Economic Analysis of American Airlines: Market and Macro Context

This report provides a comprehensive economic analysis of American Airlines (AAG), one of the largest airline companies globally, examining its market position, financial performance, and macroeconomic context from 2006 to 2019. The analysis covers AAG's market exposure, including GDP development, income elasticity, customer structure, and competitive dynamics. It delves into the company's vulnerabilities, such as procurement issues, labor problems, competition from low-cost carriers, security concerns, and technological challenges. The report also explores AAG's strategic responses to the 2008-2009 financial crisis and its current competitive advantages. The analysis incorporates financial data, market share trends, and macroeconomic indicators to assess the airline's overall performance and outlook, including factors like material price fluctuations, exchange rates, and government intervention. The report concludes with an overview of AAG's current strategic position and future prospects, highlighting its strengths and weaknesses in a volatile industry.

Running head: AMERICAN AIRLINES
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Table of Contents
Introduction to American Airlines and its Market.....................................................................2
Vulnerability of the firm............................................................................................................3
Market exposure.........................................................................................................................4
GDP Development and Income elasticity..............................................................................4
Customer Structure and degree of dependence......................................................................6
Competition and price elasticity.............................................................................................7
Macroeconomic Exposure..........................................................................................................8
Material price fluctuation.......................................................................................................8
Exchange rate.........................................................................................................................9
Government intervention.......................................................................................................9
Protection.................................................................................................................................10
Brand development and price positioning............................................................................10
Economics of scope..............................................................................................................10
Technology...........................................................................................................................11
Low cost of production and economies of scale..................................................................11
Current strategic position and competitive advantage.........................................................11
Conclusion and outlook............................................................................................................12
References................................................................................................................................13
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Introduction to American Airlines and its Market
American Airlines is one of the largest airline company of the United States of
America (USA) and the fourth largest airline in the world. The company was founded in
April 15, 1926 (93 years ago) and is headquartered in Fort Worth, Texas, within Dallas –Fort
Worth Metroplex. The first flight of the company though used for carrying mail only, the first
ever passenger plane of the company came into operation in 1934. Then onwards the
company has achieved many heights and still today it is among the largest airline company in
the world. In 1939, the company had been listed in the New York Stock Exchange. The
company is also among oldest airline company in the world and it operated under the name of
American Airways during its initial days. It completed providing service to 1 billion
customers in the year 1991(Americanairlines.in 2019). In terms of number of passengers
carried, size of fleet, passenger-kilometres covered and number of destination served the
American Airlines is the largest airline company in the world. The company has a fleet size
of 945 (mainline) aircrafts. As per record, the American Airlines along with its all
subsidiaries flies 6800 flights a day in more than 50 countries and 350 destinations. American
Airlines is among one of the founding members of the third largejst airline alliance of the
world, Oneworld Alliance (Reuters 2019).. It also employs a large number of people, in 2019
the number of employees in the company was 1,30,000 (Statista 2019). The company is
handling more than million passengers annually with an average of .5 Million passengers
daily. (Wikipedia, the free encyclopedia, 2020)
In 2013, AMR Corporation the parent company of American Airlines merged with
U.S. Airways and took the name American Airlines Group. The airline company, hold the
maximum market share among all the airline company in the US, it holds 26% of the total
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market share in 2014. American Airline Group (AAG) operates both in domestic and
international market and 57% of the total revenue it earns from the domestic market and the
rest 43% comes from the international market. Of the international earning, the contribution
of the Latin American region is 23% (Marketrealist.com 2014). The revenue that AAG earns
from the market depends upon several contributors and that includes passenger cargo and
other flight services. It serves a large number of passengers per year and is evident from the
data of the financial year 2016 that ended in the last day of December 2016. The number of
passengers it served until that day was 199 million. To serve such a large number of
passengers a year it operates 945 mainline aircrafts that were supported by 606 more regional
aircrafts. AAG penetrates the market by using several marketing strategy. It provides the
passengers to book hotel rooms, vacations cruises and cars, however it depends on the
category of the ticket booked. The airline company provides the option of four category of
seats that include Choice class, Premium economy class, First class and Business class. It
uses Boeing 777 in which luxury lounge facilities are provided. The passengers who fly
frequently via AAG flights are provided with status that has three categories namely Gold,
Platinum and Executive Platinum. AAG being the largest airline company in the world and it
operates in more than 50 countries around the world. To make the operations functional in all
of the countries, AAG has 10 main hubs in 10 major cities in the world.
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Strategy adopted during 2008-09 Financial Crisis
The year 2008-09 has seen its worst financial crisis in the history with many airlines
scrapping thousands of flights. Under the said condition, the fuel prices soared very high
significantly impacting the profitability of various airlines in the US. The American Airlines
during the said period was faced with a severe liquidity crunch and profitability issues with
parent company under severe debt burden piled up. The company adopted the strategy of cost
cutting and capacity adjustment to overcome the blow. However, the company reached the
brim of insolvency on account of such huge debts. Necessary actions were taken on the part
of the management, coupled with financial aid of the government as a bail out package, the
airline company survived one of the largest perils of the 2008. Thus, the strategy adopted by
the company in 2008 was average as other US airlines also adopted similar strategy.
Vulnerability of the Company
American Airline Group is one of the largest airline company in the world; however,
the company faces huge competition and other operational chain issues in the market that
creates vulnerable conditions for the company. The vulnerabilities are :
Procurement
Among many of its vulnerabilities, one is dependency for the aircraft parts that the company
takes from the different suppliers that are very limited in numbers. This creates a problem of
scarcity for the company as inadequate availability of airline servicing firms would delay the
process of solving the mechanical, design and performance related problems of the aircrafts
(Belobaba, Odoni and Barnhart 2015). It affects the smooth operation of the airline service
and increases the cost of operation for the company.
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Labour Problems
The company had four plans of pensions which were under funded by $ 10 Billion that it has
to pay for pending pensions as reported in the Reuters on December 1, 2011. (Reuters.com,
2020). Thus, after paying it out the company will face a significant amount of crunch in
liquidity.
Competition
Apart from internal and backward linkage vulnerabilities, it faces vulnerable conditions for
external factors such as emergence of new airline companies that operate at low cost and
offers tickets at low prices and thus market share of AAG is declining (Mbaiwa 2017). Due to
this the market share of the company has reduced over the years, in 2013 it has 26% of the
total share whereas in 2018 the percentage of market share for the company reduced to
17.8%. The said share has further decreased to 17.6% ad updated in October, 2019 as
reported by Statista. (Statista , 2020)
Many potential airline companies go into price war with the AAG both in domestic and
international market. In domestic market, the potential competitors are United Airlines,
Alaska Airlines, Southwest Airlines, Delta Airlines and Jet Blue Airlines and in the
international market there Qatar Airlines and Emirates that pose enough competition
(Borenstein 2017).
Security & Compliances
Moreover, security related issues have also been playing an adverse role against the overall
airline industry as recent hijacks and accidents have escalated the global concern regarding
security issues. Regulations regarding environment has to be complied by every airline
company in the industry. Apart from this, there exist significant amount of government
intervention in the industry and the fuel used in the aviation industry is very much costly that
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contributes to the cost of the airline industry and oil comes under operating cost and thus
importance of cost of fuel holds importance in the industry (Dincer and Acar 2016).
Liquidity
The company has also faced severe liquidity crunch during the financial crisis of 2008-09 and
has also filed for bankruptcy protection as the airline parent company had a debt overall of
$29.6 Billion. However, the company restructured its debt to protect itself from the
downward fall. (Top-Dissertations.com, 2020)
Technology
The airline is also facing a severe technological challenge on account of technological
updates and modernisation. On the basis of such upgrades, there is a severe threat to security
and company is required to invest substantially on technologies and updates. Further, the
airlines in the past has been reprimanded with the one of the largest contributor of air
pollution.
Further, the recent grounding of Boeing 737 Max, significant part of the fleet of the company
has caused a drastic impact on the profitability and financials of the company.
Hence, existence of significant number of challenges has made the AAG vulnerable to the
competition in the industry. (Sumers, 2019)
Key Market exposure
GDP Development and Income elasticity
American Airline Group is a US based airline company and it operates all over the
country with significant amount of flights per day and is the largest airline company in the
country as per market share. Thus, the GDP of the US will have significant effect on the
AAG and on the other hand considering the volume of the business of AAG any fluctuation
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in the business of the airline company would impact the GDP of the country in return. The
economy of the US has flourished over the years, is now one of the developed countries in
the world, and is evident from the GDP data of the country. The GDP of the US in 2001 was
just above $10 billion dollars and in the last 18 years, the GDP of the country has increased
more than twice and current value of GDP of the country is over $20 billion. Therefore, it can
be said that he income of the country and its economic output is very high and is capable of
supporting any industry to flourish. However, only growth in GDP is not important, as it does
not provide the overview of the individual income of people of the country. Hence, to include
the reflection of individual income data on per capita has been studied in the essay.
Figure 1: GDP of the US
Source: (Fred.stlouisfed.org 2019)
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Figure 2: Per capita GDP of the US (in $)
Source: (Data.worldbank.org 2019)
In figure 2, the data on per capita GDP of the US can be observed and it depicts that
the per capita GDP has increased over time. Thus, with increase in per capita GDP, income of
people has increased and thereby disposable income has also increased. Therefore, in recent
times people can afford more, since according to the theory of income elasticity consumption
increases with increase in income per capita. Hence, passengers who travel by economy class
10 years ago might be able to afford business class or atleast a higher tier than the previous
one (Liddle 2014). Also. the increase in per capital income more people have the capacity to
afford airlines as a means to travel. Therefore, with increase in income of the people, revenue
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for airline companies has also increased and it is evident from the revenue data of AAG given
in figure 3.
Figure 3: Revenue (in billion $) and Revenue growth (in %) of AAG
Source: (Macrotrends.net 2019)
Further, it shall be duly noted that aviation industry globally supports $ 2.7 trillion i.e. 3.6%
of the worlds gross domestic product. If the aviation industry would have been a country, it
would have ranked 20th in size by Gross Domestic Product (GDP) which is equivalent to the
GDP of Switzerland.
https://aviationbenefits.org/economic-growth/
Customer Structure and degree of dependence
The customer base of the airline industry in the US is quite strong due to two main
reasons, income of the people and the volume of business that occurs in the country. It has
been observed that around 87% of the revenue of the airline industry comes from the normal
passengers, that means the passengers who are not regular passengers and the rest amount of
revenue comes from commodity passengers that travel once (Quartz 2019). From the global
data, it is evident that the mode of air travel has been availed more than previous years.
Globally, increase in air travel has been recorded over 3%-5% and in the US the growth over
the period 2015-2020 has been recorded at 3.2% domestically. The graphical representation
of the growth of the industry is as under (Icao.int 2018):
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Therefore, the market for airlines is growing. Thus, from the above discussion it is evident
that the airline industry is dependent on passengers for revenue. Out of total passengers,
revenue above 20% comes from the passengers that travel for business purpose. Being a
business centre, the US airlines are used widely for business purpose travels. Therefore, AAG
is strongly depend on the customers that belong to the business and normal travel passengers.
Further, it is analysed from reports that around 60% of the revenue of the airline industry
comes directly from passengers and balance 40% comes from selling frequent fliers miles to
credit card companies.
https://www.investopedia.com/ask/answers/041315/how-much-revenue-airline-industry-
comes-business-travelers-compared-leisure-travelers.asp
Competition and price elasticity
AAG being the fourth largest airline company in the world has a lot of competitors
who are not much behind the company and it is evident from the data of market share
distribution given in figure 3. The airline industry is run by few numbers of companies and is
dominated by these companies as well and thus the airline industry takes the form of
oligopoly market structure. The major competitors are Southwest Airlines Company, Delta
Airlines, JetBlue Airways and United Continental Holdings. The price war has always been
the primary objective of these airline companies to remove the other company from the
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industry (Kavurmacioglu, Alanyali and Starobinski 2014). Different companies use different
types of strategy to reduce the cost of running flights so that the price of the seat can be kept
low to win over the competitors and thereby earn more revenue and profit. The airline
industry use dynamic pricing strategy based on the price elasticity of demand theory.
Applying theory of price elasticity, it can be observed that passengers are highly elastic to the
change in price of the ticket, if the date of journey is far from the date of booking ticket. On
the other hand, if the date of booking and journey are close then passengers are less elastic,
rather inelastic depending upon the importance of the journey. Thus, price elasticity plays an
important role in setting the ticket prices (Goldberger 2019). Therefore, price elasticity
provides the airline companies to charge very high prices on emergency ticket bookings and
thereby make supernormal profit in those tickets and thus to some extent the airline
companies balance the low priced that are booked way too early.
Figure 3: Airline industry market share in the US
Source: (Statista 2019)
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Global Issues
Shortage of Pilots
One of the bigger issues in the airline industry is the shortage of qualified pilot in the industry
causing the shrinkage of the pool. As per Boeing’s 2018 Pilot & Technician Outlook, the
aviation sector globally shall require 7.9 Million pilots and 7.54 million technicians
additional. Further, there shall be shortage of number of pilots by 2019. The rationale behind
shortage of pilots in the industry is limited infrastructure globally for such training.
System Failure and technology infrastructure (aging)
There has been a series of unfortunate incidents in the airline industry which has a far
reaching impact on the industry. In late January 2017, Delta Airlines one of the largest
airlines has experienced a network interruption which resulted in cancellation of 270 flights
and delay of many flights. A larger out break was experienced in 2016 grounding 2300
flights. Similar issue was faced by American Airlines on account of a bug that caused I pad
software used by the company to run into a crash, grounding dozen of flights. This failure has
been experienced by almost all large airlines in US resulted in big losses to the giant
companies. Grounding of Boeing 737 Max duly highlights the same. (Erik & Jonathan
Bernstein, 2020)
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Climate Change
Climate has been one of the critical factor in the airline industry of USA which has resulted
in financial losses to companies. Recent climate changes and summits in Davos at World
Economic Forum duly highlights the rapid transformation of climate and increase in global
temperature causing serious environmental impacts. A study by researchers at the University
of Reading in the UK, the volume of severe turbulence will double in airspace over North
America, the North Pacific, and Europe between 2050 to 2080. Given that the aviation sector
accounts for 2 to 5 percent of global emissions, airlines are also under pressure to find ways
to become more fuel-efficient and environmentally friendly. (Dwyer, 2019)
Macroeconomic Exposure
Material price fluctuation
Price fluctuation of commodities have always affected the economy of a country, if
the fluctuation occurs in the downward side then the inflation rate would fall as per
fundamental theory of macroeconomics. Similarly, on the other hand the inflation rate would
go up due to fluctuation of price occurred on the higher side. Therefore, if the price major
input of aviation industry oil rises then it will affect the price of the air tickets as well
(Withers et al. 2014). However, oil is the main input of almost every medium of transport and
thus increase in oil prices would push the transportation cost and thereby all the products in
the economy faces rise in prices and thus the price of factors of the airline industry increases
too. Thus, effect of this oil price induced inflation increase the price of airline tickets (Perez-
Segura and Vigfusson 2016). Therefore, from this effect, AAG cannot escape, but this is the
case with all the other competitors of AAG. Thus, it is not difficult for AAG to compete with
the rivals. The major impact on the airline industry would be the fall in sales, as passengers
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would take other transportation options if available. This fall in revenue would be in the
domestic market only. Graphic representation of price volatility is depicted as under:
Exchange rate
Exchange rate is another macroeconomic factor change in which impacts the
economy of a country and it impacts the international sales of the domestic products AG
operates in the international market and thus it faces competition from international Airline
companies like Emirate and Qatar Airways. The main drawback for the AAG is the highly
appreciated value of dollar in the world and thus it makes the price of the tickets of the AAG
expensive in comparison to its competitors and hence making difficult for the airline
company and thus the international market is dependent on the exchange rate (Ball 2017). On
the other hand, fluctuations in the value of exchange rate impacts the economy of the country
and thereby changes the inflation rate and trade balance of the country and thereby impact
overall economic output. Thus, exchange rate has significant role in the market of the AAG.
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Further, the dollar has lost its stability as witnessed in past year, thereby creating
significant impact on the financials of the company. The movement of US against Euro has
been quite volatile over the past 10 years and has been graphically presented as under:
Government intervention
Economy of a country is influenced by the changes in political and external changes
such as war, epidemic diseases, incidence of terrorism and international trade activities of a
country. Thus, any such activities in the US will impact the economy and also the airline
industry of the country. Thus, if the industry gets affected then AAG would also face the
consequences. Therefore, in these situations intervention of the government is the most
important remedial measure that can possibly correct the problems of the economy. It is
evident from the step of President Carter’s step of introducing Airline Deregulation Act. The
implementation of the law enacted by the Act has reduced the price of the airline significantly
and made the airline travel affordable to the middle class people and thus airline service was
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reduced to the status of expensive or luxury means of transportation to affordable one. The
act has caused 40% decline in the airline ticket fares (Forbes.com 2019). Thus, assurance of
security by the government after an incidence of terrorism and steps toward improving the
security system of a country would help the tourism from losing tourists. Therefore, more
number of tourist will help the airline industry by keeping the revenue stable. Therefore, for
stability in business in the airline industry and keeping the industry away from exploiting the
passengers by charging high air ticket fare, intervention from the government is necessary.
The government intervention has also been recently witnessed in recent trade war dispute
between China and USA which has impacted the global trade significantly out rightly
impacting the sales of airlines industry in terms of cargo and passengers.
Other factors
Global Catastrophe like Coronavirus recently, can impact the business of airline industry.
Also, the grounding of Boeing on account of faulty engine issues can also impact the industry
significantly.
Protection
Brand development and price positioning
In airline industry in the US sustainability is an important factor, as the competition is
tough and all the competitors of the AAG are very close to it as far as the business is
concerned and thus proper brand development and pricing strategy is require. As far as brand
development is concerned, AAG is a well established brand and it should capitalize on it as it
is one of the major strength of the company. The main importance should be given to the
pricing strategy as all the other competitors are in price war with an objective of capturing the
market. Thus, keeping the price low or diversify the price on the basis of class and seats and
flights would be beneficial for AAG.
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Economics of scope
AAG offers different types of ticket class from business to choice class. There are
four classes in total. Apart from that, it offers booking of other travel oriented necessities
such as hotel booking, cab booking and travel plan booking. Thus, these offers make the
service of the AAG more attractive. Thus, offering more and diversified services provide the
company economies of scope that provides the company edge over competitors
Low cost of production and economies of scale
AAG is a large airline organization and its runs 6700 flights daily all around the
world. Thus, it has large economies of scale and therefore cost per unit of seat becomes very
low. Hence, low cost enables the organization to keep its price of air tickets and thereby
operates at low profit margin to gain over the competitors. Hence, large size of AAG is an
advantage for the company.
Current strategic position and competitive advantage
AAG in its current strategy has focused on three basic things but most important part
of a business, that are financial performance, customer experiences and satisfaction and
employee satisfaction. To make the company financially more stable it has taken steps to
reduce the redundant cost of the company, providing more benefits to the employees and
improving the service and quality of flights such as no delays and cancellation, improved
facilities inside the flight and thereby improving overall customer experiences. Apart from
low price providing quality service provides the company competitive advantage over the
rivals.
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Future Outlook & Shocks
The company at present has revenue of approximately 11.31 Billion dollars with an expected
EPS ranging from $ 4 to $ 6. The total debt of the parent company is approximately $ 21.4
Billion which is similar as compared to the 2008-09 financial crisis, putting company not in a
better place to manage any future downfall. (GuruFocus.com, LLC, 2020)
Further, the interest coverage ratio of the company at September, 2019 stands at 3.67 i.e.
capacity of a company to repay interest. Further, debt to revenue ratio of the company stands
at 2.89 i.e. the number of times debt is to the revenue of the company. Further, the Altman Z
score of the company is 0.88 implying that the company is in distress zone and chances of
bankruptcy of the company in coming 2 years is possible. American Airlines Group has the
Financial Strength Rank of 3. It displays poor financial strength and is likely in financial
distress. Usually this is caused by too much debt for the company. (The Associated Press,
2020)
Thus, on the basis of above, it may be concluded that company may not able to survive any
other recession like 2008.
Conclusion and outlook
American Airlines Group is one of the largest airline company in the world and it
operates both in domestic and international airline market. It holds the largest share of
domestic airline industry in the US. The industry it operates in is of oligopoly structure. It has
been seen that the suitable economy of the US has favourable supported the growth of the
company despite existence of several potential competitors. The impact of all the
microeconomic and macroeconomic factors has impact of the business of the AAG, however,
impacts are both positive and negative. Although the any existing issue that are external to
the industry can be solved by intervention of the government. Apart from that, economic
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factors that directly influence the operational aspect of the company are mostly in favour of
the company because of its large size. The current strategy of the company seems to be
effective and will fetch gain in future.
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Strictly Privileged & Confidential
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Available at: https://skift.com/2019/09/27/whats-gone-wrong-at-american-airlines/
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The Associated Press, 2020. American Airlines profit rises 27% on strong travel demand.
[Online]
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strong-travel-demand-68476664
[Accessed 16 February 2020].
Top-Dissertations.com, 2020. PROBLEMS FACING AMERICAN AIRLINES. [Online]
Available at: https://top-dissertations.com/essays/research/problems-facing-american-airlines/
[Accessed 16 February 2020].
Wikipedia, the free encyclopedia, 2020. American Airlines. [Online]
Available at: https://en.wikipedia.org/wiki/American_Airlines
[Accessed 16 February 2020].
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