Case study 1: The European Airline Industry

Q1. Evaluate how the rivalry among existing firms has developed after 2004. (no more than 400 words)

A1. Rivalry among existing firms has developed for several reasons:

First, it is because of more and more companies realize the profitability of the airline industry.As the table shows that both average AEA operating margins of before interest and after interest were increasing obviously from 2004 to 2007. And it is worth noting that both average AEA operating margins reach the breakeven point and keeping increasing from 2004. The statistics mentioned above all indicate from 2004 airline industry become profitable.From 2004, AEA market share of the 4 and 8 largest airlines were decreased. It means that the top largest airlines¡¯ market influence are decreased and monopoly situation become weak. Then the other airlines companies has more market share, so the top largest airlines will have more

competitors. So when the profitability were found, more competitive companies came to the airline industry. And while the top airlines power were weaken from the impact, airline industry became more competitive. As a result rivalry among existing firms has developed.

Second, the revenue passenger kilometers (RPK) increased quickly from 656,677mn. to 781,165mn. from 2004 to 2007. Same as the RPK, cargo tonne kilometers increased from 36,009mn. to 38,635mn.. It indicate that the demand of cargo transport and passengers were increasing, which lead to a significant increase in supply. However, the high market share companies can not satisfy the increasing demand of passengers and cargo transport. Giving the competitive companies with lower market share a chance to get more customer. As a result, rivalry among existing firms has developed.

Q2. Evaluate the influence of rising fuel prices on the AEA airlines¡¯ profitability between 2003 and 2006. If fuel prices had not increased after 2003, what would have been the pre-interest breakeven load factor in 2006 (assuming all other factors constant)? (no more than 200 words)

A2. From 2003 to 2006, cost per kilometers increase from 54 to 56.9. And the fuel cost to total cost increase sharply from 12.1% to 22.8%. The fuel cost became a more and more important part of the total cost. Although, the demand increased, the pre-interest breakeven load factor did not change a lot just kept around 67.5%. The rising fuel prices limited the AEA airlines; profitability between 2003 and 2006.

While assuming all other factors constant,if fuel prices had not increased after 2003, the fuel price equal tocost per kilometer in 2003 timesfuel cost to total cost in 2003result in 6.5. And the cost of non-fuel cost in 2006 equal tocost per kilometer in 2006 times 1 - fuel cost to total cost in 2006 result in43.9. As for the cost per kilometer in 2006 equal to the cost of non-fuel cost in 2006 addthe fuel price result in 50.4. The pre-interest breakeven load factor in 2006 equal to cost per kilometer in 2006 divide by revenue per kilometer in 2006 equal to59.6%. So the pre-interest breakeven load factor in 2006 is 59.6%.

Q3. During the period examined, some airlines started to charge fuel surcharges to their customers. For example, late 2007 KLM charged its customers €27 on European flights and €80 on intercontinental flights. Other airlines had similar surcharges. How do such practices affect your answer to question 2? (no more than 200 words)

A3.In late2007 KLM charged its customers €27 on European flights and €80 on intercontinental flights. While use the same practices between 2003 and 2006, the revenue would increase due to the surcharge. And because the old practice did not change the pre-interest breakeven load factor, with the new practice the revenue of AEA airlines would increased faster than the cost caused by rising fuel price, and it

would be a positive influence in the profitability of AEA airline.

If the fuel prices had not increased after 2003, the cost per kilometer in 2006 still equal to 2003, however the revenue per kilometer in 2006 will higher than 84.5 because of the fuel surcharges to their customers. Therefore, because the pre-interest breakeven load factor in 2006 equals to cost per kilometer in 2006 divided by revenue per kilometer in 2006, the pre-interest breakeven load factor in 2006 will be smaller than 59.6%.

Q4. The operating margins of the AEA airlines became positive, on average, in 2004 and gradually improved thereafter. What do you think are the most important drivers behind this development? (Also consider your answers to questions 2 and 3.) (no more than 200 words)

A4. According to answers of question 2 and 3, one of the most important drivers is that the members of AEA airlines charge the customer a surcharges on fuel. The increasing of the fuel price just give them a proper reason to arise the price into a higher level. And then the other member also follow the practice.

The second reason is the fast development of AEA airlines, with the data in the table, RPK and CTK both indicate that the airline industry was expanding and the demand of customer was increasing. It indicates that the total revenue of AEA increased after 2004.The development will lead to a higher operating income.