ECO – CHARTER AIRLINE OPERATING DECISIONS

CHARTER AIRLINE OPERATING DECISIONS

Firm-specific demand in the scheduled airline industry is segmented by customer classand is highly uncertain so that an order may not lead to realized revenue and a unitsale. Airlines respond to this dynamic, highly competitive environment by tracking reservations at preannounced fares and reassigning capacity to the various marketsegments ( “ buckets ” ) as business travelers, vacationers, and convention groups book the flights above or below expected levels several days and even weeks before sched-uled departure. This systems management process combining marketing, operations,and finance is referred to as revenue management or yield management and is dis-cussed in Chapter 14.The charter airline business, on the other hand, is much less complicated becausecapacity requirements are known far in advance, and all confirmed orders lead to re-alized revenue. We consider the following three decisions for a charter airline:

(1) theentry/exit break-even decision,

(2) the operate/shut down decision to fly/not fly acharter that has been proposed, and

(3) the output decision as to how many incre-mental 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 frameand 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. 18 Some costs listed in the table have been aggregated up to the flight level froma seat-level decision where they are incurred. Others have been allocated down to theflight level from an entry/exit or maintain ownership company-level decision. Stillother costs vary with the go/no go flight-level decision itself. Your job is to analyzeeach cost item and figure out the “ behavior of cost ”— that is, with which decisioneach cost varies. Fuel and landing fees $5,200Quarterly airframe maintenance re: FAA certificate 1,000Unscheduled engine maintenance per 10 flight hours 1,200Pro rata time depreciation for 7th year of airframe 7,200Flight pay for pilots per round-trip flight 4,200Long-term hangar facility lease 6,600Annual aircraft engine operating lease 7,100Base salaries of headquarters personnel 2,000Food service with seat-by-seat purchase and JIT delivery at each departure 2,400Airport ground crew baggage handling for two flight arrivals 450

Questions
1. What are the variable costs for the decision to send one more person aboard acharter flight that is already 80 percent booked?
2. In making an entry/exit decision, if competitive pressure is projected to force theprice 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 marketand should reconsider each time it considers leaving (exiting) this businessaltogether?
3. Identify the indirect fixed costs of the charter service for a particular one of many such charters this month. Indirect FixedCost = $23,900
4. If one were trying to decide whether to operate (fly) or not fly an unscheduledround-trip charter flight, what would be the total direct fixed costs and variablecosts of the flight?
5. Charter contracts are negotiable, and charter carriers receive many contract offersthat do not promise $300 prices or 80-percent-full planes. Should the airlineaccept 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 perseat?
7. What are the net income losses for this two-day period if the airline refuses the90-seat charter, stays in business, but temporarily shuts down? What are the netincome 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 jointhe 90-seat-at-$250-per-seat charter on the same plane and same departure, butonly wishes to pay $50 per seat for 10 seats?
9. Should you accept their offer? What problems do you anticipate if both chartergroups are placed on the 737?