Economics and balancing the choices confronting airlines

Ekelem Airhihen, a chartered accountant, is an airport customer experience specialist. He can be reached on ekyair@yahoo.com and +2348023125396 (WhatsApp only)

Reaching an equilibrium in the aviation market has remained a struggle. Getting an equilibrium where the number of seats available at a specific price perfectly matches the desire of passengers to travel and the fare they are willing to pay is a challenge for aviation.

Airlines can broadly be classified as Major, Regional, Cargo and Integrators based on their business models. However some other sub classifications do exist among the major airlines category according to their business model also.

The traditional (Legacy) business model of major airlines usually has an international route structure with a range of amenities and full customer service departments. The Low Cost Carrier business model uses an aircraft type that allows lower fares to passengers. They offer fewer amenities and typically use a point–to–point route structure.

Regional airlines are companies that have regional route structures and operate a fleet of smaller aircraft. They may be independent or subsidiaries of a major airline. They operate networks over shorter distances than major airlines.

Cargo airlines are freight only airlines which focus specifically on delivery of goods rather than passengers. They may offer scheduled, charter or contract services.

Integrators are door-to-door organisations that offer door- to-door delivery of goods with an established timeframe for delivery. They often operate a fleet of aircraft and can operate full shipping networks that can also include sorting/distribution centres, delivery trucks, among others.

Air transportation is a service industry. The airlines perform a service for their customers where, for an agreed price, they transport them and their belongings or products from one place to the other. One peculiarity of the industry is that there is no physical product given for the money paid by the customer. Also, no inventory can be created and stored for sale later. Airline seats are a perishable commodity. Once an aircraft pushes back from a gate to begin a trip, those seats which were not occupied have perished.

Airline business is capital intensive. It requires large sums of money to operate effectively. To get access to capital, airlines require consistent profitability. Aeroplanes are expensive and so are maintenance hangars and other facilities required to run an airline. So when profits and cash flows of airlines begin to go south, their operations are increasingly at risk of going under.

Airline profitability is dependent on three factors, namely: costs, load factors and yield. Managers of airlines must strategically balance these factors to create sustainable profits over time. An airline could at a low price sell all seats and yet yield would be very meagre as very little revenue would have been collected. On the other hand, all first class cabins can be filled at very high fares and an empty economy cabin. Here, the load factor would be very low while yield would be high. So, airlines balance the objectives of filling every seat with paying passengers while using price discrimination to maximize profits.

Airlines are capital, labour and safety intensive companies. They must also abide by national regulations and international standards and recommended practices. There is a high degree of regulatory oversight over them. These add up to costs for airlines. Fuel, labour and equipment are major cost elements. Labour is important because the airline is a service business where customers require personal attention. And labour in the industry is highly unionised.

Even in the best of times airline business has thin profit margins. It is also a seasonal business. So, airline revenues rise and fall according to peaks and valleys in air travel patterns.

Fares and freight rates are determined by both customer demand and price of competitors. The law of demand states that fewer people make purchases when price increases and more persons will buy tickets when prices decrease. The most important variable after price which impacts demand is total trip time. Total trip time includes travel to and fro airport, processing and security wait times within an airport, boarding and unloading, flight time and any expectations of delays along the journey. When trip time is reduced, demand increases. So, on-time performance is of utmost priority to airlines.

Now, on the supply side, the routes offered by airlines are positively linked to the price passengers are willing to pay. Additional routes are offered where passengers are willing to pay more and are reduced when passengers are willing to pay less. Compared to demand, the number of seats available on a route does not change as quickly as market conditions that dictate prices travellers are willing to pay.

Trade-offs are a reality that airlines make and so do passengers. If an airline chooses to offer more frequent flights between a city pair, it may capture more of the market share within that route. However, the airline will have less capacity to serve other destinations which may potentially return higher profit margins. Passengers look at their incomes and compare fares across road, rail, sea and air to determine what mode or combinations of modes best suit their budget and give them the best satisfaction.

Airlines will continue to look out for a balance between the various conflicting requirements in the market place to stay in business and keep the hopes of the aviation industry flying high.