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Not for Sale

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24 Passenger Air Service Development Techniques Airline officials, community officials, industry trade groups, and consultants all told the study team that reducing financial risk has become a key factor in establishing effective work- ing relationships in small communities. Sharing the financial risk of commercial air service between airlines and the communities they serve has become an accepted approach within the industry. Airlines can only serve communities successfully over the long term if they are in a partnership with the community. Because of the size of the capital investment, the airlines believe that communities must share part of the risk of committing expensive aircraft to a given market. This is true in "normal" economic times, but especially during periods of severe financial stress. ASD programs help orchestrate and coordinate the risk sharing between the community and the airline. How do air carriers decide which airports they will serve? This question is deceptively difficult. The simple answer is: Airlines serve markets in which they can generate profits. In making those determinations, airlines consider many factors. If a community does not rank highly according to those factors, it may not receive service. And the factors that an airline considers may or may not coincide with issues that are important to the local community. Airlines are not motivated by altruistic concerns about local economic development. Like any business, airlines seek to maximize profitability, and do so by establishing and oper- ating routes that make a positive contribution to their bottom line. (Airline profit maximization, yield management, and route planning are complex topics beyond the scope of this guidebook.) Decisions are governed by an internal process that starts with route planners. These planners make their initial assessments before examining more in-depth considerations of market size and forecasts. Airlines also have to take other internal factors into consideration, such as frequent flyer needs. Route planners and senior managers evaluate competitive route opportunities and select those expected to provide the greatest return, giving consideration to the cost of deploying a specific aircraft on each route. A carrier's air service At the most basic level, a carrier's air service decisions are based on weighing the revenue that it can generate in a market versus the cost of providing service to that market. Depending on the decisions are based airline, another consideration is the extent to which a local community may be willing to share on weighing the the airline's risk involved in deploying an asset as expensive and valuable as a commercial aircraft. revenue that it can generate in a Passenger Demand/Operating Revenues market versus the On the revenue side of the equation, airlines focus on the size of the actual and potential under- lying market. Two general aspects of passenger demand are important: the volume of passengers cost of providing willing to get on the aircraft and the "quality" of the revenue mix that the market generates. For service to that example, there are always plenty of passengers looking for a low fare to Las Vegas or Orlando, market. but that is seldom sufficient for airlines. Network carriers need business passengers flying at higher rates. Further, network airlines are increasingly concerned with attracting enough business trav- elers who want to connect onto international routes. Market entry--when a new carrier begins to offer service at a particular airport--can cause passengers to shift away from existing travel patterns (fly on the new airline as opposed to an incumbent carrier). Market entry can also stimulate new traffic (passengers who would not have otherwise flown). Generating new travel is often preferable, because it is less susceptible to being lost back to the previous carrier through competitive offerings. A high percentage of new traffic allows carriers to build brand loyalty.

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Understanding the Role of Air Service Development 25 At all communities, but especially in smaller markets, airlines want to make sure that the mar- Especially in smaller kets are self-sustaining. That is, there should be sufficient passenger demand to allow the carrier to operate the route profitably without being subsidized or otherwise financially underwritten. communities, Airlines know that financial support programs such as grants or incentives eventually end. If the airlines want to market cannot sustain the service without assistance, it may not be worth the investment in time, make sure that effort, and personnel. there will be At the same time, however, many carriers look for--and now expect--a community to offer some form of financial risk-sharing in association with new service. The airlines recognize the enough passenger value of new service to communities. Yet they also recognize that committing an aircraft to a demand for them market is a decision that involves a major asset and potentially a large risk--particularly if the to operate the airline does not have a history with a community. route profitably The study team surveyed carriers on whether incentives were valuable in deciding about serving a community. Figure 2.1 summarizes the results of that survey. Some carriers, such as Frontier without being and AirTran, thought that incentives were very important. Others, such as Continental and subsidized. Delta, were less interested in incentives as a prerequisite for operating at a small community. The level of local support and commitment to air service can be a key factor in airlines' deci- sions to work with a local community. Support can take many forms. Communities may be will- ing to underwrite a sustained marketing campaign announcing the new service. The local cham- ber of commerce and major employers can be active in an ASD task force. Local hotels and tourist destinations may be willing to work with a carrier to develop packages. Local coopera- tion and involvement--especially on the part of the area's major employers--is noticeable to many carriers. Chapter 5 discusses many incentives in greater detail. Air Carriers' Costs On the cost side, airline costs fall into two broad categories: direct operating costs (e.g., salaries and fuel) and airport costs. In addition, carriers also absorb other costs associated with starting new service at a location. In late 2008, soaring operating costs made many markets too costly to serve. Direct operating costs are those immediately associated with operating the aircraft. They include crew salaries, capital costs (i.e., the cost of owning or leasing the aircraft), insurance, and fuel. Because smaller aircraft require relatively fewer crew, cost less to purchase or lease, and burn 100% 80% 60% 40% 20% 0% t n l d r ta an ta ti e ra te el en gi irT ni on D lle tin U A Fr A on C Figure 2.1. Percentage of markets served where financial incentive is offered.

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26 Passenger Air Service Development Techniques $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 ERJ140 ERJ145 CRJ100/200 CRJ700 CRJ900 A319 Notes: Block hours are a common measure of aircraft usage and generally are measured from the time that an aircraft pushes off a departure gate until it parks at its arrival gate. Data represent the 12 months ending March 2008. Data for CRJ aircraft operations are from SkyWest Airlines. Data for ERJ aircraft operations are from American Eagle. SkyWest and American Eagle were the largest regional operators in the United States in 2006 in terms of passenger enplanements. Data for A319s are for all aircraft used in the United States. Figure 2.2. Illustrative differences in costs per block hour. less fuel than larger aircraft, their hourly operating costs are usually less, as shown in Figure 2.2. However, operating costs per unit of service provided--a seat available for sale--are less on larger aircraft simply because there are more seats available. (See Chapter 3 for more informa- tion on airline costs.) However, high fuel prices have driven operating costs up drastically compared to historic levels. In some cases, even if an airline has a steady source of Explanatory example of business market losing business passengers from a small community, aircraft oper- service due to operating costs ating costs can make the market unprofitable. Profitability In June 2008, Delta announced that it was discon- is a function of both the revenue that can be generated on a tinuing service between its hub at Salt Lake City particular market segment with a given aircraft, and the and Bakersfield, California. The airline's decision costs of operating that aircraft. to leave was part of a 13 percent cut in domestic Airport costs are those directly associated with operating capacity announced in 2008 and was based on indi- at a particular facility. They include landing fees, gate fees, vidual flights' passenger loads, profitability, and counter and office rentals, and perhaps the costs of servic- how much money Delta makes on Bakersfield air ing aircraft at the airport. The importance of these costs can- travelers' flights to their ultimate destination, such not be underestimated. Airport costs can be very significant as New York City. Despite all those factors, a Delta for certain carriers, and the importance that carriers attach spokesperson said, "Ultimately it comes down to to airport costs can vary widely. Higher than usual airport operational costs directly related to fuel." costs can make the difference between a profitable route and an unprofitable one.