Chapter 5

Air Carriers

BRIEF HISTORY p158

• In 1908 the development of air transportation began with the U.S. Post Office examining the feasibility of providing air mail service.

• Although airplanes were used in World War I, the use of air planes for mail transport can be considered the beginning of the modern airline industry.

BRIEF HISTORY cont’

• Passenger transportation services developed as a by-product of the mail business and began to flourish in selected markets.

• Since that time, airplanes have become faster, bigger, and relatively more fuel-efficient.

• Although the level and degree of technological improvement have slowed in the airline industry, there is still opportunity for further innovation.

BRIEF HISTORY cont’

• Airline travel is a common form of transportation for long-distance passenger and freight travel and the only reasonable alternative when time is of the essence.

• The tremendous speed of the airplane, coupled with more competitive pricing, has led to the growth of air transportation, particularly in the movement of passengers.

INDUSTRY OVERVIEW AND SIGNIFICANCE p158

• The airline industry is very dependent on passenger revenues to maintain its financial viability.

• However, to characterize airlines simply as movers of people presents too simplistic a view of their role in our transportation system.

INDUSTRY OVERVIEW AND SIGNIFICANCE cont’

• Although their share of the freight movement on a ton-kilometre basis is small, the type of traffic that they carry (high-value, perishable, or emergency) makes them an important part of our total transportation system.

• Emphasis upon total logistics cost in a quick-response lead-time environment will continue to con tribute to their growth in freight movements.

TYPES OF CARRIERS p158

Private Carriers• Air carriers can be segmented into for-hire

carriers and private carriers. • A private air carrier is a firm that

transports company personnel or freight in planes to support its primary business.

• Private air transportation is predominantly used to transport company personnel, although emergency freight is sometimes carried on private airplanes as well.

For-Hire Carriers• The for-hire carriers are no longer regulated on an

economic basis by the federal government and cannot be easily categorized into specific types because carriers provide many types of services.

• For our purposes, the for-hire carriers will be discussed according to type of service offered (air taxi, commuter, charter, and international) and annual revenue (nationals, and regionals).

For-Hire Carriers cont’

• A classification frequently used by U.S. air carriers is one based on annual operating revenues.

• The categories used to classify air carriers in terms of revenue are as follows:Majors -annual revenues of more than $1

billionNationals -annual revenues of S100 million to $1 billionRegionals -annual revenues of less than $100

million

For-Hire Carriers cont’

• U.S. major carriers provide service between major population areas within the United States such as New York, Chicago, and Los Angeles.

• The routes served by these carriers are usually high- density corridors, and the carriers use high-capacity planes

• U.S. national carriers operate between less-populated areas and major population centers. These carriers operate scheduled service over relatively short routes with smaller planes.

For-Hire Carriers cont’

• Regional carriers have operations similar to the nationals. The carriers operate within a particular region of the country and connect less-populated areas with larger population centers

• The all-cargo carrier, as the name implies, primarily transports cargo.

• all-cargo carriers can freely set rates, enter and exit markets, and use any size aircraft dictated by the market. Examples of all-cargo carriers include FedEx and UPS Airlines.

For-Hire Carriers cont’

• The commuter air carrier is technically a regional carrier.

• The commuter publishes timetables on specific routes that connect less-populated routes with major cities.

• As certified carriers abandon routes, usually low-density routes, the commuter enters into a working relationship with the certified carrier to continue service to the community.

For-Hire Carriers cont’• The charter carriers, also known as air taxis, use

small to medium size aircraft to transport people or freight.

• The supplemental carrier has no time schedule or designated route.

• The carrier charters the entire plane to transport a group of people or cargo between specified origins and destinations.

• Many travel tour groups use charter carriers. • The rates charged and schedules followed are

negotiated in the contract.

MARKET STRUCTURE p160

Number of Carriers• Private air transportation has been estimated

to include approximately 60,000 company-owned planes, with over 500 U.S. corporations operating private air fleets.

• In addition, thousands of planes are used for personal, recreational, and instructional purposes.

COMPETITION p162Intermodal• Due to their unique service, air carriers face limited

competition from other modes for both passengers and freight.

• Air carriers have an advantage in providing time-sensitive, long-distance movement of people or freight.

• Airlines compete to some extent with motor carriers for the movement of higher-valued manufactured goods; they face competition from automobiles for the movement of passengers and, to a limited extent, from trains and busses.

• For short distances (under 800 km), the access time and terminal time offsets the speed of the airline for the line-haul.

Intramodal• Competition in rates and service among the

air carriers is very intense, even though the number of carriers is small.

• Carriers may also have excess capacity (too many flights and seat miles on a route) and attempt to attract passengers by selectively lowering fares to fill the empty seats.

Intramodal cont’

• New entrants to the airline market initially cause overcapacity to exist on many routes.

• To counter this and add passengers to their aircraft, carriers reduce prices and fare wars begin.

• This causes financially weaker carriers to exit the market. • This is especially true of carriers with high operating costs

(many times due to high-cost union labour contracts), high cost of debt, or high levels of fixed costs. (Many of these maintain high fixed investments in hub-and-spoke terminal operations.)

Intramodal cont’

• The remaining carriers begin to enjoy economies of density (discussed later in this chapter), and the cost per passenger kilometre will decrease and margins will increase, even in the existence of relatively low fares.

• So, even with the discounted prices in today’s airline market, many carriers have been able to remain profitable.

Service Competition• Competition in airline service takes many

forms, but the primary service competition is the frequency and timing of flights on a route.

• Carriers attempt to provide flights at the time of day when passengers want to fly.

• Flight departures are most frequent in the early morning (7:00 am. to 10:00 p.m.) and late afternoon (4:00 p.m. to 6:00 p.m.).

Service Competition cont’

• In addition to the frequency and timing of flights, air carriers attempt to differentiate their service through the advertising of passenger amenities.

• Carriers promote such things as on-time arrival and friendly employees to convince travellers that it has the desired quality of service.

• Gourmet meals and on-board movies are some of the amenities that a carrier uses to entice passengers to use and reuse its service.

Service Competition cont’

• A postderegulation development in service competition was no-frills service (Budget airlines).

• The no-frills air carrier (for example, Southwest Airlines) charges fares that are lower than that of a full-service air carrier.

• However, passengers receive limited snacks and drinks (coffee, tea, or soft drinks).

Service Competition cont’

• Another hall mark of such carriers is that they only provide one class of service.

• Also, the passengers provide their own magazines or other reading materials.

• Overall, there are fewer airline employees involved in no-frills services operations, which contribute to lower costs.

• The “no-frills” carriers have had a significant impact on fares where their service is available.

Cargo Competition• For cargo service, competition has become

intense. • As a result of the complete deregulation of

air cargo in 1977, air carriers have published competitive rates, but these rates are still higher than those available via surface carriers.

• Freight schedules have been published that emphasize low transit times between given points.

Cargo Competition cont’

• To overcome accessibility problems, some carriers provide door-to-door service through contacts with motor carriers.

• Major airline freight companies (e.g., FedEx, UPS Airlines, and DHL) have their own fleets of surface delivery vehicles to perform the ground portion of this door-to-door service.

OPERATING AND SERVICE CHARACTERISTICS p164

General• Air transportation dominates the for-hire,

long-distance passenger transportation market.

• The majority of freight using air service is high-value and/or emergency shipments.

• The high cost of air transportation is usually prohibitive for shipping low-value routine commodities unless there is an emergency.

• For emergency shipments, the cost of air transportation is often inconsequential compared to the cost of delaying the goods.

• For example, an urgently needed part of an assembly line might have a $20 value, but if the air-freighted part arrives on time to prevent the assembly line from stopping, the “opportunity” value of the part might become hundreds of thousands of dollars.

• Thus, the $20 part might have an emergency value of $200,000, and the air freight cost is a small portion of this emergency value.

• Examples of commodities that move via air carriers include mail, clothing, communication products and parts, photography equipment, mushrooms, fresh flowers, industrial machines, high-priced livestock, racehorses, expensive automobiles, and jewellery.

• Normally basic raw materials such as coal, lumber, iron ore, or steel are not moved by air carriage.

• The high value of these products provides a cost-savings trade-off, usually but not always from inventory, that offsets the higher cost of air service. The old adage “Time is money” is quite appropriate here.

Speed of Service• Undoubtedly, the major service advantage of air

transportation is speed. • The terminal- to-terminal time for a given trip is

lower via air transportation than via any of the other modes.

• Commercial jets are capable of routinely flying at speeds of 800 to 960 kilometres per hour, thus making a New York to California trip, approximately 4,800 kilometres, a mere 6-hour journey.

Speed of Service cont’

• This advantage of high terminal-to-terminal speed has been dampened somewhat by reduced frequency of flights and congestion at airports.

• Air carriers have been concentrating their service on the high-density routes like New York to Chicago, for example.

• In addition, most carriers have adopted the hub-and-spoke terminal approach, in which most flights go through a hub terminal; Atlanta (Delta) and Chicago (United) are examples .

Speed of Service cont’

• These two factors have aggravated the air traffic congestion and ground congestion at major airports and have increased total transit time while decreasing its reliability.

• The shippers who use air carriers to transport freight are primarily interested in the speed and reliability of the service and the resultant benefits, such as reduced inventory levels and inventory carrying costs.

Speed of Service cont’

• Acceptable or improved service levels can be achieved by using air carriers to deliver orders in short time periods.

• Stock-outs can be controlled, reduced, or eliminated by responding to shortages via air carriers.

Length of Haul and Capacity• For passenger travel, air carriers dominate the

long-distance moves. • The capacity of airplanes is dependent on its type.

A wide-body, four-engine jet has a seating capacity of about 370 people and an all-cargo carrying capacity of 16.6 tons.

• Table 5.3 provides capacity and operating statistics for some of the more commonly used aircraft in both domestic and international markets.

Length of Haul and Capacity cont’

• Normally, small shipments that are time-sensitive are moved by air carriers.

• In addition to small shipment sizes, the packaging required for freight shipped by air transportation is usually less than other modes.

• The relatively smooth ride through the air and the automated ground-handling systems contribute to lower damage and thus reduce packaging needs.

Accessibility and Dependability• Except in adverse conditions such as fog or snow,

air carriers are capable of providing reliable service.

• The carriers might not always be on time to the exact minute, but the variations in transit time are small.

• Sophisticated navigational instrumentation permits operation during most weather conditions.

• On-time departures and arrivals are within 15 minutes of scheduled times.

Accessibility and Dependability cont’

• Poor accessibility is one disadvantage of air carriers.

• Passengers and freight must be transported to an airport for air service to be rendered.

• This accessibility problem is reduced when smaller planes and helicopters are used to transport freight to and from airports, and most passengers use automobiles.

• Limited accessibility adds time and cost to the air service provided

Accessibility and Dependability cont’

• Even with the accessibility problem, air transportation remains a fast method of movement and the only logical mode when distance is great and time is restricted.

• The cost of this fast freight service is high, about three times greater than motor carrier and 10 times greater than rail.

• Nevertheless, the high speed and cost make air carriage a premium mode of transportation.

EQUIPMENT p167

Types of Vehicles• As previously mentioned, there are several

different sizes of airplanes in use, from small commuter planes to huge, wide-body, four-engine planes used by the nationals

• Table 5.3 compares some of the major aircraft types in terms of seats, cargo payload, speed, fuel consumption, and operating cost per hour.

• Airlines have many options to select from when purchasing equipment.

Terminals• The air carriers’ terminals (airports) are financed

by a government entity. • The carriers pay for the use of the airport through

landing fees, rent and lease payments for space, taxes on fuel, and aircraft registration taxes.

• In addition, users pay a tax on airline tickets and air freight charges.

• Terminal charges are becoming increasingly more commonplace for passenger traffic.

Terminals cont’

• The growth and development of air transportation is dependent upon adequate air port facilities.

• Therefore, to ensure the viability of air transportation, the government has the responsibility of financially contributing to the construction of airport facilities.

• The various state and local governments assume the responsibility for operating and maintaining the airports.

Terminals cont’

• At the airport, the carriers perform passenger, cargo, and aircraft servicing.

• Passengers are ticketed, loaded, and unloaded, and their luggage is collected and dispersed.

• Cargo is routed to specific planes for shipment to the destination airport or to delivery vehicles.

• Aircraft servicing includes refuelling; loading of passengers, cargo, luggage, and supplies (food); and maintenance.

• Major aircraft maintenance is done at specific airports.

Terminals cont’

• As carrier operations become more complex, certain airports in the carriers’ scope of operation become hubs.

• Flights from outlying, less-populated areas are fed into the hub airport, where connecting flights are available to other areas of the region or country.

Terminals cont’

• By using the hub airport approach, the carriers are able to assign aircraft to feed passengers into the hub over low-density routes and to assign larger planes to the higher-density routes between the hub and an airport serving a major metropolitan area.

• In essence, the hub airport is similar to the motor carrier’s break-bulk terminal.

COST STRUCTURE p169

Fixed Versus Variable Cost Components• Like the motor carriers, the air carriers’ cost

structure consists of high variable and low fixed costs.

• Approximately 80 percent of total operating costs are variable and 20 percent are fixed.

• The relatively low fixed cost structure is attributable to government investment and operations of airports and airways.

• The carriers pay for the use of these facilities through landing fees, which are variable in nature.

Fixed Versus Variable Cost Components cont’

• As indicated in Table 5.5, 30.4% of airline operating costs in 2002 was incurred for flying operations; maintenance costs equalled 12.3% of total operating costs.

• Both of these expenses are variable costs. • The next major category of expense is aircraft and

traffic servicing, which totalled about 17% of total operating costs.

• In 2002 depreciation accounted for about 6.0 % of total operating expenses.

Fixed Versus Variable Cost Components cont’

• The increased price competition in the airline industry has caused airlines to try to operate more efficiently by cutting costs where possible.

• There has been much effort put forth to decrease labour costs because the airline industry tends to be labour-intensive compared to other modes, such as railroads and pipelines.

• The air lines have negotiated significant labour cost reductions with many of the unions represented in the industry.

Fuel• Escalating fuel costs have caused problems in the

past for the airlines. • The impact that such fuel increases have had can

be shown by analyzing fuel consumption for certain aircraft that are commonly used today.

• The Air Transportation Association’s annual report shows that the number of gallons of fuel consumed per hour for the following planes is as follows (Table 5.3):

Fuel cont’

• 367-seat 747 3,411 gallons/hour = 12911 litres/hour• 286-seat DC-10 2,405 gallons/hour = 9103

litres/hour• 148-seat 727 1,289 gallons/hour = 4879 litres/hour• 101-seat DC-9 826 gallons/hour = 3126

litres/hour• Using a cost of $0.77 per gallon, the fuel cost per hour is

$2,626.47 for a 747, $1,851.85 for a DC-10, $992.53 for a 727, and $636.02 for DC-9. Consequently, rapidly escalating fuel costs in recent years have caused airlines to suffer financially in an already depressed pricing market.

Fuel cont’

• When fuel costs rise, carriers scrutinize planes in the fleet as well as routes served.

• More fuel-efficient planes have been developed and added to carrier fleets.

• In the short run, carriers are substituting smaller planes on low-density (low demand) routes and eliminating service completely on other routes.

Labour• Labour costs represented over 65 percent of total

operating expenses in 2002. In 2002 carriers employed about 601,000 people.

• Airlines employ people with a variety of different skills:

• To operate the planes, the carrier must employ pilots, co-pilots, and flight engineers.

• The plane crew also includes the flight attendants, who serve the passengers.

Labour cont’

• Communications personnel are required to tie together the different geographic locations.

• Mechanics and ground crews for aircraft and traffic service provide the necessary maintenance and servicing of the planes.

• The final component of airline employment consists of the office personnel and management.

Labour cont’

• Overall employment has decreased as airlines have moved aggressively to reduce costs to improve their competitiveness and lower prices in selected markets.

• Strict safety regulations are administered by the CAA (South African Civil Aviation Authority).

• Acceptable flight operations, as well as hours of service, are specified for pilots.

• CAA regulations also dictate appropriate procedures for flight attendants to follow during takeoff and landing.

Labour cont’

• The wages paid to a pilot usually vary according to the pilot’s equipment rating.

• A pilot who is technically capable (has passed a flight examination for a given type of aircraft) of flying a jumbo jet will receive a higher compensation than one who flies a single-engine, six-passenger plane.

Equipment• As mentioned earlier, the cost of operating

airplanes varies. • Larger planes are more costly to operate per

hour than smaller planes, but the cost per seat-kilometre is lower for larger planes.

• That is, the larger plane has the capacity to carry more passengers; thus, the higher cost is spread out over a large number of output units.

• Table 5.3 shows the hourly operating costs for four aircraft used by major carriers in 2002.

• The cost per block hour was $8,443 for the 367-seat 747 and $2,071 for the 101-seat DC-9. However, the cost per seat-mile was $0.0046 for the 747 and $0.00686 for the DC-9.

• This reduced operating cost per seat-mile for the larger planes indicates that economies of scale exist in aircraft.

Economies of Scale/Economies of Density

• Large-scale air carrier operations do have some economies of scale, which result from more extensive use of large-size planes or indivisible units.

• Of the small number of major and national carriers, approximately 25 transport over 90 percent of the passengers, indicating that large-scale operations exist.

Economies of Scale/Economies of Density cont’

• The information contained in Table 5.3 suggests the existence of economies of scale with large-size planes.

• Market conditions (sufficient demand) must exist to permit the efficient utilization of larger planes (i.e., if the planes are flown near capacity, the seat-mile costs will obviously decrease).

• Contributing to the existence of economies of scale for an aircraft is the inability to inventory an unused seat.

Economies of Scale/Economies of Density cont’

• For example, a 367-seat 747 is about to close its doors with 10 seats empty.

• If the plane takes off with the empty seats, the seats are “lost” for that flight because the airline cannot inventory the excess capacity for another flight that might be overbooked.

• On the other hand, the marginal cost of filling those 10 empty seats right before the doors on the aircraft are closed are negligible.

• This is the same concept of economies of scale as found in the railroad industry.

• The marginal cost of adding one more rail car to a train right before departure is negligible.

Economies of Scale/Economies of Density cont’

• Another factor indicating large-scale operations for air carriers is the integrated communication network required for activities such as operating controls and passenger reservations.

• Small local or regional carriers find the investment required for such a communication system rather staggering, but without the communication system, the emerging carrier cannot effectively operate (provide connecting service with other carriers and ticketing to passengers).

• Such carriers have purchased passenger reservation systems from large carriers to be competitive.

Economies of Scale/Economies of Density cont’

• Industries characterized by high variable cost ratios (airlines and motor carriers) can relatively easily add equipment to a given market.

• As such, the ability to decrease fully allocated cost per mile by adding aircraft does not exist.

• On the other hand, when high fixed-cost industries (pipe and rail) add fixed capacity, they can decrease fully allocated cost per mile by adding volume to the fixed capacity.

• In high fixed-cost industries, however, capacity is not easily added in small increments.

Economies of Scale/Economies of Density cont’

• Economies of density exist when a carrier has significant volume between an origin-destination pair to fully utilize capacity on forward-haul movements as well as utilize significant capacity on back-haul movements.

• This concept can exist across all modes of transportation.

• Economies of density, then, are important for all airlines to achieve to fully utilize capacity in a given market.

• History has shown that this has been a successful strategy for new entrants to the airline passenger market.

RATESPricing• Airline pricing for passenger service is

characterized by the discounts from full fare. • Seats on the same plane can have substantially

different prices depending on restrictions attached to the purchase, such as having to stay over a weekend or having to purchase the ticket in advance.

• Business people generally pay more for their airline travel due to the more rigid schedules they are on and the fact that they usually depart and return during the high-demand times.

Pricing cont’

The price of seats on different flights and the price of the same seat on a particular flight can vary due to:

• competition with other airlines, • the time and day of departure and return, • the level of service (first class versus coach

or no-frills service), and • advance ticket purchase.

Pricing cont’

• Cargo pricing is dependent mainly on weight and/or cubic dimensions.

• Some shipments that have a very low density can be assessed an over-dimensional charge.

• This over-dimensional charge is used to gain more appropriate revenue from shipments that take up a lot of space but do not weigh much.

Operating Efficiency

• An important measure of operating efficiency used by air carriers is the operating ratio.

• The operating ratio measures the portion of operating income that goes to operating expenses:

Operating Ratio = (Operating Expense /Operating Income) x 100

Operating Efficiency

• Only income and expenses generated from passenger and freight transportation are considered.

• The over all profit margin is small, and a loss is incurred when the operating ratio exceeds 100.

Operating Efficiency cont’

• Another widely used measure of operating efficiency is the load factor (previously discussed).

• The load factor measures the percentage of a plane’s capacity that is utilized.

Load Factor = (Number of Passengers/Total Number of Seats) x 100

• Airlines have raised plane load factors to the 65- to 70-percent range.

• The particular route and type of plane (capacity) directly affect the load factor, as does price, service level, and competition.

CURRENT ISSUES p174

Safety• The issue of airline safety is of great importance to

the airline industry. • Any incident involving airplanes receives a great

deal of publicity from the media because of the large number of people affected at one time.

• (Accidents involving motor vehicles affect only a few people in each incident but affect a greater number of people than do airline accidents in the long run.)

Safety cont’

• Several factors affect airline safety. • First, airport security has come under close

scrutiny over the past several years because of the September 11, 2001 terrorist attacks on the twin towers.

• As a result, airport security has reached an all-time high, causing more delays at airport terminals.

Safety cont’

• However, air travel is still the safest way to travel. • Even though there is a significant loss of life in an

airline tragedy, air travel is still the safest mode for passenger travel, with automobiles being the most dangerous.

• Finally, as with other transportation modes, the issue of substance abuse concerning pilots and ground crews has become important.

• Strict drug-testing policies and alcohol consumption guidelines are in effect.