The Evolving Airline Industry: Impacts on Airports
2.5 Airline Operating Costs and Productivity
FIGURE2.9 Distribution of gate delay times. (Source: Skaltsas, 2011.)
Whether the delay occurs at the departure gate or during any of the subsequent stages of the flight’s operation, a late arrival at the destination airport is an inconvenience for pas-sengers. For a flight into an airline’s hub airport, an arrival delay of even 30 to 60 minutes can translate into a major disruption of travel plans if it means that passengers cannot make their connecting flights. At best, a missed connection delays the passenger’s arrival at their destination by several hours, depending on when the next flight from the hub to the pas-senger’s destination is scheduled. However, with increasing airline load factors, reaccom-modation of disrupted passengers on later flights becomes more difficult due to a lack of available seats.
Delayed flights complicate operations for both the airline and the airport operator. Dis-rupted passengers end up spending substantially more time (and perhaps more of their money) at the airport. They inevitably end up with a negative perception of their overall travel experience that they typically attribute to both the airport and the airline (or in some cases, incorrectly to the airport alone). For airports wishing to develop and improve cus-tomer perceptions of their services, it is therefore important to identify ways in which air-port operators can collaborate with airline ground operations to reduce the negative impacts of flight delays, not only on operational factors but also on the passengers themselves.
sec-tions has contributed to substantial changes to airline cost structures and improvements in airline productivity measures. This section illustrates these trends with operating cost data for U.S. airlines and provides supporting evidence of similar trends for non-U.S. airlines to the extent data are available. It first discusses changes in the shares of different operating cost components, followed by an overview of unit cost trends and a comparison of network legacy carrier (NLC) and LCC unit costs and their convergence in the recent past. As be-fore, it considers the implications of these trends for both airlines and airports.
Airline operating costs can be allocated to different categories in a variety of ways. A common approach is that of “administrative” cost categorization. This is often used in air-line financial statements, which identify expenses for labor, fuel, capital, materials, and various services used to produce the airline’s output.Figure 2.10shows these costs as re-ported by U.S. airlines for 2011. The two largest cost categories are fuel and labor, which represented approximately 32 percent and 27 percent, respectively, of total U.S. airline op-erating expenses.
FIGURE2.10 U.S. airline operating cost breakdown, 2011. (Source: Air Transport Associ-ation, 2012.)
Historically, fuel accounted for a smaller portion of total operating expenses. Fuel costs accounted for a record high 36 percent of total airline operating expenses in 2008, com-pared to about 30 percent during the first fuel crisis after deregulation in 1980. Its propor-tion of total operating expenses again increased to 32 percent in 2011, and future fuel price increases could push this proportion higher. Labor costs, on the other hand, have declined in terms of absolute and relative contribution to total operating expenses, especially since the bankruptcies and subsequent restructuring by U.S. NLCs in the early 2000s. The share of total operating expenses related to labor decreased from 42 percent in 1978 to 27 percent in 2011. Nonlabor costs have fluctuated as a proportion of total expenses, as the role of many of the smaller contributors to nonlabor costs has changed considerably as well: Out-side maintenance, nonaircraft ownership, and aircraft rental costs have increased, while the once significant commissions (travel agency payments) category has all but disappeared.
Airport landing fees account for about 2 percent of total operating costs for U.S. airlines, but the airlines continue to express concerns about the growth of this expense category.
Airlines around the world have experienced similar changes in the share of major cost categories. They have experienced significant increases in the share of fuel costs and con-comitant reductions in the shares of other cost categories, notably reductions in labor ex-penses.Table 2.1compares cost component shares across airlines from different regions of the world. The increase in fuel cost shares between 2001 and 2008 is particularly striking, as the fuel cost component climbed to 32.3 percent of total airline operating costs from only 13.6 percent in 2001. The share of labor costs decreased in all regions (due in part to the increases in fuel cost share) over this same time, but the decrease in the labor cost shares of North American carriers is the greatest of all regions, dropping from the highest of all re-gions to approximately the world average. Asia-Pacific airlines maintained the lowest labor cost share of the regions shown.
Source: International Air Transport Association, 2010.
TABLE2.1 Share of Major Operating Cost Components by Region
Unit cost is the ratio of the airline’s total operating expenses to ASKs produced [or ATKs (available ton-kilometers) in the case of cargo airlines]. For passenger airlines, unit cost is also known as “CASK,” meaning “cost per ASK” [the equivalent measure in miles is
“CASM” (cost per available seat-mile)]. The relationships between unit costs and airline size, average aircraft capacity and average stage length are all expected to be negative, in theory at least. That is, a large airline is expected to see some economies of scale (reduc-tion in unit costs with increased output), as its fixed costs are spread over a larger output of ASKs. A larger-capacity aircraft is also expected to show some economies of aircraft size, as the fixed costs are spread over more seats for any given flight, resulting in lower costs per seat. Likewise, longer stage lengths mean that the relatively fixed costs of ground servicing, for example, can be spread over more ASKs produced by each flight.
The differences in total unit costs among airlines around the world are reflected in the comparison of 25 of the largest passenger airlines (ranked in terms of revenue passenger-kilometers carried), shown in Fig. 2.11. This graph plots the 2010 total unit costs against average stage length, as reported in the Airline Business financial database (Airline Busi-ness, 2011). In general, there exists an inverse relationship between total unit cost and av-erage stage length, which is apparent in Fig. 2.11. Several airlines with the longest stage lengths—Emirates, Cathay Pacific, EVA, and Thai Airways—report relatively low unit costs, although Singapore Airlines’ unit cost appears to be somewhat higher given its long stage length. On the other hand, large network airlines with shorter stage lengths report sig-nificantly higher unit costs. Valid comparisons of unit costs across airlines require taking average stage length into account. Looking atFig. 2.11, we cannot conclude that Delta has a cost disadvantage compared to Emirates, given the large difference in their average stage lengths. However, two airlines with similar stage lengths can be compared; for example, American’s unit cost is indeed higher than Delta’s. The true outliers are the airlines with short trip lengths and lower unit costs—specifically the LCCs—Southwest, easyJet, and JetBlue, and particularly Ryanair.
FIGURE 2.11 Unit costs versus stage length, 2010. (Source: Airline Business Database, 2011.)
A further comparison of airline unit costs focuses on three broad categories: fuel, labor, and nonlabor expenses. Fuel expenses are most straightforward to categorize, whereas labor costs include total salaries, benefits, and other costs paid to employees. Nonlabor costs include all other operating expenses. This last category includes cost items that rep-resent the “structural” costs of the airline over which management can exert influence and are therefore an indication of how airline network and product strategies affect “control-lable costs” not related to fuel or labor inputs.
The average unit cost of U.S. passenger airlines, expressed in constant dollars per ASM, has declined almost 40 percent since deregulation. In 1979, it cost the average U.S. airline an inflation adjusted118.3¢ to produce one ASM; that unit cost dropped to 11.2¢ in 2009 (Belobaba et al., 2011).Figure 2.12shows the corresponding inflation-adjusted unit costs for the fuel, labor, and nonlabor categories. A substantial part of the reduction in real non-labor unit costs since the mid-1990s can be attributed to dramatic cuts in airline distribution costs—first with the elimination of travel agency commissions in the late 1990s, followed by the use of Internet and related technologies for ticket distribution since 2000. Overall, nonlabor costs have decreased by 25 percent in real terms since 1978.
FIGURE2.12 U.S. airline real unit costs by category. (Source: Belobaba et al., 2011.)
A dramatic drop in U.S. passenger airline labor unit costs occurred between 2002 and 2006, as NLCs went through bankruptcies, layoffs, and restructuring of labor contracts. In cumulative terms, the average real labor unit cost for U.S. airlines has decreased by 55 percent since deregulation in 1978. Together, the labor and nonlabor operating cost cat-egories combined (excluding fuel) have seen a 40 percent decrease in real unit costs since then. Fuel unit costs expressed in inflation-adjusted terms, on the other hand, have exhib-ited much greater volatility than the other two cost categories. Very high fuel unit costs in the early 1980s exceeded the recent peak in 2008 in real terms, but much of the period from the late 1980s through the early 2000s was characterized by fairly low and stable real fuel unit costs. Fuel unit costs began to surge in 2005 and peaked in 2008.
Figure 2.13 compares inflation-adjusted NLC and LCC unit costs in the United States from 1990 to 2009. Over most of this period, the NLC group reported total unit costs ap-proximately 2¢ (USD) per ASM higher than the LCC aggregate. In percentage terms, the unit costs of the two airline groups have been converging. LCCs still had a clear unit cost advantage in 2009, but their unit costs relative to NLCs were about 20 percent lower in 2009 compared to 30 percent lower in 2001. The nonlabor unit cost gap between the groups has remained approximately 1¢ per ASM. This reflects the airline’s structural costs that are
driven by a variety of factors such as network structure, fleet type, and outsourcing activ-ity to name a few. NLCs have certain structural costs (hub operations, international flights, lounges, and other services) that result in this inherent and consistent nonlabor unit cost gap of about 1¢ per ASM. (Tsoukalas et al., 2008)
FIGURE 2.13 Inflation-adjusted unit costs, NLCs versus LCCs. (Source: Belobaba et al., 2011.)
Labor unit costs dropped dramatically after 2000, as Fig. 2.14 shows. Whereas labor costs in real terms gradually declined for LCCs, NLCs experienced a dramatic downturn as several of the largest carriers were able to renegotiate labor contracts and reduce work-forces after filing Chap. 11 bankruptcy. This decline in labor unit costs substantially nar-rowed the historic gap between NLCs and LCCs. NLC real labor unit costs dropped by 40 percent between 2002 and 2007, increasing thereafter as many of the labor contracts of the early 2000s were up for renegotiation by 2008.
FIGURE2.14 Inflation-adjusted labor unit costs, NLCs versus LCCs. (Source: Belobaba et al., 2011.)
The increased competition afforded by deregulation in the United States, especially the introduction and rapid growth of LCCs in U.S. domestic markets, has been the driving force behind these dramatic reductions in airline unit costs. These cost improvements were in large part passed on to consumers in the form of lower airfares. A continuing downward trend in average fares led to significant increases in the demand for air travel—in 2010, average inflation-adjusted U.S. airline fares remained at about 50 percent of their predereg-ulation levels (Belobaba et al., 2011). However, the downward trend in average fares has begun to level off, given the realities of higher fuel costs and the increasing difficulty faced by airlines hoping to achieve additional cost reductions. There is simply not much room for further declines in average fares, which raises questions about the continued rapid growth of air travel demand in the United States. Although there are still opportunities to reduce fares and stimulate demand in other world regions, the ability of airlines to manage costs will determine the extent to which this growth ultimately occurs.
Given that rapid growth of LCC competition was largely responsible for the cost reduc-tions of U.S. legacy carriers, it is reasonable to expect that some form of cost restructur-ing will come to legacy carriers elsewhere. In particular, European legacy carriers have yet to undergo the same cost cutting pains as their U.S. counterparts but will face increasing
pressure to do so in light of both increasing LCC presence within Europe and the growth of Middle East mega-carriers attempting to divert connecting traffic away from European hubs. As shown earlier in Fig. 2.11, the long-haul, large aircraft operations of the largest Middle East and Asian carriers give them a significant unit cost advantage.
In addition to reducing unit operating costs, airlines in the United States and around the world have improved aircraft and labor productivity through more efficient fleet utilization, hub network operations, and schedule optimization. In many cases, legacy airlines have adopted some of the innovative operational practices of their LCC competitors to further improve both cost efficiency and productivity. For example, legacy airlines have put an em-phasis on reducing aircraft turn times at their hubs, in some cases moving to “continuous”
banks instead of fixed connecting banks to increase aircraft productivity. They have rene-gotiated work rules with their unionized personnel to allow more cross-utilization of labor to perform different tasks—flight attendants who help clean up the aircraft cabin or assist in the boarding process at the gate are but two examples.
These strategies have led to substantial increases in aircraft and labor productivity for NLCs and LCCs alike, particularly since 2000. LCCs consistently have been able to achieve higher aircraft utilization, with more point-to-point flights and shorter turnaround times, whereas connecting hubs, international services, and even time zone constraints act to limit NLC utilization rates. For U.S. airlines, aircraft utilization has increased dramatic-ally since deregulation, by an average of 20 percent through 2007 before decreasing with the more recent financial and fuel cost challenges. These improvements in aircraft utiliz-ation by both NLCs and LCCs translate directly into lower unit costs, as fixed operating costs are spread over more block-hours per day and, in turn, increased production of output (ASKs).
Employee productivity of the LCC group of U.S. airlines remains about 10 percent high-er than that of NLCs, even as both groups have increased ASMs phigh-er employee by more than 35 percent in recent years (Belobaba et al., 2009). Figure 2.15shows the evolution of labor productivity, expressed as ASMs per FTE (full-time equivalent employee). After peaking at almost 550,000 in 2000, U.S. airline employment plummeted by over 30 percent by 2010, driven largely by the NLC labor force cuts even as LCC employment continued to grow. NLCs thus achieved increases in labor productivity through substantial reductions in their workforce as well as through the relaxation of restrictive work rules in union con-tracts. Both NLCs and LCCs have also been able to increase employee productivity by re-placing humans with technology—for making reservations, buying tickets, and checking in.
FIGURE2.15 Labor productivity of U.S. airlines. (Source: Belobaba et al., 2011.)
Differences in airline operating costs, specifically unit costs, are largely driven by dif-ferences in the productivity of inputs, specifically, aircraft and labor. With the rapid growth in the United States and around the world of LCCs as effective competitors, the focus of established airlines on reduced unit costs and improved employee and aircraft productivity has become critical to profitability. With LCCs still experiencing rapid growth in many re-gions of the world, and with the continued growth of Middle East and Asian hub network airlines with structural unit cost advantages, all airlines will continue to emphasize cost cutting and productivity gains in virtually all of their management strategies.
The pressure on airports by airlines hoping to lower costs and increase productivity will intensify as global airline competition intensifies. LCCs considering new service to an airport are becoming more aggressive in demanding not only cost concessions from air-ports in the form of lower landing fees and rental rates, but guarantees of minimum traffic and/or revenue generation in many cases. Expanding mega-carriers with large connecting hubs will pursue cost concessions from their hub airport operator in light of the increas-ing volumes of traffic they are creatincreas-ing at their hubs. At the same time, as they consider the possibility of introducing services to new spoke airports to feed their connecting hubs, these mega-carriers will look for offers of lower landing fees and/or facilities costs from airports competing for the new services. In addition, all airlines will continue to resist
in-creases in airport fees, and perhaps begin to adjust their networks and schedules in an effort to reduce the impacts of airport charges on their operating costs.