CHARTER AIRLINE OPERATING DECISION

FIRM-SPECIFIC DEMAND IN THE SCHEDULED AIRLINE INDUSTRY IS SEGMENTED BY CUSTOMER CLASS AND IS HIGHLY UNCERTAIN SO THAT IN ORDER MAY NOT LEAD TO REALIZED REVENUE AND A UNIT SALE. AIRLINE RESPONSE TO THIS DYNAMIC, HIGHLY COMPETETIVE ENVIRONMENT BY TRACKING RESERVATIONS AT PREANNOUNCED FARES AND REASSIGNING CAPASITY TO THE VARIOUS MARKET SEGMENTS (“BUCKETS”) AS BUSINESS TRAVELERS, VACATIONERS, AND CONVENTION GROUPS BOOK THE FLIGHTS ABOVE OR BELOW EXPECTED LEVELS SEVERAL DAYS AND EVEN WEEKS BEFORE SCHEDULED DEPARTURE. THIS SYSTEMS MANAGEMENT PROCESS COMBINING MARKETING, OPERATIONS AND FINANCE IS REFERRED TO AS REVENUE MANAGEMENT OR YEILD MANAGEMENT AND IS DISCUSSED IN CHAPTER 14. THE CHARTER AIRLINE BUSINESS, ON THE OTHER HAND, IS MUCH LESS COMPLICATED BECAUSE CAPACITY REQUIREMENTS ARE KNOWN SO FAR IN ADVANCE, ALL CONFIRMED ORDERS LEAD TO REALIZED REVENUE. WE CONSIDER THE LAST THREE DECISIONS FOR CHARTER AIRLINE: (1) THE ENTRY/EXIT BREAK-EVEN DECISION, (2) THE OPERATE/SHUT DOWN DECISION TO FLY/NOT FLY A CHARTER THAT HAS BEEN PROPOSED, AND (3) THE OUTPUT DECISION AS TO HOW MANY INCREMENTAL SEAT TO SELL IF THE AIRLINE DECIDES TO OPERATE THE CHARTER FLIGHT. SUPPOSE THE FOLLOWING COSTS FOR A 10-HOURS ROUND-TRIP FLIGHT APPLY TO THE TIME FRAME AND EXPENSES OF AN UNSCHEDULED 5-HOUR CHARTER FLIGHT FROM BALTIMORE TO LAS VEGAS (AND RETURN THE NEXT DAY) ON SEVEN-YEAR-OLD BOEING 737-800 WITH 120 OCCUPIED SEATS. SOME COST LISTED IN THE TABLE HAVE BEEN AGGREGATED UP TO THE FLIGHT LEVEL FROM A SEAT-LEVEL DECISION WHERE THEY ARE INCURERRED. OTHERS HAVE BEEN ALLOCATED DOWN TO FLIGHT LEVEL FROM AN ENTRY/EXIT OR MAINTAIN OWNERSHIP COMPANY-LEVEL DECISION. STILL OTHER COST VARY WITH THE GO/NO GO FLIGHT-LEVEL DECISION ITSELF. YOUR JOB IS TO ANALYZE EACH COST ITEM AND FIGURE OUT THE “BEHAVIOR OF COST” – THAT IS, WITH WHICH DECISION EACH COST VARIES. FUEL AND LANDING FEES $5,200 QUARTERLY AIRFRAME MAINTAENANCE RE: FAA CERTIFICATE $1,000 UNSCHEDULED ENGINE MAINTENANCE PER 10 FLIGHT HOURS $1,200 PRO RATE TIME DEPRECIATION FOR 7TH YEAR OF AIR FRAME $7,200 FLIGHT PAY FOR THE PILOTS PER ROUND-TRIP FLIGHT $4,200 LONG TERM HANGAR FACILITY LEASE $6,600 ANNUAL AIRCRAFT ENGINE OPERATING LEASE BASE SALARIES OF HEADQUARTERS PERSONNEL $2,000 FOOD SERVICE WITH SEAT-BY-SEAT PERCHASE AND JIT DELIVERY AT EACH DEPARTURE $2,400 AIRPORT GROUND CREW BAGGAGE HANDLING FOR TWO FLIGHT ARRIVALS $450Fuel and landing fees $5,200Quarterly airframe maintenance re: FAA certificate $1,000Unscheduled engine maintenance per 10 flight hours $1,200Pro rate time depreciation for 7th year of air frame $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 purchase and JIT delivery at each departure $2,400Airport ground crew baggage handling for two flight arrivals $450QUESTIONS: 1. WHAT ARE THE VARIABLE COSTS FOR THE DECISION TO SEND ONE MORE PERSON ABOARD A CHARTER FLIGHT THAT IS ALREADY 80% BOOKED? 2. IN MAKING AN ENTRY/EXIT DECISION, IF COMPETITIVE PRESSURE IS PROJECTED TO FORCE THE PRICE 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 MARKET AND SHOULD RECONSIDER EACH TIME IT CONSIDERS LEAVING (EXITING) THIS BUSINESS ALTOGETHER? 3. IDENTIFY THE INDIRECT FIXED COSTS OF THE CHARTER SERVICE FOR A PARTICULAR ONE OF MANY SUCH CHARTERS THIS MONTH. 4. IF ONE WERE TRYING TO DECIDE WHETHER TO OPERATE (FLY) OR NOT TO FLY AN UNSCHEDULED ROUND-TRIP CHARTER FLIGHT, WHAT WOULD BE THE TOTAL DIRECT FIXED COSTS AND VARIABLE COSTS OF THE FLIGHT? 5. CHARTER CONTRACT ARE NEGOTIABLE, AND CHARTER CARRIERS RECEIVE MANY CONTRACT OFFERS THAT DO NOT PROMISE $300 PRICES OR 80-PERCENT-FULL PLANES. SHOULD THE AIRLINE ACCEPT 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 FLIGT WITH 90 SEATS AT $250 PER SEAT? 7. WHAT ARE THE NET INCOME LOSSES FOR THIS TWO-DAY PERIOD IF THE AIRLINE REFUSES THE 90-SEAT CHARTER, STAYS IN BUSINESS, BUT TEMPORARILY SHUTS DOWN? WHAT ARE THE NET INCOME 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 JOIN THE 90-SEAT-AT$250-PER-SEAT CHARTER ON THE SAME DEPARTURE, BUT ONLY WISHES TO PAY $50 PER SEAT AT 10 SEATS? 9. SHOULD YOU ACCEPT THEIR OFFER? WHAT PROBLEMS DO YOU ANTICIPATE IF BOTH CHARTER GROUPS ARE PLACED ON 737?