Airline Costs and Expenses
The Wall Street Journal presented data suggesting that United Airlines was not covering its costs on flights from San Francisco to Washington D.C, and that they should discontinue their services there. The costs per flight included the costs of fuel, pilots, attendants, food, etc. used on the flights. They also included shared costs associated with running the hubs at the two airports, such as ticket agents, building charges, baggage handlers, gate charges, etc. Suppose that the revenue collected on the typical United flight from San Francisco to Washington does not cover the costs. Does this fact imply that United should discontinue these flights? (Brickley, Smith & Zimmerman, 2009, p. 185)
Lets examine the costs associated with costs per flight. An airline would look at both revenue and expenses. Revenue would include direct revenue and ancillary revenue tied to some extent to a flight. Expenses are allocated to the flight they belong to and would include direct fixed and variable costs, and indirect fixed costs (Gu). We have variable costs, which include fuel prices and food, and fixed costs which include building charges and overhead. Somebody on every flight helps cover crash insurance and compensation paid for bumped passengers or lost luggage. The person beside you on your next trip may be partly paying to repair baggage carts or to buy and maintain passenger oxygen and defibrillators (McCartney, 2012). “It’s like a wristwatch. You only see the face and hands, but all the parts inside are really necessary,” said former airline chief executive Gordon Bethune. In this case the total cost of production (flights from San Francisco to Washington D.C) are more than the marginal revenue for which United Airlines is producing a loss.
The goal should be to analyze all expenditures, and evaluate the potential cost burden. Essentially the biggest concern that presents itself is the hub costs to the interconnecting flights. To dismiss the data presented from the Wall Street journal as false, you would need to take a closer look at the variable costs of the hub stations and perform a marginal analysis of all costs associated. The evaluation of costs changes in the given hubs should support the idea of increased costs, but should not justify a complete loss in profitability. Concurrently, if the costs are justified and the market is a perfectly competitive market, then United Airlines should close production in those given hubs because it would not survive by passing its rates on to the customers.
Brickley, J., Smith, C., & Zimmerman, J. (2009). Managerial Economics & Organizational Architecture. (5th ed., p. 38). New York: McGraw-Hill Irwin.
Gu, L. (n.d.). Assessing route profitability. Retrieved from http://www.aci-na.org/blog/2010/09/26/assessing-route-profitability/
McCartney, S. (2012, June 6). How airlines spend your airfare. Retrieved from http://online.wsj.com/article/SB10001424052702303296604577450581396602106.html