Airline Cost Structure
Topic : Analyze airline cost structure, the nature of fixed, variable, and controllable costs, and methods employed by low-cost carriers to obtain sustainable competitive cost advantages over traditional carriers.
Write a paper on any aspect of the course that interests you within the confines of Objectives for that week’s materials you are reading. The paper (text) must be a minimum of 1000 words and be in APA formatting. APA format requires double space, cover page, headers, and a references list. Please refer to the Course Research Center in the forum area for help with writing.
Also, the paper must have at least 3-5 references, meeting the requirements of an academic reference (Wikipedia and similar sites do not count). References cannot be older than 5 years.
Airline Cost Structure
The global airline industry is one of the largest and most significant industries globally. A multibillion dollar industry, the activities of this sector have come into sharp focus in the 21st century, due to trends such as globalization and the internationalization of business and other activities (Statista, 2016). These phenomena have facilitated a greater need for and a greater demand for travel, much of which is satisfied through air travel. The travelling patterns and tendencies of airline passengers, are therefore key factors that affect the revenues of airlines. The past few decades have witnessed a radical paradigm shift in the nature of operations in the airline industry. Key among these shifts has been the percolation of trends such as informational technology, generational shifts and the emergence of low cost carriers. The cost structures for airlines are explored, as well as some of the approaches that low-cost carriers have adopted to gain a competitive advantage over traditional carriers.
The cost structure of airlines is based on a number features and factors that airlines need for their operations. For starters, the cost of labour is a significant cost, whereby Stalnaker, Usman and Taylor (2015) report that there is an increase in the unit labor costs, particularly for value carriers. The cost of labor is a variable cost which relies on the number of airplanes that an airline owns. A second cost driver is fuel. Fuel is one of the most significant costs which is a feature of the airline industry’s life cycle. Fuel is a variable cost, which, varies greatly due to global crude oil prices and geopolitical factors (Stalnaker, Usman & Taylor, 2015). There are several other drives of cost, which include food, commissions, landing fees and advertising fees. Costs such as labor costs and fuel prices are largely uncontrollable. Uncontrollability is particularly true of fuel prices, which are influenced by many external factors, which have been noted. Costs such as advertising are controllable, by regulating the level of advertising.
The past few years have witnessed the emergence of a new model of airlines, referred to as low cost carriers. These low cost carriers, as the name suggests, have their operations fashioned around cost. Their aim is to reduce the prices they charge for travelling, by cutting down on any costs that may be deemed unnecessary. Under this model, the air travel package is unpackaged from its traditional model of a unitary travel bundle, into smaller separate products, with customers paying for each component individually (O’Connell & Warnock-Smith, 2013). The unbundling of the air travel product has been necessitated by an increasing pressure to sustain profit-making, in the face of increased competition. The pioneer low cost carrier globally is Ryanair, an Irish airline founded in 2000. At its inception, Ryanair harnessed the power of the internet to facilitate hotel bookings and car hires.
As noted, the essence of the low cost carrier model is that the air travel package is unbundled. Usually, the core product is the instance of travelling. This core product is charged from the air ticket. Any additional products and services are usually charged separately. This differs from the traditional airlines, which would conventionally charge everything to the air ticket and provide additional products and services on a complementary basis. For this reason, these carriers are also often referred to as full service carriers.
Several factors have contributed to the emergence and dominance of low cost carriers. One of these factors is the internet. As has been noted, at its inception of the LCC model, Ryanair relied on the internet to enable car hires and hotel bookings. The internet also supports and facilitates a range of other capabilities, including online advertising, which is a much cheaper alternative to traditional methods of advertising. While the capability of online advertising is not a preserve of low cost carriers, it enhances the competitive advantage of low cost carriers, by keeping their operational costs low. Additionally, the Massachusetts Institute of Technology (n.d.) further points out that the internet facilitates alternative distribution channels. These alternative channels then impose downward pressures on air travel fares. These factors have not only facilitated the emergence and proliferation of low cost carriers, they have also provided or enhanced the competitive advantage for these carriers.
The internet has played a major role in facilitating the low cost carrier model. There are a number of other factors that have also been significant. First, there is the liberalization of air services. O’Connell and Warnock-Smith (2013) indicate that the liberalization of the airline industry, coupled with such factors as increasing fuel prices and higher competition in an increasingly volatile environment (Assaf & Josiassen, 2012) led to a decline in yields. Consequently, the low cost carrier model emerged as an alternative to reduce the costs associated with travel for both the consumer and the airline.
There are several features of the low cost carrier model which provide them with a competitive advantage. The first is their pricing approach, which appeals to a good deal of consumers. Consumers who wish to travel and are cash strapped are able to exploit the LCC model by paying for the basic service of travelling. Additionally, customers can pick and pay for those services which are within their price ranges. Consequently, LCCs are able to enjoy a competitive advantage in the form of carving out a market share of low budget5 travellers. Secondly, LCCs are also able to enjoy competitive advantages associated with their low cost of operations. These companies harness factors such as the internet to lower the cost of producing their services. Finally, LCC’s are able to derive a competitive advantage through the ancillary revenue approach.
The ancillary revenue approach is one
whereby airlines generate revenue based on their interactions with consumers.
Such revenues are earned from the sale of additional products or services to
consumers. Alternatively, ancillary revenues may be earned from the consumers
travel experience. Ancillary revenues are obtained from three principle
sources. These sources are a-la-carte charges, commission based revenue and
frequent flyer activities. A la carte charges are the most significant source
of ancillary revenues, and are essentially revenues from the sale of those
products and services that were unbundled from the travel product. Stalnaker, Usman and Taylor (2015) indicate
that some of the common charges are excess baggage fees, on-bard sales and
miscellaneous charges. Stalnaker, Usman and Taylor (2015) go on to indicate
that ancillary revenues earned in this manner comprised 8.0% of all revenue
earned by airlines in the year 2015. Commission based earnings come from third
parties who sell their products through airlines. Such services include hotel
charges, car hire and insurance. Finally, ancillary revenue is also earned from
frequent flyer program sales, which account for 50% of all ancillary revenue
earned by US carriers (O’Connell & Warnock-Smith, 2013). Ancillary revenues
provide competitive advantages for low cost carriers since they act as an
additional source of income. Alternatively, they can provide a cushion that
would enable low cost carriers to charge even cheaper ticket prices, knowing
that the opportunity costs would be recovered through ancillary revenue
Assaf, A. G., & Josiassen, A. (2012). European vs. US airlines: Performance comparison in a dynamic market. Tourism Management, 33(2), 317-326. Retrieved from: http://www.academia.edu/download/5834007/11_Josiassen_TM.pdf
Belobaba, P., Odoni, A., & Barnhart, C. (2015). The global airline industry. John Wiley & Sons. Retrieved from: https://books.google.com/books?hl=en&lr=&id=HwBhBgAAQBAJ&oi=fnd&pg=PA99&dq=The+global+airline+industry&ots=c0kJnsDmid&sig=JMAEk8o9rLt2wr7I4DTbyupscqk
IATA. (2016, December 8). Another Strong Year for Airline Profits in 2017. Retrieved from IATA: http://www.iata.org/pressroom/pr/Pages/2016-12-08-01.aspx
Massachusetts Institute of Technology. (n.d.). Airline Data Project. Retrieved from MIT: http://web.mit.edu/airlinedata/www/Revenue&Related.html
Statista. (n.d). Revenue of commercial airlines worldwide from 2003 to 2017 (in billion U.S. dollars)*. Retrieved from Statista: https://www.statista.com/statistics/278372/revenue-of-commercial-airlines-worldwide/
O’Connell, J. F., & Warnock-Smith, D. (2013). An investigation into traveler preferences and acceptance levels of airline ancillary revenues. Journal of Air Transport Management, 33, 12-21. Retrieved from: https://www.researchgate.net/profile/David_Warnock-Smith/publication/259139449_An_investigation_into_traveler_preferences_and_acceptance_levels_of_airline_ancillary_revenues/links/55db3dd908aed6a199ac5a91.pdf
Stalnaker, T., Usman, K., & Taylor, A. (2015). Airline economic analysis. For the Raymond James Global Airline Book, by Tom Stalnaker, Khalid Usman and Aaron Taylow. Retrieved from: http://www.oliverwyman.com/content/dam/oliver-wyman/global/en/2016/jan/oliver-wyman-airline-economic-analysis-2015-2016.pdf