Since merging with US Airways a few years ago, American Airlines (NASDAQ:AAL) has stood out within the airline industry for not offering a profit-sharing plan. Meanwhile, workers at its main competitors -- Delta Air Lines (NYSE:DAL) and United Continental (NASDAQ:UAL) -- have benefited from rising profit-sharing payouts in recent years.
Last week, American Airlines' management finally dropped its long-standing opposition to profit sharing. The company will pay out 5% of its pre-tax earnings annually as profit sharing, beginning with 2016. (The first payment will be made in early 2017 based on American's 2016 earnings.) This is a necessary step toward management-labor reconciliation at the world's largest airline.
American Airlines bucks an industry trend
Profit sharing has been an integral part of airline labor agreements for quite some time. During the lean years -- when the economy was weak or oil prices were sky-high -- airline profits were quite low, so profit-sharing payouts were minimal.
It was in this context that American Airlines originally decided not to offer profit sharing. As CEO Doug Parker later explained it, numerous external factors like economic growth, oil prices, epidemics, etc. can impact airline profitability. He felt that American's employees should get high base wages with no variable component.
Indeed, American Airlines employees have gotten big raises in the past year or two. In most cases, the new base wages have been higher than those at Delta and United.
The problem with fixed pay
However, profit sharing has soared along with profitability at Delta Air Lines and United Continental in the past couple of years. For 2015, Delta paid $1.5 billion in profit sharing -- the highest for any corporate profit-sharing plan in history. Eligible employees' profit-sharing bonuses were as high as 21% of their regular annual pay.
Even at United Continental, which is less profitable than Delta, employees earned $698 million in profit sharing for 2015. As a result, most American Airlines employees now lag their peers in terms of total compensation (i.e., including profit sharing). This has contributed to souring employee relations.
American reversed course last week. CEO Doug Parker wrote in an employee memo, "Although we continue to believe the most effective way to increase compensation is through higher base pay, we recognize there is a team-building component to profit-sharing."
The general concept remains the same. American Airlines wants to have higher base wages than rivals, while its 5% profit-sharing payout is more modest than the plans at Delta and United. But at least it now offers some kind of profit-sharing inducement to reward employees when times are good.
Better to play it safe
At this point, it's safe to say that American Airlines' experiment with higher base pay and no profit sharing was a disaster. In theory, employees might prefer to have the peace of mind that comes with constant pay. But that calculation goes out the window when their peers at other companies are receiving fat profit-sharing checks.
It also didn't help that airline wages have been rising rapidly. So while American Airlines employees received industry-leading base pay a year or two ago, in some cases subsequent pay raises at United and Delta have knocked them out of the top spot.
Obviously, by implementing profit sharing this year without asking for anything in return, American Airlines will have lower earnings in 2016. However, industry pay rates are rising, so it would have eventually had to dole out big raises anyway.
Most importantly, American will have a better chance of keeping its employees happy by following industry norms on pay and profit sharing. In the long run, that should lead to better customer service.
As if to tout its new employee-friendly credentials, American Airlines gave flight attendants an unexpected 6% raise just a day after unveiling the new profit-sharing plan. In announcing the raise, American took a not-so-subtle dig at United, where flight attendants have been protesting over slow contract negotiations. Indeed, labor strife is not unique to American Airlines -- it's an industrywide trend.
Adam Levine-Weinberg owns shares of United Continental Holdings, and is long January 2017 $40 calls on Delta Air Lines, and long January 2017 $30 calls on American Airlines Group. The Motley Fool is long January 2017 $35 calls on American Airlines Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.