Airline Companies: Supply- Demand Balance

An old anonymous quote says:

“To most people, the sky is the limit, to those who love aviation the sky is the home”.

Professionals in the airline industry are inspired with endless prospects in the sky, but how far are they successful? In a study conducted by Coelli et al. (2002) based on 28 international airline companies, it was found that these companies failed to achieve the average profit level. Surprisingly, 70% of that failure is related to capacity utilization (Coelli et al. 2002; Haerian et al. 2006).

The purpose of this article is to continue the discussion about service capacity management that was started here, and examine its application in the airline industry. In this article, the big picture of the aviation industry alongside with the related stakeholders will be illustrated. Within this context, the capacity in the airline companies is measured as the number of available seats (Slack et al. 2013, p.329), i.e. Available Seat Kilometers (ASK) or Available Seat Miles (ASM) (Mack et al. 2013, p.4).

In order to understand the big picture of the aviation business, the below figure shows the key stakeholders where airline companies play a key role in defining the capacity-related decisions along this business.pic 2.jpg

Each player has a different set of capacity measures as illustrated below (Mack et al. 2013, p.4):

  • Airports measure their capacities by ‘runway movement capacity’ and ‘terminal capacity’.
  • OEMs (Original Equipment Manufacturers) for aircraft measure their capacities by the number of airplanes they can produce.
  • ATM (Air Traffic Management) measures its capacity by ‘airways’, ‘control area capacity’ and ‘flow management capacity’.
  • Airlines measure their capacities by what is called Lift Capacity, i.e. the number of passengers (seats) and weight of cargo. This lift capacity is usually translated into ‘Available Seat Kilometres (ASK)’ or ‘Available Seat Miles (ASM)’

.Airliners have three basic business models namely (Cento 2009, p.18):

  • Full-service carrier;
  • Low-cost carrier;
  • Charter carrier.

Despite the differences, the high fixed cost and a relatively low variable cost is a common aspect. In addition, they all depend on a ‘reservation-bases demand’, have perishable inventory (Pekgün et al. 2014; Huefner 2015, p.10), have a fixed capacity and operating in a market that is divided into segments (Slack et al. 2013, p.341). All of these characteristics make the yield management approach is the best to managing capacity (Huefner 2015, p.9). The link between capacity management and yield management is that capacity management will provide an answer to the vital question “how much is truly revenue producing?” (Huefner 2015, p.40).

The complexity that is embedded in the capacity management in airline companies can be grouped as the following:

  • On the demand side, changing in customers’ characteristics due to demographic factors, politics and seasonal events to name but a few of the reasons that lead to a volatile demand (Belobaba et al. 2009, p.6; Mack et al. 2013, p.6).
  • On the supply side, the industry is affected by fluctuating fuel prices, weak economy, several financial crisis, high competition from low cost carriers (Merkert & Hensher 2011), regulatory requirements and concerns such as noise and environment (Belobaba et al. 2009, p.19) and finally the deregulation in which the governmental regulations on airline companies were loosened and hence affected the availability of the supply of airliners’ services (Belobaba et al. 2009, p.4; Cento 2009, p.13; Merkert & Hensher 2011).

Therefore, a successful airline industry is a function of complicated trade-offs between capacity management, safety, security and costs (Zografos et al. 2013).

The behavior of the airliners customers’ groups is important in managing capacity. The two main groups are ‘leisure passengers’ and ‘business passengers’ (Belobaba et al. 2009, p.63; Lemke et al. 2012). Leisure passengers have the flexibility to plan and book in advance, whilst business passengers do not have that flexibility. Instead, they usually book flights shortly before the take- off and they are willing to pay more (Lemke et al. 2012). Accordingly, airline companies sell their products, which are plane’s seats, in different classes and fares based on the provided adds-on for each seat (Lemke et al. 2012) and other factors as shown in the below figure.pic 3.jpg

The next articles will elaborate further on the concept ‘Yield Management’ and its application in service capacity management.

References

Belobaba, P., Odoni, A.R. & Barnhart, C., 2009. The Global Airline Industry 1st ed., Sussex: John Wiley & Sons, L td.

Cento, A., 2009. The Airline Industry: Challenges in the 21st Century 1st ed., Heidelberg: Physica-Verlag.

Coelli, T., Grifell-Tatje, E. & Perelman, S., 2002. Capacity utilisation and profitability: A decomposition of short-run profit efficiency. International Journal of Production Economics, 79(3), pp.261–278.

Haerian, L., Homem-de-Mello, T. & Mount-Campbell, C.A., 2006. Modeling revenue yield of reservation systems that use nested capacity protection strategies. International Journal of Production Economics, 104(2), pp.340–353.

Huefner, R.J., 2015. Revenue management: a path to increased profits [e-book] 1st ed., Business Expert Press.

Lemke, C., Riedel, S. & Gabrys, B., 2012. Evolving forecast combination structures for airline revenue management. Journal of Revenue and Pricing Management, 12(3), pp.221–234.

Mack, R., Jiang, H. & Peterson, R.B.M., 2013. A Discussion of the capacity supply – demand balance within the global commercial within the global commercial air transport industry, Available at: http: //www.boeing.com/resources/boeingdotcom/commercial/about-our-market/assets/downloads/AirTransportCapacitySupplyDemandBalance.pdf. Last viewed August 2016.

Merkert, R. & Hensher, D.A., 2011. The impact of strategic management and fleet planning on airline efficiency – a random effects tobit model based on dea efficiency scores. Transportation Research Part A: Policy and Practice, 45(7), pp.686–695.

Pekgün, P., Uyar, E. & Garner, B., 2014. Applying pricing and revenue management in the golf industry: Key challenges. Journal of Revenue & Pricing Management, 13(6), pp.470–482.

Slack, N., Jones, A. & Johnston, R., 2013. Operations Management 7th ed., Harlow, England: Pearson.

Zografos, K., Andreatta, G. & Odoni, A., 2013. Modelling and Managing Airport Performance [e-book] 1st ed., Hoboken: Wiley.

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