Introduction to Aviation Economics

1. Introduction to Aviation Economics The economic characteristics of the Airlines Business

2. Overview Economists usually describe the certificated airline industry as an oligopolistic economic structure That is, this industry composed of few firms (can be 5/ 10/ 100) producing either similar or differentiated products. Apart of few sellers and typically characterized by high barriers to entry Airline business also has its own distinguish feature Q: Name other possible oligopolistic industries

3. Other characteristics of oligopolistic industry • Substantial economic scale: Increase of size in operations leads to decrease of firm’s costs in a long term • Large scale of production afforded by intensive labor and management specialization of job responsibilities, technological and products utility efficiency make possible of low costs • So, if market demand only sufficient to support few large firms of optimum size, only few such firms will survive • It’d be hard for new and small firms to compete with these large firms

4. Growth merger: Many of oligopolies resulted from mergers of competing firms (i.e. Am Bank, CIMB) • The purpose of “merging” is to gain • Substantial increase in market share • Greater economies of scale • More buying power in purchasing of resources

5. Mutual Dependence: When there are only few firms in a market, it matters very much what their rivals do (i.e. Malaysia Airlines vs. Air Asia) • The competitor’s reactions play a vital role when setting prices • In these games, the participants try to win by formulating strategies that anticipate the counter-reactions of their opponents

6. Price rigidity and non-price competition: Firms are more likely to maintain their constant prices • As a result, firms engage in various forms of non-price competition like advertising and customer service • Price reductions occur only under severe pressures resulting from weakened demand ad excessive capacity (i.e. The case of Malaysia Airlines)

7. The Airlines Special Economic Characteristics: Despite of the economists’ point of view…. Government Financial Assistance High Technological Turnover High Labor and Fuel Expenses Sensitivity to Economic Fluctuations Close Government Regulation

8. Government Financial Assistance Unlike other oligopolistic industries (i.e. Mobile and Internet services), the government units have played a major roles in the growth of airport-airways systems (i.e. Malaysia Airlines) National airways system was maintained by the federal government at minimal cost to users of the system

9. Most commonly, the fees charged for landing aircraft, maintaining office and operational space do not repay the operating costs of the airport (Take the case of LCCT) As a result, airline industry benefited from the financing of the airport-airways system (which is the major cost element)

10. High Technological Turnover Technological advances in flight equipment over the short span of 30 years have come at an extremely rapid pace Airlines spend lots of money on flight re-equipment cycle, approximately at every 8 years Plus, capital spending in hiring and training personnel, and in modifying facilities to accommodate the new aircraft and associated equipment

11. High Labor & Fuel Expenses • These are two biggest expenses (Typically 60%) • Labor: Airline employees are men and women with highly developed skills and with correspondingly high incomes • Plus, airline needs a large number of manpower • Fuel: No other industry has been subjected to the severe increases of fuel prices that the airlines have experienced over the past 15 years.

12. Fuel price Costs Ticket Price = Less Passenger, Less Profit… At times, purchasing fuel-efficient aircraft (that burn less fuel than others) also can be very costly than do less-efficient aircraft Moreover, the actual price of fuel far outside any airline’s span of control

13. Sensitivity to Economic Fluctuations (Recession) • Unlike other durable good like automobile industries, whenever recession takes place, it is much slower for the airline industry to recover • Why? Because of the apparent impacts of recession on air travel • People postpone long-distance travel • Companies cut back business trip/ no/ of people sent on a given trip • Fewer people travel first class

14. Unlike other industries, airlines still have to continue make payments to creditors and outstanding debtors (primarily flight equipment) even during recession Further, although airline can furlough certain volume related employees, it’d involve extensive retraining costs when personnel are brought back or new personnel are hired

15. However, other economic characteristic : The Airlines as an Oligopolists? • We have discussed earlier on characteristics of oligopolistic industry • Apparently the airline industry also share some of the oligopolistic features: • Number of carriers and market share • High barriers of entry • Economies of scale • Growth through merger

16. Number of carriers and market share Recently there has been increment in airline firms with the addition of small certificated airlines and demise of some larger airlines (A once in a blue moon in M’sia but an apparent situation in the U.S. and Europe) BUT, they either liquidated, merged or never operated or decertified. So, the largest airline own ond retain the power in market share

17. Unquestionably, with this small numbers of airline companies and concentration of market share (Just like the aviation climate in M’sia).. It meets the first characteristic of oligopolistic industries

18. High Barriers of Entry • In recent years, it is difficult to get access to many markets due to • Difficulty to obtain terminal space at many hub airports • The financial outlays risk (i.e., advertising, personnel and aircraft operation cost) compete with the airline at its hub • Airport terminal capacity (i.e. Air Asia competing with M’sia Airlines at KLIA)

19. So, it is difficult to enter the airline industry and it is even harder during the start-up stage as the major airlines dominated the power to buy in the market This phenomenon match with the second criterion of oligopolistic firms

20. Growth through Merger • Airlines in particular growth through merger (Although, it is not the case in M’sia) • Merger can • Increase market share • Increase market power (greater ability to control the market for and the price of its service than does a smaller, more competitive producer) • Eliminating bankruptcy and competition

21. Like in the U.S: Merger decrease no. of certificated airlines (From 17 in 1950 to remaining 12 in 2002) This merger for growth feature makes the airline business fits as oligopolistic business

22. Mutual Dependence Airlines industry involves rivalry among a number of airlines An action taken by a particular airline would yield counter-reactions of their rivals or opponents Like, MAS vs. Air Asia (at domestic level) and MAS vs SIA (at international level) It is a fact that rivalry in airlines industry counter react with one another for profit gain

23. Let’s Recap • Oligopoly • Characteristics of oligopolistic industry • Unique characteristic of airline industry • Oligopolistic characteristics of airline industry

24. Price Rigidity and Nonprice Competition • Airline industry also oligopolistic in its price • Airliners are much comfortable maintaining constant price rather than rocking the boat, so to speak… • Why? • Mutual Dependence • Fear of Price War • Oligopolistic pricing has become the norms in airline industry

25. The major questions • If the airline industry is oligopolistic • How can a new airliner enter and survive in this industry? • How would existing airliners compete with the new airliner and retain themselves in the industry? • How to overcome to these oligopolistic barriers in airline business? • Airlines can independently make profits in each areas of aviation economic activities • This is where aviation economics deals with profit making and lowering costs in aviation activities

26. Airlines Profitable Economic Activities • There are five major parts of economic activities: • Part I: The Demand for Airline Services • Part II: Airline Route Feasibility/ Planning • Part III: Fixed-Base Operation (FBO) • Part IV: Fleet Planning • Part V: Maintenance, Repair, Overhaul (MRO) • Each of these share the aims on how to lower the costs and gain profit

27. Part 1: The Demand of Airline Services Demand is defined as the various amounts of a product or service that consumers are willing and able to purchase at various prices at a particular period of time Determining the demand would the help the airlines in setting the price, estimating and managing their costs and calculating how they can gain profits

28. This is where the airlines will deal with how certain forecasting methods can help the airline gain profit • Forecasting is • The attempt to quantify in a future time period • It is about predicting and estimating some future volume or financial situation

29. Part 2: Airline Route Planning/ Feasibility • This where airlines deal with the application of forecasting method in determining the costs of a route of one flight from one destination to another either • Domestic or • International • In terms of … • Flight personnel • Fuel consumption • Facilities and Airport cost • Passenger Movement and Air Crago

30. PART 3: Fixed Based Operations (FBO) In the aviation industry, a fixed base operator (also known as fixed base of operation), or FBO, is a service center at an airport that may be a private enterprise or may be a department of the municipality that the airport serves.

31. At a minimum, most FBOs offer aircraft fuel, oil, and parking, along with access to washrooms and telephones. Some FBOs offer additional aircraft services such as hangar (indoor) storage, maintenance, aircraft charter or rental, flight training, deicing, and ground services such as towing and baggage handling. • FBOs may also offer services not directly related to the aircraft, such as rental cars, lounges, and hotel reservations.

32. Among services provided by FBOs are • Ground Handling • Cabin Service • Catering • Ramp Service • Passenger Service • Field Operations Service

33. Ground Handling Many airlines subcontract ground handling to an airport or a handling agent, or even to another airline. Ground handling addresses the many service requirements of a passenger aircraft between the time it arrives at a terminal gate and the time it departs on its next flight. Speed, efficiency, and accuracy are important in ground handling services in order to minimize the turnaround time (the time during which the aircraft must remain parked at the gate).

34. Airlines with less-frequent service or fewer resources at a particular location sometimes subcontract ground handling or on-call aircraft maintenance to another airline, as it is a short-term cheaper alternative to setting up its own ground handling or maintenance capabilities. Most ground services are not directly related to the actual flying of the aircraft, and instead involve other tasks.

35. Cabin Services These services ensure passenger comfort. They include such tasks as cleaning the passenger cabin and replenishment of on-board consumables or washable items such as soap, pillows, tissues, blankets, etc.

36. Catering Catering includes the unloading of unused food and drink from the aircraft, and the loading of fresh food and drink for passengers and crew. Airline meals are typically delivered in trolleys. The empty or trash-filled trolley(s) from the previous flight is replaced by a fresh one. Meals are prepared mostly on the ground in order to minimize the amount of preparation (apart from chilling or reheating) required in the air.

37. Ramp Service • This includes services on the ramp or apron, such as: • Guiding the aircraft into and out of the parking position (by way of Aircraft marshalling • Water cartage (to refill fresh water tanks) • Refueling, which may be done with a refueling tanker truck or refueling pumper • Passenger stairs (used instead of an aerobridge or airstairs, some budget airlines use both to improve turnaround speed) etc.

38. Passenger Service This includes services inside the airport terminal such as: Providing check-in counter services for the passengers departing on the customer airlines. Providing Gate arrival and departure services. The agents are required to meet a flight on arrival as well as provide departure services including boarding passengers, closing the flight, etc. Staffing the Transfer Counters, Customer Service Counters, Airline Lounges, etc.

39. Field Operation Service This service dispatches the aircraft, maintains communication with the rest of the airline operation at the airport and with Air Traffic Control.

40. PART 4: Fleet Planning; Aircraft lease and Purchase Aircraft leases are a number of types of leases used by Airlines and other aircraft operators. Airlines lease aircraft from other airlines or leasing companies for two main reasons; to operate aircraft without the financial burden of buying them, and to provide temporary increase in capacity.

41. The industry has two main leasing types, wet leasing which is normally used for short term leasing and dry leasing which is more normal for the longer term leases. The industry also uses combinations of wet and dry when for example the aircraft is wet-leased to establish new services then as the airlines flight or cabin crews become trained they can be switched to a dry lease.

42. When purchasing aircraft, it allows an airline to purchase additional aircraft in the future at an agreed price and date When placing orders for new aircraft, airlines commonly obtain options from the aircraft manufacturer, for example Airbus or Boeing. These options allow the airline to delay the purchase of additional aircraft until market conditions become clearer and the purchase can be justified. It also reserves the airline a place in the manufacturing queue, for a guaranteed delivery slot.

43. When the airline finally exercises its options, it can place its order without having to join the beginning of the queue which otherwise may delay the delivery of the aircraft for years. If future conditions don't justify expansion of the airline's fleet, the airline is not obligated to purchase the aircraft

44. Depending on economic conditions, manufacturers often sell aircraft purchasing options below the real value of the aircraft Therefore, in this case determining of the demand, need and costs is important for an airline to decide whether to lease or purchase aircraft.

45. PART 5: Maintenance Repair Overhaul (MRO) • Aircraft MRO is the overhaul, repair, inspection or modification of an aircraft or aircraft component • Maintenance includes the installation or removal of a component from an aircraft or aircraft subassembly, but does not include: • Elementary work, such as removing and replacing tires, inspection plates, spark plugs, checking cylinder compression, etc

46. Servicing, such as refueling, washing windows • Any work done on an aircraft or aircraft component as part of the manufacturing process, prior to issue of a certificate of airworthiness or other certification document