Dealing with Risk, Asymmetric Information, and Incentives
Dealing with Risk, Asymmetric Information, and Incentives
Recently, the role of risk and uncertainty in making decision has attracted great interest of researchers, scholars and corporations. Risk can be defined as an outcome of a given action, usually a well calculated action, and its outcome can either be positive (gain) or negative (loss) (Simona-Valeria T. et al, 2012). Risk has two main elements namely; Systematic Risk and Unsystematic Risk. Risk can be prevented and or minimized through preventive means.
Uncertainty is defined as something that is unknown or the lack of certainty. In business environment, uncertainty refers to not being certain about the outcome of a given situation or action because its hard to define the future. Uncertainty is not measurable, not even by probability. Whereas risk can be controlled, uncertainty cannot be controlled since it’s beyond the control of the company. A clear difference between risk and uncertainty is shown the table below
|Meaning||The probability of gaining or losing is referred to as risk.||Uncertainty means the outcome of an event is not known.|
|Outcome||Possibility of the outcome is known.||Outcome is not known.|
|Control||Can be Controlled||Cannot be controlled|
|Expectation||Can be assigned||Cannot be assigned|
Taking a risk and uncertainty assessment helps decision makers in making good decisions, to avert a risk and to cushion the business from uncertainties. Different managers do have different approaches on handling risks and uncertainties, some are analytical whereas some take an intuitive approach. American airlines in the recent past have taken risks such as running their old model planes, the old type of planes consumes a lot of fuel increasing the cost of operation. Another risk and uncertainty that faced the American airlines was the computer glitch, that lead to scraping of more than 15,00 flights and angering the travelers.
Recent Action Taken by American Airlines on Handling Risk and Uncertainty
Commercial airlines are highly faced with risks and uncertainties. A basic definition of risk is probability at a which the business can suffer a loss whereas uncertainty means that the company is not sure of the outcome of a certain situation, due to its unpredictability or having control over it. American airlines have put in place measures and strategies to handle the aforementioned risks and uncertainties and these strategies include:
Flexible strategy – This strategy implies that the management of American airlines are prepared for whatever outcome in terms of risks and uncertainties. Even though, the airline is set to capitalize on the favorable conditions, they are ready to handle any situation that may arise.
Immediate response and clear communication – American airline always make sure that they are ready to get to site and investigate and respond effectively to unlikely situations. For instance, with the recent computer glitch that saw almost cancelation 15,000 flights, the company responded effectively and took strategies such as paying 50% more on the per hour charges of the pilots, thus salvaging the situation. The 14th June, computer glitch led to cancelation of about 2,750 flights (Brian, June 2018).
Strategized herself for all possible scenarios – American airlines company have always analyzed the worst possible scenario and suggested measures on how to resolve such risks and uncertainties. This approach has made them ready for any worse situation and ready to handle it. The organization is always asking itself, what if, and in this way, they are able to decide on how real the risk is which then enables them to secure mitigation plans to either reduce the impact or eliminate the risk.
Analytical techniques – This analytical technique used don’t require high standards of accuracy, but puts the airline in a position to identify risk and uncertainties and can mitigate it in time.
Developed crisis plan – The airline has a well-developed crisis plan, in this way they are able to handle the crisis swiftly and communicate effectively.
Advice on Improving Risk Management
Uncertainty and Risk is unavoidable for any ambitious company in current dynamic economy, and for a company to meet its objectives and goals there is need for mitigation of risk and uncertainties. Mitigation can be done through strategic planning and evaluation of the risk and uncertainty. Risk can well be handled by, in-technology web-based enabled system, that can accurately simulate the risk.
American Airlines is in process of upgrading their IT. The system mainly used by PSA is undergoing stabilization and system upgrade to enable clear communication and to ensure passengers arrive safely. Currently American airline uses Sabre’s Airline Solutions system, which helps in predicting any potential delays as well as improving responsiveness of both the customer and the company’s employees.
Regular maintenance – The airliner should come up with rules for regular plane checkup and maintenance. The IT, computer system, should be checked regularly and stabilized at all times to avoid such computer glitches.
Empower employees – The employees should be empowered and given audience. The American airline employees are made happy by sharing profits with them and are payed handsomely for the job.
Integrate and align risk management – The company should integrate its risk and forge a common approach to handling risks. The airline can assess the need for a position of chief risk manager to stream line all the risk. This will help in communication and integration of risk handling into critical activities of the management process such as strategic planning.
Document all the risks – All the incidences that has occurred before should be documented, clearly indicating the cause and effects it caused. This will enable the company to learn from the previous mistakes and even create a clear picture of the risk as well as improving access to information and how to handle the risk.
American Airlines has been faced with many computer glitches (Emily Price, November 21, 2018). Most of the computer glitches are caused by computer errors that have wreaked and caused havoc to the company in the recent past. These havocs have caused a lot of inconveniences to the customers and the airline, the airline has gone under a great loss due to the cancelation. The cancelation has led to negative impact on the company’s transactions. To solve this, the company should follow all the protocol for repairs, inspection and maintenance so as to meet the FAA standards and reduce such incidences, for the company to meet the current requirements, it should come up with enforceable rules towards the same and consider to migrating to better computer systems such as OpsSuite.
- Adverse Selection Problem and how to Minimize Negative Impact on Transactions
Another problem is the frequent flying of the old model type of aircrafts leading to increased use of fuel. Fuel comprise a huge part of the operation cost, therefore frequent flying of the airplanes negatively impacts on the transactions of the company and even create risks and uncertainties. To minimize on the fuel usage, the company should reduce the rate at which it flies the old model planes and embrace new technology by buying the latest models.
Moral hazard is defined as a condition whereby one party runs or make risky actions knowing in an agreement, too well that they will not incur loss or suffer the consequences of the action, because the other party will. This normally happens if the other party is insured, and both parties do not disclose their full information to each other. In the airline industry, even a small enticement either, in form of lower prices or frequent flier benefits is enough to induce moral hazard problems.
- Dealing with Moral Hazard Problem: Best Practices Used in the Industry
One key driving force in the airline is the employees. American Airline treats and respects its employees, by rewarding the loyal ones mostly on free flights, profit sharing and other benefits such as upgrade in flight class (Leonardo J. et al, 2007). In this way the employees will bring the best out of them for the betterment of the company while reducing the chances of moral hazards from occurring.
The other best practice the company exploits is the negotiated layoff, in this way the airline avoids creating anxiety among its employees and reduces the chances of them making mistakes. The employees leave the company willingly and on their own terms, and the airline provides them with their full benefits.
On the other hand, customers play a role on the growth of the company. Some of the customers can cause moral problems especially if the flight was paid for by another party. The airline appreciates its loyal customers by rewarding them with flight upgrades, free flights and other services such as enabling them change their flights at no cost. The success of the company rests solely on its ability to spot potential moral hazard and handle it efficiently.
Principal-agent Problem and Tools for Aligning Incentives and Improve Profitability.
The principle-agent problem can be defined as when one party, in this case the agent, agrees to work for another party, in this case the principle, and in return will get incentives. The decisions are decided by the agent on behalf of the principal, and in this case the principal refers to the party catering for the cost of business travel. The principal wants costs minimized whereas agents wants travels be made comfy and rewarding. The principal agent problem is interesting in that too or little conflicts among the parties lowers the profit, and with much conflict there is threat to FFP which is a major source of revenue and reward for loyalty.
American Airlines, uses fare-based rewards as a tool to align its incentives, the fare-based reward termed as “AAdvantage” (Form 10-K., 2015) gives mileage to its AAdvantage members by flying in any of its participating airlines. The mileage credits are redeemed free either, for upgraded flights and other awards. American Airlines also incorporates high levels of teamwork and cooperation to align its incentives and to improve on its profits. The principal, due to external economic state, will prefer fixed pay over the commission, since the service provider will lose the incentive for working harder.
Agents efforts are not in public domain and therefore it is difficult to know and monitor their work or the efforts of each sales members, and the best and fair solution for this is to pay based on the actual outcome of the work. This ensures that every party involved works hard towards the same goal and in the process makes money.
To fully discus on the organizational structure of American Airlines, we have to bring in its mission, leadership and its job design in that these factors do have direct effect on organizational structure. To achieve the objective of the organizational structure, the company has categorized its mission into employee based and customer based. An organization is reflective of its leadership, in that strong leadership play a key role in deciding the direction of the company.
- American Airlines Organizational Structure
The current senior most personnel on the structure, is made up the executive officer, CO-CEO and board of directors, which is the decision-making organ. Another key position is that of the executive vice president and is mandated to setting up and monitoring personnel protocols to meet the respective goals and missions. American Airlines Officers, supervisors and area managers are solely responsible for their actions, implementation and any other action related to their departments. The organizational structure of American Airline is made up of several key areas, and such areas include; communication, product division, control, team and market and are clearly defined. It is clear from above that American Airline organizational structure is complex and off hybrid, it is a multi-divisional one focused on business driven and customer concern.
Multi-divisional structure is good, in that it leads to improved control, effectiveness and therefore increased profit. Most of these divisions run independently and comes with structures that best suits its goals. American Airlines boost of strong leadership and has continued to prosper due to its organizational structure and listening to employees as well as its leaders.
Brian P., (June, 2018). American Airlines says it has fixed the computer glitch that forced its regional airline to cancel more than 2000 flights. Retrieved from https://www.businessinsider.com/american-airlines-computer-glitch-fixed-2018-6?IR=T
Emily Price., (November, 2018). American Airlines Computer Glitch Briefly Delays Travelers. Retrieved from: http://fortune.com/2018/11/21/american-airlines-computer-glitch-delays-travelers/
Leonardo J. et al., (2007). Moral Hazard and Customer Loyalty Programs
Simona-Valeria T. et al., (2012). Emerging Markets Queries in Finance and Business: Risk and Uncertainty. Elsevier
Form 10-K. (2015). American Airlines Group Inc. Retrieved from https://www.sec.gov/Archives/edgar/data/4515/000119312516474605/d78287d10k.htm