Transportation A Supply Chain

Perspective 7th Edition Coyle Solutions

Manual
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 Chapter 7
AIRLINES

Chapter Objectives:

After reading this chapter, you should be able to do the following:

1. Appreciate the importance of air transportation in the U.S. economy

2. Gain knowledge of the types and number of carriers in the U.S. airline industry

3. Understand the level of competition in the U.S. airline industry

4. Become aware of the operating and service characteristics of airline transportation

5. Be familiar with the different types of equipment used by airlines

6. Appreciate the impacts of fuel and labor costs on airlines cost structures

7. Understand the concepts of economies of scale and density in the airline industry

8. Be aware of current issues facing airlines today

Chapter Overview

Brief History

From the first flight which lasted less than 1 minute to space shuttles orbiting the earth, air transportation
has come a long way in a short period of time. Wilbur and Orville Wright made their first flight in 1903
at Kitty Hawk and sold their invention to the federal government. In 1908 the development of air
transportation began with the U.S. Post Office examining the feasibility of providing air mail service.
Although airplanes were used in World War I, the use of airplanes for mail transport can be considered
the beginning of the modern airline industry. Passenger transportation services developed as a by-
product of the mail business and began to flourish in selected markets. Since that time, airplanes have
become faster, bigger, and relatively more fuel-efficient. Although the level and degree of technological
improvement have slowed in the airline industry, there is still opportunity for further innovation.

Airline travel is a common form of transportation for long-distance passenger and freight travel and the
only reasonable alternative when time is of the essence. The tremendous speed of the airplane, coupled
with more competitive pricing, has led to the growth of air transportation, particularly in the movement
of passengers.

Industry Overview and Significance

In 2007, for-hire air carriers had total operating revenues of $173.1 billion, of which $107.0 billion (61.8
percent) came from passenger service. In 2003, air carriers transported 15.2 billion revenue ton-miles,

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 or approximately 0.4 percent of total intercity ton-miles.
The airlines are a unique and important group of carriers that meet some particular needs in our society.
Although their share of the freight movement on a ton-mile basis is small, the type of traffic that they
carry (high-value, perishable, or emergency) makes them an important part of our total transportation
system.

Types of Carriers

The for-hire carriers cannot be easily categorized into specific types because carriers provide many types
of services. For-hire carriers will be discussed according to type of service offered (all-cargo, air taxi,
commuter, charter, and international) and annual revenue (majors, nationals, and regionals).

A classification frequently used by U.S. air carriers is one based on annual operating revenues. The
categories used to classify air carriers in terms of revenue are as follows:
Majors — annual revenues of more than $1 billion
Nationals — annual revenues of $100 million to $1 billion
Regionals — annual revenues of less than $100 million

The charter carriers, also known as air taxis, use small to medium size aircraft to transport people or
freight. The supplemental carrier has no time schedule or designated route. The carrier charters the
entire plane to transport a group of people or cargo between specified origins and destinations.

Many U.S. carriers are also international carriers and operate between the continental United States and
foreign countries, and between the United States and its territories (such as Puerto Rico). Because
service to other countries has an effect on U.S. international trade and relations, the president of the
United States is involved in awarding the international routes.

Numbers of Carriers

A look at carrier revenues shows a concentration of earnings by a small group of majors, nationals, and
regionals. A majority of air movements are made by 151 carriers. The largest increase in number of carriers
has occurred among the regionals. In fact, 82 percent of total industry revenue was generated by the top 10
carriers

Private air transportation has been estimated to include approximately 60,000 company-owned planes, with
over 500 U.S. corporations operating a private air fleet. In addition, thousands of planes are used for
personal, recreational, and instructional purposes.

Deregulation in 1978 was expected to result in a larger number of airlines. The number of major airlines did
increase initially, but as Table 7.1 indicates, the number of airlines has remained steady over the last several
years, with 2007 seeing an increase. Available seat miles for 2007 increased by 3.1 percent from 2006 as
some carriers are increasing the size of their aircraft.

Competition

Intermodal

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Due to their unique service, air carriers face limited competition from other modes for either
passengers or freight as they have an advantage in providing time-sensitive, long-distance
movement of people or freight. Airlines compete to some extent with motor carriers,
automobiles and, to a limited extent, from trains and buses.

Intramodal
Competition in rates and service among the air carriers is very intense, even though the
number of carriers is small. The top 10 air carriers accounted for about 82 percent of the total
operating revenue. Due to excess capacity, airline prices have fallen 3.0 percent in 2007 (not
adjusted for inflation). During this same period, inflation (measured by the Consumer Price
Index) rose 2.8 percent.

New entrants to the airline market initially cause overcapacity to exist on many routes. To
counter this and add passengers to their aircraft, carriers reduce prices and fare wars begin.
.
Service Competition
Competition in airline service takes many forms, but the primary service competition is the
frequency and timing of flights on a route. Carriers promote such things as on-time arrival
and friendly employees to convince travelers that it has the desired quality of service.
Frequent flyer programs and special services for high-mileage customers are popular
examples of other services to attract loyal customers.

A post-deregulation development in service competition was no-frills service. One

hallmark of such carriers is that they only provide one class of service.

Cargo Competition
Competition for cargo has become intense. Major airline freight companies (such as FedEx
and UPS Airlines) have their own fleets of surface delivery vehicles to perform the ground
portion of this door-to-door service.

Another interesting dimension has been the growth in volume of express carrier traffic,
which is an important reason for the attraction of surface carriers into this segment of the
business.

Operating and Service Characteristics

General
The major revenue source for air carriers is passenger transportation. In 2007, approximately
61.8 percent of total operating revenues were derived from passenger transportation.

In 2007, approximately 14.2 percent of the total operating revenues were generated from
freight transportation. For emergency shipments, the cost of air transportation is often
inconsequential compared to the cost of delaying the goods.
The high value of products transported by air freight provides a cost-savings trade-off,
usually but not always from inventory carrying cost which might offset the higher cost of air
service. The old adage “Time is money” is quite appropriate here.
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in whole or in part.
Speed of Service

Undoubtedly, the major service advantage of air transportation is speed with a trip from New
York to California trip, approximately 3,000 miles, a mere six-hour journey.

This advantage of high terminal-to-terminal speed has been dampened somewhat by reduced
frequency of flights and congestion at airports.

Air carriers have been concentrating their service on the high-density routes like New York
to Chicago and while implementing the hub-and-spoke terminal approach which have
aggravated the air traffic congestion and ground congestion at major airports.

The shippers who use air carriers to transport freight are primarily interested in the speed and
reliability of the service and the resultant benefits, such as reduced inventory levels and
inventory carrying costs.

Length of Haul and Capacity

For passenger travel, air carriers dominate the long-distance moves. In 2007, the average
length of haul for passenger travel was 1,078 miles for air carriers.

Adding freight to the baggage compartment on passenger flights necessitates rather small-
size shipments and thus supports rate-making practices for these shipments.

Accessibility and Dependability

Except in adverse weather conditions, air carriers are capable of providing reliable service.
Sophisticated navigational instrumentation permits operation during most weather
conditions.

Poor accessibility is one disadvantage of air carriers. Passengers and freight must be
transported to an airport for air service to be rendered. Limited accessibility adds time and
cost to the air service provided but even with the accessibility problem, air transportation
remains a fast method of movement and the only logical mode when distance is great and
time is restricted.
.
Equipment

Types of Vehicles
There are several different sizes of airplanes in use, from small commuter planes to huge
wide-body, four-engine planes used by the nationals.

Terminals
The air carriers’ terminals (airports) are financed by a government entity. The carriers pay
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in whole or in part.
for the use of the airport through various fees and users pay a tax on airline tickets and air
freight charges.
The growth and development of air transportation is dependent upon adequate airport
facilities. The federal government is financially responsible for the construction of airport
facilities, the various state and local governments assume the responsibility for operating and
maintaining the airports.

The carriers perform passenger, cargo, and aircraft servicing at the airport terminal.

Certain airports have become hubs with flights from outlying areas being fed into the hub
airport to connect with other flights.

Airport terminals also provide services to passengers, such as restaurants, banking

centers, souvenir and gift shops, and snack bars.

Cost Structure

Fixed Versus Variable Cost Components

Air carriers’ cost structure consists of high variable and low fixed costs with
approximately 80 percent variable and 20 percent fixed. The relatively low fixed cost
structure is attributable to government (state and local) investment and operations of
airports and airways.

Flying operations accounted for 37.9 percent of airline operating costs in 2007 while
maintenance costs equaled 10.2 percent of total operating costs. Both of these expenses
are variable costs.

The increased price competition in the airline industry has caused airlines to try to
operate more efficiently by cutting costs where possible. There has been much effort put
forth to decrease labor costs because the airline industry tends to be labor-intensive
compared to other modes, such as railroads and pipelines.

Fuel

Escalating fuel costs have caused problems in the past for the airlines. By December
2007, the price per gallon of aviations fuel was $2.10 per gallon. Rapidly escalating fuel
costs in recent years has caused airlines to suffer financially in an already depressed
pricing market.

More fuel-efficient planes have been developed and added to carrier fleets and carriers
are substituting smaller planes on low-density routes and eliminating service completely
on others. The average cost per gallon of fuel increased from $1.97 to $2.10 from 2006 to
2007 and fuel consumption increased by 187 million gallons (1.03-percent increase) from
2006 to 2007, resulting in additional fuel expenses of $2.94 billion.
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in whole or in part.
Labor

In 2007, average salaries and wages increased by 2.7 percent but were offset by a
reduction in average benefits and pensions of 11.9 percent. In 2007 carriers employed
560,997 people at an average annual compensation of $74,786.

Airlines employ people with a variety of different skills. To operate the planes, the carrier
must employ pilots, copilots, and flight engineers. Overall employment has decreased as
airlines have moved aggressively to reduce costs to improve their competitiveness and
lower prices in selected markets.

Strict safety regulations are administered by the FAA with acceptable flight operations,
as well as hours of service, being specified for pilots.

The wages paid to a pilot usually vary according to the pilot’s equipment rating.

Wages can also vary according to whether a person works for a union airline or not.

Equipment

The cost of operating airplanes varies with larger planes being more costly to operate per
hour than smaller planes, but the cost per seat-mile is lower for larger planes.

Economies of Scale/Economies of Density

Large-scale air carrier operations do have some economies of scale, which result from
more extensive use of large-size planes or indivisible units.

Market conditions (sufficient demand) must exist to permit the efficient utilization of
larger planes (i.e., if the planes are flown near capacity, the seat-mile costs will obviously
decrease). Another factor indicating large-scale operations for air carriers is the integrated
communication network required for activities such as operating controls and passenger
reservations.

The air carrier industry overall has a cost structure that closely resembles that of motor
carriers and both industries are characterized by high variable cost ratios (airlines and
motor carriers) can relatively easily add equipment to a given market. As such, the ability
to decrease fully allocated cost per mile by adding aircraft does not exist.

Economies of density exist when a carrier has significant volume between an origin-
destination pair to fully utilize capacity on forward-haul movements as well as utilize
significant capacity on back-haul movements.

Over the years the federal government has provided direct operating subsidies (that is,
public service revenues) to air carriers to provide service to less-populated areas.
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in whole or in part.
RATES

Pricing
Airline pricing for passenger service is characterized by the discounts from full fare. Seats on
the same plane can have substantially different prices, depending on restrictions attached to
the purchase, such as having to stay over a weekend or having to purchase the ticket in
advance. Business people generally pay more for their airline travel due to the more rigid
schedules they are on and the fact that they usually depart and return during the high-demand
times.
The price of seats on different flights and the price of the same seat on a particular flight can
vary due to competition with other airlines, the time and day of departure and return, the
level of service (first class versus coach or no-frills service), and advance ticket purchase.
Discount pricing has continued throughout the 2000s as airlines have attempted to increase
their “payload.”
Cargo pricing is dependent mainly on weight and/or cubic dimensions. Some shipments
that have a very low density can be assessed an over-dimensional charge, usually based
on 8 pounds per cubic foot. This over-dimensional charge is used to gain more
appropriate revenue from shipments that take up a lot of space but do not weigh much.
Other factors affecting the price paid to ship freight via air transportation include
completeness of service.

Operating Efficiency
An important measure of operating efficiency used by air carriers is the operating ratio. The
operating ratio measures the portion of operating income that goes to operating expenses:

Operating Ratio = (Operating Expense/Operating Income) × 100

Only income and expenses generated from passenger and freight transportation are
considered.

Another widely used measure of operating efficiency is the load factor (previously dis-
cussed). The load factor measures the percentage of a plane’s capacity that is utilized.
Load Factor = (Number of Passengers/Total Number of Seats) × 100
Airlines have raised plane load factors to the 70–80-percent range. The particular route
and type of plane (capacity) directly affect the load factor, as does price, service level,
and competition.

Equipment substitution, however, might not be possible, and substitution might result in
excess capacity. The jumbo planes have large carrying capacities that might not be
utilized in low-demand routes. Thus, large-capacity planes are used on high-demand
routes such as New York–Chicago and New York–Los Angeles, and smaller capacity
planes are used on low-demand routes such as Toledo–Chicago and Pittsburgh–Memphis.

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in whole or in part.
CURRENT ISSUES

Safety

The issue of airline safety is of great importance to the airline industry.

Several factors affect airline safety. First, airport security has come under close scrutiny over the past
several years. On September 11, 2001, four aircraft were hijacked and two were flown into the Twin
Towers in New York City, killing and injuring thousands of people. As a result, airport security has
reached an all-time high, causing more delays at airport terminals.
Air travel is still the safest way to travel even thought there is a significant loss of life in an airline
tragedy; air travel is still the safest mode for passenger travel.

Finally, as with other transportation modes, the issue of substance abuse concerning pilots and
ground crews, has become important.

Security

The aftermath of the tragic fatalities of 9/11 gave rise to the establishment of the Department of
Homeland Security as well as the Transportation Security Administration (TSA). Both of these
agencies are responsible for the safety of passengers while in airports and in-flight. New screening
procedures have been established at airports for passengers and new guidelines developed for carry-
on luggage. Aircraft security is, and will continue to be, an important issue in defending the United
States from terrorist acts.

Technology
Because the airline industry must offer quick and efficient service to attract business, it
constantly needs more sophisticated equipment. The FAA and the federal government are
proposing an entire overhaul to the current air traffic control system that would rely on the use of
GPS navigation aids. This would increase the capacity for aircraft in operating space as well as
reduce travel times between origin/destination pairs. However, this change would also require
new technology on current and new aircraft.

Study Questions

1. What are the types of carriers as defined by revenue class? Who are some of the members of
each class? Do you think the members of each class would compete against or work together
with members of other classes? What about members of their own class? Use examples,
obtained from advertising or websites.

A classification frequently used by U.S. air carriers is one based on annual operating revenues.
The categories used to classify air carriers in terms of revenue are as follows:
Majors — annual revenues of more than $1 billion
Nationals — annual revenues of $100 million to $1 billion
Regionals — annual revenues of less than $100 million

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or in part.
 Examples of major U.S. carriers are American, United, Delta, US Airways, and Southwest.

Major carriers have $1 billion or more in annual revenues and examples of major U.S.
carriers are American, United, Delta, US Airways, and Southwest.

National carriers have revenues of $100 million to $1 billion and examples of U.S. nationals
include Midwest, Sun Country, and PSA Airlines.

Regional carriers have annual revenues of less than $100 million and included in the regional
category are carriers such as Air Midwest, Big Sky, and Piedmont. The regional carriers are
grouped into two categories: large ($10–$100 million) and medium (less than $10 million).

The all-cargo carrier, as the name implies, transports cargo primarily. The transportation of air
cargo was deregulated in 1977, permitting the all-cargo carriers to freely set rates, enter and
exit markets, and use any size aircraft dictated by the market. Examples of all-cargo carriers
include FedEx and UPS Airlines.

Competition is intense between various air carriers and the student should have little trouble
finding ads and webpage information support this

2. Discuss the ways in which air carriers compete with each other. How have regulatory changes
affected this competition?
Intermodal
Air carriers face limited competition from other modes for either passengers or freight. Air
carriers have an advantage in providing time-sensitive, long-distance movement of people or
freight. Airlines compete to some extent with motor carriers for the movement of higher-valued
manufactured goods; they face competition from automobiles for the movement of passengers
and, to a limited extent, from trains and buses.

Intramodal
Competition in rates and service among the air carriers is very intense, even though the
number of carriers is small. As noted, passenger air carrier regulation was significantly
reduced in 1978, and new carriers entered selected routes (markets), thereby increasing the
amount of competition).

Also, existing carriers expanded their market coverage, which significantly increased
intramodal competition in certain markets. The top 10 air carriers accounted for about 82
percent of the total operating revenue. Carriers may also have excess capacity (too many
flights and seat miles on a route) and attempt to attract passengers by selectively lowering
fares to fill the empty seats.

In 2007, airline prices fell 3.0 percent (not adjusted for inflation). During this same period,
inflation (measured by the Consumer Price Index) has risen 28.2 percent. New entrants to the
market have taken a very aggressive stance on discounting passenger fares.

The air industry was deregulated by The Airline Deregulation Act (ADA) signed into law on

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or in part.
 October 28, 1978. The main purpose of the act was to remove government control and open the
deregulated passenger air transport industry to market forces. Prior to the act the federal Civil
Aeronautics Board (CAB) regulated all domestic air transport, controlling fares and setting
routes and schedules but this law abolished that agency

3. What is the major advantage of air carriers? How does this advantage impact the inventory
levels of those firms using air transportation? Explain how this advantage relates to the choice of
modes when choosing between air carriage and other modes for freight and passengers.

Undoubtedly, the major service advantage of air transportation is speed. The terminal-to-
terminal time for a given trip is lower via air transportation than via any of the other modes.
Commercial jets are capable of routinely flying at speeds of 500 to 600 miles per hour, thus
making a New York to California trip, approximately 3,000 miles, a mere six-hour journey.
This advantage of high terminal-to-terminal speed has been dampened somewhat by reduced
frequency of flights and congestion at airports. Commuter airlines have been substituted on
some routes and the use of commuters requires transfer and re-handling of freight or passengers
because the commuter service does not cover long distances.
Air carriers have been concentrating their service on the high-density and have implemented the
hub-and-spoke terminal approach, in which most flights go through a hub terminal. These two
factors have aggravated the air traffic congestion and ground congestion at major airports and
have increased total transit time while decreasing its reliability.
The shippers who use air carriers to transport freight are primarily interested in the speed and
reliability of the service and the resultant benefits, such as reduced inventory levels and
inventory carrying costs. Acceptable or improved service levels can be achieved by using air
carriers to deliver orders in short time periods. Stockouts can be controlled, reduced, or
eliminated by responding to shortages via air carriers. Air freight shipments tend to be small,
weight less than 500 pounds, and require less packaging for shipments moving via surface
carriers.

4. Discuss the length of haul and carrying capacity of the air carriers. Explain how this both
favors and hinders air carriers from a competitive standpoint.

For passenger travel, air carriers dominate the long-distance moves. In 2007, the average length
of haul for passenger travel was 1,078 miles for air carriers. The capacity of airplanes is
dependent on its type. A wide-body, four-engine jet has a seating capacity of about 370 people
and an all-cargo carrying capacity of 16.6 tons.

5. What is the role of government in air transportation? Include both economic and safety in your
answer

The air carriers’ terminals (airports) are financed by a government entity. The carriers pay for
the use of the airport through landing fees, rent and lease payments for space, taxes on fuel, and
aircraft registration taxes. In addition, users pay a tax on airline tickets and air freight charges.
Terminal charges are becoming increasingly more commonplace for passenger traffic. Table 7.4
summarizes the various types of taxes paid by carriers, shippers, and passengers in the airline
industry.

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or in part.
 The growth and development of air transportation is dependent upon adequate airport facilities.
Therefore, to ensure the viability of air transportation, the federal government has the
responsibility of financially assisting the states in the construction of airport facilities. The
various state and local governments assume the responsibility for operating and maintaining the
airports.

The Federal Aviation Agency operates and controls the airways and employs the air traffic
controllers who manage the aircraft while airborne. Strict safety regulations are administered by
the FAA. Acceptable flight operations, as well as hours of service, are specified for pilots. Both
mechanics and pilots are subject to examinations on safety regulations and prescribed
operations. FAA regulations also dictate appropriate procedures for flight attendants to follow
during take-off and landing.

The Department of Homeland Security and the Transportation Security Administration (TSA)
were established by the federal government to monitor and regulate security for passengers and
cargo in air transportation.

6. How does fuel cost and efficiency affect both air carrier costs and pricing?

A major item is fuel which increased in cost to $2.10 in 2007 from $0.57 in 1979.. Rising fuel
costs have been a major problem for the mode. The high fuel costs have led to the development
of fuel-efficient aircraft and the use of smaller planes on low-density routes. Fuel costs have also
led to fare increases and fuel surcharges.

7. What is the current situation of labor within the air industry? Are unions a major factor? How
does skill level vary within the industry? Do you think this situation is similar to other modes? If
so, which one(s)? Explain why,

Air transportation employs many people with a variety of skills, such as aircrew and ground
crew personnel, and management. The FAA controls the nature of flight operations and hours of
service for pilots. Mechanics and pilots must pass examinations regarding safety and operations
and be licensed. Pilot wages depend upon the plane rating of the pilot. Wages also differ
between unionized and non-unionized airlines, where unionized employees will often earn more
than nonunion.

The skill levels of pilots are higher than operators in other modes but other employees’ skill
levels are similar to those in motor and rail carriers. Clerical and ramp employees of the
airlines are similar in skills required and performance duties to those working in rail and motor
carriers.

8. Do air carriers face economics of scale at any level? Discuss and support your answer with
examples.

Some economies of scale can be realized from the use of larger airplanes. However, sufficient
demand must exist in a market to justify the efficient utilization of larger aircraft otherwise this
can become more costly. The airline industry most closely resembles the motor carrier industry.

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or in part.
 In some cases, carriers will substitute smaller equipment on some routes during certain time
periods. This might help improve the load factor. However, this is not possible as many aircraft
fly on multi-legged routes and that size airplane needs to be positioned at a specific city for a
trip requiring that level of capacity.

9. How do air carriers price their services? Is the weight or density of the shipment a factor?
Explain this factor as part of your answer. How does air carrier pricing relate to the value of the
goods being transported?

Airline pricing for passenger service is characterized by the discounts from full fare. Seats on
the same plane can have substantially different prices, depending on restrictions attached to the
purchase, such as having to stay over a weekend or having to purchase the ticket in advance.
Business people generally pay more for their airline travel due to the more rigid schedules they
are on and the fact that they usually depart and return during the high-demand times. JetBlue,
Southwest, and AirTran have aggressively discounted prices in major passenger markets.
The price of seats on different flights and the price of the same seat on a particular flight can
vary due to competition with other airlines, the time and day of departure and return, the level of
service (first class versus coach or no-frills service), and advance ticket purchase.
Cargo pricing is dependent mainly on weight and/or cubic dimensions. Some shipments that
have a very low density can be assessed an over-dimensional charge, usually based on 8
pounds per cubic foot. This over-dimensional charge is used to gain more appropriate
revenue from shipments that take up a lot of space but do not weigh much. An exaggerated
example of a shipment to which this rule would apply is a shipment of inflated beach balls.
Other factors affecting the price paid to ship freight via air transportation include
completeness of service and special services

10. What are the current issues facing the air industry? Discuss how each impacts the industry,
its customers and employees?

The issue of airline safety is of great importance to the airline industry. Any incident involving
airplanes receives a great deal of publicity from the media because of the large number of
people affected at one time
Several factors affect airline safety. First, airport security has come under close scrutiny over
the past several years. On September 11, 2001, four aircraft were hijacked and two were flown
into the Twin Towers in New York City, killing and injuring thousands of people. As a result,
airport security has reached an all-time high, causing more delays at airport terminals. The U.S.
Government created the Office of Homeland Security to be the agency that monitors and
manages the security of the U.S. borders.
Air travel is more popular than ever, as indicated previously, but there is still great concern
about safety. The 1990s had some major air disasters among major carriers, such as TWA,
American, US Airways, SwissAir, and the ValuJet crash in the Florida Everglades. In addition,
the frequent reporting of near collisions, minor accidents, and airplane recalls have heightened
public awareness of the air safety problem. However, air travel is still the safest way to travel.
Table 7.8 shows the trend of aircraft accidents from 1997 through 2007. The spike in 2001 was
caused by the terrorist attack in New York City and Washington, D.C. on September 11.

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or in part.
 Finally, as with other transportation modes, the issue of substance abuse concerning pilots and
ground crews has become important. Strict drug-testing policies and alcohol consumption
guidelines are in effect for pilots and other aircraft personnel. In spite of these concerns, airline
travel is still a very safe form of transportation; however, these issues are currently being
addressed by the airlines to ensure that airline transportation remains safe.

Because the airline industry must offer quick and efficient service to attract business, it
constantly needs more sophisticated equipment. With other modes such as railroads and water
carriers, travel times are measured in days; however, air carriers measure travel time in hours.
For this reason, the airline industry has developed automated information-processing and these
improvements will allow customers to receive their inbound shipments faster than ever before.

11. What is the cost structure of the air industry? How does it compare with others modes?
How does this affect pricing, particularly passengers? Be sure your answer includes examples
from either advertising or the Internet.

Like the motor carriers, the air carriers’ cost structure consists of high variable and low fixed
costs. Approximately 80 percent of total operating costs are variable and 20 percent are fixed.
The relatively low fixed cost structure is attributable to government (state and local) investment
and operations of airports and airways. The carriers pay for the use of these facilities through
landing fees, which are variable in nature.

As indicated in Table 7.5, 37.9 percent of airline operating costs in 2007 was incurred for flying
operations and amounted to $62.15 billion; maintenance costs equaled 10.2 percent of total
operating costs. Both of these expenses are variable costs. The next major category of expense is
aircraft and traffic servicing, which totaled $22.31 billion in 2007 and about 13.6 percent of
total operating costs. In 2007, depreciation accounted for about 4.3 percent of total operating
expenses.

Table 7.5 provides a comparison of operating costs for 2003, 2004, 2005, 2006, and 2007. The
cost of flying operations increased from 2003 to 2007, as did total operating expenses. From
2003 to 2007, every cost item increased except for passenger service.

The increased price competition in the airline industry has caused airlines to try to operate
more efficiently by cutting costs where possible. There has been much effort put forth to
decrease labor costs because the airline industry tends to be labor-intensive compared to
other modes, such as railroads and pipelines. The airlines have negotiated significant labor
cost reductions with many of the unions represented in the industry in an attempt to lower
costs and compete against the low cost start- up carriers.

A “Google” Search for cost structure of the air industry yielded multiple “hits” and, while
many might not apply, the student should have little trouble with this part of the question.

Case Questions

Case 7.1: Airspace Airlines

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or in part.
 1. What suggestions would you give Jim to help Airspace lower its operating costs?

The first suggestion could be to analyze the aging turboprop fleet operated by Airspace. The
high maintenance costs of the fleet show that the turboprops have probably passed their
economic operations. The analysis should focus on the acquisition (either through purchase
or lease) of possibly regional jet aircraft. Another suggestion could be to analyze how
efficiently Airspace schedules its pilots and aircraft. Inefficient scheduling might lead to
long wait times between flights, empty repositioning of aircraft, and increased pilot down
times. Negotiating a reduction in pilot wages will probably not be an option since the pilots
are members of the APA.

2. How would you help Airspace implement those plans?

The first step would be to assess the market value of the existing fleet and/or the ability of
Airspace to terminate the leases on the aircraft (if they are leased). The second step would
be to assess the financial requirements of acquiring new aircraft and the potential sources of
funding. A critical point here is to identify the type of new aircraft needed. This decision
will be affected by the lower fare structure required by Delta and the expanded markets that
Delta is offering Airspace (that is, length of haul and number of passengers). Airspace
might also want to assess how it buys fuel and whether or not futures contracts for fuel are
on option. The third step (this is also contingent upon Delta’s request for expanded
operations) is for Airspace to analyze how the new flight schedules will impact current pilot
operating hours and the number of pilots needed. Also, new aircraft might require upgraded
flight certifications for these pilots.

3. What constraints can you identify that would prevent Airspace from implementing your
suggestions?

The first, and probably most critical, constraint is the availability and cost of capital for
Airspace to acquire more fuel efficient aircraft. Without available capital, Airspace will be
forced to continue operating with expensive equipment which could ultimately cause its
demise. The second constraint is how cooperative the pilots and their union would be to new
aircraft and operating schedules. The third constraint would be the price of fuel. If jet fuel
prices escalate as in the past, there might be little Airspace could do to significantly lower
operating costs.

4. How would you suggest Jim respond to Delta’s request for more flights at a lower cost?
Airspace should seriously investigate expanded service for Delta out of the Atlanta airport.
This relationship might result in Airspace taking advantage of Delta’s ability to buy fuel at a
lower price. Also, expanded service might result in higher capacity utilization for its
aircraft. Additional markets might allow Airspace to reduce the amount of empty
repositionings of aircraft. Airspace should also attempt to negotiate a long term agreement
with Delta to help reduce the operating cost per seat mile for its new aircraft.

Case 7.2: US Airways

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or in part.
 1. If you were the CEO of US Airways, what would you do to confront the competition from its
low-cost competitors?

There would be little choice but to cut costs wherever possible in areas ranging from salaries to
number of employees to destinations served. The new entrants have much lower costs and can
afford to offer lower prices and still make a profit. US Airways operates more types of aircraft
than any of these competitors. This results in excessive parts inventories and inefficient
scheduling. One scenario here could be for US Airways to reduce the number of types of
equipment it operates. Another cost incurred by US Airways and not incurred by these
competitors is the investment in its hubs in Philadelphia and Charlotte. These high fixed costs
exist regardless of volume. So, reducing this fixed cost by eliminating/constricting hub
operations or by putting more flights through the hubs are possible alternatives.

2. Can US Airways survive by remaining the same carrier it is today?

US Airways has already gone through one reorganization. This is evidence that its current
operating structure is not competitive with these other carriers. Its short-haul network, coupled
with the number of different types of aircraft it operates, contributes to the high cost per seat-
mile currently realized by US Airways. The student should be able to access the internet or the
press to find out the latest on the operations and financial stability of US Airways.

3. If you were AirTran, jetBlue or Southwest, how would you continue to take market share
away from US Airways?

Having a cost advantage, these competitors should continue to enter market pairs out of and into
Philadelphia and Charlotte, offering lower prices than US Airways. These competitors have
also started to offer more passenger amenities than they did as start-ups (such as frequent flier
programs). They should continue to expand their passenger services. Southwest currently does
not charge for checked luggage while US Airways does; Southwest should continue this practice.
Finally, focus on on-time flight operations.

4. Do American, Delta and United still pose competitive threats to US Airways?

They do to the extent that they service many of same market such as Delta’s competitive
northeast corridor shuttle between Boston, New York City and Washington. These other carriers
have their own cost related problems and only if they can get these under control could they
become more competitive with US Airways.

Suggested Internet Projects

1. Have the student log onto the Internet and visit several airline and ticketing sites. Have the
student prepare a report of the discussing the fares they were able to find using the same city
pairs with different carriers. Have the student do this exercise for peak/off-peak times during
the day.

2. Have the student research air freight for service and pricing. Have the student focus on the

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
 bases used for charging the prices (such as cube, weight) and any special requirements the
carriers might have for a shipment.

3. Have the student research government intervention in the airline industry including loan
guarantee programs. Also have the student research the Air Transport Association to assess
its role with the government on behalf of the airlines.

Here are some suggested addresses:

Air Transport Association: www.airlines.org

Delta Airlines: www.delta.com

Federal Aviation Administration: www.faa.gov

FedEx: www.fedex.com

United Airlines: www.united.com

United Parcel Service (UPS): www.ups.com

USAirways: www.usairways.com

Travelocity: www.travelocity.com

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.