June 2000

The Sabre Story

The making of OR magic at
AMR

By Peter Horner

Whenever operations researchers gather around the optimization model

and start discussing the greatest OR group since the advent of the
desktop computer, the conversation inevitably routes them through the
Dallas-Fort Worth Airport. That's because DFW is the hub of American
Airlines and home to Sabre, unquestionably the biggest and arguably the
best and most influential OR group in the world.

The relationship between American, Sabre and operations research is as

robust and complex as the models and problems they tackle every day,
but most of all, it's a richly rewarding relationship for all concerned.
AMR, the parent of American Airlines and stepparent of Sabre, provided
a nourishing home in which OR soared to unprecedented heights in
terms of impact — on American, on the entire airline industry and on a
good chunk of the rest of the corporate world.

The making of OR magic at AMR is a legendary tale in the operations

research community, one that is constantly pointed to as a shining
example of just how much competitive advantage can be gained when
good OR hooks up with supportive management over some juicy OR
problems. We'll pick up the story in 1982, when erstwhile college
professor Thomas M. Cook joined American Airlines. At the time, the
airline's OR group consisted of a dozen talented individuals toiling away
on potentially high-impact projects (like rudimentary yield management;
see accompanying article) while buried in the IT Department, far
removed from the consciousness of upper management.

"They didn't have a lot of corporate sponsorship," Cook recalls. "They

weren't working on as many important problems as they should have,
and there was almost no senior management visibility."

Once elevated to group director, Cook set out to raise the team's profile
within the corporation. But first things first.

"Working on important problems was the obvious way to gain senior

management's attention," Cook says. "But how do you get those
problems? The first thing we did was transition the group from a very
research/academic organization into one that looked more like a
consulting firm."

Under Cook's guidance, the OR group created formal relationships with

the internal client, American Airlines, and drew up formal proposals.
Soon the group began to hit, in Cook's words, "a lot of singles before we
went for the home run.

"We made sure that we wrote clear proposals so that the client knew
what we were going to do, and then we made sure we delivered on our
promise," Cook adds. "We did a better job of packaging our deliverables
so that they looked professional. We had a lot of small wins along the
way. We'd do a nice project, and people would hear about it. During the
first year I was there, though, I don't think Bob Crandall even knew my
name."

Crandall, the legendary boss of AMR, was widely considered the

toughest, smartest CEO in the airline industry. Crandall never built a
mathematical model, but he understood what optimization could do to
improve his company's competitive position. He wasn't afraid to take
calculated risks. As soon as he discovered the power of OR to quantify
risks, he became the profession's biggest supporter, or, as MIT professor
Arnold Barnett once described him, "The Patron Saint of Operations
Research."

"Bob was tough, smart and intellectually curious," Cook says. "He
always wanted us to explain how these models worked and why he
should have confidence in the results. He was always probing. You could
show Bob a thousand numbers, but if one of them was wrong, he would
point it out in a nanosecond. You had to be on your toes because he had
a reputation for taking no prisoners.

"If you didn't have the answer, you had to tell him. But when you knew
you were right, you had to stand up for what you believed in. If you did
those two things, you'd get along fine. Bob appreciated what operations
research brought to the table."

Within five years of Cook's arrival, the OR department had grown to

include 75 professionals who were, in Cook's words, "building models
for important decision-support systems and performing strategic studies
to support senior management decision-making at American Airlines."
The work ranged from improving crew scheduling to analyzing a multi-
billion dollar expansion at DFW. "Those were big projects, Bob
Crandall-type projects," Cook says. "That meant we got a lot of exposure
to Bob and senior management. After that, things really took off."

Cook recalls his first one-on-one meeting with Crandall in the mid-
1980s. Impressed by what he saw coming out of the OR department, the
CEO wanted Cook to draw up a business plan to expand the group. Cook
came back with a proposal to triple the number of analysts, a plan that
Crandall quickly approved. Shortly thereafter, Cook began attending all
of Crandall's staff meetings and many of the Planning Committee
meetings involving senior management. "I was there to recognize
opportunities where operations research could make a difference," Cook
says. "No matter what we were talking about, if I thought we could add
value, I'd speak up. Over time, we got a lot of assignments."

In 1987, Cook explored the possibility of marketing the OR group's

rapidly expanding expertise and portfolio of software solutions outside
of American Airlines. He drew up another business plan that was
approved by Crandall that created a new entity entitled American
Airlines Decision Technologies, or AADT. Its charter was to continue to
be the operations research arm of American Airlines, as well as create
stand-alone external business as a wholly owned subsidiary of AMR.

AADT quickly became a profit center for AMR. Amtrak was the first
external client, followed by Qantas Airlines. Business snowballed, and
Cook's biggest headache was keeping up with growth, not creating
demand. From 1988 to 1994, AADT grew from 75 people to more than
600, making it the largest OR group in the world. By 1994, AADT was
doing about $70 million a year in business, 80 percent of it outside of
American.

Rising costs and fuel prices combined with increased competition sent
the airline industry into a tailspin in the early 1990s. AMR management
responded by growing the airline where it was profitable, shrinking non-
profitable areas (i.e., closing certain hubs), and expanding the non-airline
businesses (primarily Sabre Travel Information Network, a $1 billion
travel distribution business). AADT fell into the latter category.

A series of mergers and realignments followed. Since 1993, the OR

contingent has operated under the banner of AADT, Sabre Decision
Technologies, Sabre Technology Solutions, The Sabre Group and now
simply Sabre. At each step along the way, the combined group grew —
from 600 in 1994 to 10,000 professionals worldwide today. Crandall
retired in 1998. Cook departed a year later, but not before building a
hugely successful business with operations research at its core. Although
just a fraction of the 10,000 current employees of Sabre are considered
operations researchers, their influence and impact greatly exceeds their
number. In the minds of many, the OR group founded at American
Airlines sets the standard by which all others are measured.

Mother, Father of Invention Produce Golden Child: Revenue

Management

If necessity is the mother of invention, then deregulation is the

father, and revenue management (also known as yield
management) is the couple's golden child — at least as far as
operations research is concerned.

The wave of deregulation now altering the landscape of the

communications, gas and electricity markets crashed down on the
airline industry back in the late 1970s. Deregulation spawned a
host of low-cost airlines such as People's Express and Southwest
that could make money while selling seats at a fraction of the price
charged by established carriers like Pan Am and American Airlines—
a huge competitive advantage.

The big carriers, locked into labor contracts, had no clear way of
reducing costs. So the question all major carriers faced was, How
can we compete? If we lower fares, it doesn't matter if we have a
100-percent load factor — we'll still lose money. And if we don't
match the low-cost airlines' fares, we'll lose market share, and
eventually we'll be put out of business.

American Airlines solved the dilemma by offering different fare

classes in each market. American matched the low-cost airline's
prices with a portion of its seat inventory, and then saved another
portion for late-arriving, high-yielding demand (typically, the
business traveler). Thus was born the concept of yield management
(now widely referred to as revenue management, since it doesn't
manage yield as much as it maximizes revenue).

It took a group of operations researchers at American Airlines,

however, to turn the concept into capital. After all, several major
questions remained to be answered: How many seats do you sell at
a discount? How many do you hold in reserve? When do you
change the price of each "bucket" of inventory and by how much?

The answers were found in the OR tool bag: forecasting and

optimization. Operations researchers used the former to forecast
demand by inventory bucket, and then used the latter in allocating
the discounted seats in an optimal fashion.

The initial implementation was very crude by today's standards, but

it quickly earned its keep. Tom Cook, who arrived at American in
1982 and presided over the airline's OR group for most of the past
two decades as it mushroomed, merged and morphed into what is
now known as Sabre, counts at least four basic generations of yield
management during his tenure. Fueled by constantly improving
forecasting and optimization models fed by more and better data,
each new generation produced in excess of $100 million in
incremental profitability over its predecessor. By 1998, Cook
estimates the revenue management system at American Airlines
was generating nearly $1 billion in annual incremental revenue. To
put that figure into perspective, consider that the airline's total
operating profit didn't approach $1 billion until 1997.

Today, virtually every airline in the world employs some sort of

revenue management system. The concept is also hard at work
throughout the cruise, hotel and car rental industries, and wherever
else you find perishable, limited capacity.
— Peter Horner