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Market Place: What Price Efficiency?

Focus on Costs May Have Blurred Delta's Vision

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July 25, 1997, Section D, Page 1Buy Reprints
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Yesterday was to be the day that Delta Air Lines and its longtime chairman, chief executive and president, Ronald W. Allen, celebrated the attainment after three years of an ambitious corporate goal: cutting $2 billion from the carrier's annual operating costs.

Instead, the goal has been abandoned, and Mr. Allen ousted. Delta has, in fact, cut costs -- its operations, mile for mile, are cheaper than any similar airline's -- and the carrier yesterday proudly trumpeted record operating profits of $886 million for the last fiscal year and named two interim replacements for Mr. Allen.

The price for Delta's achievements has been steep. It has lost its reputation for stellar service. Employee morale has suffered. And strains between Mr. Allen and the board, resulting from the singular focus on cost-cutting, apparently contributed to the decision in May not to keep him on, leaving the airline rudderless.

Indeed, despite its current profitability, Delta serves as a case study of a corporate overhaul gone awry. In trying to change an expensive, paternalistic culture -- Delta offered seven weeks of vacation to senior employees, for example, and blank-check health benefits to all -- Mr. Allen and the board may have cost the airline more than they saved it.

''They certainly put a big dent in Delta's corporate culture and in customer perception of service standards,'' said Samuel C. Buttrick, an airline industry analyst at Paine Webber. ''Morale fell a lot further than costs did.''

To a large degree, Delta's problems have been masked by a strong economy that has led to prosperity for all airlines. And Mr. Allen has served as a lightning rod for much of the blame for past errors.

But the Atlanta-based Delta has an extensive track record of waiting too long to act -- and often misfiring when it does -- that is unlikely to change with Mr. Allen's departure.

There are many examples, old and new:

*Following the lead of American and United in acquiring new routes across the Atlantic in 1990, Delta paid a steep premium the next year for most of Pan Am's assets, a decision that led to hundreds of millions of dollars in losses.

*In a recent news release about its new paint scheme for its planes, Delta boasted that it studied the issue for no less than four years before making a decision.

*Delta was among the last airlines to begin electronic ticketing.

There is an ingrown quality to the airline's leadership that helps explain these miscues, analysts say. The 56-year-old Mr. Allen, who had spent his entire career at Delta, had been at the helm for 10 years. The board's 11 directors, though all independent, have served for an average of 10 years.

Yesterday, the board turned to one of its own as interim chairwoman, Mary Johnston Evans, a director since 1982 and a former vice chairwoman of Amtrak. As temporary chief executive, it named Maurice W. Worth, an executive vice president.

Mr. Allen has declined to comment, and calls to the board's other members, including Ms. Evans, were not returned.

Gerald Grinstein, a director who pressed for Mr. Allen's ouster and is leading the search for his replacement, said in an announcement in May about Mr. Allen's departure: ''Ron Allen has done a terrific job of leading Delta through the most difficult time in its history and the company has emerged as a leader in world aviation.''

In a recent interview, Mr. Worth said that Delta might have cut too far, but that it needed to set an ambitious goal in 1994 when its prospects looked bleak.

''If you are in any kind of downsizing or cost-cutting mode, you almost have to go too far to insure that you've gone far enough,'' he said. ''At the time, the kind of challenges we had financially were such that we had to use some very revolutionary means to get this ship righted.''

When Delta looked around in 1994, it saw such low-cost carriers as Valujet and Southwest Airlines growing rapidly. With its own high cost structure, it also saw no end to the hundreds of millions of dollars in losses it had been reporting each year since 1991.

Delta executives say they asked themselves what cost structure they would need to compete against such upstarts and produce operating profits of 10 percent.

Mr. Allen announced the results of that number crunching at a news conference on April 28, 1994. Delta would cut $2 billion, or about 16 percent, from its annual operating costs and eliminate up to 15,000 jobs. The goal was crystallized in a program called Leadership 7.5: by the middle of 1997, Delta vowed to cut its basic operating expense, measured by the industry yardstick of what it cost to fly one passenger seat one mile, to 7.5 cents, from 9.26 cents.

''We feel it's a stretch goal,'' Mr. Allen said at the time.

In the early stages, though, Delta did not seem to stretch very far to ring up quick savings in a number of areas. It set up reservation offices on college campuses, using student labor to work at half the cost of salaried employees. It eliminated dozens of small offices by having salespeople work out of their homes. It replaced linen cocktail napkins in first-class and business-class cabins with paper. And it cut those seven-week vacations to six weeks and put a cap on health benefits. It was also the first big carrier to cut travel agents' commissions.

In 1995, Delta was hitting its interim targets and still winning awards for customer service.

Other airlines, attuned to the speedy pace of change in their business environment, might have set a shorter-term goal from the outset and declared victory. But Delta, sticking fastidiously to its three-year objective, continued to prune, and the difficulty of the task -- cutting costs while maintaining service levels and morale -- became increasingly apparent.

Fewer baggage handlers led to more lost luggage. Customers complained about the disappearance of in-flight meals. Rather than lay off the most junior workers, Delta offered severance packages to its most senior employees, losing valuable experience in the process.

Those severance packages were expensive, but they did not slow Delta's progress in reaching its cost targets. That is because they were treated as part of the $1.35 billion in write-offs the company tallied between its 1994 and 1996 fiscal years. It was an unusually large amount of one-time charges for a reasonably healthy carrier, said Philip Baggaley, an analyst at Standard & Poor's.

The company also set up a stock option program for employees as an incentive that would help compensate for flat salaries. Because options are accounted for separately from operating expenses, that program also did not hinder Delta's march to lower costs.

''We did spend some extra money that we didn't have an obligation to spend,'' said Thomas J. Roeck, Delta's chief financial officer. ''We felt that it would be short-sighted to do Draconian things because nobody would ever forget what we did.''

Despite the stock options, many employees resented the new way of doing business and expressed their displeasure in a company survey last fall. Only 22 percent rated Delta's leadership ''effective.'' Delta had just announced the start-up of its low-cost Delta Express division, but the company still got low marks for innovation, its strategy and its unwillingness to let employees make decisions. The kind of morale and support for management that once prompted the employees to buy the company a new Boeing 767, which they named The Spirit of Delta, was gone.

As the economy continued to strengthen last year, and with it the airline industry's business, Delta set aside Leadership 7.5 as a top priority and adopted instead a so-called Balanced Strategy. The new agenda set a target of reaching a 12 percent operating margin by July 1999, a figure it almost reached in the last fiscal year when its operating margin was 11.6 percent.

For the quarter just ended, its seat-mile cost was 8.75 cents, or 5.5 percent lower than when Leadership 7.5 was announced in 1994. The airline says it has the lowest costs of any big carrier that operates a hub-and-spoke route network.

Still, the company's earnings fell short of Wall Street's estimates. The company earned $3.98 a share in its fiscal fourth quarter, well shy of the $4.07 a share expected by Wall Street, according to a survey of 12 analysts by I.B.E.S. International Inc. Net income fell 8 percent, after excluding a charge of $273 million in the year-ago quarter. The one-time charge involved an early retirement program for nearly 500 pilots. In the most recent quarter, revenue rose 5.4 percent, to $3.54 billion.

Delta's stock, which fell after the earnings were reported yesterday morning, rebounded later in the day after Mr. Allen's replacements were named. The shares ended up $1.50, at $89.6875, on the Big Board.

Delta executives say they have not abandoned Leadership 7.5 but are using it instead as a reminder to remain vigilant about costs. In a worsening economy, that cost target may emerge as a necessary goal once again, they say.

Mr. Worth, the interim chief executive, said that despite all the second-guessing about Leadership 7.5, the effort was ''absolutely essential.''

He added, ''If you had brought someone in from the outside, they would have drawn the same conclusion.''

Certainly Delta's board drew the same conclusion and threw its support behind Mr. Allen. Indeed, the directors had generally shown strong support for Mr. Allen through the years, awarding him all three top titles and an unusually long 10-year employment contract.

It was while Mr. Allen was seeking another contract this spring that the board balked, apparently deciding that it was finally time for someone else to lead Delta. Because Mr. Allen held all the top jobs, there was no obvious successor.

Nor is there one now. Ms. Evans, the interim chairwoman, said yesterday that the board's search committee had interviewed several candidates, but that the directors had no self-imposed deadline to find a permanent replacement.

''The entire board of directors feels a real sense of urgency about finding a new leader for Delta,'' Ms. Evans said. ''But we don't feel rushed.''

A version of this article appears in print on  , Section D, Page 1 of the National edition with the headline: Focus on Costs May Have Blurred Delta's Vision. Order Reprints | Today’s Paper | Subscribe

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