AECMA Airline Economics South-Asia April 2004 Final

EU-ASIA CIVIL AVIATION PROJECT
A project supported by the European Commission, the European Industry and the Ministries responsible for Civil Aviation in Asia.
INTRODUCTION TO AIRLINE ECONOMICS
UNDERSTANDING THE BASICS
Presented by
Joel LUNOT
Senior Consultant
Page: 1
Colombo April 2004
S AM 1-12: Top Level Airline Management Seminar

OBJECTIVE OF ANY AIRLINE
IN A COMPETITIVE ENVIRONMENT, ANY

AIRLINE HAS TWO MAIN GOALS:
4 1st: MAKE MONEY OUT OF ITS DAILY OPERATIONS
4 2nd: CREATE VALUE FOR SHAREHOLDERS
Page: 2
Colombo April 2004

HOW TO MAKE MONEY ?
4 BASIC PRINCIPLE:
Revenue per ASK each fiscal year must be higher than
cost per ASK.
4 In order to assess these parameters, Airlines need to

know precisely three main data:
ACTIVITY REVENUES - COSTS
Page: 3
Colombo April 2004

ACTIVITY
4 PER AIRCRAFT TYPE :

Kilometers flown, landings, block hours, fuel
consumption, utilization/day
4 ASKs PER CLASS :

First, Intermediate, low & Total
4 Paying passengers & PASSENGER/KMs per class

Page: 4
Colombo April 2004

REVENUES
4 Revenues must be converted into one single currency
4 Passenger revenues broken down by class
4 Freight revenues (if applicable)
4 Mail revenues
4 Other revenues
4 Total operating revenues

Page: 5
Colombo April 2004

COSTS
4 Classical breakdown of costs are of no great use to assess

performances of an airline, a fleet or a specific route.
4 Administrative cost allocation is mostly used for

accounting purposes.
4 Functional cost allocations are preferred because they

facilitate comparisons between airlines and help identify
which cost factors need specific attention and action.
Page: 6
Colombo April 2004

COST CLASSIFICATIONS
4 Operating costs vs. Non operating costs :
Operating costs are all costs directly linked to flying activities : fuel,
cockpit crew etc. Non operating costs : interest, administrative
overheads etc.
4 DOC vs. IOC :
DOC are costs directly varying according to aircraft type (cockpit
crew, fuel, maintenance etc.). IOC are costs independent of aircraft
type (ground handling, passenger services, sales & promotion,
overheads).
4 Fixed & variable costs :
fixed costs are all costs independent of services offered : depreciation,
crew training, stations etc.
4 Traffic related costs :
All costs varying according to the number of passengers carried.
Page: 7
Colombo April 2004

TYPICAL PRESENTATION OF AIRLINE

YEARLY RESULTS
1. Activity results,
2. Revenues,
3. Costs : (fuel, navigation fees, airport fees, pax fees, pax insurance, hull
insurance, maintenance, sales costs, crew costs, ground personnel, other),
4. EBITDAR (Total 2 minus 3) : Earnings Before Interest, Tax, Depreciation,
Amortization & Rentals),
5. Aircraft rentals,
6. EBITDA (4 minus 5) : Earnings Before Interest, Tax, Depreciation &
Amortization),
7. Depreciation & Amortization,
8. EBIT (6 minus 7) : Earnings Before Interest & Tax,
9. Interest, financial charges & exceptional,
10. EBT (8 minus 9): Earnings Before Tax,
11. Tax,
12. NET RESULT (10 minus 11)
Page: 8
Colombo April 2004

AIRLINE PROFITABILITY IS POOR
4 Economists agree that to have sufficient funds to develop

operations successfully & to replace the main assets of their
business (aircraft etc.), airlines require an operating ratio
(OR), i.e. revenues/costs, of 108 as an average,
4 As an example, the first 50 airlines of the world (84% of

total revenues) had an OR of 106 between 1992 and 1996
inclusive,
4 As a comparison, other actors fared much better : GDS

130, AC manufacturers & leasers 115, Handling & catering
111, Airports 11O. (source:Mc.Kinsey, 1998)
Page: 9
Colombo April 2004

RECENT TRENDS ARE EVEN WORSE
4 IATA : 273 carriers in 143 countries : for years 2001 &

02, losses amount to $ 30 billions, equivalent to the sum of
net earnings since 1945! For year 2003, losses of $ 6.5 bns
expected
4 AEA : losses of $ 2 bns expected for 2003,
4 USA : losses of $ 18 bns in 2001 & 02, totally offsetting

net profits realized between 1995 & 2000 incl. - $6.7 bns
expected for 2003. Present situation could be worse than
after 1991 Gulf war (4 years of losses totaling $ 13.1 bns)
because of security concerns & impact of low cost carriers.
Page: 10
Colombo April 2004

US AIRLINE INDUSTRY SITUATION

4 Network airlines are in bad shape. Some are under chapter 11,
4 Total debt : more than $ 100 bns compared to an outstanding
stock valued at $ 3.2 bns only (Feb.2003)
4 Credit ratings have dramatically declined with debt of 9 US
major airlines rated as junk,
4 Only airline rated A is SOUTHWEST, biggest US domestic
airline,
4 US Low Cost Airlines : 25% of domestic traffic in 2003,
4 2002 US Yields lower than they were in 1988, in nominal $
(not inflation adjusted):
Page: 11
Colombo April 2004

US AIRLINE INDUSTRY SITUATION (2)

YIELD (US cents) CONSUMER PRICE INDEX
16 200
14 14,08 180 179,9

160 163
12 12,31 11,98
140
10 10,4 10,38 9,95 120 118,3
8,49 100 100
8
7,49
80
6
60
4 40
2 20
0 0
1975 1980 1985 1990 1995 2000 2005 1975 1980 1985 1990 1995 2000 2005
Yield do mestic Yield internatio nal Co nsumer price index
Page: 12
Colombo April 2004

US AIRLINE INDUSTRY SITUATION (3)

4 Revenue wise : For year 2002, yields are lower than in 1988 = - 3%
(even more on the international sector) despite an inflation (CPI) of + 52%.
Nominal fares at lowest since 1988, example for a 1.000 mile journey:$122 in
1988, $119 in 2002. Peak at $148 in 2001,
4 Cost wise : For the same period (1988 to 2002), Costs per ASM have
risen from 7.85 cents to 10.50 : + 34%,
4 As a consequence, Breakeven Load Factor has risen from 61.3% in 1988 to
84.1% in 02,
4 Actual Load Factors were 62.8% in 88 = profit
but only 71.8% in 02 = huge losses for the industry,
4 For year 2003 : ASMs were down 3.5% (back to 1995 level) & RPMs down
1%. Load Factor improved to 74.2% but not enough to meet Breakeven Load
Factor estimated around 81.4%.
Page: 13
Colombo April 2004

MANAGING COSTS : A MUST FOR ALL AIRLINES

4 Trend towards lower yields will probably continue : overcapacity,
fierce competition, increasingly price-sensitive flying public including
business travelers, productivity gains through bigger & more efficient
aircraft like A380 etc.,
4 Action on costs must be an every day task among airline managers,
4 A permanent follow-up of cost structure & various cost factors is
necessary to preempt or react to any uncontrolled increase,
4 Essential to know precisely your cost structure & its evolution : year
to year, quarter to quarter etc.,
4 Reducing costs may not be enough,
4 Cost Management is also required : even with higher costs, you can
be profitable if you have the right business model.
Page: 14
Colombo April 2004

COSTS BREAKDOWN IN US AIRLINE INDUSTRY

(first half 2003)
Labor 37,1%
% of operational expenses
Fuel 12,6%
AC Ownership 10%
NON AC Ownership 5,5%
Professional services 8,8%
Food and Beverage 2,1%
Landing fees 2,3%
Maintenance material 1,5%
AC Insurance 0,2%
NON AC Insurance 1,1%
PAX Commissions 1,7%
Communication 1,4%
Advertising and Promotion 0,9%
Utilities and Office supplies 0,9%
Other operating expenses 13,9%
Page: 15
Colombo April 2004


(first half 2003)
Cents/ASM 1 = Labor
2 = Fuel
3 = AC ownership
4,5 4 = Non AC ownership
4 5 = Professional services
3,5 6 = Food and Beverage
3 7 = Landing fees
2,5 8 = Maintenance material
2 9 = AC Insurance
10 = Non AC Insurance
1,5
11 = PAX Commissions
1 12 = Communication
0,5 13 = Advertising & promotion
0 14 = Utilities & Office supplies
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 15 = Other operating expenses
16 = Interest
Page: 16
Colombo April 2004

1 = Labor
700 2 = Fuel
3 = AC ownership
600 4 = Non AC ownership
500 5 = Professional services
6 = Food and Beverage
400 7 = Landing fees
300 8 = Maintenance material
9 = AC Insurance
200 10 = Non AC Insurance
100 11 = PAX Commissions
12 = Communication
0 13 = Advertising & promotion
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 14 = Utilities & Office supplies
15 = Other operating expenses
Index 1982 = 100 First half 2003 16 = Interest
17 = Composite
Page: 17
Colombo April 2004


(first half 2003)
4 Airline costs vs. 1982 = 191.3.
4 CPI vs. 1982 = 179.9
4 Presentation useful for historical comparisons &

benchmarking between airlines, especially between
network airlines & low cost carriers,
4 But some items are not specific enough : labor,

professional services or other operating expenses.
Page: 18
Colombo April 2004

IATA & AEA COST BREAKDOWN
2 main categories : DOC & IOC

DOC: 2001 figures for major european airlines (% of op exp.)
1. Flight Deck Crew 7.7%
2. Fuel & Oil 12.0%
3. Maintenance & overhaul 11.7%
4. AC depreciation 8.7%
5. Rentals 2.0%
6. Charges (en route, airport etc.) 9.3%
TOTAL DOC 51.4%

Page: 19
Colombo April 2004

IATA & AEA COST BREAKDOWN (2)
IOC:
7. Stations & Ground 13.0%
8. Cabin attendants 8.0%
9. Passenger service 6.7%
10. Load insurance 0.7%
11. Sales & Promotion 15.0%
12. General & Administration 5.2%
TOTAL IOC 48.6%

TOTAL OPERATING EXPENSES 100.0%
Page: 20
Colombo April 2004

IATA & AEA COST BREAKDOWN (3)

IOC / DOC
48,60%
51,40%
DOC IOC
DOC IOC
Flight Deck Crew 7,70% 5,20% Stations & Ground
9,30%
13%
Fuel & Oil Cabin attendants
2%
Maintenance & Passenger service
overhaul
15%
12% Load insurance
AC depreciation
8,70%
Rentals 8% Sales & Promotion
0,70%
Charges (en route, 6,70% General &
11,70% Administration
airport etc)
Page: 21
Colombo April 2004

Air France Cost Analysis : ARA

4 5 main categories :
4 1. Costs varying with traffic : distribution costs, charges
& insurance, food & beverage, clients compensations,
4 2. Costs varying with flights : maintenance, fuel, crew,
charges, handling,
4 3. Other direct costs : station fixed costs, private lounges,
connecting costs, distribution fixed costs, crew fixed costs,
4 4. Aircraft costs ( ownership & rentals ),
4 5. Support costs.
4 Total Revenue minus Costs 1 to 5 = Operational result
Page: 22
Colombo April 2004

AF Cost analysis (2)
European sector Long haul

7% 7,40%
7% 19,30% 10% 24,20%
20,50%
22,50%
45,80% 35,90%
Traffic variable costs Flight variable costs Traffic variable costs Flight variable costs
Other direct costs Aircraft Other direct costs Aircraft
Support Support
Page: 23
Colombo April 2004

AF Cost analysis (3)

Typical cost structure for european sector long haul (% of total op exp.)
1. TRAFFIC VARIABLE COSTS : 19.3% 24.2%
- Distribution 11.9% 10.7
- Charges & Insurance 1.0% 4.6
- Food & Beverage 4.9% 8.2
- Clients compensations 1.5% 0.7
2. FLIGHT VARIABLE COSTS : 45.8% 35.9%
- maintenance & overhaul 13.3% 8.5
- fuel 7.2% 12.1
- crew 5.4% 3.8
- charges 9.2% 6.2
- handling 10.6% 4.5
3. OTHER DIRECT COSTS 20.5% 22.5%
4. AIRCRAFT 7.0% 10.0
5. SUPPORT 7.4% 7.4
Page: 24
Colombo April 2004

COST DIFFERENTIALS LCC vs. NETWORK

4 High productivity :
1/ flat schedules, no seasonality
2/ fleet utilization (between 10 & 13 hours/day vs. 8.5)
3/ turnarounds in 25/30 minutes vs. 40
4/ densified aircraft & one type fleet
5/ minimum cabin crew
6/ higher productivity cockpit & cabin crew & lower salaries
7/ reduced overhead & general costs
8/ no frills : paying food & beverage, no papers
9/ multi-skill ground & cabin crew personnel
10/ cleaning of aircraft at stations by cabin crew
11/ no seat allocation
12/ no children fares
Page: 25
Colombo April 2004

COST DIFFERENTIALS LCC vs. NETWORK (2)

4 Point to point services
4 No segmentation, no pricing or very simplified, one-way pricing
4 No interlining
4 No printed tickets
4 Direct sales : no commissions, Internet & Call centers
4 No Frequent Flyer Programs
4 Less costly airports : ex: Ryanair & Southwest
4 Reduced airport charges in other airports discounts on charges,
remote check-in desks, etc...
Page: 26
Colombo April 2004

Low-cost airlines :
4 100% savings on : Catering, GDS, commissions

4 25% savings on : ground handling, crews, aircraft,
maintenance
Exemple :
4 Easyjet bookings : 90% via Internet

4 Ryanair : 70%, balance through call centers
Page: 27
Colombo April 2004


Extracts from Giovanni Bisignani address to delegates of the African
Airlines Association annual meeting in Tripoli 12/08/2003:
Our industry is just now beginning to emerge from the worst crisis
in its one hundredyear history. Total airline losses since september
11 2001: 35 billion US dollars.
The US and the UE are single markets.
Also Africa is not Europe and Asia is not North America, it is not
inconceivable today to imagine for the future an African or an
Asian single market.
Overall international passenger traffic levels in 2003 will be 1%
lower than 2002, and still below year 2000.
Page: 28
Colombo April 2004

Extracts from Giovanni Bisignani address to delegates of the African

Airlines Association annual meeting in Tripoli 12/08/2003:
Our most recent IATA forecast indicates a rebound of international

passenger traffic in 2004/05. A solid recovery is vital to the world
economy. But we will face many challenges on the way to that
recovery : among them, cost cutting has become an obsession for
all airlines.
In North America, in Europe and now in Asia, network carriers are
under pressure from low cost airlines. Here, in Africa, you probably
dont feel this kind of pressure yet. However, it would be unwise to
say : It cant happen here!
Page: 29
Colombo April 2004

4 Has anyone already experienced travel on a low

cost airline? in North America? in Europe? in
Asia? How would you decribe this experience.
4 In Europe, cost per differential between a low

cost carrier and a major network airline is
presently estimated at 40%. In the USA, the gap
may be as high as 50%.
Page: 30
Colombo April 2004

Where does the difference com from?

Lets try to identify the various cost factors involved and rank them by order of
importance.
4 Costs varying with traffic: distribution costs, charges & insurance, food
and beverage, clients compensations, interlining
4 Costs varying with flights: maintenance (material, personnel etc.) fuel,
cockpit crew, en route & airport charges, handling costs.
4 Other direct costs: station fixed costs, private lounges, connecting
expenses, distribution fixed costs, cabin crew
4 Aircraft costs: ownership & rentals (utilisation, number of seats per
aircrat, etc.)
4 Support costs
Page: 31
Colombo April 2004

EXAMPLES OF COST DIFFERENCES BETWEEN

NETWORK AIRLINES & LOW COST CARRIERS
4 United vs. JetBlue total DOC & IOC Airbus 320 on route
Washington/DIA to Oakland.Calif. In 2002. Costs/ASM in US cents :
4 UA = 10.14
4 JetBlue = 7.01 (- 30.9%)
4 JetBlue operates a younger A320 fleet (advantage estimated at 0.73

cents). With same maintenance costs as UA, cost differential in favor
of JetBlue would still be - 23.7%.
4 WHERE DOES THE DIFFERENCE COME FROM ?

Page: 32
Colombo April 2004

UNITED vs. LCC

4 70% of UA passengers fly in markets served by the three main
LCCs : Southwest, JetBlue & AirTran,
4 % of passengers purchasing premium fares (F & Business) on

UA flights went down from 41% in 1999 to 22% in 2002,
4 cost/ASM changes 1998 / 2001 % (US cents)

UA 9.25 / 11.64 + 26%
Southwest 7.32 / 7.17 - 2%,
4 Southwests output/employee = + 20% vs. UA,

Page: 33
Colombo April 2004

UNITED vs. LCC
AIRLINE Monthly flying hours per pilot

Southwest 62
Air Tran 51
US Airways 50
JetBlue 47
Delta 45
American Airlines 39
United Airlines 36
Page: 34
Colombo April 2004

LCCs in Europe
4 Ryanair & Easyjet have 37% of British domestic traffic &

25% of UK/Europe market,
4 Their combined fleets could number 500 aircraft in 2010,
4 direct maintenance costs/mile = - 40% vs. Traditional

airlines due to high utilization rate : 13 hours/day vs. 8.3,
4 LCCs operate 500 city pairs including 75% inaugurated

since Jan.. 1.2002,
Page: 35
Colombo April 2004

LCCs in Europe (2)
4 Ryanair : 24 million passengers in 2003/04, Europes 4th

airline, Ryanair close to Southwest business model : lowest
fares & secondary airports,
4 Easyjets market capitalization (more than 1 billion)

exceeds BA stock value,
4 Easyjet is now number 1 operator at Geneva airport and is

able to negotiate special conditions with airport authority
in order to reduce its station costs.
Page: 36
Colombo April 2004

LCCs in Europe (3)
Limits to LCC business model in Europe :
4 Example on Paris/Dublin route, Ryanair (with 3 daily

flights) competes with Cityjet, an AF 100% subsidiary :
with 5 daily flights, Cityjet is much stronger than Ryanair
due to the HUB TURBO EFFECT at CDG airport,
4 High criticism from consumers organizations on poor

quality, forcing Ryanair to appoint customer relations
manager
Page: 37
Colombo April 2004

LCCs in Europe (4)
Limits to LCC business model in Europe :
4 LON/FRA with Ryanair uses Hahn airport : 2 hours +

11 vs. 11 minutes & 3 by train with BA or LH,
4 Legal problems for Ryanair : before opening new routes,

negotiates with local authorities to obtain financial aids to
promote tourism & traffic. Cases with Strasbourg &
Charleroi. French court & European Union Authorities
consider that competition is biased & order suppression of
aids.
Page: 38
Colombo April 2004

LCCs in Asia
4 Just starting : 1% of traffic (excluding Australia &
Japan) vs. 25% in US & 10% in Europe,
4 New entrants : Pacific Blue Airlines, Freedom Air,

Jetstar, Virgin Blue (Unit costs = 7.5 cents/kilometer vs. 10
for QF), Valuair (2004 in Singapore?), Air Asia (the
Ryanair of Malaysia : it spends 2.5 cents to fly one
pax/kilometer vs. 4.5 for Ryanair & 7.5 for Southwest),
4 But : greater distances in Asia (food & beverage needed)

& except for Australia & New Zealand, intra-Asian routes
are not deregulated but subject to bilateral agreements.
Page: 39
Colombo April 2004

What lies ahead in the future for airlines ?

4 Co-existence of two business models : network airlines & point
to point carriers (LCCs),
4 LCCs will continue to grow : 1/3rd of european market in 2010,

38% of US domestic market in 2010 & 55% by 2020,
4 Pressure on prices will continue,
4 Cost concerns : fuel, security, insurance, interest, airport & user

charges, taxes,
4 Operating ratios and margins will remain very low.

Page: 40
Colombo April 2004

What lies ahead in the future for airlines ?
4 Bright spots : operations, distribution costs, fleet, labor

concessions, automation, electronic procurement & sales,
4 Avenues to profitability : Network (alliances,FFP,

codesharing, hub optimization), Pricing, fleet (simplification,
modernization), Product (automation, low cost distribution,
cabin simplification), Labor (productivity based
compensation),
4 Air Transport as known & operated only 5 years ago is dead

and all airlines in USA & Europe have to adapt to the new
conditions.
Page: 41
Colombo April 2004

AECMA Airline Economics South-Asia April 2004 Final

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AECMA Airline Economics South-Asia April 2004 Final

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EU-ASIA CIVIL AVIATION PROJECT

INTRODUCTION TO AIRLINE ECONOMICS

UNDERSTANDING THE BASICS

S AM 1-12: Top Level Airline Management Seminar

OBJECTIVE OF ANY AIRLINE

IN A COMPETITIVE ENVIRONMENT, ANY

4 1st: MAKE MONEY OUT OF ITS DAILY OPERATIONS

4 2nd: CREATE VALUE FOR SHAREHOLDERS

S AM 1-12: Top Level Airline Management Seminar

HOW TO MAKE MONEY ?

4 In order to assess these parameters, Airlines need to

S AM 1-12: Top Level Airline Management Seminar

4 PER AIRCRAFT TYPE :

4 ASKs PER CLASS :

4 Paying passengers & PASSENGER/KMs per class

S AM 1-12: Top Level Airline Management Seminar

4 Revenues must be converted into one single currency

4 Passenger revenues broken down by class

4 Freight revenues (if applicable)

4 Total operating revenues

S AM 1-12: Top Level Airline Management Seminar

4 Classical breakdown of costs are of no great use to assess

4 Administrative cost allocation is mostly used for

4 Functional cost allocations are preferred because they

S AM 1-12: Top Level Airline Management Seminar

S AM 1-12: Top Level Airline Management Seminar

TYPICAL PRESENTATION OF AIRLINE

S AM 1-12: Top Level Airline Management Seminar

AIRLINE PROFITABILITY IS POOR

4 Economists agree that to have sufficient funds to develop

4 As an example, the first 50 airlines of the world (84% of

4 As a comparison, other actors fared much better : GDS

S AM 1-12: Top Level Airline Management Seminar

RECENT TRENDS ARE EVEN WORSE

4 IATA : 273 carriers in 143 countries : for years 2001 &

4 AEA : losses of $ 2 bns expected for 2003,

4 USA : losses of $ 18 bns in 2001 & 02, totally offsetting

S AM 1-12: Top Level Airline Management Seminar

US AIRLINE INDUSTRY SITUATION

S AM 1-12: Top Level Airline Management Seminar

US AIRLINE INDUSTRY SITUATION (2)

14 14,08 180 179,9

Yield do mestic Yield internatio nal Co nsumer price index

S AM 1-12: Top Level Airline Management Seminar

US AIRLINE INDUSTRY SITUATION (3)

S AM 1-12: Top Level Airline Management Seminar

MANAGING COSTS : A MUST FOR ALL AIRLINES

S AM 1-12: Top Level Airline Management Seminar

COSTS BREAKDOWN IN US AIRLINE INDUSTRY

S AM 1-12: Top Level Airline Management Seminar

COSTS BREAKDOWN IN US AIRLINE INDUSTRY

S AM 1-12: Top Level Airline Management Seminar

COSTS BREAKDOWN IN US AIRLINE INDUSTRY

S AM 1-12: Top Level Airline Management Seminar

COSTS BREAKDOWN IN US AIRLINE INDUSTRY

4 CPI vs. 1982 = 179.9

4 Presentation useful for historical comparisons &

4 But some items are not specific enough : labor,

S AM 1-12: Top Level Airline Management Seminar

IATA & AEA COST BREAKDOWN

2 main categories : DOC & IOC

TOTAL DOC 51.4%

S AM 1-12: Top Level Airline Management Seminar

IATA & AEA COST BREAKDOWN (2)