Strategic Airline Management 2:Traffic

Dr Narudh Cheramakara

2/2017

Bangkok University

TRAFFIC: 1st Element of Operating Performance

TRAFFIC x YIELD> < OUTPUT x UNIT COST

= OPERATING PERFORMANCE (PROFIT or LOSS)

1. The Modelling of Demand

1.1 Demand Function (Simplest form)

2.1 Demand Curve

• An individual’s demand curve for a commodity shows how much that individual would like to consume of that commodity at each possible price. It is therefore a graph which shows the relationship between the price of a good and the quantity demanded (in a given period of time).

• For example, looking at the demand for hotel rooms, at a price of 3000 baht per night

• There would be a demand of 100 rooms.

• At a price of 2000THB there would be a demand of 150 rooms

• At a price of 4000THB there would be a demand of 50 rooms

1. The Modelling of Demand

1.1 Demand Function (Simplest form)

1. The Modelling of Demand

1.2 Demand Schedule/Demand curve

2.1 Demand Curve

• There are two effects of a price change. For example, if the price rises:

• The Income Effect – the rise in prices means people feel poorer –their purchasing power has fallen. They buy less because of this fall in purchasing power.

• The Substitution Effect – the rise in price of a commodity makes it relatively more expensive compared to other commodities, and so consumers switch from the first commodity to one which is now relatively cheaper.

• What factors might affect demand? Demand will increase

2.1 Demand Curve

• What factors might affect demand? Demand will increase

• Income goes up (unless the good is an inferior good, in which case demand will fall)

• Expectations of future price changes go up

• The price of a complement good goes down

• The price of a substitute good goes up

• Tastes move in favour of this good.

• …and vice versa for a fall in demand.

2.1 Demand Curve

• Since these factors will change demand at any given price, they lead to a shift in the demand curve. If demand at each price increases, the demand curve shifts to the right, and if demand at each price falls, the demand curve shifts to the left.

• To differentiate between a movement along a demand curve and a shift in the demand curve itself, we say that:

• A movement along the demand curve is a change in the quantity demanded

• A shift in the demand curve itself is called a change in demand.

1.1 Demand Schedule/Demand curve : Demand can shift!!

VISA

New Service

Diseases

Political Instability

2.1 Demand Curve

• Since these factors will change demand at any given price, they lead to a shift in the demand curve. If demand at each price increases, the demand curve shifts to the right, and if demand at each price falls, the demand curve shifts to the left.

• To differentiate between a movement along a demand curve and a shift in the demand curve itself, we say that:

• A movement along the demand curve is a change in the quantity demanded

• A shift in the demand curve itself is called a change in demand.

2.1 Demand Curve• Utility : measurement of "useful-ness" that a consumer obtains from

any good. Utility may measure how much one enjoys a movie, or the sense of security one gets from buying a deadbolt. The utility of any object or circumstance can be considered.

• Diminising Marginal Utility

2.1 Demand Curve

• Inferior Goods

(LCCs High/Low time case)

How about the hospitality

Sector?

2.2 Supply Curve

• The supply curve shows how much a firm is willing to supply at each possible price. It is therefore a graph which shows the relationship between the price of a good and the quantity supplied (in a given period of time).

• Considering the case of rubber plants

• Myanmar Hotel Markets

2.2 Supply Curve

• The supply curve slopes upwards. As the price goes up, more is supplied. Why?

• Costs of production – to increase production may involve increasingly higher costs. For example, a firm may have to pay its workers overtime in order to increase production, or a farmer may have to use less fertile land and therefore spend more on fertilizer. A higher price is therefore needed to persuade producers to supply the extra goods and justify the higher costs.

• Profits – if producers supply a range of products, as the price of one goes up, they might switch production from another product to the one that is now more profitable. For example, if a farmer can plant carrots or potatoes in his field, if the price of potatoes goes up he might plant fewer carrots and more potatoes.

• Entry of new firms – as the price of a good goes up, more firms may start upandsupply that good (market supply curve effect).

2.2 Supply Curve

• What factors might affect supply? Supply will increase if:• Costs of production fall – this could be a fall in the price of inputs (for

example a fall in the wage rate) or technological improvement which means the firm can produce more efficiently and require fewer inputs, or a government subsidy.

• Price of alternative products falls – if the price of an alternative good that the firm could produce falls, the supply of the original good will increase as the firm switches production to this good which is now more profitable.

• Random events occur that have a good effect - .g. good weather for agriculture.

• Future prices are expected to be high• Government Policies

2.2 Supply Curve

• Since these factors will change supply at any given price, they lead to a shift in the supply curve. If supply at each price increases, the supply curve shifts to the right, and if supply at each price falls, the supply curve shifts to the left.

• To differentiate between a movement along a supply curve and a shift in the supply curve itself, we say that:

• A movement along the supply curve is a change in the quantity supplied

• A shift in the supply curve itself is called a change in supply

2.2 Supply Curve

• Since these factors will change supply at any given price, they lead to a shift in the supply curve. If supply at each price increases, the supply curve shifts to the right, and if supply at each price falls, the supply curve shifts to the left.

• To differentiate between a movement along a supply curve and a shift in the supply curve itself, we say that:

• A movement along the supply curve is a change in the quantity supplied

• A shift in the supply curve itself is called a change in supply

2.3 Equilibrium

At the point of intersection between the demand and supply curves, there is noshortage and no surplus, and so no tendency for anything to change. This point of intersection is therefore the equilibrium point, and reveals the equilibrium, or market clearing,price and quantity.

2.3 Equilibrium

• If the price is below its equilibrium value, demand will be greater than supply and there will be a shortage of that good. This will bid up the price, which will in turn reduce quantity demanded and increase quantity supplied, until quantity demanded equals quantity supplied again, and the price is at its market-clearing level.

• If price is above its equilibrium value, supply will be greater than demand and there will be a surplus of that good. Firms will undercut each other and so the price will fall, which will increase quantity demanded and reduce quantity supplied, until quantity demanded equals quantity supplied again, and the price is at its market clearing level.

• Therefore free-markets automatically correct themselves and find their equilibrium position.

2.3 Equilibrium Anything which increases demand at each price will shift the demand curve to theright. This will create a shortage and an increase in the price. The end result is ahigher equilibrium price and quantity.

Anything which reduces demand and shifts the demand curve to the left will lead to alower equilibrium price and quantity.

If supply increases at each price, so that the supply curve shifts to the right, this willcreate a surplus, and thus price will fall. At the new equilibrium, price is lower andquantity is higher.

2.3 Equilibrium

Both the demand and the supply curve can shift at the same time.

The position of the new equilibrium then depends on the relative size of the shifts in the two curves, and it may not be possible to say whether price or quantity will definitely be higher or lower in the new equilibrium.

For example, if demand and supply both increase, equilibrium quantity will definitely be higher, but the equilibrium price could be higher or lower depending on whether the shift in the demand curve is greater than or less than the shift in the supply curve respectively.

3.1 Elasticities

• Elasticities measure the responsiveness of a thing to changes in another thing. We can calculate elasticities with respect to any two things we want. The calculation of an elasticity is always the proportional change in the variable being effected, divided by the proportional change in the variable doing the effecting.

• What we in Economics are most interested in is elasticities of demand and supply, for example, by how much quantity demanded changes when price changes (price elasticity of demand), income changes (income elasticity of demand) of the price of other goods change (cross price elasticity of demand), or by how much supply changes when the price changes (price elasticity of supply).

3.2 Price Elasticities of Demand

3.2 Price Elasticity of Demand

• Note that the elasticity is always calculated in terms of proportional (i.e. percentage) changes, rather than absolute changes. This gets round the problem of comparing changes in things measured in different units. Also, it makes clear whether we aredealing with big or small changes, which is not the case with absolute changes in prices or quantities (for example, is a £1 change in price a big change? – it depends. Yes, if we are looking at the price of a newspaper, no if we are looking at the price ofa house).

• Example:

• If a 40% rise in the price of hotel room squantity of hotel room demanded to fall by 10%, the price elasticity of demand for hotel is -10/40 = -0.25.

• Note the price elasticity of demand will always be negative, since a rise in pricereduces demand, and vice versa.

3.2 Price Elasticity of Demand Elastic demand – when the price elasticity of demand is greater than 1 in absolutevalue, i.e. more negative than -1, e.g. -2.Inelastic demand - when the price elasticity of demand is less than 1 in absolutevalue, i.e. between 0 and -1, e.g. -0.5.Unit elastic demand - when the price elasticity of demand is exactly -1.

The more elastic is demand, the flatter will be the demand curve at any point.

The more inelastic is demand, the steeper will be the demand curve at any point.

Hotel guests? Business v Leisure?

3.3 What govern price elasticity of demand?

• Number of substitute goods – the more substitutes, the more elastic is demand.

• The proportion of income spent on the good – the greater the proportion of income spent, the more elastic is demand.

• The time period under consideration – the shorter the time period, the more inelastic is demand.

• Necessity

• Also – Who’s paying // Brand Loyalty

3.3 What govern price elasticity of demand?

• Number of substitute goods – the more substitutes, the more elastic is demand.

• The proportion of income spent on the good – the greater the proportion of income spent, the more elastic is demand.

• The time period under consideration – the shorter the time period, the more inelastic is demand.

• Necessity

• Also – Who’s paying // Brand Loyalty

3.4 Price Elasticity and Firm’s Revenue

• Revenue = price x quantity.

• Therefore, if demand is elastic, revenue/expenditure falls following a price rise, since quantity demanded falls proportionally more than the price rises.

• If demand is inelastic, revenue/expenditure rises following a price rise, since quantity demanded falls proportionally less than the price rises.

• If demand is unit elastic, revenue/expenditure stays the same following a price rise, since quantity demanded falls proportionally the same amount as the price rises.

3.5 Income Elasticity of Demand

Think about the case of a Japanese restaurant business

3.7 Price Elasticity of Supply

4. Demand and Traffic

5. Traffic Defined

1. Total Enplanement (Total passenger)

- What are the problems with this measurement?

Alternatively, RPK/RASK

2. Revenue Passenger-Miles Kilometres (RPK) / RASK

- Distant weighted meatures generated by flying one revenue passenger per mile

- i.e.

RASK

CASK

Real Life Example: DD

6. Segmentation

6. Segmentation for Airlines

1. Purpose of Journey:

Business

Leisure

VFR

Nok Air Case: 40 20 40%

+ Hajj charter flight

6. Segmentation for Airlines Cont’d

2. Length of Journey

- Reasons why LCCs works with in 4 hours flying time

- Short haul, importance on airport and convenient on the ground

- Long Haul, importance in-flights service (IFE, seats)

- Still air fare will always an important factor

Considering

- 1. BKK-CNX TG 4700, FD 2000

- 2. BKK FRA EK 36000, UIA 32000

6. Segmentation for Airlines Cont’d

3. Country/Culture of Origin of the Travellers

- Different Requirements: Dietary, Religious, Booking behavior, Linguistics

- National Airlines: TG, Thainess, Culture, Linguistic

- Global Branding: Emirates, Etihad, Easyjet, Air Asia

• https://www.youtube.com/watch?v=0N3J6fE-0JI

Air France Safety Demo

International Airlines

International Airlines

6. Segmentation for airlines cont’d

1) Business

- Frequency

- Flexibility

- Benefits (FFPs, Comfort)

- Company pays!!!!

- Thai Gov’t, MPs (Freebies, VIP treatments, Front row)

- Elasticity of demand:……………. Elastic or inelastic?

6. Segmentation for airlines Cont’d

2) Leisure (+VFR)

- Price

- Self-paid

- Strong seasonal fluctuation

- Changing buying behaviours: Travel agents (commission cuts) to direct sales -> Hugh effects on the travel industry

- Elastic or inelastic demand? Price sensitivity?

- Of the two, which group of passengers do airlines preferred? Why?

7.Drivers for air transport demand

7. Drivers for air transport demand

1. Price (Remember the Elasticity of Demand)

2. Income – Disposible Income

- Emerging markets

- The rise of Middle Class

- Indonesian / Thailand Case

- How consumptions have changed in Thailand in the past 20 years?

3. Exchange Rate (Int’l Tourists – comparing different beach destinations)

7. Drivers for air transport demand

4. Service Attributes

- Schedule

- Trip time

- Inflight products/services

8. Fluctuฟะรนืห

Service attribute: What are airlines’ products?

• Airline industry product’s is intangible unlike manufacturing industry

• Instantly perishable and can not be stored

• Intangible and multifaceted

-

1. What are airlines’ products?Route as product

- The rise and fall of TPE : and potential rise again

- Connectivity through hubs: DXB v traditional kangaroo route

- Nok with the highest domestic destinations

1. What are airlines’ products?In-flight Products/Service

- Through touchpoints Booking-Baggage arrival

- What are touchpoints?

1. What are airlines’ products?Fare structure as product

Air France International Fare structure

2. Product life cycle

4. Product Life Cycle in the Aviation Industry: Boeing

4. Product Life Cycle in the Aviation Industry: Airbus

- ETOPS revolution

- Engine Change

4. Product Life Cycle in the Aviation Industry: IFE

- Audio- Feature film- Personal Screen- AVOD- Larger screens- Touch Screen- USB/ Self-content- WIFI - What’s next?

4. Product Life Cycle in the Aviation Industry: Seats

- Lounge Chair- Flat Bed- Aisle Access

7. Airline Product

7.1 Cabin and Class

- Declining Seat Pitch for Economy (min 28)

- Seat Abreast on 777, 330

- Premium Economy Class Development

- The Flatbed in Business Class and Decline of First Class

777 Cabin: United v Philippine Airlines

Economy

Premium Economy

Business Class:Highly innovative

First Class: Increasingly matched by Business class

7. Airline Product

7.2 Network, Frequencies and Timing

A. Network:

- Hub or Direct? Pros and Cons (BA v Easyjet)

- Problem of Constraint (Slot, operating hours – noise banned at night at LHR, traffic rights)

7. Airline Product

7.2 Network, Frequencies and Timing

7. Airline Product- Business

travelers require frequency and timing as they need flexibility

- Travellerswanted to arrive early and back late to utilize the full holiday leave

7. Airline Product

7.3 Punctuality

- No one would wanted to fly on a often-delayed airlines

- Compensation mechanism

7. Airline Product7.3 Point of Sale service

- Agent – Declining

- OTA

- Booking Office - Declining

- Call Centre – Declining

- E-Commerce - Leading

7. Airline Product7.3 Reservation and Overbooking

- Shuttle Service (Go-show) on important airbridges

- Overbooking to earn more revenues (highly-controversial)

- What are the points of consideration for overbooking?

7. Airline Product7.4 Airport Service

- Important part of the journey

- Particularly shorthaul

- Aiming to be stressfree, business traveler friendly

- London City Example

- Business class lounge

Inflight Service

• Crew

• Meal

• Entertainment

• Seats

• Selling through national image

Arrival

• Baggage Collection

• Priority Baggage

• Arrival Lounge

• Complaint/Baggage issue handling

Fluctuation in Demand

1. Cyclical Fluctuation

- Economic Cycles

- Demand Peaking – Seasonal Peaking / Weekly peaking/ Daily Peaking

2. Directionality

- Less pronounced than freight, why?

- Think about Asia Minor flights to BKK

Capacity Management

• Back to Supply Theory

• What can we do in Short terms?

• What can we do in Long terms?