This paper analyzes the operating income of West Coast Airlines (Westcoast Air) on its one-way flights to Fiji under multiple pricing and capacity scenarios. Using a cost breakdown that separates variable costs (fuel, food and beverage, commissions) from fixed costs (aircraft lease, ground services, flight crew), the paper demonstrates that the airline is losing money on every flight under both its current pricing structure and a reduced-fare scenario. The analysis then evaluates a charter deal offered by Travel International, showing that the charter arrangement generates a positive operating income per flight. The paper concludes that Westcoast Air should accept the Travel International offer, as it improves overall operating income and may reduce per-flight losses on regular routes by increasing average passenger load.
Operating income is typically defined to include all operating expenses other than depreciation and taxes (Investopedia, 2011). Because the aircraft are leased rather than owned, there is no depreciation for West Coast Airlines to take into consideration. The operating income calculation therefore focuses on revenue against variable costs — including fuel, food and beverage, and commissions — and fixed costs such as the aircraft lease, ground services, and flight crew.
Under its current pricing structure, West Coast Airlines is losing $31,012.50 on every one-way flight to Fiji. The cost components include variable fuel, food and beverage per passenger, commissions, the fixed lease, ground services, and flight crew wages.
If the company lowers the ticket price in order to generate an increase in passenger volume, the operating income figures change as follows: variable fuel costs total $14,000, the fixed lease remains at $53,000, and the resulting operating income is –$28,924 per one-way flight. In other words, Westcoast Air loses $28,924 per one-way flight under the lower-price, higher-volume scenario — an improvement over the baseline, but still a substantial loss.
The larger issue is that even under the reduced-fare scenario, the company loses an extraordinary amount of money per flight. The primary driver of this loss appears to be the aircraft lease. The lease is a fixed cost, yet the current flight schedule means it is being spread across too few flights, making it behave like an outsized variable cost burden per trip.
What the company needs to do is either add more flights — thereby spreading the average lease cost per flight across a greater number of departures and bringing it down to a level where profitability becomes achievable — or switch to a smaller aircraft with a lower lease price. Given that the load factor on these flights under the first scenario is a paltry 53.8%, the latter option deserves serious consideration, provided that a smaller-capacity aircraft capable of completing the route can be found at a more favorable lease rate.
With the Travel International (TI) offer, several changes apply to the income statement. First, food and beverage and fuel costs are removed, since TI is covering those expenses directly. The lease amount per flight remains the same, as Westcoast Air is operating the same total number of flights. Additionally, agent commissions are eliminated, since travel agents are not involved in selling charter tickets. The assumption is also made that total passenger numbers do not change across the network.
Westcoast Air should accept the Travel International offer. The TI charter arrangement yields an operating income of $7,500 per flight. The charter flight figures are as follows: revenue of $1,800,000 across 24 flights, ground services of $180,000, flight crew of $168,000, and a fixed lease allocation of $1,272,000, producing an operating income of $180,000 — or $7,500 per flight. While Westcoast Air will still lose money overall, these charter flights are individually profitable, which cannot be said of the airline's regular scheduled service.
Another factor in this decision is the potential impact of TI's flights on regular Westcoast Air flights. If no passenger cannibalization is assumed, Westcoast Air's regular demand of 36,400 passengers will be distributed across 184 flights instead of 208, raising the average to approximately 197.8 passengers per flight. This would mean that the losses on regular flights would be somewhat lower than at present, even though Westcoast would still be losing money on those routes. A discussion of cannibalization in airline revenue management is relevant here: any scenario in which the cannibalization rate is less than 100% produces an incremental benefit for the regular flight schedule.
"Combines own-flight and charter figures for final recommendation"
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