The Delicate Dance of Airline Profitability

Airlines walk a tightrope between costs, revenue, and passenger loads. Only by balancing these factors can they stay airborne in the fiercely competitive market.

The following example highlights how slight variations of the Fixed and Variable costs have a deep impact on airline profitability. It also illustrates the critical role of Passenger Load Factor (PLF) on the profitability of the route. Even with a moderate increase in ticket price, a significant decrease in PLF can result in losses.

Consider this:

An airline, Turbulence & Tea Airlines (TNT Airlines for short), decides to start a new route, New York City (JFK) to Los Angeles (LAX), which is a distance of approx. 2,500 miles, with its Boeing 737-800 aircraft having a capacity of 189 seats.

The competitor next door, Lost & Found Airways (LAF Airways for short), is already selling seats for the same route at $ 325. TNT’s Sales Department thinks they can fill around 80% of the aircraft (about 152 seats) on each flight if they price their tickets right, just a little bit lower than LAF’s fares: at an average of $ 320 per seat. Thus, the total revenue per TNT’s flight would be around $ 48,640 (152 seats @ $320 per ticket).

TNT estimates that the Fixed Cost for this route would be around $ 20,000 per flight and the Variable Cost would be around $ 22,800 (152 seats @ $ 150 per seat).

TNT’s Finance Department calculates that the profitability for this route would be $ 5,840 per flight (Revenue of $ 48,640 - Fixed Cost of $ 20,000 - Variable Cost of $ 22,800). They launch the route and the flights are filling up at the expected PLF of 80%. Everyone goes home happy, thinking that they will make a cool profit of around US$ 2 Million annually (365 days @ $ 5,840 per day = $ 2,131,600) by operating just one flight per day between JFK and LAX!

Right? Wrong! Here is what happens next…..

The sales team of the rival LAF Airways wasn’t sleeping. It dropped the price of their tickets from $325 to $ 315 per seat, and got back some of its customers. This resulted in the PLF of TNT to plummet from 80% to 60% (114 Seats). Its revenue dropped to $36,480 (@ 320 per seat), while fixed costs stayed at $20,000. Variable costs, however, dipped to $17,100 due to fewer seats filled (114 seats @$150). As a result, It still made a loss of US$ 620 per flight. This translated to a whopping annual loss of $226,300 for TNT – a stark reminder of the delicate balance between pricing and profitability.

Now, to mitigate this loss, TNT matched the competitor LAF Airway's price war, and slashed their fare to $315. This lured back some customers to TNT, boosting PLF to 65% (123 seats), and revenue recovered to the extent of $38,745 (123 seats @ $315). While fixed costs remained at $20,000, variable costs rose slightly to $18,450 (123 seats @ $150) squeezing profit to a wafer-thin $295 per flight!

However, the HR department of TNT had another problem. The Employee Union of the rival LAF Airways next door had reached an agreement with its management for a 10% wage increase after months of wrangling. LAF Airways now lured away some of TNT’s pilots with a 10% pay raise, forcing TNT to also increase the pay of all their pilots. Unfortunately, you can’t fly aircraft without pilots, for now. This bumped up the Fixed Costs per flight of TNT by $300, increasing the Fixed Cost to $ 20,300 per flight. This would increase the Total Cost per flight from $38,450 ?to $38,750 resulting in $5 per flight in the red, despite unchanged revenue of $38,745. TNT’s management, prioritizing staff retention, swallowed the hit.

They say trouble comes in pairs. Like Lille and Thompson. Or Sachin and Shewag. The Purchase Department of TNT was throwing fits because although they had budgeted for a cyclic increase in fuel prices in the winters due to supply and demand economics in colder months, however an unusual geo-political event in Europe caused the fuel prices to skyrocket by 20%! The Variable Cost shot up by $ 13 per seat, taking it to $20,049 per flight, pushing Total Costs to $40,349 per flight (Fixed Cost 20,300 + Variable Cost $20,049). The PLF (65%) and revenue ($38,745) remained unchanged. This double whammy of increase in wages and price of fuel pushed TNT to a $1,604 loss per flight, bleeding around half a million annually ($ 567,575) – demonstrating aviation's fragile profitability.

Not a very happy situation, you might say!

It is important to note that there are several techniques and strategies to preempt the above circumstances, even before they occur. Not only that, even if some situations are unavoidable, there are still ways and methods to mitigate the risks involved.

The above example focuses on a single flight and while it provides a basic understanding of flight profitability, is not indicative of the overall profitability of the route or airline. Flight Profitability is complex and influenced by more than just ticket sales. A more comprehensive analysis would be necessary to determine the precise profitability of a specific flight or entire route network.

Costs like Maintenance Costs, Parts & Materials, Ground Handling Fees, Catering, In-flight entertainment, Airport Charges,?Landing, Navigation, Flight Planning & Dispatch Costs, Passenger Facility, Aircraft Lease or Financing Costs, Depreciation, Insurance, Taxes & Fees, Unexpected Events like Delays &?Cancellations, Unforeseen Circumstances, Altitude & Weather conditions, etc. can significantly impact profitability and play a crucial role. Ultimately, airlines aim to maximize revenue, control fixed costs, and optimize passenger load to stay profitable. Airlines also actively manage variable costs through sophisticated techniques and fuel-efficient aircraft for operational efficiency and yield management.

I hope this example gives you an idea of the impact of costs, revenues and PLF on the profitability scenario. Please let me know if you have any questions?!