The Airlines Confidential podcast hosted former American Airlines CEO Bob Crandall. One of the most interesting pieces of the discussion came after Crandall dropped off. Host and former Spirit Airlines CEO Ben Baldanza told a story about Bob Crandall and paying minute attention to costs.

In my first year working for American Airlines, so this was back in the mid-1980s, and I was just out of college and went to this meeting that Bob used to host in the first quarter of each year he would go out to lots of stations and what what were called Presidents Conferences or Presidents meetings…he’d go and he’d give an update on the company to employees and answer questions, it was great.

So I’m sitting there, been with the company for a couple of months, and this question comes up…as part of the answer Bob says “everybody look down here at the front, this is Bob, Bob runs our Oklahoma City station. Bob, tell everybody here how much you spent on rags at your station last month.”

..Bob says something, and Crandall looks up and with a finger says “I’m telling all of you people who run airports out there, if you don’t know how much you spent on rags last month you don’t know enough about your station.”

Baldanza relayed that he “thought of that story throughout my entire career” about the importance of sweating all of the details. Baldanza of course was very concerned with costs at Spirit Airlines

Bob Crandall Was Known For Attention To Costs

There’s a famous story about Bob Crandall insisting that an olive get removed was the CEO he told the story of from first class salads to save the airline $40,000 a year. One olive multiplied by every seat in first class, across every flight every day, over a full year adds up. And $40,000 is a lot if you take that decision and multiply it out across every employee making a cost-saving decision in every element of the business.

Sometimes Crandall’s stories seem apocryphal but they serve a purpose – to communicate an extreme attention to costs. In another story about diving into the minute details of expenses at a single outstation, he even claimed to have replaced a night watchman with a sign about a guard dog.

These Stories Reflect A Unique Insight Into What It Takes To Make A Business Profitable

What Crandall intuitively understands is that passenger airlines are a low margin business (outside of areas where government limits competition, such as through slot controls, foreign ownership rules, bans on cabotage, and long-term leases on gates at government airports that block new competitors).

As a result it’s crucial to guard against cost disease and expense creep.

Crandall used his stories to make his point about attention to detail to keep costs low without noticeably sacrificing quality.

Airlines Experience Cost Disease

Cost disease, attributable to William Baumol, describes increased labor costs for jobs despite not seeing comparable increases in productivity. The happens in part due to rising salaries elsewhere in the economy. Economist Alex Tabarrok explains,

In 1826, when Beethoven’s String Quartet No. 14 was first played, it took four people 40 minutes to produce a performance. In 2010, it still took four people 40 minutes to produce a performance. Stated differently, in the nearly 200 years between 1826 and 2010, there was no growth in string quartet labor productivity.

…Fortunately, most other sectors of the economy have experienced substantial growth in labor productivity since 1826. …In 1826 the average hourly wage for a production worker was $1.14. In 2010 the average hourly wage for a production worker was $26.44, approximately 23 times higher in real (inflation-adjusted) terms. Growth in average labor productivity has a surprising implication: it makes the output of slow productivity-growth sectors (relatively) more expensive. In 1826, the average wage of $1.14 meant that the 2.66 hours needed to produce a performance of Beethoven’s String Quartet No. 14 had an opportunity cost of just $3.02. At a wage of $26.44, the 2.66 hours of labor in music production had an opportunity cost of $70.33. Thus, in 2010 it was 23 times (70.33/3.02) more expensive to produce a performance of Beethoven’s String Quartet No. 14 than in 1826.

Union work rules preserve headcount. So do government safety rules – you need a flight attendant for each 50 seats on board an aircraft. Compensation rises with seniority, too – even though an employee doesn’t necessarily become more productive, they’re paid more. The longer an airline has been in business, with average seniority increasing, its labor costs rise even though those employees aren’t producing more flying.

One area where airlines may benefit long term from the pandemic is in cost-cutting by eliminating management positions (several airlines shaved about 30% of headcount here) and retiring older aircraft. There may also temporarily forestall increased labor costs. Some airlines have had success in buying out more senior unionized employees such that their labor costs on each trip will be lower going forward as well.

Supply Costs Go Up Year After Year, Too

Large organizations – like major airlines – can become sclerotic in other areas as well. Managers who might have once paid attention to the cost of rags in a single station have a difficult time paying attention at that level of detail, and communicating cost control in rags at the station level, when they rise to become senior executives. They pick and choose their battles, and rag expenses rise at each station year after year because each small expense isn’t worth the tradeoff in their time to pay attention to.

But since employees generally incur the consequences of higher spending on rags or any other single item, they don’t hold costs down. They accept minor cost increases year over year rather than shopping vendors or engaging in difficult negotiations over small amounts. People get lazy, or are bad at their jobs. And those small cost increases compound over time.