AN INTERNATIONAL COMPARATIVE STUDY OF THE OPERATIONAL PERFORMANCE OF FULL SERVICE, REGIONAL AND LOW-FARE AIRLINES

AN INTERNATIONAL COMPARATIVE STUDY OF THE OPERATIONAL PERFORMANCE OF FULL SERVICE, REGIONAL AND LOW-FARE AIRLINES Antonio Henriques de Araujo Junior Production Engineering Department, CENTRO UNIVERSITARIO DE VOLTA REDONDA UNIFOA, Brazil Isabel Cristina dos Santos Faculty of Economics, Business Administration and Accounting, TAUBATE UNIVERSITY Taubaté - SP, Brazil Clarissa Côrtes Pires Production Engineering Department, AERONAUTICS TECHNOLOGICAL INSTITUTE ITA, Brazil ABSTRACT In this paper the results are published of post-doctorate research done at the Brazilian Aeronautics Technological Institute (ITA) in 26. The purpose of this paper is to evaluate and to discuss the operational performance of the main Brazilian carriers in the period from 2-25, by comparing their productivity growth and operational performance metrics with those of full service companies (FSC), regional airlines and low-fare/low-cost companies (LCC), chosen from among benchmarks in this industry. Keywords: Productivity, efficiency, air transport productivity. INTRODUCTION Until recently, scheduled passenger and freight services were heavily regulated in most countries in both domestic and international markets. Meanwhile, there is a consensus among air transport specialists that unnecessary restrictive regulations may have led to significant losses in efficiency. The governments of different countries, among them Brazil, have recognized this limitation and started a deregulation process in the last decade, aiming to improve efficiency and cost reductions in air transport by enhancing competition among carriers. This article is based on research undertaken for a post-doctoral research project called Productivity Analysis of the International Air Transport Industry, done at the Brazilian Aeronautics Technological Institute. FINDINGS AND PRACTICAL IMPLICATIONS Until recently, scheduled passenger and freight services were heavily regulated in most countries, both in domestic and international markets. Meanwhile, there is a consensus

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 2 among air transport specialists that unnecessary restrictive regulations may have led to significant losses in efficiency and that, as a consequence, a large share of the population is not being granted access to air transport. The governments of different countries, among them Brazil, have acknowledged this limitation and started a deregulation process in the last decade, aiming to improve efficiency and cost reductions in air transport by enhancing competition among carriers. In the case of Brazilian air transport, some factors contributed to the search for efficiency and productivity growth, for example: increases in the main production costs and financial expenses (thus diminishing profits); the growing indebtedness of Brazilian airlines, which affected their cash situation, and increasing competition in domestic and international markets, forcing them to increase their operational and managerial efficiency, so as to guarantee their survival. THE PAPER STRUCTURE A short introduction to the paper is made in Section 1. The structure of the paper can be seen in Section 2. An overview of the Brazilian air transport market is shown in Section 3. A short theoretical framework for the paper is in Section 4. Section 5 deals with the data, sources, and the productivity measurement method utilized in the paper, as well as the sampling criteria. This section also discusses the option of using the physical productivity concept in the case of the Brazilian air transport industry. The research results are discussed in Section 6, and finally the conclusion is presented in Section 7. THE BRAZILIAN AIR TRANSPORT INDUSTRY The Brazilian air transport domestic market is the largest Latin American market. According to the Air Transportation Action Group, Brazilian airlines hold a 4.6% share in America s international passenger market, transporting 7.2 million passengers a year. This is expected to reach a 2-million-passenger flow in 215. The Brazilian air transport industry is responsible for 3% of Brazilian GDP with a direct impact of US$ 6.7 billion and indirect impact of US$ 18 billion, generating about 35, direct jobs in 23. From the end of the 197 s to the end of 25, the air transport industry s share in the Brazilian transportation matrix went from.7% to 2.7%. The annual growth rate was 6.5% between 1997 and 21. The growth peak occurred in 1998, with a passenger transportation increase of 22% in the domestic market. In 25, the Brazilian market was served by two Brazilian airlines in international markets (VARIG and TAM), and by three carriers in the national market (VARIG, TAM and GOL). Brazil is the only Latin American country with a consolidated aeronautical industry, and part of its fleet is Brazilian made. In 22, VASP went bankrupt a nd currently GOL and VARIG are in a merger process. Their market shares are 43%, 28% and 26%, respectively. THEORETICAL FRAMEWORK Deregulation of the US airline industry in 1978 initiated an abundance of literature concerned with the effect these recent changes have had on productivity (and, similarly, whether changes to European legislation would precipitate similar observed productivity advances). The demonstrable effects of successful US deregulation and ongoing inefficiency

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 3 in the industry may have influenced the European Commission to introduce certain reforms to promote competition and thus increase the efficiency and productivity of the European airlines. Much of the literature has concentrated on productivity in the United States compared against that in Europe (McKinsey 1992, McGowan and Seabright 1989, Good et al 1993), whereas only a small proportion of papers present productivity estimates for the European countries individually (Encaoua 1991). Moreover, many authors prefer to concentrate on Total Factor Productivity (Windle 1991) in favour of a labour productivity measurements. METHOD AND DATA Productivity measurement method A Multi-Factor Productivity (MFP) index, which includes the main production factors labor and capital, was used to measure the productivity of companies surveyed from 2 to 25. Multi-factor productivity Total Factor Productivity (TFP) or Multifactor Productivity (MFP) is defined as the ratio in the quantities/volumes produced and a weighted combination of quantities and volumes of the different inputs used in the production process. Kendrick s productivity measurement method is used with changing-weight indices of outputs and inputs according to Kendrick, Creamer (1965). The Multi-Factor Productivity Index MFP is represented as the ratio between the output and input index, where inputs are weighted by their share in production costs. AVt MFP = a ( Lt ) + b ( K t x1 ) (1) MFP in equation (1) indicates the Multi-Factor Productivity index measured in monetary terms, according to Kendrick s method, which in this case is calculated from the ratio between the added value of the airlines in year t and the weighted relationship of labour, e.g. salaries (L t ) and capital, e.g. capital assets (K t ) in the same year, where a and bo represent labour and capital weights, respectively. MFP = a ( L t AV / L t / AV ) + b ( K t / K x1 ) (2) Equation (2) is derived from equation (1), which makes it possible to calculate productivity growth in physical terms in a time period [, t], where AV t is the number of passengers transported or the Revenue seat-km (RSK), L t represents the number of employees at the end of period t (31 st December), and K t the number of aircraft operated at the end of same period. Different labour and capital productivity weights, taken from IATA s Economic Report (25), take into account the inputs share in the carriers operational costs, according to the airline of origin, as shown in Table 1. Equation 2 gives the productivity change from a basis period to a future time t:

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 4 TABLE 1: Weights for Labour and Capital Productivity Airlines (a ) (b ) North American,66,34 European,72,28 Asian,57,43 South American,61,39 Some authors, among them Moreira (1994, p.12), propose that weights a and bo be substituted, periodically, in order to reflect alterations in the production structure and changes in relative prices of capital and labour. Some organizations, like the National Bureau of Economic Research, recommend changes every five years. The option for physical productivity An important question in the productivity measurement context is: should the productivity index be measured in physical or in monetary terms? In the case of a comparison in different economic sectors, this is only possible by means of an economic productivity index, measured in monetary terms. The productivity measurement in monetary terms, in the case of Brazilian air transportation (in which the main revenue is generated in an unstable currency and in which costs are either incurred or indexed to a stable currency - the American dollar, for instance) can lead to distortions. To avoid a measurement bias in Brazilian air transport, a physical productivity method was chosen. Performance metrics The following metrics were used to evaluate the operational performance of the airlines: Transported passenger per employee Revenue seat-km per employee and aircraft Passenger load factor Hours flown per aircraft and day Data The information and data for the year 2 and 25 was collected from international and Brazilian publications: World Air Transport Statistics (IATA), the Digest of Statistics (ICAO); Fleet and Personnel Series (ICAO), the Financial Data Series (ICAO) and the Brazilian ANAC commercial aviation yearbook. Two categories of inputs were used: labour and flight equipment. Labour is computed as a multi-lateral index of 5 categories: pilots, co-pilots, other cockpit personnel, cabin attendants and other personnel. Output is composed of two separate components: scheduled revenue passenger-km, and passenge rs transported. Capital is represented by the number of aircraft operated. Sampling criteria 45 carriers were selected and grouped as follows: 26 full service

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 5 7 low-cost/low fare and 13 regional airlines The airlines were sampled according to the following criteria: (i) representativeness and importance of the airlines in their markets (North and South American, European and Asian airlines); (ii) carriers whose data availability and previous studies indicated good operational performance and productivity were chosen. The airlines included in the sample are detailed below: Full Service - Aeroflot, Aerolineas, Aeromexico, Air Canada, Air France, Alitalia, Austrian American Airlines, British Airways, China Southern Continental, Delta, Iberia, JAL, Korean, Lan Lufthansa Malev, SAS Singapore, Airlines, Swiss, TAP, Thai, Turkish Airlines, TAM and VARIG; Low-cost/low-fare - Air Berlin, Air Europa, America West, GOL, Jet Airways, Ryannair and Virgin Express, and Regionals Alaska, Nordeste, Oceanair, Pantanal, Passaredo, Penta, Portugalia Airlines, Rico Riosul, TAF, Total, US Airways. Airlines with strong output and input variations due to a restructuring process, like Malev, SAS, Air Canada, TAP and Transportes aéreos Fortaleza were not considered in this analysis of productivity. RESEARCH RESULTS Productivity growth and operational performance Table 2 provides a decreasing rank ordering of the 45 airlines in the sample by MFP change from year 2 to 25. Air Berlin is ranked number 1, GOL and TAM, the two largest Brazilian airlines are placed second and fifth respectively. Among the 1 best productivity growths, 4 are from low cost/low fares companies, 1 to a regional airline and 5 to the full service category. The average productivity growth of the sample was 16.% in the period 2-25, or 3.% p.a. compared with a 2.% p.a., and is higher than the MFP growth of the air transport industry in the 1972-21 period (2.% p.a.), as estimated by Duke, Torres (25).

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 6 TABLE 2: MFP 1 Growth 2-25 Pos. Airlines MFP 1 Pos. Airlines PMF 1 1 Air Berlin 2,556 19 British Airways 1,42 2 GOL 1,551 2 Continental 1,4 3 TAP 1,478 21 Air Europa 1,28 4 JAL 1,384 22 Singapore Airlines 1,8 5 TAM 1,346 23 Air France,995 6 Aeroflot 1,327 24 Lan,982 7 Swiss 1,327 25 Lufthansa,978 8 US Airways 1,35 26 Turkish Airlines,976 9 China Southern 1,266 27 Aeromexico,974 American 1 Airlines 1,235 28 Virgin Atlantic,959 11 Alaska 1,231 29 Thai,949 12 Austrian 1,227 3 Jet Airways,939 Portugalia 13 Airlines 1,162 31 Rico,91 14 Delta 1,153 32 Alitalia,9 15 Iberia 1,145 33 Total,65 16 America West 1,131 34 Aerolineas,583 17 Pantanal 1,83 35 Korean,48 18 VARIG 1,47 Average productivity growth in 2-25 = 1.16; Standard deviation =.339. Source: the authors. The two largest Brazilian airlines (GOL and TAM) had much better productivity growth, 7.7% p.a., than the average for the sample, while productivity performance of all the Brazilian airlines, including the regionals, is below the international standard for regionals in the same period (1.8% p.a.) and is below the standard of the foreign regional airlines in the same period (+1.9% p.a.). A graphical overview of this situation is shown in Fig. 2. Multifactor productivity was measured in two ways: MFP 1 considered the number of passenger transported as output, and MFP2 the Revenue Pax-km number. Figures for the Brazilian airlines are in white in Fig. 3. 2,5 2, 1,5 Productivity average growth =1.124, Std. Deviation =.339 MFP 1 1,,5, Air Berlin GOL TAP JAL TAM Aeroflot Swiss US Airways China Southern American Airlines Alaska Austrian Portugalia Airlines Delta Iberia America West Pantanal VARIG British Airways Continental Air Europa Singapore Airlines Air France Lan Lufthansa Turkish Airlines Aeromexico Virgin Atlantic(UK) Thai Jet Airways (India) Fig.3: MFP growth in 2-25. Source: the authors. Rico Alitalia Total Aerolineas Korean

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 7 Transported passengers per employee Concerning labour productivity (passengers transported per employee) in 2, no traditional full service company was among the 1 best airlines, and among the top 2 carriers, only 6 are represented, as shown in Figure 4. Almost all the companies improved their performance from 2 to 25. Ryannair and Air Berlin (LCC) companies had the best performance. The hypothesis has been confirmed that due to a better load factor and a lean personnel structure, LCCs transport more passengers per employee than FSCs. Passenger transported per employe 8. 7. 6. 5. 4. 3. 2. 1. Ryannair Air Berlin Nordeste TAM Air Europa JAL Riosul Rico Average =136pas/employee.; Std. Deviation = 1148 Delta US Airways GOL America West Korean Aeromexico Turkish Airlines Alaska Alitalia Lufthansa American Airlines Singapore Airlines passenger/employee 2 passenger/employee 25 Fig.4: Comparison of passengers transported per employee in 2-25 (2 best performance from the sample). Source: the authors. Revenue Seat-km per employee and aircraft As can be seen in Figure 5, the best performance in this metric in 25 was that of Air Berlin and Virgin Atlantic, two well known European low-cost/low fare companies. Large full service airlines like American Airline, British Airways and Delta did not perform well due to their expanded personnel and fleet structure. The amplitude of the sample by this metric is very large because of the great differences in the profile of the companies and also in the way they operate. In the sample, the largest full service companies (FSC) had the worst performance. The standard deviation in this case was particularly high. 18, RSK per employee and aircraft 16, 14, 12, 1, 8, 6, 4, 2,, Air Berlin Virgin Atlantic (UK) Passaredo Portugalia Airlines Singapore Airlines Pantanal Aerolineas Austrian Korean Air Canada Thai America West Lan AirChina US Airways Total British Airways Delta China Southern American Airlines Average=36.73 RSK/employee*aircraft ; std deviation =37.95 Fig.5: RSK per employee and aircraft in 25. Source: the authors.

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 8 Hours flown per aircraft and day Low-cost/low fare companies (LCC) and airlines with a large share in continental flights had, as expected, made the best use of aircraft in terms of hours flown. The best position was that of Virgin Atlantic and Singapore Airline. The average aircraft usage was 9.1 h/day and the standard deviation in the sample was small (2.92). In 25, Virgin Atlantic and Singapore Airlines flew an average of 14.4 and 13.6 hours a day, respectively. The number of hours flown is supposed to be underestimated, due to fact that in this case, only scheduled operation is considered in the IATA figures. Hours flown per aircraft and day 16, 14, 12, 1, 8, 6, 4, 2,, Virgin Atlantic(UK) Singapore Airlines TAP Swiss Delta Korean US Airways America West British Airways Average=9.1 [h/d]; Std deviation=2.92 Air Canada Iberia GOL Continental Thai JAL AirChina Air France Lufthansa Lan Alitalia Fig.6: Hours flown per aircraft in 25. Source: the authors. Passenger load factor Concerning the passenger load factor in 25, Aerolineas and Air Canada had the best performance in the 45- airline sample. On average, their fleet had an 81.4% and 8.1% load factor, respectively. Varig, due to its economic situation, and strong tariff reduction, reached the best passenger load factor among the Brazilian airlines (77%), and was followed by GOL (74%) and TAM (73%). Passenger Load Factor (%) 82, 8, 78, 76, 74, 72, 7, Aerolineas Air Canada Continental America West Air France American Airlines Average=7.2 (%) Std deviation =1.4 Lufthansa Iberia Swiss Delta VARIG British Airways US Airways Air Berlin Singapore Airlines Virgin Atlantic (UK) Air China Fig.7: Passenger load factor in 25. Source: the authors. CONCLUSION The liberalization and opening up of the market in the beginning of the 199s exposed Brazilian carriers to competition that consequently led them to cut prices, with an impact on demand, as a strategy to maintain or to increase their market share. There was widespread Lan GOL Austrian

ARAUJO JR, SANTOS, PIRES An international Comparative Study of the Operational 9 and accentuated improvement in productivity among Brazilian airlines in the period following deregulation, as also reported in the case of the American and European carriers as mentioned in the technical literature. This paper has documented a productivity advantage for the LCC over a sample of 38 FSC and regional airlines. Comparing productivity growth by airline class, the best performance was that of the LCCs (+4.4% p.a.), followed by the FSC (+3.% p.a.) and the regionals (+1.1% p.a). Brazilian companies operating domestically increa sed productivity above the average for the sample (+7.7% p.a.). On the other hand, the performance of the Brazilian regionals was below the overall average (-1.8% p.a.) due to the low demand density for the routes and the low utilization of their fleet. In a general sense, the LCCs had the best operational performance in comparison with the FSCs and regional airlines, as regards passengers transported per employee and RSK per employee. This can be explained by better use of their aircraft in terms of hours flown per airplane day (14 h/d) in comparison with the average for the whole sample (9.25 h/d) in 25. The study demonstrated a high statistical correlation between productivity growth, hours flown per aircraft, and the passenger load factor. ACKNOWLEDGMENTS The authors thank the National Research and Development Council Conselho Nacional de Pesquisa e Desenvolvimento (CNPq) for the Project Research support (Grant nr. 154 23/26-8),that made this paper possible. REFERENCE Airlines Annual Report (1991-1995), IATA, Paris. Araújo Jr, A.H. (24), Analysis of the Brazilian air transport productivit. Doctoral Thesis submited to Escola Politecnica, São Paulo University, São Paulo. Araujo Jr, A.H. (24), Evaluating the efficiency of Brazilian regional airlines. In: Annals of the V SITRAER, vol.1, 179-184. Association of European Airlines, various Yearbooks, AEA, Brussels. Charnes, A., Cooper, W.W., and Rhodes, E. (1978), Measuring the efficiency of decision making unit, European Journal of Operational Research 6, 429-444. Distexhe, V. and Perelman, S. (1994), Technical efficiency and productivity growth in an era of deregulation: the case of airlines, Swiss Journal of Economics and Statistics 13, 4, 669-689. Duke, J.,Torres, V. (25), Multifactor productivity change in the air transportation industry, Monthly Labour Review, March, 32-45. Encaoua, D. (1991), Deregulating European Airlines, International Journal of Industrial Organisation 9, 61-81. Farrell, M.J. (1957), The measurement of productive efficiency, Journal of Royal Statistical Society Series A (General) 12, 2, 253-281. Gönenç, Nicoletti (1986), The implementation and the Effects of regulatory Reform: past Experience and current Issues, OECD Economic Economics Department Working Papers, n. 5. Good, D. H., Nadiri,M. I., Roller, L.H. and Sickles, R.C.(1993), Efficiency and Productivity Growth Comparisons of European and US Air Carriers: A First Look at the Data. The Journal of Productivity Analysis, vol. 4, 115-125. Kendrick, D.A. (1996), Chapter 6: Sectoral Economics in Hans M. Amman, David A. Kendrick, and John Rust (eds) Handbook of Computational Economics, volume 1, Handbooks in Economics 13, Elsevier: Amsterdam.

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