Airline Operating Costs Dr. Peter Belobaba

Airline Operating Costs Dr. Peter Belobaba Istanbul Technical University Air Transportation Management M.Sc. Program Network, Fleet and Schedule Strategic Planning Module 12: 30 March 2016

Lecture Outline Cost Categorization Schemes Administrative cost allocation Functional cost categories and typical breakdown Flight Operating Costs Comparisons across aircraft types Total costs vs. unit costs Comparisons across airlines Impacts of stage length on unit costs Unit Cost Trends Fuel, labor and non-labor unit costs Aircraft and Employee Productivity 2

US DOT Form 41 Database Form 41 contains traffic, financial, and operating cost data reported to the DOT by US Major airlines Data is reported and published quarterly for most tables Detail of reporting differs for different expense categories Aircraft operating expenses by aircraft type and region of operation Other expenses more difficult to allocate by aircraft type Cost categorization schemes differ, but all are affected by accounting and allocation assumptions Administrative cost categories financial reports Functional cost categories airline cost and productivity comparisons 3

Administrative Cost Breakdown US Airlines 2013 AMORTIZATION 0.7% DEPRECIATION 4.7% OTHER 3.5% LANDING_FEES 2.1% RENTALS 7.0% SALARIES_BENEFITS 29.0% SERVICES_TOTAL 15.9% MATERIALS_TOTAL 37.1% Source: US DOT Form 41 Financial Reports 4

Functional Cost Categories Aircraft operating costs Expenses associated with flying aircraft, also referred to as Direct Operating Costs (DOC) Aircraft servicing costs Handling aircraft on the ground, includes landing fees Traffic service costs Processing passengers, baggage and cargo at airports Passenger service costs Meals, flight attendants, in-flight services Promotion and Sales costs Airline reservations and ticket offices, travel agency commissions Other costs, including: General and administrative expense Depreciation and amortization 5

Functional Cost Breakdown US Airlines 2013 ADMINISTRATIVE 8.3% ADVERTISING RESERVATION 0.9% SALES 4.8% TRAFFIC SERVICE 10.6% DEPREC AND AMORTIZATION 0.6% Fuel costs comprised 34.6% of total; more than half of Aircraft Operating Costs AIRCRAFT SERVICE 6.1% AIRCRAFT OPERATING COSTS 61.9% PASSENGER SERVICE 6.9% Source: US DOT Form 41 Financial Reports 6

Typical Costs by Functional Category Aircraft Operating Costs Per Block Hour (for example, $4500 for 150-seat A320 in 2013) Aircraft Servicing Costs Per Aircraft Departure (average $1200) Traffic Servicing Costs Per Enplaned Passenger (average $20) Passenger Servicing Costs Per RPM (average $0.013) Reservations and Sales Costs % of Total Revenue (average 7%) Other Indirect and System Overhead Costs % of Total Operating Expense (average 12%) 7

Back of the Envelope Break Even Fare Boston-Orlando A320 Flight 80% LF AOC 3.0 block hours @ $4500 $ 13500 Aircraft Servicing (1 departure @ $1200) $ 1200 Traffic Servicing (120 pax @ $20) $ 2400 Pax Servicing (132000 RPM @ $0.013) $ 1716 System Overhead Costs (12% of sub-total) $ 2566 Sub-total $ 21382 Break Even Net Revenue per Pax (120) $ 178 Distribution and Sales Costs (7% of fare) $ 13 Break Even Average Fare $ 191 8

Airline Operating Cost Breakdown Adapted from Form 41, used by Boeing, MIT (and Aviation Daily) for more detailed comparisons FLIGHT (DIRECT) OPERATING COSTS (DOC) = 50% All costs related to aircraft flying operations Include pilots, fuel, maintenance, and aircraft ownership GROUND OPERATING COSTS = 30% Servicing of passengers and aircraft at airport stations Includes aircraft landing fees and reservations/sales charges SYSTEM OPERATING COSTS = 20% Marketing, administrative and general overhead items Includes in-flight services and ground equipment ownership Percentages shown reflect historical rules of thumb. 9

World Airline Operating Cost Breakdown ICAO OPERATING COST CATEGORIES 1992 2002 2005 Direct Aircraft Operating Costs 44.0 49.1 54.0 Flight Operations (Total) 26.1 30.7 37.7 Flight Crew 7.2 9.0 7.8 Fuel and Oil 12.2 13.0 21.9 Other 6.7 8.7 8.0 Maintenance and Overhaul 10.9 11.3 10.2 Depreciation and Amortization 7.0 7.1 6.1 Indirect Operating Costs 56.0 50.9 46.0 User charges and station expenses (Total) 17.2 17.0 16.2 Landing and associated airport charges 3.9 4.0 3.8 Other 13.3 13.0 12.4 Passenger services 10.8 10.3 9.3 Ticketing, sales and promotion 16.4 10.7 9.1 General, administrative and other 11.6 12.9 11.4 Source: ICAO, Belobaba et al (2009) 10

Flight Operating Costs Flight operating costs (FOC) by aircraft type: Reflect an average allocation of system-wide costs per block hour, as reported by airlines for each aircraft type Can be affected by specific airline network or operational patterns Collected by US DOT as Form 41 operating data from airlines Typical breakdown of FOC for US carrier: CREW: Pilot wages and benefits FUEL: Easiest to allocate and most clearly variable cost MAINTENANCE: Direct airframe and engine maintenance cost, plus burden or overhead (hangars and spare parts inventory) OWNERSHIP: Depreciation, leasing costs and insurance 11

Example: Airbus 320 (avg. 150 seats) Costs per block-hour 2005 2007 2013 CREW $ 470 $ 454 $ 652 FUEL $1327 $1713 $2385 MAINTENANCE $ 524 $ 576 $ 716 OWNERSHIP $ 570 $ 570 $ 726 TOTAL FOC $2891 $3313 $4567 Based on reported average stage length and block-hr daily utilization (weighted averages): Different stage lengths and utilization by different airlines result in substantial variations in block-hour costs for same aircraft type Also, differences in crew (union contracts, seniority), maintenance (wage rates), and ownership costs (age of a/c) Source: US DOT Form 41 Statistics 12

A320 Aircraft Operating Costs 2013 Form 41 System Data CREW COST FUEL/OIL MAINTENANCE OWNERSHIP TOTAL AOC UNITED $793 $2,407 $624 $1,079 $4,903 DELTA $964 $2,254 $916 $536 $4,670 US AIRWAYS $431 $2,375 $1,014 $686 $4,506 VIRGIN AMERICA $419 $2,476 $362 $1,163 $4,420 FRONTIER $449 $2,488 $477 $827 $4,241 JETBLUE $665 $2,417 $700 $451 $4,233 SPIRIT $518 $2,233 $381 $921 $4,053 LCCs report 2% to 17% lower AOC per block hour than NLCs Source: US DOT Form 41 Statistics 13

Comparison of FOC Across Aircraft Types All else equal, larger aircraft should have higher flight operating cost per hour, lower unit cost per ASM: There exist some clear economies of aircraft size (e.g., two pilots for 100 and 400 seat aircraft, although paid at different rates) Also economies of stage length, as fixed costs of taxi, take-off and landing are spread over longer flight distance But, many other factors distort cost comparisons: Pilots paid more for larger aircraft that fly international routes Newer technology engines are more efficient, even on small planes Reported depreciation costs are subject to accounting procedures Aircraft utilization rates affect allocation of costs per block-hour 14

FOC Selected Aircraft Types 2013 Form 41 System Data Aircraft Type Average Seats AOC/ Block-hr AOC/ Seat-hr Average Stage (mi.) E190 100 $3,612 $36.12 599 9.4 Utilization (blockhrs/day) 737-700 139 $4,358 $30.63 762 10.1 A320 150 $4,479 $29.86 1181 11.5 757-200 177 $5,839 $32.99 1523 10.1 A330-200 272 $8,795 $32.33 3645 14.6 747-400 375 $15,153 $40.41 4861 11.4 15

Total Operating Costs vs. Unit Costs Total operating costs increase with size of airline, aircraft size and stage length Increased output (ASMs) leads to higher total operating costs Bigger aircraft cost more to operate (per block hour, per flight) Longer stage length means more fuel burned, more pilot and flight attendant hours But, due to high fixed costs, airlines should have economies of scale in unit costs (in theory): Larger aircraft should have lower operating costs per seat and per seat-mile (ASM) Longer stage lengths should lead to lower unit costs Larger airlines with bigger aircraft flying longer stage lengths should have lowest unit costs. 16

Impacts of Stage Length on Unit Costs Industry unit cost curve is downward sloping with respect to the average stage length. A large proportion of the overall cost base is fixed, at least in the short-term Ownership costs, maintenance and ground infrastructure, reservations/sales and overhead Contributing factors: With longer stage lengths All fixed costs can be spread over more ASMs Shorter turn times relative to block times allow greater aircraft and crew utilization Average block speed increases and fuel burn decreases with more time spent at cruise altitude Cycle-related maintenance requirements are reduced 17

2012 Unit Cost (CASK) Selected Non-US Airlines Unit Cost vs Average Sector Length, 2012 NLCs ULCCs LCCs Source: Emirates Open Sky 2/14, CAPA Data 18

CASM vs. Stage Length US Airlines 2014 Unit Cost vs Stage Length, 2014 10 9.5 CASM ex Fuel & Transport 9 8.5 8 7.5 7 6.5 6 LCCs NLCs 5.5 5 0 200 400 600 800 1000 1200 1400 1600 1800 2000 Average Stage Length ULCCs Allegiant Spirit Frontier United Delta American JetBlue Southwest Virgin America Alaska Source: MIT Airline Data Project 19

CASM Breakdown CASM can be broken down as follows: Transport Related expenses excluded for comparisons Total CASM Transport Related Fuel CASM ex. Transport and Fuel Labor CASM Non-labor CASM 1 2 3 4 5 20

Fuel, Labor and Non-Labor Costs Compare macro trends over time and across airlines Fuel Costs have been increasing to over 30% Most variable cost, typically driven by global oil prices and factors outside of airline control Labor Costs have been decreasing in share With greater emphasis on cost re-structuring and increasing labor productivity Significant cost advantages for newer airlines and LCCs Non-labor Costs represent structural differences In networks, product mix and operations 21

Operating Cost Breakdown by Region Fuel component has increased for all regions, while labor percentages have declined. Labor share dropped the most for North America airlines. Source: IATA 22

US Airlines CASM* Components 1995-2014 16.00 14.00 TOTAL CASM (cents) 12.00 10.00 8.00 6.00 36.8% 29.8% NON-LABOR LABOR FUEL 4.00 2.00 33.4% 0.00 Source: MIT Airline Data Project * CASM excl. Transp. Related Expenses 23

US Airlines CASM* Components 1995-2014 6.00 5.00 4.00 CASM (cents) 3.00 2.00 FUEL LABOR NON-LABOR 1.00 0.00 Source: MIT Airline Data Project * CASM excl. Transp. Related Expenses 24

Aircraft Productivity Aircraft utilization measured in block-hours/day: Block hours begin at door close (blocks away from wheels) to door open (blocks under wheels) Gate-to-gate time, including ground taxi times Productivity measured in ASMs per aircraft per day: = (# departures) X (average stage length) X (# seats) Increased aircraft productivity achieved with: More flight departures per day, either through shorter turnaround (ground) times or off-peak departure times Longer stage lengths (average stage length is positively correlated with increased aircraft utilization = block hours per day) More seats in same aircraft type (no first class seating and/or tighter seat pitch ) 25

Aircraft Productivity Stage Length vs. Departures per Day 1,400 6.00 1,300 5.50 Average Stage Length (mi) 1,200 1,100 1,000 900 800 5.00 4.50 4.00 3.50 3.00 Average Departures per Day per Aircraft Ave Stage Length Departures/day 700 2.50 600 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2.00 Source: MIT Airline Data Project 26

Aircraft Utilization Block Hours per Aircraft per Day 14.00 12.00 Block Hours per Aircraft per Day 10.00 8.00 6.00 4.00 +25% NLC Narrow body LCC Narrrow body NLC Wide body 2.00 - Source: MIT Airline Data Project 27

A320 Productivity Comparison 2013 Form 41 System Data TOTAL AOC Stage Number Departures Block Hours ASMs AOC per PER BLK-HR Length (mi) of Seats per Day per Day per Day ASM UNITED $4,903 1165 142 4.6 10.2 760,666 $0.066 DELTA $4,670 888 150 5.3 9.6 702,985 $0.064 US AIRWAYS $4,506 1090 150 4.9 12.4 796,868 $0.070 VIRGIN AMERICA $4,420 1575 147 4.6 12.5 1,071,914 $0.052 FRONTIER $4,241 1057 168 5 10.1 894,791 $0.048 JETBLUE $4,233 1361 150 5.1 12.9 1,042,392 $0.052 SPIRIT $4,053 968 178 6.9 12.9 1,193,464 $0.044 LCCs generate 20-60% more output than NLCs with same aircraft type. Source: US DOT Form 41 Statistics 28

Employee Productivity Measured in ASMs per employee per period As with aircraft, employee productivity should be higher with: Longer stage lengths (amount of aircraft and traffic servicing for each flight departure not proportional to stage length) Larger aircraft sizes (economies of scale in labor required per seat for each flight departure) Increased aircraft productivity due to shorter turnaround times (more ASMs generated by aircraft contribute to positive employee productivity measures) Yet, network airlines with long stage lengths and large aircraft have lower employee productivity rates 29

ASM per Employee 3.50 3.00 +60% 2.50 +35% 2.00 1.50 NLC LCC 1.00 0.50 - Source: MIT Airline Data Project 30

NLC employment down by 36% since 2000, a loss of 150,000 jobs 450,000 400,000 350,000 300,000 250,000 200,000 NLC LCC OTHER 150,000 100,000 50,000 - Source: MIT Airline Data Project 31

Concluding Thoughts Legacy carriers made dramatic progress in cost cutting and productivity improvement 2001-2007 Labor and distribution costs saw biggest reductions Productivity improvements through network shifts, work rules and use of IT for passenger processing Not much room for further cost reductions Labor will push to recover wage and benefit concessions Distribution costs can t go much lower Aging fleets will push up maintenance costs Recent return to industry profitability has relied heavily on demand growth and revenue generation Capacity discipline higher yields and higher load factors 32