1 Answer

Sheronda · Answer 1 · 2022-04-20T06:30:22+0000

Airline Economics

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 barbershops. 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.

Unlike many service businesses, airlines need more than storefronts and telephones to get started. They need an enormous range of expensive equipment and facilities, from airplanes 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.

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 jeopardized.

Airlines also are labor intensive. Each major airline employs a virtual army of 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. Labor costs per employee are among the highest of any industry.

Every airline has what is called a break-even load factor. That 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.

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. If low prices are what an airline's customers favor, it will seek to maximize 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. The key for most airlines is to strike the right balance to satisfy its mix of customers and thereby maintain profitability.