- Nov 9, 2003
- 16,512
- 5,865
Much has been written in various threads about CCY's near tunnel-vision on the cost side of the cost vs revenue equation. So let's examine the equation closely, starting with revenue.
As most of you know, revenue is usually stated as revenue per available seat mile (RASM for short). This figure is derived from 3 major components plus some number of minor components. The minor components (and usually very minor) could include income from performing contract maintenance or training, interest earned, etc. Like any manufacturer, the major components are - how many "widgets" do you manufacture (available seat miles), how many do you sell (load factor), and what do you charge for each (yield). Increasing either (or both) of the latter two more than the first (or conversely decreasing them less than the first) increases RASM. This is usually accomplished by a combination of advertising and product differentiation.
How much are we doing of either? Advertising speaks for itself. But what differentiates our product from our competitors?
In the case of the other network carriers, we are at something of a disadvantage because of our limited geographical coverage. Why choose us when going from Richmond to San Antonio, changing to AMR in Dallas, when you can ride AMR all the way? The codeshare with UAL (& ultimately the STAR alliance) helps but doesn't quite make up the difference. Why ride us from Erie to Boise (or Tokyo) when you have to connect with UAL in Chicago (a different terminal) when you can just ride UAL all the way?
With respect to the LCC's, there are several obvious differences. International service, first class, service to more airports within our geographical coverage to mention a few. For those prospective passengers to whom any or all of these are important, the LCC's are out of contention. For the prospective pax whom aren't interested in any of these, we have to differentiate our product to either sell more seats (load factor) or charge more (yield).
If you're flying in coach from Albany to New Orleans, what do I get on US Airways that I don't get on Southwest?
In short, we can't just sit back and say "We're flying to the places people want to go" and count on the passengers showing up. We have to try to entice more people to choose us in the first place - advertise a product they want. Once they're on board, we have to give them a reason to come back, something they won't get on the LCC's - product differentiation.
Now for the other side of the equation - cost. Again, most will know that this is usually expressed as cost per available seat mile or CASM for short. Going back to "widgets" for a moment, the total cost of being in business divided by total widgets manufactured (ASM's) equals cost per widget (CASM).
At first glance, this side of the cost/revenue equation is simple - lower the costs and CASM will come down. But a closer look will reveal another component - ASM's. IF the ASM's are reduced nearly as fast as the costs, the CASM changes less than the cost.
In other words, if your plant is producing 200 widgets a month and the cost of the plant, equipment, labor, etc. is $2000 a month, the cost per widget (CASM) is $10. By laying off employees, reducing wages, etc., costs can be reduced to $1200 per month (40% reduction). But you only produce 150 widgets (33% reduction) so the cost per widget is $8 (25% reduction). Taken to extremes, cost per widget actually goes up - ulitmately to infinity. How so? Fire everybody but the boss and you're still paying for the plant & equipment. Costs might only be $100, but you're producing no widgets.
Still, in this period of lower demand ASM's have to come down. Why produce more widgets than you can reasonably sell? So that leaves costs as the remaining big variable. Given all the talk from CCY about employee costs, one would think that is all there is to cost. But employee costs are but one component of total costs - airplanes, terminal space, hangers, etc. all add to the cost. Many of these are either not controllable or can only be influenced (helped by bankruptcy). Moreover, we have to remember that CCY wants to lower CASM's. As in the widget example above, there is not a direct correlation between lower labor cost and CASM. Looking at U's 3rd quarter results, employee expenses (labor cost) was 4 cents per ASM***, while CASM was 11 cents. A 50% reduction in employee costs (to 2 cents per ASM) would lower CASM to 9 cents, a 22% reduction. (***It should be noted that that employee costs in the 3rd quarter were artificially inflated by the repayment of the pay deferrals that began in the 2nd quarter)
When we talk about CASM, we're really talking about efficiency - productivity is the economist's term. Productivity applies to both human and non-human assets, and is the true driving factor behind CASM. This is where we have a disadvantage, not just compared to the LCC's but to the other network carriers.
We lease a gate in PIT and use it for 4-5 flights a day. Southwest leases a gate in BWI and uses it for 8-10 flights a day. American leases a gate in DFW and uses it for 6-7 flights a day. Who gets the least productivity from their gates? Lower productivity equals higher CASM.
We lease a 737 and fly it 9-10 hours a day. Southwest leases a 737 and flies it 11-12 hours a day (no hubbing). American leases a 737 and flies it 10-11 hours a day (rolling hub concept). Who gets the least productivity from their 737? Lower productivity equals higher CASM.
We hire a ramp crew to work 4-6 flights a day (hubs). Southwest hires a ramp crew to work 8-10 flights a day (focus city). American hires a ramp crew to work 6-8 flights a day (rolling hub). Who get the least productivity from their ramp crews? Lower productivity equals higher CASM.
We have very few active employees hired after 1990 - top of pay scale in their jobs. Southwest probably has 50% of their employees hired after 1990 - at various levels of pay scale in their jobs. American has 20-25% of their active employees hired after 1990 - various levels of pay scale in their jobs. In addition to pay scale, there's amount of annual vacation, amount of sick time with older vs. younger workers, etc. Who gets the least productivity from their employees? Lower productivity increases CASM.
Finally, a word about RJ's. On identical routes, RJ's cost less to operate than 737's or Airbuses, but they also produce less seat miles. Once you get to CASM, RJ's are higher cost than the 737's or Buses. Mesa is probably the lowest cost RJ operator of any size in the country and their 3rd quarter CASM was 13.3 cents, after being reimbursed for fuel and insurance and not having to pay for gates. The moral being that RJ's are perfect for "thin" routes where pax loads won't support larger equipment. This can either be because of the market (hub bypass point to point or small city) or time of day (off peak). However, if the market will support a mainline aircraft, substituting RJ's just drives up the CASM.
I'll close with this from Herb about Southwest:
Maintaining a low cost structure is no simple task. It requires 35,000 People doing thousands of small things every day. But, the key word is People. Our People are the best. They are productive, friendly, service oriented, smart, and good. And, we think they are also happy to be with a Company that treasures their job security.
While other airlines are shedding employees and asking those that remain to take sizeable pay cuts, Southwest has negotiated nine new contracts with higher compensation and enriched benefits...
As most of you know, revenue is usually stated as revenue per available seat mile (RASM for short). This figure is derived from 3 major components plus some number of minor components. The minor components (and usually very minor) could include income from performing contract maintenance or training, interest earned, etc. Like any manufacturer, the major components are - how many "widgets" do you manufacture (available seat miles), how many do you sell (load factor), and what do you charge for each (yield). Increasing either (or both) of the latter two more than the first (or conversely decreasing them less than the first) increases RASM. This is usually accomplished by a combination of advertising and product differentiation.
How much are we doing of either? Advertising speaks for itself. But what differentiates our product from our competitors?
In the case of the other network carriers, we are at something of a disadvantage because of our limited geographical coverage. Why choose us when going from Richmond to San Antonio, changing to AMR in Dallas, when you can ride AMR all the way? The codeshare with UAL (& ultimately the STAR alliance) helps but doesn't quite make up the difference. Why ride us from Erie to Boise (or Tokyo) when you have to connect with UAL in Chicago (a different terminal) when you can just ride UAL all the way?
With respect to the LCC's, there are several obvious differences. International service, first class, service to more airports within our geographical coverage to mention a few. For those prospective passengers to whom any or all of these are important, the LCC's are out of contention. For the prospective pax whom aren't interested in any of these, we have to differentiate our product to either sell more seats (load factor) or charge more (yield).
If you're flying in coach from Albany to New Orleans, what do I get on US Airways that I don't get on Southwest?
In short, we can't just sit back and say "We're flying to the places people want to go" and count on the passengers showing up. We have to try to entice more people to choose us in the first place - advertise a product they want. Once they're on board, we have to give them a reason to come back, something they won't get on the LCC's - product differentiation.
Now for the other side of the equation - cost. Again, most will know that this is usually expressed as cost per available seat mile or CASM for short. Going back to "widgets" for a moment, the total cost of being in business divided by total widgets manufactured (ASM's) equals cost per widget (CASM).
At first glance, this side of the cost/revenue equation is simple - lower the costs and CASM will come down. But a closer look will reveal another component - ASM's. IF the ASM's are reduced nearly as fast as the costs, the CASM changes less than the cost.
In other words, if your plant is producing 200 widgets a month and the cost of the plant, equipment, labor, etc. is $2000 a month, the cost per widget (CASM) is $10. By laying off employees, reducing wages, etc., costs can be reduced to $1200 per month (40% reduction). But you only produce 150 widgets (33% reduction) so the cost per widget is $8 (25% reduction). Taken to extremes, cost per widget actually goes up - ulitmately to infinity. How so? Fire everybody but the boss and you're still paying for the plant & equipment. Costs might only be $100, but you're producing no widgets.
Still, in this period of lower demand ASM's have to come down. Why produce more widgets than you can reasonably sell? So that leaves costs as the remaining big variable. Given all the talk from CCY about employee costs, one would think that is all there is to cost. But employee costs are but one component of total costs - airplanes, terminal space, hangers, etc. all add to the cost. Many of these are either not controllable or can only be influenced (helped by bankruptcy). Moreover, we have to remember that CCY wants to lower CASM's. As in the widget example above, there is not a direct correlation between lower labor cost and CASM. Looking at U's 3rd quarter results, employee expenses (labor cost) was 4 cents per ASM***, while CASM was 11 cents. A 50% reduction in employee costs (to 2 cents per ASM) would lower CASM to 9 cents, a 22% reduction. (***It should be noted that that employee costs in the 3rd quarter were artificially inflated by the repayment of the pay deferrals that began in the 2nd quarter)
When we talk about CASM, we're really talking about efficiency - productivity is the economist's term. Productivity applies to both human and non-human assets, and is the true driving factor behind CASM. This is where we have a disadvantage, not just compared to the LCC's but to the other network carriers.
We lease a gate in PIT and use it for 4-5 flights a day. Southwest leases a gate in BWI and uses it for 8-10 flights a day. American leases a gate in DFW and uses it for 6-7 flights a day. Who gets the least productivity from their gates? Lower productivity equals higher CASM.
We lease a 737 and fly it 9-10 hours a day. Southwest leases a 737 and flies it 11-12 hours a day (no hubbing). American leases a 737 and flies it 10-11 hours a day (rolling hub concept). Who gets the least productivity from their 737? Lower productivity equals higher CASM.
We hire a ramp crew to work 4-6 flights a day (hubs). Southwest hires a ramp crew to work 8-10 flights a day (focus city). American hires a ramp crew to work 6-8 flights a day (rolling hub). Who get the least productivity from their ramp crews? Lower productivity equals higher CASM.
We have very few active employees hired after 1990 - top of pay scale in their jobs. Southwest probably has 50% of their employees hired after 1990 - at various levels of pay scale in their jobs. American has 20-25% of their active employees hired after 1990 - various levels of pay scale in their jobs. In addition to pay scale, there's amount of annual vacation, amount of sick time with older vs. younger workers, etc. Who gets the least productivity from their employees? Lower productivity increases CASM.
Finally, a word about RJ's. On identical routes, RJ's cost less to operate than 737's or Airbuses, but they also produce less seat miles. Once you get to CASM, RJ's are higher cost than the 737's or Buses. Mesa is probably the lowest cost RJ operator of any size in the country and their 3rd quarter CASM was 13.3 cents, after being reimbursed for fuel and insurance and not having to pay for gates. The moral being that RJ's are perfect for "thin" routes where pax loads won't support larger equipment. This can either be because of the market (hub bypass point to point or small city) or time of day (off peak). However, if the market will support a mainline aircraft, substituting RJ's just drives up the CASM.
I'll close with this from Herb about Southwest:
Maintaining a low cost structure is no simple task. It requires 35,000 People doing thousands of small things every day. But, the key word is People. Our People are the best. They are productive, friendly, service oriented, smart, and good. And, we think they are also happy to be with a Company that treasures their job security.
While other airlines are shedding employees and asking those that remain to take sizeable pay cuts, Southwest has negotiated nine new contracts with higher compensation and enriched benefits...
