Philippine State College of Aeronautics Learning Module 03 PDF

PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation LEARNING MODULE 03: Economic Characteristics of the Air Transpo...

PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation LEARNING MODULE 03: Economic Characteristics of the Air Transportation Air Transport Economics and Management Prepared by: AERO-AT FACULTY 1 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation TABLE OF CONTENTS TIME TOPIC - ALLOTMENT THE AIRLINES AS OLIGOPOLISTS 6 OTHER UNIQUES ECONOMIC CHARACTERISTICS 9 THE SIGNIFICANCE OF AIRLINE PASSENGER LOAD 12 1.5 hours FACTORS FUEL CONSUMPTION OPTIMIZATION 13 AIRLINE OUTSOURCING 17 TIME ACTIVITY PAGE ALLOTMENT ENRICHMENT ACTIVITY 3.1 21 1.5 hours HONESTY CLAUSE As an institution of higher learning, students are expected to display highest degree of honesty and professionalism in their class work, requirements, and activities; thus, in no case that cheating—or any form of it, may it be plagiarism, copying other students' works, and fabrication of materials—shall be tolerated. The college assumes as a simple and minimal preferred of habits in academic matters that students be truthful and that they publish for deposit solely the merchandise of their personal efforts. 2 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation REFERENCES Brenner, M. & Leet, J. & Elihu S. (1985). Airline Deregulation. Westport, Conn.: ENO Foundation for Transportation. Civil Aeronautics Board, Office of Economic Analysis. (1979). Aircraft Size, Load Factor, and On-Demand Service. Washington, D.C.: CAB. Frederick, J. (1961). Commercial Air Transportation. Homewood, Ill.: Irwin. Fruhan, W. (1972). The Fight for Competitive Advantage: A Study of the United States Domestic Trunk Air Carriers. Cambridge, Mass.: Harvard University Press. Gill, F. & and Bates, G. (1949). Airline Competition. Cambridge, Mass.: Harvard University Press. Holloway, S. (1982). Straight and Level: Practical Airline Economics. Aldershot, UK: Ashgate. James, G. (1982). Airline Economics. Lexington, Mass.: Heath. Jenkins, D. (1995). Handbook of Airline Economics. New York: McGraw-Hill. Kneafsey, J. (1974). The Economics of the Transportation Firm: Market Structure and Economic Performance in the Transportation Industries. Lexington, Mass.: Lexington Books/Heath. Kneafsey, J. (1975). Transportation Economics Analysis. Lexington, Mass.: Lexington Books/Heath. Morrison, S. & Winston, C. (1986). The Economic Effects of Airline Deregulation. Washington, D.C.: The Brookings Institution. Morrison, S. & Winston, C. & MacLaury, B. (1994). The Evolution of the Airline Industry. Washington, D.C.: The Brookings Institution. O’Connor, W. (2000). An Introduction to Airline Economics (6th ed.). New York: Praeger. Ogur, J. & Wagner, C. & Vita, M. (1988). The Deregulated Airline Industry: A Review of the Evidence. Washington, D.C.: Bureau of Economics, Federal Trade Commission. Radnoti, G. (2002). Profit Strategies for Air Transportation. New York: McGraw-Hill. Fouris, T. (2010). Rationalizing Aircraft Performance Dynamic Modeling in Airplane Fleet Planning Decisions. Macrothink Institute. Air Transport Action Group. (2006). Analysis of Air Transportation Systems. Zeinali, M & Rutherford, D. (n.d.). Trends in Aircraft Efficiency and Design Parameters. International Coucil on Clean Transportation (ICCT). Yutko, B. & Hansman, J. (2011). Approaches to Representing Aircraft Fuel Efficiency Performance for the Purpose of a Commercial Aircraft Certification Standard. MIT International Center for Air Transportation (ICAT). Climate and Environmental Responsibility. (2012). Fuel Efficiency at the Lufthansa Group – Cutting Cost & Protecting the Environment. Polek, G. (2012). New Airline Demands for Range and Payload Prompt Boeing to Optimize Fleet. Aviation International News. Singh, V. & Sharma, S. (2015). Fuel Consumption Optimization in Air Transport. European Transport Research Review. Nygren, E. & Aleklett, K. (2009). Aviation fuel and future oil production scenarios. Energy Policy 37(10):4003–4010. Mazraati, M. (2010). World aviation fuel demand outlook. OPEC Energy Rev 34:42–72. Schlumberger, CE. & Wang, D. (2012). Air transport and energy efficiency. The International Bank for Reconstruction and Development. The World Bank. Henderson, RP. & Martins, JRRA. & Perez, RE. (2012). Aircraft conceptual design for optimal environmental performance. 3 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation Green, JE. (2009). The potential for reducing the impact of aviation on climate. Tech Anal Strat Manag 21(1):39–59. Grote, M. & Williams, I. & Preston, J. (2014). Direct carbon dioxide emissions from civil aircraft. Atmos Environ 95:214–224. Lee, JJ. & Lukachko, SP. & Waitz, IA. & Schäfer, A. (2001). Historical and future trends in aircraft performance, cost and emission. Graham, W. & Hall, C. & Vera Morales, M. (2014). The potential of future aircraft technology for noise and pollutant emissions reduction. Transp Policy. Rutner, S. & Brown, J. (1999). Outsourcing as an Airline Strategy. Journal of Air Transportation World Wide. Nebraska: Aviation Institute. Polat, G. (2018). Outsourcing in Aviation: Contracts and Current Situation. Durmaz, V. (2010). Outsourcing in Air Transportation Industry: The Case of Turkish Airline. Wakelee Smith, T. (1995). Don't Just Talk; Airlines Turn To Outsourcing of Services. Airline Business. Feldman, J. (1992). Airlines Lighten the Load. Air Transport World. Leenders, M. & Nollett, J. (1984). The Gray Zone in Make or Buy. Journal of Purchasing and Materials Management. Gillentt, J. (1994). The Cost Benefit of Outsourcing: Assessing the True Cost of Your Outsourcing Strategy. European Journal of Purchasing and Supply Management 1. Condom, P. (1994). Is Outsourcing the Winning Solution?. Interavia Business & Technology. 4 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation LEARNING OUTCOMES Course Learning Outcomes [CLO] Module Learning Outcomes [MLO] CLO 2. Explain the different processes and functions of the aviation industry by mapping the MLO 1. Explain the structure of air Topic Learning Outcomes [TLO] structure of factors that affects the transport industry through interpreting performance of the producers and the total performance system TLO 5. Identify the factors that affect consumers in air transport industry. structure. the performance of the air transport industry by interpreting the total CLO 3. Distinguish approaches to MLO 2. Explain the oligopolistic performance system structure of air economic studies mostly used in an air approach of the air transport industry transportation. transport industry by explaining the by listing the economic characteristics economic characteristics of the air of air transportation and included TLO 6. Explain the oligopolistic market transport industry and its included organizations. structure of the aviation industry by organizations. determining the economic characteristics of air transportation and CLO 4. Identify the ideal structure of included organizations. an air transport industry by illustrating and reviewing management and organizational structure and explain the functions they play in the industry. CLO 6. Explain the economic and financial concepts relevant and related to air transport industry by identifying the factors that affects the economy and financial status of air transport industry. CLO 9. Display professional commitment by complying with the academic requirements such as problem sets, research papers, and other modular activities. This module discusses the total performance system structure; it discusses the oligopolistic approach of the air transport industry and the different economic characteristics of air transportation and included organizations; identifies other unique characteristics of the air transportation and included organizations; discusses the system and consumption of fuel and oil in the aviation industry; and explains the principles and fundamental concepts of airline outsourcing. 5 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation THE AIRLINES AS OLIGOPOLISTS Economists usually describe the certificated airline industry as closely approximating an oligopolistic market structure. An oligopoly is an industry composed of a few firms producing either similar or differentiated products. Fig. 3-1. Total Performance System Structure. Source: Adopted from the IPO Chart of the ACE Handbook of Philippine Airlines. Number of Carriers and Market Share With the easing of the deregulations and passage of the airline liberalization, the industry entered an era of intense competition. Major airlines and the former local- service carriers began competing with one another; the established major airlines, with the exception of those that were failing, shared in the traffic growth, but the new entrants made substantial inroads into market share. Unfortunately, instead of the industry expanding, as many proponents of deregulation visualized, some of the carriers either were merged, liquidated, or decertified or were not operating or never did operate under a certificate. The total number of carriers has increased in recent years with the addition of smaller certificated carriers and the demise of some of the larger airlines, the shrinking number of larger carriers has improved the market share of the remaining major carriers, such that the largest carriers now have a somewhat greater market share than before deregulation. Unquestionably, the airline industry, with its small number of companies and concentration of market share, meets the first characteristic of oligopolist firms. 6 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation High Barriers to Entry Oligopolistic industries typically are characterized by high barriers to entry. One expectation in air transport industry was that carriers would have relatively free access to markets because of the mobility of the airlines’ chief assets—aircraft. Carriers dominating individual markets would not charge monopolistic fares, according to this theory, because of the ease with which a competitor could enter the market and compete with the incumbent carrier by charging reduced fares. Thus, the mere threat of entry was expected to discipline pricing. Access to markets has become extremely difficult in recent years because of the difficulty of obtaining terminal space at many hub airports and the risk associated with competing with an airline at one of its hubs. A competitor that wishes to challenge another carrier at its hub faces considerable financial outlays. The cost of providing a competitive level of service at a hub is substantial: expenditures for advertising, personnel, and aircraft operations are crucial during start-up, when the competitor attempts to win business away from the major carrier. The risk of being unable to recover these outlays is the largest single deterrent to entry at hub airports. Airport terminal capacity can also be a barrier to entry for new and existing carriers seeking to enter new markets. Entering a market requires the ability to lease or develop gates, baggage handling and airport maintenance facilities, and ticketing and passenger waiting areas. Little underused gate capacity and related terminal space is available at major airports in the short term. Over the longer term, it is possible for carriers to enter many markets, but the experience of recent years indicates that such entry is neither easy nor inexpensive. Another barrier to entry has become the dominated hubs. As carriers build the connection banks required to make a hub work, their presence in the local market can become so pervasive as to approach being a monopoly. Airlines use hubs to shield some of their output from competition. As more flights are connected to a hub, the number of passengers available to support additional flights grows. Making the connecting banks work for these flights requires many gates because of the desire to minimize the delay between connections. Because few airports have excess capacity in the short run, hubs tend to become dominated by one or two major carriers who use up the existing capacity. Economies of Scale Oligopolistic industries may be characterized by economy of scale; economists mean decreases in a firm’s long-term average costs as the size of its operations increases. Firms in oligopolistic industries typically require large-scale production to obtain low unit costs. Large-scale production is afforded by intensive labor and management specialization of job responsibilities, utilization of the most efficient technology available, and effective use of by-products. If total market demand for the product or service is sufficient to support only a few large firms of optimum size, competition generally ensures that only a few such firms will survive. 7 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation Like all oligopolists, airlines must achieve a large volume of output in order to lower the cost per unit of output. To achieve economies of scale in production, the carriers, like other oligopolists, utilize the principle of labor specialization. Because of the number of workers, jobs can be divided and subdivided. Instead of performing five or six distinct operations in the production process, each worker may have only one task to perform. Workers can be used full-time on the particular operations for which they have special skills. Union rules about what specific workers can and cannot do also reinforce this principle. Thus, a skilled machinist with a major carrier might spend an entire career in a particular shop working on one component of the aircraft. If the volume of output must be reduced because of a falloff in traffic, something has to give, or else the firm will experience what economists refer to as diseconomy of scale, in which cost per unit begins to rise. In such a case, airlines are forced to furlough volume-related workers as well as administrative personnel. The remaining administrative workers must broaden their responsibilities by taking on new job assignments. The established carriers can utilize the latest technology available, which also brings about economies of scale. Small firms often are unable to utilize the most efficient and productive equipment. In many cases, the most efficient equipment is available only in very large and extremely expensive units. Furthermore, effective utilization of this equipment demands a high volume of output. This means that only larger carriers can afford and operate efficiently the best available equipment. Growth through Merger Another clear characteristic of oligopolists, in general, and airlines, in particular, is growth through merger. It is a major factor in explaining the small number of firms. The motivations for mergers are diverse. Many of the oligopolies that exist today have resulted from mergers of competing firms. The purpose of most mergers is to achieve greater economies of scale. Another significant motive underlying the urge to merge is the market power that may accompany a merger. A firm that is larger, both absolutely and relative to the market, may have greater ability to control the market for and the price of its service than does a smaller, more competitive producer. Furthermore, the larger firm may gain leverage as a big purchaser by being able to demand and obtain lower prices in buying goods and services. Mutual Dependence Regardless of the means by which an oligopoly evolves, rivalry among a small number of firms clearly interjects a new and complicating characteristic: mutual dependence. Imagine that three carriers—A, B, and C—serve the same route and that each has about one-third of the market. If A cuts its price, its share of the market will increase, but B and C will be directly, immediately, and adversely affected by A’s price-cutting. Thus, we can expect some reaction on the part of B and C to A’s behavior: B and C may match A’s price cut or even undercut A, thereby starting a price war. This response suggests that no firm in an oligopolistic industry will dare to alter its price policies without attempting to calculate the most likely reaction of its rivals. This is consistent with economic theory and characteristic of pricing at concentrated gate- and slot-constrained airports where two or three competitors hold the majority market 8 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation share. However, not enough oligopoly pricing exists to cover the industry’s fixed costs and offset steep discounting in competitive markets. The pricing decisions of individual carriers usually make economic sense from the carrier’s perspective. But for the industry as a whole, these decisions contribute to the continual price erosion that has restricted the ability of all carriers to increase revenues to keep up with rising costs. Price Rigidity and Nonprice Competition Oligopolistic industries may be characterized by price rigidity and nonprice competition; firms in oligopolistic industries are much more comfortable maintaining constant prices than rocking the boat, so to speak, because of mutual dependence and fear of a price war. The tendency has been to fight it out in the nonprice arena, using advertising and increased customer services as the major weapons. Price reductions, when they occur, are sporadic and usually come about only under severe pressures resulting from weakened demand or excessive capacity. This situation prevailed in the airline industry before 1978. At that time, however, the door was opened to new competition, and the airline price wars began. Under the old regulatory framework, the price of an airline seat was directly related to the cost of producing it. Prices were simply based on costs, allowing for a given rate of return. OTHER UNIQUE ECONOMIC CHARACTERISTICS Government Financial Assistance Unlike other oligopolistic industries, various government units have played major roles in financing the growth and development of the Philippine airport-airways system. High Technological Turnover Technological advances in flight equipment over the short span have come at an extremely rapid pace. Airlines have led all other industries in the rate of increase in capital spending because of technological advancement. Technological advances and competition have forced the carriers to undertake a re-equipment cycle. Besides calling for huge amounts of capital spending, these cycles mean heavy expenses in hiring and training personnel and in modifying facilities to accommodate the new aircraft and associated equipment. High Labor and Fuel Expenses Because an airline’s costs define the limit of how low it can profitably price its service, and because most airline customers value low prices above all other carrier selection factors, the carrier with the lowest costs has a powerful competitive advantage. The fact that most carriers have a difficult time differentiating their products from those of their competition makes this especially true. Thus, cutting costs to the lowest possible level has become a key strategic necessity in today’s airline industry. Unfortunately, reducing costs is easier said than done. In addition to a carrier’s high fixed costs, many of the so-called variable costs, if not completely out of the airline’s control, are very difficult to manage. Two of the biggest are labor and fuel expenses. 9 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation Airline employees are men and women with highly developed skills and with correspondingly high incomes. The high level of unionization in the airline industry, particularly among the more established carriers, also reduces the extent to which labor costs can truly be considered variable. Labor typically represents the largest cost advantage start-up airlines have over more established carriers. Moreover, despite its reliance on high technology, the business is very labor intensive. New entrants often outsource many functions to service providers that pay their employees minimum market rates and provide few, if any, benefits. Because these providers draw from a large pool of experienced workers trained by carriers that have failed, new entrants often offer service that is qualitatively indistinguishable from that offered by long- established carriers. In contrast, the older carriers operate under the terms of union contracts that prevent them from making changes to match the costs of new entrants. These contracts typically include extraordinarily complex work rules that sharply reduce the carriers’ ability to improve labor productivity. Moreover, the work force of the traditional carrier typically is much older than that of a start-up airline, creating an even greater disparity in wage rates, as a 10- or 20-year airline veteran will invariably have achieved a far higher wage than his or her counterpart at a start-up carrier. No other industry has been subjected to the severe increases in fuel prices that the air carriers have experienced. Although an airline can maximize its efficiency by purchasing aircraft that burn less fuel than others, fuel-efficient airplanes often have much higher capital costs than do less fuel-efficient aircraft. Moreover, the actual price of fuel is contingent on factors far outside any airline’s span of control. Thus, fuel costs are only marginally manageable. Labor and fuel costs typically represent around 60 percent of a carrier’s operating expenses. The Competitive Advantage of Schedule Frequency The effect of a slight change in departure time on passenger buying behavior creates a powerful incentive for carriers to increase flight frequency, even when there are plenty of seats available on existing flights. Moreover, when one carrier enjoys a schedule frequency advantage over another on a particular route, the competitive value of that advantage is more than proportional. For example, if Carrier A has six daily flights between two points and Carrier B has only three, the relative strength of Carrier A versus Carrier B is greater than two to one. The reason for this is that Carrier A’s customers—in addition to having two times as many chances to match a flight to their needs—will perceive the more frequent service as offering them more flexibility to change their plans at the last minute. The fact that customers see the airlines’ product, a seat on an airplane, as a relatively undifferentiated product notwithstanding, each time a network-based airline offers a new flight; it commits an additional city to all the others served by the hub, and thus introduces a number of new products. Additionally, by widening the reach of its network, it strengthens its entire existing product line. In most industries, increased production, by itself, does not enhance an individual competitor’s sales potential or competitive position. However, in the airline industry, 10 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation the fact that more capacity represents more schedule frequency gives every airline an incentive to use every airplane as intensively as possible. Although this strategy makes sense for each individual carrier, it results in a tendency toward perpetual overcapacity. Excess Capacity and Low Marginal Costs The airline industry historically has tended both to produce excess capacity and to price its product below fully allocated costs. The demand of consumers for schedule frequency produces tremendous excess capacity with no shelf life, pushing costs up. The demand of consumers for low prices and the perception that air transportation is virtually an undifferentiated commodity drive prices down to levels that, too often, fail to cover fully allocated costs. Once a scheduled flight pulls away from the gate, any empty seats are lost forever. Seeking to sell as much of that perishable inventory as possible, carriers offer the same fares as the lowest-price provider in an effort to grasp an ascending and, too often, elusive break-even load factor and preserve market share. Sensitivity to Economic Fluctuations The susceptibility of air transportation demand to the business cycle was underlined by the recession happened in the industry. Although the impact of a recession is not unique to the airline industry, what is different is the fact that as a service industry (unlike durable goods such as automobiles), it is much slower to recover because spending on air travel is discretionary. People have to be working again and the economy has to be well on the way to recovery before spending on air travel starts to pick up momentum. The effects of a recession on air travel are obvious. Both pleasure and business travel are curtailed during periods of sharp and sustained downturn in the general economy. In a recession, people tend to postpone long-distance travel to save not only on airfares but also on the expenses associated with the trip. Companies tend to cut back on business trips or on the number of people sent on a given trip. Travel is one of the expenses a business can cut immediately during tough economic times. Fewer people travel first class, so that the dollar yields realized are reduced. The impact of a recession on the airlines is intensified by the high rate of traffic growth they experience during periods of prosperity. When the economy moves into a recessionary period, the carriers find themselves with substantial excess capacity. Unlike manufacturing industries, they cannot inventory goods or cut back production until the economy improves. Interest payments to creditors on outstanding debts (primarily flight equipment) must be paid, and facilities that were geared to handle a prerecession volume cannot be closed. Although airlines can furlough certain volume- related employees, they must carefully consider this move because of the extensive retraining costs involved when personnel are brought back as volumes increase. 11 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation Close Government Regulation Unlike other oligopolistic industries, but like other transportation modes, the airlines have a long history of both support and regulation by government. THE SIGNIFICANCE OF AIRLINE PASSENGER LOAD FACTORS One of the most vital statistics in the airline business is load factor. Given the multimillion-dollar investment represented by the modern jetliner, airlines are naturally concerned with equipment utilization. One measure of utilization is the revenue passenger load factor. Load factor has a critical impact on the cost and quality of air transportation services offered. Approximately 65 percent of an airline’s costs are directly related to the operation of aircraft and are independent of the number of passengers on the aircraft. Therefore, a high load factor will allow the allocation of these costs over a large number of passengers, resulting in lower costs per passenger, which allows for lower fares. Traffic Peaks and Valleys All transportation modes must operate during traffic peaks and valleys in order to meet the public need. Buses and commuter trains in every major city are full in one direction during rush hours and virtually empty on the return trip. At midday, in the early morning and late evening, and on weekends, passenger loads are also light. That’s the nature of public transportation, whether buses, trains, or planes. Airline load factors during any one year vary from month to month depending on the season. Daily and hourly load factors fluctuate even more. Averages for the peak day of the peak month might be 75 percent, and for the peak hour 80 percent; many flights in these hours are at or near 100 percent capacity. Furthermore, a nationwide transportation network requires that some flights with light patronage be operated to position aircraft for other flights with higher loads. Sometimes, aircraft must be flown virtually empty from one city to another late at night or early in the morning to have the plane ready to meet rush-hour demand. These positioning flights certainly affect the average load factor figure used to describe air transportation productivity. Capacity Versus Demand Demand for air transport services has always been highly cyclical, with greater or lesser demand depending on time of day, day of week, and season, as well as on broader market fluctuations from year to year. For example, that discretionary leisure traffic picks up in the summer, thereby allowing the industry to enjoy higher load factors for the third quarter. On a macro level, when the economy is growing and consumer confidence is strong, demand grows, improving airline load factors and allowing carriers to raise yields and profitability. When the economy falters, however, unemployment rises, consumer 12 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation confidence declines, and individuals postpone discretionary travel; as a result, airline load factors, yields, and profits suffer. The realities of public transportation, whether bus, train, or plane, result in an imbalance between the number of seats, or capacity, available and the current demand for travel by the public. The two simply do not mesh at precisely the same time, the same place, and the same rate. Airlines cannot fine-tune capacity to match demand, because capacity can only be added or taken away in total planeloads. The aircraft unit itself is obviously inflexible. Within limits, the total number of flight frequencies on a given day can be varied, and this is done where feasible. Pricing in Relation to Load Factor One approach that carriers have used quite extensively over the years to improve load factors is off-peak pricing. This involves the introduction of a promotional fare designed to attract passengers during an otherwise slack period. Off-peak pricing dates back to the earliest days of the airline industry. It has always been recognized that both the public and the industry benefit if the empty seats on low-traffic days are filled with passengers who are willing to travel on those less popular days in exchange for some fare reduction. The additional passengers add very little to costs (primarily meal service), but they add a great deal to the flight’s total revenue. Off-peak pricing has not been without its problems. One problem is the fact that the timing of the peak has varied from route to route and even from one direction to the other on the same route. Off-peak pricing, by its nature, injects complications into the pricing structure. In contrast, some pricing developments in recent years have aimed for the simplicity of overall fare reductions, applied across the board, without restrictions. Although such overall fare reductions have the welcome effect of reducing the complexity of the fare structure, they do require higher load factors to remain viable, and they cannot themselves channel traffic to off-peak times and days to achieve optimal load factors. Therefore, this particular pricing trend brings into play the full force of high load factors on space restrictions without softening the impact of such restrictions on the normally peak times. FUEL CONSUMPTION OPTIMIZATION Air transport industry acts as a catalyst to the economic and social development of a nation. This industry encompasses all those activities which involve transportation of goods and people, by air. Air transport connects people, countries and cultures across the face of the globe. Additionally, it opens up a market to global players, thereby supporting trade and tourism significantly. The air transport industry has contributed significantly to the growth of commerce, communication, trade and tourism globally. In spite of a marked expansion, the air transport industry is faced with major issues like high fuel consumption, fuel prices, air traffic growth, competition, economic crisis, aviation emission, safety, design and 13 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation operational challenges. Fuel consumption has been considered, to be a major challenge for the air transport industry. Attributable to high oil prices and an escalation of competition, fuel consumption is rapidly becoming a critical aspect of the air transport industry. Widespread improvement in the global economy during the past year has also contributed to the demand of oil, thereby inflating its price. Fuel consumption is one of major direct operating cost parameter in the air transport industry. Air transport fuel remains the most significant and variable component of operating costs and managing this aspect is an increasing challenge for the air transport sector. The economy of a country largely depends on fuel prices. Increases in fuel consumption have an influence on the airlines in two ways; direct impact on the operating cost, and declines the demand for air travel and air cargo. At one time fuel extraction cost and availability had little impact on the evolution of the air transport industry. Furthermore, aircraft fuel burn is proportional to CO2 emission. Therefore, as the fuel consumption increases the aviation emission shall also increase and that is a big environmental concern today. The higher fuel consumption of aircrafts is one of the major causes of inefficiency of airlines. Therefore, in such a highly competitive environment, in order to reduce the direct operating cost of an aircraft the Fuel Consumption Optimization (FCO) is essential. FCO in air transport means finding a minimum value of fuel consumption function of several variables subject to a set of constraints and improving the energy efficiency of the aircraft system. The researchers, airlines, aircraft manufacturer and regulatory organizations are continuously trying to reduce the air transport fuel consumption along with the economic cost of flying an aircraft. Further, this reduction will also lead to the reduction of the greenhouse gas emission, caused by the air transport. Aircraft Technology and Design Today airlines operate in an increasingly competitive environment caused by the globalization of air transport network worldwide and therefore a necessary condition for airlines are commercially successful is the reduction of direct operating costs, which mainly depends on the technological & design characteristics of the aircraft used. Technology development is going on at a rapid rate and we can effectively make use of this technological revolution to reduce the fuel consumption of a commercial aircraft. Moreover, the fuel consumption of air transport can be reduced through the variety of options such as increased aircraft efficiency, improved operations, use of alternate fuels, socioeconomic measures, and improved infrastructure, but most of the gain so far have been resulted from the aircraft technological improvement. Aircraft technological improvement mainly depends upon the three factors: structural weight, aircraft aerodynamics, and engine specific fuel efficiency. Moreover, the aircraft technological efficiency is described by three aircraft performance metrics: engine efficiencies are expressed in terms of thrust specific fuel consumption (TSFC), aerodynamic efficiencies are measured in terms of maximum lift over drag ratio and structural efficiency is quantified using operating empty weight (OEW) divided by maximum takeoff weight (MTOW). Further, consider the classical range equation in order to understand how the aircraft technology affects the fuel burn. Fuel consumption per payload range of idealized cruise, keeping the aircraft operating parameters fixed are expressed in terms of aerodynamic efficiency, structural efficiency, engine efficiency, and calorific value of the fuel. 14 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation In addition, a study explained the fuel burn reduction by considering aircraft technology & design studied the aircraft design for optimal environmental performance and the design variables considered in this study for optimization problems were from aircraft geometry, engine parameters, and cruise setting. This concludes that the aircraft optimized for minimum fuel burn encompass a high aspect ratio wing with lower induced drag, high bypass ratio engines and high core pressures and temperatures. In addition, the mission range and cruise Mach number were also optimized for maximum payload fuel efficiency. Furthermore, the possibility of designing larger aircraft for shorter ranges was also examined and result shown that the reduction in structural weight can be achieved by reducing fuel burn. Currently the evolutionary developments of engine technology, airframe technology, and use of advance light weight alloys and composite material, have resulted in a positive trend of fuel efficiency improvements. The merging technology and optimized design dimensions finally lead to the fuel consumption optimization. Aircraft technology and design have the highest potential to optimize the aviation fuel consumption, and some of their successful applications in the FCO have been proposed. Aviation Operations and Infrastructure The amount of fuel consumed by an aircraft during its operation from start-up through to taxi and takeoff, to cruise, to approach for landing and taxiing on arrival, depends upon several factors. Many of the factors can be influenced by airlines with proper operations planning and strategies. The current operational practices are not always optimal from the fuel consumption point of view and hence there is need for operational improvements. Operational improvement can be expressed in term of operational efficiency, which is the combination of ground and airborne efficiency. In general, the actual aircraft performance can be determined by how the aircraft is operated subject to operational constraints and the efficient operational procedures are those, in which the actual fuel burn used falls close to the theoretical minimum. Furthermore, the operational efficiency can be expressed in term of operational and payload-fuel energy intensity, and the payload factor. Also, the operational factors to reduce the fuel consumption per passenger-km include the increasing load factor, optimizing the aircraft speed and fuel weight, limiting the use of auxiliary power, eliminating the non- essential weight, and reducing taxiing. In addition, highly sophisticated flight-planning system also improves the aircraft fuel efficiency because this allows pilots to exploit prevailing wind conditions, calculate precise fuel loads & set different flight levels and speeds for the aircraft to achieve the most economic performance. For a typical flight there are a number of factors such as cruise altitude and speed, mass, and weather conditions that affects the fuel consumption. Therefore, by optimizing the aircraft operations from start-up through to taxi and takeoff, to cruise, to approach for landing and taxiing on arrival, have the significant to reduce the fuel burn. Aviation infrastructure also plays an important role in fuel consumption optimization. Infrastructure improvements present a major opportunity for fuel consumption reduction in aviation. The design of an airport, including the location of the runways and taxiways relative to terminal buildings, clearly has an effect on aircraft fuel burn, because reduction of delays and decreased taxiing time can provide significant aircraft 15 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation fuel burn reduction. Airport congestion and improper air traffic management increase the fuel consumption. Airport congestion occurs whenever the actual traffic demand is greater than what the system can handle without the delay. Air Traffic Management (ATM) plays an important role in reducing the environmental impacts of air transportation by reducing the inefficiencies during the operations of an aircraft. In addition, the better terminal design can also reduce the fuel consumption. There are a number of ways that airports, airlines and ATM providers can improve the air transportation system to minimize fuel burn and emissions. These include improving the use of the airspace, air traffic control and operations and further improving the use of airspace and air traffic control includes the flexible use of airspace, route redesign, using the new tools and programs to find most effective route, and reduced separation between the aircraft. Socioeconomic and Policy Measures Aviation is the fastest growing sector of the economy. It provides the number of socioeconomic benefits. There are many socioeconomic & political factors which affect the airline fuel consumption optimization. If these factors are carefully managed then a significant amount of fuel can be saved. Also, the social awareness levels of the society, regarding the impact of the aviation emission on climate change plays a key role in fuel consumption reduction. Currently, the scientific knowledge and the social demand for low-emission aircraft is not strong enough because the general public is not well aware of the harmful impacts of aviation emissions on the global climate. The strong social pressure sends the signal to the government and the government takes the necessary action after scientifically confirming the problem. As in the cases of the automobile emission and aircraft noise significant technological and operational improvements have been reported, because the general public was well aware of the health damages caused by these. Also, the education and awareness are very important social measure in air transport and there will be many airline customers who have never thought of aviation emission as an environmental problem. Information should be widely available regarding the impact of flying, so that airlines have the background information they need to understand the changing circumstances of aviation. Informed choice is a key component of the transport demand and environmental policy implication. Furthermore, the economic/policy measures for reducing the fuel consumption includes the emission trading, taxes on aviation fuel, and carbon emission charges. Beside this, there are some constraints on the airline operations, training, maintenance & reservations, planning & routes, scheduling, airways, and labor, these constraints should be removed for fuel burn reduction. In addition, the economic and policy measures should be introduced in an incremental fashion to give the air transport and consumers time to adjust to the changes. So therefore, by optimizing the socioeconomic & political factors, we can improve the air transportations fuel efficiency. Aviation Alternative Fuels and Fuel Properties Aviation alternative fuels can also play an important for the optimization of aviation fuel consumption. Since the energy crises of the 1970s, all the aircraft companies, aviation sectors, engine companies, and other government organization are working for practicality of using alternative fuel in aircraft. A viable alternative aviation fuel can stabilize fuel price fluctuation and reduce the reliance from the crude oil. Economic 16 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation sustainability, environmental concerns, energy supply diversity, and competition for energy resources are the main drivers for alternative jet fuels development. The replacement for current alternative fuels needs no aircraft modifications and can be used with the current aviation system, encompassing existing distribution and refueling infrastructure. Therefore, a suitable alternative fuel can be selected on the basis of a variety of criteria, societal priorities, economic viability, and sustainability considerations, which will further reduce the aviation fuel consumption. AIRLINE OUTSOURCING Today's competitive business environment has forced companies to identify methods to improve efficiency. A common solution is to outsource certain nonstrategic business functions. The company thus removes distractions and focuses managerial attention on operations within the scope of its core competencies. The airline industry is a prime example of the stiffened competition as a result of deregulation. Many airlines have used outsourcing as a method to control costs, improve efficiencies, and hopefully increase profitability. While airlines continue to outsource, it is unclear what are the appropriate levels of outsourcing, or which functions should be maintained by the airline. Outsourcing which is not directly related activities in order to minimize the cost of the services offered by firms in the form of economic distress are transferred to another firm. Outsourcing is defined as outsourcing of companies doing their own business to other companies or companies. In other words, it is the external supply of the goods or services offered. In order to keep up with the developing technology and competitive environment, the enterprises are trying to keep up with the market conditions by transferring other services they offer to other companies as well as their basic activities. The most important feature of outsourcing is to increase efficiency and to save time. In general, the characteristics of outsourcing can be listed as follows: a. Outsourcing is a technique that ensures that financial resources are used at the highest level of efficiency. b. Outsourcing is a long-term management strategy. c. Outsourcing is the focus on the best-known work. d. Outsourcing helps many businesses. e. Outsourcing helps to do many activities with the help of external sources. Outsourcing Terminology and Strategies Most business professionals are familiar with the concept of outsourcing, "the decision to buy goods and services from external sources rather than producing them in-house when internal provision is not justified in light of existing or anticipated business conditions." An airline industry definition of outsourcing mirrors the general definition by stating that outsourcing is "shedding non-core functions or spinning them off into semi-autonomous subsidiaries or profit centers." 17 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation A common function outsourced by airlines is maintenance. Maintenance provides a good example since it is a non-core activity. Non-core activities are items that may provide critical functions to the running of the business, but are "not a unique ingredient of the product." Maintenance is a necessity, but it should not be a unique product ingredient. Every airline must continuously maintain aircraft to provide safe operations, but maintenance is rarely seen as a unique part of the airline service. An overall goal of the outsourcing strategy is to form strong relationships between companies. Outsourcing can help to create strategic alliances between the two firms creating a stronger relationship base and increasing value throughout an entire supply chain. The goal of this relationship is to create a source of competitive advantage for the company that outsources a service or part. Given these benefits, it would appear that outsourcing strategies ought to dominate the airline industry. While it is true there are many examples of outsourcing, there are examples of the opposite behavior as well. The practice of insourcing is gaining popularity in the airline industry. Insourcing is the process of providing non-core services or parts for other companies, often competitors, to increase revenue, minimize labor idle time and offset high domestic labor costs. Insourcing permits airlines that practice it to achieve economies of scale; i.e. they are able to produce at a lower cost per unit. This allows both the insourcing firm and the buyers to benefit. An additional benefit of insourcing is the gains in goodwill with employees. Airline Operations and Services Typically Outsourced Like most businesses, airlines are also outsourcing. The airline sector is very sensitive against developments in technology and changes in the world. For this reason, it has to keep up with all developments and changes in the global sense and to keep up with these developments. In doing so, they are trying to do as much as possible without increasing their costs. At the same time, it is very important for each unit in the enterprise to focus on their own business and to work in a safe way, with a focus on their own business. The competition between the airline companies and the preference of air transportation, the development of technology and the globalization have increased. Businesses go to outsourcing in order to maintain their current position and to hold the market. At the same time, outsourced companies focus on their core capabilities and transfer the activities outside of these capabilities to subcontractors. Outsourcing is particularly advantageous for airlines. There are many operating branches in airline companies. The execution and coordination of these activities harms businesses in terms of time and cost. In this case, airlines use outsourcing. The areas where the airline companies go to outsourcing can be listed as ground handling, catering, social responsibility projects and advertising, banks, fuel, cargo facilities, and storage. 1. Ground Services. Ground Handling is a unit that provides all kinds of services that an airline will need at the airport. These services; passenger services, ramp services, cargo and postal services, flight operations/load control and communication services, representation and surveillance services. 18 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation 2. Catering Service. Catering is a service provided during the flight. There are many companies that provide passengers (food and beverage) to passengers during the flight. These companies are generally referred to as catering companies. Airline companies are working with the catering companies in the airports they have agreed to as hubs. But in places where the flight density is high, catering is done. Especially at long-haul flights, catering companies work intensively. 3. Social Responsibility Projects. Another area of activity for which airlines are outsourced is social responsibility projects and advertisements. 4. Cargo Facilities and Storage. Airline companies use outsourcing to stock the cargo they carry. In this way, they minimize the costs and provide advantages because they save more time in focusing on their own basic capabilities by doing their storage activities in another business. Reduced storage costs due to agreements between the continents and the inter- cities provide great advantages to airlines. 5. Banks. Airlines apply to banks under the name of outsourcing on financial stability, financial flexibility and ensuring adequate liquidity. In this sense, companies have to; the commission has to make payments, such as currency translation fees and interest rates. The use of airline companies from banks can be listed as follows: a. to fulfill operational cash needs, b. to provide the necessary liquidity in the short and long term, c. to carry out bilateral agreements in transactions such as capital cost and commission, currency translation, d. to take necessary actions in order to protect against financial risks. At the same time, the airline is able to make flights to the passengers who want to buy air tickets via the airline companies' agreement with the cards are carried out. 6. Fuel. Since the fueling process requires a number of procedures, airlines are outsourcing and take advantage of the time by transferring fuel consumption to the fuel supplier companies. Since each oil company cannot establish a fuel station at each airport, an airline can negotiate with different fuel suppliers for different airports. Certain applied procedures are available for fueling. The procurement process when performing these procedures must be at the time of ground time determined by the airlines. 7. Technical Services. Aircrafts are subject to mandatory maintenance by both international and national organizations. These treatments are daily, weekly and annual maintenance. At the same time, maintenance is carried out against any technical problems that may be experienced by air vehicles in the ground or in the air, or technical services are provided to solve these problems after a technical problem. The provision of technical services is very important for both airlines and passengers. The fact that an airplane fails to perform its existing flights due to 19 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation malfunction causes huge income losses for the airline business. Therefore, the airline companies that are not able to provide themselves can go to outsourcing. Factors to be Considered in Outsourcing Businesses may not always achieve the performance they want. There may be problems in the outsourcing activities used. In this case, the entity may supply a new external source or, with the existing outsourcing company, be able to reach a restorative agreement. Problem-solving issues can be identified and studies can be done to solve the problem after the source is found. At this point the contracted supplier should be selected very well. In order for the supplier to be ideally analyzed, the following questions must be answered: a. What is the purpose of outsourcing? b. What is the reason for these parameters? c. How will the efficiency in the intended areas be measured? d. What kind of activities are expected by the intended activity? e. Is there a list of activities intended for priority activities? f. Will the targeted activities be carried out? g. How much of the specified areas can be outsourced? h. What kind of collaboration is planned? The basis of the outsourcing practices is based on having some businesses done outside and within the enterprise’s own control, rather than having them outsourced. For this reason, there is a sharing relationship between the enterprises that have to cooperate with each other towards the same target. As a result of these relations, it is necessary to accept that outsourcing practices can bring with them some dangers. The main benefits of outsourcing process are; cost savings, focusing on core competencies, organizational restructuring, flexibility, quality increase and shortening of the order cycle process, creating new income areas, falling in fixed investments, maximizing the use of functional experts, gaining competitive advantage, and following technological developments. To take under several headings: 1. Reducing Costs. The effect of outsourcing on costs is not limited to operating activities. At the same time, it reduces the cost of establishment and new investment and brings financial freedom. Thus, the enterprise gains competitive advantage by using less capital through outsourcing. 2. Quality. The issue of quality should be taken together with the cost factor by both the client company and the service provider and the sensitive balance between the relevant factors should be kept as constant as possible. The most important tool in ensuring quality and cost balance is outsourcing contracts. By clearly determining the minimum service limits in outsourcing contracts, the company maintains continuity at the standard service level and is also protected from the negativities that may arise due to deterioration in service quality. 20 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation 3. Competitive Advantage. Organizations need to provide a competitive advantage in order to become more profitable than their competitors. To gain and maintain a competitive advantage, it should be able to show a comparative or different value than an organization's competitors. They will be able to generate this value in a shorter time by outsourcing. Businesses renew their strategic management processes with outsourcing. Elimination of non-value-added jobs for the enterprise or the use of external resources in the activities where the basic capabilities of the enterprise are not used, and in this way, it is possible to ensure activity and efficiency. In addition to the renewed processes, enterprises that can gain the ability to respond faster to their customers' requests increase their competitiveness. ENRICHMENT ACTIVITY 3.1: Identify and explain, briefly, the following topics based on the module—additional information is encouraged; you may search the web or other resources for references: 1. Outsourcing a. airline outsourcing; b. services typically outsourced in aviation; c. factors to be considered in outsourcing. 2. Fuel consumption optimization, in terms of (Choose ONLY one (1) of the following) a. aircraft technology and design; b. aviation operations and infrastructure; c. socioeconomic and policy measures; d. aviation alternative fuels and fuel properties. 3. Economic characteristics of airlines as oligopolists; Note: For all the enrichment activities provided in this module: input your work on an A4-sized paper with your complete name, year, section, course, and signature over printed name indicating that you are accepting the terms indicated by the honesty clause; saved as PDF file with file name, “AE 413 Enrichment Activity 3.1 – Surname”; and submit in the Learning Management System (LMS) platform provided by the instructor on a designated deadline. Follow the necessary rubric, “Rubric for Short Answers”, provided at the last page of the module for pointing system. 21 PHILIPPINE STATE COLLEGE OF AERONAUTICS INSTITUTE OF ENGINEERING AND TECHNOLOGY AERONAUTICAL ENGINEERING – AIR TRANSPORTATION DEPARTMENT Learning Module 03: Economic Characteristics of the Air Transportation RUBRIC FOR SHORT ANSWERS NEEDS EXCELLENT GOOD FAIR CRITERIA IMPORVEMENT (4 POINTS) (3 POINTS) (2 POINTS) (1 POINT) Answers are Answers are Answers are not comprehensive, Answers are partial or comprehensive accurate, and accurate and incomplete. The or completely complete. Key complete. Key key points are not Content stated. Key ideas are clearly points are clear. The points are stated, explained, stated and question is not addressed, but and well supported. adequately not well supported. answered. supported. Inadequate The organization or Well organized, organization is development. Organization and coherently Organization mostly clear The structure structure detract developed, and and easy to of the answer from the answer. easy to follow. follow. is not easy to follow. Displays one to Displays three Displays no errors Displays over five three errors in to five errors in in spelling, errors in spelling, spelling, spelling, Writing punctuation, punctuation, punctuation, punctuation, Conventions grammar, and grammar, and grammar, and grammar, and sentence sentence sentence sentence structure. structure. structure. structure. Reference: Professor, M. (n.d.). Rubric gallery. Retrieved from https://www.rcampus.com/rubricshowc.cfm?sp=yes 22