Applications in Corporate Finance
Buy custom Applications in Corporate Finance essay
The point of this analysis is to come up with how best DanAir Airlines can continue to be a thriving industry in the 21st century. This is accomplished by providing a background region analysis of the global industry of airlines. Current and future evolvement of the industry also has to be considered as do the reasons why airlines fail and how to achieve success.
While route scheduling, as well as, the air ticket price has been de-regulated for some time and many of the sections are still under tight control. Governments own and regulate the airports in their regions and control key bottlenecks to airline services such as access to boarding gates and runways. Most airport commissions allocate gates without a formal market mechanism such as a bidding process. In addition, international routes have been de-regulated only gradually, through negotiated bilateral open-sky agreements, which generally allow airline companies from two countries to fly planes within and to each other without restrictions. In many airports, airlines must obtain a slot for their aircraft to land or take off. The regulations that were designed to avoid congestion in extremely busy airports have lagged behind market realities (Vasigh, Fleming, and Mackay, 2010).
Service to some small and isolated markets is also subsidized and regulated by said the government. Airline competition has not benefited all consumers. Business travelers paying full fare usually enjoy a superior product in terms of service and flexibility. There is an increased demand for air travel, thus, there are new passengers who air travel. This means that even though competition among airlines may not necessarily profit all categories of passengers, there is an increase of the passengers, which lowers average prices (Shaw, 2007).
While profits are volatile, industries without volatile profits operate without substantial government regulation. Free are an advantage for the big industries because they give provisions for firms when it comes to innovation to demand and cost systems. Free markets provide incentives for innovations to spread, thereby increasing efficiency.
Impact of Policy on Competition
Airlines are a complex mix of competition and standardization, the policy choices made could affect its competition. Policies are the mechanism for allocating airport gates and facilities. The airport commissions usually rely on the mechanisms not from market formations to allocate these resources (Renga and Mentges, 2010). Changes in these policies force the authorities to increase supply as the bid values go higher than the costs. Evidence suggests that the airfares increase as concentration in the market increases and this harms consumers.
The concentrated markets benefit from the consumers by creating bigger networks with better flights. A third significant policy dimension involves restrictions on substantial foreign ownerships of airlines and on domestic flights by foreign owned airlines. While profits have fluctuated a great deal in the airline industry, DanAir has been characterized in the past by steady growth, and falling prices.
Since the horrendous attacks of September 11 2001, global airlines have registered abysmal performances especially when compared with their recorded profits in the years before 2001. The airline industry is structurally challenged by its very nature, facing high fixed costs, and cyclical demands. As such, the number of bankruptcies continues to pile up as airlines seek protection from creditors and look for ways to restructure costs. Facing increase competition and fighting to retain customers and thrive, most airlines have introduced cost cutting measures such as frequent flier programmes that reward customer loyalty with tickets, cabin upgrades, priority check ins, priority boarding, lounge access among other privileges.
Passengers can also accumulate mileage point based on distances travelled and in what travel class and then redeem those miles for rewards such as free or discounted tickets. Loyalty programs such as these are often more profitable than other forms of marketing like comparison of routes, services and price. Both airlines and consumers benefit from the advent of loyalty programs. Airlines benefit from a faithful consumer base that remains even with increased fares and passengers earn free tickets and other rewards.
Hardly any airline, no matter its largesse or scope is able to efficiently provide service to all the destinations of the world. To counteract this fault, airlines, even gigantic airlines, form alliances with other airlines to overcome their limited abilities and reap a profit. By amalgamating, they also increase their market presence and expand their network. While larger airlines opt for agreements with regional carriers, the trend of alliances is now beginning to go international. The benefits of this to the consumer are clear: more reachable destinations, lower prices, and more departure times, access to more lounges, faster mileage rewards and around the world tickets. This is the result of the airlines sharing facilities, cooperating in sales and making investments in different regions of the world (Morrel, 2007).
Profitability in the Air Industry
The ultimate challenge for airlines is selling the most tickets for at the highest prices and targeting the right customers so that price discrimination will occur where customers pay different rates for the very same destination and service. Airlines face additional pressure to fill seats because empty seats are considered perishable goods with the airline having to fly even with empty seats. Striking an ideal balance between price and demand is undoubtedly difficult and airlines resort to a lot of market research to categorize their customers. There are business travelers, and those travelling for urgent personal reasons, and there are leisure travelers who are price sensitive and an influence demands.
At the extreme end, of the economy spectrum is the least expensive seat, which may be four times less the most expensive seat. Understandably, airlines will focus on filling their first and second class sections which more than over the cost of their lowest economy class seats.
Managing Cost Structure
In stark contrasts with the management of other service businesses, airlines today need an extensive range of expensive equipment in order to operate efficiently. Companies have traditionally financed their costs by loans or public stock offerings, but recently, airlines are leasing equipment such as aircraft, baggage vehicles, and hangars, having realized that those leases provide greater flexibility in updating equipment while keeping upfront costs down. If the lease is a capital lease, an airline records the asset and a lease liability that is generally equal to the sum of the present value of the lease payment during the lease term.
Another benefit of the capital lease is the depreciating expense relating to the asset over the economical life of the asset. Aiming to limit their long-term liabilities, most airlines prefer operational leases (Crans, 1996). In these, neither the asset nor the lease liability is included in the balance sheet. Leases also provide airlines with flexibility. In times of increase of demand, airlines can quickly utilize larger planes to accommodate all their customers.
In the post September 11, 2001 era, most airlines have espoused cost-cutting measures as a goal to pursue. The airline industry is labor intensive, and so pilots, flight attendants, baggage handlers, dispatchers, and customer service comprise the biggest portion of the airlines operating expenses. This is due to a highly tenured workforce, higher pension costs, and work rules because of hiring unionized labor. The maintenance department is also under operations focusing on aircraft condition to preserve the airlines’ most valuable capital asset, the airplanes. This group is essential to the airlines because it can affect the airlines’ bottom line. Aircrafts cost the airline a lot, whether just sitting idle or in full flight. As a result, maintenance personnel are often charged to keep the planes in tiptop shape to minimize downtime.
Reducing Costs of Fuel
In consistently seeking to lower fuel costs, management and operations will fill aircraft with more fuel than is necessary for the trip to its destination, as the cost of fuel in the place where it is going may be more than what it is in other areas. To save fuel, pilots use single engine emergency procedures when they doing normal drills as well as selective engine shutdown when the ground procedures are under delay. Cargo personnel can reduce and weigh more effectively the onboard weight while redistributing belly cargo to save on fuel. Pilots can also cruise longer at high altitudes while employing shorter and steeper approaches. DanAir can also optimize flight planning for a minimum fuel burn routes and altitudes.
Hubs and schedules should be redesigned to alleviate congestion and DanAir can acquire fuel-efficient airplanes to save on fuel. High priced localities as far as fuel is concerned are also to be avoided. There is another risky option for decreasing fuelling costs, fuel hedging. The basic premise is to purchase a contract that locks in a fuel price in the future at which point the airline will pay that strike price should the price of fuel increase above the current price. Through forward contracts, future contracts and optional swaps, an airline can manage its fuel price risks. The primary difference between forward contracts, future contracts, and optional swaps is that options grant the airline the power to buy or sell at a specific time without obligation whereas future and forward contracts will result in direct losses if fuel prices drop below the contract price, as there is an obligation to pat the contract price.
Airport and en route charges are a significant expense in flight operation costs. Both private and public airports charge airlines for the use of their runway and terminal facilities. These fees are quite considerable taking into account the number of aircraft landing and departing each day. Due to the considerable cost of airport charges, DanAir should attempt to fly fewer planes into the priciest airports and try to maximize their load factors during times of high fuel prices.
In response to the most recent economic downturn, airlines have begun to charge extra fees for services that were once considered complimentary. These include checked baggage, food and beverage, seat selection, priority boarding, ticket changes, reservations via telephone or internet, and carryon baggage fees (Salerno, 2010).
Data revealed in specific metrics can underscore why some airlines are profitable and others slump into bankruptcy. It will underline efficiency measures undertaken in both cutting costs and in generating maximum revenue from each passenger (Banfe, 1992). In revenue metrics, rather than looking at system total operating revenue when comparing airlines, one can glean more information from system passenger revenue per available seat mile. Revenue per available seat mile, which includes both passenger revenue, as well as revenue earned from freight, is also used to compare airlines. It represents how much revenue an airline generates per seat per mile flown. In theory, higher revenue per seat mile translates into higher profit.
Analyzing airline expenses exposes a significant difference between the airlines that dedicate themselves to serious cost minimizing and those that place less value on it. The lower an airline’s cost per available seat mile; the more efficient for the airline operations then the airline probably post a profit avoiding bankruptcy.
Laborers in the airline industry have constantly sought to re-negotiate contracts and fight when their demands are not met. It is a constant battle between the airlines who struggle to cut costs to avoid bankruptcy and the labor unions that seek higher wages or better benefits. To cut costs, some airlines ascribe to employees extra duties that do not fall under their original portfolios but that they can perform easily and efficiently such as asking maintenance personnel to wash parts of the plane (Morrison and Winston, 1995).
That can actually increase the bottom line of the said airline by lowering the overhead costs, as well. Stage length is an important strategy to consider, as well. It refers to the average flight times of a particular airline. As stage lengths increase, costs tend to go down which bodes well for the long haul airlines that have fewer take offs and landings.
Traffic and Capacity Metrics
The most fundamental metrics related to the airline industry are traffic and capacity, which are used as the basis for unit revenue and unit costs. They also provide the essential metric of load factor, which measures the percentage of seats sold out of the available seating places available. Total available seat miles determine which airline has the largest seating capacity as total available seat miles is equal to increasing seats proportionally to the number of miles flown (Doganis, 2002).
Airlines strive for the highest load factor as they face high fixed costs for each plane flying. As the plane will typically fly regardless of its load factor, the airline will lose revenue for each seat that goes unsold as it absorbs operating costs, such as fuel, labor and landing costs. It is, therefore, critical for airlines to attempt to sell each seat, as the airline with the largest load factor is likely generating the most revenue for from each flight. Since reaching the low point of 2001, most airlines have steadily increased their load factors. This is primarily due to more efficient and sophisticated yield management systems which allow the airlines to more accurately estimate demand at different price levels resulting in more sold seats.
In addition, some airlines have also reduced the number of flights, which increases load factor due to offering less capacity yet facing rising demand. However, while load factor provides insight into how much revenue an airline generates from each flight, it disregards expenses. Moving into the next decade, the airline industry is still at crossroads, and while demand for air travel has increased exponentially, many of the carriers continue to struggle in their quest to turn a healthy profit. A few steps can be taken to avoid bankruptcy and start the journey towards earning ever-increasing profits.
(a)Cross utilization of employees. The major airlines must negotiate with their labor unions to seek changes to their agreements as concerns their duties. Management should highlight the advantages of cross utilization to the leaders of the unions, which can translate to a superior working environment, as employees are not limited to one function only. From a corporate perspective, this of course leads to productivity increases thereby decreasing costs (Haines, 2004).
(b)Maintaining cost discipline. Airlines need to adopt efficiencies that include eliminating in-flight services such as food and snack distribution, flying more point-to-point routes, and decreasing turnaround times, which contribute to aircraft utilization.
(c)Breakeven load factor. This is acquired by decreasing costs. It is the average percentage of seats that must be filled on an average flight at average fares for the airlines’ passenger revenue to break even with the airline’s operating expenses. It is imperative for major airlines to reduce their breakeven load factors by focusing on reducing their unit costs thereby increasing their margins.
(d)Intangible. Airlines should provide a fun atmosphere in their aircrafts that promote a fun outlook. They should also source for new aircraft if their present machines are dilapidated and not adopt a policy of providing frugal amenities, which can taint an airline for a long time with a reputation of stinginess.
Buy custom Applications in Corporate Finance essay