Capacity Cushions and the Airline Industry


The Capacity Cushion is the amount of reserve capacity a business maintains to handle sudden increases in demand or temporary losses of production capacity; it measures the amount by which the average capacity utilization falls below 100 percent.


Overview

Measuring the Capacity Cushion
Capacity and the Airline Industry
Maximizing Capacity in the Airline Industry
Airline Capacity Cushions – Overbooking
Dealing with Demand Fluctuations

References

Additional Reading

External Links

Measuring the Capacity Cushion

To measure the capacity cushion in a business, one must subtract demand from effective capacity. To minimize both costs and losses, a business must take care when determining the size of its capacity cushion. Large capacity cushions are common in industries where demand is highly variable and there is low capital intensity. Companies with less flexibility, higher costs and high capital intensity maintain smaller cushions. When a business’ capacity is less than the capacity required to meet demand, it is said to have a negative capacity cushion.

Capacity and the Airline Industry

In the airline industry capacity is the number of seats available to sell per flight. In order to maximize profit, airlines aim to dispatch aircraft with as many seats filled as possible. Seeing as the seats are perishable, and cannot be carried over to the next flight, airlines have very minimal flexibility. Airlines are extremely capital intensive and must attempt to maximize their payload on every sector.

Maximizing Capacity in the Airline Industry

Maximizing capacity in the airline industry is controlled by yield management through segregated ticket prices. Each fare price group is based on a certain percentage of available seats remaining on the flight - controlled by a computer algorithm. When the flight is initially created, prices are at a reasonable level to attract customers and cover fixed costs associated with the operation of the flight. As the departure date draws closer (within 2 weeks) the fares rise in price. At a predetermined point before the flight (2 or 3 days prior), prices are lowered in order to attract more passengers and fill the empty seats. Finally, on the departure date, fares are raised to attract those passengers that need to get on the flight on a last minute basis and are willing to pay whatever the cost. As bookings increase, cheaper fare levels disappear and higher fare prices remain. Finally, if there is excess capacity on a flight, airlines will either reduce the aircraft size or offer highly discounted ticket prices in order to maximize profits based on pure volume of passengers. Discounting tickets will not produce a high yield; however, because the seats are perishable, even a mere profit on the seats is better than leaving the seats empty.

Airline Capacity Cushions – Overbooking

It is common for scheduled airlines to overbook their flights. The reason for this is to maintain as close to full capacity as possible. Based on historical data, each airline has their own method of forecasting demand. This forecast will determine the number of flights, routes, and seats available (capacity). It will also predict how many people will not show up for each flight. This is termed a ‘no show rate’ and industry wide, there is said to be an approximate 10% no show average. Keeping in mind the 10% no show rate and the perishability of each empty seat, airlines will overbook their flights. The yield on extra tickets sold for the flight offsets the costs associated with inconveniencing and rebooking passengers when their forecasts fail.

Dealing with Demand Fluctuations

Due to the volatile nature of the airline industry, there are many contingency plans in effect to deal with demand fluctuations. Capacity can be adjusted to better meet demand and to better yield a profit for the airline. When demand is lagging, airlines can adjust the equipment that is used to operate a certain flight. By reducing available seat miles (ASM) airlines are able to decrease capacity. By reducing seats where demand lags, airlines are able to maintain a higher load factor. The load factor is the quotient of revenue passenger miles (RPM) divided by available seat miles and is a standard for measuring success in the industry. Theoretically, a higher load factor yields a larger profit margin. Although ASMs change only when aircraft with different seating capacities are swapped in order to complete a flight, RPMs fluctuate based on the amount of passengers carried on each flight segment. Figure 1 below shows three different seating charts for various Boeing 767 aircraft.




Figure 1: Boeing 767 seating chart

References

GOL Announces Traffic Statistics for September 2004. (2004, October 09). Retrieved February 09, 2008, from BNET: http://findarticles.com/p/articles/mi_m0EIN/is_2004_Oct_9/ai_n6229172

Ritzman, L. P., Krajewski, L. J., Malhotra, M. K., & Klassen, R. D. (2007). Foundations of Operations Management - 2nd Canadian ed. Toronto: Pearson Education Canada.

Wells, A. T.,Wensveen, J.G. (2004). Air Transportation, A Management Perspective, 5th Edition. Toronto: Nelson Thompson Learning.

R, H., & S, W. (1984). Restoring our Competitive Edge: Competing Through Manufacturing. John Wiley and Sons.

Boeing.(2008).Retrieved February 11,2008,from Boeing: http://www.boeing.com


Further Reading

http://www.armchair.com/info/overbook.html

http://www.airsafe.com/complain/bumping.htm

http://airconsumer.ost.dot.gov/publications/flyrights.htm#overbooking

http://www.rediff.com/money/2006/feb/04hol.htm

External Links

http://www.airliners.net/

http://www.flightglobal.com/home/default.aspx

http://www.pilotpointer.com/

http://frequentflyer.oag.com/airlines_airports/seating.asp

http://www.boeing.com/

http://www.fly-winair.com/

http://www.corsairfly.com/

http://www.avcanada.ca/