Analysis of Cost Behavior in Air Transportation Business Before and During Covid-19 Pandemic: Case Study of Garuda Indonesia
Benito Sabastian1*, Ruslan Prijadi1
1 Faculty of Economics and Business, University of Indonesia, Jakarta, Indonesia
*Corresponding Author: [email protected]
Accepted: 15 July 2021 | Published: 1 August 2021
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Abstract: The airline industry is widely regarded as a regulatory-intensive, advanced technology, and low-profit margins industry. Therefore, airlines need to conduct the best possible cost management, especially in facing a crisis like Covid-19 pandemic. Failure to understand cost behavior might lead to improper cost management strategies and cause substantial losses. The current study aims to analyze the cost behavior of one of the largest airlines in Indonesia. This research employs cost behavior analysis based on data collection from financial statements, data observations, and in-depth interviews with related persons in charge. The results show that cost management should focus on a more dominant cost structure under crisis conditions. This research sheds light on maintaining a competitive advantage in the airline industry, especially regarding cost management strategies.
Keywords: crisis, cost behavior, cost structure
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1. Introduction
Airlines operated in a regulated environment where governments had high control over where airlines could fly and what rates they could charge (Vasigh et al., 2014). Therefore, airlines must operate efficiently to generate profit (Triwijanarko, 2018). Therefore, airlines must control costs and monitor their behavior within their operations. On the other hand, fail to have a fundamental understanding of controlling costs, companies will struggle to earn a profit unless they enjoy significant market power, which most do not (Vasigh et al., 2014). In facing a crisis like the Covid-19 pandemic, airlines loss their market power. As a result, airlines' revenue has decreased significantly while airlines still have huge costs, especially for full- service carriers.
The four expensive operating costs on the airlines are fuel costs, crew costs, maintenance costs, and fleet costs (ICAO, 2017). The cost structure proportion could be change depends on the circumstance crisis. For example, when there is increasing in fuel price, the most expensive cost tends to be fuel costs. While during the Covid-19 pandemic, the number one expensive cost tends to be fixed costs such as fleet costs.
One of the largest airlines in Indonesia, Garuda Indonesia, is a full-service carrier that has a struggle in facing a Covid-19 pandemic. Based on the annual report of Garuda Indonesia, the margin between revenue and operation cost about 1%-6% for 2017 until 2019. On the other hand, the margin between revenue and operation costs is -97% from January until September 2020 (Garuda Indonesia, 2020). Garuda Indonesia posted a loss of up to IDR 16.03 trillion as
of September 2020 (Bisnis.com, 2020). The condition in Garuda Indonesia has raised several questions, such as how is the cost structure? How is the cost behavior?
This research employs cost behavior analysis of the airline's strategy based on data collection from financial statements, data observations, and in-depth interviews with related persons in charge. This research aims to figure out the cost structure and cost behavior in Indonesia's largest airlines. This research sheds light on maintaining a competitive advantage in the airline industry, especially regarding cost management strategies.
2. Literature Review
2.1 Costs
Costs are resources that are sacrificed or incurred to achieve a specific goal (Hilton & Platt, 2017). Based on Hilton and Platt (2017), costs can be classified by cost object and cost behavior. The cost object categorizes costs into direct and indirect costs. A cost that can be traced to a particular cost object is called a direct cost. Meanwhile, a cost that is not directly traceable to a particular cost object is indirect.
On the other hand, the cost behavior categorizes costs into fixed costs and variable costs. A variable cost changes, in total, in direct proportion to a change in the level of activity (Bender
& Ward, 2009). Meanwhile, a fixed cost remains unchanged in total as the level of activity varies. The airline industry also uses this term.
Airlines operated in a regulated environment where governments had complete control over where airlines could fly and what rates they could charge (Vasigh et al., 2014). Therefore airlines must control cost and monitor its behavior within their operations (Triwijanarko, 2018).
Without a fundamental understanding of controlling costs, companies will struggle to earn a profit unless they enjoy significant market power, which most do not (Vasigh et al., 2014).
2.2 Airlines operating costs
Total operating costs (TOCs) are divided into direct operating costs (DOCs) and indirect operating costs (IOCs) (Aircraft Commerce, 1998). DOCs are items directly related to the operation of an aircraft, predominantly ownership/lease costs, insurance, maintenance, crew, fuel, navigation, and landing fees (ICAO, 2017). IOCs are items not directly related to the operation of an aircraft, including administration, marketing, training, catering, and aircraft handling. They are independent of the aircraft type. The comparison of DOCs provides a measure of the cost-effectiveness of two similar aircraft. IOCs are largely a measure of the efficiency of the airline itself and the total amount of overhead that cannot be apportioned to a specific route or aircraft type.
Typical breakdown costs in flight (direct) operating costs are fleet/ownership cost, fuel cost, crew cost, maintenance cost (ICAO, 2017). Meanwhile, the breakdown cost of IOCs is the overhead cost that comes from ground operating and system operating areas. Fuel cost is a variable cost where the fuel cost increases linearly with the consumed fuel. The fuel cost very much depends on the fuel's price. For example, the price of fuel in the eastern area of Indonesia is higher than in Java. In addition, the consumed fuel for operating depends on the length of the aircraft flown, the flight time, and the weather factors. Therefore, the fuel cost could be
Fleet/ownership cost is the most significant element of DOCs. The cost depends on when the airline decides to purchase or lease the aircraft. If the airlines lease the aircraft, it will be lease cost. If the airline elects to purchase an aircraft, its ownership cost will depend on depreciation and funds. Crew cost is a cost incurred to pay and provide labor to fly the aircraft and service during flight operation. Crew cost consists of cockpit crew cost for operating the aircraft and cabin crew cost for providing services to customers while flying. Crew costs are usually measured based on flight hours or monthly wages. Aircraft maintenance cost is a cost incurred to maintain the aircraft's airworthiness (the aircraft's physical and system conditions) and maintain flight safety. Maintenance costs are related to the age of the aircraft and the utilization of the aircraft. Maintenance cost consists of labor costs (technicians and engineers) and material costs for rectifying the aircraft back to serviceable condition.
3 Research Method
This research adopted qualitative research using a case study methodology. In addition, this research employed cost behavior analysis of the airline based on data collection from financial statements, data observations, and in-depth interviews with related persons in charge. The analysis results described the cost structure and cost behavior in crisis conditions.
The picture of cost structure is obtained based on the operating cost data comparison of Garuda Indonesia's experience during the crisis when fuel prices spiked in 2017 and during the pandemic in 2020. Furthermore, the concept of cost analysis is used to describe the cost behavior in each crisis condition. This study limits the analysis to the top four expensive costs in each crisis period. The research conduct triangulation method aims for valid data and a comprehensive understanding of the company's situation (Patton, 2001). The results of this analysis shed light as a consideration on determining the enhanced strategy for the company.
The flow process of this research figure out as follows:
Figure 3.1: Research flow process
1 • Company preview 2017-2020
2 • Overview of the cost structure
3 • Cost behavior analysis
4 •Conclusions and recommendations
Annual reports, Management reports,
Financial reports
Newspaper and magazine articles
Observation Data
Interview data from key person
4. Result and Discussion
Company profile & condition
According to table 1, Consolidated Profit and Loss Report 2017 to 2020 (Annualized), the difference between operating expenses and company income had a margin of 1%-6% before the Covid-19 Pandemic. As a result, the company had profit in 2019 and losses in 2017 and 2018. During a pandemic, the proportion of income to operating expenses has a large margin.
The company has an operating expense of 197% from revenue, so there is a 97% excess from operating expenses compared to the income in the company. In addition, the proportion of airline operating expenses has exceeded the company's revenue by 114% and then followed by the proportion cost of maintenance and repair expenses by 30% and the proportion cost of general and administrative expenses by 20%.
Table 1: Consolidated Profit and Loss Report 2017 to 2020 (Annualized)
Description 2017 % 2018 % 2019 % 2020
Annualized % Scheduled airline services 3,402 81 3,529 82 3,773 83 1,223 81
Non-scheduled airline services 301 7 267 6 250 5 63 4
Others 474 11 534 12 549 12 233 15
OPERATING REVENUES 4,177 100 4,330 100 4,573 100 1,518 100
Flight operations expenses (2,478) 59 (2,738) 63 (2,549) 56 (1,736) 114 Maintenance and repairs expenses (429) 10 (567) 13 (538) 12 (450) 30 General and administrative expenses (383) 9 (224) 5 (250) 5 (304) 20 User charges and station expenses (324) 8 (405) 9 (385) 8 (173) 11 Ticketing, sales and promotion expenses (299) 7 (297) 7 (343) 7 (143) 9
Passenger services expenses (266) 6 (292) 7 (272) 6 (138) 9
Hotel operation expenses (26) 1 (31) 1 (32) 1 (25) 2
Transportation operations expenses (21) 1 (28) 1 (29) 1 (16) 1.0
Network operation expenses (12) 0.3 (12) 0.3 (10) 0.2 (9) 0.6
OPERATING EXPENSES (4,238) 101 (4,594) 106 (4,409) 96 (2,993) 197 *In Million Dollar
According to table 2, Growth of Profit and Loss 2017 to 2020 (annualized), the company's revenue trend had increased from year to year (2017-2019) before the pandemic. But during the pandemic, the company's revenue decreased very drastically. The company's income decrease by 67% in 2020 (annualized) from the previous year. Meanwhile, the company's operating expenses in 2019-2020 (annualized) only decreased by 32%. Based on data of the growth of company operating expenses for 2019-2020 (annualized), increased cost only in administrative and general expenses by 22%, while other operating expenses decreased but not as much as decreased income.
Table 2: Growth of Profit and Loss 2017 to 2020 (annualized) Description 2017-2018 2018-2019 2019-2020
(Annualized) CAGR
Scheduled airline services 4% 7% -68% -23%
Non-scheduled airline services -11% -6% -75% -33%
Others 13% 3% -58% -16%
OPERATING REVENUES 4% 6% -67% -22%
Flight operations expenses 10% -7% -32% -9%
Maintenance and repairs expenses 32% -5% -16% 1%
General and administrative expenses -41% 12% 22% -6%
User charges and station expenses 25% -5% -55% -14%
Ticketing, sales and promotion expenses -1% 15% -58% -17%
Passenger services expenses 10% -7% -49% -15%
Hotel operation expenses 20% 2% -23% -1%
Transportation operations expenses 33% 5% -47% -7%
Network operation expenses 1% -15% -15% -8%
OPERATING EXPENSES 8% -4% -32% -8%
During the pandemic period in the 3rd quarter of 2020, flight operating expenses accounted for 114% of the total operating revenue. The proportion of operating expenses during the pandemic has almost doubled than the proportion before the pandemic with 56% -63% in 2017-2019. In the next section, the operational expense is analyzed in more detail to describe the cost structure that needs to be highlight in the current pandemic era.
Structure cost
According to the company's condition described in the previous sub-chapter, it is interesting that operating expenses also decreased during the pandemic. Still, the decline was not significant enough compared to the decrease in income. In addition, the proportion of company operating expenses to operating income during the pandemic has almost doubled in proportion compared to the period in previous years (2017-2019). With a Pareto analysis of the proportion of the cost structure, each crisis's dominant costs can be shown in figure 1 and figure 2.
6 Month:
Pandemic Fuel price increased
Figure 1: Pareto Analysis Pandemic and Fuel price increased-6 month
33 Month:
Pandemic Fuel price increased
Figure 2: Pareto Analysis Pandemic and Fuel price increased-33 month
The proportion of this cost structure differed between the conditions when fuel prices increased in 2017 compared to the pandemic conditions in 2020. From the Pareto cost analysis results in each situation, the study shows that the four highest costs between the positions when fuel prices increased in 2017 and the pandemic conditions in 2020 have slightly different variables.
Before the pandemic, the costs that are the top four most significant costs are fleet cost, fuel cost, maintenance cost, and crew cost. However, in the data for the last six months during the pandemic, cost variables such as maintenance costs and fuel costs experienced a decrease in proportion. Thus, the pandemic situation affects the behaviour of the ratio of costs. The top four most significant costs during the pandemic are fleet cost, crew cost, overhead cost, and fuel cost. The increased proportion also reflects the reduction in the efficiency and effectiveness of the expenses in the company. The results before the pandemic are similar to an article by ICAO (2017) related to cost structure proportion along with worldwide airlines.
Cost Behavior analysis
According to data collection results related to the most significant cost proportions, the cost has behavior and is different in each condition. A description of the cost behavior from fleet cost, fuel cost, and overhead cost are described in the following Figure 3.
Fleet Cost Fuel Cost
Overhead Cost
Based on figure 3, literature review, and the results of interviews with key persons in the area, the cost behavior of fleet costs, fuel costs, and overhead costs is described as follows:
Fleet cost
Fleet cost consists of rental fees, insurance costs, and aircraft depreciation costs. The conditions of the Covid-19 pandemic in 2020 and when the fuel prices increase tend to have the same value. This condition because the number of aircraft from that period is relatively the same.
Meanwhile, the cost of aircraft depreciation causes fleet costs to fluctuate depending on the age and due date of heavy maintenance of each aircraft chartered and owned by Garuda Indonesia.
Fuel cost
Fuel cost increase depends on the volume of used fuel and the selling price of fuel. The volume of used fuel depends on aircraft operations such as distance traveled, flight frequency, flight time, weather, and aircraft fuel efficiency. The selling price of fuel and increased production led to an increase in fuel costs in 2017, while during the Covid-19 pandemic in 2020, the volume of used fuel decreased as production decreased.
Overhead cost
The company's head office overhead costs have increased during the Covid-19 pandemic in 2020. This increase is due to the early retirement program offered by the company to employees who are almost entering their retirement age. On the other hand, when the fuel price increased in 2017, the overhead also has increased. In addition, the company was growing new employees in 2015-2017 regarding the addition of the fleet in 2017. Therefore, the overhead costs increased in value and proportion during the Covid-19 pandemic compared to the two conditions.
5. Conclusion
The results before the pandemic are similar to an article by ICAO (2017) related to operating cost structure proportion along with worldwide airlines. Before the pandemic, the operating costs that are the top four most significant costs are fleet cost, fuel cost, maintenance cost, and crew cost. On the other hand, the top four most significant costs during the pandemic are fleet cost, crew cost, overhead cost, and fuel cost.
The behavior of cost before and during pandemic have a different impact to cost value in each situation. But the driver cost still the same as a fundamental of the airline business. For example, the fuel cost increase depends on the volume of used fuel and the selling price of fuel.
The fleet cost depends on rental rate, depreciation, and insurance. And for the overhead cost depends on the organization and management of airlines. The airlines need to align their cost to be efficient and effective regarding facing external conditions such as the Covid-19 pandemic. Understanding cost structure and cost behavior would be the insight for management to develop the best strategy to do.
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