Log In

Sign Up
Explore
most commonly identied as truly variable costs. As a nal step in
estimating thenet revenue generated from a fare reduction, the
additional variable passenger costsincurred should also be deducted,
particularly if the trafc increase is expected to belarge.5.
Add spill.
When a newly introduced fare is especially low and is matched by
allmajor competitors in the market, it has the potential to stimulate
primary demand tosuch a high level that certain carriers may benet
by picking up trafc that is spilledto them by other carriers that
cannot accommodate all of their potential trafc due toexcessively
high load factors.6.
Add rejected demand by other airlines.
At times, certain airlines will tightly restrict thenumber of seats sold
at a particular discounted-fare level, on the assumption thatthey can
ll the same seats with higher-fare passengers. This can result in a
rejecteddemand by the restrictive carrier, which can be absorbed by
another carrier that is lessrestrictive in controlling its own discount
seat inventory.
Steps in Analyzing a Fare Increase.
In the case of a fare increase, there are fewer factorsto consider in
estimating the net economic impact. The formula becomes simply:
revenuegain or loss from elasticity plus passenger variable costs
avoided. With the introductionof a fare increase, spin and rejected
demand are irrelevant. Likewise, there is no potentialfor refunds, and
it is highly unlikely that a carrier will choose to advertise a fare
increase.The one important nuance is that passenger variable costs
will be lowered as a function ofeach passenger who, facing a higher
fare, chooses not to y or selects an alternate modeof
transportation.The objective of
inventory management

is to maximize individual ight revenue. In thesimplest terms,

inventory analysts face the task of selling as many seats as possible
atthe highest possible fares. This usually means making available an
adequate numberof lower-fare seats far in advance of the departure
date in order to accommodate price-sensitive business travelers. Its a
tricky balancing act that requires a keen understandingof the
competitive dynamics and trafc composition of individual markets
and ights.Additionally, it is the analysts responsibility to overbook
the ights just enough to makeup for the number of passengers who
can be expected not to show up for their ight.What makes the
inventory management job especially difcult is that bookings for
anyparticular departure may begin to materialize months before the
time the ight actuallydeparts, and its not unusual for an individual
analyst to be responsible for 50 to 100 dailydepartures. As eight or
more fare classes are multiplied across the extended control
timeframe of weeks or months, and as these factors are multiplied
again over the workloadof 50 to 100 daily ight departures, the job of
inventory management can become quitecomplex.Ultimately,
inventory analysts are evaluated on their ability to do the
followingsimultaneously: (1) minimize low-yield revenue spin (the
unnecessary loss of lower-fareexcursion revenue resulting from the
allocation of too few discount-fare seats); (2) minimizehigh-yield
revenue spill (the unnecessary loss of higher-fare business revenue
resultingfrom the allocation of too few high-fare seats); (3) minimize
the cost of spoiled seats
T h e R o l e o f I n v e n t o r y
M a n a g e m e n t
C H A P T E R
1 0

A I R L I N E
P R I C I N G ,
D E M A N D
A N D
O U T P U T
D E T E R M I N A T I O N 3 0 3
A I R L I N E C O S T S
Cost is a major determinant in pricing the airline product. The price or
average revenue perpassenger mile own must be sufcient to cover
average cost per passenger mile own.Broadly speaking, airline costs
can be categorized as operating costs or nonoperatingcosts.

D i r e c t O p e r a t i n g C o s t s
Direct operating costs
are all those expenses associated with and dependent on the type
ofaircra being operated, including all ying expenses (for example,
ight crew salaries andfuel and oil), all maintenance and overhaul
costs, and all aircra depreciation expenses.
Flight Operations.
The largest category of direct operating costs is for ight operations.It
includes the following items:
Flight crew expenses.
These expenses involve not only direct salaries and traveling expenses but also allowances, pensions, and insurance. Flight crew costs
can be calculateddirectly on a route-by-route basis or, more
commonly, can be expressed as an hourlycost per aircra type. In
the laer case, the total ight crew costs for a particular route
orservice can be calculated by multiplying the hourly ight crew costs
of the aircra beingoperated on that route by the
block speed
time for that route. Block speed is the averagespeed of an aircra as
it moves through the air.
Fuel and oil.
Another major cost element of ight operations is fuel and oil. Fuel
con-sumption varies considerably from route to route in relation to the
stage lengths, aircraweight, wind conditions, cruise altitude, and so
forth. Thus, an hourly fuel cost tends to be even more of an
approximation than an hourly ight crew cost, so fuel
consumptionnormally is computed on a route-by-route basis. In
addition to aviation fuel, oil con-sumption must be determined.
However, oil consumption is negligible and, rather thantrying to
calculate it directly for each route, the normal practice is to establish
hourly oilconsumption for each type of engine. The oil consumption
on a particular route is thencalculated from the number of engines on
the aircra ying the route multiplied by thehourly oil consumption
for that engine and by the block speed time. Fuel and oil costsinclude
all relevant taxes and duties, such as taxes on fuel and oil levied by

governmen-tal units, and fuel throughput charges levied by some

airport authorities on the volumeof fuel uplied.
Airport and en route charges.
Airlines must pay airport authorities for the use of the run-way and
terminal facilities. Airport charges normally have two elements: (1) a
landing fee(seats spoil when demand is sufcient to ll the aircra
but the analyst underestimates thenumber of no-show passengers and
the ight departs with empty seats); and (4) minimizethe cost of
denied boardings (when a passenger is denied boarding because an
analyst hasoverestimated the no-show rate on a high-demand ight,
the airline usually must placethe passenger on another carrier, at a
relatively high ticket price).
A I R
T R A N S P O R T A T I O N 304
related to the weight of the aircra and (2) in some cases, a
passenger facility charge lev-ied on the number of passengers boarded
at that airport. Additionally, if an aircra staysat an airport beyond a
stated time period, it will have to pay parking or hangarage fees.These
are relatively small compared to the basic landing and passenger
charges. It should be noted that not all airports use a standardized
system for implementing charges. Manyairports, especially those
seeking increased business, are willing to negotiate charges onan
individual basis. This is especially true of secondary or peripheral
airports where fa-cilities are underutilized. In many cases,
underutilized airports are willing to contributeresources toward the
marketing of new air service as well as to reduce costs for
variousground handling charges.
Aircra insurance costs.
The aircra hull and liability insurance expenses amount to
arelatively small part of ight operation costs. The hull premium is
generally calculated asa percentage of the value of the ight
equipment and may range from 1 to 2 percent, orlower, depending on
the airline, the number of aircra insured, and the geographic areasin
which its aircra operate. Liability premiums are generally based on
the estimatednumber of revenue passenger miles own. Additional
coverages, such as war risk cover-age, may be purchased for an
additional premium. The estimated annual premium can be converted

into an hourly insurance cost by dividing it by the projected aircra

utiliza-tion, that is, by the total number of block speed hours that each
aircra is expected to yduring the year.
Other ight-operations expenses.
Finally, there may be some expenses related to ight op-erations that
do not fall into any of the preceding categories. These additional
expensesmay include the cost of ight crew training and of route
development. However, if train-ing costs are amortized over two or
three years, then they are generally grouped togetherwith
depreciation. Some airlines may have to pay rental or lease charges
for the hiring orleasing of aircra or crews from other airlines. These
expenses are usually considered partof ight-operations costs.
Maintenance and Overhaul Costs.
Total maintenance costs cover a wide range of costsrelated to
dierent aspects of maintenance and overhaul. Flight equipment
maintenancecosts are divided into three categories: direct
maintenance on the airframe, directmaintenance on the engines, and a
maintenance burden. The maintenance burden is basically the
administrative and overhead costs associated with the maintenance
functionthat cannot be aributed directly to a particular airframe or
engine but allocated on afairly arbitrary basis. U.S. air carriers must
furnish the DOT with these three categoriesof maintenance costs
separately for each aircra type that they operate. These data
arepublished quarterly and provide an excellent basis for the
comparison of maintenancecosts among airlines and also among
dierent aircra types and engines.Individual carriers, having
estimated the total maintenance costs for one particularaircra type,
may convert these costs into an hourly maintenance cost by dividing
them by the total number of block speed hours own by all the
aircra of that particular typeoperated by the airline.
Depreciation and Amortization.
Depreciation of ight equipment is the third componentof direct
operating costs. Airlines tend to use straight-line depreciation over a
givennumber of years, with a residual value of 0 to 15 percent.
Depreciation periods can vary

C
P
O
D

H
R
U
E

A P
I C
T P
T E

T E R
1 0

A I R L I N E
I N G ,
D E M A N D
A N D
U T
R M I N A T I O N 3 0 5

by aircra, with the period for wide-body jets ranging from 14 to 16

years. For smallershort-haul aircra, depreciation periods are
shorter, generally 8 to 10 years.The annual depreciation charge or cost
of a particular aircra in an airlines eetdepends on the depreciation
period adopted and the residual value assumed. Forexample, an
aircra with a purchase price of $90 million and another $10 million
forspare parts depreciated over a 15-year period to a 10 percent
residual value would carrya depreciation of $6 million per year:
Price of aircra and spares $100less residual value (10%)
10divided by 15 years $ 90Annual depreciation $ 6
If an airline chooses a shorter depreciation period, then the annual
depreciation costwill rise. The hourly depreciation cost of each
aircra in any one year can be established by dividing its annual
depreciation cost by the aircras annual utilization, that is,
thenumber of block speed hours own in that year. Thus, if our
example aircra achieved3,000 block speed hours in a year, its
hourly depreciation cost would be $2,000 ($6 milliondivided by
3,000). If the annual utilization could be pushed up to 4,000 hours,
then thehourly cost would be cut to $1,500 ($6 million divided by
4,000). Clearly, any changes inthe depreciation period, in the residual
value, or in the annual utilization will aect thehourly depreciation
cost.Many airlines amortize the costs of ight crew training, as well
as any developmentaland preoperating costs related to the
development of new routes or the introduction ofnew aircra. In
essence, this means that such costs, instead of being debited in total to
theyear in which they occur, are spread out over a number of years.
Such amortization costsare grouped together with depreciation.
I n d i r e c t O p e r a t i n g C o s t s
Indirect operating costs
are all those costs that will remain unaected by a change ofaircra
type because they are not directly dependent on aircra operations,

includingexpenses that are passenger related rather than aircra

related (such as passengerservice costs, costs of ticketing and sales,
and station and ground costs) and general andadministrative costs.
Station and Ground Expenses.
Station and ground costs are all those expenses, apartfrom landing
fees and other airport charges, incurred in providing an airlines
servicesat an airport. Such costs include the salaries and expenses of
the airline sta located atthe airport and engaged in the handling and
servicing of aircra, passengers, or freight.In addition, there are the
costs of ground handling equipment, of ground transportation,of
buildings and ofces and associated facilities, and of communication
equipment. Costsalso arise from the maintenance and insurance of
each stations buildings and equipment.Rents may have to be paid for
some of the properties used.
Passenger Service Costs.
The largest single element of costs arising from passengerservices is
the payroll, allowances, and other expenses related directly to
aircra cabinsta and other passenger service personnel. Such
expenses include hotel and other costs
A I R
T R A N S P O R T A T I O N 306

associated with overnight stops, as well as the training costs of cabin

sta where theseare not amortized. Because the number and type of
cabin sta may vary by aircra type,some airlines consider cabin
sta costs to be an element of ight-operations costs and, assuch, a
direct operating cost.A second category of passenger service costs are
those directly related to the passengers.They include the costs of inight catering, the meals and other facilities provided on theground
for the comfort of passengers, and expenses incurred as a result of
delayed orcanceled ights.
Reservations, Sales, and Promotional Costs.
All costs associated with reservations,sales, and promotional
activities, as well as all ofce and accommodation costs arisingfrom
these activities, are included in this category. Sta expenses at retail

ticket ofces,whether at home or abroad, also are included. In

addition, the costs of all advertisingand any other form of promotion,
such as familiarization ights for journalists or travelagents, fall in
this category. Finally, commissions or fees paid to travel agencies for
ticketsales normally are included.
General and Administrative Costs.
General and administrative costs are usually arelatively small element
of an airlines total operating costs, because many
administrativeexpenses can be related directly to a particular function
or activity within the carrier, suchas maintenance or sales.
Consequently, general and administrative costs should includeonly
those expenses that are truly general to the airline or that cannot
readily be allocatedto a particular activity. Interairline comparison of
these general costs is very difcult, because airlines use dierent
accounting systems.
N o n o p e r a t i n g C o s t s a n d R e v e n u e s
Nonoperating costs and revenues
include those expenses and revenues not directlyrelated to the
operation of an airlines own air transportation services. Major
nonoperatingcosts and revenues include the following:1. Gains or
losses arising from the retirement of property or equipment, both
aeronauti-cal and nonaeronautical. Such gains or losses arise when
there is a dierence betweenthe depreciated book value of a particular
item and the value that is realized whenthat item is retired or sold
o.2. Interest paid on loans, as well as any interest received from
bank or other deposits.For some accounting purposes, some carriers
include interest paid on aircra-relatedloans as an operating cost.3.
All prots or losses arising from an airlines afliated companies,
some of which may be directly involved in air transportation, such as
an owned commuter carrier.4. A wide range of other items that do not
fall into the preceding three categories, suchas losses or gains arising
from foreign exchange transactions or from sales of sharesor
securities.5. Direct government subsidies or other government
payments.
C H A P T E R
1 0

A I R L I N E
P R I C I N G ,
D E M A N D
A N D

O U T P U T
D E T E R M I N A T I O N 3 0 7
The traditional classication of costs just described is essentially a
functional one. Costsare allocated to specic functional areas within
the airline, such as ight operations andmaintenance, and are then
grouped together in one or two categories, as either direct orindirect
operating costs. This cost breakdown is of considerable value for
accounting andgeneral management purposes.To aid in economic
analysis and management decision making, variable costs and
xedcosts must be distinguished. Clearly, some costs may be
immediately avoidable as a resultof some management decision.
Furloughing employees and eliminating meal service oncertain ights
would be examples. Other costs associated with mortgage payments
on buildings and hangars may not be avoided except in the long run.
The most commonway of distinguishing between those costs that can
be varied in the short run and thosethat cannot is through the concept
of variable costs and xed costs. Airlines identify thoseelements of
cost generally accepted as being direct operating costs and further
subdividethem into xed costs and variable costs.
Variable Costs.
Variable costs
are those costs that increase or decrease with the levelof output, or
available seat-miles
(
ASMs
), that an airline produces. (A seat-mile is onepassenger seat
transported one statute mile.) These costs, for the most part, are
avoidablein the short term. For example, if a ight or series of ights
is canceled, the airline isno longer responsible for ight crew
expenses, fuel charges, landing fees, and the costsof passenger meals.
These are fairly self-evident. Less obvious are the engineering
andmaintenance costs, which should be classied as variable. Certain
maintenance checksof dierent parts of the aircra, involving both
labor costs and the replacement of spareparts, are scheduled to take

place aer so many hours of ying or aer a prescribednumber of

ight cycles. (A
ight cycle
is one takeo and landing.) Because a large partof direct maintenance
is related to the amount of ying or the ight cycles, canceling
aservice will immediately reduce both the hours own and the ight
cycles and will savesome engineering and maintenance expenditures,
most notably on the consumption ofspare parts, and some labor costs.
Fixed Costs.
Fixed costs
are those direct operating costs that, in total, do not vary withchanges
in ASMs.-They are costs that are unavoidable in the short term.
Having plannedschedules for a particular period and adjusted its eet,
sta, and maintenance requirementsaccordingly, an airline cannot
easily cut back its schedules and services beyond a certainminimal
level because of its obligation to the public. Thus, xed operating
costs may not be avoidable until the carrier can change its scheduled
service.Although most indirect operating costs are xed costs in that
they do not depend in theshort term on the amount of ying
undertaken, others are more directly dependent on theoperation of
particular ights. This is particularly true of some passenger service
costs,such as in-ight catering, and some elements of cabin crew
costs. Fees paid to serviceorganizations or other airlines for ground
handling of aircra, passengers, or freight may be avoided if a ight
is not operated. Some advertising and promotional costs may
beavoidable in the short run. This leaves within the indirect cost
category costs that are notdependent on the operation of particular
services or routes. Lease payments on ightequipment and
maintenance burden security services are clear examples of costs that
arexed in the short term.
F i x e d Ver s u s Var i a b l e C o s t s
A I R
T R A N S P O R T A T I O N 308
Air Transportation a Management Perspective
Add To Collection
35.4K

Reads
67
Readcasts
40
Embed Views

Published by
Cordelia Ezhil

TIP Press Ctrl-F to search anywhere in the document.

Sections
About the Author
Aviation: An Overview
INTRODUCTION
THE AEROSPACE INDUSTRY
THE AIR TRANSPORTATION INDUSTRY
Historical Perspective
THE FORMATIVE PERIOD: 19181938
THE GROWTH YEARS: 19381958
MATURITYJETS ARRIVE: 19581978
ECONOMIC DEVELOPMENTS PRIOR TO
DEREGULATION
FEDERAL LEGISLATION AND THE AIRLINES

 POSTDEREGULATION EVOLUTION
GENERAL AVIATION
Air Transportation: Regulators and Associations
THE DEPARTMENT OF TRANSPORTATION
THE FEDERAL AVIATION ADMINISTRATION
THE TRANSPORTATION SECURITY ADMINISTRATION
THE NATIONAL TRANSPORTATION SAFETY BOARD
MAJOR AVIATION ASSOCIATIONS
The General Aviation Industry
GENERAL AVIATION STATISTICS
THE GENERAL AVIATION SUPPORT INDUSTRY
THE AVAILABLE MARKETTHE USERS
The Airline Industry
STRUCTURE OF THE AIRLINE INDUSTRY
MAJOR AND NATIONAL CARRIERS
REGIONAL CARRIERS
AIRLINE STATISTICS
DATA COLLECTION BY THE DOT
INDUSTRY AGREEMENTS
TRAFFIC AND FINANCIAL HIGHLIGHTS: 19602005

 Economic Characteristics of the Airlines

THE AIRLINES AS OLIGOPOLISTS
OTHER UNIQUE ECONOMIC CHARACTERISTICS
THE SIGNIFICANCE OF AIRLINE PASSENGER LOAD
FACTORS
Airline Management and Organization
Dene management and organization
MANAGEMENT
THE NEW CORPORATE STRUCTURE
FUNCTIONS OF MANAGEMENT
ORGANIZATION
THE ORGANIZATIONAL CHART
LINE DEPARTMENTS
Forecasting Methods
THE PURPOSE OF FORECASTING
FORECASTING METHODS
Airline Passenger Marketing
DEVELOPMENT OF THE MARKETING CONCEPT
THE MARKETING MIX
THE CONSUMER-ORIENTED MARKETING CONCEPT

 MARKETING STRATEGIES SINCE DEREGULATION

Airline Pricing, Demand, and Output Determination
THE TREND IN DOMESTIC PASSENGER AIRFARES
PRICING AND DEMAND
NO-FRILLS AIRFARE AND SURVEY WARFARE
TYPES OF PASSENGER FARES
THE PRICING PROCESS
AIRLINE COSTS
PRICING AND OUTPUT DETERMINATION
HISTORICAL OVERVIEW
AIR CARGO TODAY
THE FUTURE
THE MARKET FOR AIR FREIGHT
TYPES OF AIR FREIGHT RATES
SPECIAL AIR FREIGHT SERVICES
FACTORS AFFECTING AIR FREIGHT RATES
Principles of Airline Scheduling
THE MISSION OF SCHEDULING
EQUIPMENT MAINTENANCE
FLIGHT OPERATIONS AND CREW SCHEDULING

 GROUND OPERATIONS AND FACILITY LIMITATIONS

SCHEDULE PLANNING AND COORDINATION
EQUIPMENT ASSIGNMENT AND TYPES OF SCHEDULES
HUB-AND-SPOKE SCHEDULING
DATA LIMITATIONS IN AIRLINE SCHEDULING
Fleet Planning: The Aircra Selection Process
FACTORS IN FLEET PLANNING
DESIGN AND DEVELOPMENTTHE
MANUFACTURERS VIEWPOINT
THE FLEET-PLANNING PROCESS
THE DECISION TO UPGRADE OR REPLACE
APPENDIX: FLEET PLANNING AT AMERICAN AIRLINES
Airline Labor Relations
THE RAILWAY LABOR ACT AND THE AIRLINES
HISTORICAL OVERVIEW OF AIRLINE UNION ACTIVITY
LABOR RELATIONS SINCE DEREGULATION
HUMAN RESOURCES IN THE 21ST CENTURY
Airline Financing
SOURCES OF FUNDS
SOURCES AND USES OF FUNDS BY THE U.S.
SCHEDULED AIRLINES

 CASH MANAGEMENT AND FINANCIAL PLANNING

International Aviation
THE QUESTION OF SOVEREIGNTY IN AIRSPACE
INTERNATIONAL AIR LAW
THE FORMATION OF IATA
THE BERMUDA AGREEMENT OF 1946
THREE DECADES LATER: FROM BERMUDA TO
DEREGULATION
THE PURSUIT OF OPEN SKIES
GLOBALIZATION
FUTURE CHALLENGES
QUOTES
ARTICLE
CHOOSING AND GETTING YOUR FIRST JOB IN
AVIATION
THE INTERVIEW
GLOSSARY
INDEX
Info and Rating
Category:
Rating:
Upload Date:

Uncategorized.
05/02/2011

Copyright:
Attribution Non-commercial
Tags:
This document has no tags.
Free ebook download as or read book online for free.
Flag document for inapproriate content
Download and print this document
Choose a format to download in

.PDF

.TXT
Recommended

24 p.
William Gibson - Airline Fleet Planning and Aircraft Investment
App...

WEGibson
4220 Reads

8 p.
Airline Industry Marketing
Sandra Oprea
335 Reads

9 p.
Factors Affecting General Aviation
Ap Mani Maran
293 Reads

5 p.
Air Transport Management
mathguruu
101 Reads
More From This User

10 p.
10.1.1.119.861
Cordelia Ezhil
56 Reads

22 p.
JIT Implementation in Egyptian
Cordelia Ezhil
91 Reads

22 p.
InTech-Lean Six Sigma
Cordelia Ezhil
48 Reads

146 p.
Francois Fleuret - C++ Lecture Notes
Cordelia Ezhil
26 Reads
Featured

14 p.
Adventures Across the World
I.B.Tauris

45 p.
Paris in Black & White
Aradhea Dwinarendra

29 p.
The Beggar King
AmazonCrossing

41 p.
Hockey's Great Escapes
Wiley Canada
Comments

About
About Scribd
Blog
Join our team!
Contact Us
Premium
Premium Reader
Scribd Store
Advertise with us
Get started

 AdChoices
Support
Help
FAQ
Press
Partners
Publishers
Developers / API
Legal
Terms
Privacy
Copyright
Copyright 2013 Scribd Inc.
Language:
English