Over recent years, the airline industry been keen to stress the strides it is making to improve cost efficiency. In particular, airline managements have laid great store by gains in labour productivity and aircraft utilisation. However, there remains an important question over how productivity is actually being measured. If the basic measures are focused in the wrong direction, then there is a risk that the apparent gains being made will be, at best, illusory and at worst, dangerously misleading.
The first warning is the familiar one; that capacity growth on its own is not the answer to raising performance. The inexorable quest for market share, in increasingly open markets, will almost by definition result in profitless growth at least until the point at which a market stabilises. The US majors may have shown the benefits of dominating in a mature domestic market, but that has only arrived some 20 years after deregulation.
Meanwhile, the industry remains under pressure from the investment community to improve its returns if it is to seriously compete for attention in the capital markets. Airline shares are not a "must have" for investment portfolios. Thus, airline boardrooms, like others before them, have begun to focus on shareholder value as a key criteria for success. In essence, the requirement is to earn a return greater than the average cost of the capital (equity and debt) employed in the business. In essence that means balancing two requirements. Not only to maximise profits and minimise cost, but also to do so while employing an appropriate level of capital. While the term "appropriate" is deliberately vague, the underlying need is to raise the value delivered by aircraft assets, and for that matter labour too.
Under present market conditions, there is little if any prospect of a sustained rise in unit revenues, putting the emphasis on a structural change in unit costs. Since some 70-80% of airline costs are determined by external factors - such as fuel prices - options for getting in control of the cost base are limited. That leaves labour and equipment as the two main areas where a real influence can be exerted.
Misleading measures
Yet the traditional yardsticks by which improvements are measured in those areas are often badly flawed. For example, the classic measure of labour productivity has been in the form of available tonne kilometres (ATKs)per employee, or of course, the equivalent in miles. Such measures are admittedly only used as a headline indicator of overall improvement. But there is still a risk that a misleading headline will do damage if it helps to distract attention from the real story beneath.
Other things being equal, an improvement in ATKs per employee may indeed be a sign of an underlying improvement in airline performance. But other things may not be equal. A change in fleet or route composition - perhaps flying on longer sectors - would also show through as a "productivity" increase. However, another outcome of that strategy would be to reduce the unit yield per kilometre. The same might be true of moving up to a larger aircraft type on a short haul route. There, greater supply would tend to decrease the ability to maintain both load factor and yield.
It is possible in either of these examples, that profits may fall despite an improvement in headline productivity. The real issue for profitability is not how many ATKs were delivered per employee, but whether, as a result of that increase, costs have fallen faster than revenues. If they have not then the apparent productivity gain will be an illusion.
Under further analysis there are ways to adjust the raw ATK/employee measure to get closer to the truth. For example, delving into ATKs per departure, may show quite a different picture than the headlines suggest. In a number of cases, employing larger aircraft to fly further has been the principal reason for a rise in headline productivity. Yet it has had no positive impact on the ability to deliver a greater return on the assets employed. And this ultimately is one of the key measure by which investors will judge the company.
Aircraft productivity measures can have similar flaws. The classic test of aircraft utilisation has been the number of hours in service per day. Again, this can overstate the real picture. Indeed, although the term "revenue hours" is often used, there is a real risk that the extra hours flown are not, in fact, yielding extra revenue. It is clear, for example, that the effect of delays will be to increase flight hours, but that hardly represents an increase in operating efficiency. In that case the revenue productivity of the aircraft is reduced, since no additional passengers have been added, as they would if the flying was carried out on an additional frequency.
Revenue per cost unit
Throughout, the underlying need is for the key productivity statistics to show how much revenue each area of cost produces. Therefore, the volume of revenue produced by each unit of labour expense is a far better measure of underlying productivity than traditional ATKs per employee. It often tells a radically different, but arguably, more accurate story. It is not exceptional to see a carrier steaming towards losses, aggravated by high labour costs, while at the same time apparently demonstrating major gains on nominal employee and aircraft productivity.
Of course, even revenues per employee has to be treated with care as a universal measure of health. Adjustments need to be made for differing operational profiles to ensure that cross-industry comparisons are fair and accurate. Over the next few months, this issue will be explored further in Airline Business - separating out the reality of productivity from the myth.
For the time being, the basic warning still applies. Unless you measure performance against the right parameters, the scope for reaching the wrong conclusions can not only be enormous but costly too.
Source: Airline Business
