Airline Operating Costs Dr. Peter Belobaba

Network, Fleet and Schedule

Strategic Planning

Module 12: 30 March 2016

Istanbul Technical University

Air Transportation Management

M.Sc. Program

2

Lecture Outline

Cost Categorization Schemes Administrative cost allocation Functional cost categories and typical breakdown

Flight Operating Costs Comparisons across aircraft types

Total costs vs. unit costs Comparisons across airlines Impacts of stage length on unit costs

Unit Cost Trends Fuel, labor and non-labor unit costs

Aircraft and Employee Productivity

3

US DOT Form 41 Database

Form 41 contains traffic, financial, and operating cost data reported to the DOT by US Major airlines Data is reported and published quarterly for most tables Detail of reporting differs for different expense categories

Aircraft operating expenses by aircraft type and region of operation Other expenses more difficult to allocate by aircraft type

Cost categorization schemes differ, but all are affected by accounting and allocation assumptions Administrative cost categories – financial reports Functional cost categories – airline cost and productivity

comparisons

4

Administrative Cost Breakdown US Airlines 2013

Source: US DOT Form 41 Financial Reports

SALARIES_BENEFITS29.0%

MATERIALS_TOTAL37.1%

SERVICES_TOTAL15.9%

LANDING_FEES2.1%

RENTALS7.0%

DEPRECIATION4.7%

AMORTIZATION0.7%

OTHER3.5%

5

Functional Cost Categories

Aircraft operating costs Expenses associated with flying aircraft, also referred to as “Direct

Operating Costs” (DOC)

Aircraft servicing costs Handling aircraft on the ground, includes landing fees

Traffic service costs Processing passengers, baggage and cargo at airports

Passenger service costs Meals, flight attendants, in-flight services

Promotion and Sales costs Airline reservations and ticket offices, travel agency commissions

Other costs, including: General and administrative expense Depreciation and amortization

6

Functional Cost Breakdown US Airlines 2013

Source: US DOT Form 41 Financial Reports

AIRCRAFT OPERATING COSTS

61.9%

PASSENGER SERVICE

6.9%

AIRCRAFT SERVICE6.1%

TRAFFIC SERVICE10.6%

RESERVATION SALES4.8%

ADVERTISING0.9%

ADMINISTRATIVE8.3%

DEPREC AND AMORTIZATION

0.6% Fuel costs comprised 34.6% of total; more than half of Aircraft Operating Costs

7

Typical Costs by Functional Category

Aircraft Operating Costs Per Block Hour (for example, $4500 for 150-seat A320 in 2013)

Aircraft Servicing Costs Per Aircraft Departure (average $1200)

Traffic Servicing Costs Per Enplaned Passenger (average $20)

Passenger Servicing Costs Per RPM (average $0.013)

Reservations and Sales Costs % of Total Revenue (average 7%)

Other Indirect and System Overhead Costs % of Total Operating Expense (average 12%)

8

“Back of the Envelope” Break Even Fare Boston-Orlando A320 Flight 80% LF

AOC 3.0 block hours @ $4500 $ 13500

Aircraft Servicing (1 departure @ $1200) $ 1200

Traffic Servicing (120 pax @ $20) $ 2400

Pax Servicing (132000 RPM @ $0.013) $ 1716

System Overhead Costs (12% of sub-total) $ 2566

Sub-total $ 21382

Break Even Net Revenue per Pax (120) $ 178

Distribution and Sales Costs (7% of fare) $ 13

Break Even Average Fare $ 191

9

Airline Operating Cost Breakdown

Adapted from Form 41, used by Boeing, MIT (and Aviation Daily) for more detailed comparisons FLIGHT (DIRECT) OPERATING COSTS (DOC) = 50%

All costs related to aircraft flying operations Include pilots, fuel, maintenance, and aircraft ownership

GROUND OPERATING COSTS = 30% Servicing of passengers and aircraft at airport stations Includes aircraft landing fees and reservations/sales charges

SYSTEM OPERATING COSTS = 20% Marketing, administrative and general overhead items Includes in-flight services and ground equipment ownership

Percentages shown reflect historical “rules of thumb”.

10

World Airline Operating Cost Breakdown

ICAO OPERATING COST CATEGORIES 1992 2002 2005

Direct Aircraft Operating Costs 44.0 49.1 54.0Flight Operations (Total) 26.1 30.7 37.7Flight Crew 7.2 9.0 7.8Fuel and Oil 12.2 13.0 21.9Other 6.7 8.7 8.0Maintenance and Overhaul 10.9 11.3 10.2Depreciation and Amortization 7.0 7.1 6.1

Indirect Operating Costs 56.0 50.9 46.0User charges and station expenses (Total) 17.2 17.0 16.2Landing and associated airport charges 3.9 4.0 3.8Other 13.3 13.0 12.4Passenger services 10.8 10.3 9.3Ticketing, sales and promotion 16.4 10.7 9.1General, administrative and other 11.6 12.9 11.4

Source: ICAO, Belobaba et al (2009)

11

Flight Operating Costs

Flight operating costs (FOC) by aircraft type: Reflect an average allocation of system-wide costs per block

hour, as reported by airlines for each aircraft type Can be affected by specific airline network or operational patterns Collected by US DOT as Form 41 operating data from airlines

Typical breakdown of FOC for US carrier: CREW: Pilot wages and benefits FUEL: Easiest to allocate and most clearly variable cost MAINTENANCE: Direct airframe and engine maintenance cost,

plus “burden” or overhead (hangars and spare parts inventory) OWNERSHIP: Depreciation, leasing costs and insurance

12

Example: Airbus 320 (avg. 150 seats)

Costs per block-hour 2005 2007 2013 CREW $ 470 $ 454 $ 652

FUEL $1327 $1713 $2385

MAINTENANCE $ 524 $ 576 $ 716

OWNERSHIP $ 570 $ 570 $ 726

TOTAL FOC $2891 $3313 $4567

Based on reported average stage length and block-hr daily utilization (weighted averages): Different stage lengths and utilization by different airlines result in

substantial variations in block-hour costs for same aircraft type Also, differences in crew (union contracts, seniority),

maintenance (wage rates), and ownership costs (age of a/c) Source: US DOT Form 41 Statistics

13

A320 Aircraft Operating Costs 2013 Form 41 System Data

CREW COST FUEL/OIL MAINTENANCE OWNERSHIP TOTAL AOCUNITED $793 $2,407 $624 $1,079 $4,903DELTA $964 $2,254 $916 $536 $4,670US AIRWAYS $431 $2,375 $1,014 $686 $4,506VIRGIN AMERICA $419 $2,476 $362 $1,163 $4,420FRONTIER $449 $2,488 $477 $827 $4,241JETBLUE $665 $2,417 $700 $451 $4,233SPIRIT $518 $2,233 $381 $921 $4,053

LCCs report 2% to 17% lower AOC per block hour than NLCs

Source: US DOT Form 41 Statistics

14

Comparison of FOC Across Aircraft Types

All else equal, larger aircraft should have higher flight operating cost per hour, lower unit cost per ASM: There exist some clear economies of aircraft size (e.g., two pilots

for 100 and 400 seat aircraft, although paid at different rates) Also economies of stage length, as fixed costs of taxi, take-off

and landing are spread over longer flight distance

But, many other factors distort cost comparisons: Pilots paid more for larger aircraft that fly international routes Newer technology engines are more efficient, even on small

planes Reported depreciation costs are subject to accounting

procedures Aircraft utilization rates affect allocation of costs per block-hour

15

FOC Selected Aircraft Types 2013 Form 41 System Data

Aircraft Type

Average Seats

AOC/ Block-hr

AOC/ Seat-hr

Average Stage (mi.)

Utilization (block-hrs/day)

E190 100 $3,612 $36.12 599 9.4

737-700 139 $4,358 $30.63 762 10.1

A320 150 $4,479 $29.86 1181 11.5

757-200 177 $5,839 $32.99 1523 10.1

A330-200 272 $8,795 $32.33 3645 14.6

747-400 375 $15,153 $40.41 4861 11.4

16

Total Operating Costs vs. Unit Costs

Total operating costs increase with size of airline, aircraft size and stage length Increased output (ASMs) leads to higher total operating costs Bigger aircraft cost more to operate (per block hour, per flight) Longer stage length means more fuel burned, more pilot and

flight attendant hours

But, due to high fixed costs, airlines should have economies of scale in unit costs (in theory): Larger aircraft should have lower operating costs per seat and

per seat-mile (ASM) Longer stage lengths should lead to lower unit costs

Larger airlines with bigger aircraft flying longer stage lengths should have lowest unit costs.

17

Impacts of Stage Length on Unit Costs

Industry unit cost curve is downward sloping with respect to the average stage length.

A large proportion of the overall cost base is fixed, at least in the short-term Ownership costs, maintenance and ground infrastructure,

reservations/sales and overhead

Contributing factors: With longer stage lengths All fixed costs can be spread over more ASMs Shorter turn times relative to block times allow greater aircraft and

crew utilization Average block speed increases and fuel burn decreases with

more time spent at cruise altitude Cycle-related maintenance requirements are reduced

18

2012 Unit Cost (CASK) Selected Non-US Airlines

Source: Emirates Open Sky 2/14 , CAPA Data

ULCCs

Unit Cost vs Average Sector Length, 2012

NLCs

LCCs

19

CASM vs. Stage Length US Airlines 2014

Source: MIT Airline Data Project

5

5.5

6

6.5

7

7.5

8

8.5

9

9.5

10

0 200 400 600 800 1000 1200 1400 1600 1800 2000

CASM

ex

Fuel

& T

rans

port

Average Stage Length

Unit Cost vs Stage Length, 2014

Allegiant Spirit Frontier United Delta American JetBlue Southwest Virgin America Alaska

NLCs

LCCs

ULCCs

20

CASM Breakdown

1 2 3 4 5

Transport Related

Total CASM

Fuel

Labor CASM

Non-labor CASM

CASM ex. Transport and Fuel

CASM can be broken down as follows: Transport Related expenses excluded for comparisons

21

Fuel, Labor and Non-Labor Costs

Compare macro trends over time and across airlines

Fuel Costs have been increasing to over 30% Most “variable cost”, typically driven by global oil prices and factors

outside of airline control

Labor Costs have been decreasing in share With greater emphasis on cost re-structuring and increasing labor

productivity Significant cost advantages for newer airlines and LCCs

Non-labor Costs represent structural differences In networks, product mix and operations

22

Operating Cost Breakdown by Region

• Fuel component has increased for all regions, while labor percentages have declined. • Labor share dropped the most for North America airlines.

Source: IATA

23

US Airlines CASM* Components 1995-2014

* CASM excl. Transp. Related Expenses Source: MIT Airline Data Project

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

TOTA

L CAS

M (c

ents)

NON-LABOR

LABOR

FUEL

36.8%

29.8%

33.4%

24

US Airlines CASM* Components 1995-2014

* CASM excl. Transp. Related Expenses Source: MIT Airline Data Project

0.00

1.00

2.00

3.00

4.00

5.00

6.00

CASM

(cen

ts)

FUEL

LABOR

NON-LABOR

25

Aircraft Productivity

Aircraft “utilization” measured in block-hours/day: Block hours begin at door close (blocks away from wheels) to

door open (blocks under wheels) Gate-to-gate time, including ground taxi times

Productivity measured in ASMs per aircraft per day:

= (# departures) X (average stage length) X (# seats)

Increased aircraft productivity achieved with: More flight departures per day, either through shorter turnaround

(ground) times or off-peak departure times Longer stage lengths (average stage length is positively

correlated with increased aircraft utilization = block hours per day) More seats in same aircraft type (no first class seating and/or

tighter “seat pitch”)

26

Aircraft Productivity Stage Length vs. Departures per Day

Source: MIT Airline Data Project

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

600

700

800

900

1,000

1,100

1,200

1,300

1,40019

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

14

Aver

age D

epar

ture

s per

Day

per A

ircra

ft

Aver

age S

tage

Leng

th (m

i)

Ave Stage Length

Departures/day

27

Aircraft Utilization Block Hours per Aircraft per Day

Source: MIT Airline Data Project

-

2.00

4.00

6.00

8.00

10.00

12.00

14.00

Bloc

k Hou

rs pe

r Airc

raft

per D

ay

NLC Narrow body

LCC Narrrow body

NLC Wide body

+25%

28

A320 Productivity Comparison 2013 Form 41 System Data

TOTAL AOC Stage Number Departures Block Hours ASMs AOC perPER BLK-HR Length (mi) of Seats per Day per Day per Day ASM

UNITED $4,903 1165 142 4.6 10.2 760,666 $0.066DELTA $4,670 888 150 5.3 9.6 702,985 $0.064US AIRWAYS $4,506 1090 150 4.9 12.4 796,868 $0.070VIRGIN AMERICA $4,420 1575 147 4.6 12.5 1,071,914 $0.052FRONTIER $4,241 1057 168 5 10.1 894,791 $0.048JETBLUE $4,233 1361 150 5.1 12.9 1,042,392 $0.052SPIRIT $4,053 968 178 6.9 12.9 1,193,464 $0.044

LCCs generate 20-60% more output than NLCs with same aircraft type.

Source: US DOT Form 41 Statistics

29

Employee Productivity

Measured in ASMs per employee per period

As with aircraft, employee productivity should be higher with: Longer stage lengths (amount of aircraft and traffic servicing for

each flight departure not proportional to stage length) Larger aircraft sizes (economies of scale in labor required per

seat for each flight departure) Increased aircraft productivity due to shorter turnaround times

(more ASMs generated by aircraft contribute to positive employee productivity measures)

Yet, network airlines with long stage lengths and large aircraft have lower employee productivity rates

30

ASM per Employee

Source: MIT Airline Data Project

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

NLC

LCC

+35%

+60%

31

NLC employment down by 36% since 2000, a loss of 150,000 jobs

Source: MIT Airline Data Project

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

NLC

LCC

OTHER

32

Concluding Thoughts

Legacy carriers made dramatic progress in cost cutting and productivity improvement 2001-2007 Labor and distribution costs saw biggest reductions Productivity improvements through network shifts, work rules and

use of IT for passenger processing

Not much room for further cost reductions Labor will push to recover wage and benefit concessions Distribution costs can’t go much lower Aging fleets will push up maintenance costs

Recent return to industry profitability has relied heavily on demand growth and revenue generation Capacity discipline – higher yields and higher load factors