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Air Carriers

By Joshua Roberts,2014-07-14 09:37
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Air Carriers

Air Carriers

Chapter Objectives:

The major objectives of this chapter are:

    1. Identify and describe the nature, characteristics, and organization of the air transportation

     industry.

    2. Evaluate the market structure and competitive environment of air transportation.

    3. Describe the operating and service characteristics of air transportation and the nature of modal equipment and terminals.

    4. Analyze and describe the cost structure of the air transportation industry.

    5. Explain airline and air cargo pricing and analyze the mode's operating efficiency.

6. Discuss the current issues affecting air transportation.

Chapter Overview

Brief History

    From 1903 when the Wright brothers made their first flight in 1903 and sold their idea to the Postal Service, the use of airplanes for mail transport can be considered the beginning of the modern airline industry.

    Airline travel is a common form of transportation for long-distance passenger and freight travel and the only reasonable alternative when time is of the essence. The tremendous speed of the airplane coupled with more competitive pricing have led to the growth of air transportation, particularly in the movement of passengers.

Industry Overview and Significance

In 2002, for-hire air carriers had total operating revenues of $106.9 billion, of which $73.3 1 billion (68.6 percent) came from passenger service.In 2002, air carriers transported 24.5 2 million revenue ton-miles, or approximately 0.5 percent of total intercity ton-miles.

    The airlines are a unique and important group of carriers that meet some particular needs in our society. Although their share of the freight movement on a ton-mile basis is small, the type of traffic that they carry (high-value, perishable, or emergency) makes them an important part of

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our total transportation system.

Types of Carriers

    The for-hire carriers cannot be easily categorized into specific types because carriers provide many types of services. For-hire carriers will be discussed according to type of service offered (all-cargo, air taxi, commuter, charter, and international) and annual revenue (majors, nationals, and regionals).

    A classification frequently used by U.S. air carriers is one based on annual operating revenues. The categories used to classify air carriers in terms of revenue are as follows: Majors annual revenues of more than $1 billion

    Nationals annual revenues of $100 million to $1 billion

    Regionals annual revenues of less than $100 million

    The charter carriers, also known as air taxis, use small to medium size aircraft to transport people or freight. The supplemental carrier has no time schedule or designated route. The carrier charters the entire plane to transport a group of people or cargo between specified origins and destinations.

    Many U.S. carriers are also international carriers and operate between the continental United States and foreign countries, and between the United States and its territories (such as Puerto Rico). Because service to other countries has an effect on U.S. international trade and relations, the president of the United States is involved in awarding the international routes.

Numbers of Carriers

    A look at carrier revenues shows a concentration of earnings by a small group of majors, nationals, and regionals. A majority of air movements are made by 141 carriers. The largest increase in number of carriers has occurred with the regionals. In fact, 96 percent of total industry revenue was generated by the top 25 carriers

    Private air transportation has been estimated to include approximately 60,000 company-owned planes, with over 500 U.S. corporations operating a private air fleet. In addition, thousands of planes are used for personal, recreational, and instructional purposes.

    Deregulation in 1978 was expected to result in a larger number of airlines but by 1994 the number of carriers had decreased.. Available seat miles for 2002 declined by 4.1 percent as some carriers traded larger aircraft for regional jets.

Competition

Intermodal

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Due to their unique service, air carriers face limited competition from other modes for either

    passengers or freight as they have an advantage in providing time-sensitive, long-distance movement of people or freight. Airlines compete to some extent with motors, automobiles and, to a limited extent, from trains and buses.

Intramodal

    Competition in rates and service among the air carriers is very intense, even though the

    number of carriers is small. The top 25 air carriers accounted for about 96 percent of the total operating revenue. Due to excess capacity, airline prices have fallen 8.4 percent (not adjusted for inflation). During this same period, inflation (measured by the Consumer Price Index) has risen 28.2 percent.

    New entrants to the airline market initially cause overcapacity to exist on many routes. To counter this and add passengers to their aircraft, carriers reduce prices and fare wars begin. .

    Service Competition

    Competition in airline service takes many forms, but the primary service competition is the frequency and timing of flights on a route. Carriers promote such things as on-time arrival and friendly employees to convince travelers that it has the desired quality of service. Frequent flyer programs and special services for high-mileage customers are popular examples of other services to attract loyal customers.

A post-deregulation development in service competition was no-frills service. One hallmark

    of such carriers is that they only provide one class of service.

Cargo Competition

    Competition for cargo has become intense. Major airline freight companies (e.g., FedEx, UPS Airlines, and DHL) have their own fleets of surface delivery vehicles to perform the ground portion of this door-to-door service.

    Another interesting dimension has been the growth in volume of express carrier traffic, which is an important reason for the attraction of surface carriers into this segment of the business.

Operating and Service Characteristics

General

    The major revenue source for air carriers is passenger transportation. In 2002, approximately 68.6 percent of total operating revenues were derived from passenger transportation.

    In 2002, approximately 12.5 percent of the total operating revenues were generated from freight transportation. For emergency shipments, the cost of air transportation is often

    inconsequential compared to the cost of delaying the goods.

     The high value of products transported by air freight provides a cost-savings trade-off,

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    usually but not always from inventory carrying cost which may offset the higher cost of air service. The old adage ―Time is money‖ is quite appropriate here.

Speed of Service

Undoubtedly, the major service advantage of air transportation is speed with a trip from

    New York to California trip, approximately 3,000 miles, a mere 6-hour journey.

This advantage of high terminal-to-terminal speed has been dampened somewhat by

    reduced frequency of flights and congestion at airports.

Air carriers have been concentrating their service on the high-density routes like New York

    to Chicago and while implementing the hub-and-spoke terminal approach which have aggravated the air traffic congestion and ground congestion at major airports.

    The shippers who use air carriers to transport freight are primarily interested in the speed and reliability of the service and the resultant benefits, such as reduced inventory levels and inventory carrying costs.

Length of Haul and Capacity

    For passenger travel, air carriers dominate the long-distance moves. In 2002, the average length of haul for passenger travel was 852 miles for air carriers.

    Adding freight to the baggage compartment on passenger flights necessitates rather small-size shipments and thus supports rate-making practices for these shipments.

Accessibility and Dependability

Except in adverse weather conditions, air carriers are capable of providing reliable service.

    Sophisticated navigational instrumentation permits operation during most weather conditions.

    Poor accessibility is one disadvantage of air carriers. Passengers and freight must be transported to an airport for air service to be rendered. Limited accessibility adds time and cost to the air service provided but even with the accessibility problem, air transportation remains a fast method of movement and the only logical mode when distance is great and time is restricted.

    .

    Equipment

Types of Vehicles

    There are several different sizes of airplanes in use, from small commuter planes to huge wide-body, four-engine planes used by the nationals.

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Terminals

    The air carriers’ terminals (airports) are financed by a government entity. The carriers pay for the use of the airport through various fees and users pay a tax on airline tickets and air freight charges.

    The growth and development of air transportation is dependent upon adequate airport facilities. The federal government is financially responsible with the construction of airport facilities, the various state and local governments assume the responsibility for operating and maintaining the airports.

    The carriers perform passenger, cargo, and aircraft servicing at the airport terminal.

    Certain airports have become hubs with flights from outlying areas being are fed into the hub airport to connect with other flights.

    Airport terminals also provide services to passengers, such as restaurants, banking centers, souvenir and gift shops, and snack bars.

Cost Structure

Fixed Versus Variable Cost Components

    Air carriers’ cost structure consists of high variable and low fixed costs with approximately

    80 percent variable and 20 percent fixed. The relatively low fixed cost structure is attributable to government (state and local) investment and operations of airports and airways.

    Flying operations accounted for 30.4 percent of airline operating costs in 2002 while maintenance costs equaled 12.3 percent of total operating costs. Both of these expenses are variable costs.

    The increased price competition in the airline industry has caused airlines to try to operate more efficiently by cutting costs where possible. There has been much effort put forth to decrease labor costs because the airline industry tends to be labor-intensive compared to other modes.

Fuel

    Escalating fuel costs have caused problems in the past for the airlines. By December 2002, the price per gallon of aviations fuel was $0.77 per gallon. Rapidly escalating fuel costs in

    recent years has caused airlines to suffer financially in an already depressed pricing market.

    More fuel-efficient planes have been developed and added to carrier fleets and carriers are substituting smaller planes on low-density routes and eliminating service completely on

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    others. Even though the average cost per gallon of fuel increased from $0.62 to $0.77 from January 2002 to December 2002, fuel consumption declined by 1.2 billion gallons 13 (6.5-percent reduction) from 2001 to 2002, resulting in a fuel savings of over $2 billion.

    Labor

    Labor costs represented over 65 percent of total operating expenses in 2002.

Airlines employ people with a variety of different skills. To operate the planes, the carrier

    must employ pilots, copilots, and flight engineers. Overall employment has decreased as airlines have moved aggressively to reduce costs to improve their competitiveness and lower prices in selected markets.

    Strict safety regulations are administered by the FAA with acceptable flight operations, as well as hours of service, being specified for pilots.

The wages paid to a pilot usually vary according to the pilot’s equipment rating.

    Wages can also vary according to whether a person works for a union airline or not.

Equipment

    The cost of operating airplanes varies with larger planes being more costly to operate per hour than smaller planes, but the cost per seat-mile is lower for larger planes.

Economies of Scale/Economies of Density

Large-scale air carrier operations do have some economies of scale, which result from more

    extensive use of large-size planes or indivisible units.

    Market conditions (sufficient demand) must exist to permit the efficient utilization of larger planes (i.e., if the planes are flown near capacity, the seat-mile costs will obviously decrease). Another factor where economy of scale could come into play is the integrated communication network required for activities such as operating controls and passenger reservations.

    The air carrier industry overall has a cost structure that closely resembles that of motor carriers and both industries are characterized by high variable cost ratios (airlines and motor carriers) can relatively easily add equipment to a given market. As such, the ability to decrease fully allocated cost per mile by adding aircraft does not exist.

Economies of density exist when a carrier has significant volume between an

    origin-destination pair to fully utilize capacity on forward-haul movements as well as utilize significant capacity on back-haul movements.

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Over the years the federal government has provided direct operating subsidies (i.e., public

    service revenues) to air carriers to support provide service to less-populated areas.

RATES

    Pricing

    Airline pricing for passenger service is characterized by the discounts from full fare. Seats

    on the same plane can have substantially different prices, depending on restrictions attached to the purchase, such as having to stay over a weekend or having to purchase the ticket in advance. Business people generally pay more for their airline travel due to the more rigid schedules they are on and the fact that they usually depart and return during the high-demand times.

    The price of seats on different flights and the price of the same seat on a particular flight can vary due to competition with other airlines, the time and day of departure and return, the level of service (first class versus coach or no-frills service), and advance ticket purchase. \Discount pricing has continued throughout the 2000s as airlines have attempted to increase their ―payload.‖

    Cargo pricing is dependent mainly on weight and/or cubic dimensions. Some shipments that

    have a very low density can be assessed an over-dimensional charge, usually based on 8 pounds per cubic foot. This over-dimensional charge is used to gain more appropriate revenue from shipments that take up a lot of space but do not weigh much. Other factors affecting the price paid to ship freight via air transportation include completeness of service. Operating Efficiency

    An important measure of operating efficiency used by air carriers is the operating ratio. The

    operating ratio measures the portion of operating income that goes to operating expenses:

    Operating Ratio = (Operating Expense/Operating Income) × 100

    Only income and expenses generated from passenger and freight transportation are considered.

    Another widely used measure of operating efficiency is the load factor (previously dis-cussed). The load factor measures the percentage of a plane’s capacity that is utilized. Load Factor = (Number of Passengers/Total Number of Seats) × 100

    Airlines have raised plane load factors to the 6570-percent range. The particular route and

    type of plane (capacity) directly affect the load factor, as does price, service level, and competition.

    Equipment substitution, however, might not be possible, and substitution might result in excess capacity. The jumbo planes have large carrying capacities that might not be utilized in low-demand routes. Thus, large-capacity planes are used on high-demand routes such as New YorkChicago and New YorkLos Angeles, and smaller capacity planes are used on

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     low-demand routes such as ToledoChicago and PittsburghMemphis.

    CURRENT ISSUES

Safety

    The issue of airline safety is of great importance to the airline industry.

    Several factors affect airline safety. First, airport security has come under close scrutiny over the past several years, four aircraft were hijacked and two were flown into the Twin Towers in New York City, killing and injuring thousands of people. As a result of September 11, 2001 airport security has reached an all-time high, causing more delays at airport terminals. Air travel is still the safest way to travel as even thought there is a significant loss of life in an airline tragedy, air travel is till the safest mode for passenger travel.

    Finally, as with other transportation modes, the issue of substance abuse concerning pilots and ground crews has become important.

    Technology

    Because the airline industry must offer quick and efficient service to attract business, it constantly needs more sophisticated equipment.

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ANSWERS TO STUDY QUESTIONS

    1. What are the types of carriers as defined by revenue class? Who are some of the members of each class? Do you think the members of each class would compete against or work together with members of other classes? What about members of their own class? Use examples,

    obtained from advertising or Websites.

    Answer: A classification frequently used by U.S. air carriers is one based on annual operat-ing revenues. The categories used to classify air carriers in terms of revenue are as follows: Majors annual revenues of more than $1 billion

    Nationals annual revenues of $100 million to $1 billion

    Regionals annual revenues of less than $100 million

    Examples of major U.S. carriers are American, United, Delta, US Airways, and Southwest.

    Major carriers have $1 billion or more in annual revenues and examples of major U.S. carriers are American, United, Delta, US Airways, and Southwest.

    National carriers have revenues of $100 million to $1 billion and examples of U.S. nationals include JetBlue, Sun Country, and Frontier Airlines.

    Regional carriers have annual revenues of less than $100 million and included in the regional category are carriers such as Air Midwest, Allegheny, and PSA. The regional carriers are grouped into two categories: large ($10$100 million) and medium (less than

    $10 million).

    The all-cargo carrier, as the name implies, transports cargo primarily. The transportation of air cargo was deregulated in 1977, permitting the all-cargo carriers to freely set rates, enter and exit markets, and use any size aircraft dictated by the market. Examples of all-cargo carriers include FedEx and UPS Airlines.

    Competition is intense between various air carriers and the student should have little trouble finding ads and webpage information support this

    2. Discuss the ways in which air carriers compete with each other. How have regulatory changes affected this competition?

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Intermodal

    Air carriers face limited competition from other modes for either passengers or freight. Air carriers have an advantage in providing time-sensitive, long-distance movement of people or freight. Airlines compete to some extent with motor carriers for the movement of higher-valued manufactured goods; they face competition from automobiles for the movement of passengers and, to a limited extent, from trains and buses.

Intramodal

    Competition in rates and service among the air carriers is very intense, even though the number of carriers is small. As noted, passenger air carrier regulation was significantly reduced in 1978, and new carriers entered selected routes (markets), thereby increasing the amount of competition).

    Also, existing carriers expanded their market coverage, which significantly increased intramodal competition in certain markets. The top 25 air carriers accounted for about 96 percent of the total operating revenue. Carriers may also have excess capacity (too many flights and seat miles on a route) and attempt to attract passengers by selectively lowering fares to fill the empty seats.

     Since 1992, airline prices have fallen 8.4 percent (not adjusted for inflation). During this New same period, inflation (measured by the Consumer Price Index) has risen 28.2 percent.entrants to the market, such as Airtran and JetBlue have taken a very aggressive stance on discounting passenger fares.

    The air industry was deregulated by The Airline Deregulation Act (ADA) signed into law on October 28, 1978. The main purpose of the act was to remove government control and open the deregulated passenger air transport industry to market forces. Prior to the act the federal Civil Aeronautics Board (CAB) regulated all domestic air transport, controlling fares and setting routes and schedules but this law abolished that agency

    3. What is the major advantage of air carriers? How does this advantage impact the inventory levels of those firms using air transportation? Explain how this advantage relates to the choice of modes when choosing between air carriage and other modes for freight and passengers.

    Answer: Undoubtedly, the major service advantage of air transportation is speed. The terminal-to-terminal time for a given trip is lower via air transportation than via any of the other modes. Commercial jets are capable of routinely flying at speeds of 500 to 600 miles per hour, thus making a New York to California trip, approximately 3,000 miles, a mere 6-hour journey.

    This advantage of high terminal-to-terminal speed has been dampened somewhat by reduced frequency of flights and congestion at airports. Commuter airlines have been substituted on some routes and the use of commuters requires transfer and re-handling of freight or passengers because the commuter service does not cover long distances.

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