SYST 660Airline Operating Costs and Airline

Productivity

Robert Eftekari

Airline Business Model

• American Airlines is considered a Network Legacy Carrier (NLC):– American is a more traditional airline that operates large hub-and-

spoke networks consisting of regional, domestic, and international services.

– Characteristics in contrast with those of typical Low Cost Carriers (LCC):

• Multiple aircraft types from various airframe manufacturers.• Connecting hubs.• Labor unions.• Various classes of service (e.g., first class, economy).• Seat assignments.• Frequent flyer program.• Connection to travel agencies and global distribution systems (GDS)

Term Definitions

• RPMs = revenue passenger miles– ∑(number of passengers per flight i)(distance flown by flight i)

• ASMs = available seat miles– ∑(number of seats per flight i)(distance flown by flight i)

• RASM = revenue per available seat mile or unit revenue– (total revenue)/ASM

• CASM = cost per available seat mile or unit cost– (total operating expenses)/ASM

• Yield = average fare paid per passenger per mile– (passenger airfare revenue)/RPM

• PRASM = passenger revenue per available seat mile or passenger unit revenue– (passenger revenue)/ASM

Term Definitions

• Fuel Consumed = amount of fuel consumed over some time t– e.g., gallons/quarter, pounds/hour

• Fuel Costs per ASM = cost of fuel per available seat mile– (total fuel cost)/ASM

• Non-Fuel Costs per ASM = non-fuel cost per available seat mile– Wages, salaries, etc.– Other rentals and landing fees– Depreciation and amortization– Maintenance materials and repairs– Commissions, booking fees, credit card expense– Aircraft rentals– Food service– Other operating expenses/special charges/grants

Chart 1

Note: total (mainline and affiliate) RPM and ASM were available, but total load factor was not; the latter was computed via total RPM/ASM

Chart 1

• Observations:– ASM is always greater than RPM (load factor is less than 100%); logical

as the number of enplaned passengers cannot exceed the number of available seats.

– Economic crises of 2001 and 2008 can be seen by significant decreases in RPM in the last quarter for both years.

– For any given year RPM, ASM, and load factor appear to be greatest during quarters two and three; this implies a seasonal correlation; business appears to improve during the months of April through September; logical as many people take vacations during this time period and students are available to travel.

– Load factor appears to improve steadily over time; the chart suggests that the airline took actions to reduce the delta between ASM and RPM; possibly via a smaller fleet, switch to smaller aircraft, or network changes.

Chart 2

01 Q1

01 Q2

01 Q3

01 Q4

02 Q1

02 Q2

02 Q3

02 Q4

03 Q1

03 Q2

03 Q3

03 Q4

04 Q1

04 Q2

04 Q3

04 Q4

05 Q1

05 Q2

05 Q3

05 Q4

06 Q1

06 Q2

06 Q3

06 Q4

07 Q1

07 Q2

07 Q3

07 Q4

08 Q1

08 Q2

08 Q3

08 Q4

09 Q1

09 Q2

09 Q3

09 Q4

-2000

-1000

0

1000

2000

3000

4000

5000

6000

7000

8000

Income Before Taxes, Total Operating Expenses, Total Operat-ing Revenue vs. Year & Quarter

Income Before Taxes

Total Operating Expenses

Total Operating Revenue

Year & Quarter

Mil

lio

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of

Do

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Chart 2

• Observations:– Although income before taxes appears to be total operating revenue minus

total operating expenses, upon closer inspection it is not. Total operating revenue minus total operating expenses = operating income (different parameter in data file). Income before taxes includes the following:

• Operating income• Interest income, interest expense, interest capitalized• Miscellaneous

– The overall trend for American appears to be consistent losses with few profitable quarters; potential cause for recent bankruptcy.

– The recession of 2001 appears to be evident in the data for 2001 and 2002 as operating expenses well exceeding operating revenues; this could be explained by greater fuel costs and fewer business and personal travelers.

Chart 3

Chart 3

• Observations:– As previously seen with operating expenses and operating revenue, cost per

available seat mile (CASM) tends to exceed revenue per available seat mile (RASM) with few exceptions (indicating fairly consistent losses); two large “spikes” in CASM can be seen near the ends of 2001 and 2008, likely due to economic recessions and increased fuel costs.

– Passenger revenue per available seat mile (PRASM) is consistently less than RASM which is expected per term definitions as RASM includes additional non-passenger revenues.

– Excluding data spikes, the overall trend for yield per RPM is a slight increase which suggests that the airline took action to increase fares in the presence of aforementioned losses (CASM > RASM).

– Excluding data spikes, the overall trend for all other parameters is a mild increase which is not ideal. Increasing RASM and PRASM vs. decreasing CASM would be ideal.

Chart 4

Chart 4

• Observations:– Non-fuel operating expenses appear to fluctuate from 2001 though

2002; this is potentially due to the economic crisis of 2001 and potential expenses for aircraft security upgrades.

– From 2003 through 2009 non-fuel operating expenses appear to remain fairly level (excluding a spike in the second quarter of 2008).

– However, the overall trend for fuel operating expense is a continuous increase followed by a slight decrease in late 2008 through 2009

– Excluding fluctuations in 2001 through 2002, the overall trend for fuel consumed is a steady decrease.

– This chart indicates that despite efforts to maintain stable non-fuel expenses and decrease fuel consumption, fuel operating expenses continued to climb significantly increasing total operating expenses.

Chart 5

Note: jet fuel price per month was converted to quarterly data by averaging values corresponding to appropriate three month time periods.

Chart 5

• Observations:– Despite the division by ASM, expense data in this chart strongly

correlates to that in chart 4; excluding spikes in 2001 through 2002 and 2008, non-fuel expenses per ASM tend to remain fairly stable; fuel operating expenses per ASM tend to continuously increase with a slight decrease in late 2008 through 2009 (as does jet fuel price).

– Of note is the significant difference in slope between jet fuel price and fuel operating expense per ASM; this indicates that some action was taken to mitigate effects of rising jet fuel prices.

– If no action was taken (e.g., fleet/seats and routes/total distance flown remained unchanged) fuel operating expense per ASM should have increased with the same rate as jet fuel price as ASM would be a constant.

Effect of Fuel Prices

• Expenses– Charts 3, 4, and 5 show that trends (increasing slope) are similar for CASM,

aircraft fuel operating expense, and aircraft fuel operating expense per ASM; increasing slope for overall fuel price trend indicates correlation.

– However, the slope for fuel price trend is significantly greater than slopes for aforementioned parameter trends. This, in combination with an overall decreasing slope for fuel consumed indicates that the airline took actions to mitigate the effects of fuel prices.

• Airline Finance– Chart 2 shows that total operating expenses for American typically exceeded total

operating revenues, leading to consistent losses.– An additional computation shows that fuel operating expense (on average) was

23.6% of total operating expense; this implies that fuel prices were a significant contributor to the observed losses.

– A slight increase in airfares, reflected by yield per RPM in chart 3, may have been one potential action in response to increasing fuel costs.

Effect of Fuel Prices

• Airline Network Structure– Chart 1 shows that the delta between ASMs and RPMs (ASM – RPM) was

steadily reduced from 2001 to 2009.– This is also reflected by load factor (RPM/ASM) with a steadily increasing

trend.– These relationships, in combination with a decrease in fuel consumption

shown in chart 4, and in light of increasing fuel costs over the same period, indicate that fleet and/or network changes were made.

– Increased load factor can result from use of smaller aircraft (less seats available for some given passenger demand) or reduction of number of flights between points A and B.

– Decrease in fuel consumption could also result from smaller aircraft, less flights, and/or route changes (smaller distances flown or fewer routes).