Jet Deal Signals Confidence for the Long Haul
American Airlines’ recent landmark agreement to buy dozens of Boeing airplanes during the next two decades at preset prices, including 103 planes right away for $6.5 billion, speaks volumes about the true state of the global economy and the outlook for U.S. business.
“We laid out our growth plans for the next quarter-century and arranged to acquire planes as we need them,” an airline spokesman says.
The deal and that statement are astounding. Little more than three years ago, there were fears for the future of American and all other U.S. airlines. President Clinton convened a White House conference to discuss the survival of the airline industry.
Concern was warranted. U.S. airlines collectively lost more money in the early 1990s than the industry had earned since the Wright brothers. American, having lost $750 million in the previous three years, was looking to its Sabre computerized reservation system as a more promising source of profit than flying passengers and freight. Yet this year American will earn about $1 billion and is operating confidently on a 25-year growth plan. Its recovery and the new deal with Boeing offer significant clues to the outlook for world business.
To begin with, two savvy companies foresee no major inflation for decades ahead. The pricing agreement contains some minor escalator clauses, sources say, but basically airline and plane manufacturer see a continuing stable environment, barring war or other global catastrophe. The outlook is for healthy growth--but not boom and bust. The airline will increase its 640-plane capacity roughly 2% a year for the next five years. “We want to grow at the rate the market grows,” says Robert Crandall, chairman of AMR Corp., American’s parent company.
But that doesn’t mean stalled profits. Flexibility, technology and improved labor relations brighten the outlook for American, which can stand as a model for other airlines and for a lot of U.S. companies now focusing on global growth after a siege of cost cutting.
The purchase agreement to 2018 gives American the right to order a plane on 15 months’ notice, so it can respond quickly to changing market conditions. It’s a more flexible and cost-effective arrangement than the old system of options on future aircraft.
For Boeing, confidence in a long-term relationship with a major customer means it can plan production schedules more accurately at a considerable cost saving. The deal could spell an end to the airlines’ ruinous cyclical practice of ordering planes in good times only to take delivery as the economy enters recession--although competitive pressures could upset that optimistic perspective.
Computer networking technology may be a two-edged sword for airlines, but it too promises cost reductions. Yes, the Internet will cap airline growth somewhat by allowing business people to hold long-distance conferences without flying off to meetings.
But just as the computer has filled airplane seats by allowing an incredible variety of bargain prices, so networking will reduce the cost of ticket distribution. Travel agent commissions, sales staff wages and the costs of tickets themselves amount to 30% of the price of the ticket, explains Don Garvett, a vice president of Simat, Helliesen & Eichner, a New York-based aviation consulting firm.
Ticketless travel and a reduction in agent commissions, which amount to 8% of American Airlines revenue, will make a difference. “In a business that makes less than a nickel per dollar of sales, a few percentage points of cost reduction makes a major contribution to profit,” says Garvett. Travel agents have a future as consultants, but the ticket-issuing function is threatened by technology.
Above all, the AMR-Boeing deal signals that the airline business is entering a new phase. In the long shakeout that followed airline deregulation in 1978, the number of passengers doubled, total airline operating revenue increased fourfold and net profits vanished. In fact, 1995 was the first year of this decade that the industry as a whole showed a profit.
The prospect of extinction chastened the industry. “Fare wars now occur at a higher-priced, profitable level,” observes Barbara Beyer, head of AvMark, an Arlington, Va., consulting firm.
Excess capacity is being reduced. New planes are replacing aircraft that either cannot be used or must be expensively retrofitted to meet noise regulations. Thus regulation is forcing innovation and improving the business.
A recognition is dawning that this is a very large industry that needs to be more stable. “There are now 12,000 aircraft in the world. A normal 5% a year replacement of worn-out equipment indicates a demand for 600 planes a year. But that is more than major manufacturers are currently turning out,” notes analyst Wolfgang Demisch of Bankers Trust Securities.
Most of all, American’s purchase of 103 planes--including 12 long-range 777s for flights to Asia, Latin America and Europe--plus the promise of 527 more new planes over the next 20 years--reflects a new policy of growth and a message to its employees.
The order is contingent on American’s pilots accepting a new contract, on which union members will vote this month.
“Everybody today is uncertain, asking: ‘Where is my company going to be in 10 years? Where is my job going to be?’ ” says an American spokesman. “This order pledges that American is going to grow internationally and domestically--and there will be a lot of opportunities.”
There always are, but now it appears that a chastened U.S. airline industry will be able to take advantage of them.
