# Airline Economics

This report contains some of the basic measures used in airline economics. It is followed by a practical application from a case study comparing two competing airlines. The aim is to give you an appreciation for the terms used and to explain why we need these Key Performance Indicators (KPIs) to be able to then analyse an airline’s successes and failures.

Common Terms include:

Available Seat Mile (ASM): The Basic Measure of Capacity

1. One seat (empty or filled) flying one mile is an ASM.
2. A 140-seat MD-80 flying a 500-mile segment creates how many ASM? 70,000 ASMs.
3. System ASMs are simply the sum of each of these individual segment calculations.

In a typical day in 2007, American Airlines made available about 465 million ASMs.

RPM or RPK

Revenue Passenger Mile (RPM): The Basic Measure of Production

1. A paying passenger flying one mile creates one RPM.
2. 100 passengers flying 500 miles generates how many RSM? (50,000 RPMs)
3. System RPMs are the sum of this calculation for each of the revenue segments we fly.

In a typical day in 2007, American produced 380 million RPMs.

Production compared to Capacity

1. To calculate system-wide load factors, divide RPMs by ASMs.
2. In 2007, for American Airlines that is 138.5 billion RPMs divided by 169.7 billion ASMs, or 81.6 percent.
3. For an individual flight, divide the revenue passengers on board by the aircraft capacity; in the MD-80 example above, it is 100 divided by 140, or 71.4 percent.
4. High load factors are important as it allows costs to be spread over more passengers and therefore reduces unit costs. It does not however tell us how much each passenger pays, therefore high load factors doesn’t necessarily mean a profitable airline.

Yield:

Is The Average Revenue Collected per Revenue Passenger Mile  or km.

1. To calculate system yield, divide passenger revenue by total RPMs.
2. For American Airlines in 2007, this is \$18.2 billion divided by 138.5 billion RPMs, or 13.1 cents per mile.
3. To calculate a customer’s individual yield, divide ticket price by mileage.
4. If a customer pays \$98.00 for the 500-mile segment above, the yield would be 19.6 cents per mile.

Revenue per Available Seat Mile (R/ASM): The Best Basic Measure

1. Multiply load factor by the yield to get the measure of how much revenue we generate per increment of capacity.
2. Using the 2007 example above, it’s 81.5 percent times 13.1 cents which equals 10.7 cents.

Cost per Available Seat Mile (C/ASM): The Basic Measure Of Cost

1. Unit costs represent how much it costs to fly one seat (empty or filled) one-mile.
2. To calculate unit costs, divide total operating expenses by Total ASM capacity.
3. For American Airlines in 2007, this is \$19.24 billion divided by 169.9 billion, or 11.3 cents per mile.

What are Operating Costs?

• Fuel costs
• Wages of company employees
• Maintenance
• Airport and ATC costs (landing fees , Airway usage).
• Advertising/travel agent commission.
• Transport Related (delivery Trucks, holiday coaches).
• In-flight service costs such as clean toiletries, food and drink if supplied.
• Administration costs. (insurance, IT).

Revenues available:

Fare Revenues & Non-Fare Revenues

Depending on the airline, the fare paid for a ticket may just be for the seat and nothing else, or it may include additional items such as baggage, food and drinks for example. However, there has been a move towards unbundling of fares across most airlines.

This means that an airline can advertise its cheapest price for the most price sensitive customers and offer ancillary services to allow customers to select the products and services that matter to them, i.e., baggage, seat allocation, speedy boarding, extra legroom and victual. This creates ancillary revenues, driving up yield, but also allows the airline to appear very price competitive on internet searches.

Fuel Hedging

Fuel Hedging is a contractual tool some large airlines use to reduce their exposure to volatile and potentially rising fuel costs.

A fuel hedge contract allows an airline to establish a fixed cost for fuel. They enter into hedging contracts to mitigate their exposure to future fuel prices that may be higher than current prices and/or to establish a known fuel cost for budgeting purposes. However, if the price of fuel declines, the company will effectively be forced to pay an above-market rate for fuel.

Generally, these are primary methods by which airlines acquire aircraft:

• Cash purchase –

The aircraft is a capital asset for the airline, so pricing can be negotiated on favourable terms, particularly regarding larger orders. There’s little flexibility and the aircrafts depreciates over approximately 15 years.

• Bank Loan –

Less capital required with this method. Interest payments are available, with variable costs due to said interest.

• Leasing –

The aircraft can be leased quickly and returned to a leasing company if required. This method improves flexibility and as a further bonus, it will approximately cost 1% of aircraft value per month A380 \$4m per month.

Try consolidating on this section by completing the Competing Airlines, Practical Exercise.