Airline Business Lecture 1
Airline Cost
- Operating costs depends on core activity! moving passengers form A to B with distinctive
strategy.
- Direct operating costs depend on the flee.
- Indirect operating costs; not dependent on fleet (e.g. ticket system)
Fixed costs vs variable costs depends on time frame (planning horizon)
" Short run; stick to schedule. Why? Low customer satisfaction with delays. Stick to schedule,
even if costs are high.
" Medium run; schedule minor technical adjustments. Can make some changes in the schedule.
" Long run; can (almost) do anything. Long run is reason for fixed costs (Fixed flight crew).
Fixed costs are high in aviation, this causes the need for Economies of scale (economies of density)
Density Economies
" Average costs per customer on a link decreases if number of passengers on that link increases =
economies of density
Return to density parameter = 1/ density of output
- Increase output by 1 %, costs increase with less than 1 %.
- Increase number of seats per km, average costs per seat km goes down.
Returns to density;
> C= Q-θ/2*Q2
# MC= 1-θQ !(derivative)
# AC= 1-θ/2*Q !(cost functie devided by Q)
Conclusion; MC<AC. !MC is decreasing, therefore next unit is cheaper to produce,
so average cost decreases.
Why economies of density? Larger aircraft burns more fuel, but lower operating cost per passenger.
Higher densities (passenger) allows more flight hours & intensive use of ground facilities/
personnel.
> Many fixed costs duplicated for every link
> More links ! more coordination costs
If fixed costs are divided by more people, average cost is lower per unit of output.
Airline Pricing
Derived demand; demand that you face as an airline.You fly to go somewhere.
" Trip purpose important; Business, Leisure, VFR; all have different WTP.
" Timing important! peak load problem (high season)
" What drives demand? Individual preferences. WTP for ticket depends on net value of activity of
trip purpose
Business travel
> Relatively high WTP & Insensitive to prices (inelastic)
> Small proportion (high income) of population responsible for disproportionally large share of
trips
Leisure travel
> Relatively low WTP & Sensitive to prices (elastic)
> Low cost airlines made air travel available to ‘the masses’
,Demand segmentation: identify groups of passengers so that service and prices are group specific.
Why? This gives more control over what I charge you. MAXIMIZE PROFIT
Price discrimination;
Use of Elasticities; Segmenting Demand management:
- You want passengers that pay high prices (keep seats open for inelastic demand).
- You need passengers that are not willing to pay high prices (elastic demand). To fill aircraft
capacity for ED
Different fares for different segments: price discrimination; based on preferences.
> Maximize revenues (costs fixed in short run)
> Overbooking: rely on the fact that some passengers don’t show up (if overbooked; convince to
take another flight)
Airline types
FSC > focussed on one or more hubs (central airports)
> passengers between non-hub airports fly indirectly ! Exploitation of density (scale)
economies: larger aircraft used or aircraft used more intensively on remaining routes (segmentation
is necessary)
Hub-and-spoke; Airlines operate from 1 central airport and routes are searched from this hub for
optimization and better service. Normally there are instead of 1 hub, multiple ones to have more
control and manage more routes.
Segmentation
> High frequencies for high yield passengers
> Business and leisure flying direct; high ticket classes
> High yield passengers on indirect routes (no direct option available)
> Fill remaining seats with low yield passengers: Leisure flying direct; low ticket classes
> Indirect travelers (low ticket classes): Necessary to fill empty seats
Requirements? Network must allow transfers, high indirect cost, airline must have market power.
Deregulation: opened markets for new airlines. LCC (emerged after market deregulation), strategy:
eliminate everything not essential to core product, so offer flight between origin and destination.
! Why? Different target group than legacy airlines, so different core product.
“Ryanair minimizes cost, KLM does not.” ! Not true, both minimize cost given their core product.
Low cost carriers
> Negotiated contracts in deregulated market (different labor contracts): Lower wages, “pay to
fly” (low direct costs)
, " Differentiated strategies: No frills; unbundling, no primary airports, no hub-spoke, single
aircraft type, outsourcing,
no price discrimination. There is no standard low cost strategy.
" Simple network: low indirect cost; Often P2P (sometimes hub-spoke)
Shift to commodity; reason why low cost airlines are successful
> Low cost airlines made air travel available to “other classes (with lower WTP)”
> Demand stimulation (Southwest effect; travel increase due to lowers cost/
improvements).
> Also some markets not served by conventional airlines, as it is not interesting for them.
Low cost airline failures; Expansion into thin markets & Increasing competition between low-cost
airlines
LCC doesn’t specifically target low income customers, as they offer flights from A to B to whoever
wants to pay.
Low cost airlines cost savings: - Higher seating density (most savings)
- Higher aircraft utilization
- Lower flight and cabin crew expenses
- Use cheaper secondary airports
- Outsourcing maintenance - Single aircraft type
- No catering - No agent’s commission
- Reduced sales/reservation costs - Smaller administration costs
- Efficiency gains LCC > Mainly on short haul, as long haul has different cost model and less
competition.
- Conventional airlines starting/buying own LCCs; not successful as it is founded by FSC
managers (think different)
Network convergence: Different modes can be used on a single network e.g. LCC & FSC.
(Convergence= 2 or more things joining together e.g. long haul & LCC)
Conventional airlines do “unbundling”= loskoppelen van 2 of meer processen en deze tegen eigen
prijs aanbieden (aanbieden van extra services, los van de ticket zoals; seat selection, catering etc.)
Low cost airlines can have “hybrid” model; offer attributes that add value. E.g. business-like class;
preferred seating etc. Why? That’s what competitors did as well.
Low cost airlines have low fixed costs as they outsource certain facilities (vb. maintenance). If
variables costs are higher then you make more seats and try to have density economies in the
variable cost function.
—————————————————————————————————————————————
Lecture 2 Network Optimality
Hub-Spoke Network; Network where only the hub is directly connected to all other airports.
- Traveling between 2 airports that aren’t hubs requires transfer at hub (airline( partners) must offer
this!!)
!Self-hubbing: passengers make connections by themselves. Risk? Won’t be compensated if
you miss it
- Spatial concentration: centered around hub.
- Temporal concentration: convenient transfer times. High temporal concentration: big focus on 1
specific hub.
In practice; multiple hubs or direct travel between non-hubs is possible.
Airline Cost
- Operating costs depends on core activity! moving passengers form A to B with distinctive
strategy.
- Direct operating costs depend on the flee.
- Indirect operating costs; not dependent on fleet (e.g. ticket system)
Fixed costs vs variable costs depends on time frame (planning horizon)
" Short run; stick to schedule. Why? Low customer satisfaction with delays. Stick to schedule,
even if costs are high.
" Medium run; schedule minor technical adjustments. Can make some changes in the schedule.
" Long run; can (almost) do anything. Long run is reason for fixed costs (Fixed flight crew).
Fixed costs are high in aviation, this causes the need for Economies of scale (economies of density)
Density Economies
" Average costs per customer on a link decreases if number of passengers on that link increases =
economies of density
Return to density parameter = 1/ density of output
- Increase output by 1 %, costs increase with less than 1 %.
- Increase number of seats per km, average costs per seat km goes down.
Returns to density;
> C= Q-θ/2*Q2
# MC= 1-θQ !(derivative)
# AC= 1-θ/2*Q !(cost functie devided by Q)
Conclusion; MC<AC. !MC is decreasing, therefore next unit is cheaper to produce,
so average cost decreases.
Why economies of density? Larger aircraft burns more fuel, but lower operating cost per passenger.
Higher densities (passenger) allows more flight hours & intensive use of ground facilities/
personnel.
> Many fixed costs duplicated for every link
> More links ! more coordination costs
If fixed costs are divided by more people, average cost is lower per unit of output.
Airline Pricing
Derived demand; demand that you face as an airline.You fly to go somewhere.
" Trip purpose important; Business, Leisure, VFR; all have different WTP.
" Timing important! peak load problem (high season)
" What drives demand? Individual preferences. WTP for ticket depends on net value of activity of
trip purpose
Business travel
> Relatively high WTP & Insensitive to prices (inelastic)
> Small proportion (high income) of population responsible for disproportionally large share of
trips
Leisure travel
> Relatively low WTP & Sensitive to prices (elastic)
> Low cost airlines made air travel available to ‘the masses’
,Demand segmentation: identify groups of passengers so that service and prices are group specific.
Why? This gives more control over what I charge you. MAXIMIZE PROFIT
Price discrimination;
Use of Elasticities; Segmenting Demand management:
- You want passengers that pay high prices (keep seats open for inelastic demand).
- You need passengers that are not willing to pay high prices (elastic demand). To fill aircraft
capacity for ED
Different fares for different segments: price discrimination; based on preferences.
> Maximize revenues (costs fixed in short run)
> Overbooking: rely on the fact that some passengers don’t show up (if overbooked; convince to
take another flight)
Airline types
FSC > focussed on one or more hubs (central airports)
> passengers between non-hub airports fly indirectly ! Exploitation of density (scale)
economies: larger aircraft used or aircraft used more intensively on remaining routes (segmentation
is necessary)
Hub-and-spoke; Airlines operate from 1 central airport and routes are searched from this hub for
optimization and better service. Normally there are instead of 1 hub, multiple ones to have more
control and manage more routes.
Segmentation
> High frequencies for high yield passengers
> Business and leisure flying direct; high ticket classes
> High yield passengers on indirect routes (no direct option available)
> Fill remaining seats with low yield passengers: Leisure flying direct; low ticket classes
> Indirect travelers (low ticket classes): Necessary to fill empty seats
Requirements? Network must allow transfers, high indirect cost, airline must have market power.
Deregulation: opened markets for new airlines. LCC (emerged after market deregulation), strategy:
eliminate everything not essential to core product, so offer flight between origin and destination.
! Why? Different target group than legacy airlines, so different core product.
“Ryanair minimizes cost, KLM does not.” ! Not true, both minimize cost given their core product.
Low cost carriers
> Negotiated contracts in deregulated market (different labor contracts): Lower wages, “pay to
fly” (low direct costs)
, " Differentiated strategies: No frills; unbundling, no primary airports, no hub-spoke, single
aircraft type, outsourcing,
no price discrimination. There is no standard low cost strategy.
" Simple network: low indirect cost; Often P2P (sometimes hub-spoke)
Shift to commodity; reason why low cost airlines are successful
> Low cost airlines made air travel available to “other classes (with lower WTP)”
> Demand stimulation (Southwest effect; travel increase due to lowers cost/
improvements).
> Also some markets not served by conventional airlines, as it is not interesting for them.
Low cost airline failures; Expansion into thin markets & Increasing competition between low-cost
airlines
LCC doesn’t specifically target low income customers, as they offer flights from A to B to whoever
wants to pay.
Low cost airlines cost savings: - Higher seating density (most savings)
- Higher aircraft utilization
- Lower flight and cabin crew expenses
- Use cheaper secondary airports
- Outsourcing maintenance - Single aircraft type
- No catering - No agent’s commission
- Reduced sales/reservation costs - Smaller administration costs
- Efficiency gains LCC > Mainly on short haul, as long haul has different cost model and less
competition.
- Conventional airlines starting/buying own LCCs; not successful as it is founded by FSC
managers (think different)
Network convergence: Different modes can be used on a single network e.g. LCC & FSC.
(Convergence= 2 or more things joining together e.g. long haul & LCC)
Conventional airlines do “unbundling”= loskoppelen van 2 of meer processen en deze tegen eigen
prijs aanbieden (aanbieden van extra services, los van de ticket zoals; seat selection, catering etc.)
Low cost airlines can have “hybrid” model; offer attributes that add value. E.g. business-like class;
preferred seating etc. Why? That’s what competitors did as well.
Low cost airlines have low fixed costs as they outsource certain facilities (vb. maintenance). If
variables costs are higher then you make more seats and try to have density economies in the
variable cost function.
—————————————————————————————————————————————
Lecture 2 Network Optimality
Hub-Spoke Network; Network where only the hub is directly connected to all other airports.
- Traveling between 2 airports that aren’t hubs requires transfer at hub (airline( partners) must offer
this!!)
!Self-hubbing: passengers make connections by themselves. Risk? Won’t be compensated if
you miss it
- Spatial concentration: centered around hub.
- Temporal concentration: convenient transfer times. High temporal concentration: big focus on 1
specific hub.
In practice; multiple hubs or direct travel between non-hubs is possible.
