Systems in Transportation The case of the Airline Industry

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Systems in Transportation The case of the Airline Industry

    Systems in Transportation: The case of the Airline Industry

    by Pedro Ferreira

    for ESD.83 Research Seminar in Engineering Systems

    Fall 2001


    This paper discusses the development of the airline industry, as a branch of transportation systems, and highlights the “systems characteristics” of the sector. The paper starts with an overview of early historical events that opened up the way to the establishment of the airline industry, as we know it today. Emphasis was given to the deregulation process that took place in the 1970s, since it was the major event that altered completely the way in which the industry operated. With deregulation, the industry became physically structured as a network, and a systems thinking view became the prevailing tool to

    model and talk about commercial aviation.

The paper also analyzes some sub-systems of the industry, namely the aircraft and the

    Air Traffic Control, and discusses its relationship to other industries and to the environment. This discussion shows that people have been enlarging the system drawing its boundary further away from the center of the industry, which one might argue to be the technology.

    The last chapter (before conclusions) provides a brief overview on what university-based

    thR&D in related fields has looked like in the second half of the 20 century.


1 Historical Events (1900-1970)

    Using the skies has been a dream for men ever since, but it was just in the beginning of

    th century that some experiments were successfully conducted. The first interesting the 20

    records date from 1903, when Orville and Wilbur Wright (later known as the Wright brothers) took the first powered flight in a heavier-than-air machine. Before, people had just flown balloons and gliders. This was a 120-foot 12-second flight in North Carolina. Eleven years later, the first scheduled air service began in Florida. This was a plane, designed by Glenn Curtiss, which took one passenger at a time across Tampa Bay. The trip was 18 miles long and took about 23 minutes, for a price of $5.

    Many innovations took place during the second half of the 1910s with the advent of the World War I, which boosted the demand for aircrafts. These became more powerful and larger, but were mainly designed for military purposes. In fact, there was no significant commercial aviation at that time. In England, people used to fly over the English channel, but in the US there was no such natural obstacle isolating major cities and railroads were enough to transported people comfortably.

    In the years after WWI, a new and important source of demand for aircrafts came from airmail. In 1917, the Congress appropriated $100000 for an experimental airmail service to be conducted jointly by the Army and the Post Office between New York City and Washington DC. However, by that time, planes could not flight at night and mail had to be handed off to trains by the end of the day. The next important development was the installation of beacons, allowing pilots to do night flights. The first beacon system was deployed in Ohio with beacons visible in 10-seconds intervals. Quickly, this system spread nation-wide and airmail could be delivered within 29 hours eastbound and 34 hours westbound (prevailing winds from the west accounted for the difference).

    In 1925, with the Contract Air Mail Act (later known as the Kelly Act, after its chief sponsor Rep. Clyde Kelly of Pennsylvania), government moved airmail traffic to the private sector, using competitive bids. This was the first major step towards the creation


    of a private US airline industry. Five contracts were granted to National Air Transport, Varney Air Lines, Western Air Express, Colonial Air Transport and Robertson Aircraft Corporation. National and Varney became later part of United Air Lines, Western merged later with other companies to form Transcontinental and Western Air (TWA) and Colonial and Robertson also merged later with other airlines to form American Airways, the predecessor of American Airlines.

    Also in 1995, President Calvin Collidge appointed the Morrow board (named after its chairman Dwight Morrow, a senior partner at J.P. Morgan) to recommend a national aviation policy. This board concluded that the government should set specific standards for civil aviation outside the military. These standards were accepted immediately and put into practice by the Air Commerce Act of 1926, by which the government stipulated that airmail should be paid according to weight, which simplified payments significantly.

    In 1927, two key events altered the history of aviation. First, Henry Ford designed the first duralumin aircraft, the Tim Goose. This was the first aircraft designed primarily to carry passengers. The Tim Goose also had the Ford Trimotor, which allowed it to travel at speeds of 130 mph. Second, Charles Lindberg completed the first non-stop flight across the Atlantic Ocean. He flew from NYC to Paris in about 33 hours with the Spirit of St. Louis, a 28-feet long plane with a wing-span of 46 feet. These two events brought a tremendous momentum to aviation, which became a much more established industry.

    In 1930, with the Watres Act (sponsored by Rep. Laurence Watres from Pennsylvania), the government authorized again the Post Office to enter into long-term contracts for airmail, with rates based on volume. This decision was a mistake. The Army was not familiar with airmail routes at the time and a number of accidents occurred. With the Air Mail Act of 1934, the government returned airmail to the private sector under a few new rules. Most notably, the government enforced dismantling vertical holding companies, thus mitigating market power abuse in the industry.


    Throughout the 1930s, an entire array of innovations allowed the industry to keep improving planes: air-cooled engines and lighter material allowed for constructing larger and faster planes; and innovations for the cockpit improved the flight conditions for pilots: better altimeters, airspeed indicators, rate-of-climb indicators, compasses, artificial horizon and radio beacons. Modern airliners appeared in 1933, with the Boeing 247 (10 passengers and 155 mph) and the DC-3 (21 seats, 16 hours coast-to-coast), which was the first commercial airplane yielding profit. Later, Boeing introduced pressurized cabins, with the Stratoliner, a plane deriving from the B-17. Pressurized cabins allowed for flying at 20000 feet at speeds of 200 mph.

    In the late 1930s, the airline industry was gaining all its momentum and in 1938, with the Civil Aeronautics Act, the government created an independent agency, the Civil Aeronautics Authority (CAA), to regulate fares, mergers and routes.

    In the 1940s, World War II lead to very interesting developments in the industry. In the US, the industry installed mass production of planes. By the end of 1945, 50000 planes were produced per year. Meanwhile, Europe contributed with paramount innovations, such as the Jet Engine (designed by Whittle in 1930 and built by von Ohain in 1939) and the radar (credit to British scientists in the early 1940s).

    During the 1950s and 1960s, the Cold War fueled funding to develop jets and transfer technology to the commercial sector. An example is the Boeing 707, with was adapted from the KC-135, a jet tanker. Other innovations from these decades include swept-back wings and the use of Kerosene.

    However, also during these two decades, many accidents happened with airplanes. In 1956, two airplanes collided above Grand Canyon, killing 128 people. The airspace was getting too crowded and Congress passed in 1958 the Federal Aviation Act. This act lead, in 1967, to the creation of Federal Aviation Agency (FAA) and the Department of Transportation (DOT). The agency was established to run a broad Air Traffic Control (ATC) system and to certify aircraft designs, airline training programs and maintenance.


    The late 1960s brought the wide-bodies and the supersonics. Boeing launched the Boeing 747 (2 aisles, 4 engines, 450 passengers). Douglas Aircraft Company launched the DC-10 and Lookheed the L1011, planes carrying 250 passengers. In terms of supersonics, the Tupolev 144 appeared in December 1968 and the Concord was presented two months later.

2 The Industry as a System and the Process of Deregulation

    The history of the airline industry until the 1970s is pretty much related to improving

    thaircrafts and flight conditions. In the first half of the 20 century, this was done with a

    military focus, because demand for aircrafts came mostly from World War I and World War II. It was only in the second half of the century that innovations started to spill over to the commercial side and planes to carry passengers started being designed. By the end of the 1970s, aircraft technology seemed finally to mature and people worldwide started looking for air transportation services.

    Before the 1970s, people did not talk or write about the airline industry as a system, nor they have used words that characterize a systems approach. Attention was mainly devoted to a particular aircraft or to a particular flight and there was no notion, or at

    least not significantly, of a system of flights. As referred before, it was only in the late 1960s that the idea of a nation-wide ATC was put forward. Today, the ATC is a major piece of the airline system, as we will see in section 6.

    People started looking at the airline industry as a system and a sub-system of the larger economy in the early 1970s. The oil embargo of 1973 made fuel prices to skyrocket and people in the industry felt strongly, and for the very first time, that airlines interconnect

    to other industries and receive inputs from them, such as fuel. Also in the 1970s, and

    with the establishment of mature flight technology, people started talking about the purpose of the airline industry, which is related to transport people. The industry started being seen as a system of interdependent airlines that needed specific policy tools and

    actions for development, design and management.


    Throughout the 1970s, the industry became deregulated. Deregulation also embeds the idea of looking at the industry as a system. Deregulation applies to a system of flights and not to single flight and the results people predict from deregulating an industry emerge because the industry is a system of interconnected agents and not isolated entities. For example, a deregulated industry is said to be more competitive, but competition emerges precisely from the interaction (a systems characteristic) among firms in a frictionless

    market, which drives them to undercut each other’s price until selling at marginal cost.

    Several Acts came along to deregulate the various parts of the industry. In 1977, air cargo deregulation took place. Carriers were then free to operate on any domestic route and charge whatever the market would bear. Also in the 1970s, express packet delivery was deregulated. Carriers were allowed to operate overnight and charge higher prices for that kind of service. This opened the way for providing customized service to users (for example, priority airmail) and charging accordingly. Passenger deregulation followed. By December 1981, all restrictions on routes and services have been eliminated. Rate regulation ended completely by January 1983 and, in 1985, CAA (called Civil Aeronautics Board (CAB) by that time) ceased functions.

    The effects of deregulation were enormous. In terms of physical arrangement, the Hub-and-Spoke model prevails. Hubs are strategically located airports used as transfer points for cargo and passengers, at which airlines schedule banks (dozens of planes within minutes) of in and out flights per day. They allow to serve far more markets with the same size fleet, relative to a point-to-point configuration, because at a Hub passengers have hundreds of connecting flights, which also makes it easier for an airline to keep passengers end-to-end and to achieve higher load factors. The Hub-and-Spoke model is a true network of airports, which calls for systems oriented tools for design and planning.

    Deregulation has also encouraged new carriers to enter the market. There were 43 carriers in 1978. Today there are twice as much. Deregulation also increased competition (today, 85% of the passengers have a choice of 2 or more carriers for their flights) and boosted


    air travel (240 million passengers in 1977 and 640 million in 1999). Today, more than 80% of the US population has flown at least once. Fares have declined 35% since 1978 and traveling public save about 20$ billion/year (due to discount fares and increased service frequency, which avoids overnight stays).

    Other innovations following the deregulation of the industry include frequent flyer programs, computer reservation systems and code-sharing flights. However, more importantly than all these innovations, deregulation shifted focus to competition and

    interaction among airlines, bringing a systems thinking paradigm to the airline sector.

    The 1970s was the clearest turning point to a systems approach to the airline industry.

3 Structure of the Industry and of an Airline

    The structure of the airline industry presents many aspects of a system and also many characteristics of a complex system. Part of the work developed by the DOT and the FAA is concerned with defining the major element of the industry: the airline. Airline must be

    certified by the DOT, which issues a “fitness” certificate (issued when financing and management are in place to provide scheduled service) and by the FAA, which issues a “operation” certificate (issued when a list of 121 requirements are satisfied).

Moreover, the airline industry is a complex system tackled at different levels or scales (a

    characteristic of complex systems analysis, as seen before in this course). Airlines are classified into Majors, Nationals and Regionals according to their revenue. Majors get more than $1000 million/year and provide nation- and world-wide service. Nationals make between $100 and $1000 million/year and serve among particular regions using medium- and large-sized jets. Regionals make between $20 and $100 million/year and serve a region with planes up to 60 seats.

    Within the industry, an airline is itself a system. Its organic picture reflects the combination of functions assembled together to produce a final and unique output. A

    very high-level functional chart of an airline is shown in Figure 1.


    Line personnel

    Sales and marketingOperations


    MaintenanceReservations and ticketing

    Staff personnel

    Figure 1- Functional chart of an airline and relationships among functions.

    In the picture, Line Personnel includes every person related to operating a flight, that is, mechanics, pilots, reservation clerks, airport and gate personnel, ramp-service agents and security guards. Note that this chart includes sub-contracting. Typical sub-contracted services include cleaning, fueling, security, food and maintenance. Explicitly introducing and considering sub-contracting acknowledges the existence of a system surrounding

    the airline industry and inter-industry interactions. In other words, the airline is put into

    a context, a web of interacting industries. Consequently, it may be less expensive to acquire services from other industries than having people able to perform every single task.

4 Economics of an Airline

    The airline industry is a very particular system. Airlines provide a service, which is to transport a passenger between two cities at an agreed price. There is no physical product given to the consumer, nor inventory created and stored. Airlines also exhibit very particular economics that, over time, have motivated specific management concepts,

    tools and practices. Some of them are analyzed in this section.

    The industry is capital intensive but also labor intensive. The setup costs for an airline are huge (airplanes, hangars, flight simulators) and most capital is financed through loans. In addition, airlines employ many people (from pilots to baggage handlers, from cooks to lawyers). Usually, wages take 1/3 of the airline revenues.


    Profit margins are seasonal and thin. The net profit of an airline is between 1 and 2%. It increases in the summer, when most people take vacations, and decreases during winter (expect for holidays). Demand for air transport clearly presents peaks and valleys. Airlines deal with this by shifting customers across the year using discounts and promotions (e.g. double air miles during winter).

    Airlines’ revenues come primarily from passengers (75% passengers, 15% cargo shippers). Most of the revenue associates with passengers (around 80%) come from domestic travel. Travel agencies, with computer-based reservation systems, are paramount in ticket sales. They account for 80% of the tickets issued. Note that travel agencies are elements outside the airline itself that have a huge impact on the economics of the system. Therefore, when drawing the boundary of the airline industry, one has to

    take them into account.

    The management tools employed in the industry include general principles applied to very particular concepts of an airline. For example, a very useful indicator is the break-

    even load factor, which in the context of this industry means the percentage of seats that an airline has to sell to cover its costs. This is usually around 66%. Airlines operate near this margin and 1 or 2 seats in a flight can make the difference between profit and loss.

    Other issue carefully analyzed in the industry is seat configurations. More seats in an airplane entail more revenue at the same cost, but also less comfort for passengers. The best strategy is to analyze the market for each flight and check what passengers prefer. If they value more low price tickets, use a plane with more seats. If they belong to a business community, use a plane with fewer seats (pricing higher), but that gives them more comfort and workspace.

    Another strategy commonly used by airlines is overbooking, which occurs when there are more passengers for a flight than seats available. Overbooking is done carefully and is based on the observed past behavior of passengers, which allow the airline to be sure that a certain number of passengers will, most likely, not show up to a particular flight.


    Finally, pricing and scheduling are also two major, very complex, tasks that an airline must perform. Pricing is purely competitive since deregulation of the industry. Each ticket is sold according to the value that the passenger gives to having a seat in a particular flight. The goal of the airline is to maximize its revenue in each flight (because the cost associated with a particular flight is pretty much fixed) offering the correct mix of tickets (full-fare, discounted, upgraded). This is a complex optimization process, accomplished today by specific computer software. Scheduling is also free since the late 1970s. It is also obtained using powerful computer software that takes into account demand, crew availability, maintenance, airport restrictions and aircrafts.

5 Engineering an Aircraft and a Flight

    This section looks at the engineering side of the industry and highlights its systems characteristics. The first example is the aircraft, which is itself a (mechanical) system. Systems Dynamics approaches have been largely used to improve aircraft performance and flight conditions.

    Figure 2 depicts an airplane and its sub-systems: the fuselage, the spoilers, the rudder, among others. Airplanes fly when the movement of air across their wings creates an upward force on the plane that is greater than the force of the gravity. This is known as

    ththe Bernoulli Principle, after the discoveries of Daniel Bernoulli, an 18 century Swiss

    mathematician who found that the pressure exerted by a moving fluid is inversely proportional to its speed.

    Figure 2- Schematic representation of an airplane.


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