Airline Economics

IEN315 English for Airline Business Summer semester of academic year 2007 A. Joseph Hermanek

Economics of the Airline Business 

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Airlines are a service business. There is no physical product given to the customer, no inventory created and stored for later sale. Once a flight leaves the gat e, the opportunity to sell remaining empty seats is los t. The airline industry is a capital-intensive business, requiring large sums of money to operate effectively. Airlines must invest in airplanes, maintenance faciliti es, offices, computer systems, etc.

Economics of the Airline Business 

Airlines also are labor intensive. Each major airline employs a virtual army of pilots, flight attendants, mechanics, baggage handlers, reservation agents, gate agents, security personnel, cooks, cleaners, managers, accountants, lawyers, etc. Computers have enabled airlines to automate many tasks, but there is no changing the fact that they are a service business, where customers require personal attention. More than onethird of the revenue generated each day by the airlines goes to pay its workforce. Labor costs per employee are among the highest of any industry.

Economics of the Airline Business 

Labor accounts for 35 percent of the airlines' operating expenses and 75 percent of controllable costs. Fuel is the airlines' second largest cost, and travel-agent commissions is third. Commission costs, as a percent of total costs, have recently been declining, as more sales are now made directly to the customer through electronic commerce. Another rapidly rising cost has been airport landing fees and terminal rents.

Economics of the Airline Business 

The airline business historically has been very seasonal. The summer months were extremely busy, as many people took vacations at that time of the year. Winter, on the other hand, was slower, with the exception of the holidays. The result of such peaks and valleys in travel patterns was that airline revenues also rose and fell significantly through the course of the year. This pattern continues today, although it is less pronounced than in the past.

Economics of the Airline Business 

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Most of the airline industry’s revenue comes from passenger ticket sales, with a small amount coming from cargo and other services. Fewer than 10 percent of passengers pay full fare, most of them last-minute business travelers. The maj ority of business travelers, however, receive discount s when they travel. A relatively small group of travele rs (the frequent flyers who take more than 10 trips a year) account for a significant portion of air t ravel trips taken.

Economics of the Airline Business 

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Every airline has what is called a break-even load factor. That is the percentage of the seats the airline has in service that it must sell at a given yield, or price level, to cover its costs. Since revenue and costs vary from one airline to another, so do es the break-even load factor. Overall, the break-even load fac tor for the industry in recent years has been approximately 66 percent. 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.

Economics of the Airline Business 

Adding seats to an aircraft increases its revenue-generating power, without adding proportionately to its costs. However, the total number of seats aboard an aircraft depend on the operator's marketing strategy. If low prices are what an airline's customers favor, it will seek to maximize the number of seats to keep prices as low as possible. On the other hand, a carrier with a strong following in the business community may opt for a large business-class section, with fewer, larger seats, because it knows that its business customers are willing to pay premium prices for the added comfort and workspace. The key for most airlines is to strike the right balance to satisfy its mix of customers and thereby maintain profitability.

Economics of the Airline Business

 Airlines

set fares in response to both customer demand and the prices of competitors. As a result, fares change rapidly, and passengers sitting in the same section on the same flight often are paying different prices for their seats.

Economics of the Airline Business 

Although this may be difficult to understand for some travelers, it makes perfect sense, considering that a seat on a particular flight is of different value to different people. It is far more valuable, for instance, to a salesperson who suddenly has an opportunity to visit an important client than it is to someone contemplating a visit to a friend. The pleasure traveler likely will make the trip only if the fare is relatively low. The salesperson, on the other hand, likely will pay a higher premium in order to make the appointment.

Economics of the Airline Business 

For the airlines, the chief objective in setting fares is to maximize the revenue from each flight, by offering the right mix of full-fare tickets and various discounted tickets. Too little discounting in the face of weak demand for the flight, and the plane will leave the ground with a large number of empty seats, and revenue-generating opportunities will be lost forever. On the other hand, 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).

Economics of the Airline Business 

The process of finding the right mix of fares for each flight is called yield, inventory or revenue management. It is a complex process, requiring sophisticated computer software that helps an airline estimate the demand for seats on a particular flight, so it can price the seats accordingly. And, it is an ongoing process, requiring continual adjustments as market conditions change. Unexpected discounting in a particular market by a competitor, for instance, can leave an airline with too many unsold seats if they do not match the discounts.

Economics of the Airline Business 

Airlines adjust their schedules often, in response to market opportunities and competitive pressures. Along with price, schedule is an important consideration for air travelers. For business travelers, schedule is often more important than price. Business travelers like to see alternative flights they may take on the same airline if, for instance, a meeting runs longer or shorter than they anticipate. A carrier that has several flights a day between two cities has a competitive advantage over carriers that serve the market less frequently, or less directly.

Economics of the Airline Business 

If you plan your travel dates and time, you may save money. Factors that may reduce the price you pay and influence your choice of airline include: – – – – – – – – – – – – – –

Minimum and maximum stay requirements Advance purchase requirements Refunds/Cancellation penalties Saturday night stay Late night (red eye) flights Mid-week flights Nonstop flights, direct flights, connections Off-season flights Low-cost vs. full-service airlines Standby flights Alternate airports Frequent flyer miles Special discounts (student, child, senior citizen, affinity group, etc.) Baggage allowances

Economics of the Airline Business

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on airline schedules and fares is available from different sources: Travel Agents, Airline Reservation Agents, Airline W ebsites, Internet Booking Services, Newspap er Ads.