AIRLINE

Case
6

You are taking over management of a small regional airline. Air transportation, a highly
competitive industry, can be segmented based on the type of service offered. Cargo airlines
transport goods, usually light freight that needs to be delivered in a timely manner, while
passenger airlines primarily transport people, though they may offer limited cargo service on
passenger flights. Passenger service can further be divided into international, national, and
regional service. Major carriers tend to serve the national and international markets, leaving
routes connecting medium-sized and small cities to the regional airlines.
In the regional markets, flights are relatively short and traffic, light compared to routes
connecting major cities. This, combined with limited facilities at local airports, makes regional
routes unattractive to the larger carriers. The smaller airlines serving regional routes tend to use
turboprops and regional jets seating 20–75 passengers to keep operating costs low. The airline
you will be managing has been in operation for several years and is well known to thousands of
people living in small communities scattered throughout one of the regions in the simulation.
However, the long-term viability of the firm is in question due to changes in the competitive
environment. To insure its survival, you will have to make critical strategic decisions as well as
maintain an efficient operation. This case provides important information about the firm and the
industry in which you will be competing.
 7

History of the Airline

An investor-backed, fixed-base operator started your airline to fill the void when a larger carrier
abandoned the region. The airline grew from a fledgling carrier, transporting 10,500 passengers
in its first year, to a regional airline serving five routes and carrying over 37,000 passengers last
quarter. The airline has had a cyclical history of profitability, ranging from small losses to small
profits. The present fleet consists of three TP-300 aircraft, turboprops which can carry 30
passengers. Two of the aircraft were purchased at start-up, while the third was added under a
lease agreement to expand the number of routes served. About 18 passengers are needed to
break even on each flight. Loads have been from 8 to 26 passengers per flight, with load factor
(number of paid seats divided by total seats) averaging 60% last quarter.
Operating History (Preceding 8 Quarters)
Yield per Yield per
Revenue Fuel Cost
Available Revenue Available Load Net
Qtr. Passenger (Spot/
Seat Miles Passenger Seat Mile Factor Profit
Miles Contract)
Mile ($) ($)
0 7,681,480 12,864,000 0.350 0.209 59.7% $5,253 1.97/1.96
-1 7,470,125 12,864,000 0.347 0.202 58.1% ($8,572) 1.97/1.99
-2 7,733,462 12,624,000 0.340 0.208 61.3% $4,374 1.95/1.96
-3 7,496,131 12,624,000 0.340 0.202 59.4% $1,483 1.92/1.91
-4 7,271,424 12,624,000 0.335 0.193 57.6% ($6,761) 1.87/1.89
-5 5,343,706 8,576,000 0.340 0.212 62.3% $5,878 1.90/1.92
-6 5,155,891 8,576,000 0.330 0.198 60.1% $3,504 1.88/1.88
-7 5,048,691 8,576,000 0.326 0.192 58.9% ($2,387) 1.85/1.84
8

Regulatory Environment

Although there is considerable freedom in setting fares and deciding which routes to serve, your
airline and the industry as a whole tend to be heavily regulated in several areas. Aircraft that
have more than 30 seats require special certification. Safety regulations require a flight attendant
on almost all aircraft used in regional service.
Minimum equipment maintenance schedules are specified and monitored by government
agencies. Some airlines choose a maintenance program exceeding regulatory requirements to
decrease unplanned out-of-service time and to increase safety. This can improve perceived
quality, which may be important for airlines catering to higher-end customers.
Minimum levels of pilot training are mandatory and become a cost of doing business. Some small
airlines provide training beyond the minimum level to increase pilot effectiveness, while others
fear that extensive training results in the loss of a greater portion of their pilots to larger airlines.
Regulations require extensive record keeping. The paperwork to document compliance with all
these regulations can result in increased staff size. Compliance with regulating agencies is costly
to the airlines in terms of staff needed, paperwork required, and direct costs incurred.
 9

Airline Equipment

Your company has several types of fixed assets: airplanes, ground equipment (i.e., ground power
units, tugs, de-icing equipment, baggage carts, and trucks), maintenance hangars, office facilities,
and computers. In addition, preventive and corrective maintenance require an inventory of spare
parts that may include extra engines. This inventory can tie up significant amounts of cash. Some
fluctuation in equipment and parts occurs based on the size and the composition of the fleet.
Your airline competes with other regional as well as some national airlines for modest numbers
of passengers departing from a location. This smaller market is reflected in the type of equipment
flown. The available aircraft range in size from 30-passenger propjets to 50-passenger fanjets. In
addition, seats can be added or removed to target specific customer segments. Although some
of the equipment dates back to the 1980s, newly developed regional aircraft contain state-of-
the-art technology in materials, fuel efficiency, noise abatement, and nonflammable cabin
materials. Since there is an abundance of pre-owned equipment available as larger and more
profitable carriers “trade up,” airlines have a diversity of aircraft to choose from if they decide to
expand.
The composition of the fleet of any airline may reflect corporate strategy. Airlines may select
from a variety of aircraft to balance customer preferences with operating costs. Although airlines
may maximize revenue by acquiring aircraft tailored to each route, flying many types of planes
results in high costs, as the maintenance department has to stock more parts and train mechanics
to work on a larger variety of aircraft. Pilot training costs are increased as well.
Passengers prefer jet aircraft, but turboprops are in wide service. Smaller aircraft work well on
shorter routes, making it economical to provide the convenience of multiple flights per day for
commuter traffic. Larger, faster aircraft are better for longer routes, especially in resort and
foreign markets. While the TP-300s have served the company well so far, the airline will have to
diversify its fleet to expand service to new markets and control costs.
The table below provides a description of the aircraft available in Airline, along with costs. In
addition to the purchase or leasing cost of an aircraft, you will need to consider the cost of
operating it.
10

Fuel Efficiency
Maintenance
Seats

Cruise MPH
Max. Lease

Rating
(min/ Cost
Aircraft Type Daily per Description
normal/ (M$)
Miles Quarter
max)

A workhorse for regional

24 airlines. Relatively slow
turbo-
TP-300 30 270 1800 $3.1 $132,000 7 3 and noisy but works well
prop for short flights with
33
frequent runs.
Identical to the TP-300
but with fuel-efficient
24 engines that can save 10–
turbo-
TP-300E 30 270 1800 $3.2 $136,000 8 6 12% in fuel costs.
prop Maintenance costs,
33
however, are slightly
higher.
A medium-sized aircraft
at the high end of the
turboprops. Works well
turbo- 28
for normal and discount
TP-340 prop 34 290 2000 $3.4 $144,000 6 5
flights, but luxury
37
passengers much prefer
the quieter and faster RJ-
350.
Ability to transport more
passengers than other
turbo- 38 turboprops at a lower
TP-450 prop 45 300 2000 $4.4 $185,000 8 7 operating cost than a jet.
50 Good choice for discount
airlines flying foreign and
resort routes.
A medium-sized jet;
quieter and faster than
the turboprops but may
30
be more expensive to
RJ-350 jet 35 400 2400 $4.3 $184,000 3 2
operate, especially on
40
short hauls. Luxury
passengers look for
carriers using this jet.
Otherwise identical to the
RJ-350, the fuel-efficient
30
engines reduce fuel costs
RJ-350E jet 35 400 2400 $4.5 $193,000 4 5
by 10–12% and slightly
40
increase maintenance
costs.
Regional jet providing
size, speed, and comfort
42
for passengers. Works
RJ-500 jet 50 450 2400 $5.8 $240,000 2 4
well on longer routes,
54
such as the foreign and
resort routes.
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Maintenance and fuel efficiency ratings help you assess potential operating costs. Ratings range
from 1 to 10. Aircraft with lower maintenance ratings are less expensive to maintain. Though
actual maintenance costs depend on the size of the aircraft and the diversity of the fleet, all things
equal, you can expect a savings of about 2% for each reduction of 1 in the maintenance rating.
Higher fuel efficiency ratings indicate the aircraft is more efficient at cruising speed, but less
expensive aircraft with low fuel-efficiency ratings may still be cost-effective on short routes. An
increase of 1 in fuel efficiency represents a savings of about 4% in fuel costs.
The aircraft in the simulation are generic and have been given descriptive labels to help you
identify them. The prefix “TP” is given to turboprops, while “RJ” is used for regional jets. The
digits which follow indicate the size of the aircraft, with the first two digits specifying the number
of seats in the normal configuration. Fuel-efficient versions of aircraft are identical to their
regular counterparts except that they consume less fuel and tend to have slightly higher
maintenance costs. These are tagged with a trailing “E” to indicate they are fuel-efficient models
of the aircraft.
12

Regions and Routes

When you take over management, your firm has a presence in a single region in the Airline
industry. Within that region, you serve five of seven different route types. The routes are
designated A, B, C, D, E, F and R, and each has its own unique set of associated characteristics in
terms of geographic location, flight distance, demographics, and level of demand. In addition,
each route starts with a different level of competition. Route types A though D all start with two
competitors. Route type E has just one firm serving its population, a temporary monopoly
position for the firm. The table below provides a summary of the route types, initial demand, and
the number of competitors at the start of the simulation.
Qtr. 0 Daily Qtr. 0 Round-
Market
Seats Sold Number of trip Description
Type
per Firm Competitors Miles
From your hub to a medium city with light
A 35 2 600
manufacturing and service businesses.
Service between 2 medium cities. One has many
B 49 2 400
service businesses, and the other, a military base.
From your hub to a bigger regional hub that has
C 37 2 340
many heavy manufacturing firms.
From your hub to a medium city that has a major
university and extensive business services, with a
D 54 2 360 stopover halfway out from the hub at small but
growing technology cluster. For simplicity, fares
are the same to either destination.
From your hub to a medium city that has a new
E 59 1 400
and growing industrial park.

Estimates indicate that current service is not meeting demand on these routes, and there is room
for growth if more convenient flights, better service, and more favorable pricing are offered.
However, sales for individual firms will fluctuate depending on economic and competitive
conditions. As more companies come to market with different pricing, schedules, and amenities,
the market may become saturated. You’ll want to monitor this as competitors add routes and
schedule more flights.
In addition to serving cities in the region, your firm has the opportunity to offer service to two
new types of markets—foreign (F) and resort (R). The foreign market provides you with the
opportunity to become an international carrier. The route goes from your hub to a foreign city
that has a diversified industry and tourist trade. Demand is expected to be between 30 and 60
seats per day for each firm.
The resort market represents major resort and recreation areas popular with people in the
region. Resorts are currently served by charter flights operated as tours, but it is thought that the
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regional airlines can develop demand if they provide sufficient fare sales to compete. While any
of the available aircraft can be used, jets would be ideal for the longer route. Sales for each firm
are projected to be from 40 to 50 seats per day.
While passengers prefer nonstop flights at convenient times, there may not be sufficient demand
to provide direct flights on all routes and cover fixed costs. Instead, regional airlines generally fly
routes terminating in larger cities such as your hub, where passengers can make connections with
major airlines. In addition, regional airlines may provide direct service (on the same plane) to a
hub city but make one or more stops along the way, as your airline does with the D route. The
route map below may help you visualize the available markets and their relationships. This map
only shows the routes for one hub in one region. At the beginning of the simulation, there is one
region for each pair of firms, and each region has two hubs that connect the same cities.
Route Map for Airline Firms

R
C

F 340 miles
600 miles

420 miles

Your Hub 400 miles E

B
360 miles
400 miles 600 miles
D Stopover

D
B A
In addition to expanding service within your region, you also have the opportunity to add a hub
in a new region and start servicing a new set of routes. Adding a new hub costs $250,000 for
facilities and equipment, which will add $5,000 to your depreciation expense each quarter. You
will also need to acquire new aircraft to serve routes in the new region, since aircraft can only be
used in a single region during a quarter.
14

Flight Scheduling

Airplanes do not generate revenues when they sit on the ground. Therefore, utilization is a
variable that can affect successful operations. A typical aircraft can be flown for 10 to 14 hours a
day, which allows for overnight maintenance and an average of 10 to 12 legs per day. This works
out to 1,800 miles flown per day per aircraft for the airline’s current fleet of TP-300 aircraft.
The number of flights per day is a crucial factor to the success of an airline. Too few flights prompt
prospective passengers to drive to the nearest competing hub, and too many can be too costly
to maintain. Except for the resort and foreign runs, it is not practical to fly only one or two round-
trip flights per day into a market; there would be no passenger loyalty and the cost to maintain a
station there would be prohibitive. The careful balancing of flights and seats on a route is an
important decision for your firm as the passenger load factor is a major driver of success. At
current prices, the break-even point for a flight is a load factor of about 60%.

Fares and Marketing

Airline fares are one of the more complex pricing systems in the free-enterprise world. All airlines
post a standard fare for each portion of a route, known as the “Y” fare. These fares are set
artificially high and are used as a baseline for discounts and to calculate portions of tickets that
are issued in conjunction with other airlines. Last quarter, the firm charged 35 cents per seat-
mile-flown for its fare. However, the airline is not very profitable at that level, and managers
believe that fares could be increased one or two cents without much decrease in demand.
Airlines develop promotional fare packages from time to time to introduce new service or offset
sluggish demand. In Airline, fare sales of a third off can be offered for one, two, or three months.
Promotional fares stimulate demand but reduce revenues, sometimes creating a loss for that
route. The competitive market is generally very responsive to fare sales; thus, fare reductions
tend to be copied by competitors and the benefits to a single airline are short-lived.
Fare prices must also align with a company’s overall strategy. Pricing as a low-cost airline may
help stimulate demand, but one must also watch expenses very carefully. Pricing as a luxury/high-
end airline may improve your margins but only if the service provided is seen as enough of a
benefit that you can charge a higher price without hurting demand. Positioning your company to
provide improved service will also require an upgrade to your fleet as customers will not see your
TP-300s as a luxury flying experience (insufficient legroom, relatively noisy).
Airlines spend a significant amount of money to attract passengers. A unique aspect of this
industry, however, is that much promotional activity is directed toward online travel services,
 15

travel agents, and other specialists who dispose of extra seats. These sources are responsible for
75% of the tickets sold.
Last quarter, your firm spent $2,500 on promotional and $2,500 on advertising activities; this is
a very minimal amount. As your fleet increases and you expand into new routes, you will need to
budget substantially more. Promotions include packaged vacations, incentive plans for travel
agents who sell large numbers of tickets, frequent flyer programs, familiarization (FAM) trips for
travel agents, etc.
Airlines advertise through a variety of media: print, television and radio, and internet. Firms
trying to attract the business traveler will use different media than those that target the casual
traveler. Some firms participate in customized “in-flight” magazines placed on board the aircraft
to enhance and promote their image. Your firm has not been producing an on-board magazine
for your passengers; the cost for this would be $500 per aircraft per quarter in addition to your
normal advertising budget.
Your firm does not have any sales force now due to its small size. However, as you grow you may
want to add salespeople. The cost of each salesperson is $12,000 per quarter, which includes the
employee’s salary, travel allowance, and fringe benefits. You will also incur an automatic $3,000
hiring expense for each sales person hired. Airlines employ a sales force to act as a go-between
to promote business with corporations and travel agents. One advantage of building a sales force,
in addition to increased sales, is the possibility of greater volume of direct sales to corporations
and tour promoters, thus lowering the amount paid as commission to intermediaries.
Social responsibility is an important aspect of any business. A firm has responsibility to many
“publics” in addition to its stockholders: employees, suppliers, creditors, competitors,
government, the local community, and the natural environment. The firm has never budgeted
funds for social responsibility, but you may choose an amount and an area where funds are to be
used.
16

Operations and Organization

A significant cost to airlines is the operation of “stations” in the airports. The station provides
boarding, baggage handling, and ground services to the passengers and aircraft. A well-run
counter is important for both corporate image and maintaining employee competence. Opening
a station for a new route incurs a one-time charge of $10,000. This charge is in addition to the
depreciated cost of the hub for the region.
Flight operations include crew cost; dispatching and weather services; baggage, mail, and cargo
handling; and aircraft ground handling. Maintenance is the cost associated with servicing the
planes. Passenger service includes the cost of the reservation and ticketing service, ticket
counters, terminal baggage service, and rental of terminal passenger areas.
Fuel is one of the most unpredictable expenses incurred in operations. Fuel can be purchased
either on the open market (as needed at various airports) or on a three-month contract at a fixed
rate. The contract price can either be somewhat higher or lower than the “spot” price at the time
the contract is negotiated, depending on the forecasted price of fuel for the next quarter. Your
fuel has been purchased on the open market in the past. Fuel prices over the past eight quarters
are shown in the table below.
Fuel Prices (last 8 quarters) *
Quarter 0 -1 -2 -3 -4 -5 -6 -7
Average Spot 1.97 1.97 1.95 1.92 1.87 1.90 1.88 1.85
Contract 1.96 1.99 1.96 1.91 1.89 1.92 1.88 1.84
*Note: Fuel prices in the simulation will not equate to prices in the “real world” but have been set
in relation to other simulation variables.
Your airline is organized into four small departments: marketing, human resources, operations,
and finance. There is little overlap between the areas, and employees must have specialized
training as required by regulatory agencies.
Organizational Chart
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These departments handle all functions, including setting fares, promotion, compensation,
training, flight scheduling, maintenance, passenger service, and asset management. For regional
operators, creating an efficient organization is difficult and costly in terms of personnel. Those
airlines that are dual designators with major airlines may receive services such as ground
operations or computer information systems as part of the agreement. Remaining autonomous
is expensive in terms of organizational design and attracting passengers.
Currently, your company has 81 employees, an average of 27 employees per aircraft. Because of
its small size, the salaries and wages of employees have been below the “market” for airline
employees of national and major airlines. Station personnel are frequently paid minimum wage;
this salary differential holds true for pilots and ground crews. Thus, they have become a training
ground for the larger airlines, with relatively high employee turnover (12% or more) causing
additional expense to the airline. Strategies used by other regional airlines to counteract this
problem:

• Encourage a sense of ownership in the company through stock options and profit-
sharing. Employees are called “managers” of the position they hold (e.g., a ticket agent
becomes a customer service manager).
• Design jobs of ground crews to include rotation through several types of positions.
• Develop clearly defined “career paths.”
Historically, your company has been passive about the turnover problem and views it as a cost of
doing business. However, as the airline expands, the cost may have a greater impact on the
bottom line, and the problem will need to be addressed.
18

Financing

Assets are financed through several channels. Aircraft may be leased or purchased. Leasing
provides advantages to an airline that does not have cash available for a loan down payment,
does not have sufficient collateral, or wants to use a specific type of equipment for a limited
period of time. Airplane leases may be either operating or, if selected by your instructor, capital.
Operating leases do not appear as assets on the balance sheet and do not increase the value of
the company to its owners. A capital lease appears as an asset and as a long-term liability on the
financial statements.
Financing options available for purchasing aircraft include a conventional loan and issuing stock.
Loans require down payments plus some assurances to the lender (collateral) that the payments
can be made. The typical loan period is 10 to 12 years. Issuing stock may require increased
dividend payments and can dilute shareholder value.
Fledgling airlines frequently need a line of credit to finance current assets and meet ongoing
expenses (working capital). This is usually handled by a line of credit (demand notes) that ranges
upward from 2% over the prime interest rate. As with other businesses, an inability to meet
current expenses can be the downfall of an otherwise solvent commuter/regional airline. The
risks in acquiring all of the necessary funds are higher, but a well-managed company may be able
to finance purchases for a lower cost of capital by issuing stock.
 19

Reports

Each quarter your team will have access to reports to assist you in making your decisions.
Company reports include an income statement and balance sheet as well as other internal
reports. Analysis tools are integrated into decision pages to help with evaluating route
profitability, scheduling aircraft, and projecting cash flow. Market reports provide competitive
information on the industry and can help in deciding which markets to enter.
The income statement shows the airline’s revenues and expenses over a period of time. Revenues
come mainly from ticket sales to passengers, with adjustments made for commissions and
refunds. The largest portion of expenses is direct flight expense, which includes flight operations,
fuel, maintenance, and passenger service. Historically, direct flight expenses have represented
approximately 65% of gross revenues, so these four items are clearly very important to monitor.
There are two other major expense items to watch. First is the cost of owning or leasing the
planes. This cost will show up as either a lease payment or depreciation (plus interest expense if
you’ve financed the planes using a loan). The second is overhead, such as the general and
administrative expense, which will increase as your fleet expands. Other expenses, such as
marketing and training, correspond directly to quarterly decisions. A summary of the income
statement for the quarter preceding your takeover of the airline is shown below.
Income Statement
% of Gross
Item Value
Revenue
Gross Revenue $2,688,518 100.0%
Commissions $244,625 9.1%
Refunds $260,786 9.7%
Net Revenue $2,183,107 81.2%
Direct Flight Expense $1,689,234 62.8%
Marketing Expense $36,000 1.3%
Lease Payment $132,000 4.9%
Depreciation $96,000 3.6%
General & Administrative $166,200 6.2%
Total Operating Expense $2,119,434 78.8%
Interest Expense $54,919 2.0%
Profit Before Tax $8,754 0.3%
Less Income Tax (40%) $3,501 0.1%
Net Profit $5,253 0.2%
The balance sheet provides a summary of your firm’s assets, liabilities, and equity. It “balances”
because assets must equal the sum of liabilities and equity. Examples of assets are cash,
receivables, aircraft, and equipment. The total cost of aircraft owned is shown, along with the
20

cumulative depreciation of the aircraft. Aircraft are depreciated at the rate of 1.75% of their
purchase cost per quarter, while depreciation of facilities and equipment for each hub is $5,000
per quarter. Receivables are revenues that have been booked, but payment has not yet been
received. They represent about 40% of quarterly ticket sales. Liabilities include accounts payable
and loans. Accounts payable is the amount owed to suppliers and payroll taxes collected but not
yet paid to the government. Equity consists of the original value of stock issued, along with
retained earnings. Unlike the income statement, which shows results over a specified time
period, the balance sheet is a snapshot of your business at a particular point in time. The balance
sheet as you take over the airline is shown below.
Balance Sheet
Account Value Account Value
Cash $113,440 Accounts Payable $623,506
Accounts Receivable $1,075,407 Loans $2,419,540
Parts Inventory $37,008 Total Liabilities $3,043,046
Aircraft Cost $5,200,000
Less Depreciation $1,274,000 Common Stock $2,250,000
Net Aircraft $3,926,000 Retained Earnings $13,809
Net Facilities/Equipment $155,000 Total Equity $2,263,809

Total Assets $5,306,855 Total Liabilities & Equity $5,306,855

The income statement and balance sheet provide an overview of the financial health of the
company. Managers use them to identify potential problems in the business. Correcting
problems will require taking a closer look at additional reports. The cash flow statement,
operations, sales, and fleet status reports are internal reports that help management make better
decisions. The cash flow statement shows the sources and uses of the firm’s cash. A healthy
company will have positive cash flow generated by core operations, though a negative cash flow
as a result of investment in the company could be a sign of future growth.
The operations report provides critical information for evaluating the performance of your airline.
Along with quality and reliability ratings, it contains the following important measures:

Measure Description
A measure of airline “production” calculated as
Revenue Passenger Miles
passengers per flight × number of flights* × route miles
The capacity to carry passengers, calculated as:
Available Seat Miles
seats per flight × number of flights* × route miles
A measure of how well aircraft are being utilized. It is
Passenger Load Factor
revenue passenger miles ÷ available seat miles
 21

Yield per Revenue Passenger Calculated by dividing Gross Revenue (on the Income
Mile Statement) by Revenue Passenger Miles.
Yield per Available Seat Mile
This is Gross Revenue divided by Available Seat Miles.
(YASM)
Cost per Available Seat Mile Total expenses (including commissions, refunds, and
(CASM) interest) divided by Available Seat Miles.
*Note: In the simulation, there are 80 flying days per quarter, so the calculation uses the number
of daily flights times 80.
The company sales report provides sales and load factor information for each route the airline
serves. Use it to assess the effectiveness of fare sales and to evaluate the profitability of individual
routes.
Several reports are available to provide competitive data and information on the business
environment. Some information, such as the industry news on the dashboard and the financial
summary report provide publicly available information and are available at no cost. Other
information, such as the operating statistics, sales, and marketing reports must be purchased.
Each quarter, as you make decisions for your airline, you should take advantage of the analysis
tools on the decision pages. For example, when scheduling be sure to monitor the total miles
flown for each aircraft type so you are not over- or under-utilizing aircraft. Also when scheduling,
estimate the number of passengers required to break even by using the route profitability tool
for each route. Analysis of your human resources decisions will give you an idea how changes in
compensation policy will impact costs. Analysis of your financing decisions will help ensure you
raise enough capital to meet the needs of expansion and don’t run out of cash.
22

Strategic Options

The owners of the airline believe that they are at a crossroads. In an environment of increasing
competition in their own routes and the opportunities in new markets now available, there is no
question that their business is about to change dramatically. Staying on the same course is
unlikely a path to success. A consultant hired by the owners has provided strategic options to
consider and identified potential threats to the business.
There are two basic responses you can make to increased competition from other airlines. You
can attempt to reduce costs as much as possible and offer discount pricing to attract additional
passengers, or you can provide luxury service at premium prices to differentiate your airline from
its competitors. If you maintain the current pricing structure, it is also possible to pursue both
strategies in a targeted way by improving amenities to attract new passengers, while offering
pricing promotions in select markets to appeal to price-sensitive customers.
A discount pricing strategy will require paying strict attention to control operating costs and will
require appropriate marketing to ensure that passenger loads are sufficient to cover overhead.
You will need to monitor load factors for each route quarterly and add or remove flights to
maintain high loads. Choice of aircraft is critical. While smaller, more economical turboprops
work well for short routes, larger turboprops or jets are appropriate for longer routes, especially
in the foreign and resort markets. Adding seats to aircraft will allow you to carry more passengers
on each flight without a significant increase in overhead. While improvements in quality and
service may be welcomed by passengers, spending too much in these areas will not be profitable
because of low margins.
Luxury passengers expect a quality experience with reliable service. To be successful with this
strategy, you will need to focus on customer needs and set price high enough to maintain
profitable margins. Excessive use of fare sales to improve loads will hurt the bottom line. Luxury
passengers prefer jet aircraft but will tolerate turboprops on short flights if the service is good.
Removing seats to provide more legroom will attract passengers, especially if spending on
advertising is sufficient to communicate a luxury brand image. Good employees are key to a
quality experience for passengers, so you cannot neglect training and compensation when
targeting luxury passengers.
Your airline starts out as a mid-priced carrier, and staying in the normal price range can be an
effective strategy. However, you will need to provide amenities beyond what competing discount
airlines are offering, while keeping costs below those of the luxury airlines. Your airline can be
quite profitable with moderate improvements to quality and service to maintain customer
loyalty, along with judicious use of fare sales to target price-sensitive flyers. While they prefer
jets, most regional passengers in the normal price range expect turboprops, especially on the
 23

shorter routes, and your choice of aircraft should reflect the ones that are most economical to
operate for your firm.
In addition to choosing a pricing strategy, your firm will need to decide how to expand to
maximize profitability. At the start of the simulation, there are markets that are not being served
in your region that present opportunities for new sales. But you can also add a hub in a new
region and attempt to take sales away from existing competitors. Entering a new region requires
a $250,000 investment in the hub, which adds $5,000 to depreciation expense each quarter.
Adding service on a new route incurs a one-time cost of $10,000. It takes time to develop new
markets, and the slim profits the airline is generating means you will need enough working capital
to last several quarters before reaching breakeven on new routes.
The consultant suggests that in the coming years there may be opportunities outside the
traditional business of a regional airline which can help your firm to diversify its operations. These
include adding cargo service to passenger flights, providing limited charter or air ambulance
service, and opening an auto rental agency at one of the airports. Though not all these
opportunities may be available over the course of the simulation, you should be ready to respond
to them if they arise.
As your airline expands, you will need to acquire additional aircraft to service the routes. While
you do have access to capital markets for either a loan or issuing stock, the owners are concerned
about the risk associated with taking on debt or the dilution effects of selling stock on shareholder
value. Leasing aircraft is an alternative to raising the capital to purchase, but you should consider
the total cost of each option before making a decision. In any event, be careful about expanding
too quickly. The increased overhead from rapid expansion, along with reduced load factors as
you develop new markets and the threat of a response from competitors, can lead to large losses.
In addition to creating a strategic plan and implementing it, your management team needs to be
aware of potential threats to the business. Changes in the economy can affect both the cost of
capital and your sales. Fuel is a big cost in the operation of the airline, and a spike in fuel cost
could have a serious impact on profits. New competitors entering your region and the potential
for a resulting fare war to gain or retain passengers can also affect the bottom line. Flight
disruptions due to security threats and bad weather are a constant in the airline industry. New
regulations due to concerns over the rights of passengers or the environmental impact of your
operations can increase the cost of doing business. It is essential that you understand all these
external forces which have the potential to affect your strategy.
24

Next Steps

The owners are confident you will make the right choices as you take over management of the
airline. The first task is to give your airline a name. Be sure to plan a course of action before you
begin; then coordinate your decisions to implement the plan, monitor the results to make sure
you are on track, and make adjustments as needed. Keep in mind that maintaining the current
course is not an option in this competitive environment, while expanding too quickly can cause
severe cash flow problems. Best of luck in running your airline!
 25

Summary of Decision Variables

A summary of simulation variables is provided below and should be used as a reference aid when
making decisions in Airline. Along with each decision variable, this summary includes suggested
limits, costs, other factors, and general parameters of the simulation.
Decision Variables
Decision Description Value Ranges
Select a fare structure (discount, normal, luxury)
Fare 28–31, 35–40, or 48–51
and fare per mile in cents.
Cabin Food Level of food service on the plane. Cost of
none, $1, $2, or $5
Service service is per passenger.
Promotion Spending on promotion in the quarter. (This is
0–99,999
Budget separate from fare sales on routes.)
Advertising Spending on advertising for the quarter. 0–99,999
In-flight Customized magazine to promote the airline’s
Yes/No
Magazine image. Cost: $500 per quarter.
Salespersons Add sales force to promote the business. Cost
0–4 (negative to fire)
Hired per salesperson is $3k to hire, $12k a quarter.
In region: yes/no;
You start in one region but may expand to
marketing effort: 0–100
Regions others. Establishing a hub in a new region costs
(sum over all regions is
$250k, which is depreciated $5k per quarter.
100%)
Quality and Enter spending on a quality program and
0–100,000
Training employee training.
0–7% above norm; no
Increase compensation above industry average
Compensation bonus, stock bonus, or
for all or select employees.
profit sharing
Basic maintenance is required, but increase at Level 1, 2 (+$3,500), or
Maintenance
additional cost to improve reliability. 3 (+$5,000)
Fuel can be purchased on the spot market, All spot; half spot, half
Fuel Contract
under contract, or a mix. contract; or all contract
Purchase or lease up to 8 aircraft of 2 types per
Aircraft Aircraft type, number
period. Purchased aircraft are depreciated at a
Acquisition (0–8), purchase/lease
rate of 1.75% per quarter.
Change number of seats in aircraft for a fee, and
Aircraft seat layout (discount,
move to different region if you’ve entered more
Change normal, luxury), region
than one.
Dispose of aircraft at any time. Costs $50,000 to
Aircraft
cancel a lease. Purchased aircraft disposed of at Keep or Dispose
Disposal
book value at a cost of 1% of value.
26

Choose routes to serve and fare sale (1/3 off) for aircraft and fare sale
Routes
each route. Costs $10k to enter a new market. (none, 1, 2, 3 months)
Social Choose from among nine causes to support in 0–100,000 plus area
Performance the community. choice
Enter amount of capital needed and shares will
Stock Sold 0–5,000,000
be sold at current stock price to raise amount.
Pay cash dividend or optional stock dividend. 0–1,000,000 cash and
Dividend Paid
Cash dividend cannot exceed profit for quarter. yes/no stock
Short-term loan is interest-only; enter negative None to available credit
Loans value repay to repay. 2% of long-term balance or negative value up to
repaid automatically. balance
Extra cash can be invested in a CD for the
Certificate of
quarter. Investments do not renew 0–1,000,000
Deposit
automatically.
Special There may be other one-time or on-going Choices vary by special
Decisions decisions. decision.