Tourism Economics TRM 490 Dr. Zongqing Zhou Chapter 5: Airline Economics

Chapter 5: Airline Economics (1) Overview –In early 1990s, about 800 carriers who employ more than 3 million people –About 9000 aircrafts and 14,000 airports –The largest US airlines: American, Delta, United, US Air, Northwest, Continental, Southwest, and Trans World –In 1992 US airlines lost $4.4 billion.

Chapter 5: Airline Economics (2) Factors affecting the costs and earnings –Economy –Labor costs –Fuel prices –Operating efficiency –Price wars –Relationship with the unions –Attendance salaries ($85,000/year for Japanese attendants) –Cyclical nature of the business

Chapter 5: Airline Economics (3) Cost breakdown: –See Fig. 5-3 on page 97 –Principal costs: fuel, labor and investment (aircraft purchases) Economics of Airline Operations –Measurement of efficiency Cost per available seat mile –9.3 cents for U.S. Airlines –8.93 cents for American Load factor: the percentage of seats filled Salaries and benefits are about the same as the hotel labor costs. –Southwest has a decided cost advantage in salaries and benefits No frills: minimum service Lean: sales commissions constitute only 6.5% while UAL 16.3% Flat and organization structure: senior management arrive on the job between 7:30 and 8am Simple fare structure: only two levels –Peak or executive during the day, Monday to Friday –Off-peak or pleasure during the evenings and weekends Monday to Friday. Employee profit sharing: own 12% of the airline and share the profits. Newer planes and one type of planes: lower maintenance cost and training cost of the pilots Fly only the profitable routes

Chapter 5: Airline Economics (4) Fuel prices –OPEC: The Organization of Petroleum Exporting Countries controls the oil output and prices Airlines Statistics –Load factor: a measure of efficiency and productivity that shows the percentage of seats filled. See fig. 5-5 on page 101

Chapter 5: Airline Economics (5) Airline Pricing –Consolidation and competition keep the price low –Price wars –Depending heavily on business travelers (first-class fares cost 3 to 4 times as much as coach fares) –Manipulation of seats (space and comfort) to charge higher fares –Frequent flier programs can be a cost –Getting whatever is possible for those ‘last unsold seats’ is considered better than leaving them vacant: the marginal cost of taking one additional passenger is less than one-fourth of the full cost.

Chapter 5: Airline Economics (6) Forecasting airline demand –Almost every tactical or strategic decision taken by management is based on forecasting –Short-term and long-term forecasting Aircraft purchase decisions Operational budgets –Forecasting demand by market segments Business Pleasure Fare types Forecasting is difficult with the intense competition

Chapter 5: Airline Economics (7) Methods of Forecasting –Historical trend or trend analysis/time series –Market studies In-house outside research firms –Airline manufacturers’ forecast –Management experience and judgment based on the incoming data –Delphi studies Based on expert’s opinions –Multiple regression

Chapter 5: Airline Economics (8) Yield management: a tool for maximizing revenues by the management of seat inventory and forecasting demand a fares charged popular starting early 1980s –Yields are raised by taking as many reservations as possible at the highest possible fares –Yield management means lowering the price of seats according to expected demand and relying heavily on computers and modeling techniques –As departure times approach, discounted seats are added or subtracted, the goal being to fill all seats with the highest possible fares, using booking trend on specific flights to predict the number of seats that will be sold and at what prices.

Chapter 5: Airline Economics (9) Hub-and-Spoke Economics –Hub-and-spoke concept in the 1980s In theory, the hub concept worked to the airlines financial benefit. But the hub-and-spoke concept cannot compete cost wise with the low-cost carriers like Southwest on point-to-point short flights. Problem: cost of maintenance and efficiency Computer Reservation systems as airline assets –As a marketing tool –As a financial investment

Chapter 5: Airline Economics (10) Gates as assets –Preferential position –Can be subleased Economic future of airlines –Continue to grow –Rapid grow in Asia –Consolidation –Transnational ownership