Experiential Airlines Case Study Experiential Airlines is a


Question Description:

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Experiential Airlines is a medium sized airline located in a small nation and is government-owned.  The country in which Experiential is located has been ruled by the same president for more than 30 years.  During this time, tight controls were placed on all aspects of the economy.  Over time, the country’s wealth was concentrated in the hands of a few powerful supporters of the president.  The economy stagnated, and basic infrastructure fell into disrepair.  Recent violent protests, however, have led the aging president to announce his retirement.  He has scheduled an election to be held in three months’ time.  At stake in the election will be the presidency as well as all the seats in their legislature.  Several political parties have been organized and are fielding viable candidates.  All the major parties agree that opening the economy to competition is necessary for the country’s financial recovery.

The Current Situation

“As you know,” Experiential’s CEO continued, “we have enjoyed monopoly status on all domestic routes under the current government.  That has made life pretty comfortable for us.  Unfortunately, that also means we’ve served our markets without much thought to the quality of the service or facilities that we provide.  But last night each of the three major presidential candidates indicated that, if elected, he/she will privatize our company and open our market to competition.  Their plans are similar.  Experiential Airlines will become an independent corporation.  Some of the corporate stock will be distributed to current employees based on salary and length of service.  But most of the shares will be distributed to the local government bodies whose committees we serve.  These shares will be allocated based on the volume of service we currently provide to each community.  A temporary advantage for our current management team is that none of these bodies has any experience running an airline.  In addition, no single shareholder will initially have a controlling interest.  Thus our management team should have a pretty free hand in running the company for the next several months.  The new company’s shareholders, however, will have the right to sell their shares.  It seems likely that many will choose to sell and that a private investor or group of investors will eventually gain effective control.  Thus our time to shape our own destiny may be short.”

The CEO then held up the diagram in Figure 1 and summarized operations.  “Domestically, Experiential operates out of a primary hub in our capital city (FOS) and two subsidiary hubs in OLP and RAV.  The company serves six international destinations, four large domestic cities (including the two subsidiary hubs), and five small regional cities from FOS.  There is a direct service between OLP and RAV.  In addition, there are six small regional cities served from OLP and four regional cities served from RAV.  Table 1 provides our schedule of daily flights.

“At present, there is reciprocal service on the international routes but without “beyond rights.”  That is, for each international destination that we serve, an airline from the destination country (usually the flag carrier) is allowed to serve FOS.  But those carriers aren’t allowed to serve any domestic cities beyond FOS.  Similarly, we serve only one city each of our international destinations.  The competitive change that will occur is that the reciprocal carriers will be offered ‘beyond rights” so they can serve any of our destinations.  This right will include carriage of passengers from one domestic city to another.  The offer of ‘beyond rights,” of course, will be subject to our gaining similar rights in the corresponding international market.

MIR

Figure 1:  Experiential Airlines Route Map

TSI
GDC
ARF
RUB
RHL
NIW
RAV
ALB
VOL
DLV
ELP
ATV
BAG
SUR
OL
FOS
MAJ
SEN
RAV
LIS
RAK
MIS
SAM
 
 
RAT
LOT
ILS
OLP

International Route        Large-City Route          Regional-City Route

Table 1:  Experiential Airlines Daily Flight Schedule

All flights operate 365 days per year

 

 

 

HOME CITY

 

 

 

DESTINATION

 

ONE-WAY

DISTANCE (miles)

 

 

MARKET

SEGMENT*

 

 

 

EQUIPMENT**

 

ROUND-TRIP

FLIGHTS

PER DAY

ANNUAL

PASSENGER

MILES FLOWN

(millions)

FOS GDC 2,800 I JJ 1 480.3
  ARF 2,500 I JJ 1 465.3
  TSI 1,800 I JJ 1 329.8
  RHL 3,200 I JJ 1 630.7
  MIR 1,200 I JJ 1 223.3
  NIW 3,500 I JJ 1 608.1
  RUB 280 C MJ 2 32.7
  OLP 240 C MJ 6 98.9
  SUR 270 C MJ 2 32.7
  RAV 260 C MJ 6 103.7
  ALB 125 R TP 4 7.7
  VOL 160 R TP 3 6.3
  ELP 170 R TP 2 4.2
  DLV 140 R TP 2 2.2
  ATV 130 R TP 6 3.9
OLP RAV 225 C MJ 4 60.5
  BAG 180 R TP 2 2.1
  MAJ 170 R TP 2 2.2
  RAK 200 R TP 3 8.8
  SAM 130 R TP 3 4.6
  ILS 170 R TP 4 3.9
  RAT 120 R TP 2 1.2
RAV SEN 190 R TP 4 6.7
  LIS 125 R TP 2 1.6
  MIS 120 R TP 4 2.5
  LOT 135 R TP 2 1.2
            3,125.1

* I=International,  C=Large City,  R=Regional City                                 ** JJ=Jumbo Jet,  MJ=Medium Jet,  TP=Turboprop

“In my opinion, we have one of two ways to go.   We can try to be a major, full-service carrier, or we can focus on being a low-cost carrier for our local markets.  We need to decide which approach is more viable.  Do we expand our international reach, or should we focus on improving our local services?”  With that question left unanswered, the CEO handed the meeting over to the CFO.

“Reviewing the current situation, I am pleased to report that we are in a strong financial position.”  The CFO explained, “With the exception of a couple of quarters when fuel prices spiked, we’ve been consistently profitable.  We’re also in the enviable position of owning our own aircraft, and yet we have almost no debt.  This situation is the result of our policy of acquiring aircraft only when the government has had the funds to buy them outright.  On the other hand, it also means that some of our aircraft are quite old.”

“Our fare structure is very simple,” the CFO continued.  “We match the hard-currency denominated prices charged by our competitors on the international routes.  We have a slight advantage because government employees have access only to the local currency, the Klaga, which we readily accept at the official exchange rate.  Depending on the status of the international money markets, our competitors sometimes impose a surcharge on payments made in Klaga.  The result is that we feel only moderate pressure on prices on these routes, and we currently average 165 Klaga for a one-way international flight.

“Fares on domestic flights are negotiated annually with our government’s Aviation Oversight Agency.  Government policy has been to allow us a ‘reasonable’ overall profit.  We use two types of aircraft on our domestic routes: medium-sized jets on the large-city routes and turboprops for the regional cities.  Customers find the turboprops less desirable, so we charge lower fares on them.  Right now the agreed fare structure is 89 Klaga for a one-way ticket on a medium-sized jet and 49 Klaga for a one-way flight on a turboprop.  This two-tier fare     structure simplifies marketing but doesn’t reflect differences in distances traveled on each route.”

Table 2: Experiential Airlines

Last Year’s Income Statement (in millions)

Revenues   316.9
Aircraft costs    
   Fuel 158.1  
   Depreciation   44.4 202.5
Personnel costs    
   Pilot crew   24.8  
   Cabin crew   17.7   42.5
Ground costs    
   Gate rental     2.8  
   Ground staff     6.1     8.9
Corporate costs    
   Marketing   21.5  
   General admin.   17.4   38.9
Net Income     24.1

Condensed Income Statement by Market Segment  (in millions)

                                         Large      Regional

Int’l          city            city         Total

Revenues 180.7 116.9 19.3 316.9
Aircraft operating costs 177.4   21.3    3.8 202.5
Other costs   35.3   42.3   12.7   90.3
Net income (32.0)   53.3     2.8   24.1

The CFO then handed out Table 2 and said, “I hope this document will help you understand how we perform.  The top part is last year’s income statement.  In the second part I’ve divided the costs and revenues by our three major market segments: international routes, large-city routes, and regional-city routes.  It was easy to identify revenues by market segment.  Costs, however, were more difficult.  To split the costs, I allocated aircraft operating costs to each segment based on the relative number of passenger-miles-flown in each market.  [Passenger-miles-flown is the industry’s measure of volume.  Ten passenger-miles could represent one passenger flying 10 miles, five passengers flying 2 miles, or some other similar combination.]  I used passenger-miles because the aircraft operating costs depend on both the distances flown and the number of passengers carried.  The other costs we incur are primarily related to the number of passengers served, so I used last year’s passenger counts to split those costs.  The numbers in Table 2 are approximations, but they clearly show that we’re operating at a loss in the market segment where we face competition.  Our challenge will be to stay profitable when competition expands to our domestic market.”

As the meeting ending, the CEO said, “For our next meeting, I want each of you to give some thought to the challenges we face.  I intend to start next time with a SWOT analysis.  I hope that exercise will then help us identify a viable strategy for our future.  In the short run, I think survival is our paramount goal.  As most of you know, the failure rate is quite high for former monopolies suddenly thrust into a competitive market.  But we need to consider our longer-term strategy also.”

The Challenge

You are a manager in the Financial Services Department at Experiential Airlines.  A few days ago after the meeting, several of the younger company managers stopped by your office.  “You know, most of the other managers are fairly old, set in their ways, and have never worked in a competitive environment.  I don’t think many of them will survive the changeover,” one of your colleagues said.  Another commented, “Their departure will open up career opportunities for those of us who can adapt, assuming we do.  I suggest we work together as a team to analyze the situation and come up with recommendations in time for the next executive committee meeting.  That will increase our chances of being appointed to leadership positions in the transition process.”  There was quick agreement on a plan of action and the team agreed to meet the following Friday.

The information provided in Tables 3 and 4 was distributed on Friday afternoon.  “I haven’t had a chance to analyze the information,” the person who gathered the data in Table 3 and 4 said.  “Unfortunately, I also haven’t been able to get as much detailed information as I would have liked.  But the executive committee meeting is on Monday so we need to proceed with what we have now.”

You then suggest, “Let’s spend the weekend at my house going through the material.  We can start by digging into the financial details.  I suggest we examine the relative profitability of the market segments and determine our breakeven passenger volume for one of our routes, say the FOS to ELP regional route.  These exercises should familiarize us with our basic cost structure.  Then let’s prepare a SWOT analysis as requested by the CEO.  But our most important task is to come up with a recommendation for a strategy.

The Assignment

  • Prepare an analysis of the profitability of each market segment
  • Determine the breakeven passenger volume for the FOS to ELP route
  • Determine breakeven passenger and breakeven fare for each route
  • Prepare a SWOT analysis for the firm
  • Recommend a strategy for the firm
  • Prepare a formal presentation for the executive committee
Table 3:  Further Information on Experiential Services and Competition

Our customer base is pretty thin.  Few of our citizens can afford to travel for personal reasons.  We serve far more small regional locations than most other national airlines.  The government directed that some of our routes be undertaken to boost local economic development.  Another factor is the abysmal condition of most of our country’s roads.  Few of our customers are willing to undertake the rigors of intercity road travel if they can avoid it.

We have the annual passenger volumes for each route, but we don’t know how those loads are distributed throughout the week.  I was told that patronage was light on our domestic weekend services.

Our firm hasn’t conducted formal customer surveys, but the general impression from friends and colleagues is that we are below average in customer satisfaction.  Our lack of domestic competition has allowed us to get away with offering pretty basic service.  For example, we don’t have entertainment systems in any of our aircraft, our spacing between seats is tight, and there is no beverage service on domestic flights.  Our on-time performance is far below industry standards.

On the other hand, our safety record is very good.  Because there is little pressure to adhere to our published schedule, flights are routinely delayed or cancelled whenever there’s an indication of an equipment malfunction.  Our only accidents to date have been quite minor.  Our worst accident occurred a couple of years ago when a plane hit a cow on one of the regional runways while landing.  There were a few minor passenger injuries but nothing serious.  Yet we got a lot of unwanted “humorous” attention from the news.

Our ground facilities are generally in poor condition.  This is especially true at the regional destinations.  Ground facilities are owned by the local government bodies, and we pay rent for their use.  But little of our rent money has gone into maintaining the facilities.

Our international flights leave early in the morning so travelers can reach their destination in time to conduct business during the day or to catch connecting flights if they are travelling farther.  Our planes then sit idle at the destination airport until about 6pm local time when they return home.  Our competitors for the most part fly here only in the late afternoon and then return to their home country in the early evening.  They don’t want to have a plane sitting here idle overnight or during the day.  Thus we operate our international morning flights at near capacity.

 

 

Table 4:  Experiential Airlines Summary of Selected Cost and Operating Data

Average Passenger Loads and Distances

 

Average Passenger Loads and Distances

One-way Flights                               Annual Passenger-

per day                             miles (millions)

International (Jumbo Jet)                                       12                        2,737.5

250 passengers flying 2,500 miles

City (Medium Jet)                                                     40                                            328.5

90 passengers flying 250 miles

Regional (Turboprop)                                              90                                              59.1

12 passengers flying 150 miles

TOTAL                                                                                                                          3,125.1

 

Annual Fuel Costs                                                                                                                           Millions

 

International      Kr 10,000 per flight + Kr 0.02 ppm   = Kr 43.8 + Kr 54.7                       98.5 Kr

City                        Kr   2,500 per flight + Kr 0.015 ppm = Kr 36.5 + Kr   4.9                       41.4

Regional               Kr      500 per flight + Kr 0.03   ppm  = Kr 16.4 + Kr   1.8                       18.2

TOTAL                                                                                                                                               158.1 Kr

Aircraft Fleet

Average               Original                                                 Annual

Seating                                Aircraft                    Cost                    Useful            Depreciation

Capacity               Age (yrs)              (millions)               Life                   (millions)

6 Jumbo Jets                         300                           7                         600 Kr                       20                        30.0 Kr

10 Medium Jets                                   100                         14                        250 Kr                       20                        12.5

25 Turboprops                        25                         22                          57 Kr                       20                          1.9

TOTAL                                                                                                                                                                   44.4 Kr

Annual Cost for Pilots

Crews                  Number of                                          Total

Market                                 Needed                    Pilots                 Average              cost

Segment                              per year                  per year               Salary             (millions)

International                         24                                3                      175,000 Kr           12.6 Kr

City                                           40                                2                      100,000 Kr              8.0

Regional                                  30                                2                        70,000 Kr               4.2

TOTALS                                                                                                                                24.8 Kr

  • A crew flies one one-way international flight per day. Crews for the large-city routes fly one round-trip flight per day. The regional crews fly three round trips per day.  But crews don’t work every day, so there needs to be an allowance for holidays, sickness, etc.  Thus the firm hires an equivalent of twice the number of crews needed per day.

Annual Cost for Cabin Crews

Crews                   Number of                                          Total

Market                                 Needed              Attendants          Average              cost

Segment                              per year                  per year               Salary             (millions)

International                         24                              10                       50,000 Kr            12.0 Kr

City                                           40                                3                        40,000 Kr               4.8

Regional                                  30                                1                        30,000 Kr               0.9

TOTALS                                                                                                                                17.7 Kr

  • Cabin crews put in same amount of flight time as pilots

Gate Charges    

Average               Annual

Number of            Gate                      Cost

Type of Gate                                           Gates               Rental              (millions)

International Destinations                   6                      150,000 Kr           0.9 Kr

International Gates at FOS                   3                      200,000 Kr           0.6

City Gates at FOS                                     3                      100,000 Kr           0.3

Other City Gates                                      5                        60,000 Kr            0.3

Regional Gates at FOS                            4                        50,000 Kr            0.2

Other Regional Gates                           20                       25,000 Kr            0.5

TOTALS                                                                                                              2.8 Kr

  • Gates are dedicated to each type of aircraft. Thus, there is no sharing of gates among the three market segments.  There is one large-city gate at RUB, OLP, and SUR, and there are two large-city gates at RAV.  Each regional city has one gate.  There are three regional-city gates at OLP and two at RAV.

Ground Staff Salaries

Total                  Annual

Number of          Number of          Average                 Cost

Location of Staff                               Locations             Employees            Salary               (millions)

International Destinations                 6                              24                     50,000 Kr              1.20 Kr

Primary Hub (FOS)                                 1                              40                     42,000                   1.68

OLP                                                              1                              20                     40,000                   0.80

RAV                                                             1                              12                     40,000                   0.48

RUB & SUR                                                1                                8                      35,000                   0.28

Regional Destinations                        15                             60                     27,000                   1.62

TOTALS                                                                                                                                              6.06 Kr

  • An informal time study shows that the staff at the primary hub spends 30% of their time servicing international flights, 40% on domestic large-city flights, and 30% on regional flights. The staff at OLP spends 40% of their time devoted to large-city flights and 60% to regional-city flights.  The staff at RAV spends 50% of their time on large-city flights and 50% on regional flights.

Answer

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