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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 car¬riers transported 15.2 billion revenue ton-miles, or approximately 0.4 percent of total intercity ton-miles. The air-lines 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 dis¬cussed 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 operat¬ing 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 desig¬nated 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 conti¬nental 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 carri¬ers. 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 pri¬vate 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 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 per¬cent 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 competi¬tion 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 serv¬ices 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 per¬form 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 trans¬portation. 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. 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 bag¬gage 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 pro¬viding 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 trans-portation remains a fast method of movement and the only logical mode when dis¬tance 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 nation¬als. Terminals The air carriers’ terminals (airports) are financed by a government entity. The car¬riers pay 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 air¬port facilities. The federal government is financially responsible for the con¬struction 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 gov¬ernment (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. Rap¬idly 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 gal¬lons (1.03-percent increase) from 2006 to 2007, resulting in additional fuel expenses of $2.94 billion.
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 pas¬senger 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.
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 hav¬ing 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 usu¬ally 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 ship¬ments 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, serv¬ice 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.
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 concern¬ing 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 busi¬ness, 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 operat¬ing 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 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 trans¬portation 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 (mar¬kets), thereby increasing the amount of competition).
Also, existing carriers expanded their mar¬ket coverage, which significantly increased intramodal competition in certain mar¬kets. 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 per¬cent (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 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 termi¬nal. 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 lev¬els 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 car¬riers 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 increas¬ingly more commonplace for passenger traffic. Table 7.4 summarizes the various types of taxes paid by carriers, shippers, and passengers in the airline industry. The growth and development of air transportation is dependent upon adequate air¬port facilities. Therefore, to ensure the viability of air transportation, the federal government has the responsibility of financially assisting the states in the con¬struction 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 regu¬lations 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. 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 hav¬ing 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 usu¬ally 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 ship¬ments 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 serv¬ices 10. What are the current issues facing the air industry? Discuss how each im¬pacts the industry, its customers and employees? The issue of airline safety is of great importance to the airline industry. Any inci¬dent 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 carri¬ers, 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. Finally, as with other transportation modes, the issue of substance abuse concern¬ing 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 busi¬ness, it constantly needs more sophisticated equipment. With other modes such as railroads and water carriers, travel times are measured in days; however, air carri¬ers 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 gov¬ernment (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 air¬lines have negotiated significant labor cost reductions with many of the unions rep¬resented 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 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 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 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 US Airways: www.usairways.com Travelocity: www.travelocity.com Instructor Manual for Transportation: A Supply Chain Perspective John J. Coyle, Robert A. Novak, Brian Gibson, Edward J. Bardi 9780324789195
