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For a long period, the airline business has been categorized as ‘lucrative’. The notion that the airline business is lucrative is partly perpetuated by the fact that it is the most costly form of transport. Also, the huge capital base of the airline business makes it one of the most stable types of business. For instance, the assets of an airline at any given time include planes, hangers, and cargo bays, which translate into a lot of capital base for an airline.
Consequently, various airlines utilize a set of factors when they are coming up with different costs for their products and services. However, sources of revenue for an airline remain the most prominent determinant of cost. This is also the reason why there are big disparities in costs between different airlines. This report seeks to identify the factors that contribute to the cost of an airline using Air France as a model.
Besides, the report describes the different sources of revenue for the airline. Air France (AF) is the main airline in France and it has its headquarters in Paris. The airline is owned by the Sky Team Global Alliance jointly with Air France-KLM. AF’s business includes cargo and passengers in both France and 93 other countries around the world. The airline has been in existence since 1933 as a result of a merger between several airline-businesses of the time.
Currently, the airline is categorized as a business leader due to the market share it commands in France and other parts of the world. Consequently, at any given time matters to do with costing and revenue are pertinent to AF. As a big business, AF encounters significant direct and indirect operating costs, which are correlated with revenue to determine appropriate costing. This report utilizes the annual financial report for AF to identify the factors that contribute to its costs about its various sources of revenue.
Direct Operating Costs
AF’s direct operating costs constitute a wide range of factors but wages, salaries, and fuel dominate this category. Fuel costs make up the second-highest operating costs and they reflect global patterns in the airline industry. However, the escalating salary costs have to do with the size of the AF. As a ‘giant’ airline, AF requires a higher threshold of employees for its maintenance needs. For its costing needs, the airline is more likely to rely on salary and wage costs because this factor is more stable than fuel prices. For instance, the company’s long-term plans are often destabilized by changes in fuel costs.
Equipment and plant maintenance make up 9% of all direct costs at AF. This unexpected factor is constant and it is only expected to affect the prices of air tickets in the long term. Although fuel is only the second significant factor as far as direct costs are concerned, its fluctuating nature makes it a major determinant of short-term airline-costs. Catering and chartering costs makeup only a small portion of AF’s online but the company’s annual report reveals their significance in attracting and retaining customers (Air France 2012). For example, most of AF’s advertisements focus on passenger comfort for the company to gain a much-needed market share.
Indirect Airline Operating Costs
The indirect airline operating costs are also a significant factor in airline costs although they do not carry as much weight as direct factors. Nevertheless, indirect operating costs are significant as far as industry standards are concerned. In the case of AF, most of its indirect operating costs are incurred through landing fees and en-route charges. These cost factors are important to AF because they are part of the core determinants of product costs.
For example, these types of costs are different and vary from one area of jurisdiction to the other. The airline does not have any powers to control these types of costs and the customer often bears these expenses directly. Handling charges and other operating costs also make up a significant portion of the indirect operating costs. This category of expenses is important for AF in the company’s quest to maintain high standards. This cost factor is also static and it is directly passed on to consumers.
Another indirect cost factor is aircraft operating and lease costs. This factor changes by various stages of business. AF can use the lease costs to stabilize its business in instances of unstable environments. In early 2012, “faced with negative results, the Air France-KLM Board of Directors set three priorities: restoring competitiveness through cost-cutting, restructuring the short and medium-haul operations and rapidly reducing debt” (Air France 2012). For example, leased aircraft can be essential in bringing supply and demand equilibrium to the business. This cost factor is a good cost strategy for AF to gain lost ground in instances of slowdowns in performance
Passengers are the main sources of revenue for AF and this trend aligns with the company’s business model. Overall, AF generated approximately 25.63 billion Euros, and passengers accounted for 79% of this income. On the other hand, this revenue indicates success on the part of AF whereby the company can record a load factor of 83.1 %. Eventually, the company’s costing practices are substantiated by the revenue it generates from its passenger service.
There is an ongoing struggle among various airline businesses to make cargo a significant income-generating factor. Consequently, all major airlines around the world endeavor to generate at least 10% of their revenue from cargo business. Unlike passenger-related prices, cargo costs remain largely stable. Therefore, the 12% revenue from the cargo business indicates that AF is indeed a global leader in the airline business. The most important costing factor for AF as per the company’s revenue structure is fuel costs, human resource elements, and advertising costs. As a big company, AF manages to rake in revenue from its maintenance business whereby it handles 1,300 aircraft per year. Also, AF has managed to earn an additional 5% in revenue from its diversified business sources.
AF costs are mainly aimed at maintaining the airline’s position as a market leader whilst managing to achieve positive growth. The airline’s operations still follow the traditional business model of business whereby various types of products are offered with the view of maximizing revenue and catering to a wide range of customers. This costing method follows a model whereby “the price is fixed and the main task of revenue management is to maximize returns by controlling capacity” (Fedorco & Hospodka 2013). An analysis of AF indicates that wages, salaries, and fuel costs make up the majority of operating costs at 71%.
Consequently, these two factors have a significant impact on the costing strategies that are used by AF. Fuel constitutes 35% of AF’s total direct-operational costs and this element is passed on to the customer directly. When the prices of oil keep changing from time to time, it becomes difficult for an airline to maintain stability in its prices. Some companies deal with this uncertainty by maintaining stable fare prices and adding fuel surcharges when necessary.
AF’s pricing strategy is based on class categories where the number of seats in each passenger category remains fixed. Consequently, the complexities of customer service lead to high costs in employee wages and salaries. The fuel and wage factors are responsible for the constantly changing AF ticket prices. For instance, sometimes the prices of AF air tickets changes from week to week depending on forecasts and capacities. Other than fuel and wages, all other direct airline-operating costs for AF do not have any significant effects on costs. On the other hand, indirect operating costs also carry a significant pricing factor.
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Most indirect costs affect passenger’s ticket prices depending on seasons. For instance, high-demand seasons naturally nullify the indirect costs factor in several ways. The major indirect costs for AF are landing and handling costs. If an airplane does not stay on the runway for a significant period, these costs automatically come down. The reason why the airline is focused on passenger satisfaction and accommodation too much is that this is the main revenue generator for AF. Consequently, AF’s costs are dominated by employees’ wages because this factor directly contributes to obtaining more passengers.
Air France, 2012, Horizons: 2012 annual report. Web.
Fedorco, L & Hospodka, J 2013, Airline pricing strategies in European airline market. Web.