American Airlines Value Pricing Debriefing Professor Joel Huber Fuqua School of Business Duke University

American - What Happened? April 9 - American April 12 - TWA April 13 - US Air, Continental, America West Announces Value Price Investment banks “brilliant strategic move Marketing press “Bob Crandall gave a tutorial to the airline industry.” AA up 3 1/4 to 71 7/8 Delta up 1 1/2 to 60 3/4 United up 2 1/2 to 133 1/4 Undercuts AA by 10-20% Cut Prices Note speed of response: due to the magic of computerized reservations

American - What Happened? April 20 - American May 20 - American May 26 - Northwest May 27 - American May/June - Other Airlines 1992 Q2 Matches competitor’s cuts on most leisure routes Raises fares 10-25% on many routes Grown-ups fly free Cut fares 50% for travelers in summer months Match 50% off Operating losses by all major carriers Note: American tried to raise fares elsewhere Northwest is hurting AA where it most hurts: leisure traveler Note: a 10-day sale in those days resulted in losses for the next three quarters

Could we predict who would defect? Yield .18 .16 .14 .12 .10 (Case exhibit 2) PROFITS USA DEL AA NW LOSSES UA Note: Three generic strategies: SWA low cost, USAir focus, AA and Northwest and Delta: differentiation better product (schedules, speed, service) Continental and TWA are vulnerable and cannot afford to have empty seats! CON TWA SWA AW .10 .12 .14 .16 .18 .20 Operating Expense per Rev. Pass. Mile

American: Take Aways Key Tools from Class American’s mission, assumptions (Company) Porter’s 5 Forces (Competition) Segmentation Analysis (Customer) Expected Value Calculation (Marketing Math) American tried to be the price leader…cutting price is not appropriate unless you want a shake out… That may have been Crandall’s goal. The goal of simplification was good, but almost certainly misread by the competition. Customers Large and small business, sensitive and insensitive leisure segments. Notice how much is available from Public sources.

How Crandall limited airline competitiveness through partitioning Hubs: Separates competitors—tie flights to the same carrier Load management: lowered costs, facilitated selective retaliation Frequent flier programs: partitioned customers from each other, lowered price sensitivity TACO’s increased agent loyalty, less incentive to search for prices

Why he could not succeed Forces creating intense competition: Michael Porters 5-forces Balanced competitors Slow industry growth High fixed costs Low customer loyalties Added capacity comes in large increments Diverse competitors High strategic stakes High exit barriers Yes

American: Takeaways Understand company’s limitations—Can AA enforce price leadership? Understand what benefits exist for your segments - how will customers react? Understand what benefits/liabilities exist for your competitors - how will they react?

Wisdom With few exceptions, when a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact. Warren Buffet