Strategic AIrlines Management 5. unit cost

Strategic Airline Management :5 Unit Cost

Dr Narudh Cheramakara

2/2017

Bangkok University

Reducing Unit Cost is the KEY of LCC Strategy

Cost Elements revisited

• TOTAL COST = Variable Costs + Fixed Costs

• However, for a better understanding try the Operating cost model

• TC = Non-operating Costs + Operating Costs (consists of Direct and Indirect operating costs)


1. Non Operating Costs

- Interest Expenses

- Loss on assent disposals

- Affilate’s Loss

- Miscellanous item (e.g. Foreign Exchange)


2. Operating Cost (IOC + DOC)

2.1 IOC – Indirect Operating Costs

- Ticketing, sales, and promotion

- Passenger service (Handling, catering, liability insurance)

- Cargo sales and handling

- Station and ground (facilities and equipment)

- Admin



2.2 Direct operating Cost

Fixed

- Aircraft ownership (including depreciation, lease rental unrelated to FH/BH)

- Fixed Maintenance (Calendar-driven charges such as airframe anti-corrosion measures)

- Fixed flight crew (monthly salary, benefits and social costs)

- Fixed cabin crew



2.2 Direct operating Cost

Variable

- Fuel and oil

- FH/Cycle driven maintenance

- Airport charges

- ATC charges

- Variable Flight crew

- Variable cabin crew

EACH AIRLINE HAS ITS OWN UNIQUE COST STRUCTURE

Alternative Approaches to Cost Analysis

1. By Department – Budget allocation and spending

2. By Products (For example by class, by fare type: Corporate, Flexi, Gov’t, etc)

3. By routes (See exel file)

4. By fleet

5. By Activity (Check-in, ground handling, promotions, etc.)

6. By Contribution (Nok Air strategy is to keep the routes that contribute to the fix cost opened)

Cost ManagementFuel Cost Driver

1. Aircraft Age/Fuel Efficiency


2. Fuel Price


3. Network Design (Hub location)

4. Local airport fuel service provider competition (BKK just BAFS)

5. Exchange rate

Cost Management

Fuel Cost Driver

3. Network Design (Hub location)

4. Local airport fuel service provider competition (BKK just BAFS)

5. Exchange rate

Fuel Cost Management

• Hedging

• Operational Practices

- Reducing aircraft weight (cabin, seat, service items)

• Fleet modernization and modification

Airport/ATC Cost1. Airport Charge: Weight-based and duration-based (738 MTOW 85T)

Monopolistic power of AIrport

• This is why Ryanair uses smaller airports for better landing fee

• Sometimes subsidized rate (illegal under the EU competition law)

• Frankfurt Hahn, Paris-Beauvais, They even advertised Bratislava as Vienna (A whole different country)

• Also better traffic

• This would not work with a network carrier

• BA has to create its niche operation at LCY

Airport/ATC costs

2. Ground Handling

- No choice (RGN for example, many companies, same rate, 1000 USD for a Q400 flight)

- Choices (DMK in the past, CX, KL, BA, TAGS, TG)

- Current Status at SVB (TG, BAGS, self-handled –not allowed to offer service to other carriers any longer)

- Lack of transparency and lack of competition in most cases.

ATC

- Airspace Management

- Infrastructure Development

Cost Drivers and Management: International Operating Systems

1. Service Design

- Network and Schedule

a. Hub and Spoke Network Design

b. Stage-length (Longer sector cheaper unit costs)

- Use the aircraft in accordance to optimal range (738 to PHS? 738 to ICN?)

Cost Drivers and Management: International Operating Systems

1. Service Design

- Network and Schedule

c. Density (Traffic size

- Done through balancing aircraft size/frequency/ Or adding seats

D. Service Attribute – Choosing the right service for the right market

TG – PNH 330 Case,

Decided to use 330 to gain high yield passengers from using premium products against high frequency PG

BKK generally gets old versions of C class from European carriers (JFK, Japan, get them first)

Labour Costs: Labour Cost Driver

• Staff numbers (Consider Staff per aircraft ratio)

• Salaries and Benefits (TG case)

• Labour contract (Norwegian Case)

• Seniority

• Training

• Outsourcing

Labour Costs: Issues• Unionisation (LCCs tend not to have unionised workers)

Labour Costs: Issues

• Cultures! Airlines are often international by nature

Maintenance Costs: Drivers

• Aircraft Age (Ryan Air and SQ strategy is to use new aircraft while DL and PG use the cheap airframe) Which one is correct?

• Fleet Composition – Commonality

• Network design (Longer stage-length, lower cycle// proximity to maintenance facility – DD sends its ATR to KUL)

• Aircraft Utilisation

• Maintenance Planning

• Maintenance input costs (i.e. Labour, material, overhead)

• Scale (do they have economy of scale?)

Maintenance Costs: Management

• Outsourcing MRO Not always the case

• Increasing use of engine diagnostic tools

• Maintenance programme design

• PMA Parts (part manufacturing approvals Instead of using the OEM parts)

Other Costs

• Security

• Environmental Costs (EU Carbon Emission trading scheme etc)

• Taxes and charges

• Passenger Rights (Taking care of passengers during the delays)

PRODUCTIVITY Aircraft Utilization (LCC can achieve

Higher a/c utilization) // Also ASK

Distribution Channel

1. Distribution Channel

• B2C

Website

• Currently the largest portion of most LCC

• Easy to use

• Swift booking experience

• Payment options

• Back to the Nok Air principle of not taking too much information

Mobile web/App: fastest growing

• Thais are particularly addicted to mobile phone

• Nok Air has 21% from mobile we have dedicted mobile department – Most are from app than m.web

1. Distribution Channel

• B2B

Advantages of B2C

• Direct to customers

• No commission

• Cheaper

• The essence of low cost airlines

• Some airlines offer low price guarantee

B2B: Travel Agent

• In some cases, close relationship with customers

• Have to pay commissions, and competing with other airlines

• Decreasing role in the industry

B2B: Travel Agent

• Online travel agent:

• Very powerful

• Traveloka, Expedia, Agoda etc.

• Airlines have to please OTA

• Traveloka keeps fare low by cutting its own commissions

• Each country has it’s own preferred OTA

Meta search

GDS – Global distribution system

• Very important for international airlines

• LCCs traditionally shy away from this as it has high cost (10 USD per ticket)

• Can help attracting foreign customers

• Most LCCs use their own booking portal

LCC Cost Strategies

FSC Restructuring Strategies

1. Organisation Restructuring

2. Process reengineering

3. Network Redesign (AZ moved from FCO to MXP)

4. LCC operations (Thai Smiles, Dragon Air)

5. Alliance

6. Offshore Relocation (call centre, maintenance in Latin America for US carriers)

7. Offshore staffing (JAL using Thai crew)