Question

(Related to the Apply the Concept on page 376) An article in the New York Times on the airline industry described airlines as being "burdened by high fixed costs." What are likely to be the most important fixed costs for an airline? Are airlines likely to have particularly high fixed costs relative to their variable costs when compared with, say, an Old Navy clothing store or a Panera Bread restaurant? Briefly explain.

Short answer

Some of the important fixed costs for an airline are the costs of acquiring, maintaining, and storing aircraft, and costs of staffing and operating airports and offices. These are significantly higher compared to businesses like Old Navy or Panera Bread restaurant that have lower infrastructure and equipment costs. Thus, airlines do have particularly high fixed costs relative to their variable costs.

Step-by-step solution

Identify Airline Fixed Costs

The key fixed costs for airlines include costs associated with acquiring aircraft, costs of maintaining and storing aircraft, and costs of staffing and operating airports and offices. These costs must be paid regardless of the number of passengers flown on any given day.

Compare with Variable Costs

Variable costs for airlines include mainly fuel and to a lesser extent, in-flight provisions and crew costs. Now, these costs increase as more flights are made. Comparing these, it can be seen that fixed costs are high relative to variable costs due to significant investments required for aircraft purchases, infrastructure, and staffing.

Comparison with Other Businesses

When compared to Old Navy clothing store or a Panera Bread restaurant, airlines do have particularly high fixed costs. This is because the nature of the costs in these other businesses (rent, wages, cost of goods sold) are quite different. While they do have fixed costs, these costs are lower relative to their variable costs compared to airlines, which have significant infrastructure and equipment costs.

Key concepts

Variable Costs

In the airline industry, variable costs are expenses that change in proportion to the level of activity or service offered. Unlike fixed costs, which remain constant regardless of operations, variable costs fluctuate based on the number of flights and passengers.

Key examples of variable costs for airlines include:

• Fuel costs: These are one of the most significant variable expenses, fluctuating with the number of flights. The more the aircraft fly, the more fuel is consumed.
• In-flight provisions: These costs include food, beverages, and other passenger services that vary depending on the number of passengers being served.
• Crew costs: Payments to flight attendants and other staff can increase with longer flight times and additional flights. They also incorporate overtime pay when needed.

Airlines must manage these variable costs efficiently. Understanding them is crucial for pricing tickets and planning business operations, as they significantly affect the company's profitability.

Infrastructure Costs

Infrastructure costs in the airline industry pertain to the expenses related to the physical setup necessary to support operations.

These costs include:

• Acquiring aircraft: Purchasing or leasing planes is a massive investment and represents a large portion of an airline's fixed costs.
• Maintenance and storage: Regularly maintaining aircraft for safety and performance, along with storing them when not in use, incurs ongoing costs.
• Airports and offices: Operating gateways and administrative functions demand substantial resources for management and operation.

These infrastructure costs are essential for the functioning of any airline and must be paid regardless of how many flights are made. The high cost of these elements is why airlines face significant fixed costs compared to other industries. Understanding infrastructure costs helps highlight the operating challenges and investment requirements within the airline business.

Comparative Industry Analysis

When comparing the airline industry to businesses like clothing stores or restaurants, such as Old Navy or Panera Bread, significant differences in cost structure quickly become apparent.

Airlines deal with distinctly higher fixed costs due to their reliance on expensive equipment and infrastructure.

• In clothing stores, costs such as rent and wages are fixed but relatively lower compared to airlines.
• For restaurants, fixed costs include lease agreements and staffing, but they too remain smaller relative to variable costs per customer.
• Airlines must also consider substantial safety and regulatory compliance costs, unlike these other businesses.

Thus, the airline industry's fixed cost to variable cost ratio is higher compared to these industries due to the intensive capital and infrastructure required. This type of analysis is critical for stakeholders and decision-makers to understand the financial demands and risks associated with operating an airline.