Airline Economics Consolidated 21

Airline Economics • • • •

Fuel and Oil Outsourcing Low Cost Carriers Impacts of Unforeseen events

Fuel and Oil The role of fuel and oil in the airline industry • • • •

Cooking and lighting lamps 1941- the invention of the jet engine 2000- anticipated recovery from the past decade 2001- the 9/11 attacks, Iraq wars and SARS outbreak

Economic impacts • OPEC- Organization of Petroleum Exporting Countries - Airlines’ next big enemy • Taxation • Potential Causes – Unexpected events – Demand- Supply Relationship

Pricing • Expected affluence due to perceived economic recovery in 2000 • Environmental issues • Shortage? – Demand exceeding Supply

• Growing industry – New airlines – Low cost carriers

Operational Impacts • Contingency fuel – Extra fuel carried preempts revenue load – Ground and Flight crew conflict

• Alternate Airports – Causes excessive fuel consumption

• Use of APUs – Auxiliary power unit – Due to lack of GPUs in most airports

Operational Impacts • • • •

Lack of Refueling points Empty fuel tanks Fuel Theft Fuel Burnout – Due to excessive hand-carry baggage

• Fuel Contamination • Environmental Issues • “Corrective” measures

Operational Impacts • Save fuel – Direct routing – Re- evaluation of hub operations – Calculating the pros and cons of using APUs as to GPUs – Buying new aircrafts with new engines – Adding winglets – Reducing contingency fuel – Collect fuel surcharges to customers

Future fuel saving • Development of efficient flight routing systems – FRS to CRS – Avoiding flight disturbances such as weather problems

Outsourcing •delegation of non-core operations or jobs from internal production within a business to an external entity (such as a subcontractor) that specializes in that operation •pertains to the procurement of supplies, materials and spare parts using the e-business vehicle for almost real time inventory, ordering and delivery on just in time mode

Economic Issues An airline can exist virtually without having physical assets in terms of facilities and equipment and much of the labor force The core is able to do away with the burdens of having to worry about airline activities. On the other hand, it has to consider looking for the best service providers.

Operational Issues

Image and Identity

Commitment to Vision and Mission

Product and Service Quality

Legal and moral issues There has been no legacy airline that succeeded in becoming a virtual or a low-cost or a no-frill airline Having dual identity in the airline industry is a problematic proposition Legacy airlines have legal and moral responsibilities to their employees

Outsourcing ADVANTAGES Outsourcing is a business decision that is often made to lower costs The company competences

can

focus

on

core

The firm's motivation to outsource is trying to maximize the quality of its product given cost (its productivity)

Outsourcing DISADVANTAGES One criticism of outsourcing is that product quality suffers The decision to outsource is like any other business investment decision in that there is risk The downside of this is the tacit repudiation of the opportunity to diversify business within the airline umbrella

Low cost carriers vs. Legacy Airlines Legacy airlines Concept of full service  market segment

Low cost carriers vs. Legacy Airlines • Objective: most modern gadgetries – Widest and most convenient seats – All amenities – Providing privacy – Best in-flight cuisine • Operation: giant aircraft/smaller but equally modern sophisticated aircraft • Connection: within 1 hour or take advantage of the airport amenities • Must: their airport are the biggest, most modern and most fully equipped with all the modern tools, equipment and gadgetries of trade

Low cost carriers vs. Legacy Airlines Vs LCC  offers pure air transportation without any frills but with lots of warmth, love and friendliness

Low cost carriers vs. Legacy Airlines • All employees’ job: – public contact – backroom experience

• Business precepts by Don Burr: to ooze humanity, service commitment, best in air transport, high quality leadership, becoming role model to others, simplicity and maximum profits

Low cost carriers vs. Legacy Airlines Competition • Legacy Airlines – AA’s SABRE screen science enable to put their flights not only on the first screen but also online – frequent flyer program to create brand loyalty among the high-end – super saver fares for the low-end

• LCC – establish the LCC standards – the value of commonality in a fleet of one aircraft type and the advantages of outsourcing much of the task

Low cost carriers vs. Legacy Airlines Misery • Events: – 1978-deregulation and crippling walkout of air traffic controllers – 1979-economis crash – 1980-recession – Domestic passenger traffic fall from 317M in 1979 to 279M in 1980 and 286M in 1981

- 2001-9/11 bombing - fuel price increases - roller costing global economy - Iraq war - War against terrorism - SARS - 2004-Asian tsunami

Low cost carriers vs. Legacy Airlines Vision, Mission and Goals • LCC – to provide inexpensive air transportation to the widest segment of society – to tap the vast majority of people who might not have experienced how it is to fly – to take away 50% traffic from legacy airlines – no interline whatsoever to whomsoever

Low cost carriers vs. Legacy Airlines No cost booking, selling,checking-in • LCC – 75% on the web – 24% call centers – 1% mobile phones or the ATM – hosted by Navitaire, charges .20-.30 dollar per passenger – do not use travel agent, no direct booking – low operating expense budget for distribution cost – office are located on inexpensive low-cost area

Low cost carriers vs. Legacy Airlines No cost booking, selling,checking-in • Legacy Airlines – Have CRS, GDSs and Agents to interface with costly CRS charges – $4 per line segment of booking to major GDSs like SABRE, Galileo, Amadeus, Worldspan and Abacus – travel roundtrip=2 line segment=$8 per passenger – pay 7%-9% commission to travel agent – use travel portals – offices are in the central business district

Low cost carriers vs. Legacy Airlines More convenient, secured and safer airport operation •

LCC

– operate in secondary airport to reduce the cost of operation – minimum security inspection – double duty high productivity – hub-and-spoke crossroads – commonality in fleet,engine and all

•

Legacy Airlines

– big airports, big aircrafts and big airlines – redundant checking starting miles away from the airport – cars and vehicles are inspected creating traffic jams – they pack the passenger in the jumbo jets and take them from one hud to another connect them to smaller aircraft to their final destination

Low cost carriers vs. Legacy Airlines • economies of scale • operational Cost differential Low-cost vs Legacy Airline • basics of aircraft/month economics

Impacts of unforeseen events While the international airline industry has been propelled forward at an extraordinary pace of progress and development, a number of disastrous events such as 911, SARS, Iraq War, Bird Flu, etc have greatly set the industry back on an unprecedented level.

Impacts on International level • Sep 11 attack: Just after the attack, United States’ aviation system was shut down and produced a cash “burn rate” for the industry in excess of $ 300 million per day for the duration of the stoppage. It has been estimated that just in the first week after the tragedy the US airline industry lost between $1 billion and $2 billion.

SARS According to the World Health Organization (WHO) the following countries and regions suffered the worst exposure to the SARS outbreak: China, Hong Kong, Singapore, Taiwan, and Canada. Each of these markets registered a severe drop in travel to the U.S. in April and May 2003. The impact of SARS is evident. However, each of these markets also registered declines in March and most registered declines in February as well, indicating that the drop in arrivals is a combination of economic, political, and SARSrelated concerns that dissuaded travelers.

2003 Arrivals Key SARS Markets Jan. Feb. Mar. Apr. May ASIA 437,550 387,205 359,449 251,346 326,143 CHINA, PRC 18,005 13,129 10,760 7,035 326,143 TAIWAN 29,945 16,304 14,003 9,451 6,441 HONG KONG 13,705  7,881 6,588 4,443 10,191 SINGAPORE 7,546  5,313 5,271 2,715 5,588 CANADA 863,767 770,967 1,144,466 980,655 1,005,147

Percent Change 2003/2002 Markets Jan. Feb. Mar. Apr. May ASIA 6.60% -2.20% -22.90% -39.10% -35.10% CHINA, PRC -8.90% -13.60%  -31.3% -60.60% -69.40% TAIWAN 9.00% -23.80%  -24.3% -46.80% -62.20% HONG KONG 17.90% -31.40%  -33.5% -46.30% -53.00% SINGAPORE 4.30% -2.60%  -18.7% -61.20% -49.10% CANADA 4.80% 1.70%  -5.7% -11.10% -8.70%

Impacts in the Philippines • The impact of 911: The knee-jerk reaction, particularly of the US, when the 911 incidents happened was to shut down its airspace, grounding every single aircraft in all of North America. PAL aircrafts were caught in flight and on the ground followed by almost a week of no operation into the US, which happened to be its major market. • The impact of SARS: it was much more devastating. It happened at the peak of airline operation at a time when school was about to close and usher the onset of summer vacation. Necessarily, the airlines lost during the peak months and lost as well during the lean months resulting in another disastrous fiscal year.

Threat of overcapacity • Internationally speaking, while more and more airworthy aircrafts and mothballed capital equipments are needed in the market, more and more venerable airlines have to stop operation for lack of revenue traffic to service. • In the sense of the Philippines, thanks to robust OFWs traffic, the airline industry can be greatly relied upon it prosperously.

Runway insurance problem • Because of the threat of terrorism, the airline industry insurers decided to hike the premium at astronomical levels, all airlines were faced with the inevitability of either biting the bullet or stop operating. • While airports refused to allow airlines to operate unless sufficiently covered by insurance, some airlines specially from developing countries had to cease operation under operational and financial pressures.

Unleveled playing field • While airlines of the affluent countries are receiving additional subsidy and loan guarantee from their governments to bailout from their new economic strain in terms of paying insurance covers and new equipments such as Kevlar cockpit doors, stun guns, x-ray machines, etc because of terrorism and of SARS, airlines from developing or less affluent countries again have to shoulder these new expenses by themselves creating a truly lopsided playing field in favor of the rich and the powerful.

Remedial measures available

• The government may provide relief in terms of legislations to alleviate the flight of the industry on certain issues such as aeropolitics, economics, particularly on the oil issues, the level of charges in facilities mostly owned by government to counteract the unleveled playing field.

Remedial measures available • The aggrieved airlines continue making representations to both the legislative and executive bodies of their governments to enlighten and guide them towards arriving at proper legislations responsive to the industry’s needs. • The aggrieved airlines also can ask support in other areas like in the bilateral negotiations with different organizations.