- Email: [email protected]
Peak charges revisited
Journal of AirTmmpon
ur-rEnvvonrn EINEMANN
Mana,qemen~ Vol 1. No 4, pp. 259-260, 1994 Copyright Q 1995 Elsevier Science Ltd Printed in Great Britain. A11 rights reserved 0?369-6997/94 $10.00 + .oO
Open forum
Unfair air fares in Europe Sir In his draft obituary for the competitive era in Europe (Issue 1 of the Journal), Professor Doganis pointed out that comparatively few European routes have benefited from liberalization. I also fear for the future of the remaining smaller airlines that have achieved even this limited impact on the ‘Big Brothers’. Furthermore, on most routes, as soon as controls were relaxed in 1991, the airlines pushed up the ondemand fares by around a third. This was in spite of the 1990 IATA cost committee report, which showed that in Europe, pre-recession, business class achieved a 16% margin, versus a 12% loss in the rear cabins. (The Atlantic routes achieved a 49% operating profit, and a 7K% loss respectively.) And the airlines have said that Eurobudget is one of their most profitable fares, further emphasizing the losses arising from the discount fares, even before the further price cuts during the recession. This is a central reason for complaints from many users, forced to pay the bloated on-demand fares. Southwest claims that two thirds of US passengers opt for their ‘no frills, minimum fare’ formula, which generally has been spumed in Europe. And simplistic fares comparisons often are misleading; one must have ~fo~ation on yields. For example, 1991 Government the International Passenger Service data show that though the Frankfurt-London business fare was higher than London-Frankfurt, German businessmen paid less on average, because far more of them secured Eurobudget and similar fares. A major feature of the Air France recovery plan is to ensure that, in future, its on-demand passengers are charged as much as possible! Dr Hanlon, in his article, examined the question of discriminator fares, and the difficult task of identifying
those that are predatory. The proposed Commission criterion of ‘90% of the fully allocated operating cost’ may be appropriate for the ‘full’ fares, but for the troublesome discount fares, there is evidence that 60% may mark the watershed. The 1977 joint CAAlBEA working party report (in CAP 409), responding to the 1976 Airline Users Committee paper, still contains valuable lessons. The fare type costing for six major routes found that while &he on-demand economy fares were profitable, 15 of the 25 discount fares (and five of the six first class!) were not. Apart from the ‘standby’ fares, none cost less than 60% of the economy fare, unless the airlines’ ‘schedule convenience’ argument was accepted, in which case the cost of the ‘special group inclusive tour’ fare fell to 30-40% of the economy cost. In the 4193 IATA journal, BA’s Chief Financial Officer demanded that airlines must monitor the volume/yield play off and control discounting by obliging sales forces to justify and record all deals. Airlines sales people must stick to the rules and check that
travel agents are doing so too! This indicates that they are not doing so, and perhaps the basic problem is that too many sales and marketing people believe that the marginal cost of the last passenger is always the airport passenger charge, plus a meal, and a little extra fuel. Certainty - if the passenger turns up as the door is closing, with hand baggage only. But when he arrives via an agent, he incurs commission and reservation charges. Then he checks in, also generating baggage handling and security work, and one can be reasonably certain that the staff could be reduced, if the number of discount tickets was cut. I have the gravest doubts about BA‘s recent &59 London-Paris return fare, even though it was probably merely bait. The CAA, or Brussels, or
both, should investigate this offer in depth. In the early 1980s BA did some sums, and found that it was folly for them to sell a London-Paris seat for less than f28 one way. Initially, the railways also believed that the last passenger or ton of freight could be carried for practically nothing, but when they began to use regression analysis techniques for product costing, they found that at least 60% of their costs were variable (Thompson, 1991). Perhaps the airlines should be employing more dour, elderly, Scottish cost accountants, advising ‘Never sell for less than twice the variables’! In my early days in business I learned much from one such, notably when I realized that what he was saying was ‘You just don’t realize how many of your costs are in fact variable’. I suspect this is a lesson that many airline people have yet to learn. A J Lucking
Reference Thompson, GL (1991) ‘Myth and rationality in management dewron-making. The evolution of American railroad product costing Journnl of Transport History l2 (1) l-10
Peak charges revisited Sir I would like to comment on the correspondence generated by Mike Toms’ paper ‘Charging for airports’ in Issue 2 (June 1994). In the September issue, David Cox argues that airlines satisfy peak demand at normal fully costed fares, and offer discounted fares in order to entice extra passengers to fill off-peak capacity. In circumstances where competitive market pressures exist I believe he is broadly correct in saying this. In a detailed analysis of the competitive charter market (Journal of
259
Open forum Transport Economics Policy, January 1992) and Bishop Thompson concluded that at off-peak times, fares reflect direct operating costs, while in peak times, prices are marked up above direct operating costs to a level needed to balance demand to capacity available; the sum of the mark-ups over all periods of peak demand (weekends, summer etc) is just sufficient to remunerate airlines for their fixed costs. In this sense airlines can be said to be both satisfying peak demand at fully costed fares, and endeavouring
260
to provide capacity for the peaks (but only to the extent that the fixed costs of fleet expansion can be covered by the peak period mark-ups that airlines are able to charge). However, where it is not possible to expand capacity, at congested airports for example, the Bishop-Thompson analysis indicated that charter airlines charge a premium in excess of their costs, in order to balance peak demand to the available supply of seats (in economic parlance the airlines at such times obtain a scarcity rent).
Of course, whether one uses terms such as peak/off-peak or standard/ discount, the essential point is that airline prices (or average yields) do vary according to the level of demand and the availability of capacity. Therefore, should not the same underlying principles carry over from the pricing of airline services into the pricing of airport services? David Starkie Economics-Plus Ltd London
ur-rEnvvonrn EINEMANN
Mana,qemen~ Vol 1. No 4, pp. 259-260, 1994 Copyright Q 1995 Elsevier Science Ltd Printed in Great Britain. A11 rights reserved 0?369-6997/94 $10.00 + .oO
Open forum
Unfair air fares in Europe Sir In his draft obituary for the competitive era in Europe (Issue 1 of the Journal), Professor Doganis pointed out that comparatively few European routes have benefited from liberalization. I also fear for the future of the remaining smaller airlines that have achieved even this limited impact on the ‘Big Brothers’. Furthermore, on most routes, as soon as controls were relaxed in 1991, the airlines pushed up the ondemand fares by around a third. This was in spite of the 1990 IATA cost committee report, which showed that in Europe, pre-recession, business class achieved a 16% margin, versus a 12% loss in the rear cabins. (The Atlantic routes achieved a 49% operating profit, and a 7K% loss respectively.) And the airlines have said that Eurobudget is one of their most profitable fares, further emphasizing the losses arising from the discount fares, even before the further price cuts during the recession. This is a central reason for complaints from many users, forced to pay the bloated on-demand fares. Southwest claims that two thirds of US passengers opt for their ‘no frills, minimum fare’ formula, which generally has been spumed in Europe. And simplistic fares comparisons often are misleading; one must have ~fo~ation on yields. For example, 1991 Government the International Passenger Service data show that though the Frankfurt-London business fare was higher than London-Frankfurt, German businessmen paid less on average, because far more of them secured Eurobudget and similar fares. A major feature of the Air France recovery plan is to ensure that, in future, its on-demand passengers are charged as much as possible! Dr Hanlon, in his article, examined the question of discriminator fares, and the difficult task of identifying
those that are predatory. The proposed Commission criterion of ‘90% of the fully allocated operating cost’ may be appropriate for the ‘full’ fares, but for the troublesome discount fares, there is evidence that 60% may mark the watershed. The 1977 joint CAAlBEA working party report (in CAP 409), responding to the 1976 Airline Users Committee paper, still contains valuable lessons. The fare type costing for six major routes found that while &he on-demand economy fares were profitable, 15 of the 25 discount fares (and five of the six first class!) were not. Apart from the ‘standby’ fares, none cost less than 60% of the economy fare, unless the airlines’ ‘schedule convenience’ argument was accepted, in which case the cost of the ‘special group inclusive tour’ fare fell to 30-40% of the economy cost. In the 4193 IATA journal, BA’s Chief Financial Officer demanded that airlines must monitor the volume/yield play off and control discounting by obliging sales forces to justify and record all deals. Airlines sales people must stick to the rules and check that
travel agents are doing so too! This indicates that they are not doing so, and perhaps the basic problem is that too many sales and marketing people believe that the marginal cost of the last passenger is always the airport passenger charge, plus a meal, and a little extra fuel. Certainty - if the passenger turns up as the door is closing, with hand baggage only. But when he arrives via an agent, he incurs commission and reservation charges. Then he checks in, also generating baggage handling and security work, and one can be reasonably certain that the staff could be reduced, if the number of discount tickets was cut. I have the gravest doubts about BA‘s recent &59 London-Paris return fare, even though it was probably merely bait. The CAA, or Brussels, or
both, should investigate this offer in depth. In the early 1980s BA did some sums, and found that it was folly for them to sell a London-Paris seat for less than f28 one way. Initially, the railways also believed that the last passenger or ton of freight could be carried for practically nothing, but when they began to use regression analysis techniques for product costing, they found that at least 60% of their costs were variable (Thompson, 1991). Perhaps the airlines should be employing more dour, elderly, Scottish cost accountants, advising ‘Never sell for less than twice the variables’! In my early days in business I learned much from one such, notably when I realized that what he was saying was ‘You just don’t realize how many of your costs are in fact variable’. I suspect this is a lesson that many airline people have yet to learn. A J Lucking
Reference Thompson, GL (1991) ‘Myth and rationality in management dewron-making. The evolution of American railroad product costing Journnl of Transport History l2 (1) l-10
Peak charges revisited Sir I would like to comment on the correspondence generated by Mike Toms’ paper ‘Charging for airports’ in Issue 2 (June 1994). In the September issue, David Cox argues that airlines satisfy peak demand at normal fully costed fares, and offer discounted fares in order to entice extra passengers to fill off-peak capacity. In circumstances where competitive market pressures exist I believe he is broadly correct in saying this. In a detailed analysis of the competitive charter market (Journal of
259
Open forum Transport Economics Policy, January 1992) and Bishop Thompson concluded that at off-peak times, fares reflect direct operating costs, while in peak times, prices are marked up above direct operating costs to a level needed to balance demand to capacity available; the sum of the mark-ups over all periods of peak demand (weekends, summer etc) is just sufficient to remunerate airlines for their fixed costs. In this sense airlines can be said to be both satisfying peak demand at fully costed fares, and endeavouring
260
to provide capacity for the peaks (but only to the extent that the fixed costs of fleet expansion can be covered by the peak period mark-ups that airlines are able to charge). However, where it is not possible to expand capacity, at congested airports for example, the Bishop-Thompson analysis indicated that charter airlines charge a premium in excess of their costs, in order to balance peak demand to the available supply of seats (in economic parlance the airlines at such times obtain a scarcity rent).
Of course, whether one uses terms such as peak/off-peak or standard/ discount, the essential point is that airline prices (or average yields) do vary according to the level of demand and the availability of capacity. Therefore, should not the same underlying principles carry over from the pricing of airline services into the pricing of airport services? David Starkie Economics-Plus Ltd London