Airline Operating Costs

Dr. Peter Belobaba

Istanbul Technical University Network, Fleet and Schedule

Air Transportation Management Strategic Planning
M.Sc. Program Module 3: 10 March 2014
 Lecture Outline

 Cost Categorization Schemes

 Administrative cost allocation
 Functional cost categories and typical breakdown
 Cost trends by category

 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

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 2012
DEPRECIATION AMORTIZATION
4% 1%
OTHER
4%

RENTALS
LANDING_FEES 7%
2%
SALARIES_BENEFITS
28%

SERVICES_TOTAL
15%

MATERIALS_TOTAL
39%

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 2012
DEPRECIATION AND
AMORTIZATION With high fuel
2.0%
ADVERTISING prices, total Aircraft
0.9% GENERAL
RESERVATIONS AND ADMIN Operating Costs
SALES
4.8%
8.4% sum to 61%

TRAFFIC SERVICE
10.1%

AIRCRAFT SERVICE AIRCRAFT

5.7% OPERATIONS
61.4%
PASSENGER
SERVICE
6.6%

Source: US DOT Form 41 Financial Reports

6
 Activity Drivers by Functional Category

 Aircraft Operating Costs

 Per Block Hour (for example, $4400 for 150-seat A320 in 2011)
 Aircraft Servicing Costs
 Per Aircraft Departure (average $1200)
 Traffic Servicing Costs
 Per Enplaned Passenger (average $15)
 Passenger Servicing Costs
 Per RPM (average $0.015)
 Reservations and Sales Costs
 % of Total Revenue (average 9%)
 Other Indirect and System Overhead Costs
 % of Total Operating Expense (average 10%)
7
 “Back of the Envelope” Break Even Fare
Boston-Orlando A320 Flight 80% LF

AOC 3.0 block hours @ $4400 $ 13200

Aircraft Servicing (1 departure @ $1200) $ 1200

Traffic Servicing (120 pax @ $15) $ 1800

Pax Servicing (132000 RPM @ $0.015) $ 1980

System Overhead Costs (10% of sub-total) $ 2020

Sub-total $ 20200

Break Even Net Revenue per Pax (120) $ 168

Distribution and Sales Costs (9% of fare) $ 17

Break Even Average Fare $ 185

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
 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
11
 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

12
 US Airlines: Airbus 320 (avg. 150 seats)

 Costs per block-hour 2005 2007 2012

CREW $ 470 $ 454 $ 562
FUEL $1327 $1713 $2578
MAINTENANCE $ 524 $ 576 $ 774
OWNERSHIP $ 570 $ 570 $ 653
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)

13
 Comparing 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 2012

Aircraft Average FOC/ FOC/ Average Utilization

Stage (block-
Type Seats Block-hr Seat-hr
(mi.) hrs/day)
E190 100 $3,152 $31.52 610 9.9

A319 128 $4,099 $32.02 850 10.6

737-800 158 $4,662 $29.50 1263 10.4

757-200 179 $5,939 $33.18 1472 9.9

A330-200 268 $8,882 $33.14 3812 14.7

747-400 380 $14,257 $37.52 4979 11.7

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
 2010 Unit Cost
(Operating Expense per ASK)
$0.120

Air Canada
$0.100

US Airways Air China

$0.080
Air Berlin American
Qantas United Singapore
GOL Turkish
Delta
Southwest TAM LAN
$0.060 Korean
Hainan
EasyJet JetBlue Aeroflot Cathay Pacific Emirates
Thai EVA Air

$0.040

Ryanair

$0.020

$‐
0 1000 2000 3000 4000 5000 6000

Source: Airline Business Database 2011 18

 2010 Unit Cost (CASK)
US NLC vs. LCC
8.00

NLC American

7.50
Northwest
Delta
7.00
US Airways
Alaska
Continental
United
6.50
LCC
CASK (USD cents)

Southwest

6.00
AirTran jetBlue
Frontier
5.50
Virgin America

5.00

4.50

4.00
‐ 500 1,000 1,500 2,000 2,500 3,000
Average Stage Length (km)

Source: MIT Airline Data Project

19
 2012 Unit Cost (CASK)
Selected Non-US Airlines

Source: Emirates Open Sky 2/14 , CAPA Data

20
 CASM Breakdown

 CASM can be broken down as follows:

 Transport Related expenses excluded for comparisons

Total CASM

Transport Related

Fuel

Labor CASM
CASM ex.
Transport and
Fuel Non-labor CASM

1 2 3 4 5

21
 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

22
 US Airlines: Inflation Adjusted CASM*
Down 35% Since 1978

$0.20

$0.15

$0.10

$0.05

$0.00

* CASM excl. Transp. Related Expenses

Fuel Labor Non-Labor
Source: MIT US Airline Productivity Study, 2011
23
 Inflation Adjusted Unit Costs –
Fuel, Labor, Non-Labor

Source: MIT US Airline Productivity Study, 2011

24
 Jet Fuel Price Volatility

$145
Five‐Day Moving‐Average Price

$135 Jet Fuel (USGC)

$125

$42 Spread
$115
Crude Oil (Brent)
$105

$95

$85

$75 Crude Oil (WTI)

$65
4-Jan-10

12-Aug-
10-Mar-

14-May-

18-Jul-10

25-Nov-

16-Oct-
29-Jan-

4-Apr-11

8-Jun-11

20-Dec-
21-Sep-

11
11
10

10

11
10
10

11
* Refining margin (difference between jet fuel and crude oil price)
Source: ATA and EIA (for WTI and Brent crude oil and U.S. Gulf Coast jet fuel) 25
 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

26