Posted Monday, May 7, 2012, at 10:33 AM
Photograph by Allison Joyce/Getty Images.
Back in 1981, American Airlines needed cash. Interest rates were sky high, so rather than borrowing the money, they hit upon a weird idea: sell lifetime passes good for unlimited first-class air travel for $250,000. Add a companion pass for $150,000 more. The resulting program, the AAirpass, turned out to be a huge disaster brilliantly chronicled over the weekend in the Los Angeles Times. Losing millions of dollars a year on its highest-use members, American has in recent years been employing investigators to try to find instances of rule violations that let them cancel members' passes.
I absolutely love this story because it illustrates so much about the business and economics worlds. It highlights the fact that there are a lot of ways to engage in "hidden borrowing" and that this kind of hidden leverage is often very costly. It illustrates the importance of avoiding adverse selection if you want to succeed. And most of all, it illustrates that over and above the structural issues facing the notably unprofitable U.S. aviation industry there also seems to be a problem of systematic mismanagement and repeated blunders.