Maintenance Management
Airline Economics and Maintenance Costs
Aim:
To provide an understanding of the economics and maintenance
costs involved in operating an airline.
Objectives:
• List the areas of income and expenditure that an
airline generates
Explain the factors involved in:
• Seating Arrangements
• Seat Pricing
• Flight Scheduling
• Fleet Planning
• State the variable, fixed, and other costs of maintaining
aircraft and equipment
Service Industry
Because of all of the equipment and facilities involved in air
transportation, it is easy to lose sight of the fact that this
is, fundamentally, a service industry.
Airlines perform a service for their customers -
transporting them and their belongings (or their
products, in the case of cargo customers) from one point
to another for an agreed price. In that sense, the airline
business is similar to other service businesses like banks,
insurance companies or even hairdressers.
There is no physical product given in return for the money
paid by the customer, nor inventory created and stored for
sale at some later date.
Capital Intensive
Unlike many service businesses, airlines need more than a
shop front and telephones to get started. They need an
enormous range of expensive equipment and facilities, from
aircraft to flight simulators to maintenance hangars.
As a result, the airline industry is a capital-intensive
business, requiring large sums of money to operate
effectively. Most equipment is financed through loans or
the issuance of stock.
Increasingly, airlines are also leasing equipment, including
equipment they owned previously but sold to someone else
and leased back. Whatever arrangements an airline chooses
to pursue, its capital needs require consistent profitability.
Labour Intensive
Each major airline employs 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 one-third of the revenue generated each day by
the airlines goes to pay its workforce. Labour costs per
employee are among the highest of any industry.
High Cash Flow
Because airlines own large fleets of expensive aircraft which
depreciate in value over time, they typically generate a
substantial positive cash flow (profits plus depreciation).
Most airlines use their cash flow to repay debt or acquire
new aircraft. When profits and cash flow decline, an airline's
ability to repay debt and acquire new aircraft is jeopardised.
Profit Margins
The bottom line result of all of this is small profit margins,
even in the best of times. Airlines, through the years, have
earned a net profit between one and two percent, compared
to an average of above five percent for national industry as a
whole.
Seasonal Factors
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 troughs 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
due to the growth in the demand for air transportation.
Question
Where does the airline
revenue come from?
Revenue
10%
Passengers
15%
Cargo
Transport Related
75% Services
Airline Revenue - Where the Money Comes From
About 75 percent of the airline industry's revenue comes from passengers
About 15 percent comes from cargo shippers
The remaining 10 percent comes from other transport-related services.
For the all-cargo carriers, cargo is the sole source of transportation
income. For the major passenger airlines which also carry cargo, less than
10 percent of revenue comes from cargo (in many cases far less).
A large proportion of the tickets sold are discounted. Fewer than 10
percent of travellers pay full fare, most of them last-minute business
travellers. The majority of business travellers, however, receive
discounts when they travel.
Travel agencies play an important role in airline ticket sales. Eighty percent
of the industry's tickets are sold by agents, most of whom use airline-
owned computer reservation systems to keep track of schedules and fares,
to book reservations, and to print tickets for customers. Airlines pay
travel agents a commission for each ticket sold.
Question
Where does the airline
revenue go?
Costs
6%
6%
27% Flying Operations
10% Maintenance
Aircraft & Traffic services
Promotion/Sales
9% Passenger Services
Transport Related
13% Administration
13% Depreciation
16%
Airline Costs - Where the Money Goes
According to reports filed with the Department of Transportation in 1999, airline
costs were as follows:
• Flying Operations - costs associated with the operation of aircraft, such as
fuel and pilot salaries - 27%
• Aircraft and Traffic Service - basically the cost of handling passengers,
cargo and aircraft on the ground and including such things as the salaries of
baggage handlers, dispatchers and airline gate agents - 16%
• Maintenance - both parts and labour - 13%
• Promotion/Sales - including advertising, reservations, travel agent commissions - 13%
• Transport Related - delivery trucks and in flight sales - 10%
• Passenger Service - mostly in flight service including such things as food and
flight attendant salaries - 9%
• Administration - 6%
• Depreciation - equipment and plant - 6%
Major Costs
Labour costs are common to nearly all of those categories,
accounting for 35% of the airlines operating expenses and 75%
of controllable costs.
Fuel is the airlines second largest cost (about 10 - 12% of total
expenses)
Travel agent commissions is third (about 6%). Commission
costs, as a percent of total costs, have recently been declining,
as more sales are now made directly to the customer through
electronic means.
Other rapidly rising costs have been airport landing fees
and terminal rents.
Break-Even Load Factors
Every airline has what is called a break-even load factor, which 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
does the break-even load factor. Escalating costs push up the
break-even load factor, while increasing prices for airline
services have just the opposite effect, pushing it lower.
Overall, the break-even load factor 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.
Question
How can an operator increase
its revenue-generating
power, without adding
proportionately to its costs?
Seat Configurations
If low prices are what an airline's customers favour, it will seek
to maximise 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.
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.
The key for most airlines is to strike the right balance to satisfy
its mix of customers and thereby maintain profitability.
Overbooking
Airlines occasionally overbook flights, booking more passengers than the
amount of seats on the same flight.
The practice involves careful analysis of historic demand for a flight,
economics and human behaviour.
Historically, many travellers, especially business travellers buying full-fare
tickets, have not travelled on the flights for which they have a reservation.
Changes in their own schedules may have made it necessary for them to take
a different flight, maybe with a different airline, or to cancel their travel
plans altogether, often with little or no notice to the airline.
Both airlines and customers are advantaged when airlines sell all the
seats for which they have received reservations. An airline's inventory
is comprised of the seats that it has on each flight. If a customer does
not fly on the flight which they have a reservation, the seat is unused
and cannot be returned to inventory for future use as in other
industries.
Overbooking
Importantly for travellers, airlines do not overbook haphazardly.
They examine the history of particular flights, in the process
determining how many no-shows typically occur, and then decide how
much to overbook that particular flight. The goal is to have the
overbooking match the number of no-shows.
In most cases the practice works effectively. Occasionally,
however, when more people show up for a flight than there are
seats available, airlines offer incentives to get people to give up
their seats. Free tickets are the usual incentive; those
volunteering are booked on another flight.
Normally, there are more volunteers than the airlines need, but when
there are not enough volunteers, airlines must bump passengers
involuntarily. In the rare cases where this occurs, regulations require
the airlines to compensate passengers for their trouble and help them
make alternative travel arrangements. The amount of compensation is
determined by government regulation.
Pricing
Since deregulation, airlines have had the same pricing freedom as
companies in other industries. They set fares and freight rates in
response to both customer demand and the prices of competitors
As a result, fares change much more rapidly than they used to, and
passengers sitting in the same section on the same flight often are
paying different prices for their seats.
Although this may be difficult to understand for some travellers, 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 traveller likely will make the trip only if the fare is
relatively low. The salesperson, on the other hand, is likely to pay a
higher premium in order to make the appointment.
Pricing
For the airlines, the chief objective in setting fares is to maximise 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).
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.
An ongoing process, it requires continual adjustments as market conditions
change. Unexpected discounting by a competitor, for instance, can leave an airline
with too many unsold seats if they do not match the discounts.
Scheduling
Since deregulation, airlines have been free to serve whatever domestic
markets they feel warrant their service, and they adjust their schedules
often, in response to market opportunities and competitive pressures.
Along with price, schedule is an important consideration for air travellers.
For business travellers, schedule is often more important than price.
Business travellers 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.
Airlines establish their schedules in accordance with demand for their
services and their marketing objectives.
Scheduling
Scheduling, however, can be extraordinarily complex and must take into
account of:
• aircraft availability
• crew availability
• maintenance needs
• airport operating restrictions.
Airlines do not cancel flights because they have too few passengers for
the flight. The nature of scheduled service is such that aircraft move
throughout an airline's system during the course of each day.
A flight cancellation at one airport means the airline will be short an aircraft
someplace else later in the day, and another flight will have to be cancelled.
If an airline must cancel a flight because of a mechanical problem, it may
choose to cancel the flight with the fewest number of passengers and utilise
that aircraft for a flight with more passengers.
While it may appear to be a cancellation for economic reasons, it is not. The
substitution was made in order to inconvenience the least number of passengers.
Fleet Planning
Selecting the right aircraft for the markets an airline wants to serve is
vitally important to its financial success. The selection and purchase of new
aircraft is usually directed by an airline's top officials, although it involves
personnel from many other divisions.
There are numerous factors to consider when planning new aircraft
purchases:
• Do existing aircraft need to be replaced?
• What plans does the airline have to expand service?
• How much fuel do they burn per mile?
• How much are maintenance costs?
• How many people are needed to fly them?
In general, newer aircraft are more efficient and cost less to operate than
older aircraft. A Boeing 727, for example, is less fuel efficient than the
757 that Boeing designed to replace it. In addition, the larger 757 requires
only a two-person flight crew, versus three for the 727. As planes get
older, maintenance costs can also rise appreciably.
Fleet Planning
However, such productivity gains must be weighed against the cost of
acquiring a new aircraft and poses further questions:
• Can the airline afford to take on more debt?
• What does that do to profits?
• What is the company's credit rating?
• What must it pay to borrow money?
• What are investors willing to pay if additional shares are floated?
A company's finances play a key role in the aircraft acquisition
process. Marketing strategies are important, too. An airline
considering expansion into international markets cannot pursue that
goal without long-range, wide body aircraft. If it has been largely a
domestic carrier, it may not have that type of aircraft in its fleet..
Changes in markets already served may require an airline to reconfigure
its fleet. Having the right-sized aircraft for the market is vitally
important. Too large an aircraft can mean that a large number of unsold
seats will be moved back and forth within a market each day. Too small an
aircraft can mean lost revenue opportunities.
Fleet Planning
Since aircraft purchases take time (often two or three years), airlines must also do
some economic forecasting before placing new aircraft orders. This is perhaps the
most difficult part of the planning process, because no one knows for certain what
economic conditions will be like many months, or even years, into the future.
An economic downturn coinciding with the delivery of a large number of expensive
new aircraft can cause major financial losses. Conversely, an unanticipated boom in
the travel market can mean lost market share for an airline that held back on
aircraft purchases while competitors were moving ahead.
Sometimes, airline planners determine that their company needs an aircraft that
does not yet exist. In such cases, they approach the aircraft manufacturers about
developing a new model.
Start-up costs for the production of a new aircraft are enormous, so manufacturers
must sell substantial numbers of a new model just to break even. They usually will not
proceed with a new aircraft unless they have a launch customer, meaning an airline
willing to step forward with a large order for the plane, plus smaller purchase
commitments from several other airlines.
Fleet Planning
In recent years there have been several important trends in aircraft
acquisition.
One trend is the increased popularity of leasing versus ownership
Leasing reduces some of the risks involved in purchasing new
technology. It also can be a less expensive way to acquire aircraft, since
high-income leasing companies can take advantage of tax credits.
A second trend relates to the size of the aircraft ordered.
The development of hub-and-spoke networks resulted in airlines adding
flights to small cities around their hubs. This has enabled airlines to
respond more effectively to consumer demand. In larger markets, this
often means more frequent service. These considerations, in turn,
increased the demand for small and medium-sized aircraft to feed the
hubs. Larger aircraft remain important for the more heavily travelled
routes, but the ordering trend is toward smaller aircraft.
Fleet Planning
The third trend is toward increased fuel efficiency.
As the price of fuel rose rapidly in the 1970s and early 1980s, the
airlines gave top priority to increasing the fuel efficiency of their
fleets. That led to numerous design innovations on the part of the
manufacturers. Airlines, today, average about 40 passenger miles
per gallon - a statistic that compares favourably with even the most
efficient automobiles.
The fourth trend has been in response to airline and public concerns
about aircraft noise and engine emissions.
Technological developments have produced quieter and cleaner-burning
jets. Hush kits are also available for older engines, and some airlines have
chosen to pursue this option rather than make the much greater financial
commitment necessary to buy new aircraft. Others have chosen to re-
engine, or replace their older, noisier engines with new ones that meet
noise standards. While more expensive than hush kits, new engines have
operating-cost advantages that make them the preferred option for some
carriers.
Fleet Planning - Summary
• Factors to consider when planning new aircraft
• Company finances
• Marketing strategies
• Economic forecasting
• New aircraft design
• Leasing versus ownership
• Aircraft size
• Fuel efficiency
• Noise and engine emissions
Maintenance costs
Unscheduled maintenance and maintenance scheduled on the
basis of flying time vary with aircraft usage and, therefore,
the associated costs are considered variable costs.
In addition to the costs of normal maintenance activities,
variable maintenance costs shall include:
• aircraft refurbishment, such as painting and interior
restoration
• performing overhauls and modifications required by
service bulletins and airworthiness directives.
Agencies may consider all of their maintenance costs as
variable costs and account for them accordingly. Otherwise,
certain maintenance costs will be considered fixed.
Variable Costs
Maintenance labour - This includes all labour (i.e. salaries and
wages, benefits, travel, and training) expended by mechanics,
technicians, and inspectors, exclusive of labour for engine overhaul,
aircraft refurbishment, and/or repair of major components.
Maintenance parts - This includes cost of materials and parts
consumed in aircraft maintenance and inspections, exclusive of
materials and parts for engine overhaul, aircraft refurbishment,
and/or repair of major components.
Maintenance contracts - This includes all contracted costs for
unscheduled maintenance and for maintenance scheduled on a
flying hour basis or based on the condition of the part or
component.
Engine overhaul, aircraft refurbishment, and major component
repairs - These are the materials and labour costs of overhauling
engines, refurbishing aircraft, and/or repairing major aircraft
components.
Fixed Costs
These costs include certain maintenance and inspection activities which
are scheduled on a calendar interval basis and take place regardless of
whether or how much the aircraft are flown.
Maintenance labour - This includes all projected labour by mechanics and
inspectors associated with maintenance scheduled on a calendar interval
basis. This does not include variable maintenance labour or work on items
having a time between overhaul (TBO) or retirement life.
This category also includes costs associated with unallocated maintenance
labour expenses, i.e., associated salaries, benefits, travel expenses and
training costs. These costs should be evenly allocated over the number of
the aircraft in the fleet.
Maintenance parts - This includes all parts and consumables
used for maintenance scheduled on a calendar basis.
Maintenance contracts - This includes all contracted costs for
maintenance or inspections scheduled on a calendar basis.
Other Costs
All accident repair costs:
These costs include all parts, materials, equipment
and maintenance labour related to repairing
accidental damage to airframes or aircraft
equipment.
All accident investigation costs.
Aim:
To provide an understanding of the economics and maintenance
costs involved in operating an airline.
Objectives:
• List the areas of income and expenditure that an
airline generates
Explain the factors involved in:
• Seating Arrangements
• Seat Pricing
• Flight Scheduling
• Fleet Planning
• State the variable, fixed, and other costs of maintaining
aircraft and equipment
Any Questions?
