Introduction to
Aviation Economics
The economic characteristics of
the Airlines Business
Introduction to Airline industry
• Air travel remains a large and growing industry.
• It facilitates economic growth, world trade, international
investment and tourism and is therefore central to the
globalization taking place in many other industries.
• Travel for both business and leisure purposes grew
strongly worldwide
Introduction to Airline industry
• In domestic and
international competitive
market, aviation economic
should be well managed
with the existence of LCC
airline companies.
• To compete with the
LCCs, aviation fraternity
should understand the
concept of aviation
economics characteristics
and strategies.
Overview
• Economists usually describe the certificated
airline industry as an oligopolistic economic
structure
• That is, this industry composed of few firms
(can be 5/ 10/ 100) producing either similar or
differentiated products.
• Apart of few sellers and typically characterized
by high barriers to entry
• Airline business also has its own distinguish
feature
• Q: Name other possible oligopolistic industries
Other characteristics of oligopolistic industry
• Substantial economic scale: Increase of
size in operations leads to decrease of
firm’s costs in a long term
– Large scale of production afforded by intensive labor
and management specialization of job responsibilities,
technological and products utility efficiency make
possible of low costs
– So, if market demand only sufficient to support few
large firms of optimum size, only few such firms will
survive
– It’d be hard for new and small firms to compete with
these large firms
Other characteristics of oligopolistic industry
• Growth merger: Many of oligopolies
resulted from mergers of competing firms
(i.e. Am Bank, CIMB)
– The purpose of “merging” is to gain
• Substantial increase in market share
• Greater economies of scale
• More buying power in purchasing of resources
Other characteristics of oligopolistic industry
• Mutual Dependence: When there are only
few firms in a market, it matters very much
what their rivals do (i.e. Malaysia Airlines
vs. Air Asia)
– The competitor’s reactions play a vital role
when setting prices
– In these games, the participants try to win by
formulating strategies that anticipate the
counter-reactions of their opponents
Other characteristics of oligopolistic industry
• Price rigidity and non-price competition:
Firms are more likely to maintain their
constant prices
– As a result, firms engage in various forms of
non-price competition like advertising and
customer service
– Price reductions occur only under severe
pressures resulting from weakened demand
ad excessive capacity (i.e. The case of
Malaysia Airlines)
However, other economic characteristic :
The Airlines as an Oligopolists?
• We have discussed earlier on
characteristics of oligopolistic industry
• Apparently the airline industry also share
some of the oligopolistic features:
– Small Number of carriers and market share
– High barriers of entry
– Economies of scale
– Growth through merger
– Mutual Dependence
– Price rigidity and non-price competition
Number of carriers and market share
• Recently there has been increment in
airline firms with the addition of small
certificated airlines and demise of some
larger airlines (A once in a blue moon in
M’sia but an apparent situation in the U.S.
and Europe)
• BUT, they either liquidated, merged or
never operated or decertified.
• So, the largest airline own and retain the
power in market share
Number of carriers and market share
• Unquestionably, with this small numbers of
airline companies and concentration of
market share (Just like the aviation climate
in M’sia)..
• It meets the first characteristic of
oligopolistic industries
High Barriers of Entry
• In recent years, it is difficult to get access
to many markets due to
– Difficulty to obtain terminal space at many hub
airports
– The financial outlays risk (i.e., advertising,
personnel and aircraft operation cost)
compete with the airline at its hub
– Airport terminal capacity (i.e. Air Asia
competing with M’sia Airlines at KLIA)
High Barriers of Entry
• So, it is difficult to enter the airline industry
and it is even harder during the start-up
stage as the major airlines dominated the
power to buy in the market
• This phenomenon match with the second
criterion of oligopolistic firms
High Barriers of Entry
• Defunct airlines
AIRLINE
IATA
ICAO
CALLSIGN
COMMENCED
OPERATIONS
CEASED
OPERATIONS
August 1, 2006
September
30,2007
January 20, 2004
2006
Borneo Airways
FlyAsianXpress
D7
Ked-Air
Malaysia-Singapore Airlines
MH
MAS
MALAYSIAN
1966
1972
Pelangi Air
PG
PEG
PELANGI
AIRWAYS
1989
2001
Saeaga Airlines
SG
SGG
SAEAGA
1995
1998
Growth through Merger
• Airlines in particular growth through
merger (Although, it is not the case in
M’sia)
• Merger can
– Increase market share
– Increase market power (greater ability to
control the market for and the price of its
service than does a smaller, more competitive
producer)
– Eliminating bankruptcy and competition
Growth through Merger
• Like in the U.S: Merger decrease no. of
certificated airlines (From 17 in 1950 to
remaining 12 in 2002)
• This merger for growth feature makes the
airline business fits as oligopolistic
business
Mutual Dependence
• Airlines industry involves rivalry among a
number of airlines
• An action taken by a particular airline
would yield counter-reactions of their rivals
or opponents
• Like, MAS vs. Air Asia (at domestic level)
and MAS vs SIA (at international level)
• It is a fact that rivalry in airlines industry
counter react with one another for profit
gain
Price Rigidity and Nonprice Competition
• Airline industry also oligopolistic in its price
• Airliners are much comfortable maintaining
constant price rather than rocking the
boat, so to speak…
• Why?
– Mutual Dependence
– Fear of Price War
• Oligopolistic pricing has become the
norms in airline industry
The Airlines Special Economic Characteristics:
•
•
•
•
•
Government Financial Assistance
High Technological Turnover
High Labor and Fuel Expenses
Sensitivity to Economic Fluctuations
Close Government Regulation
Government Financial Assistance
• Unlike other oligopolistic industries (i.e.
Mobile and Internet services), the
government units have played a major
roles in the growth of airport-airways
systems (i.e. Malaysia Airlines)
• National airways system was maintained
by the federal government at minimal cost
to users of the system
Government Financial Assistance
• Most commonly, the fees charged for
landing aircraft, maintaining office and
operational space do not repay the
operating costs of the airport (Take the
case of LCCT eg: exclude insurance)
• As a result, airline industry benefited from
the financing of the airport-airways system
(which is the major cost element)
High Technological Turnover
• Technological advances in flight
equipment over the short span of 30 years
have come at an extremely rapid pace
• Airlines spend lots of money on flight reequipment cycle, approximately at every 8
years
• Plus, capital spending in hiring and
training personnel, and in modifying
facilities to accommodate the new aircraft
and associated equipment
High Labor & Fuel Expenses
• These are two biggest expenses (Typically
60%)
• Labor: Airline employees are men and
women with highly developed skills and
with correspondingly high incomes
– Plus, airline needs a large number of
manpower
• Fuel: No other industry has been
subjected to the severe increases of fuel
prices that the airlines have experienced
over the past 15 years.
High Labor & Fuel Expenses
• Fuel price Costs Ticket Price = Less
Passenger, Less Profit…
• At times, purchasing fuel-efficient aircraft
(that burn less fuel than others) also can
be very costly than do less-efficient aircraft
• Moreover, the actual price of fuel far
outside any airline’s span of control
Sensitivity to Economic Fluctuations
(Recession)
• Unlike other durable good like automobile
industries, whenever recession takes
place, it is much slower for the airline
industry to recover
• Why? Because of the apparent impacts of
recession on air travel
– People postpone long-distance travel
– Companies cut back business trip/ no/ of
people sent on a given trip
– Fewer people travel first class
Sensitivity to Economic Fluctuations
(Recession)
• Unlike other industries, airlines still have to
continue make payments to creditors and
outstanding debtors (primarily flight
equipment) even during recession
• Further, although airline can furlough
certain volume related employees, it’d
involve extensive retraining costs when
personnel are brought back or new
personnel are hired
Close Government Regulation
• Impact on generating the economics
activities.
• Carry the country’s name to a worldwide
standard.
• Avoid accidents of surely death that would
harm the country’s value.
• Avoidance of terrorist, illegal product
enter the country.
The major questions
• If the airline industry is oligopolistic
– How can a new airliner enter and survive in this
industry?
– How would existing airliners compete with the new
airliner and retain themselves in the industry?
• How to overcome to these oligopolistic
barriers in airline business?
– Airlines can independently make profits in each areas
of aviation economic activities
• This is where aviation economics deals
with profit making and lowering costs in
aviation activities
Airlines Profitable Economic Activities
• There are five major parts of economic
activities:
– Part I: The Demand for Airline Services
– Part II: Airline Route Feasibility/ Planning
– Part III: Fixed-Base Operation (FBO)
– Part IV: Fleet Planning
– Part V: Maintenance, Repair, Overhaul (MRO)
• Each of these share the aims on how to
lower the costs and gain profit
Part 1: The Demand of Airline Services
• Demand is defined as the various amounts
of a product or service that consumers are
willing and able to purchase at various
prices at a particular period of time
• Determining the demand would the help
the airlines in setting the price, estimating
and managing their costs and calculating
how they can gain profits
Part 1: The Demand of Airline Services
• This is where the airlines will deal with
how certain forecasting methods can help
the airline gain profit
• Forecasting is
– The attempt to quantify in a future time period
– It is about predicting and estimating some
future volume or financial situation
Part 2: Airline Route Planning/ Feasibility
• This where airlines deal with the
application of forecasting method in
determining the costs of a route of one
flight from one destination to another
either
– Domestic or
– International
• In terms of …
–
–
–
–
Flight personnel
Fuel consumption
Facilities and Airport cost
Passenger Movement and Air Cargo
PART 3: Fixed Based Operations (FBO)
• In the aviation industry, a fixed base
operator (also known as fixed base
of operation), or FBO, is a service
center at an airport that may be a
private enterprise or may be a
department of the municipality that
the airport serves.
PART 3: Fixed Based Operations (FBO)
• At a minimum, most FBOs offer aircraft
fuel, oil, and parking, along with access to
washrooms and telephones. Some FBOs
offer additional aircraft services such as
hangar (indoor) storage, maintenance,
aircraft charter or rental, flight training,
deicing, and ground services such as
towing and baggage handling.
• FBOs may also offer services not directly
related to the aircraft, such as rental cars,
lounges, and hotel reservations.
• Among services provided by FBOs are
– Ground Handling
•
•
•
•
Cabin Service
Catering
Ramp Service
Passenger Service
– Field Operations Service
Ground Handling
• Many airlines subcontract ground handling to an
airport or a handling agent, or even to another
airline.
• Ground handling addresses the many service
requirements of a passenger aircraft between
the time it arrives at a terminal gate and the time
it departs on its next flight.
• Speed, efficiency, and accuracy are important in
ground handling services in order to minimize
the turnaround time (the time during which
the aircraft must remain parked at the gate)
Ground Handling
• Airlines with less-frequent service or fewer
resources at a particular location
sometimes subcontract ground handling or
on-call aircraft maintenance to another
airline, as it is a short-term cheaper
alternative to setting up its own ground
handling or maintenance capabilities.
• Most ground services are not directly
related to the actual flying of the aircraft,
and instead involve other tasks.
Cabin Services
• These services ensure passenger comfort.
They include such tasks as cleaning the
passenger cabin and replenishment of onboard consumables or washable items
such as soap, pillows, tissues, blankets,
etc.
Catering
• Catering includes the unloading of unused food
and drink from the aircraft, and the loading of
fresh food and drink for passengers and crew.
• Airline meals are typically delivered in trolleys.
The empty or trash-filled trolley(s) from the
previous flight is replaced by a fresh one.
• Meals are prepared mostly on the ground in
order to minimize the amount of preparation
(apart from chilling or reheating) required in the
air.
Ramp Service
• This includes services on the ramp or
apron, such as:
– Guiding the aircraft into and out of the parking
position (by way of Aircraft marshalling
– Water cartage (to refill fresh water tanks)
– Refueling, which may be done with a refueling
tanker truck or refueling pumper
– Passenger stairs (used instead of an
aerobridge or air stairs, some budget airlines
use both to improve turnaround speed) etc.
Passenger Service
• This includes services inside the airport terminal
such as:
• Providing check-in counter services for the
passengers departing on the customer airlines.
• Providing Gate arrival and departure services.
The agents are required to meet a flight on
arrival as well as provide departure services
including boarding passengers, closing the flight,
etc.
• Staffing the Transfer Counters, Customer
Service Counters, Airline Lounges, etc.
Field Operation Service
• This service dispatches the aircraft,
maintains communication with the rest of
the airline operation at the airport and with
Air Traffic Control.
PART 4: Fleet Planning; Aircraft lease
and Purchase
• Aircraft leases are a number of
types of leases used by Airlines and
other aircraft operators.
• Airlines lease aircraft from other
airlines or leasing companies for two
main reasons; to operate aircraft
without the financial burden of buying
them, and to provide temporary
increase in capacity.
PART 4: Fleet Planning; Aircraft lease
and Purchase
• The industry has two main leasing types,
wet leasing which is normally used for
short term leasing and dry leasing which is
more normal for the longer term leases.
• The industry also uses combinations of
wet and dry when for example the aircraft
is wet-leased to establish new services
then as the airlines flight or cabin crews
become trained they can be switched to a
dry lease.
PART 4: Fleet Planning; Aircraft lease
and Purchase
• When purchasing aircraft, it allows an airline to
purchase additional aircraft in the future at an
agreed price and date
• When placing orders for new aircraft, airlines
commonly obtain options from the aircraft
manufacturer, for example Airbus or Boeing.
• These options allow the airline to delay the
purchase of additional aircraft until market
conditions become clearer and the purchase can
be justified. It also reserves the airline a place in
the manufacturing queue, for a guaranteed
delivery slot.
PART 4: Fleet Planning; Aircraft lease
and Purchase
• When the airline finally exercises its
options, it can place its order without
having to join the beginning of the queue
which otherwise may delay the delivery of
the aircraft for years.
• If future conditions don't justify expansion
of the airline's fleet, the airline is not
obligated to purchase the aircraft
PART 4: Fleet Planning; Aircraft lease
and Purchase
• Depending on economic conditions,
manufacturers often sell aircraft
purchasing options below the real value of
the aircraft
• Therefore, in this case determining of the
demand, need and costs is important for
an airline to decide whether to lease or
purchase aircraft.
PART 5: Maintenance Repair
Overhaul (MRO)
• Aircraft MRO is the overhaul, repair,
inspection or modification of an aircraft or
aircraft component
• Maintenance includes the installation or
removal of a component from an aircraft or
aircraft subassembly, but does not include:
– Elementary work, such as removing and
replacing tires, inspection plates, spark plugs,
checking cylinder compression, etc
PART 5: Maintenance Repair
Overhaul (MRO)
– Servicing, such as refueling, washing
windows
– Any work done on an aircraft or aircraft
component as part of the manufacturing
process, prior to issue of a certificate of
airworthiness or other certification document
Question 1
The market structure of airline industry has undergone
important changes that construct a dynamic economic
model structure.
a)Describe what do you understand about the general
characteristics of oligopolies and prove that aviation
industry is oligopolistic. (9 marks)
b) Name three other possible oligopolistic industries.
State your reason. (3 marks)
c) From your opinion why competition in aviation industry
has been has been substantially increasing in Malaysian
market? (3 marks)
Question 2
The aviation industry faced one of the biggest
development in the new era, riding on the wave of
the new economy and a greater demand for travel.
a)Explain in your own word the airlines special
economic characteristics. (8 marks)
b) Discuss the concept of price rigidity and non-price
competition in aviation industry. Provide example
to support your answer. (4 marks)
c) From your observation, why food and education
industries are not badly impact as aviation industry
to economic downturn. (3 marks)
Question 3
Airlines can independently make profits in each areas of
aviation economic activities which deals with profit
making and lowering costs in aviation activities.
a)Explain in your own word the airlines profitable
economic activities.(9 marks)
b) What are the two major operating expenses in airline
industry and why are they so high? (3 marks)
c) In your own words, which aviation economic
activities could obtain the highest gross profit and
state your reasons. (3 marks)
Question 4
In the aviation industry various factors such as
authorities, airports, airlines and passengers combine
to determine the affect the airline strategy and
business organization.
a)Explain in your own word the reason for the small
number of certificated airliners.(5 marks)
b) Define economies of scale, and discuss how they
relate to the airline industry. (5 marks)
c) In your own words, discuss the types of aircraft
leasing. Which types of aircraft leasing would you
prefer and state your reason. (5 marks)