Airlines’ cost dilemma: Do Airlines control costs or otherwise?

In the recent days, one common phenomenon that we have observed in Aviation industry is, most of the Airlines with exception to few, are struggling with losses. It so happened that their revenues have grown up year on year, but expenses have been outgrowing rapidly hence bottom line is taking a hit. While every airline that has been seeing losses have their own story, one factor that is common to them is rising fuel costs, which is spiraling out of their hand. Though Airlines do hedge the fuel costs, which truly mitigate the risks but not entirely helping as setting up the fuel prices is not in their hands. Apart from fuel, there are different types of costs- to put them organized- we will classify them as 1. Fixed costs 2. Direct operating costs or variable costs. Fixed costs are those associated with Aircraft purchase costs, Crew layover, corporate overheads etc and direct operating costs are those associated with running flights such as Fuel, landing, ground handling, over flying, Aircraft maintenance, in-flight catering etc.

While one cannot do much about fixed costs as Airlines has to bear that with or without flying (Unless in extreme scenarios like selling off), but some of the direct operating costs can be kept under control with good operational strategy. This article’s aim is to analyse Airlines costs holistically and share KPIs that will help Airlines to keep track of costs and know the state of profitability proactively.

First and foremost, Airlines need to look at how much money they are making and how much cost they are incurring in their business to the most granular level i.e. per KM per seat. The metrics that will provide answer are, RASK and CASK

  1. RASK (Revenue per Available Seat Kilometre) - Revenue generated by an Airline per seat by flying one Kilometre. In the past, revenue is derived from seat revenues and even now most of the airlines follow the same methodology. But, with ancillary share is picking up, Airlines need to revisit the calculation of RASK. My take is, ancillary revenues coming from flights during block hours must be added such as food, drinks, Wi-Fi etc.

2. CASK (Cost per Available Seat Kilometre) - Cost incurred by an Airline per seat by flying one kilometre. This is widely used when comparing the efficiency of one carrier versus another, or in assessing the merits of one aircraft type versus others. It is very important KPI but also a tricky one. For example, for an airline with flights both short-haul and long-haul, measuring CASK at Network level will not give right picture. Say, for an Airline ABC, which has long haul flights of 5% of total flights but amount to 60% of ASKs due to long distance, will bring down network level CASK dearly. So, Airlines have to efficiently adjust this factor (Though Adjusted stage length is one way, but experts say it is very crude of doing it). But, on high-level, this KPI will give a picture on how Airlines costs are going. Are they within budget or exceeding the budget and with forecasting in place, they can even foresee whether they going to make profit or loss.

To put things in perspective, let me explain with below example, As you could see in below table, Jet’s RASK (4.19) is better than IndiGo(3.62) for year 2018. But, looking at CASK, Jet is at 4.45 and IndiGo at 3.28. So, Profit/loss per available Kilometre, for Jet (Loss) is at 0.26 and IndiGo (profit) at 0.34, if you multiply these numbers with ASK, Jet’s loss is, INR 14.45 billion and IndiGo’s profit is, INR 21.6 billon! So, a fraction of difference in RASK and CASK could make really big difference!

3. Break-even load factor: This KPI tells how many seats must be flown by passengers in order to break-even. This is calculated using the formula [(Total cost/Net revenue) *(RTKM/ATKM)]. RTKM refers to Revenue Tonne kilometre, which is actual revenue earning load of passengers and excess baggage and ATKM refers to Available tonne kilometres derived by multiplying the capacity in metric tones (payload available for passengers) by kilometres flown. Airlines must keep a target of this KPI for each month, route and region and monitor continuously whether it is reaching the target or below the target and take necessary steps.

4. Operating ratio: This KPI comes by dividing Net revenue by Total costs. For well performing airlines, it is normally above 100%. It helps Airlines in giving an indicator on whether costs are higher than revenues or not on network level and if it is below 100, then Airlines need to dig into which region/routes are performing badly and take necessary action.

5.Sector passenger yield: This is derived by taking Net-net of passenger revenue divided by flown passenger number. It is a good indicator to understand sector wise performance of yield per passenger.

The above 5 KPIs are key indicators that can tell how the wind is blowing in terms of profitability, a progressive airline uses advanced forecasting techniques to calculate each of these metrics for future months and compare them with target numbers and take proactive steps to fix problem areas in advance. There is an age-old saying in Telugu language (My mother tongue), which translates, there is no point in holding medicinal leaves after burning one's hands. It tells, to take all due care in not burning hands in first place so that there is no need to search for medicine leaves, which aptly suits for most of the airlines that are crushing under cost burdens, we believe. Their situation often pokes the question in mind, are Airlines really controlling their costs or costs are controlling Airlines?

Author: Prakash Babu Devara
Source: https://www.linkedin.com/pulse/airlines-cost-dilemma-do-control-costs-otherwise-prakash-babu-devara/

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