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Airline Economics and Maintenance Costs
To provide an understanding of the economics and maintenance costs involved in operating an airline.
List the areas of income and expenditure that an airline generates Explain the factors involved in: Seating Arrangements Seat Pricing Flight Scheduling Fleet Planning State the variable, fixed, and other costs of maintaining aircraft and equipment
it is easy to lose sight of the fact that this is. fundamentally. nor inventory created and stored for sale at some later date. Airlines perform a service for their customers transporting them and their belongings (or their products. insurance companies or even hairdressers.Service Industry Because of all of the equipment and facilities involved in air transportation. . in the case of cargo customers) from one point to another for an agreed price. In that sense. There is no physical product given in return for the money paid by the customer. the airline business is similar to other service businesses like banks. a service industry.
As a result. . its capital needs require consistent profitability. requiring large sums of money to operate effectively. airlines need more than a shop front and telephones to get started. They need an enormous range of expensive equipment and facilities. Increasingly. including equipment they owned previously but sold to someone else and leased back. Most equipment is financed through loans or the issuance of stock. from aircraft to flight simulators to maintenance hangars.Capital Intensive Unlike many service businesses. Whatever arrangements an airline chooses to pursue. airlines are also leasing equipment. the airline industry is a capital-intensive business.
More than one-third of the revenue generated each day by the airlines goes to pay its workforce. where customers require personal attention.Labour Intensive Each major airline employs pilots. Labour costs per employee are among the highest of any industry. etc. accountants. baggage handlers. gate agents. Computers have enabled airlines to automate many tasks. cleaners. lawyers. managers. but there is no changing the fact that they are a service business. cooks. security personnel. flight attendants. reservation agents. mechanics. .
High Cash Flow Because airlines own large fleets of expensive aircraft which depreciate in value over time. Profit Margins The bottom line result of all of this is small profit margins. compared to an average of above five percent for national industry as a whole. When profits and cash flow decline. have earned a net profit between one and two percent. through the years. even in the best of times. they typically generate a substantial positive cash flow (profits plus depreciation). . Airlines. an airline's ability to repay debt and acquire new aircraft is jeopardised. Most airlines use their cash flow to repay debt or acquire new aircraft.
on the other hand. although it is less pronounced than in the past due to the growth in the demand for air transportation. as many people took vacations at that time of the year. was slower. Winter. This pattern continues today. . The result of such peaks and troughs in travel patterns was that airline revenues also rose and fell significantly through the course of the year. The summer months were extremely busy.Seasonal Factors The airline business historically has been very seasonal. with the exception of the holidays.
Question Where does the airline revenue come from? .
Revenue 10% Passengers 15% Cargo Transport Related Services 75% .
most of them last-minute business travellers. The majority of business travellers. less than 10 percent of revenue comes from cargo (in many cases far less).Airline Revenue . For the all-cargo carriers. Travel agencies play an important role in airline ticket sales. cargo is the sole source of transportation income. most of whom use airlineowned computer reservation systems to keep track of schedules and fares. For the major passenger airlines which also carry cargo. however. Fewer than 10 percent of travellers pay full fare. . receive discounts when they travel. and to print tickets for customers. Airlines pay travel agents a commission for each ticket sold. to book reservations.Where the Money Comes From About 75 percent of the airline industry's revenue comes from passengers About 15 percent comes from cargo shippers The remaining 10 percent comes from other transport-related services. Eighty percent of the industry's tickets are sold by agents. A large proportion of the tickets sold are discounted.
Question Where does the airline revenue go? .
Costs 6% 27% 10% 6% 9% 13% 13% 16% Flying Operations Maintenance Aircraft & Traffic services Promotion/Sales Passenger Services Transport Related Administration Depreciation .
Airline Costs .16% Maintenance .both parts and labour . dispatchers and airline gate agents .13% Transport Related .6% .costs associated with the operation of aircraft.delivery trucks and in flight sales .basically the cost of handling passengers.13% Promotion/Sales .6% Depreciation . reservations.equipment and plant . airline costs were as follows: Flying Operations .27% Aircraft and Traffic Service .mostly in flight service including such things as food and flight attendant salaries .Where the Money Goes According to reports filed with the Department of Transportation in 1999.including advertising.9% Administration . such as fuel and pilot salaries . travel agent commissions . cargo and aircraft on the ground and including such things as the salaries of baggage handlers.10% Passenger Service .
as a percent of total costs. Commission costs.12% of total expenses) Travel agent commissions is third (about 6%). Fuel is the airlines second largest cost (about 10 . accounting for 35% of the airlines operating expenses and 75% of controllable costs. have recently been declining. Other rapidly rising costs have been airport landing fees and terminal rents.Major Costs Labour costs are common to nearly all of those categories. . as more sales are now made directly to the customer through electronic means.
Since revenue and costs vary from one airline to another. so does the break-even load factor.Break-Even Load Factors Every airline has what is called a break-even load factor. Overall. Airlines typically operate very close to their break-even load factor. The sale of just one or two more seats on each flight can mean the difference between profit and loss for an airline. while increasing prices for airline services have just the opposite effect. . Escalating costs push up the break-even load factor. pushing it lower. the break-even load factor for the industry in recent years has been approximately 66 percent. to cover its costs. or price level. which is the percentage of the seats the airline has in service that it must sell at a given yield.
without adding proportionately to its costs? .Question How can an operator increase its revenue-generating power.
Seat Configurations If low prices are what an airline's customers favour. with fewer. the total number of seats aboard an aircraft depend on the operator's marketing strategy. larger seats. without adding proportionately to its costs. The key for most airlines is to strike the right balance to satisfy its mix of customers and thereby maintain profitability. On the other hand. it will seek to maximise the number of seats to keep prices as low as possible. because it knows that its business customers are willing to pay premium prices for the added comfort and workspace. Adding seats to an aircraft increases its revenue-generating power. a carrier with a strong following in the business community may opt for a large business-class section. . However.
have not travelled on the flights for which they have a reservation. booking more passengers than the amount of seats on the same flight. Both airlines and customers are advantaged when airlines sell all the seats for which they have received reservations. often with little or no notice to the airline. Historically. or to cancel their travel plans altogether. maybe with a different airline. many travellers. economics and human behaviour. . especially business travellers buying full-fare tickets. An airline's inventory is comprised of the seats that it has on each flight. The practice involves careful analysis of historic demand for a flight. the seat is unused and cannot be returned to inventory for future use as in other industries.Overbooking Airlines occasionally overbook flights. Changes in their own schedules may have made it necessary for them to take a different flight. If a customer does not fly on the flight which they have a reservation.
airlines offer incentives to get people to give up their seats. when more people show up for a flight than there are seats available. Normally. however. In the rare cases where this occurs. there are more volunteers than the airlines need. and then decide how much to overbook that particular flight. The amount of compensation is determined by government regulation. . but when there are not enough volunteers.Overbooking Importantly for travellers. those volunteering are booked on another flight. Occasionally. regulations require the airlines to compensate passengers for their trouble and help them make alternative travel arrangements. The goal is to have the overbooking match the number of no-shows. Free tickets are the usual incentive. in the process determining how many no-shows typically occur. They examine the history of particular flights. airlines do not overbook haphazardly. airlines must bump passengers involuntarily. In most cases the practice works effectively.
to a salesperson who suddenly has an opportunity to visit an important client than it is to someone contemplating a visit to a friend. fares change much more rapidly than they used to. . for instance. airlines have had the same pricing freedom as companies in other industries. The salesperson. They set fares and freight rates in response to both customer demand and the prices of competitors As a result. The pleasure traveller likely will make the trip only if the fare is relatively low. It is far more valuable. on the other hand. Although this may be difficult to understand for some travellers. it makes perfect sense.Pricing Since deregulation. is likely to pay a higher premium in order to make the appointment. and passengers sitting in the same section on the same flight often are paying different prices for their seats. considering that a seat on a particular flight is of different value to different people.
by offering the right mix of full-fare tickets and various discounted tickets. and revenuegenerating opportunities will be lost forever. On the other hand. Unexpected discounting by a competitor. it requires continual adjustments as market conditions change. . The process of finding the right mix of fares for each flight is called yield.Pricing For the airlines. An ongoing process. can leave an airline with too many unsold seats if they do not match the discounts. for instance. so it can price the seats accordingly. the chief objective in setting fares is to maximise the revenue from each flight. requiring sophisticated computer software that helps an airline estimate the demand for seats on a particular flight. Too little discounting in the face of weak demand for the flight. too much discounting can sell out a flight far in advance and preclude the airline from booking last-minute passengers that might be willing to pay higher fares (another lost-revenue opportunity). It is a complex process. inventory or revenue management. and the plane will leave the ground with a large number of empty seats.
schedule is often more important than price. . Along with price. a meeting runs longer or shorter than they anticipate. airlines have been free to serve whatever domestic markets they feel warrant their service. Business travellers like to see alternative flights they may take on the same airline if. schedule is an important consideration for air travellers.Scheduling Since deregulation. A carrier that has several flights a day between two cities has a competitive advantage over carriers that serve the market less frequently. for instance. in response to market opportunities and competitive pressures. or less directly. For business travellers. and they adjust their schedules often. Airlines establish their schedules in accordance with demand for their services and their marketing objectives.
however. . A flight cancellation at one airport means the airline will be short an aircraft someplace else later in the day. The nature of scheduled service is such that aircraft move throughout an airline's system during the course of each day. it is not. can be extraordinarily complex and must take into account of: aircraft availability crew availability maintenance needs airport operating restrictions. and another flight will have to be cancelled. While it may appear to be a cancellation for economic reasons. The substitution was made in order to inconvenience the least number of passengers. If an airline must cancel a flight because of a mechanical problem. it may choose to cancel the flight with the fewest number of passengers and utilise that aircraft for a flight with more passengers.Scheduling Scheduling. Airlines do not cancel flights because they have too few passengers for the flight.
A Boeing 727. As planes get older. There are numerous factors to consider when planning new aircraft purchases: Do existing aircraft need to be replaced? What plans does the airline have to expand service? How much fuel do they burn per mile? How much are maintenance costs? How many people are needed to fly them? In general. In addition. versus three for the 727. The selection and purchase of new aircraft is usually directed by an airline's top officials. the larger 757 requires only a two-person flight crew. for example. is less fuel efficient than the 757 that Boeing designed to replace it. . maintenance costs can also rise appreciably.Fleet Planning Selecting the right aircraft for the markets an airline wants to serve is vitally important to its financial success. newer aircraft are more efficient and cost less to operate than older aircraft. although it involves personnel from many other divisions.
. Marketing strategies are important. it may not have that type of aircraft in its fleet. Changes in markets already served may require an airline to reconfigure its fleet. An airline considering expansion into international markets cannot pursue that goal without long-range. If it has been largely a domestic carrier. Too small an aircraft can mean lost revenue opportunities. wide body aircraft.Fleet Planning However. Having the right-sized aircraft for the market is vitally important. such productivity gains must be weighed against the cost of acquiring a new aircraft and poses further questions: Can the airline afford to take on more debt? What does that do to profits? What is the company's credit rating? What must it pay to borrow money? What are investors willing to pay if additional shares are floated? A company's finances play a key role in the aircraft acquisition process.. Too large an aircraft can mean that a large number of unsold seats will be moved back and forth within a market each day. too.
they approach the aircraft manufacturers about developing a new model. into the future. because no one knows for certain what economic conditions will be like many months. airline planners determine that their company needs an aircraft that does not yet exist. This is perhaps the most difficult part of the planning process. Sometimes. or even years.Fleet Planning Since aircraft purchases take time (often two or three years). In such cases. airlines must also do some economic forecasting before placing new aircraft orders. They usually will not proceed with a new aircraft unless they have a launch customer. Conversely. an unanticipated boom in the travel market can mean lost market share for an airline that held back on aircraft purchases while competitors were moving ahead. An economic downturn coinciding with the delivery of a large number of expensive new aircraft can cause major financial losses. Start-up costs for the production of a new aircraft are enormous. . so manufacturers must sell substantial numbers of a new model just to break even. meaning an airline willing to step forward with a large order for the plane. plus smaller purchase commitments from several other airlines.
. The development of hub-and-spoke networks resulted in airlines adding flights to small cities around their hubs. It also can be a less expensive way to acquire aircraft. One trend is the increased popularity of leasing versus ownership Leasing reduces some of the risks involved in purchasing new technology. since highincome leasing companies can take advantage of tax credits. increased the demand for small and medium-sized aircraft to feed the hubs. This has enabled airlines to respond more effectively to consumer demand. this often means more frequent service. In larger markets. These considerations.Fleet Planning In recent years there have been several important trends in aircraft acquisition. A second trend relates to the size of the aircraft ordered. but the ordering trend is toward smaller aircraft. Larger aircraft remain important for the more heavily travelled routes. in turn.
a statistic that compares favourably with even the most efficient automobiles. noisier engines with new ones that meet noise standards. and some airlines have chosen to pursue this option rather than make the much greater financial commitment necessary to buy new aircraft. Others have chosen to reengine. today. new engines have operating-cost advantages that make them the preferred option for some carriers. or replace their older. . Hush kits are also available for older engines. Airlines. While more expensive than hush kits.Fleet Planning The third trend is toward increased fuel efficiency. That led to numerous design innovations on the part of the manufacturers. The fourth trend has been in response to airline and public concerns about aircraft noise and engine emissions. average about 40 passenger miles per gallon . the airlines gave top priority to increasing the fuel efficiency of their fleets. Technological developments have produced quieter and cleaner-burning jets. As the price of fuel rose rapidly in the 1970s and early 1980s.
Summary Factors to consider when planning new aircraft Company finances Marketing strategies Economic forecasting New aircraft design Leasing versus ownership Aircraft size Fuel efficiency Noise and engine emissions .Fleet Planning .
In addition to the costs of normal maintenance activities. Agencies may consider all of their maintenance costs as variable costs and account for them accordingly. such as painting and interior restoration performing overhauls and modifications required by service bulletins and airworthiness directives. certain maintenance costs will be considered fixed. . therefore. Otherwise. the associated costs are considered variable costs.Maintenance costs Unscheduled maintenance and maintenance scheduled on the basis of flying time vary with aircraft usage and. variable maintenance costs shall include: aircraft refurbishment.
salaries and wages. refurbishing aircraft.This includes cost of materials and parts consumed in aircraft maintenance and inspections. and inspectors. . and/or repair of major components.Variable Costs Maintenance labour . aircraft refurbishment. benefits.This includes all labour (i. and major component repairs . and/or repair of major components. Engine overhaul. and training) expended by mechanics. exclusive of labour for engine overhaul.This includes all contracted costs for unscheduled maintenance and for maintenance scheduled on a flying hour basis or based on the condition of the part or component. Maintenance contracts . Maintenance parts . technicians. exclusive of materials and parts for engine overhaul. and/or repairing major aircraft components. travel. aircraft refurbishment.e. aircraft refurbishment.These are the materials and labour costs of overhauling engines.
This does not include variable maintenance labour or work on items having a time between overhaul (TBO) or retirement life.This includes all projected labour by mechanics and inspectors associated with maintenance scheduled on a calendar interval basis. travel expenses and training costs. Maintenance parts . These costs should be evenly allocated over the number of the aircraft in the fleet.Fixed Costs These costs include certain maintenance and inspection activities which are scheduled on a calendar interval basis and take place regardless of whether or how much the aircraft are flown. Maintenance contracts . associated salaries.e.This includes all parts and consumables used for maintenance scheduled on a calendar basis.This includes all contracted costs for maintenance or inspections scheduled on a calendar basis. i.. . This category also includes costs associated with unallocated maintenance labour expenses. Maintenance labour . benefits.
.Other Costs All accident repair costs: These costs include all parts. materials. equipment and maintenance labour related to repairing accidental damage to airframes or aircraft equipment. All accident investigation costs.
and other costs of maintaining aircraft and equipment . fixed.Aim: To provide an understanding of the economics and maintenance costs involved in operating an airline. Objectives: List the areas of income and expenditure that an airline generates Explain the factors involved in: Seating Arrangements Seat Pricing Flight Scheduling Fleet Planning State the variable.
Any Questions? .
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