By Bjorn Fehrm
April 04, 2018, © Leeham News.: In the first article about Long-Haul LCC and if it’s a viable business, we looked at ticket pricing strategy used by airlines to maximize revenue on a route. Now we look at the cost side of the equation.
The cost level for a Long-Haul LCC is of utmost importance. A lower cost level than the Legacy carriers flying the same routes is the only way the company can compete. It’s seldom it offers origins or destinations not offered by other airlines. Its mission is to offer a popular air transport service at a lower cost.
Before we start to discuss how a Long-Haul LCC works to keep its costs low, we need to understand which cost types are important. First the overall cost types:
Of these two major cost items, the Operational costs are dominant. An LCC lives of low SG&A costs and a Long-Haul LCC is no different. Typically the SG&A costs are around 10% of total costs, with Operational costs being the rest.
We will look at the operational costs of flying our New York to London route with two different aircraft types. A narrowbody and a widebody. The narrowbody will be of the Boeing 737 MAX 8/9 or Airbus A321LR type. The widebody will be of the Boeing 787-9 or Airbus A330-900 type. The cost levels of these aircraft are close. We will use an average cost level between them for the discussion.
Which of these are the best for the route is not our target for the articles, we want to understand if a Long-Haul LCC model is viable. For this, the average costs will be fine.
The operational costs for the airliners are divided between:
Historically the dominant cost. With present lower fuel prices, it has come close to the other large cost item, crew costs.
This is an important cost item for a Long-Haul LCC. It’s the second most dominant cost and the crew cost level will decide the competitiveness of an LCC. The largest cost is the Flight Crew cost. It doesn’t scale with passenger number (which Cabin Crew cost does) other than between Narrowbody and Widebody. To a certain level, the wage and therefore cost difference between a Narrowbody and Widebody flight crew is motivated by the number of passengers flown.
Normally the Flight Crew cost contains the cost for a Captain and a First Officer on the route. On flights over eight hours, a third Flight Crew member needs to give duty hours relief to the Pilots. This is often a Pilot only cleared for cruise duty, typically a new recruit gathering experience. Our crossing of the North Atlantic does not require a third Flight Crew member, it’s a six-hour flight.
Regulations for most airlines prescribe a Cabin Crew member for every 50 passengers. Therefore our Cabin crews numbers and by it cost will differ between the aircraft types. The cost per passenger mile will be similar, however.
Countries charge airlines who use their airspace Navigation or Underway fees. The fees shall cover the country’s cost of upholding a controlled and safe airspace. This requires setting up and maintaining a navigation infrastructure and staffing the required Air Traffic Control (ATC) centers.
The US doesn’t charge for domestic aircraft using the US airspace but it charges foreign airlines using the US airspace (as our Long-Haul LCC is European we will be charged for our flight from New York). The Underway fees vary by country but are generally based on the aircraft’s registered Maximum Take-Off Weight (MTOW).
Airports charge landing and handling fees to pay for its infrastructure and services. These charges vary from airport to airport. The larger and more attractive the airport, the higher the fees.
Maintenance costs for the aircraft are divided between the airframe and engine maintenance costs. Of these, the engine costs dominate. Often the relationship is two-thirds engine and one-third airframe costs for maintenance.
This is why airlines use derate (reduced thrust) for Take-Off and Climb. The lower the maximum thrust used during the mission, the longer the engines can stay on the wings before needing a visit to the overhaul shop.
The above costs are summed as Cash Operating Costs (COC). These are the costs an airline has to pay beyond capital costs for the aircraft.
To go from Cash Operating Cost to Direct Operating Cost (DOC) we need to add the costs of owning or renting an aircraft.
Owning an aircraft means we need to consider the cost of the capital frozen in the aircraft, whether we have loaned the money to buy it or not. With today’s low lending costs for aircraft investments (aircraft are considered a good collateral for loaned money), it’s unusual for airlines to invest more own capital in its fleet than necessary.
About 40% of the world’s aircraft are rented (leased) from aircraft leasing companies. These companies are specialized in financing aircraft on good terms and looking after the aircraft’s status when it rents them to airlines. Any missed rent payment or mismanagement of the aircraft by the airline and the leasing company will repossess the aircraft, to lease it to someone else.
To safeguard for any accidents (small or large) that might happen to the aircraft, the aircraft are always insured to their full value. The cost for the insurance is included in the Capital costs.
When ownership costs and insurance costs are added to Cash Operating Cost we have the airlines Direct Operating Cost.
In the next article in the series, we will give examples of these costs for our Narrow and Widebody fleets.