Aviation Costing Methods Essay Example
Aviation Costing Methods Essay Example

Aviation Costing Methods Essay Example

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  • Pages: 11 (2918 words)
  • Published: July 5, 2018
  • Type: Essay
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Airlines must establish cost leadership to gain a competitive advantage in the industry, as competition poses a significant threat.

Managing increasing operational expenses and decreasing revenues is a major challenge for the airline industry as it seeks to maximize profits. Therefore, airlines must understand the costing process and explore various strategies to reduce costs. To assess performance and efficiency, the industry utilizes trend and horizontal analysis. Moreover, the airline sector can be divided into international, national, regional, and cargo operations.

The airline industry incurs major costs in the form of weather, fuel, and labor. This term paper will explore how fluctuations in these costs impact the industry's services. These expenses have resulted in considerable losses for the industry, prompting restructurings and bankruptcies that may usher in changes. The period from 2001 onwards witnessed several factors like sluggish economic conditions, terrorist attacks' aftermath,

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soaring fuel prices, military actions, and fierce competition leading to reduced demand and unprecedented financial deficits within the airline sector.

Despite the challenges faced by the airline industry in terms of financial results, many airlines have taken steps to minimize losses. These measures include reducing capacity, employee headcount, and service offerings. Additionally, they have renegotiated labor contracts and adjusted flight schedules while implementing efficiency and cost-cutting initiatives. However, despite these efforts, the airline industry continues to experience financial losses in 2006 with potential for further reorganizations, bankruptcies, or consolidations. These events could potentially undermine AirTran's cost advantage and have a negative impact on its business as well as the overall industry. Major airlines are also adopting strategies to reduce their own costs which may further diminish AirTran's competitive edge. Ultimately, the significant losses within the industry

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have led to restructuring and bankruptcy proceedings that may bring about changes within the sector.

Since 2001, due to slower economic conditions, the aftermath of the September 11, 2001 terrorist attacks, attempted terrorist attacks, high fuel prices, military action overseas, and intense competition, the airline industry has witnessed a decrease in demand and subsequent financial losses. In response to these unfavorable results, most airlines have taken measures to minimize losses, including reducing capacity, workforce reduction, limited service offerings, labor contract renegotiation, flight schedule reconfiguration, and other cost-cutting initiatives. However, despite these actions, financial losses within the airline industry persisted throughout 2006. It is anticipated that further restructurings, bankruptcies, or consolidations in the airline industry may occur. Such events could potentially diminish AirTran's cost advantage. AirTran cannot guarantee that these events or subsequent changes resulting from them will not negatively impact its business or the industry as a whole. Major airlines are currently implementing strategies to reduce their cost structures through various means, which could potentially erode AirTran's competitive edge. The airline industry has experienced significant losses leading to restructurings and bankruptcies that may result in transformations within our industry.

The airline industry has faced a decline in demand, resulting in financial losses due to slower economic conditions, the impact of the 2001 terrorist attacks, high fuel costs, and military action in Iraq. Many airlines have taken measures such as reducing capacity, cutting employees, limiting services, renegotiating labor contracts, adjusting flight schedules, and implementing cost-cutting strategies to reduce losses. However, despite these actions taken in 2005,the industry has continued to suffer financially. There is also a possibility of future reorganizations or consolidations that could further diminish our cost

advantage and negatively impact our business and the industry as a whole. Major airlines are currently implementing methods to lower their costs which may erode our competitive edge. Our industry has already experienced significant losses leading to restructurings and bankruptcies that may bring about changes within our industry.

In light of unfavorable economic conditions, the repercussions from the 2001 terrorist attacks, elevated fuel costs, and military intervention in Iraq, the airline sector has experienced a decline in demand and significant financial setbacks. To counteract these negative financial outcomes, most airlines have implemented measures aimed at minimizing losses. These measures include reducing capacity and workforce size, limiting services, renegotiating labor agreements, reconfiguring flight schedules, and implementing other cost-cutting strategies. Nevertheless, despite these efforts made by the industry as a whole to mitigate losses throughout 2005, financial deficits persist. It remains possible that further restructurings or consolidations within the airline industry may occur which could impact our business and the industry overall. We cannot guarantee that such events or any resulting changes will not negatively affect our business or the aviation industry as a whole.

Major airlines are seeking ways to reduce costs, which could affect our competitive advantage. The merging or consolidation of airlines may have unpredictable effects on our operations. The airline industry's strategic landscape undergoes periodic changes as carriers try different tactics to increase profits. This includes consolidating for larger operations and market dominance, as well as forming global alliance partnerships. Furthermore, if any of our competitors declare bankruptcy or go through reorganization, it could lead to significant changes in the competitive environment in certain markets. This might involve reduced operational expenses for competitors or the

emergence of new rivals in our markets.

In addition, our efforts to acquire gates and assets from other carriers have encountered additional obstacles. If we do succeed in completing one or more acquisitions, there are various risks involved. These risks include challenges in integrating the acquired assets or operations into our existing ones, higher expenses, unforeseen problems with the acquired assets or entities (such as different flight equipment, outdated technologies that are incompatible with ours, labor disputes), and a failure to achieve the anticipated synergies and efficiencies. Any of these risks could negatively impact our operations. We cannot predict how changes in the strategic landscape will affect our business, financial condition, and results.

Regarding labor costs, the global airline industry is facing increasing fuel and labor expenses. These costs play a significant role in operational expenses for airlines worldwide. The graph clearly shows an inverse relationship between the proportion of fuel costs and labor costs within total operating costs. In approximately 2005, North American airlines had equal shares of labor and fuel costs in their operating expenses; however, due to consistent rises in Aviation Turbine Fuel prices over time, the proportion of labor costs has been decreasing compared to total operating costs.

Both the aviation industry and major airlines worldwide are facing a common challenge. The matrix below illustrates the percentage distribution of different costs in total operational expenses across various sectors globally. It is worth mentioning that North American airlines have witnessed a considerable reduction in their labor cost as part of their overall operating expenditures, decreasing from 36% in 2001 to 21%.

Between 1980 and 2008, fuel costs in the global airline industry experienced a significant increase

from 0.5% to 5% of total expenses due to higher proportion and lower labor costs. This trend is evident in the matrix as fuel remained the primary expense item for airlines in 2008.

In 2019, fuel accounted for approximately 32.3% of the total operating cost among 45 major global passenger airlines, marking an increase compared to the 27.4% recorded in 2007. These findings reflect the fuel share trends within the global aviation industry. Conversely, the percentage of expenses attributed to labor (including pension) decreased from 22%.

Global aviation traffic experienced a significant increase from 8% in 2007 to 20.1% in 2008. However, the following year, 2009, witnessed a decline of both global traffic and yields by 3.1% compared to the previous year.

Despite the usual labor disputes that arise from significant workforce reductions in older airlines with multiple unions, there was an unexpected lack of opposition to cutbacks in 2009. The unions acknowledged the industry's ongoing downturn and accepted the necessity for drastic measures, understanding the potentially dire circumstances. Consequently, most airlines were able to negotiate fair agreements by effectively communicating with their employees and emphasizing the urgent need for change. As we enter the second decade of the 21st century, there are encouraging indications of a gradual recovery, such as higher passenger numbers and profitability in the premium market.

Union leaders may struggle to acknowledge the need for cost reduction as the airline industry continues to grow. In February 2010, seat capacity increased by 5% globally compared to the same month in 2009. Furthermore, there was a 4% rise in global frequencies, resulting in a total of 2.

In February 2010, there are 2 million flights scheduled. The low-cost

sector has seen an increase of 11% in global frequency and capacity compared to last year, with an additional 40,704 flights and 6.1 million more seats. The recovery in the industry will result in some gradual capacity expansion, as new aircraft orders are introduced to the market. This expansion may lead to profitability for certain airlines. However, for legacy airlines, the argument for reducing costs will become more challenging.

And the restraint demonstrated by labor in 2009 is likely to no longer exist. This indicates that the upcoming year could be challenging for employee relations, particularly in Europe and North America. CAPA anticipates that 2010 will bring about industrial conflicts, potentially leading to significant transformations such as the market departure of renowned brands. At the very least, there will be substantial changes in the structure of these well-known entities, even if economic recovery begins to mitigate the consequences.

7|Page The specimen of the airline and its operating cost is given below: 8|Page From the above study it can be concluded that fuel and labor costs are the two main expenses in the airline industry that make up more than half of an airline's operating costs. While fuel costs are uncontrollable for airlines, labor costs can be controlled and restricted within the operational cost structure. This can be achieved through multi-tasking, where staff members specialize in multiple areas of work, such as ticketing and boarding. Additionally, following Standard Operating Procedures (SOPs) is crucial in ensuring employees know their tasks and gain expertise in their respective fields.

Simplification: It is important to keep tasks simplified so that they are understandable to all. Complications or complexity in the work

do not interest employees. By simplifying tasks, they can be conducted with perfection.
Training and Development: Upgrading the skills and knowledge of current employees is crucial to keep them updated with new technology and processes. This directly impacts productivity and profitability for organizations. It also helps control attrition.
Crew Planning: Inadequately planned crew resources can cause serious operational disruptions and result in significant financial losses. Crew shortages often occur due to oversights and cannot be quickly resolved, leading to flight cancellations or sub chartering.

? "ON 31 JULY 2003 ONE OF THE MAJOR US CARRIERS CANCELLED MORE THAN 80 FLIGHTS, WITH ADDITIONAL PRE-CANCELLED FLIGHTS IN AUGUST DUE TO AN “INCORRECT PILOT STAFFING MODEL." ?

Proper Mix: A proper mix of Part/Full time employees coupled with proper policies and procedures when added with a compact shift time designing structure would definitely result in cost saving from the labour factor in the operations.

There is obviously an enormous hidden potential for improvements in airline and air transport cost efficiency. Most of the risks in the above mentioned areas are induced by the lack of knowledge and information which are the prerequisites for improvements. While sophisticated optimization tools necessary to help solve the information problem are still a remote option, airlines should adopt a more realistic approach towards a solution that will provide essential, less complex but more effective operation.

This will help them develop the much-needed awareness of costs and a mindset of considering the overall system, resulting in less risky and more profitable operations. Weather plays a significant role in the cancellation of flights, with hurricanes, blizzards, fog, and floods being key factors. Airlines have policies in place for passengers

when flights are cancelled due to adverse weather conditions. The combination of bad weather and low fuel often leads to flight diversions. The implementation of cost-saving strategies by airlines may contribute to increased costs within the aviation system.

The graph shows the number of diverted airline flights from 1995 to 2008. A diverted flight refers to when a flight departs from its scheduled departure airport but lands at a different destination point. Cost reduction strategies are employed, particularly during financial difficulties and when faced with weather-related factors such as aircraft mechanical issues, passenger or crew medical emergencies, airport closures due to poor weather conditions, and changes in airline operating strategies.

Airlines are claiming to reduce overall costs in two ways: reducing flights, consolidating schedules, using larger aircraft, reducing fuel costs, and lighter take-off weights. Airlines are also consolidating operations into largest hubs during peak hours and using larger aircraft which require greater spacing for departure and arrival. Fuel costs refer to the cost incurred by the airplane for day-to-day operations in the airline industry. Brent crude oil prices have dropped 16.1% from their highs in April to $104.13 per barrel (Rs 5,165 today). However, the hope that this drop in fuel costs will bring relief to aviation firms and boost their stock prices is unlikely to be realized.

Investors closely monitor crude prices due to fuel accounting for up to half of airlines' operating costs. However, in this instance, a decline in benchmark fuel prices is not significant for these companies. The Indian crude basket has only decreased by 10% since April, whereas Brent has experienced a more significant decrease. Additionally, the depreciation of the rupee against the

dollar has meant that import costs have not decreased significantly. The local currency has dropped by 10 units.

As of August, there has been a 6% increase in prices that has essentially negated the benefits of lower crude prices. Indian aviation companies purchase their domestic aviation turbine fuel from local oil marketers, who adjust prices on the 1st and 16th of each month according to international crude prices. Currently, the average price for jet fuel is $127 per barrel for the quarter, compared to $131 per barrel in the previous quarter (April-June). Despite this increase, domestic travel has still seen a remarkable growth of 18.6% compared to other industries.

15 | P a g e Airline operators have not been able to raise prices or offset the rising costs due to increasing capacity faster than demand. The table below justifies the fuel costs experienced by the airline industry globally, showing the correlation between total revenue and annual increases in jet fuel prices. Fuel constitutes over 30% of an airline's total revenue, making it their largest expense. Therefore, airlines must find strategies to boost revenues or reduce costs in order to cope with these substantial fuel price hikes.

Fuel Conservation Strategies Cost Index

Cost index (CI) is defined as the ratio of the time-related cost of an airplane operation and the cost of fuel. The CI value reflects the relative effects of fuel cost on overall trip cost compared to time-related direct operating costs. In equation form: CI = Time cost ~$/hr Fuel cost ~ cents/lb. The denominator of the CI ratio is the cost of fuel, but factors such as highly variable fuel prices among operating locations,

fuel tankering, and fuel hedging can complicate this calculation. An evaluation at an airline yielded interesting results, summarized in A study that determined the optimal CI for their 737 and MD-80 fleets. The optimal CI for all 737 models was found to be 12, while for the MD-80 it was 22.

16 | P a g e The table illustrates the impact on trip time and possible savings over the course of a year by changing the CI for a typical 1,000-mile trip. The airline has the potential to save between US$4 million and $5 million annually by adjusting the CI, while the schedule remains unaffected. Fleet Current ($000’s) 737-400 737-700 MD-80 Time Cost The numerator of the CI is often referred to as time-related direct operating cost (excluding fuel expenses). Elements such as flight crew wages may have an hourly cost or be a fixed cost that does not vary with flight duration. Engines, auxiliary power units, and airplanes can be either leased by the hour or owned, and maintenance costs can be calculated based on aircraft hours, calendar time, or cycles. Consequently, each of these factors may have a direct hourly cost or a fixed cost over a specific period with little to no correlation to flight time.

When faced with high direct time costs, airlines may opt for a larger CI in order to minimize both time and cost. On the other hand, if most costs are fixed, the CI can be very low as the main goal is to reduce fuel cost. While pilots can easily comprehend the need to minimize fuel consumption, it becomes more challenging when another factor dominates the cost

reduction strategy. 30 45 40 Optimum 12 12 22 +1 +3 +2 Time Impact minutes US $754-771 $ $1790-1971$ $319-431 $ Annual Cost Savings 17 | P a g e Fuel Hedging Fuel Hedging involves the use of contractual tools by large fuel-consuming companies, such as airlines, to lower their vulnerability to fluctuating and potentially increasing fuel prices. Through a fuel hedge contract, these companies can establish a fixed or capped cost using commodity swap or option agreements. The purpose of entering into hedging contracts is to mitigate exposure to future fuel prices that may surpass the current rates, as well as to determine a known fuel cost for budgeting purposes.

The text below contains references and their corresponding hyperlinks:

- http://www.airlinenewsindia.com/2011/09/lower-crude-prices

- http://blogs.star-telegram

Article on fuel saving strategies by Bill Roberson, Senior Safety Pilot, Flight Operations. ? Paper on "THE HIDDEN COSTS OF AIRLINE OPERATIONS NEW INITIATIVE FOR IMPROVING AIRLINE OPERATIONAL AND COST EFFICIENCY" by Jasenka Rapajic.

? Airline Industry Revenue - Cost Analysis from AirlineFinancials.com ? ? ? ? ? ? IATA Economic Briefing February 2010. "Airport Manpower Planning Case Study"- Seabury Aviation Aerospace. This excerpt is from the AAI 10-K filed on March 1, 2007 and the AAI 10-K filed on August 9, 2007 and August 9, 2006.

Excerpt from the AAI 10-K filed on March 9, 2006. 18 | P a g e

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