We will keep our heads down and stay focused.”

Labor Integration Remains Key


Another key challenge that the new American must navigate is the integration of two sets of employees, which its management team likely mismanaged in the America West–US Airways merger. Even today, pmUS pilots are referred to as “East and West,” and accordingly it was unclear whether the new American would be able to successfully merge myriad workgroups.

Further adding to the worries, Airways News sources at United Airlines pointed to the tortured relations between labor and management, and the inability of the two parties to agree on acceptable contracts as a major factor holding back productivity, and thus realization of synergies at United. And a key question emanating from the merger was whether the new American would succumb to similar pressures.

According to Goulet, “The teams have come together very well. As [CEO] Doug Parker likes to say: ‘You can go into meetings and not really know who is legacy US and who is legacy American.’ A lot of the success is about Doug’s leadership – he is a big proponent of communication with frontline employees and HQ. Things are going well in that regard. We have very honest conversations [with their employees] about where we can do better then we have.

An American Airlines flight attendant on the inaugural Boeing 777-300ER flight.

An American Airlines flight attendant on the inaugural Boeing 777-300ER flight.

Indeed, in planning its merger, pmAA and pmUS partly took a page out of the Delta-Northwest playbook by securing approval from various pmAA labor groups for the merger by promising substantial increases in wages (distributing a share of the synergies to employees), and implicitly winning approval from pmUS labor (for whom equalization with pmAA wages would already represent a substantial raise, let alone an increase above that level).

And in a surprisingly heartwarming turn of events, American management delivered on that promise, most notably in negotiating a new contract with the Association of Professional Flight Attendants (APFA) to cover the more than 20,000 flight attendants for the company.

American management worked with APFA leadership to deliver a new contract that would make American’s flight attendants the highest paid in the industry and deliver $193 million in increased annual compensation to them. But late last month, the flight attendants rejected the contract by just 16 votes (out of 16,376 cast), moving into an arbitration process that will cap their annual increase in compensation at $111 million instead, saving American nearly $82 million annually in labor expenses.

The key takeaway for the integration process is that American is willing to negotiate in good faith and pay money ensure a smooth integration of its labor workgroups and avoid the “East-West” dichotomy that limited pmUS. And, of course the $82 million annual savings ($410 million over five years – $300 million in discounted present value) is a nice boost to American’s bottom line, with the only drawback being that the flight attendants may blame American management for the worse-than-expected contract, instead of (rightly) pointing the finger at militant pmAA union members (primarily in the Miami and New York domiciles) who were the deciding votes in turning down the contract.

Even as American has turned toward the even more complex task of negotiating with formidable pilot unions, Parker is upbeat on his management team’s ability to push forward on contract negotiations: “Fortunately, the unions and the company had the foresight to put in place procedures that said if we can’t get something agreed to, we go to arbitration. Arbitration will result in joint contracts, but this is always a challenge. Even if though you have the right process, you want to do it in a way that everyone feels good about.”

And Parker professed strongly that his team had negotiated in good faith. “As we saw [last month], our flight attendants narrowly rejected a proposal that we thought was a good bit better than what we are going to do in arbitration. So it’s a challenge that we really didn’t anticipate, but we will work through.”

Already Starting to Realize Synergies


Even though it has yet to fully integrate operations, American has already begun to take advantage of some of the synergies offered by combining operations. One of the key initiatives implemented by the new management team is the re-banking of the Dallas/Fort Worth, Chicago O’Hare, and Miami hubs. American is counting on re-banking to boost connectivity at these hubs, with a commensurate jump in revenue.

The plan is driven by the experience of pre-merger US Airways, who rode banked hubs at Philadelphia and especially Charlotte to high profitability despite limited O&D markets.

American Airlines Terminal 8 at JFK

American Airlines Terminal 8 at JFK

“The new management team thought this was a good idea to implement,” notes Goulet. “[Pre-merger American used to operate banked hubs 12 years ago or so. To reduce costs, we de-peaked our hubs. But, from the standpoint of connectivity and revenue, banked hubs drive results.”

Relative to the rolling hub structure that American currently uses with flights spaced (relatively) evenly throughout the day, the newly banked hubs will feature far more volatility. In a banked hub structure (the most common type around the world), flights depart and arrive in alternating waves, and at hubs of this size, these waves might number 50 or 60 cities at a time.

Banked hubs offer more connectivity in terms of city pairs than rolling ones, which raises revenue potential, but they also cause challenges in terms of asset utilization and cascading delays at certain airports. However thanks to the new American’s favorable asset costs (tied to its well negotiated order for 460 Airbus and Boeing aircraft in 2011), and bankruptcy-restructured operation, the normal expenses of banked hubs might be reduced somewhat.

Another key area of synergies lies in cross-fleeting, in which pmUS aircraft operate flights at pmAA hubs and vice versa. To date, American has engaged in very little cross-fleeting, with two daily flights to two destinations at Los Angeles, six daily flights to five destinations at Miami, one daily flight to one destination at Washington Reagan, five daily flights to four destinations at Phoenix, two daily flights to two destinations at Charlotte, and one flight to one destination at Philadelphia – a far cry from the massive cross-pollination seen at United and Delta today.

Even at the same point in United’s merger, when it too had not combined operating certificates, it was engaging in cross fleeting to a far more substantial degree. “We rolled out the first wave of domestic aircraft cross fleeting, moving [Airbus] A319s into Miami and [Boeing] 737-800s over to Phoenix,” said  Goulet, “Cross-fleeting is not as easy as it might sound due to operational and customer-facing challenges. We’re monitoring this first phase to see how it goes.

An American Airlines 787-9 under construction at Boeing Everett, Washington, plant.

An American Airlines 787-9 under construction at Boeing Everett, Washington, plant.

Luckily for American, notes Goulet, the carrier will not face many challenges in combining fleets and reconfiguring aircraft. “[The fact that] there wasn’t a lot of fleet overlap was an interesting aspect of this merger. The nice thing about it is the relative lack of overlap. US was primarily Airbus and American was primary Boeing, [so there’s] not as much fleet modification work [required].”

And the new American has already begun to leverage the combined power of its merged network by allowing code shares between American and US Airways. Goulet says that the airline remains on track to realize merger synergies, and the $1.2 billion net profit (excluding special items) recorded in the third quarter of 2014 validates her claim.

Consumer-Facing Competence


In terms of its interaction with its customers, the new American has already won positive reviews for its handling of two key issues that affect high-value business travelers and frequent flyers in 2014.

The first is the seemingly mundane issue of meal windows – setting flight length cutoffs for the serving of meals in first class (versus the distribution of a snack basket). American initially published a blended policy more generous than that of pmUS but less generous than that of pmAA, but reversed the cutbacks when pressured by a vocal subset of high value customers (HVCs).

American Airlines new Business Class meal service includes the ability to pre-order prior to the flight.

American Airlines new Business Class meal service includes the ability to pre-order prior to the flight.

While meal windows affect a tiny minority of customers, they are symbolic of a broader worry on the part of pmAA customers that Parker, who took a notably dour stance on service elements when running US Airways, would pare back pmAA’s notably strong inflight service and amenities. But the meal window situation proved that when pressed by HVCs, Parker and American management were willing to compromise.

American also scored with HVCs when it preserved most elements of the pmAA AAdvantage frequent flyer program through combination in 2015. While American is likely to follow peers Delta and United in opting for a revenue-based frequent flyer program, it opted to preserve most elements of the exceedingly popular AAdvantage program, even making the program more customer-friendly in a few areas.

By waiting to make wholesale changes until after the merger is complete, American at the very least ensured that customers would not have to deal with too much change in too short of a time – winning brownie points even if it eventually opts for the financially prudent revenue-based program.

And in addition to these well-managed instances, American has been remarkably quick in combining processes. In fact, 2015 will be the last year in which most customers will have to interact with two distinct airlines, literally and in practice.

The two airlines will receive a single operating certificate in the second quarter of 2015, but as Goulet notes, the “biggest event is when we [American] transition to a single reservations system. At that point, we will have a single AA [IATA] code and a single website, and our target is the back half-of 2015.”

Other visual elements will also consolidate in 2015. “Airport branding will coalesce under the new American branding, while uniforms are to be determined,” said Goulet. In fact the only major visible integration marker that will remain distinct past the end of 2015 is the livery on American’s fleet. “The painting of aircraft will be completed by 2017. We have to be prudent about it and not take any more planes out of the system than need be, especially at peak times in the schedule,” she said.

As the first anniversary of the closing of the merger and listing on the NASDAQ stock exchange approaches, American Airlines has made substantial progress in combining its operations. The smooth and well thought out integration process has positioned American to thrive financially and operationally for years to come, perhaps allowing it to even (one day) challenge Delta for pole position as the talisman of the US airline industry’s rebirth.

 

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About Author

Vinay Bhaskara

Vinay Bhaskara

Senior Business Analyst, Big Airline Enthusiast, Avid Airport Connoisseur, Frequent Flyer, Globetrotter. I Miss Northwest Airlines Every Day. vinay@airwaysmag.com @TheABVinay

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