Winning Airlines

The airline industry is a vital part of the world economy. In 1996, the world had approximately 1,200 scheduled airlines, of which 300 served international markets. In 1996, International Air Transport Association’s (IATA) 255 member airlines collectively earned US$134.3 billion from international scheduled services. Also, the mere existence of the commercial airline industry is an important reason why the world has airports, air traffic control and navigation systems, and commercial aircraft industries. The airline industry is perhaps far more important than the amount of total revenues earned by all these industries. That is, it plays a key role in development of the world economy, tourism and related activities, by facilitating international trade and economic relations between countries and by stimulating exchange of people and ideas.

The international air transport plays a key role in the development of the world economy, stimulating exchanges between countries and facilitating international economic relations. At the same time, its economic well-being depends on the state of the world economy. Increasing demand for mobility, further globalization of society, and changing consumer behaviour lead to growth in traffic flow and segmentation of the air transport industry. Economic downturns, on the other hand, bring financial difficulties to the airlines — diiiculties which at times have been financially disastrous.

International air transport has been and is still closely regulated. Thus, the regulatory environment in which international airlines operate will continue to have major impacts on airline network structures, management strategies, and consequently, airline productivities and efficiencies. Therefore, it is important to review developments in international regulatory structure in order to have a better understanding of airline competitive positions.

This chapter gives a brief overview of selected airlines. It examines airline network characteristics and changes in input prices in order to provide a context for analysing changes in airline productivity, efficiency, and cost structures. It also examines the relationship between exchange rate fluctuations and input factor prices, as well as the growing practice of global sourcing of input factors.

This chapter first describes airline output and input variables which are required for performance analysis. It then presents and discusses results of airline partial factor productivity and input efficiency measurement.

This chapter examines airline overall productive efficiency using such methods as Total Factor Productivity (TFP), residual TFP, and Stochastic frontier method. These concepts and methodologies are also described briefly.

This chapter examines airline cost structures and its changes over time. It provides a preliminary analysis of the effects of network and operating characteristics, and exchange rate fluctuations on airline costs. Thus, it prepares ground for further analysis of airline cost competitiveness.

Widely-based airline deregulation and liberalization have intensified competition in the international airline industry. This in turn has forced airlines to undertake major restructuring in order to improve efficiency of operations, and thereby, reduce costs. Judging from industry trends, airlines’ real yields will not likely increase under competitive pressures for market share. Therefore, airlines must remain cost competitive in order to survive and prosper in the globalizing airline industry. This chapter investigates issues related to cost competitiveness, focusing on identifying sources of airline cost competitiveness.

Cost competitiveness is an important determinant of carrier profitability. However, airline profitability also depends on the ability to price above costs. And the ability to set prices above cost depends on market power and the firm’s ability to make use of innovative (demand-responsive) pricing techniques and market information. Although cost advantages may confer carriers a basis to exercise market power and price leadership, market power in the airline industry, for most part, has been created by regulatory protection of carriers. Most international airline markets are regulated by bilateral air agreements which restrict competition. As a result, duopolies and oligopolies are the norm rather than exception in many international air transport markets. In such regulated markets, carriers tend to charge high markups over costs. In the past therefore, some carriers have been profitable without being cost competitive because they were able to charge exorbitant prices to consumers. However, as explained in Chapter 3, even the international airline market has become increasingly competitive as a result of a series of liberalization and open skies measures undertaken by the U.S. and other governments, and also as a result of the collapse of IATA as a price cartel. This trend will continue to accelerate and put increasing pressure on high cost carriers.

The focus of this book was to investigate cost competitiveness of the world’s airlines. Cost competitiveness (or equivalently, cost advantage) is determined by productive efficiencies and input prices. Initially, we attempted to include nearly 5O airlines in our analysis, but it was impossible to compile complete and consistent time series data on many of these airlines. As a result, our analysis was confined to 22 major world airlines. It is regrettable that we could not compile reliable and systematic data for any of the South American carriers.