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American Airlines is learning the hard way that smaller and more profitable beats bigger and less profitable any day.

After more than five years as the nation's No. 1 airline, American fell behind United Airlines in terms of revenue passenger miles last year. Figures from the U.S. Transportation Department show American last year was flat vs. 1992, with 97 billion revenue passenger miles to United's 101 billion, up 8.6%.

But the bigger threat these days comes from the likes of Southwest Airlines and other short-haul, no-frills carriers. American's cost per available seat mile is 8.36 cents compared with Southwest's 7.2 cents, the lowest of the major carriers.

American simply can't compete in that marketplace until it cuts costs. Until then, the carrier that touts itself as "Something special in the air" has little choice but to concentrate on the higher-paying passenger.

"The only route to success in our business is to achieve competitive costs," American's no-nonsense and outspoken chairman, Robert Crandall, told shareholders in May.

While American has no intention of taking the low-cost route for now, every move-from marketing to route structure and fleet size-is aimed at restoring the airline and parent AMR Corp. to sustained profitability.

After American failed to implement a value-pricing plan in 1991 because other carriers undercut its so-called everyday low fares, management began developing an interim plan to fix the financial picture.

The plan calls for strengthening American on profitable routes, shrinking service in areas where it can't compete effectively and expanding profitable non-airline businesses such as Sabre Group and Management Services Group. Sabre specializes in data and information, and includes the U.S.' No. 1 computerized reservations system; Management Services provides management consulting and training, investment services, and airline and airport ground services.

If American can't grow profitably, it will shrink profitably.

The corporate work force has been reduced by more than 5,300, or 4.4%, since 1992, said Al Becker, American's managing director of external communications. And officials acknowledge as many as 3,000 more headquarters staffers could be laid off this fall, further reducing its 114,000-person staff.

While the company was encouraged by the airline's pre-tax earnings of $149 million in the second quarter compared with a loss of $6 million for the same period last year, Mr. Crandall is far from satisfied.

"While second-quarter profits of this size are clearly insufficient, they underscore the inherent power of our route network, the efficiency of our modern fleet and the commitment and capability of our employees," he said. "They confirm that when we achieve our cost objectives, AMR will be a much more successful company."

During the transition, American is focusing on the people it needs most now: those who fly more than 25,000 miles a year. That group makes up the top 5% in the carrier's 23 million member AAdvantage frequent-flier program.

For example, gold and platinum members will be given preferred seats and, for a small fee, upgrades into first class.

"All things taken together, we still believe the business flier is the key element for our marketing strategy and we are looking for ways to differentiate our product," said Henry Joyner, VP-marketing planning.

That means an increased emphasis on direct marketing, he said. Mr. Joyner would not provide budget figures, but a person close to the company said the direct marketing focus is at the expense of measured media.

Spending has been heading south since the late 1980s, with a 9.8% drop in 1993 U.S. measured media to $92 million compared with 1992. Newspaper advertising took the biggest hit, dropping 35.2% to $35 million, according to Competitive Media Reporting.

Network and cable TV ad spending showed double-digit increases, reflecting a major push last fall to target business passengers with a new image campaign from domestic agency Temerlin McClain, Dallas. DDB Needham Worldwide has the international business.

American executives bristle at the notion that less measured media spending means the airline is doing less to market itself. "We are doing marketing more selectively and more efficiently and getting maximum impact for our dollar," Mr. Becker said.

Even so, American will keep its employee-focused TV image campaign that was launched last fall.

Still, the leisure market is not being totally abandoned. Earlier this month, American began an unusual approach for an airline with Donnelley Marketing's Carol Wright program.

Consumers in New York, Philadelphia and Boston received an offer for American's Fly AAway Vacation packages in Carol Wright's August mailing, created by DDB Needham. A second drop is set for Sept. 11. And in October and November, Dallas/Fort Worth, Chicago, Miami and Los Angeles will be added to the program.

"American has taken a different approach of being a full-service carrier aimed at premium traffic," said Edward Starkman, principal at Transportation Group (Securities), a New York aviation research consultancy. "... American is one of the best-positioned carriers, though they're nowhere near their own profitability goals."

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