Airline Cost Categorization
Administrative vs. Functional Cost
Categories
•
One approach to airline cost categorization makes use of “administrative cost
categories,” which are typical of financial accounting statements used in many
industries. Administrative cost categories include separate reporting of the
following:
–
Salaries and related fringe benefits for all personnel, including general management, flight
personnel, maintenance labor, aircraft & traffic handling personnel, other personnel.
–
Materials purchased, e.g., aircraft fuel & oil, maintenance materials, passenger food, other
materials.
Administrative vs. Functional Cost
Categories
– Services purchased, such as advertising & promotions,
communications, insurance, outside maintenance, commissions,
other services.
– Additional categories for landing fees, rentals (including aircraft),
depreciation (including aircraft), other expenses.
Administrative vs. Functional Cost
Categories
• Administrative cost categorization is
typical of financial statements, as it reports
funds expended for labor (salaries),
materials and services used as inputs for
the “production” of the airline’s output.
administrative categorization of
airline costs,
Functional cost categories
• An alternative approach to the categorization of airline
operating costs is to define “functional” cost categories,
in a way that allocates costs to different functions within
the airline’s operation.
• Specifically, the three major functional cost categories
for airlines are;
– flight operating costs,
– ground operating costs and
– system operating costs.
Functional cost categories
“Flight operating costs”
• “Flight operating costs” include all
expenses associated with operating
aircraft, and are also referred to as “direct
operating costs” (DOC) or “aircraft
operating costs.”
Functional cost categories
“Flight operating costs”
• Flight operating costs represent the largest
proportion of an airline’s operating
expenses (typically and are usually
allocated against the number of block
hours operated by the airline’s fleet.
Functional cost categories
“Flight operating costs”
• the following cost items contribute to flight
operating costs:
– Flying operations: This function consists of
“expenses incurred directly in the in-flight
operation of aircraft”, including all costs
associated with flight crew and fuel costs.
Functional cost categories
“Flight operating costs”
– Maintenance: Maintenance expenses are “all
expenses, both direct and indirect, specifically
identifiable with the repair and upkeep” of
aircraft and equipment. This element includes
both routine maintenance and more extensive
major checks, with costs driven in large part
by extensive use of labor and the
consumption of spare parts.
Functional cost categories
“Flight operating costs”
– Depreciation & amortization:This function
spreads the capital cost of the airline’s assets
– specifically, aircraft – over their expected
lifetime.
Functional cost categories
“Ground operating costs”
• “Ground operating costs” are incurred at
the airport stations in handling
passengers, cargo and aircraft or by the
airline in making reservations and ticket
sales, and are directly incurred in
providing transportation services to the
customer.
Functional cost categories
“Ground operating costs”
• The three major components of ground
operating costs are:
– Aircraft servicing costs incurred in handling aircraft on
the ground, including landing fees.
– Traffic servicing costs of processing passengers,
baggage and cargo at airports.
– Promotion and sales costs associated with airline
reservations centers and ticket offices, including
travel agency commissions and distribution system
fees.
Functional cost categories
“System operating costs”
• “System operating costs” are the indirect
operating costs remaining after ground
operating costs are accounted for.
Functional cost categories
“System operating costs”
• They are not directly associated with
supplying the transportation service, but
are more of a corporate overhead
expense.
• For example, advertising costs are those
spent to increase system revenues, while
on-board passenger service
expensesinclude food, entertainment and
cabin crew costs.
Functional cost categories
“System operating costs”
• The major components of system operating
costs can be summarized as follows:
– Passenger service costs, including meals, flight attendants and in-flight
services.
– Advertising and publicity expenses.
– General and administrative expenses that are truly general to the airline
or those that cannot be associated to a particular activity.
– Transport-related expense items are costs associated with “the
generation of transport related revenues”. They include fees paid to
regional airline partners for providing regional air service, extra baggage
expenses and other miscellaneous overheads.
Functional cost categories
The ICAO cost categories
The ICAO cost categories
Low cost airlines
• NLCs (“network legacy carriers”) are typically more
traditional airlines that operate large hub-and-spoke
networks consisting of regional, domestic and
international services. LCCs (“low-cost carriers”), on the
other hand, tend to operate smaller networks that tend to
include a higher proportion of “point-to-point” or non-hub
services – although many LCCs around the world
operate networks that include “focus cities” as
connecting points for passengers. LCCs typically offer
reduced levels of service and low fares, although the
wide range of LCC characteristics makes it difficult to
identify a single representative LCC “business model.”
The LCC “Business Model”
characteristics and operating strategies
• Use of a single aircraft type or interchangeable family of aircraft.
“fleet commonality” reduces the costs of spare parts, maintenance
and crew training
• Operation of “point-to-point” instead of connecting hub networks:
focusing on non-stop flights serving only local passengers flying
from point A to point B reduces costs associated with the handling of
connecting passengers, and improves the productivity of both
aircraft and crews.
• No labor unions and lower wage rates for employees: keeping their
employees non-unionized allows LCCs to pay lower salaries and
achieve higher productivity due to less restrictive work rules.
The LCC “Business Model”
characteristics and operating strategies
• Single cabin service, with no premium classes offered: given that
LCCs focus on very low fares aimed at price-sensitive leisure
travelers, multiple product offerings would both increase complexity
and costs.
• No seat assignments: open seating means less time spent on
processing passengers at the airport and no need to print boarding
passes, again improving productivity and reducing costs.
• Reduced “frills” and seating space on board: elimination of food and
beverages reduces passenger service costs, while reduced seating
space increases the ASK produced by each flight, in turn lowering
its unit costs.
The LCC “Business Model”
characteristics and operating strategies
• No frequent-flyer loyalty programs: such programs incur
administrative costs that can be avoided.
• Avoid use of traditional distribution channels: travel
agencies still receive commission fees in many
countries, and make use of computer reservations
systems called “global distribution systems (GDS)”. GDS
charge fees for booking ands ticketing, which can be
avoided if the LCC limits its passengers to making
reservations and buying tickets directly from the airline,
either on its website or by telephone.
The LCC “Business Model”
characteristics and operating strategies
• Southwest Airlines (USA) is the oldest, most
successful and most studied LCC in the world. Many
believe that it still maintains all of the typical LCC
characteristics. Southwest does indeed operate a single
aircraft family (Boeing 737), offers a single cabin service
and no seat assignments. On the other hand, Southwest
does offer complimentary snacks and beverages, its
aircraft have leather seats with legroom similar to that of
legacy carriers. While the airline’s network is not a
classical hub structure, it has many
The LCC “Business Model”
characteristics and operating strategies
• “focus cities” at which a large proportion of
its passengers make connections. And,
perhaps most surprisingly, Southwest is
the most heavily unionized airline in the
USA; its employees’ salaries are very
similar to those paid by US legacy carriers
The LCC “Business Model”
characteristics and operating strategies
•
JetBlue (USA) was launched in 2000, and has grown very rapidly ever
since. While a successful LCC, it has even fewer of the typical LCC
characteristics than Southwest. Unlike Southwest, it has avoided employee
unionization to date, making it more “typical” in this respect. On the other
hand, JetBlue operates two very different aircraft types (the Airbus 320 and
Embraer 190), and its focus on flights to and from its home base at JFK
Airport in New York has given it a natural connecting hub there. JetBlue
also offers advance seat assignments to all passengers, on-board service
(and live television) that is perceived by consumers to be superior to that of
legacy airlines, a frequent-flyer program, and in 2007 made its flights
available through traditional distribution channels
(GDS).
The LCC “Business Model”
characteristics and operating strategies
• The third largest US LCC is AirTran and, as
shown in Figure 5.6, it has none of thetypical
characteristics shown, but it is a successful and
low-cost operator. Some ofAirTran’s employees
are unionized, and the airline operates a
traditional connectinghub at Atlanta. It is the only
LCC shown that also offers a business-class
product withmore seating space and enhanced
on-board passenger service.
The LCC “Business Model”
characteristics and operating strategies
• One of the largest European LCCs is easyJet
(UK), based at Luton Airport outside ofLondon.
This airline has more of the typical LCC
characteristics than any of the NorthAmerican
LCCs discussed above. However, some of its
employee groups are unionized(e.g., pilots) and
it now operates two different aircraft families, the
Boeing 737 and Airbus 319 types.
The LCC “Business Model”
characteristics and operating strategies
• The other large European LCC is Ryanair
(Ireland), and it is the only airline in
thiscomparison that has all of the “typical”
characteristics of an LCC business
model.Ryanair has indeed been both
profitable and successful, and it remains
the largest (butonly one of a few) LCCs
that meet all six of the criteria
The LCC “Business Model”
characteristics and operating strategies