Deming had once commented that you cannot improve what you cannot measure.
As one of the biggest yet one of the most vulnerable industries, airline industry is currently under one of its worst periods of bust. At these times, focus does shift on optimising and rationalizing capacity and decreasing costs. This also leads us to tackle one of the trickiest challenges in any business – identifying and choosing the right set of metrics.
With changes in the business models and dramatic shifts in the industry, the traditional and oft used metrics could turn misleading.
A case in point was presented by a BCG report on US airlines in 2006: Within the period 2001-06, the legacy and full service carriers (FSC) had favourable big numbers in almost all the commonly used metrics-
- 90% share of revenues
- 85% share of seat capacity
- 85% share of departures
Yet together the FSCs lost close to $30 bn during that period, while LCCs made a profit of $3 bn during the same period, despite their lower numbers in the metrics. This disagreement between the metrics and profitability was largely attributed to the change in the industry cost structure brought about by the low cost carriers.
In this post, we would analyze the commonly used airline operating metrics that are largely used for modelling profitability. Profitability is defined in terms of Income per ASM (Available Seat Miles) which is determined by 3 factors – yield, load factor and operating expenses. Yield is attributed to total revenues per RPM (revenue passenger miles), while load factor is the ratio of RPM and ASM. The third factor is the total operating expenses per ASM.
Thus increasing profitability would require optimizing any of these factors:
Revenues/RPM – The primary determinant of this factor is the level and intensity of the competition on the routes flown. Also, the airline’s ability to attract high paying business customers through superior customer service - could also be one of the determinants of this factor.
Load Factor – is one of the most commonly used operating benchmark metric, which is largely determined by the efficiency of route planning, the ability to foresee passenger demand to match airplane size for individual routes and the competitiveness of prices. A common industry benchmark states that an airline would require to have an at least a 80% load factor (with today’s yield) to make money.
Operating Expenses/ ASM – Operating costs largely comprise of aviation fuel, airport charges, labor costs and administrative expenses. As discussed in one of the earlier posts, almost 60-70% of the total costs is non controllable by the airline management, leaving little room for flexibility of this lever.
While traditional metrics of revenue and capacity are essential components to model profitability, alternative complementary metrics are time and again explored that track more accurately the changing industry models.
References: ‘Strategy: KSFs’ – Robert Grant
