International Review of Business Research Papers Vol. 3 No. 3 August 2007 Pp The Determination of Load Factors in the Airline Industry

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1 Inernaional Review of Business Research Papers Vol. 3 No. 3 Augus 2007 Pp The Deerminaion of Load Facors in he Airline Indusry Hashem Salarzadeh Jenaabadi* and Noor Azina Ismail** Load facor is a measure of efficiency and herefore mos commonly used o describe performance of airlines. This paper models load facors as a funcion of nine poenial variables. Daa were obained for seven major airlines in Iran and he period of sudy is from 1997 o The resuls obained suggesed ha companies should increase heir invesmen in compuerized reservaion sysems, improve on heir operaion planning, change in managemen syle and have more conrol in managing heir airlines. The governmen of Iran should also mainain or coninue giving subsidy in order o improve load facors and hence he performance of Iran Airlines. Field of Research: Operaion Managemen 1. Inroducion Passenger load facor or someimes simply called load facor is a measure of an airline s passenger carrying capaciy. I is also known as a measure of efficiency and hence mos commonly used o describe he performance of an airline. Achievemen of high load is deemed essenial for airline s profiabiliy and i is ineresing o invesigae facors ha are expeced o affec load facors. Furhermore, knowing hese facors would help organizaions or companies make more effecive decisions and planning. These decisions or planning could include providing raining, changing he mind-se among airline saff, increasing he number of ravel agencies or changing he pracices in heir managemen, increasing human resource, increasing invesmen in adverising, and many ohers ha can improve he performance of hese companies. *Hashem Salarzadeh Jenaabadi, Faculy of Economics & Adminisraion, Universiy of Malaya, Kuala Lumpur, Malaysia. salarzadeh@um.edu.my **Associae Professor Dr Noor Azina Ismail, Deparmen of Applied Saisics, Faculy of Economics & Adminisraion, Universiy of Malaya, Kuala Lumpur, Malaysia. nazina@um.edu.my

2 Jenaabadi & Ismail 190 This paper focuses on esimaing load facors of he aircrafs in Iran. Duliba, Kauffman and Lucas (2001) modeled he impac of load facors using five variables. These variables are he number of ravel agencies using each compuerized reservaion sysem, average lengh in miles of all of he airline s fligh beween ciy-pairs, number of deparures for each carrier, adverising expenses for each carrier and he change in vehicle miles as a conrol variable for indusry growh. In his paper, we consider four addiional variables o be included in he model. These variables are ype of organizaion, subsidy, inflaion rae and number of seas, afer aking ino consideraion Iran s poliical, social, culural and economic siuaion. Variables ha conribued in explaining he load facor in his sudy can hen be used as inpu variables in measuring performance. 2. Lieraure Review There have been a number of sudies of he airline indusry, however, only a few have ried o esimae load facor alhough his variable is normally used o describe he performance of an airline. Higher load facor is also associaed wih higher produciviy levels (Caves e al, 1981). Duliba, Kauffman and Lucas (2001) esimaed load facor for he American airline indusry using he number of ravel agen locaions using each compuerized reservaion sysem; he average lengh in miles of all of he airline s flighs beween ciy-pair; number of deparures for each carrier; adverising expenses, and he change in vehicle miles, he firs difference a ime of oal air ranspor indusry vehicle miles. They found ha number of deparures for each carrier and adverising expenses were significan, whereas compuerized reservaion sysem, he average lengh in miles of all of he airline s flighs beween ciy-pair and he firs difference of oal air ranspor indusry vehicle miles were no significan in explaining load facor for he American airline. Pegels and Yang (2000) evaluaed he impac of he cogniive and demographic characerisics of op managemen eam (TMTs) on he sraegic asses acquisiion performance in organizaions. They esed a model for domesic air ransporaion indusry in he USA. This model conains load facor as dependen variable and available sea miles, available on miles, oal asses; and adverising expendiures as independen variables. In anoher sudy, Hernadez and Salgado (2005) measured cos performance of he European Airline Indusry. They considered fifeen airlines and daa from 1984 o They esimaed wo models for cos funcions. In one of he cos funcions hey use prices of four inpus: energy, labor, maerials and capial. In he variable cos funcion, hey subsiued he price of capial by he number of planes as a proxy of he size of he company. As he vecor of producion is an aggregae measure of he real vecor, hey have added a se of variable o qualify 190

3 Jenaabadi & Ismail 191 he producion in order o inroduce more informaion abou he producion characerisics of he differen carries. These variables are: he average sage lengh (measured as number of kilomeers divided by he number of deparures.), which is a measure of he average lengh of rips, he load facor and he number of roues served. In conclusion, here are a few variables ha can be aken ino accoun in explaining load facor in he sudy of airlines. These variables include compuerized reservaion sysem; he average lengh in miles of all of he airline s flighs beween ciy-pair; number of deparures for each carrier; adverising expenses, and he change in vehicle miles. Besides hese variables, his sudy includes some oher variables in he Iran case. One of he imporan variables is he ype of organizaion of ravel agencies, which underake he ask of selling he airline ickes. In Iran, ickes should be booked hrough ravel agencies. There are wo kinds of airline ravel agencies. One of hem is he agency which works for he airline which belongs o he Iranian governmen and we classify hese agencies as governmenal organizaions. Travel agencies can also be independen of he airline, which means independen people underook o esablish a ravel agency wih heir own capial. These ypes of ravel agencies are classified as privae organizaions. The airlines have no direc conrol in erms of managemen over he agencies. In Iran, he governmen gives subsidy o he airline depending on he airlines operaing disance. This subsidy is received by all Iranian airlines and i is called fuel subsidy. This subsidy is awarded o he companies due o he high and varian coss of fuel, repairs and mainenance. The airlines do no receive he same amoun of subsidy and his amoun is given depending on heir operaional funcion. Anoher variable ha will be aken ino accoun is he inflaion rae. This variable is included o measure purchasing power of airlines cusomers. Lasly, he number of seas was also aken ino consideraion insead of number of planes since differen planes have differen number of seas. Therefore, i will be beer o use number of he available seas as a variable in order o remove he confusion. 3. Research Mehodology The Iranian commercial aviaion came ino exisence in 1927 and has several privae and public companies in operaion. In oal, here are 18 operaing airlines. This paper only considers seven major commercial airlines. These airlines are Iran Air (IA); Iran Air Tour (ITA); Mahan (MA); Aseman (AA); Kish Air (KA); Caspian (CA); and Aria (ARA). The daa are obained from he Iran Airline Associaion for he ime period from 1997 o Therefore, his sudy 191

4 Jenaabadi & Ismail 192 considers a panel daa se where, for each poin ime =1,, T here are k=1,,k differen airlines. The mahemaical definiion of load facor is as follows: r Number of carried passenger * dis an ce Load Facor = *100% * an i= 1 Avalable sea dis ce where r is he number of roues; number of carried passenger is he number of passengers carried in he roue beween wo ciies or saions; eiher in one counry or wo differen counries; disance is defined as he disance beween wo saions and is measured by kilomeer; and available sea is he number of available seas in he aircraf and i varies depending on he kind of aircraf. To explain he calculaion of load facor, wo examples are presened. In he firs example, he disance beween wo ciies has been covered by one fligh and he second example he disance has been covered by wo flighs. Example 1: The air disance beween he wo ciies, A and B, is 1200 kilomeers and he ype of he aircraf used is Boeing 747 which has 285 seas and he number of passengers in his fligh is 203. A 1200 kilomeers B Disance beween A and B 1200 Number of passenger 203 Avalable seas 285 The load facor is calculaed as follows: Load Facor = LoadFacor = Number of carried passenger * dis an ce *100% Avalable sea * dis an ce 203*1200 *100% = 71.22% 285*1200 The calculaed load facor in his case is abou 71%, which is a prey accepable value. Example 2: Suppose a TU-154 aircraf flew beween ciies A o C and on is roue i sopped a ciy B. Some passengers disembarked in ciy B and some passengers go on and raveled o ciy C from B. The aircraf lef A wih 130 passengers. A B, 45 passengers disembarked and 62 passengers boarded. The 192

5 Jenaabadi & Ismail 193 disance beween A and B is 1358 kilomeer and he disance beween B and C is 856 kilomeer kilomeers 856 kilomeers A B C 130* * Load Facor = *100% = *100% 160* * = 79.31% As a resul he load facor beween he wo ciies of A & C will be abou 79%. Load facor varies beween 0% and 100%. The closer load facor o 100%, he beer he operaional funcion of he company would be, and he closer is load facor o 0%, he weaker he operaional facor of he company would be. In his sudy, we consider he model below: Load Facor = β 0 + β1 Compueriz ed Sysem 1 + β Average Lengh + β Deparures 3 + β β Adveri sin g Expenses 5 + β Subsidy 6 + β 7 Inflaional Rae + β Number of sea 8 + β Change InVehicle Kilomeer 9 Organizaion + ε (1) where Load Facor is he oal load facors in year ; β 0 is a regression consan; β1, β 2, K, β8 are coefficien of independen variables; β 9 is a coefficien for he conrol variable for indusry growh and ε is an error erm wih normal disribuion. The independen variables can be described below: Compuerized Sysem is he number of agencies using compuerized reservaion sysem. The average lengh is he average disance in kilomeer of he airline s flighs beween he ciy pairs. Deparures is he number of deparures in a year. 193

6 Jenaabadi & Ismail 194 Organizaion is a binary variable where 1 denoes privae organizaion and 0 denoes governmenal organizaion. Adverising expenses is he sum of expenses for each airline in a year. Subsidy is he amoun of subsidy in US $ given by Iran governmen o he airline companies. Inflaion rae is he rae of increase of he average price level and given by he formula below: Price1 Price0 Inflaion Rae = 100 where Price Pr ice 1 Pr ice 0 = he curren average price level = he average 0 price level a year ago. Number of Sea is he oal number of seas for every airline. For example, if Iran Air our airline has 12 aircrafs in ype of TU-154 and every aircraf has 160 seas and hen he number of sea for his airline is 12*160=1920 seas. Change In Vehicle Kilomeers is he firs difference of air ransporaion vehicle kilomeers beween year and -1. Compuerized Sysem is labeled as Sysem Locaion by Duliba, Kauffman and Lucas (2001) and i is lagged one year o ake ino accoun he learning curve of he ravel agency, expecing ha he full impac of auomaing a ravel agency should be fel during he year afer he auomaion occurs. In his paper, Sage Lengh, i.e. he average lengh in miles of all he airline s flighs beween ciy-pairs is represened by Average Lengh, i.e. he average disance in kilomeer of he airline s flighs beween he ciy-pairs. We compued generalized leas squares soluion for his model using SPSS Discussion of Findings Figure 1 below shows ha he average load facor in Iranian airline companies has increased over he years. Alhough he difference beween he highes and he lowes value of average load facors is only 10%, his is considered o be a significan increase as far as he airline indusry is concerned. The highes load facor is in he year 2006 and he lowes is in This could be due o he economic downurn during his period. 194

7 Jenaabadi & Ismail % 70.6% 71.0% LOAD FACTOR 70% 68% 66% 64% 63.5% 65.5% 68.3% 66.7% 68.1% 67.3% 62% 61.7% 61.0% 60% YEAR Figure 1.Average Load Facor ( ) The resuls of fiing Equaion (1) are given in Table 1. Table 1: Esimaed Load Facor Coefficien -Saisic Prob. Load Facor Compuerized Sysem 1.683E Average Lengh E Deparures 1.003E Organizaion 6.211E Adverising Expenses 3.602E Subsidy 2.723E Inflaion Rae 3.172E Number of Seas E Change in Vehicle Kilomeer 3.225E Consan R 2 = I can be observed ha Compuerized Sysem, Average Lengh, Governmenal organizaion, Subsidy and Change in Vehicle Kilomeer are significan. However, Deparures, Adverising Expenses, Inflaion Rae and Number of Seas are no significan in explaining he variaion in load facors. All of he significan variables have a posiive relaionship wih load facors excep for Average Lengh. This resul indicaes ha load facor increases as he average disance in kilomeer of he airline s flighs beween he ciy-pairs decreases. I should also be noed ha he coefficiens for Average Lengh, Subsidy and Change in Vehicle Kilomeer are very small, since he uni of Average lengh and Change in Vehicle Kilomeer are in kilomeer and one kilomeer is considered very shor in erms of air disance. The same goes for subsidy since a USD1 subsidy is considered o be a very small amoun in helping he survival of he 195

8 Jenaabadi & Ismail 196 airlines. Taking collecively, his model explains 82% of he variaion in load facors. 5. Conclusion Unlike he case of he American Airlines, Deparures and Adverising Expenses are no significan in he case of Iran Airlines. This could be due o differen economic siuaions of Iran and Unied Saes. In Iran, he adverising expenses do no conribue o he load facor since he price of he ickes of every airline is he same and he governmen deermines he exac price of ickes for every roue. On he oher hand, he number of deparures per year can be well planned in advance by he airlines since more han eighy percen of he flighs are domesic flighs. Mos of he cusomers use domesic flighs for business, official, and pilgrimage raveling and herefore here are many regular ravelers for differen ypes of airlines. In his way, airlines can plan for he number of deparures per year for each roue o maximize load facors. The wo new variables included in his sudy are also no significan. They are Inflaion Rae and Number of Seas. In Iran, even when he inflaion rae is high, professionals are able o earn exra income and herefore hey could afford o ravel by air even during his period (despie he high price). As far as Number of Seas is concerned, he decision of buying an aircrafs in Iran is limied by he Unied Saes due o he economical and poliical sancions and only a few aircrafs were purchased during he period of 1997 o Hence here is very lile variaion in he number of seas during his period. Furhermore, mos of he operaional funcion of he airlines was conrolled by he Iranian governmen and very few of he airlines were able o purchase he aircrafs. For hese reasons he wo facors were no significan in explaining he variaion in load facors. In his paper, five main variables ha affec he increase of load facors in Iran airlines are Compuerized Sysem, Average Lengh, Organizaion, Subsidy and Change in vehicle Kilomeer. The compuerized reservaion sysem is no significan in explaining load facors as far as he Unied Saes is concerned. However, in Iran his variable is significan and his could be due o he absence of he on-line reservaion sysem in Iran. Hence seps should be aken o increase he number of agencies using compuerized reservaion sysems. The airlines should urn heir compuerized reservaion sysem ino highly successful specialized asses by invesing more resources on hem. The Iran Airlines should also reduce he average disance in kilomeer of he airline s flighs beween he ciy-pairs since mos ravelers only ravel in shor disances. Hence airlines should plan for a shorer raveling disance, if possible. 196

9 Jenaabadi & Ismail 197 In his sudy, we find ha here is a benefi of being a privae organizaion since he governmen has very limied conrol on heir managemen in erms of planning for he roues of he flighs. Hence hey can plan in such a way ha hey can maximize load facors. The fuel subsidy given by he governmen allows companies o discoun he price of ickes for cerain air ravelers and hence has a poenial in increasing load facor. Lasly, he change in vehicle kilomeers is a conrol variable for he growh in business. Therefore, i is expeced ha as here is an increase growh in business, he load facor will increase. In conclusion, he Iranian airlines should increase heir invesmen in compuerized reservaion sysem and have proper operaion planning. They should also consider changing he mind-se of he saff and pracices in heir managemen so ha hey can compee wih he privae organizaion. The governmen of Iran and Unied Saes should lax heir conrol over he airline companies so ha he airlines can operae beer. In order o help he survival of he airline companies, he governmen of Iran should coninue o subsidize he fuel prices. References Caves, D.; Chrisensen, M. & Treheway, M U.S runk air carriers, : A mulilaeral comparison of oal produciviy. T. Cowing, R. Sevenson, eds. Produciviy Measuremen in Regulaed Indusries. Academic Press, New York. Duliba, K. A.; Kauffman, R. J & Lucas, H. C Appropriaing value from compuerized reservaion sysem ownership in airline indusry. Organizaion Science, Vol. 12, No. 6, pp Hernadez, M. & Salgado, H Economies of densiy, nework size and spaial scope in he European airline indusry. Insiue of ransporaion sudies, Universiy of California a Berkeley working paper UCB-ITS-WP Pegels, C. C. & Yang, B Top managemen eam impac on sraegic asses accumulaion capabiliies. Managemen Decision, volume 38 Number 10 pp