You can only envy the residents of Phoenix, Arizona. Not only do they live in one of the most beautiful US states - boasting dramatic sunsets, Indian art, cactus fields and Grand Canyon scenery - but should they absolutely have to leave home, they have the choice of two of the lowest-fare airlines in the country.
Both Southwest Airlines and America West have major operations in Phoenix. This is the city where point-to-point Southwest comes closest to hubbing. For America West, Phoenix is a true hub, a home base and the focal point for its growth strategy.
Following a tumultuous few years, America West is back on its feet. Having shaped itself into one of the lowest-cost and most profitable of the US airlines, it is more than happy to nest in Phoenix. But its chequered history since its birth in 1981 has given Wall Street ample reason to feel jittery, despite the latest accomplishments.
A fledgling of US deregulation, the airline expanded rapidly during the first 10 years. Starting out with a single Boeing 737-200, by 1990 it had a fleet of 104 aircraft, including four B747s, 11 B757s and 104 B737s. It also reported a record net income of $20 million, and was reclassified as a major airline by the US Department of Transportation.
By 1991, however, America West's fortunes were taking a distinct turn for the worse. An experiment with international operations, with a service to Nagoya, Japan, was terminated within 14 months and the airline entered a Chapter 11 bankruptcy that was to last three years.
Under new chairman and chief executive officer William Franke, however, America West underwent a remarkable resurrection that was fitting for an airline whose home city is named after the mythical bird that rose from the ashes. In 1994, it again reported record net earnings of $37 million. Emergence from bankruptcy followed, as did 14 consecutive profitable quarters.
Then the bird had its wings clipped. Operational problems combined with poor revenue management decisions to slam the airline back into the red in 1996, when it went from a record second quarter net income of $30 million to a third quarter net loss of $53 million. Since then, the bird has been shaking off the ashes all over again. Its 1997 fourth quarter results made short work of the task - a record net income of $20 million on revenues of $473 million. That profit, up 112 per cent over the 1996 fourth quarter, was a weighty contributor to the airline's 1997 full year results of $75 million net on $1.9 billion revenues.
Much of the latest turnaround is attributed to chief financial officer Douglas Parker, an avid revenue management fan who identified the financial blindspots of the company and set about introducing remedies. The fourth quarter results, he feels, are the first real proof that those remedies are working and, more importantly, form a foundation that will protect the airline from future drastic swings.
'The most pleasing element of the 1997 results is the momentum. The fourth quarter was outstanding; we ended the year much stronger than we began,' says Parker. 'We ended the year with a real nice momentum and the story of that momentum is a revenue story. In the last four or five months we have seen a dramatically improved revenue environment at America West.'
That momentum story convinces Parker that he can feel 'pretty bullish' as he looks forward. But Wall Street, while impressed with the figures, is keeping the champagne on ice. 'Sure, America West has been our top tick in our airline group for six months,' says Samuel Buttrick at PaineWebber in New York. 'But there's still no strategic vision there. Phoenix is a place, not a strategy. But I think their problems have been overstated by Wall Street. Certainly, what they lack in strategy they make up for in profits.'
Betsy Snyder, a director at Standard & Poors, has the same mixed feelings and points out that the fourth quarter results of America West, Southwest and Alaska were all much better than those of the larger majors. 'They did make very good progress in the fourth quarter - those results were very impressive. The question is, is it sustainable? Maybe they have learned from past mistakes. A lot of the positive things that are happening come down to revenue management, which they must be given credit for learning. But they had a lot of positive things going on before.'
Still, Parker insists the company has moved on and Wall Street, in general, is murmuring approvals. 'Everyone is now listing us as a 'buy' or a 'perform'. I think that's outstanding. The bullish attitude of Wall Street shows that this is a company that is on track and undervalued,' he says. 'We have hit all the numbers in 1997 and our fourth quarter blew everyone away. It's a material difference; a significant change that I would argue should have been in place three or four quarters ago. But credibility is back now and we are not going to lose it.'
The analysts uniformly chorus approval on the subject of costs, which the airline has kept firmly in check despite adding a first class cabin and upgrading passenger services. In fact, operating costs per available seat mile came down by another 2.2 per cent to 7.27 US cents in 1997.
This year, labour negotiations are outstanding with both the flight attendants and the mechanics, and the company acknowledges that maintaining those low costs will be a 'big challenge'. Parker estimates that, excluding any changes in fuel cost, unit costs should rise by no more than 1 or 2 per cent. That is 'doable', he says, even allowing for 'nice pay increases', because further savings can be made by increasing automation.
Analysts will be watching this carefully. 'America West's dominant virtue is its low operating costs,' remarks Buttrick. Company chairman Franke does not doubt it. 'The single biggest key to our success is sustaining our low costs,' he says. 'By maintaining our cost base we give ourselves the opportunity to develop revolutionary changes with some insurance.' Among the 'revolutionary changes', Franke highlights the move to improve passenger mix and yields. 'We used to price at the bottom of our spectrum and have the highest load factors, but generally also the lowest yields,' says Franke.
In particular, the airline concentrated on ferrying leisure passengers between Phoenix and its second hub, Las Vegas, even setting up a 'Nite Flite' service that ran through the late-night hours and included hotel packages in Vegas. While that remains important to the airline's philosophy of high utilisation - its aircraft are in the air just over 12 hours a day - the new management team is taking a more money-minded attitude towards that service. 'We have reduced our exposure to Vegas over the last three or four years,' says Franke. 'Vegas is a 24-hour city so we view it as a utilisation city - it's incremental flying. But now we are prepared to take a service out where we see that it's not a cash producer.'
Franke says that Phoenix, one of the fastest growing cities in the US, will remain the airline's key focus, with less attention on its other hubs at Vegas and Columbus, Ohio. 'Phoenix is experiencing significant growth and clearly we want to serve that growth,' he says.
In 1997 and early 1998, the airline has added frequencies and nonstop flights out of Phoenix, particularly to cities in the northeast like Baltimore, Boston, Detroit and Newark. Recently, it began the first nonstop service between Phoenix and Baltimore, and added a fourth daily nonstop flight between Phoenix and Newark. Such services are aimed at the business traveller who might find a more attractive fare at America West than with the larger majors, while avoiding Southwest's multi-stop longer haul flying.
Franke says this direct linking of Phoenix to strong business cities has so far been accepted by competitors along the east coast, such as US Airways and Delta Air Lines. 'There is a general industry tolerance for an airline having a market right to fly to its hub from other cities, and so far we have not met any real challenge,' he says. 'What we have done is expanded selectively and thoughtfully. There have been little dust ups now and then, but by and large the majors recognise that we are going to fly to our hub.'
Franke does not see America West becoming subject to a takeover, even in the current climate where analysts are predicting more US consolidation in the wake of the proposed alliance between Continental and Northwest. 'We are a public company, so I never say never. But with our low costs it would take an unusual set of circumstances for us to add value to a major airline,' he says. 'Our 7 cent costs would have to rise to their 9 cents, which would suck out our profitability.'
Almost by chance, America West has found itself sitting pretty in the Continental/Northwest deal. It has enjoyed a lucrative codeshare with Continental, worth some $20 million a year, since 1994, as well as a smaller arrangement with Northwest in which it ferries transpacific passengers to Phoenix and Vegas from Los Angeles and San Francisco. Franke says that neither codeshare is directly affected by the new alliance, but he is hopeful that America West may be able to expand its relationships with the two majors - especially Northwest. Standard & Poors' Snyder agrees. 'I think they will be a big beneficiary of the Continental and Northwest deal,' she says.
Potentially more problematic is America West's codeshare with the Mesa Air Group, which gives it a regional feeder service from small towns in the southwest to Phoenix and Vegas. Mesa's many financial and management woes in recent months have put a question mark over its future, but America West would clearly be sorry to lose this partner. 'Concern is too strong a word, but we are quite interested in what is happening at Mesa,' admits Franke. 'They are a valuable codeshare partner and they provide a service we could not effectively provide. We would work with them to bring them along. Sometimes you have to be a partner and sometimes you have to be big brother. We are happy to do either.'
Conversely, America West also admits that much of the territory surrounding its homebase is 'classic RJ country' so it has not ruled out the idea of purchasing regional jets at some time in the future for its own commuter network. There is no pilot scope clause to block that idea and America West says it has done 'a lot of work' analysing the potential of regional jets.
America West also has a small codeshare with British Airways. 'It's small but very valuable,' observes Franke. 'It adds power to our frequent flyer programme and it is nice to be associated with a quality product.'
Much of the airline's ability to reshape itself this time around has taken place against a background of cultural change that was largely instigated by Richard Goodmanson, president and chief executive officer, when he joined the company in 1996. Australian by birth and an outsider to the airline industry, analysts credit him taking a fresh look at the company and solving its operational problems.
Goodmanson says he took both top-down and bottom-up approaches towards changing the way employees worked. 'We created a lot more alignment and focus, with the aim that it would make them excited to have their parents fly on this airline,' says Goodmanson.
While culture change has become something of an over-used phrase in the US, Goodmanson believes it is definable and that it has worked at America West. He holds management group meetings one evening a week to analyse all of the issues affecting the airline, from meal service to repainting the fleet. Workshops address problems in detail, with each making a formal presentation of its conclusions and suggestions directly to senior management. 'There's nothing new here,' admits Goodmanson. 'But a way to get people to do the work is have them problem-solve. It's an empowering system. In 1997 we had 13 major workshops.'
Establishing an atmosphere of trust and teamwork has freed up the company to concentrate on and define its future, according to Goodmanson. 'Going forward, we intend to remain a value-leader in the industry, but we will not be as aggressive as we were price-wise. We intend instead to address frequency schedules aggressively, especially out of Phoenix. So, our growth over the next several years will reflect that strategy.'
Julius Maldutis, aviation director at Salomon Smith Barney, believes the strategy is right this time. 'I think it is a company that has found its niche, which is why I have changed my recommendation to a buy,' he says.
America West's Franke sums it up even more clearly: 'I think we have proved that the airline is a survivor.'
Source: Airline Business
