Flying Off Course

Airline Economics and Marketing

Rigas Doganis

• Publisher: Routledge
• Year: 2019
• Print ISBN: 9781138224230
• eBook ISBN: 9781315402963
• Topic: Business
• Subtopic: Business General
• Index: Business

Aviation is one of the most widely talked about industries in the global economy and yet airlines continue to present an enigma. Between 2010 and 2018 the global airline industry experienced its longest period of sustained profitability; however, huge global profits hid a darker side. Many airlines made inadequate profits or serious losses while others collapsed entirely. This fifth edition of Flying Off Course explains why.

Written by leading industry expert, Rigas Doganis, this book is an indispensable guide to the inner workings of this exciting industry. Providing a complete, practical introduction to the fundamentals of airline economics and marketing, it explores the structure of the market, the nature of airline costs, issues around pricing and demand, and the latest developments in e-commerce. Vibrant examples are drawn from passenger, charter and freight airlines to provide a dynamic view of the entire industry. This completely updated edition also explores the sweeping changes that have affected airlines in recent years. It includes much new material on airline alliances, long-haul low-cost airlines, new pricing policies and ancillary revenues in order to present a compelling account of the current state of the airline industry.

Offering a practical approach and peppered with real examples, this book will be valuable to anyone new to the airline industry as well as those wishing to gain a wider insight into its operations and economics. For undergraduate or postgraduate students in transport studies, tourism and business the book provides a unique insider's view into the workings of this exciting industry.

1 Characteristics and trends in the airline operations

We have to adapt to low margins and high investments. In a life and death business that is a crazy combination.

(Carsten Spohr, CEO Lufthansa, May 2016)

1.1 The nature of the airline product

The airline industry has three key characteristics. First, the demand for air services, whether for passengers or freight, is a derived demand. Second, the product is very homogenous and, third, it cannot be stored. These are fairly obvious features but are crucial to understanding the economies of airline operations. They also ensure that the airline industry is dynamic and exciting.

As far as passenger services are concerned, the air journey is seen not as an end in itself, but as part of a business trip, a two-week or two-day leisure trip, or a weekend visit to see relatives. The air journey is a part of a variety of other products or services. A number of important considerations flow from this. The demand for passenger air services is a derived demand. It is dependent on the demand for these other activities. This means that to forecast the demand for air services one needs ideally to forecast the demand for all these other types of expenditure. It also means that there has been strong pressure on the airlines to expand vertically into other areas of the travel industry, such as hotels, travel agencies, car hire or tour organisers, in order to gain greater control over the total travel product. There is also a direct effect on airline marketing techniques in the sense that these are frequently oriented towards selling and promoting the total product, whether it be a business or holiday trip or a weekend excursion, rather than selling a particular airline. In newspaper and television advertisements airlines often try to interest the reader or viewer in a particular destination or a particular type of trip, and only as an afterthought, almost, do they suggest the airline that might be used.

On the other hand, airlines have to face the realisation that one airline seat is very much like another and that from the passenger’s viewpoint there is little difference between one jet aircraft and another. Equally, for the shipper or freight forwarder the major decision will be whether to ship by air or surface and having taken the decision to use air he may have difficulty in perceiving any significant difference in quality of service between one airline and the next serving a particular route with similar frequencies.

Thus, while air journeys may be only one part of a variety of heterogeneous products or services with different market structures, the air service part of these products is itself fairly homogeneous. One airline seat is very much like another and one freight hold is no different from the next. Even when airlines wish to differentiate their products, competitive forces and the fact that they are flying similar or identical aircraft have meant that they often end up offering very similar products. This is especially so in Economy class cabins and on shorter sectors.

The consequences of the homogeneous nature of the airline product are two-fold. First, in competitive markets, it pushes airlines into making costly efforts to try to differentiate their services and products from those of their competitors. They do this by being first to introduce new aircraft types, by increasing their frequency of service, by spending more on ground services, by focusing on their premium cabins, by building a more user-friendly website, by advertising and by effective use of social media. Moreover, much of the advertising is aimed at trying to convince passengers or freight agents that the product they offer is appreciably better than that of their competitors because of the friendliness of the hostesses or the culinary expertise of their chefs, the comfort of their seats, or because of other claims, all of which may be dubious and difficult to assess. In the end, because of the difficulties of substantiating many claims related to service quality, airlines very frequently resort to competing on price, which is tangible and price differences are demonstrable. This is the strategy most clearly adopted by the low-cost airlines.

Second, the homogeneous nature of the airline product makes the emergence of entirely new airlines or the incursion of new airlines on existing routes relatively easy.

This dichotomy between the heterogeneity of the various products, of which the air service is only a part, and the homogeneity of the air services themselves is a constant constraint in airline planning, a constraint which often results in apparently contradictory decisions and actions by airline managements.

A third defining characteristic of the airline industry, one which it shares with other transport modes but also with hotels, is that its product cannot be stored. It disappears the moment it is produced. Once a flight takes off, any empty seats or unused cargo capacity is lost forever. It wastes immediately. This is costly for airlines. As a consequence, airline executives make great efforts to reduce such wastage by pushing up the occupancy or load factor of each flight. They use whatever means they can, but most critical is pricing. Different pricing strategies have been used to push up occupancy of both passenger and all cargo flights. One clear consequence of having unsold seats is that those passengers who are on a flight must meet not only their own costs but also cover the costs of the unsold seats. This further complicates pricing and tariff structures.

In short, the airline industry is characterised by trying to meet a demand for its products, which is a derived demand dependent on demand for other products and services. Its products are largely homogenous and difficult to differentiate. Worst of all, they cannot be stored.

1.2 Airline business models

The priciples of airline economics discussed in the chapters that follow are relevant to all sectors of the industry. But one needs to be aware that not all airlines are the same. For historical reasons and especially because of the impact, in the past, of both domestic and international regulations, quite different airline business models have emerged.

The traditional regulatory regime, as described in Chapter 2, ensured that airlines could only fly from and to their own country. With a few exceptions they could not operate air services and carry passengers between points in two countries outside their own. This inevitably meant that airlines developed both domestic and international routes that radiated from their home base. In most cases, the home base was the airport of their own capital city. These bases became ‘hubs’ where passengers could transfer from one flight to another to fly between two points, which the airline could not serve with direct non-stop flights. The vast majority of traditional scheduled passenger airlines around the world operate radial networks.

In the United States, for somewhat different reasons, the larger airlines also developed hub-based radial networks though they often operated from two or more major hubs and several smaller hubs. The larger number of hubs resulted from the numerous mergers of airlines with complementary radial networks. Scott Kirby, president of United Airlines, early in 2018 summed up the essence of hub networks as follows: ‘A hub-and-spoke airline is really a manufacturing company and it is about manufacturing connections’ (quoted in Airline Leader, Jan–Feb 2018).

Airlines whose business model is critically dependent on operating radial networks based on one or more hubs, where passengers can be transferred between flights, are referred to in the following chapters as ‘legacy’ or ‘network’ airlines.

The network airline model enjoys numerous economic advantages but also suffers some cost disadvantages (Chapter 5, Section 5.7). This model contrasts with that of the ‘low-cost or budget’ airline model which has emerged over the last 30 years or so. Low-cost airlines (LCCs) have been launched and grown rapidly in response to the progressive liberalisation of both domestic and later international air services. Freed from the constraints of out-dated regulations, they developed networks based on offering direct non-stop services between many points both within and outside their own country or state. They have services radiating from their major base but these are integrated into a matrix of services that criss-cross the country or the region in which they operate.

The low-cost carrier Southwest, the fourth largest US airline, has somewhat distorted the simple point-to-point low-cost model, because it has developed such high frequencies on many of the routes between its various airports that they provide convenient and fast connections for passengers wishing to fly to points not served from their own airport. Effectively Southwest operates 20–25 mini hubs and attracts a significant share of transfer passengers.

Basically, the LCC model’s network structure and shape is quite different from that of the traditional scheduled network airlines. This a fundamental difference that affects many aspects of the operations and economics of both models. This will continue to be so even if in some respects the two models appear to be coming closer (for instance, by not offering free on-board catering or charging for seat allocation).

In addition to these two significant business models there are a number of other airline models that have their own distinctive characteristics and are discussed in later chapters.

The third model on the passenger side of the industry is that of the ‘leisure or charter’ airline. These are airlines, many of them owned or linked to holiday companies, whose primary business is to sell holiday packages that include flights, hotel rooms and/or car hire or other holiday elements such as sea cruises or tours to historical sites. The holidays are put together and sold by the parent holiday company or any other holiday company that buys seats from the leisure airline. The latter may also sell some of its seats without a holiday package directly to passengers. Leisure or charter airlines are important in Europe and less so in North America but play an insignificant role elsewhere in the world.

Finally, there are two distinct airline business models concerned with the carriage of freight. The most significant in terms of volume of freight transported and size of fleets are the so-called ‘integrators’. These companies are essentially door to door carriers. They not only fly freight between key points but they also provide surface transport to collect freight from its actual origin and deliver it to its ultimate destination. For the air freighting part, the integrators will use freighter aircraft but also book space on passenger services operated by network carriers. The second air freight model is that of the specialist ‘all-cargo’ airline whose business is to transport cargo on dedicated freighters.

While most network airlines carry both passengers and freight, some are much more heavily involved in air freight, which may represent up to 40–50 per cent of their total traffic in terms of tonne-kms performed by weight (Section 1.9). Unlike most passenger-focused airlines, these airlines heavily involved in the carriage of freight also operate a small but significant number of freighter aircraft. Do...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Acknowledgements
• Abbreviations
• Introduction
• 1     Characteristics and trends in the airline operations
• 2     International regulation – bilateralism or ‘open skies’
• 3     Understanding the structure of airline costs
• 4     Determinants of airline costs
• 5     The economics of the low-cost model
• 6     The economics of leisure charters
• 7     Alliances as a management tool
• 8     Airline marketing – the role of passenger demand
• 9     Forecasting demand
• 10     Product planning
• 11     Pricing for profit?
• 12     The impact of ancillaries
• 13     The economics of air freight
• 14     Strategies for success
• Appendix A     Freedoms of the air
• Appendix B     Non-economic technical and safety regulation
• Glossary
• Bibliography
• Index