Economics

Read "American Airlines," located in Chapter 24 of the textbook, Managerial Economics: A Problem Solving Approach. American Airlines announced a new pricing strategy that they believed would address concerns and benefit the company. Conduct further research on American Airlines' value pricing. Analyze American Airline's structure and decision to implement value pricing and discuss the following (750-1,000 words):

Discuss the decision behind American Airlines developing and implementing value pricing to gain more market shares.

Evaluate the impact competitors and additional economic factors had on the results of the value pricing strategy. What factors contributed to the advantages and disadvantages of this new pricing strategy.

Provide alternative recommendations to the value pricing strategy that would result in a different outcome when implementing the strategy.

Prepare this assignment according to the guidelines found in the APA Style Guide

GALVESTON, Tex., July 21— With videotapes, flip-charts, enlargements of once-secret memos and thousands of documents, armies of lawyers in Federal District Court here are re-enacting the airline fare war of 1992.

In an elegantly restored courtroom with carved wooden panels and silk drapes, Continental Airlines and Northwest Airlines are trying to draw blood, demonstrating that American Airlines engaged in "predatory pricing." That means setting fares so low that American would lose money, but so would its weaker rivals, who might be forced out of business.

Continental and Northwest say American's policies cost them at least $1 billion last year. American Airlines, whose executives deny they engaged in predatory pricing, say Continental and Northwest stumbled because of mismanagement. Crandall Meets Jamail

For many people at the courthouse here, the anticipated highlight of the trial will come next week, when Robert L. Crandall, the chairman of American Airlines' parent, the AMR Corporation, will take the stand. Mr. Crandall is known for his outspoken views, and his grilling at the hands of Joseph D. Jamail, the folksy Houston lawyer representing Continental, is much awaited.

"Joe Jamail is no wilting flower," said the presiding judge, Samuel B. Kent, of the man best known for winning a multibillion-dollar judgment against Texaco Inc. in 1985 for his client, Pennzoil, in a fight over who would acquire Getty Oil. "I may have to eat a power bar that day."

Of the testimony so far, the highlights have been the appearance today of Robert R. Ferguson 3d, president and chief executive of Continental Airlines, and of John Dasburg, chief executive at Northwest Airlines, last week.

Mr. Ferguson testified that he believed American's pricing strategy and its half-price summer sale last year delayed Continental from emerging from bankruptcy, derailed the airline's ambitious improvement plans and thrust the airline into a fight for survival.

After Continental matched American's new and lower fares in April 1992, Mr. Ferguson said, the airline lost $30 million a month and an additional $60 million to $70 million during the summer fare war.

By July, he said, Continental had only two days' worth of cash on hand, about $29 million, but managed to win concessions from some lessors of its planes so it could continue operating.

Mr. Ferguson told the court that American's deep fare cuts were "both predatory and below cost." If Continental and Northwest had gone out of business, he said American could have raised prices by 10 to 20 percent in selected markets.

On cross-examination, Irv Terrell, a lawyer for American Airlines, produced a Continental marketing report on the airline's plans for fall 1992 that said American's pricing strategy left business customers "up for grabs" and had the effect of "leveling the playing field." Mr. Ferguson said he did not recall seeing the document.

Mr. Ferguson will be back on the stand on Thursday morning.

In testimony last week, Mr. Dasburg told the court that Mr. Crandall had put pressure on him, in a conversation in September 1991, to join in raising airline ticket prices.

Mr. Dasburg said Mr. Crandall and Donald V. Carty, an AMR executive vice president, took him aside after a dinner gathering of airline and aerospace executives and "lectured me with regard to pricing at Northwest Airlines."

Mr. Crandall, he testified, "stated that we were a discount carrier and I personally ought to make sure I was supervising pricing." Mr. Dasburg said he interpreted that to be a suggestion that Northwest raise its fares, and he said he reported the discussion to Northwest's general counsel.

American Airlines executives have disputed that the conversation ever took place. 'Value Pricing' at Heart

At the heart of the case is what American Airlines called "value pricing," introduced on April 9, 1992. The airline said the approach was a way to end the confusing array of ticket prices by offering only four fares: first class, coach and two discount fares requiring advance purchase.

American hoped that other carriers would go along with plan, and many did. But a month later, Northwest fired the first shot of the summer fare war by offering a promotion of a free ticket for each adult paying a fare for a child. American volleyed back, offering 50 percent on domestic fares to all leisure passengers who could meet certain restrictions.

An all-out fare war ensued, and industry losses mounted. Continental, which at the time was operating under bankruptcy protection, and Northwest, which Mr. Dasburg said was almost out of money, say they lost a combined $1 billion as a result of American's actions.

In court documents, American has denied pricing its fares below its costs.

Lawyers for Northwest and Continental have been trying to use American's own internal documents to make their case that American slashed prices even though it would cost it hundreds of millions of dollars. Economist on Stand

On Monday and Tuesday, these lawyers questioned a Massachusetts Institute of Technology economist who performed a computer analysis of American's projections for its value-pricing plan.

The economist, Franklin Fisher, said it was "preposterous" for American officials to believe the would make money under the value-pricing plan. "It's plain that unless they damaged or weakened competition, it could never pay off," he testified.

American reported a $935 million loss last year, and Dr. Fisher said hundreds of millions of those dollars came from the value-pricing plan and the summer half-price sale.

But if American succeeded in pushing weaker rivals out of business, he said, it would reap about a $500 million a year in additional profits by raising fares, recouping its losses in no more than two years.

A lawyer for American Airlines, Robert Cooper, countered that that Dr. Fisher's estimates for recoupment were based on theory and not market realities. He defended American's simplified fares as a legitimate competitive strategy and noted that in 1990, Northwest said predatory pricing "just can't happen" in the airline industry because of the competitive environment.

Northwest and Continental lawyers say they expect to finish presenting their evidence by Friday. Parade of Charts

The proceedings have been moving at a brisk pace: the jury of three women and nine men has viewed videotaped testimony by several American pricing officials and its chief financial officer, listened to testimony by a Northwest pricing executive and expert witnesses and seen a dizzying parade of air fare charts, route maps and memos on projector screens.

If the jury should conclude that American Airlines violated antitrust laws, it could assess punitive damages up to three times the amount claimed.