AIRLINE BUSINESS SUMMARY
HC 1
AIRLINE COST
Fixed Costs
• Committed fixed costs: do not vary with output, and cannot be readily changed
• Discretionary fixed costs: do not vary with output, but can readily be changes (e.g.
advertising)
Fixed vs variable costs depends on time frame
• Short run: stick to schedule. Why? Because it shows that you are a reliable airline if you stick
to your schedule. = <12 months
• Medium run: schedule and minor technical adjustments
• Long run: (almost) everything goes
Fixed costs high in aviation economic implication: economy of density = the more passengers you
have in the airplane, the lower the costs per passenger. Average cost decrease with density.
MC = 1-ƟQ
C = Q- Ɵ/2*Q^2
AC = 1- Ɵ/2 *Q
MC < AC
Why economies of density?
• Larger aircraft burns more fuel, but operating cost per passenger are lower
• A plane flies anyway. Higher densities (passenger flow) allow for more flight hours per day.
, • Higher densities (passenger flow) allows for more intensive use of ground facilities and
personnel. (check in desks etc)
• To spread all of these costs, higher passenger density is better.
- Costs per seats and not costs
per passenger, so no
evidence for economies of
density.
- The smaller airplanes need to
land more often than the
larger planes because the
fuel capacity is higher for
larger airplanes.
AIRLINE PRICING
Derived demand
People don’t travel to travel, but to go somewhere
• Trip purpose important
• Timing important peak load problem: summer peak, Christmas peak, morning peak
• What drives demand? value of time, price, your preferences: willingness to pay (WTP)
What you can/want to pay for a ticket depends on the net value of activity of trip purpose.
Demand characteristics
Business travel
• Relatively high WTP
• Relatively insensitive to prices
(inelastic)
o Also within this sector, there
is price elasticity.
Multinationals can pay a lot
for a ticket but some
companies do not have that
much money.
• 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 design and prices are group
specific. Why? Airlines try to get the people who want to pay most on t airplane. Price
discrimination
In-flight comfort: comfort during the trip in the aircraft
,Use of elasticities: segmenting
Demand Management:
• You want passenger that pay high prices (keep some seats open; inelastic demand)
• You need passengers that are not willing to pay high prices (elastic demand), because
lowering the average cost there are empty seats that will not be filled otherwise. You
need those people as well.
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 do not show up
AIRLINE TYPES
Hub-spoke network: focusing on a central airport where aircrafts fly to and fly from. Some airlines
have multiple hubs.
Different names, same airline type:
• Legacy airlines (established prior to deregulation)
• Network airlines (hub-spoke network)
• Full-service airlines (relatively high service)
All use hub-and-spoke network
• Focussed on one or more hubs (central airports)
• Passengers between non-hub airports fly indirectly
o Exploitation of density (scale) economies: larger aircraft used, or aircraft used more
intensively on remaining route
Segmentation
• High frequencies for high yield passengers
o Business and leisure flying direct; high ticket classes (high price) those people you
want
o (Some) indirect travellers; low ticket classes (low price) necessary to fill empty
seats
• Fill remaining seats with low yield passengers
• Complicated network must allow transfers, high indirect cost.
Low-cost airlines
(Ryanair, Easyjet,
Southwest (US))
• Deregulation
opened markets
for new
scheduled
airlines (easyjet
can fly in
France)
• Low cost airline
strategy:
, eliminate everything not essential to core product, a flight between origin and destination.
o To lower the cost
o Passengers do not miss all of these services (e.g. tax free shop on board)
• KLM and Ryanair are both private airlines. Ryanair is a low cost airline, KLM a legacy carrier.
They both try to minimize costs.
• Many failures of low-cost airlines as
well. Expansion into thin markets,
increasing competition between
low-cost airlines
Low cost carriers (LCC)
• Negotiated contracts in
deregulated environment
o E.g. different labor
contracts
▪ Lower wages, “pay
to fly”
▪ Low direct cost
• Differentiated strategies
o “No frills” (unbundling), no primary airports, no hub-spoke, single aircraft type,
outsourcing, no extensive yield management (price discrimination). But there is no
standard low cost strategy.
▪ Unbundling: pay for every extra service (more leg space, heavy check in bags,
drinks on board)
▪ No hub-spoke: no service for baggage bringing from one to another airplane
simple network to save ground costs and accommodate passengers.
o Simple network: low indirect cost.
• Shift to commodity
o Low cost airlines made air travel available to “other classes”
o Demand stimulation due to lower prices (“Southwest effect”)
o Also in markets not service by conventional airlines
Conventional airlines response to LCC’s
• Bankruptcy: abuse the law to block yourself from competition
• Renegotiation of labor contracts
• Efficiency gains: mainly of short haul (short distances): there is competition
• Setting up (or buying) own LCC’s not always successful: try to do a low cost strategy with a
legacy mindset. That doesn’t work.
Low cost airlines: “hybrid” model
- Simplicity (low cost), but offer attributes that add value (unbundling)
Why would ryan air offer business class (as a low cost carrier (LCC))?
Focusing more markets on markets where money is to be made (legacy). In other markets (small
airports), money cannot be made.
Network convergence: low cost carriers and legacy carriers move up together. Strange because the
best performing firms are at the extreme opposites of the scale, rather than hybrids (porter, 1980)
HC 1
AIRLINE COST
Fixed Costs
• Committed fixed costs: do not vary with output, and cannot be readily changed
• Discretionary fixed costs: do not vary with output, but can readily be changes (e.g.
advertising)
Fixed vs variable costs depends on time frame
• Short run: stick to schedule. Why? Because it shows that you are a reliable airline if you stick
to your schedule. = <12 months
• Medium run: schedule and minor technical adjustments
• Long run: (almost) everything goes
Fixed costs high in aviation economic implication: economy of density = the more passengers you
have in the airplane, the lower the costs per passenger. Average cost decrease with density.
MC = 1-ƟQ
C = Q- Ɵ/2*Q^2
AC = 1- Ɵ/2 *Q
MC < AC
Why economies of density?
• Larger aircraft burns more fuel, but operating cost per passenger are lower
• A plane flies anyway. Higher densities (passenger flow) allow for more flight hours per day.
, • Higher densities (passenger flow) allows for more intensive use of ground facilities and
personnel. (check in desks etc)
• To spread all of these costs, higher passenger density is better.
- Costs per seats and not costs
per passenger, so no
evidence for economies of
density.
- The smaller airplanes need to
land more often than the
larger planes because the
fuel capacity is higher for
larger airplanes.
AIRLINE PRICING
Derived demand
People don’t travel to travel, but to go somewhere
• Trip purpose important
• Timing important peak load problem: summer peak, Christmas peak, morning peak
• What drives demand? value of time, price, your preferences: willingness to pay (WTP)
What you can/want to pay for a ticket depends on the net value of activity of trip purpose.
Demand characteristics
Business travel
• Relatively high WTP
• Relatively insensitive to prices
(inelastic)
o Also within this sector, there
is price elasticity.
Multinationals can pay a lot
for a ticket but some
companies do not have that
much money.
• 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 design and prices are group
specific. Why? Airlines try to get the people who want to pay most on t airplane. Price
discrimination
In-flight comfort: comfort during the trip in the aircraft
,Use of elasticities: segmenting
Demand Management:
• You want passenger that pay high prices (keep some seats open; inelastic demand)
• You need passengers that are not willing to pay high prices (elastic demand), because
lowering the average cost there are empty seats that will not be filled otherwise. You
need those people as well.
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 do not show up
AIRLINE TYPES
Hub-spoke network: focusing on a central airport where aircrafts fly to and fly from. Some airlines
have multiple hubs.
Different names, same airline type:
• Legacy airlines (established prior to deregulation)
• Network airlines (hub-spoke network)
• Full-service airlines (relatively high service)
All use hub-and-spoke network
• Focussed on one or more hubs (central airports)
• Passengers between non-hub airports fly indirectly
o Exploitation of density (scale) economies: larger aircraft used, or aircraft used more
intensively on remaining route
Segmentation
• High frequencies for high yield passengers
o Business and leisure flying direct; high ticket classes (high price) those people you
want
o (Some) indirect travellers; low ticket classes (low price) necessary to fill empty
seats
• Fill remaining seats with low yield passengers
• Complicated network must allow transfers, high indirect cost.
Low-cost airlines
(Ryanair, Easyjet,
Southwest (US))
• Deregulation
opened markets
for new
scheduled
airlines (easyjet
can fly in
France)
• Low cost airline
strategy:
, eliminate everything not essential to core product, a flight between origin and destination.
o To lower the cost
o Passengers do not miss all of these services (e.g. tax free shop on board)
• KLM and Ryanair are both private airlines. Ryanair is a low cost airline, KLM a legacy carrier.
They both try to minimize costs.
• Many failures of low-cost airlines as
well. Expansion into thin markets,
increasing competition between
low-cost airlines
Low cost carriers (LCC)
• Negotiated contracts in
deregulated environment
o E.g. different labor
contracts
▪ Lower wages, “pay
to fly”
▪ Low direct cost
• Differentiated strategies
o “No frills” (unbundling), no primary airports, no hub-spoke, single aircraft type,
outsourcing, no extensive yield management (price discrimination). But there is no
standard low cost strategy.
▪ Unbundling: pay for every extra service (more leg space, heavy check in bags,
drinks on board)
▪ No hub-spoke: no service for baggage bringing from one to another airplane
simple network to save ground costs and accommodate passengers.
o Simple network: low indirect cost.
• Shift to commodity
o Low cost airlines made air travel available to “other classes”
o Demand stimulation due to lower prices (“Southwest effect”)
o Also in markets not service by conventional airlines
Conventional airlines response to LCC’s
• Bankruptcy: abuse the law to block yourself from competition
• Renegotiation of labor contracts
• Efficiency gains: mainly of short haul (short distances): there is competition
• Setting up (or buying) own LCC’s not always successful: try to do a low cost strategy with a
legacy mindset. That doesn’t work.
Low cost airlines: “hybrid” model
- Simplicity (low cost), but offer attributes that add value (unbundling)
Why would ryan air offer business class (as a low cost carrier (LCC))?
Focusing more markets on markets where money is to be made (legacy). In other markets (small
airports), money cannot be made.
Network convergence: low cost carriers and legacy carriers move up together. Strange because the
best performing firms are at the extreme opposites of the scale, rather than hybrids (porter, 1980)
