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The universal industry expressions that report an airline’s passenger numbers, load factors, available seats, and unit revenue and cost are efficient ways to gauge performance and compare carriers of different sizes.  RPMs, ASMs, PRASM, CASM and yield define individual aspects of aircraft economics and the effectiveness of airlines to work their assets.  But are these statistics measuring the true performance of an expensive airplane and invested capital?

Downward Fares for Upward Share
 
The emergence of the low-cost and ultra low-cost airline segments with their unbundled product philosophies have redefined the architecture of traditional ticket pricing, particularly among full-service mainline carriers.  As LCCs captured a greater share of an expanding air travel market, their competitors often responded by either allocating more discounted seats or adding capacity to try to lower their CASM.  Those additional seats were often priced to match LCC fares which further intensified competition. The drive for market share supremacy prompted carriers to add even more seats with even steeper discounts.

It is a vicious cycle that, especially for domestic airlines in India since 2009, has proven to be financially disastrous. From an economic perspective, is the marginal cost of flying an additional seat (assuming it can be sold) on a bigger aircraft covered by the lower fare it generates?

Seats and Sandwiches

The rise of LCCs also triggered the growth in the sale of ancillary airline products and services. For many low-cost carriers, revenue from on-board sales, baggage fees and priority seating and boarding can mean the difference between profit and loss.
Mainline carriers jumped on the ancillary product bandwagon when they realized that ticket revenue alone could no longer offset the operating cost of a flight. But sales of ancillary products have limits, both in volume and price.  Aircraft were never intended to be (rather expensive) flying sandwich shops. Is this really a sustainable business model that maximizes the return on an aircraft asset?

You Can’t Take Cost Per Seat To Shareholders

It’s essential to have the lowest possible CASM when operating in a competitive low-fare environment and following a strategy driven by market share. CASM and PRASM go hand-in-hand to measure gross profit per seat-mile from which you can calculate margin for any flight or route. For shareholders seeking to maximize the return on their investment, it may be more relevant to understand how effectively a carrier’s airplanes are performing. Return on assets (ROA) is a common indicator of a company’s overall profitability but it can be adapted specifically to aircraft:

 Annual Profit per Seat/Aircraft Value per Seat = Return on aircraft Asset (ROaA)
        

 


Generally, smaller-capacity aircraft have higher PRASM when sound inventory control methods are applied. Simulations conducted by M.I.T. and PODS Research (USA) show that revenue per seat for a 110-seat jet can be up to 30% greater than for a 170-seat jet. That higher PRASM, in turn, generates a higher ROaA for the smaller jet.

 

Strategy, Capacity and Optimization

Airline route managers may be averse to turning away any fare-paying customer, particularly in competitive markets with a high component of low-fare travelers, when extra seats need to be filled on large aircraft. But when the revenue from those customers weakens profitability, smaller-capacity airplanes with the right frequency can improve the bottom line.
Notwithstanding operational reasons for using large aircraft, flying jets with fewer seats can generate higher returns, especially if the flight schedule and product differentiation are sufficient to attract high-yield passengers. Bigger may seem to be better, but as the ROaA measure shows, it may not necessary be more profitable.

For a more detailed illustration on how small-capacity aircraft can generate higher returns, visit www.newmetricsofsuccess.com.