Question

Charter Airline Operating Decisions

Firm-specific demand in the scheduled airline industry is segmented by customer class and is highly uncertain so that an order may not realize revenue and a unit sale. Airlines respond to this dynamic, highly competitive environment by tracking reservations at preannounced fares and reassigning capacity to the various market segments (“buckets”) as business travelers, vacationers, and convention groups book the flights above or below expected levels several days and even weeks before scheduled departure. This systems management process combining marketing, operations, and finance is referred to as revenue management or yield management and is discussed in Chapter 14. The charter airline business, on the other hand, is much less complicated because capacity requirements are known far in advance, and all confirmed orders lead to realized revenue. We consider the following three decisions for a charter airline: (1) the entry/exit break-even decision, (2) the operate/ shut down decision to fly/not fly a charter that has been proposed, and (3) the output decision as to how many incremental seats to sell if the airline decides to operate the charter flight.

Suppose the following costs for a 10-hour round trip flight apply to the time frame and expenses of an unscheduled 5-hour charter flight from Baltimore to Las Vegas (and return the next day) on a seven-year old Boeing 737-800 with 120 occupied seats. Some costs listed in the table have been aggregated up to the flight level from a seat- level decision where they are incurred. Others have been allocated down to the flight level from an entry/exit or maintain-ownership company- level decision. Still other costs vary with the go/no go flight-level decision itself. Your job is to analyze each cost item and figure out the “behavior of cost” –that is, with which decision each cost varies.

Fuel and landing fees $5,200

Quarterly airframe maintenance re: FAA certificate 1,000

Unscheduled engine maintenance per 10 flight hours 1,200

Pro rata time depreciation for seventh year of air frame    7,200

Flight pay for pilots per round – trip flight 4,200

Long-term hanger facility lease    6,600

Annual aircraft engine operating lease    7,100

Based salaries of headquarters personnel 2,000

Food service with seat-by-seat purchase and JIT delivery at each departure 2,400

Airport ground crew baggage handling for two flight arrivals 450

Questions

1. What are the variable costs for the decision to send one or more person aboard a charter flight that is already 80 percent booked?

2. In making an entry/exit decision, if competitive pressure is projected to force the price down to $300, what is the break-even unit sales volume this company should have projected as part of its business plan before entering this market and should reconsider each time it consider leaving (exiting) this business altogether?

3. Identify the indirect fixed costs of the charter service for a particular one of many such charters this month.

4. If one were trying to decide whether to operate (fly) or not fly an unscheduled round-trip charter flight, what would be the total direct fixed costs and variable costs of the flight?

5. Charter contracts are negotiable, and charter carriers receive many contract offers that do not promise $300 prices or 80-percent full planes. Should the airline accept a charter flight proposal from a group that offers to guarantee the sale of 90 seats at $250? Why or why not?

6. What are the total contributions of the charter flight with 90 seats at $250 per seat?

7. What are the losses for this two-day period if the airline refuses the 90-seat charter, stay in business, but temporarily shut down? What are losses if it decides to operate and fly the charter that has been proposed?

8. What is the segment-level contribution of a separate group that is willing to join the 90-seat-at-$250-per-seat charter on the same plane and same departure but only wishes to pay $50 per seat for 10 seats?

9. Should you accept their offer? What problems do you anticipate if both charter groups are placed on the plane?

Answer 1