Analyzing Air Algeria's Profitability: Financial Ratios & Challenges

This report delves into the profitability of Air Algeria, examining both macro and microeconomic factors influencing its financial performance. It explores key microeconomic concepts such as pricing decisions, aircraft acquisition strategies, output decisions, and opportunity costs. The analysis identifies determinants of airline profitability, including net profit, efficiency, load factor, pricing strategies, daily aircraft utilization, employee productivity, and leverage. It also addresses critical issues affecting airline profitability, such as unprofitable airlines continuing to operate, high fixed and variable costs, aggressive price competition, exogenous events, and reputation for hassles and poor service. The report employs quantitative data, including financial ratios like net profit margin, operating ratio, return on equity (ROE), and return on invested capital (ROIC), to assess Air Algeria's financial structure and performance. Qualitative determinants, such as foreign exchange risk, fuel costs, and labor costs, are also considered. The study concludes by highlighting the challenges faced by the airline industry and offering potential strategies for Air Algeria to enhance its profitability. Desklib provides this and other solved assignments to aid students in their studies.

Introduction………………………………………………………………………………3
1. Airlines Profitability………………………………………………………….……….3
1.1 In the macro and micro view……………………………………….……….3
1.2 Microeconomics concept…………………………………………………….4
1.2.1 Pricing decision…………………………………………………………..5
1.2.2 Aircraft acquisition……………………………………………………....6
1.2.3 Output decision. ……………………………………………………..….6
1.2.4 Choice and opportunity cost…...……………………………...………..7
2. Determinants of Airlines profitability………………………………………………..7
2.1 Measures of Profitability in the Airline Industry …………………………10
2.1.1 Operating Ratio ………………………………………………………….10
2.1.2 Net Profit Margin ……..............................................................................10
2.1.3 Return on Invested Capital (ROIC)…….………………………………10
2.1.4 Return on Equity (ROE)…………………………………………............10
2.2 Determinants of profitability………………………………………………...11
2.2.1 Net Profit………………………………………………………………….11
2.2.2 Efficiency………………………………………………………………….11
2.2.3 Load Factor……………………………………………………………….11
2.2.4 Pricing……………………………………………………………………..12
2.2.5 Daily Aircraft Utilization………………………………………………...12
2.2.6 Employee Productivity…………………………………………………...13
2.2.7 Leverage…………………………………………………………………...13
2.3 The airline's profitability main issues………………………………………..13
2.3.1 Unprofitable Airlines continue to fly…………………………………….14
2.3.2 High fixed and variable cost……………………………………………...14
2.3.3 Aggressive price Competition………………………………….………...14
2.3.4 Exogenous events…………………………………………………………15
2.3.5 Reputation for hassles and poor service………………………………...15
3. Methodology versus data……………………………………………………………...15
3.1 Model Variables……………………………………………………………….16
3.2 Performance Earning Ratios…………………………………………………17
3.2.1 Net profit margin…………………………………………………………17
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3.2.2 Operating ratio…………………………………………………………...17
3.2.3 Return on equity (ROIC)………………………………………………...17
3.2.4 Return on equity (ROE)………………………………………………….18
3.3 Source of Data ……………….………………………………………………..18
4. Quantitative data description…………....…………………………………………...19
4.1 Financial structure of Air Algeria ...………………………………………...20
4.2 Return on Capital Employed (ROCE)..…………………………………….21
4.3 Return on Assets (ROA)…………………………………………..….……...21
4.4 Fixed Assets Turnover……...………………………………………………..21
4.5 Coverage interest Ratio ….…………………………………………….........22
4.6 Net Margin, Operating ratio and Return on Equity (ROE)……………....22
4.7 Load factor…………………………………………………………………...23
4.8 CASK and RASK………….……………….…………………......................23
4.9 Ratios Analysis .................................................................................................23
4.9.1 Ratios Analysis Summary...........................................................................24
5. Qualitative Determinants by the airline industry…………………………………..24
5.1 Foreign exchange risk……………..………………………………………...25
5.2 Fuel cost……………………………………………………………………....26
5.3 Labor cost………………………………………………………………...…..27
5.4 Challenges…………...…………………………………………………..........28
References…………………………………………………………………………...……30
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Introduction
This study aims to demonstrate the options to analyze the profitability of the enterprise in the
macro and micro environment particularly focusing on the growth of airline Air Algeria. The major
goal of the assignment is to offer them alternatives to increase their performance based on the
rationale and methodology that will be chosen during the study. In December 2017, the International
Air Transport Association (IATA) which represents over 280 air carriers spoke about the profitability
estimates for 2018. According to Bottom Line (2017) strong profitability which was reported in 2017
would continue into 2018 yielding an estimated $ 38.4 billion globally. However, in the month of June
of 2018, IATA announced that the profitability of world’s biggest airlines headed for a dip. The
determinants of Aviation Profitability and the stated reasons that make profitability fall will be
addressed in the next chapters.
1.4 The Airline industry overview
Aviation began early in the 20th century and entered the modern age after WWII. It has become a
trend toward deregulation in 1978 and turned into a mass market product that disseminated
internationally ever since. Airlines are a tool for economic development, it is an industry that is
essential to the economic system of the modern age. The airlines must follow the safety regulations
(EASA, FAA, ICAO, and IATA), environmental regulations and airport restrictions. In the Airlines,
there are many different stakeholders as: passengers, employees, airports, financiers, suppliers,
governments, air navigation providers, marketing partners, etc.
The major characteristics of airline industry are:
 Commercial systems
 Booking and reservation systems
 Revenue and pricing management
 Customer management
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 Social media
 Scheduling systems
It is a business where losses are more certain than profits and shorts are the usual occurrence.
Everyone who dreams about starting an airline is aware of such risks, yet there are always
entrepreneurs, who are eager to send them aloft and investors willing to gamble on the venture. They
are driven by the very human aspiration to succeed where others have failed
The systems to management, planning and control:
Flight Operations systems:
 Crew planning and scheduling
 Flight planning; OCC: (flight tracking; hub control; weather)
Airport systems:
 Departure control (check-in, load sheet, weight and balance)
 Airport flight information and customer systems
 Maintenance planning and control
 Financial systems and accounting
In such market, where equipment is very expensive, inventory can be spoiled every time a
flight takes off with unsold seats. So, the bottom line is very vulnerable to GDP growth due to several
reasons including the price of fuel. With relatively minimal profit margins, the financial condition of
the airline industry is highly dependent on global economic conditions. During the times of economic
boom, profits soar and in times of recession airlines are forced to reduce capacity. Prior 1978, the
industry was relatively stable based mainly on the government's enforcement of non-competitive
regulation and pricing. In the post-deregulation era, the industry took on more cyclical nature of a
sector industry, where periods of financial results could be followed by a turbulent economic period.
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The financial condition of the air transport industry is relevant to the economic growth, so it is
therefore not surprising that the airline industry suffered when the economy stalled. Before
deregulation, domestic traffic was organized according to the rule established by each country. For
each country, the local authority was responsible to determine how carries should choose their routes
and specify capacity each approved carrier could offer on each route along with fares to be charged. In
the United States, the Civil Aeronautics Act of 1938 was introduced to regulate and control
competition between US domestic’s carriers. Uncontrolled competition had led to anarchic economic
conditions, little security to investors and low safety margins. Three arguments were used to justify
the implementation the Civil Aeronautics Act of 1938. The first one was about the absence of any
regulation of market entry, which would lead to a destructive competition. The fact that the industry
has non-differentiated product and relative low barriers for new entrants, the small new entrant airlines
would not have a cost disadvantage when competing against much larger incumbents. These new
entrants into particular market would try to establish themselves by under-cutting existing fares, which
certainly causes price war with dramatic consequences for the air transportation industry. The second
argument favoring regulation was that air transport is a public utility, arising economic, social and
political benefits. Hence, regulation is more than needed in order to ensure that the benefits were not
endangered. The public utility of air transport was considered significantly important that most
countries except the United States launched their flag carriers with direct government participation.
"The same carrier often operated domestic services and acted as the designated foreign carrier, it
was a natural extension of this point of view to believe that free and unregulated competition on
international air routes would endanger national interests because it might adversely affect that
national state owned airlines" (Doganis 2010).
The third argument was about supporting regulation of international air transport, rapid
development of charter flights. It further was argued that scheduled traffic was relatively thin for even
a small loss of traffic and this might jeopardize the continuation of scheduled operations.
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During the 1960s, economists began to question the benefits of regulation and argued the
advantages of deregulation and free competition by explaining existing regulation limited pricing
freedom, restricted capacity growth and excluded new entrants. If deregulation was implemented, a
more competitive environment would provide more benefits to the consumers in terms of fares. Some
inefficient airlines would be forced to leave some market or even the industry. Similarly, lower fares
would force the airlines to review their costs and to improve their efficiency and productivity.
Economist Iatrou and Oretti (2007) explained that the airline industry was not different from
the other industrial and service sectors, so neither the airlines nor the consumers needed special
protection, and the anti-monopoly regulation is sufficient to protect the consumer interest. If due to
bad management the incumbent airlines went bankrupt, others would position in the market. In 1978,
the newly elected president Carter, who made support for consumers a key part of his election
platform, signed the Airline Deregulation Act into law on 24 October. This set off a chain of events
which over the next 30 years were to transform international air transport from a protected and highly
regulated industry into one which is more truly open and competitive industry (Stephen Shaw 2010).
The deregulation came to Europe more than 10 years later. Right before the deregulation introduction,
European air transport was dominated by state owned carriers or flag carriers. Due to the protection
from their respective government, their networks were immune to competition. Consequently, some
airlines had seldom recorded a profit during their entire existence relying fully on government
subsidies.
In 1987, the European Commission introduced its three phase’s ten- year’s reform process. The EU
airlines were gradually granted rights to operate on any route in the EU, including flight wholly within
another country (Cabotage). In late 1992, the European Union (EU) had passed legislation
deregulating the airline industry. By January 1993 the European airlines had free access to all
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international routes in the EU and set their own fares. The step following the deregulation Act was the
open skies agreement.
In 1993 the US and the Netherland Government negotiated an open sky agreement followed by
a large number of agreement between the US and others Governments. Allowing each side designate
the number of airlines; so, these airlines are then free to fly to any city with no limitations on their
capacity and pricing decision.
Following the increasing number of air services agreement between individual European
countries and foreign countries, the European Court published a judgment on 5 November 2002. The
Court considered that any individual member governments of the European Union offended against
EU competition law if they signed Air Services Agreements with other countries that limited the use
of traffic right purely to airlines were owned and controlled by their citizens.
Such rights should had potentially to be available to all EU airlines. If they were not, such
discrimination was an infringement of the competition articles in the Treaty of Rome. The outcome of
this judgment was a completely new system, the European Commission would take over the
negotiation of external aviation relationship with other countries on behalf of all EU members’ states.
In less than 30 years, from 1992 to 2010, the airline industry had known an amazing change,
many of the airlines that dominated the industry during a long period of time, such as Panama, TWA,
Sabena or Swissair declared bankruptcy and ultimately ceased operation, others like Delta, Northwest,
United and Continental survived bankruptcy but merged post-bankruptcy.
Low cost airlines had appeared as major players in the market, they began to make their mark
with lower prices and new routes, recording a high growth in North America, Europe and Asia,
however, the established airlines maintained control over their regional hubs. New entrant carriers had
only limited access to landing slots at major airports and the importance of secondary airports started
to grow.
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The most significant transformation in the airline industry after the deregulation remains the
airline alliances. It was estimated that in 2010, more than 95% of all airline passengers had boarded a
flight that was operated as part of an alliance. Airline alliances are known as the innovative efforts
which helps in providing suitable assistance to its customers and also tried to improve the level of
customer satisfaction.
The large number of members of global alliances can increase their negotiating power, when
dealing with suppliers, Iatrou and Oretti (2007) mention fuel, spare parts, maintenance, catering,
airports, charges or cabin crew training as potential sources of cost reduction they can also reduce the
cost of labor by sharing the sales office and bases, members can use cheap labor force (pilots, flight
attendants) of its allies from the other nation without reducing the service quality and the same time
reducing the cost (Iatrou 2004).
After African countries became independent, national governments established their own
airlines. Many newly independent countries desired to have their own flag carriers to showcase their
independence, and those countries wanted large jets like DC-10s and 747s even if the air demand did
not warrant those jets.
Some airlines, like Air Afrique, were jointly sponsored by multiple governments. Some joint
carriers, such as Central African Airways, East African Airways, and West African Airways, were
established when the United Kingdom colonized parts of Africa.
The knowledge of aircraft, the airline industry, and financial capital, originating from the
Europeans, was used to establish the new African carriers. Aircrafts in Africa tend to be older. In
2010, 4.3% of all aircraft in the world fly within Africa. Of older aircraft, 12% fly within Africa.
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While older aircraft have low prices, they have higher fuel consumption rates and maintenance costs
than newer aircrafts.
Because many African airlines have low credit ratings. Africa has a low level of leasing
contracts in which only 5% of leased aircrafts in the world fly in Africa.
In general, the outlook of the airline industry felt to be positive with Boeing predicting (2012)
an average growth of 3.2 % over the next 20 years. This figure is further reaching 5.2 per cent and 5%
for cargo and passenger traffic respectively, which shows that airline business is an expanding
business for the aviation industry.
The profit to revenue ratio is small, and airlines are still depending on global events and the vagaries
of the global economy, which have impact for airline business, such as, profitability, revenue, oil price
and bankruptcies. The incident of 9/11 was the example of the event that can destroy the aviation
business development.
In Algeria, “Air Algérie is the flag carrier of Algeria. It is the national airline owned by the
government with almost no competition on domestic routes while its international competition is
based on bilateral agreements. As such it has significant advantages to grow and become a leading
carrier.
Strategic advantages - Algeria is a country that became independent in 1962 and since 2002
enjoys relative political stability and developing into an emerging economy - the largest country in
Africa and the Mediterranean - 41 million of population that grows at 1.5% annually - Almost 3.5 %
average annual GDP growth (for the last 10 years) - 30% of population under 15 years old - 6th
largest natural gas producer in the world - One of the top suppliers of oil and natural gas to Europe -
Largest Francophone country in the world after France - Location between Europe and West Africa
Challenges After airline deregulation started taking place, there have been a few countries
where state/government owned airlines have proven to be among the best in the world regarding
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operational excellence, customer service and profitability. In many cases, however, government
ownership has led to intervention in the airlines’ functions resulting in corruption and bureaucracy.
Air Algérie, as the national carrier, can strongly capitalize on Algeria’s strategic advantages.
The identification, rationalization and materialization of clear strategic objectives (such as: financial
performance, customer service, operational excellence, support of communities etc.) and the business
plan and strategies to achieve them is a must for Air Algérie.
Usually, it is very challenging for any Government to develop appropriate framework that
allows a government airline to develop its full potential. There is quite a number of examples of state
owned airlines that struggle to compete in today’s business environment. Most of them have faced and
underwent tremendous and severe changes (Alitalia, JAL, SAA etc.).
Some of them had to totally disappear as they could not keep up with the changes in the airline
business landscape (Olympic, Sabena). AH and the Algerian government face such a challenge and
very quickly have to decide to make the necessary changes to adapt to the new business
environment.” (Source: IATA’s Report, Aug, 2010, page 24)
1.5 The foundation and beginning of Air Algeria
Air Algeria has produced an acceptable commercial performance, according to the Medium-
Term plan; it carries more than 6.2 million passengers in 2016, with a fleet of 59 aircrafts.
Air Algeria development process is constantly and substantially being involved in order to be
in tune with international airlines standards. This happens by modernizing management tools and
information systems as well as leveraging activities to standards in an ever-changing air industry
environment and competitive landscape.
Air Algeria (IATA code: AH, code OACI: DAH) is the Algerian national airline. It was
created in 1947, when the Compagnie Générale de Transport (C.G.T.) was formed, whose network
was mainly oriented towards France.
Air Algeria operates from Houari Boumediene Airport in Algiers flying to 28 countries in
Europe, Africa, Asia, North America and the Middle East. It also serves 32 destinations in the
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Algerian territory. She is a member of the International Air Transport Association, the Arab Air
Carriers Organization and the Association of African Airlines.
Air Algeria is a joint stock company with a capital of 43 billion Algerian dinars
(approximately 403.4 million euros) wholly owned by the Algerian
1.6 Organizational structure of Air Algeria (organigram)
Air
The Algeria’s organization consists of 4 divisions and the division includes the Commercial
Division, the General Affairs Division, the Exploitation Division and the Maintenance Division. Every
division oversees its different directions, 7 other directions are directly related to the CEO, like the
audit direction, the communication direction and the strategy and prospection direction.
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The CEO oversees the operations, AH organization also consists of 5 subsidiaries that are:
1-Amadeus Algeria
2-AH Cargo
3-AH Maintenance
4-AH Catering
5-AH Handling
AH has a vertical organization, the airline emphasizes on efficiency, where the decisional
process is centralized and problem tends to be solved by the upper layer of the hierarchy. In this case,
the structure seems to lack in flexibility because of the high specialization and division of the different
tasks.
1.7 Strategic plan (2012-2017) of Air Algeria
1- Company restructuration by creating four subsidiaries (Catering, Ground handling, Tour
operator and Maintenance): In order to reduce cost, to improve management, reduce hierarchical layer
and emphasis efficiency Air Algeria plans to create four subsidiaries.
2- The implementation of the training center: The project consists of building a training center
in Algiers, where it would be hold all the necessary trainings of Air Algeria 's staff but also other
airline's staff, the center would include a pilot school.
3- Upgrade the maintenance base by introducing up to date technologies in order to reduce the
outsourcing cost: Some aircraft checks are outsourced by Air Algeria . In order to reduce the
maintenance cost, Air Algeria aims to develop its maintenance base by acquiring new technologies
that gives the necessary knowledge to ensure its own maintenance, save costs and provide
maintenance services to other airlines.
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4- The implementation of Algiers Hub in partnership with SGSIA: In order to increase its
market share in African market, Air Algeria is implementing its airport base in Algiers as a hub, and
this is done in collaboration with SGSIA, by catching African passengers travelling between Europe
and Africa.
5- Performance enhancement and market shares improvement: Consists of increasing its
capacity and load factor by increasing its market not only in the existing market but also by
developing new markets.
6- Optimization of the operating schedule: Consists of the optimization of the flights schedules
that allows an optimal use of crews in term of annual total hours flown and the highest daily aircraft
hours utilization average.
7- Implementation of the software development plan.
8- Development of internal and external communication: To adapt an efficient communication
strategy even internally (with its staff) and externally (with its customers).
9- Infrastructure improvement and properties development: The building of the new
fashionable headquarter in Algiers, to replace the actual out of date building
10- An alliance integration: Consist of joining one of the three existing alliances, believing that
joining an alliance would sustain its business and increase its purchasing power.
Air Algeria launched its Catering subsidiary in 2015, but the Ground handling. Tour operator
and the Maintenance are still in the project stage.
The implementation of the Algiers Hub was delayed until 2019, date at which the new terminal
of Algiers Airport will be operational, Algiers HUB will benefit from privileged location, perfectly
positioned between the wealthy economies of Western Europe and the emerging African market.
Algiers Airport (ALG) is competing with Casablanca Airport (CMN) for transfer passengers
between Europe and Africa, for the market share Air Algeria has increased its total passengers
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transported by 13% between 2014 and 2017, in terms of operating schedule optimization, Air Algeria
has improved its on time departure rate from only 45% in 2013 to 75% in 2017.
By the end of 2018 only 30% of the 5 years strategic plan will be achieved.
1.8 Destinations and fleet
Air Algeria flies to 43 international destinations: 11 in France, 17 in Europe excluding
France, 6 in Asia, 8 in Africa and 1 in North America.
France Europe Middle east &
North Africa Africa Long Haul
Paris Orly
Paris CDG
Marseille
Lyon
Metz
Lille
Nice
Bordeaux
Toulouse
Montpelier
Bâle-Mulhouse
Madrid
Barcelona
Palma
Alicante
Milan
Roma
London LHR
Frankfurt
Brussels
Geneva
Vienna
Budapest
Lisbon
Moscow
Budapest
Istanbul
Luxembourg
Dubai
Amman
Beirut
Cairo
Jeddah
Casablanca
Tunis
Abidjan
Bamako
Dakar
Nouakchott
Niamey
Ouagadougou
Beijing
Montreal
Table 1 Air Algeria destinations
Air Algeria has a total of 59 aircraft: 58 passenger aircraft and 1 dedicated cargo plane, for
domestic flights, Air Algeria maintains a fleet consisting of Boeing 737s and ATR72. For
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international passenger services, the company primarily uses Airbus 330s, Boeing 737s and B767s for
the cargo services the company uses the Locked 382G and Boeing737/700.
The average age of the entire fleet is 11.40 year (Table 2 shows the composition of Air
Algeria 's fleet and its average age at the end of June 2018)
Aircraft types Nbre of aircrafts Seats nbres/versions Average age
Passengers fleet
Airbus A330
Boeing B767-300
Boeing B737-800
Boeing B737-600
Boeing B737-700
ATR72
8
3
25
5
2
15
269/251
253
162/144/148
101
112
66
9.49
27.86
9.18
16.09
1.93
10.88
Sub Total 58 - 10.97
Cargo Fleet
Locked 382G 1 Cargo 36.00
Sub Total 1 - 36
Total 59 - 11.40
Table 2 Air Algeria Fleet
1.9 Competitors
Air Algeria competitor in domestic routes is Tassili Airlines which began its operation in 1999,
owned by Sonatrach (the state owned Oil Company). The Tassili Airline is operating 4 Boeing 737-
800 and 4 Dash 8 (Bombardier aircraft), few years ago Tassili Airlines started operating some routes
that are not operated by Air Algeria .
Air Algeria is competing also against Air France, Aigle Azur, Vueling, Emirates, Qatar
Airways, Lufthansa, British Airways, Iberia, Tunisair Royal Air Maroc, Royal Jordanian, Saudia,
Alitalia, Egypt Air and Air Canada Rouge. For example, a search on the net for trip from Montreal in
Canada to Algiers in Algeria for two weeks in August 2018 produced a price of 526 Euros with Star
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Alliance's Airlines Air Canada and Lufthansa with one stop at Frankfurt during the return flight, with
connecting time of 2 hours and 35 minutes whereas Air Algeria rate was 866 Euros for a nonstop
flight.
For the traffic between Algeria and France Aigle Azur remains the main competitor. Aigle
Azur is connecting several city-pairs between the two countries while Air France is only operating
between Paris Charles de Gaules and Algiers Houari Boumediene airport and recently replaced Aigle
Azur in the route between Montpelier and Algiers.
The Market between the two countries represents more than 5 million passengers per years,
where Air Algeria has a market share of 2 576 857 passengers, representing a ratio of 50% of total
market shares.
Another competitor for African passengers connecting Via North Africa is the Royal Air
Maroc RAM, Competing Via its Casablanca's HUB. For example a flight from Paris to Dakar in
Senegal, the lowest fare in the RAM's website was 726 USD, where the lowest fare for Air Algeria ’s
website was at 520 USD.
Airlines Headquarter Sales
Euros
Year sales
growth
Net Income
Million
euros
Fleet
Size
Alliance
member
Aigle Azur Paris 290 Million -1.2 10 No
Ram Casablanca 1.3 Billion + 7.3% 21 58 No
AH Group Algiers 99.5Million + 8 % 14 59 No
Table 3 Air Algeria 's Competitors performances
1.10 The PESTEL Analysis
The PESTEL framework categorizes environmental factors into key types. PESTEL focuses in
six environmental factors in particular: political, economic, social, technological, ecological and legal.
This range of factors underlines that the environment is not just about economic forces: there is an
important non-market environment. Organization needs to consider both market and non-market
aspects of strategy.
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In practice, political, economic social, technological, ecological and legal factors are often
interconnected. Nevertheless, going through each of the six PESTEL factors, helps raise a wide range
of potentially relevant issues, as follow:
 Politics highlight the role of the state and other political forces .The state is often important as
a direct economic actor. For instance, as potential customer, supplier or owner of businesses.
However, there are also influences from various political movements, campaign group or
concerned media.
 Economics refer to macroeconomics factors such as exchange rates, business cycles and
different economic growth rates around the world. It is important for a business to understand
how its market are affected by the prosperity of the economy as a whole. Managers should
avoid over-confidence at the top of the business cycle, and excessive caution at the bottom.
 Technological influences refer to influences such as the internet or rise of new composite
materials. As in the case of internet in retailing, new technologies open up opportunities for
some (e.g Amazon), while challenging others (traditional stores).
 Ecological stands specifically for green environmental issues, such as pollution, waste and
climate change. Environmental regulations can impose additional costs, for example the new
businesses that emerged around mobile phone recycling.
 Legal embraces legislative and regulatory constraints or changes. For example, legal changes
might include restrictions on company mergers and acquisitions or new tax treatments of
profits earned overseas. On the other hand, legal changes can provide opportunities.
The PESTEL framework can be used to identify how future issues in political, economic,
social, technological and legal environments might affect organizations. PESTEL analysis provides
the broad data from which to identify key drivers of change.
These key drivers can be used to construct scenarios of alternative possible futures.
1.10.1 Political Factors:
Terrorism and political instability
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The years at the beginning of the millennium were some of the most difficult that the aviation
industry has ever faced. They showed that, with wars, terrorism and the effects of political instability a
constant threat, the airline industry must address the sudden traffic downturns that can result from
traumatic political events, whilst spending very heavily to keep its own activities as secure as possible.
The time since the 11 September attacks has seen continuing problems related to security
issues. The American government, aided and abetted by several others, notably Britain, has mounted
so called "War on Terror".
New security measures are raising the cost of the airline business but has made the task of
terrorist groups a harder one, so they target aircraft less frequently.
Airlines do not have control over the size of the markets they have available to them because
wars and terrorist’s attacks- or the threat of them- can have a sudden, strong and negative impact.
Given the growing instabilities in the world political scene, it is unlikely that this will change
significantly in the industry's favor.
The industry will therefore have to accept a growing burden of security costs (through the
United States government has continued to pay US carriers' security costs. Airlines in the rest of the
world have not been so fortunate).
It will also have to understand that demand for air travel from those who do not have to do so
will be held back as a result of some people at least, feeling that the airport hassles associated with air
journeys just render the whole exercise too difficult and time-consuming to be worthwhile. These
people will either not travel at all, or will choose a surface mode of transport where the security
measures are noticeably less onerous.
Deregulation
Through the Airline’s history has been constrained by decisions made politicians and
governments. Governments have controlled where airlines can fly, and aspects of their product
planning and pricing policies.
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They also in the past had a major involvement in the industry through the ownership of
airlines. Finally, political decisions have often affected the extent, nature and geographical distribution
of demand.
Almost from the inception of the commercial aviation industry, governments regulated airlines.
They had always had a role in regulating airline safety standards. A role that remains important and, in
principle, relatively non-controversial. Government regulation, though, traditionally went very much
further than this.
For many years, and in almost all aviation markets. Governments controlled airline' route entry
and capacity and frequency decisions. Very commonly too, and astonishingly by today's standards,
governments intervened to stop airlines engaging in price competition.
Between the passing of the Federal Aviation Act in 1938 and the Airline Deregulation Act in
1978, carriers could only enter new routes by going through a cumbersome and extremely slow
bureaucratic procedure. A similar process was needed before service could be withdrawn from an
unprofitable route.
At the same time, regulatory approval was needed before fares could be raised or lowered. The
actions of the regulatory body concerned - the Civil Aeronautics Board- ensured that where two
airlines competed on a particular route, their fares were generally identical.
Another extreme case of a highly regulated domestic market was that of Australia. For many
years prior to 1990, Australia pursued a so-called 'Two Airline' policy. Under this, only two airlines
were granted access to Australian domestic trunk routes, Ansett Airlines and Trans-Australia Airlines
(later renamed Australian Airlines).
Even though theses carriers were supposed to compete with each other, in practice almost all
the areas where competition might have occurred were regulated, including the question of price
levels.
In terms of regulatory change, the US led the Airline Deregulation Act in 1978. This allowed
for much greater freedom for airlines to enter new markets and to exploit them free of constraints on
capacity or pricing policies.
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However, one important regulatory limitation remained-that of ownership. Still today, it is
necessary for 75 per cent of the voting shares of an airline to be owned by United States citizens
before that airline is allowed to fly domestic routes in the US. This means that foreign-owned carriers
are still denied the much prized Cabotage rights to fly internal routes in the US.
With domestic aviation, the European Union now provides an interesting case. By a
progressive process of liberalization ( completed in 1997), the countries of the European Union
effectively set up a domestic Single Aviation Market which freed airlines to make their own decisions
regarding market access, capacity and fares.
In turn, this has led to airlines such as EasyJet and Ryanair stablishing a true pan-European
presence, which includes many domestics operations in other countries.
Open skies agreements
Open skies agreement are bilateral and sometimes multilateral agreements between two or
more nations, where the aim is to liberalize the regulation of the international civil aviation industry,
and ultimately leads to removal or reduction of the barriers that prevent competition (Europa, 2007).
These agreements make it possible for any airline to operate routes internationally from its home
country (Smith & Cox, n.d.).
Furthermore, open air agreements have made it possible for airlines to enter into partnership
with foreign partners. Open skies agreements between countries have proved to be an efficient way to
remove barriers that prevent competition. Open skies agreements benefits travelers because a
consequence of the increased competition is on average lower airline fares (Vasigh, et al., 2008).
Additionally, the agreements make it possible to connect city pairs- foreign and domestic- that
was not previously possible. However, for airlines, open skies agreements may lead to more variations
in profitability. Depending on airlines market position, some airlines may benefit from these
agreements.
Airlines that have not previously had the right to operate certain routes have more to gain than
airlines that already operate the same route. The incumbent airline will lose the protection against
competition with open skies agreements, whereas the previous excluded airlines can challenge and
gain market share on new routes.
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As previously mentioned, the aviation market in Europe was liberalized in 1997, forming a
single European aviation market. The single European aviation market represented Europe’s first
successful open skies agreement.
In addition for airlines to be able to offer routes from a domestic destination to a foreign one,
the single European act made airline able to offer routes between airports in a foreign country (within
the union), something that was not previously possible.
Vasigh (et al, 2008) argue that the establishment of a single European aviation market is the
prominent reason for the massive expansion amongst European LCC’s like Ryanair and EasyJet.
These airlines, among others, were no longer bound to the limitation of just operating its domestic
market, but could also operate foreign routes.
The European union have been successful in the deregulating the European aviation market.
The United States of America and the European Union first signed an open skies agreement in 2007,
effective from 2008 (Europa, 2007). This enabled any European airline to operate routes to and from
the US, from any European airport.
Prior to this, many European countries had negotiated separate open skies agreements with the
US. However, European airlines were not allowed to own a controlling interest of American carriers
(<=50% ownership), and vice versa.
Privatization
Until the mid-1980s, almost all the world's major airlines, with the exception of those from the
US, were state owned. The Brazilian carrier VARIG and Korean -based Korean Air were at that time
rare exceptions to the general rule.
Since then, the situation has been transformed. The fashion in political and economic thinking
has turned full circle, with the emphasis now on the benefits in efficiency likely to result from private
rather than public ownership.
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At the same time, the airline industry has matured. It has become impossible to argue that a
global industry such as aviation, now operating on a massive scale, is an infant one in need of the
protection of widespread state ownership.
Privatization has changed the competitive scene substantially. Competition with a state-owned
airline has always been a different proposition from that with a privately-owned carrier. State
ownership has always been a virtual guarantee that an airline would not be allowed to go out of
business, with state subsidy being used to cover operating losses.
State-owned airlines may, therefore, have been able to take greater risks in defining their
business and marketing strategies, a factor which made it more difficult for privately-owned firms to
compete effectively against them. At the same time, though, state ownership brought real problems.
Government airlines often suffered from a poor image associated with subsidy and bureaucracy.
Government have intervened to ensure that a new airline has arisen from ashes of the old when
following the bankruptcy of a privately-owned airline, a new airline has been created. For example,
this was the case in 2002 when the Swiss government was heavily involved in the efforts that saw a
new carrier, Swiss International Airlines, born following the bankruptcy of Swissair.
State Aid
After the events of 11 September 2001, many governments paid compensation to airlines for
the losses incurred during the four days after the attacks when United States airspace was closed to all
commercial airliners.
However, the US government's attitude regarding aid to the American airline industry went
very much further than this. Large direct subsidies were paid to all the US major carriers. These were
intended to cover not only the immediate losses due to the airspace closure, but also to compensate
airlines for the effect of the severe and long lasting traffic downturn which followed.
As a further piece of state aid, US carriers were offered government loan guarantees of
significant value. These allowed struggling US carriers to borrow money at much lower rates than
they would otherwise have had to pay.
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In Europe, when agreement was reached to set up the single aviation market of the European
Union in 1993, it argued -entirely correctly- that government subsidies were incompatible with the
concept. It was impossible for competition to take place on a level playing field when some
government -owned airlines were receiving subsidies whilst privately -owned carriers were not.
Slot Allocation
At many major hub airports, such as London Heathrow, where demand is strong and there is a
high propensity to fly, the level of congestion can determine whether or not an airline is able to have
access to the market. Severe slots constraints can prevent market entry unless an airline withdraws a
service and sells its slots. This can protect incumbent carriers from the effect of new entrants by acting
as a barrier to entry.
The allocation of slots at level 2 and 3 airports is dealt with by the International Air Transport
Association (IATA) scheduling committees and slot conferences. Within this slot allocation process,
the most important feature is the principle of grandfather rights, which means that if an airline
operated a slot in the previous season it has the right to operate it again.
This is as long as it meets the slot the slot retention requirements or so called 'use it or lose it'
rule, which states that the airline must operate at least 80% of the flights associated with the slot.
There are also lower-priority rules that apply which relate to giving preference to services for a longer
time period, and to those which balance different types of services or market at airports (IATA2014).
Slot allocation is used to manage demand and slot trading has become the principal mechanism
through which airlines can enter the market and expand. The scarcity of slots makes them valuable
assets and they can be traded for millions of dollars. In February 2015, SAS, the Scandinavian airline,
reportedly sold a pair of slots at London Heathrow for US$60 million
1.10.2 Economic factors
If there is a clear and important interplay between the world of politics and airline industry,
then there is a relationship of equal or even greater importance between airline industry and economic
change and development.
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Economic Growth and the Trade Cycle
The demand for air travel is characterized by a very high income elasticity, with forecasters
often using figures as high as 2.0 as an estimate of income elasticity. Therefore, as the world economy
has grown, so the demand for air travel has increased too. Growth in GDP of 3 per cent might in turn
cause 5 or 6 percent increase in demand for air travel (Stephen Shaw 2011).
In 2016 Air Algeria reported an increase in demand of 11 per cent while the annual GDP
growth was at 3.5 per cent.
This continuous growth has given both enormous opportunities and great challenges to the
airline industry. The opportunities come with the chance to exploit a growing market, this is
something which would be the envy of managers in many other industries.
The challenges are to accommodate the growth through suitable infrastructure development
and without unacceptable environmental consequences and to exploit the demand whilst achieving the
stable profits which industry has so often found elusive.
Besides a clear pattern of growth, growth rates are uneven through time. Just as one would
expect, air transport industry growth rates are tied closely to those in the world economy. If growth in
the economy is rapid in a particular year, so is the increase in air travel demand.
Periods of economic stagnation see a significant slowing of the rate of increase in demand
whilst recession and economic decline are associated with a fall in both air passengers’ numbers and
in the quantity of freight moving by air (Stephen Shaw 2011).
Airlines tend to give too much efforts to develop the first and business class market, a market
which appears to be very strong when times are good, but which suffers particularly severely during
downturn when firms require their executives to travel in economy or coach class to save money. A
final problem often is that in upswing periods, insufficient attention may be given to the control of
costs, particularly labor costs.
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Pay increases that can easily be financed in good times may turn out to be a crippling burden
when, in downturn, yields are forced lower because of an overcapacity situation, to levels which do
not allow costs to be covered.
The price of jet-fuel
Total cost of jet-fuel for the global airline industry reached $208 billion in 2013 (IATA, 2014
B). The total fuel cost in 2013 represents an increase of more 3 times relative to 2004, when fuel cost
amounted to $65 billion in total. A total fuel expenditure of $208 billion is actually the highest ever
recorded by IATA, but it happened twice- in 2012 and 2013.
During the ten years, the average price per barrel of crude increased from $38.3 to $108.8. The
price of crude oil has increased massively, but it is to be noted that crude oil and jet-fuel is not the
same. Jet fuel is a refinery product made from crude oil. However, the price of jet-fuel has historically
been closely related to the price of crude oil.
1.10.3 Social Factors
E-commerce growth
The use of GDS (Global Distribution Channel) has played an important role in the airlines
ticket sales, but with the introduction of internet, passengers have an alternative to have access to the
airlines ticket, internet has completely changed the way that people purchase their airline tickets and
research travel options. This has helped to create a better informed customer.
Approximately 70% of the world population is currently on line. This is not surprising that an
increasing number of airline customers are choosing to research their options and buy tickets online.
For the European low cost carriers such as Ryanair and Easy Jet, hundred per cents of their
sales are made online. For Air Algeria the total sales online in 2017 accounted only for 5% of the total
sales.
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The Ageing Population
In Europe and North America in particular, the average age of population is now increasing
steadily in many countries, fewer babies are born, and improving medical provision is allowing more
people to live longer.
The ageing of population has some obvious, and some subtle, implications for airlines
marketing. Clearly, the product that airlines offer will have to evolve, with more provision being made
for disabled passengers and those needing help at airports, and medical care services will have to be
improved. There may also be opportunities for more specialists brands to be launched, reflecting the
needs and aspirations of older people. In terms of subtler changes, the travel industry may have to
adjust its promotional policies.
In advertising to promote leisure air travel, the industry still overwhelmingly focuses on
images younger people. The very fact that such advertising implies that a resort area is likely to be
popular with such people is likely to discourage many older travelers from visiting it.
1.10.4 Technological Factors
Video conferencing
Airlines have always assisted people to communicate, as travel allows opportunities for face-
to-face meetings. It should not be assumed any longer, though, that travel is essential for such
meetings to take place.
The world is undergoing a revolution based on video conferencing, conference calling and e
mail. The future will see video conferencing becoming even cheaper, of better quality and more
widely spread. More companies are now investing in video conferencing suites for their staff.
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Also, almost all personal computers are being sold with in-built web cameras, allowing video
conferencing to come to the desk top. These are all indicators of the substantial amount of competition
that airlines are already facing from the telecommunications industry.
The degree of this competition will increase further in the future, especially during
recessionary times when many firms are under acute pressure to save money. Due to the nature of
threat of video conferencing, a progressive response will be required from airlines in their strategy, in
terms of the product which is offered to the customer, greater emphasis will be required on
convenience to enable business travelers to fly with the minimum impact on their working time,
allowing the benefits of face to face meeting to outweigh the time required to travel to such a meeting.
Issues such as a frequency of direct flights with the right timings to allow for day return trips
will become still more important Airlines advertising approaches will also have to change. In the past,
most airlines have simply concentrated on promoting the merits of their services against those of rival
airlines. In the future, they will have to accept telecommunications companies as being amongst their
most formidable competitors. Advertising will be needed to promote the benefits of face-to-face
meetings as opposed to conducting these meetings via video-conferencing or conference calls.
New Aircraft Developments
Despite aircraft innovation, it is probably aircraft that are at the time of writing still under
development that will result in the greatest changes in the product that airlines offer to their customers.
Both Boeing, with the 787 and Airbus with its A350 are working on bringing significant
amounts of new technology to the aircraft they will offer on to airlines for their long-haul routes of
medium traffic density.
The 787 is an aircraft of about 250 seats in a mixed class configuration and the A350 is slightly
bigger. In both cases, their advanced technological specification means that airlines using them will be
able to achieve seat kilometers costs that will be significantly lower than the current generation
aircraft in their size category.
In the past, in order to achieve the lowest seat-kilometer costs, airlines have had to use a wide
body aircraft on its long-haul network, which is generally the B747, as they sought to exploit the
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economies of scale that large aircraft offered them. In the turn, this means an extensive reliance on the
hub and spoke network principle, as traffic was gathered together from a large number of origin points
to make up the dense combined traffic flows necessary to reach breakeven load factors.
In the future, this will not be necessary to the same extent. Given a reasonable amount of
traffic growth combined with the much better operating economics of 787 and A350, it will be
possible for airlines to open up a greater number of point-to-point services whilst continuing to offer a
good flight frequency.
This will, in turn improve the product from passenger's viewpoint as it will mean fewer time-
consuming and stressful transfer at hub airports. For airlines, it may mean that some of the very
powerful hubs that they have built up will increasingly be challenged as their competitors adopt
strategies of 'hub overflying'. Such strategies also threaten the position of major airports that have
provided the facilities for airlines to build their hubs (Stephen Shaw 2011).
By 2020, it is expected that other , fuel efficient aircraft types will enter into service, with the
Embraer E2 , Airbus A330 neo and Boeing 777X joining the fleet.
In addition to the latest propulsion technology, additional technological features have been
included to maximize fuel efficiency. Improved aerodynamics, new manufacturing techniques and
composite materials plays prominent role in determining how much fuel is burned on any given flight.
Carbon composite are being increasingly used to build parts of aircraft, particularly the wings,
which improves fuel efficiency through decreasing weight. Some engine manufacturers have taken
advantage of another new material, ceramic-matrix composite used in jet engines, which allow the
engine to operate at a higher temperature resulting in better fuel efficiency. Like the composite
materials used to make wings, this materials is also lighter than traditional metal alloys, which further
cuts fuel burn (ATAG).
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Biofuels
A potential for an alternative fuel such as biofuels or solar power to complement or replace
traditional jet fuel has increased significantly in the past decade, and a number of successful test
flights have been performed. As well as having potential environmental benefits, alternative fuels have
the added benefit of reducing reliance on expensive, unpredictable and finite oil reserves.
Before biofuels can be used, they must satisfy a number of vital criteria. They must:
 Be compatible with conventional jet fuel and use the same infrastructure and supply
lines.
 Not require adaptation to existing aircrafts or engines.
 Lead to lifecycle carbon reductions, require little use of fresh water and not compete
with other land uses.
Biofuel are less carbon intensive than jet fuel. This is because feedstocks absorb CO2 as they
grow, which acts to offset the carbon released when they are eventually burnt. While not entirely
carbon neutral (CO2 is emitted during refining and transport to market), the life cycle of biofuels is
cyclical and renewable, unlike conventional and traditional jet fuel. Possible options include
exploiting the substantial methane clathrate reserves residing in deep oceans (Lucy Budd and Stephen
Ison, 2017).
Online technologies
The new online technologies also provide opportunities for airlines to implement new
strategies to differentiate themselves from the competition and capture market share.
Some airlines are using the development in computer technology to improve the customer
relationship management (CRM). AS an alternative to mass marketing airlines can now collect
information on individual customers and then target their marketing in 1 to 1 manner based on
individual needs, behaviors and preferences, an optimized CRM strategy can help to differentiate an
airline from its competitors.
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1.10.5 Environmental Factors
Events in the spring of 2010 served as a very good reminder to airlines that they ignore
questions of the possible impact of the environment on their operations at their peril. Cloud of
volcanic dust plagued the industry for many weeks, causing the closure of airspace and resulting in
very large financial losses.
However, besides the question of direct environmental effects on the industry's operations,
there are a number of areas where environmental issues affect both the nature and characteristics of
airlines demand. Also environmental questions pose an increasingly important issue in terms of airline
promotional policies.
Climate Change and Global warming
The undoubted economic and social benefits of aviation are clear, with the growth of the sector
being important for all countries, both developed and developing. However, these benefits also come
with an environmental cost.
For aviation to grow sustainably, it is vital that the industry balances the advantages of air
travel with the responsibility to act on climate change. This responsibility is something that the global
aviation sector takes very seriously and it ties in with a number of SDGs.
Aviation accounts for roughly 2% of man-made CO2 emissions. Through the burning of 728
billion liters of jet fuel. Producing 739 million tonnes of CO2. These emissions are equivalent to the
annual emissions of a country such as Iran or Mexico (ATAG).
Around 80% of aviation emissions are produced from long distance flights. Journeys where
there is no other practical alternative for flying. The challenge for aviation is to reduce these
emissions, while retaining the benefits of air transport.
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To meet this challenge, industry leaders joined together in 2008 to announce plan, based
around these global goals, which the entire sector has committed to. These are (ATAG):
1- To achieve a 1.5% average annual fuel efficiency improvement from 2009 to 2020 (a goal is
already being surpassed with an average improvement of 2.4% per year).
2- Stabilize net Co2emission at 2020 levels through carbon neutral growth.
3- Reduce net emission to 50% of what they were in 2005 by 2050.
1.10.6 Legal Factor
Many countries have introduced different rules, regulation, and quality standards for airlines in
order to ensure safety and security of passengers. The compliance to these rules and regulations is
compulsory for any airline travelling to and from these countries. This has increased the costs for
many airlines and they have to maintain certain level of services and standards. It is also difficult for
new airlines to get operating license in some countries due to different legal restriction and
requirements (lexology.com).
The different types of law suits against airlines has increased in last few years that means
customers has very higher expectations and law is becoming more strict against airlines. This has also
become a bigger challenge for airlines.
More airlines are constantly bombarded with lawsuits from displeased clients and staff. This
has made airlines to be more cautious in their approaches as well as strategic plans. In addition to this,
there are several changing regulations that require airlines to protect consumers and offer quality
services.
1.10.2 PESTEL analysis summary
The table below summarize the previous PESTEL analysis
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2. Airlines Profitability
2.1 In the macro and micro view
“In terms of macro-output effectiveness, the enterprise must be able to be effective in applying
and maintaining the appropriate product/service, and product/service mix in the right target markets
and market segments. The macro view looks at the interaction of the enterprise with its external
environment (Figure 1), the micro view focuses within the enterprise (Figure 2).
Figure 1 The “macro view”
32
Politics terrorism and political instability
Deregulation
Open skies agreements
Privatization
The State aid
Slot Allocation
Economics Economic growth and the trade cycle
The price of jet fuel
Social E- Commerce growth
The ageing population
Technology Video conferencing
New aircraft development
Utilization of Biofuels
Online technologies
environment Climate change and global warming
Legal Compliance to therules

Figure 2 The “micro view”
This analysis focuses on resources, the outputs they provide into activities, and the resources
and activities consumed by products and services (both internal and external). The study of the micro
view of the enterprise conversion process takes on a similar but more specific and focused analysis.
The micro view of conversion optimization, although similar in many ways to the macro optimization
scheme contains more permutations.
2.2 Microeconomics concept
Microeconomics deals with behavior of individual households and businesses (decision-
making units). It depend heavily on the concepts of supply and demand, that is, the way in which the
market determines the price of goods and services and the level of production.
The Airlines provide particularly good examples for the decision making aspect of
microeconomics since they respond swiftly to changing market conditions by altering supply and/or
prices by utilizing sophisticated pricing techniques. The capacity (quantity) management is a good
example of microeconomic decisions. During the Gulf War airlines experienced a significant decline
in traffic, so they reduced their capacity (Supply) by 10 per cent over period of about one year
(Vasigh 2013).
The revenue management for airlines is an important factor in a microeconomic for a decision
making. Another example, Airbus and Boeing are two rivals in the aircraft industry, they are seeking
to increase their position in the market share by introducing more efficient aircraft.
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2.2.1 Pricing Decision
Based on pricing, businesses can forecast what a consumer may buy, and how many units of
that product or service will be sold.
The basic concept of the revenue management is that the airlines price seats are set differently
according to several variables including: service level, time (before flight) and day of the week to
flight.
The idea is to charge consumers the maximum of what they are willing to pay based on their
personal characteristics. The business traveler with little flexibility and last-minute travel needs,
would intuitively be willing to pay a great deal more than the casual vacationer who is much more
price sensitive.
Airlines separate the aircraft into cabins: economy, business, and first in the typical three-class
system, that are further separated into classes, each with its own price point and often slightly different
ticket characteristics like flexibility and refund ability.
Pricing the cabins according to the classes and the pricing of the cabins allow the airline to
maximize its revenue based on traveler preferences, because it can charge a higher price to those who
are willing to pay it, and use them to cross-subsidize, in sense, those who would be much more price
sensitive.
The entire exercise of revenue management is predicted on microeconomic decision-making-
travelers with certain characteristics are likely to support a higher price than others, and pricing
according to those characteristics benefits both the airline and the consumers.
In 2008 on London - Dublin flight, Aer Lingus introduced a charge of £9 for checked in
baggage in each direction, £10 in each direction for a seat reservation in the two wider emergency exit
rows, £5 each way for a seat in the first five row or £2 for pre-assigned seat anywhere else or no
charge for getting a seat allocation on check in. Air Canada is another airline that adopted a similar
strategy of complex charges and-on fees (Vasigh 2013).
In 2000 and 2001, the Belgian airline Sabena, which was facing growing financial pressures,
was offering by far the lowest fares across the Atlantic and to Africa for passengers from elsewhere in
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Europe prepared to transfer through its Brussels hub. It was desperate for cash .It nevertheless
collapsed by the end of 2001 (Doganis2010).
Low costs carriers LCCs Ryanair and EasyJet pricing is simple. They start selling the cheapest
advertised lead-in fares when bookings for flights open and then their booking systems automatically
moves to higher fares which are triggered as seats sold at each fare level for any particular flights pass
certain pre-planned numbers or as seat sold at each fare level for any particular flight pass certain pre-
planned numbers or as the departure date approaches.
At any one time there is only one fare available for purchase on each flight, though it will often
vary between flights on the same route to reflect difference in demand levels between times of the day
or week (Doganis 2010).
2.2.2 Aircraft acquisition
A decision including aircraft acquisition, fleet selection, and route planning are all
microeconomic decision-making activities. Will this new aircraft have a justifiably high load factor if
employed on this route? Given route characteristics, will adding this new aircraft to the fleet result in
an optimal mix? Is there a large enough market on this route to support the entrance of a new airline?
All these decisions are based on the behavior of individual consumers, and the effect that is
charging certain variables will have on individual choices.
To reduce cost fuel costs, airlines are placing orders for more cost-efficient aircraft like the
Airbus 330 neo, Boeing 737 MAX, and the Bombardier CSeries and retiring older , more expensive
airframes (Vasigh 2013).
2.2.2 Output decision
In the output decisions for airline often come in the form of capacity decisions, aircraft size,
aircraft type, and schedule selection. Capacity decisions fall under the umbrella of microeconomic
decision, in recent years airlines have shifted capacity away from domestic US markets to more
profitable international markets.
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In April of 2008, Emirates Airline started a New York service with a double deck aircraft, but
pulled it two months later and replaced it with the smaller Boeing 777. In response to soaring fuel
costs, a Frontier cut one-third of its daily departures from Milwaukee, from 67 to 45 (Vasigh2013).
In May 2011, Ryanair announced a capacity cut by grounding 80 aircrafts in the winter
schedules between November 2011 and April 2012 due to high cost of fuel and continuing weak
economic conditions. Ryanair clearly focused on a strategy that is low in cost structure, which allowed
them to charge low fares.
2.2.3 Choice and opportunity cost
Choosing to utilize a resource has an implicit cost referred to as an opportunity cost,
opportunity cost can be defined as the true cost of using resource, which is the benefits that could
accrue if the resources were not being utilized in the current allocation. In other words, the next best
use of the resource is the true cost of using it.
This is why it may be efficient for executives to outsource their travel arrangements to their
executive assistant, the opportunity cost of the assistant's time are less than the executive's- the latter
could be better employed in running the company and generating profits.
Based on their relative opportunity cost of their time exceed the potential benefits. The
executive assistant can spend 30 minutes at the same task because of lower opportunity costs and
therefore has a better chance finding a better deal.
3. Determinants of Airlines Profitability
In this chapter we will explore in depth the ways of calculating financially based on rations
already approached at the introduction.
Any financial analysis of the profitability of the airline industry suggests that the industry
should probably focus on its cost structure and should strive to achieve higher levels of productivity.
The airline industry is highly capital intensive, and consequently its profitability is strongly affected
by fuel efficiency and aircraft utilization in addition to high labor costs.
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A proliferation of low-cost models and cost competitiveness helps low cost airlines to
outperform their competitors in the market and remain profitable. Low cost airlines are generally more
cost competitive than the legacy airlines, mostly due to their substantially higher input productivity
and/or lower labor costs.
Profitability means the ability to make profit from all the business activities of an organization,
company, firm, or an enterprise. It shows how efficiently the management can make profit by using all
the resources available in the market. According to" Howard & Upton" profitability is the ability of a
given investment to earn a return from its use".
There has been only minor improvement in return for investors in the airline over the past
business cycle. There were demand and supply shocks challenging the industry while facing the
impact of the bursting of the technology bubble such as the 9-11 terrorist attack and SARS as well as
the Icelandic volcanic clouds.
During the most recent cycle the global financial crisis was followed by the deepest economic
downturn since the 1930's, however, even in the good years, airlines return was inadequate. The
shocks themselves were not the main cause of persistently poor airline profitability, the profitability of
the airline industry had traditionally been quite low.
From 1992 to 2006, the average return on invested capital (ROIC) of airlines in the US had
been 5.9%, the lowest of all US industries (with 14.9% being the average industry ROIC in the US). It
was estimated that from 1945 to 2010, airlines had earned a 6% return on capital employed, 2-3%
below their cost of capital. (Competing trough alliances in the airline industry HEC Paris).
In 2011 many airlines around the world had a market value that was far below the resale value
of their fleet, in October 2011, American Airline's market capitalization was equivalent to the value of
three Boeing 777 aircraft, while the company owned 47 such aircrafts and had a total fleet of 619
aircrafts, similarly, Air France-KLM's market value was less than the cost of six aircrafts with a total
fleet size of over 350 aircrafts.
Other business related to the airline industry had been slightly better, on average, airport
operators had earned 10%, airline catering companies 10-13%, handling companies 11-14%, aircraft
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lessors 15%, aircraft manufacturers 16% and global distribution (such as Sabre, Amadeus or Galileo)
more than 30% (Competing trough alliances in the airline industry HEC Paris).
Despite its low profitability, the airline had attracted investors over years. Real estate tycoon
Donald Trump (current US President) had created Trump Airlines in the 1990's ( Time Staff
April ,29th ,2011), while former Formula 1 Champion Nikki Lauda had started first Lauda Air (which
went bankrupt and was acquired by Austrian Airlines) (https://www.independent.co.uk/travel/news-
and-advice/ryanair-austria-niki-lauda-airline-latest-boeing-airbus-a8264471.html ).
An airline's main costs were for aircrafts, fuel and labor. Purchasing costs were mainly to the
purchase or lease of aircraft, fuel, spare parts and insurance. The market for aircraft is highly
concentrated. There are only two suppliers for long or medium haul aircraft (Airbus and Boeing) and
small number of manufacturers of short haul aircraft (i.e Bombardier, Embraer, etc). (Vasigh 2013).
The cost of fuel is determined by global oil prices and because it accounts for significant
shares of total costs and tended to vary considerably, some airlines had turned to extensive hedging,
with seemingly ambiguous effects: while Air France had benefitted a lot from its hedging policy in
2007/2009, it suffered greatly in 2009/2010, paying over $65 a barrel when world prices for oil had
dropped to about $35 (Competing trough alliances in the airline industry HEC Paris).
For a given flight, costs are predominantly fixed: the marginal cost of adding a passenger to the
flight is negligible. Because of this, most airlines implemented sophisticated "yield management"
systems that were aimed at maximizing total revenue per flight. These systems constantly adjust fares
based on observed reservation levels.
The use of such "yield management" systems resulted in fares varying dramatically depending
on travel date, travel time, and on when a reservation was made. Contrary to the marginal cost of
adding a passenger to an existing flight, the marginal costs incurred when adding an incremental flight
to a schedule are quite significant, as are the costs of adding extra planes to an existing fleet.
Most airline cost items do not increase in proportion to length of the flight: cost per available
seat kilometer (CASK, the average cost of one seat, occupied or empty, flown for one kilometer,
which was the usual unit of cost used in the industry) is lower for airlines that fly long distances.
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Many industry insiders and analyst consider that airline size is critical to success and predict
that, in the future, only a handful of large airline groups would survive.
They based their opinion on the fact that, because of high fixed costs, economies of scale are
huge: only those airlines capable spreading these high fixed costs on more flights and more passengers
would be able to keep their costs per passengers down and make profit.
To increase profit and lower cost, major airlines operate a so-called hub-and-spoke system
"spoke" flights on smaller aircraft fed passengers from smaller cities with a relatively lower air travel
demand into "hub" major cities with a higher travel demand, and then from the hub to their final
destinations. The hub and spoke network system had paved the way for large scale alliance groups that
emerged in the late 1990s.
3.1 Measures of Profitability in the Airline Industry
Different measures have been employed by airlines to measure their profitability. The most
usual are described below (Airline Finance):
3.1.1 Operating Ratio
The operating ratio shows the efficiency of a company's management by comparing operating
expenses to net sales. A smaller ratio, the greatest the organization's ability to generate profit. An
alternative formulation of this ratio that avoid the operating lease/owned distortion is operating profit
aircraft (after interest’s charges) expressed as a percentage of operating revenues.
3.1.2 Net Profit Margin
Net profit margin, or net margin, is equal to net income or profits divided by total revenue and
represents how much profit each dollar of sales generates. Net profit margin is the ratio of net profits
or net income to revenues for a company. However, the margin for a particular year may be increased
or reduced by large asset sales, restructuring costs or asset write-down.
3.1.3 Return on Invested Capital (ROIC)
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Return on invested capital (ROIC) is a calculation used to asses a company's at allocating the
capital under its control to profitable investments. Return on invested capital (ROIC) is a calculation
used to assess a company's efficiency at allocating the capital under its control to profitable
investments. Return on invested capital gives a sense of how well a company is using its money to
generate returns on invested capital.
3.1.4 Return on Equity (ROE)
Return on equity (ROE) is the amount of net income returned as a percentage of shareholder'
equity. Return on equity (also known as return on net worth) measures a corporation's profitability by
revealing how much profit a company generates from the money shareholders have invested.
3.2 Determinants of profitability
The following paragraphs are dedicated to explain the determinants and major factors that
affects profitability.
3.2.1 Net Profit
There are two determinants of net profit, namely the operating revenues and the operating
costs, while the operating costs of the airline are a direct function of the schedule structure, the ratio of
departures to block time, stage length, and the basic structure of flights (point to point or hub-and-
spoke) determine the rest of the maintenance drivers, labor staffing levels and non aircraft capital
costs.
Airlines revenues in the other hand, are completely unrelated to this structure for any
individual airline. Airlines prices are often market competitive or regulated by a formula based on
mileage.
For an airline to be profitable, it needs to increase its revenues and reduces its costs. The unit
cost for the airline is measured in CASK (Cost per Available Seat Kilometer) and CATK (Cost per
Available Tone Kilometer) for cargo. While the unit revenue is measured by yield (Revenue per
Passenger Kilometer or Revenue per Tone Kilometer for cargo flight).
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The yield is the revenue received by the airline per passenger kilometer or tone kilometer for
cargo. However, maximizing yield will not necessary produce higher profits, as it may have a negative
effect on load factor, to cope with, airlines use revenue management system to maximize yield while
at the same time maintaining load factor at the highest level possible.
Unit cost is a function of various costs in the airline fixed or variable, direct and indirect,
operating and non-operating costs. Aircraft acquisition cost, aircraft fuel, wages and salaries, aircraft
maintenance cost, airport charges and navigation fees are some of the major costs of an airline.
Fuel cost has been the major cost for the airlines accounting for 25-30% of total costs, while
wages are the second biggest expenses in the airline industry.
3.2.2 Efficiency
Efficiency means producing more outputs with less input. In the airline industry the following
factors are used to bring a better efficiency.
3.2.2.1 Load Factor
The load factor is a ratio between available seat kilometer (ASK) and revenue passenger
kilometer (RPK) or available tone kilometer (ATK) and revenue tone kilometer (ATK). The load
factor is a key performance indicator (KPI) that the airlines struggle to keep it as high as possible or at
least above its breakeven load factor at which the airline is neither generating profit nor supporting
losses.
Airlines need to adjust costs, fares and load factor to produce a profitable combination. Low
costs carriers continue to make profit even during the economic downturn , because of their high load,
Ryanair load factor for the financial year 2017 was at 91% (according to their annual financial
statement).
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3.2.2.2 Pricing
Pricing is crucial element in airline management. It is only one of several products and service
features which are planned and combined in order to generate demand. But it is the key mechanism,
whereby the demand of air services is matched with the supply.
An airline's primary aim is to sell the capacity it is prepared and able to offer at prices which
will generate enough demand to ensure an adequate level of profit. A great deal hinges on what each
airline considers an adequate profit.
"We have been doing à-la-carte pricing for six years and it is popular with our
customers ...About 47 per cent of our customers choose a higher fare product for its attributes - even
with lower fare available...” (Montie Brewer, CEO, Air Canada 2009).
3.2.2.3 Daily Aircraft Utilization
It is defined as aircraft hours flown (Block to Block) divided by the numbers of days the
aircraft is available for service. Aircrafts flying long haul routes have a higher average daily aircraft
utilization than aircrafts flying short haul or medium haul flights. Aircrafts generating more revenues
are those flying for longer time with minimum turnaround time.
3.2.2.5 Employee Productivity
Employees productivity is another important key performance indicator, Revenue per
employee and available seat kilometer (ASK) per employee is extensively used a measure of
employee productivity. However, as there is a significant difference in wages level between countries,
measuring revenue per employee doesn't show real financial efficiency.
Revenue to salary and wage expense ratio will be a better measure of financial efficiency to
measure employee productivity in global airline industry. (THOREN, 2002)
The impact of higher labor productivity on costs was illustrated by 2002 study of European
pilot wages and work hours carried out by the European Cockpit Association. This showed that pilots
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in the larger European Low Cost Carrier LCCs were paid on average 27 per cent less than short-haul
pilots flying for the major European network carriers.
They were paid less but flew about 200 hours more in year. Lower pay combined with more
block hours meant that the salary cost per hour for LCC pilots in 2002 was 46 per cent lower than
network pilots on similar short-haul aircraft (Doganis 2010).
3.2.3 Leverage
The financial structure of a firm plays an important role in its financial performance. Financial
structure, or capital structure, is referred to the proportion of debt and equity in a firm. According to
(KUMAR, 2008) debt positively affects returns in good times and adversely affects them in bad times
and creates financial leverage.
A firm that is profitable can use debt to maximize return to owners by using debt as leverage.
However, a firm that incurs losses will be affected negatively by using high level of debt.
The determinants of leverage are factors that limit the amount of debt that a firm can get from
creditors. The earning before tax and interest (EBIT) of the firm should at least cover debt expense,
and debt expenses is a function of cost of debt and actual debt balance of the firm.
But when a firm increases its debt it will increase the assets of the company. As leverage ratio
increases, profitability would turn to be less stable. However, higher debt level is a tool in the hand of
shareholders to prevent managers from wasting firm's resources.
There are various theories on the determinants of leverage and various factors have been
identified as significant determinants of leverage. The factors include profitability and cost of debt,
market value of the firm, size, country legal environment, tax law, experience of management and
ownership.
3.2.4 The airline's profitability main issues
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The Airline industry is no stranger to bankruptcies. American Airlines, United Airlines and
Delta have at one point filed for bankruptcy, but they all recovered by merging with other airlines. The
list of airlines that were not so lucky is even longer.
Considering the vital nature of the service it provides and its invaluable contribution to making
the world a smaller place, why is the airline industry synonymous with ongoing losses and
insolvency? Some reasons why airlines are always struggling are listed below:
In the airline industry, Swissair, or its parents company that was then called SAir Group,
suffered a sharp deterioration in financial fortunes in 2000: worsening profits and large provisions in
2000 resulted in debt/equity ratio deterioration 1.01:1 at end December 1999 to 4.68:1 at the end 2000.
It filed for bankruptcy at the beginning of October 2001 (Morell 2013).
Austrian Airlines used shareholder's equity as a percentage of total assets (and liabilities) for
their target. It had a medium-term target of keeping this above 25 per cent in 2011. It was only 17.7
per cent at the end of December 2005, with British Airways just below this figure at end March 2006.
Lufthansa had a medium-term target to raise its percentage from 23.5 per cent in 2005 to above 30 per
cent in 2011 (Morell 2013).
3.2.4.1 Unprofitable Airlines continue to fly
Many unprofitable airlines continue to fly despite years of substantial losses, because
stakeholders cannot afford to close them. The failure of those airlines would involve the loss of
thousands of jobs, inconvenience to hundreds of thousands of travelers, and millions in losses for the
airline's creditors, without saying the loss of national pride in the case where the airline is a national
carrier, e.g, Alitalia refuses to die despite its huge financial problems.
Because closing down an airline is politically unpalatable, government will subsidies the
floundering airlines, in order to maintain it in the business. But struggling airlines often have resort to
cut-throat pricing to fill up their excess capacity, and as a result, even the stronger players in the
industry are highly affected by this lack of pricing power.
3.2.4.2 High fixed and variable cost
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Airline's equipment such as Aircrafts are expensive assets acquired by the airlines through
large lease or loan operation. Large commercial aircrafts have a lifetime period of 25-30 years. The
complex of operations of these jets requires a large labor forces that have to be incurred month after
month. Volatility in oil prices is yet another cost that have increased after 9/11. There are only few
airlines that succeeded to overcome the obstacle of their high-cost structure.
3.2.4.3 Aggressive price Competition
Due the aggressive price competition, each airline is happy to draw passengers away from a
competitor, if each airline could refrain from stealing the other customers they might both enjoy a
normal profit rather than being in bankruptcy.
This is a classic "prisoner's dilemma" since each airline cannot "trust" the other to refrain from
cutthroat pricing, even though both would prefer to cooperate and stop such aggressive price
competition. Of course, any attempt of cooperation to set prices is complicated by the fact that
government anti-trust policy prohibits arranging such cooperation via formal contracts and makes it
difficult, probably prohibitively risky, to make an illegal arrangement in secret.
At first glance, the misery experienced by airline investors from pricing below costs appears to
be a precious gain for air travelers-as if most carriers were perpetually selling at below cost, "going
out of business" bargain rates. And what may be in fact the case.
Most economist have viewed excessively low long-run returns as a problem that will
eventually take care of itself as needed. That is if many investors and lenders don't think it is worth
investing in the airlines, then they can stop financing them until capacity drops enough to raise prices
3.2.4.4 Exogenous events
The most marked collapse in average yields came in the period after 2001 when a cyclical
downturn in demand was made much worse by the terrorist attacks in the US in September 2001, the
Gulf War in 2003 and the later SARS and avian flu epidemics.
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For example, In April of 2010, airlines collectively estimated to have racked up losses of $2
billion from the closure of European airspace, caused by massive ash clouds following a volcanic
eruption in Iceland.
For a time, demand growth rates collapse in several markets. Airlines cut fares to stimulate
demand. Matters were made worse by growing over-capacity in long haul routes and market attacked
by low cost airlines in the shorter routes in the USA, Europe and Australia.
3.2.4.4 Reputation for hassles and poor service
Long lines due to security procedures at check in, cramped seating, inconvenient schedules,
and poor service-the list of passenger complaints is long. The perception that air travel is an ordeal
makes it very difficult for airlines to charge the higher prices that are necessary to return to
profitability.
4. Methodology versus data
The research methodology taken by the concerned profitability in airline industry, based on the
variables, rationale and also the issues and weaknesses faced by the concerned by it can be seen to be
as follows:
Research Design The concerned research takes the descriptive research design
by taking into consideration the different aspects of costs,
market expansion as well as factors like those of high traffic of
passengers, new market opportunities and also aspects like
turnover, revenues and operating costs, in order to analyse the
performance of the airline industry in the contemporary period.
(Taylor, Bogdan and DeVault 2015).
Research Approach The concerned study takes an explorative and inductive
approach in the place of deductive approach. This approach
facilitates the study of different aspects related to the
profitability and performance of the airline industry and then
the detailed studying of these factors to reach to conclusions
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and inference about the performance of the airline industry and
the factors facilitating or barring the overall performance of the
airline industry. (Alvesson and Sköldberg 2017).
Data Types and
Analysis
The research taken into consideration, deals with secondary
data collection, taking into consideration both quantitative as
well as the qualitative types. To measure the profitability, the
quantitative data has been used which include those of PPE
turnover, Capex spend, Return on Equity, Return on Assets,
Return on Capital Employed, Load Factor as well as those like
RASM and CASM.
On the other hand, for the purpose of determination of risks,
the concerned research also takes into consideration the
qualitative aspects like that of rising fuel costs, labour costs
and others and also describes the prospects and challenges
faced by the airline industry on the basis of these qualitative as
well as quantitative data. (Panneerselvam 2014).
Based on the intuitive analysis the data collected, the
concerned research reaches to the inferences about impressive
performance of the concerned industry, despite the presence of
different challenges faced by the same.
(Maxwell 2012).
4.1 Model Variables
As presented in the literature, numerous factors affect profitability. For the purpose of this
study the performance earnings ratios represented by net profit margin, operating ratio, return on
equity (ROIC) and return on equity (ROE). Thus variables were selected by their ambiguity relation
with airlines profitability in the literature part of this study, besides the data used for these variables
can be verified.
4.2 Performance Earning Ratios
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Performance ratios will need to be calculated in order to be able to assess past trends of a
particular airline or to compare different airlines. These can be helpful in evaluating a shareholder's
investment in airline or in an assessment by banks.
Some ratios use only profit and loss account data, some use only balance sheet data, and some
combine data from each of these statements. The latter needs to take into accounts the fact that balance
sheet items are measured in a particular date, whereas profit and loss account are summed over a
particular period (usually one year).
4.2.1 Net profit margin
Net profit margin is after tax profit expressed as a percentage of operating revenue or turnover.
This ratio has the advantage over the operating ratio in that it is free of the operating lease distortion,
in the airline industry smaller airlines would require higher margins to survive than larger airlines.
4.2.2 Operating ratio
Operating ratio is defined as operating revenue expressed as a percentage of operating
expenditure; operating margin is an alternative expression that is similar to margin on sales.
The operating ratio gives an indication of management efficiency in controlling costs and
increasing revenues. However, it can be distorted by changes in depreciation policy, or a switch from
ownership of aircraft (involving both depreciation and interest charges, only the first of which is
shown under operating costs).
4.2.3 Return on equity (ROIC)
Return on invested capital (ROIC) is a calculation used to assess a firm's efficiency at
allocating the capital under its control to profitable investments. Return on invested capital gives a
sense of how well a firm is using its money to generate returns. Comparing a firm's return on invested
capital with its weighted average cost capital reveals whether invested capital is being used
effectively.
4.2.4 Return on equity (ROE)
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Return on equity is the net profit after interest and tax expressed as a percentage of
shareholder's funds. The numerator is before deducting minority interests and the denominator
includes the capital belonging to these interests. This percentage gives an idea of how successful the
airline's management is in using the capital entrusted to it by owners of the company, or equity
shareholders. It is sensitive to the method of financing. Similar comments apply as for return on
capital employed, in terms of marked year to year fluctuations.
4.3 Source of Data
There are two different types of data, qualitative and quantitative. Quantitative data consists of
numeric data, whereas qualitative data consists of non-numeric data. Simply put, qualitative data often
include words, but can also include diagrams and pictures. On the other hand, it consists of
information that can be measured in numbers.
Furthermore, empirical data used in research can be divided into primary and secondary data.
Empirical data is considered to be primary when the researcher has collected the data themselves.
However, empirical data that already exists is called secondary data.
Primary data can be collected through e.g. interviews or experiments, whereas secondary data
can be collected from research papers, journal, annual reports and the airline's internal data.
This thesis has used qualitative and quantitative secondary data, which have some advantages.
Advantages with secondary data is that is that researchers can evaluate the data to see if it is relevant
prior to using it (Saunders et al., 2009).
Secondary data is often retrieved from public sources: hence it is easy for many to check this
information. This means that is likely to be criticized and corrected if they were wrong. However, data
is collected to answer a research question. Once collected, may have been to answer different research
question that we aim to answer, thus the data can be inappropriate.
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There are disadvantages in using secondary data, as once collected some years ago, thus
perhaps making it less relevant.
In order to test the hypothesis and analyze the regression results, only audited reports (Balance
Sheet and Income Statements data) of Air Algeria from 2014 to 2016 was used. Regarding the trust
worthiness of the sources the researchers have no reasons to doubt on the validity, since the entire
material are from the official reports of Air Algeria .
The material was all audited by external auditing firms and all data that are used on the
hypothesis testing are collected directly from Air Algeria 's annual reports. But there is also the
possibility of transference errors, such a typing the wrong number into excel. To avoid this kind of
mistakes the data had been double checked, however there may be always possibility that something
has gone unnoticed.
So, the determinants of Air Algeria’s profitability, researchers take full responsibility for any
kind of mistakes. Investigation also relies on books and scientific articles, which are related to
accounting and financial theories.
Even though much of the secondary data we have collected is existing empirical data including
origin from Air Algeria’s data base and international Air Transportation Association (IATA) reports.
In addition to this, information is gathered from Journal Air Transportation Management, Aviation
Management related books and accounting and financial books.
5. Quantitative data description
“There are two major comparisons that ratio analysis provides and these are comparisons of
the firm across time and comparisons of the firm with the industry. (…) The various ratios used in the
analysis can be classified into four categories based on what portion of the company that they are
analyzing: Profitability ratios; Liquidity ratios; Long-term risk ratios and Stock market ratios.
Profitability ratios help describe the efficiency or success of the business. Liquidity ratios
describe the firm’s ability to meet short term obligations. Long-term risk ratios analyze the capital
structure of a company and take a more macro-level approach to analyzing the company. Calculating
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various financial ratios is merely an academic exercise unless they are compared to other firms
competing in the same industry.” (VASIGH, 2017).
When calculating airline passenger load factor, the value is generally irrelevant unless
compared to the breakeven load factor. Breakeven load factor is defined as the average percentage of
an airline’s capacity that must be covered for the airline to make zero profit. As a result, breakeven
load factor takes into consideration the costs required to provide the product” (VASIGH, 2017).
The Quantitative analysis is the first step in this part of the study, where, we collect the
financial data and the calculation in different ratios as well some key performance indicators.
5.1 Financial structure of Air Algeria
In this section all values were taken from Air Algeria’s Balance sheet and its financial
statement, we are going to present some financial items collected from Air Algeria’s finance
department, these items are used to calculate the ratios responsible of the evaluation of the
performance and the profitability of the firm.
Assets ( Billion of Dinars) 2015 2016
Non Current Assets 151,9 169,3
Current assets 27,1 28,5
Cash 33,1 22,6
Total Assets 212,2 220,5
Table 4: Air Algeria’s Asset
The total assets of Air Algeria had increased from 212.2 Billion dollars in 2015 to 220.5
Billion dollars in 2016 while the non-current assets had reported an increase of 11.9% between 2015
and 2016 (figures on table 1).
Table 2 shows Air Algeria’s Liabilities, while the liabilities remain constant at 82.2 Billion
Dinars, the debt had increased from 130 Billion Dinars in 2015 to 138.3 Billion dinars in 2016:
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Liabilities (Billion of Dinars) 2015 2016
Shareholder's quity 82,2 82,2
Non Current Liabilities 94 96
Current Liabilities 36 42,3
Total Liabilities 212,2 220,5
Table 5 Air Algeria’s Liabilities
5.2 Return on Capital Employed (ROCE)
Return on capital employed is an useful metric to compare profitability cross firms based on
the amount of capital used. There are two metrics required to calculate the return on capital employed,
earnings before interest and tax (EBIT) and capital employed (investopedia.com)
Capital employed is the total amount of capital that a company has utilized in order to generate
profits. It is the sum of shareholder's equity and debt liabilities. Also, it can be simplified as total
assets minus current liabilities.
The table below Shows ROCE of the two fiscal years ended December 31, 2015 and
December 31, 2016, respectively.(All values were taken from Air Algeria’s Balance sheet and its
financial statements).
( Billion of Dinars) 2015 2016
Sales 99 113
EBIT 1,06 1,53
Total Assets (TA) 212,2 220,5
Current Liabilities (CL) 36 42,3
Capital Employed (CE) 176,2 178,2 TA-CL
ROCE 0,006 0,008 EBIT/CE
Table 6 Return on Capital Employed (Air Algeria)
5.3 Return on Assets (ROA)
In the ROA tells what earnings were generated from invested capital (Assets).
ROA= (Net Income + Interest Expense) / Average Total Assets
Year Net Income Total Assets ROA
2015 1,499 212,2 1%
2016 2,206 220,5 1%
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Table 7 Air Algeria’s ROA
5.4 Fixed Assets Turnover
The fixed asset turnover ratio or PPE turnover ratio (property, plant and equipments), is used to
measure operating performance, it is the ratio of net sales to fixed assets. It measures a company's
ability to generate net sales from fixed assets investment. The collected data from Air Algeria has
allowed to calculate the following ratios for three consecutive years of 2014, 2015 and 2016
Years 2014 2015 2016
PPE Turnover ratio 0,587 0,609 0,612
Table 8 AH turnover ratio
The fixed asset turnover ratio is calculated as: Fixed Asset Turnover = Net Sales
Fixed Asset
There is not an exact number or range that dictates whether a company has been efficient at
generating revenue from such investments. That is why, it remains essential for managers and
investors to compare a company's most recent ratio to both its historic ratios and ratios value from
peer companies and/or industry averages.
5.5 Coverage interest Ratio
A coverage interest ratio measure of a firm's cash generating ability to meet its debt and its
financial obligations.
Years 2015 2016
Net debt (in millions DA) 72 839 74 372
Operating surplus Crude (in million DA) 9 248 11 895
Abililty to meet financial obligations 7,9x 6,3x
Table 9 Coverage ratio
From the table above (table 6), Air Algeria’s ability to meet its debt and other obligation was
equal to 6.3 during the year 2016 and 7.9 during the years 2015n for Ethiopian interest coverage ratio
was 3.98 and 5.61 for the respective years of 2015.
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2014 2015 2016
Air Algerie 7,5 7,9 6,3
Ethiopian 3,45 3,98 5,61
0
1
2
3
4
5
6
7
8
9
Interest coverage ratio
5.6 Net margin, Operating ratio and Return on Equity (ROE)
Table 7 illustrates the performance's ratios of Air Algeria for the respective years 2014, 2015
and 2016, the definition of the net profit margin, operating ratio and return on equity ratio were seen
earlier in this study, a financial data to calculate those ratios were collected from the financial
department of Air Algeria.
2014 2015 2016
Net profit margin 0,0156 0,0102 0,0132
Operating ratio 0,979 0,989 0,982
Return on equity (ROE) 0,016 0,019 0,012
Table 10: Air Algeria 's performance ratios
5.7 Load Factor
We have already seen in this study the definition of the load factor (2.2.3). The data collected
from Air Algeria gives the following values:
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Statistics Passengers
Tranported
Kilometers
Flown ASK RPK Load factor
Year 2014 5 426 522 69 621 800 11 279 535 674 7 318 247 674 64,88%
Year 2015 5 616 262 68 417 774 11 325 982 864 7 376 303 735 65,11%
Year 2016 6 296 407 75 670 133 12 244 849 964 8 264 944 127 67,50%
Difference 14/15 189 740 -1 204 026 46 447 433 50 559 804 0,18%
Difference 14/15 in % 3% -2% 0,41% 1%
Difference 15/16 752 322 7 252 359 918 867 100 888 640 392 2,39%
Difference 15/16 in % 12% 11% 8% 12%
Table 11 Load factor illustration
5.8 CASK and RASK
The CASK is commonly used to measure the unit cost in the airline industry, expressed in
cents, to operate each seat kilometer offered, and is determined by dividing operating costs by ASK,
this number is frequently used to allow cost comparison between different airlines or across different
periods. A lower CASK means that is easier for the airline to make profit, as they have to charge less
to break even.
The RASM is a measure of the unit revenue for airlines, expressed in cents received for each
available seat kilometer. This number is used to allow comparison between different airlines or a
comparison of the same airline across periods. In theory the higher RASK the more profitable the
airline should be.
At constant prices, world airlines RASK fell by 51% from 17.5US Cents in 1960 to 8.6 Cents
in 2015, while CASK went down from 17.5 to 8.1.
Data Collected from Air Algeria gives the following values for CASK and RASK:
CASK (DZD) CASK us cent RASK (DZD) RASK us cent
2014 7,81 9,68 12,31 15,3
2015 8,66 8,6 13,42 13,3
2016 9,1 8,3 13,67 12,4
Table 12: Air Algeria’s CASK and RASK
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2014 2015 2016
CASK 9,68 8,6 8,3
RASK 15,3 13,3 12,4
0
2
4
6
8
10
12
14
16
18
RASK versus CASK FY 2016
5.9 Ratios Analysis
According to Atrill and McLaney (2006: 68), financial analysis using the financial ratios
provides a quick and relatively simple means of assessing the financial health of a business. The ratio
is also helpful when comparing the financial health of different businesses. By calculating a relatively
small number of ratios, it is possible to build up a good picture of position and performance of a
business.
Merely calculating a ratio will not indicate very much the position or performance of a
business. It would not be possible to deduce from financial performance without comparison whether
this particular level of performance was good, bad or indifferent. It is only when we compare this ratio
with some ‘benchmark’ that the information can be interpreted and evaluated.
Various ratios are used by managers and investors to analyze and forecast the profitability and
efficiency of a company. Listed in this section are the key ratios for airline industry used for the
financial analysis:
 Return on assets
 Return on equity
 Net profit margin
 Operating ratio
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 Return on capital employed (ROCE)
 Fixed assets turnover
 Revenue Passenger Kilometer (RPK)
 Available Seat Kilometer (ASK)
 Load factor
The Table below summarize the various ratios of Air Algeria for the financial years 2014,
2015 and 2016.
2014 2015 2016
ROCE 0,006 0,008
ROA 1% 1%
PPE Turnover 0,587 0,609 0,612
Coverage Ratio 7,9 6,3
Net operating margin 0,0156 0,0102 0,0132
Operating ratio 0,979 0,989 0,982
ROE 0,016 0,019 0,012
Load factor 64,88% 65,11% 67,50%
ASK 11279353674 11325982864 12244849964
RPK 7318247674 7376303735 8264944127
CASK us cent 9,68 8,6 8,3
RASK us cent 15,3 13,3 12,4
Table13: Air Algeria’s financial ratios
Return on Assets
For every dollar that Air Algeria invested in assets during 2015 and 2016 generated 1 cent of
net income. The factors affecting this ratio are sales, revenue and total assets or aircraft fleet, the latter
represents the biggest amount of assets in the balance sheet.
Airlines having a favorable return on assets ratio are using operating lease strategy as the
leased aircrafts do not appear in their balance sheets, whereas Air Algeria is using its owned aircrafts
in the larger amount with an unfavorable ROA ratio, having a ROA of 1%, Air Algeria is far below
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the industry average which is equal to 6.32% (csimarket.com) and Ethiopian Airlines ROA of 7.12%
(Ethiopian financial statement 2016).
2014 2015 2016
Ethiopian 3,7 4,68 7,12
Air Algerie 1 1 1
0
1
2
3
4
5
6
7
8
9
ROA
Return on equity
It measures the return on the money the investors have put into the company. This is the ratio
potential investors look at when deciding whether or not to invest in the company. For Air Algeria the
ROA has increased from 0.016 (1.6%) in 2014 to 0.019 (1.9%) in 2015 but then recorded a slight
decline to 0.012 (1.2%) in 2016.
Air Algeria had low value for return on equity during the analyzed period compared to the
aviation industry average which is around 30% (csimarket.com) and 24.09% for Ethiopian Airline
(Ethiopian financial statement 2016).
This low ratio of return on equity is due essentially to the low performance of the airline in
terms of net profit caused by the high based cost of the company.
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2014 2015 2016
Ethiopian 16,32 18,76 24,09
Air Algerie 1,6 1,9 1,2
0
5
10
15
20
25
30
Return on equity
Net profit margin
Air Algeria’s net profit margin had dropped from 1.56% in 2014 to 1.02% in 2015, this was
caused by the increasing capacity and expansion plans for the firm supported to grow its sales while
cost of sales and operating costs were experiencing an incremental change more than the incremental
change of sales.
This excessive increase in costs caused a decline in operating profits compared to 2014, at
which the company’s operating profit was the highest. The increase in Air Algeria’s costs was mainly
due to an increase in labor cost but also the depreciation of the local currency.
The net profit margin had known a slight increase in 2016 reaching the value of 1.32%, this
slight improvement is due to the profit generated by the Catering (a subsidiary of Air Algeria launched
in 2016).
Nevertheless, these ratios realized by Air Algeria remains far behind Ryanair with a ratio of
21%, Emirates with 9% and the African carrier Ethiopian airline with a ratio of 11.26% (the respective
ratios are taken from the published financial ratios of these airlines).
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2014 2015 2016
Ethiopian 6,5 7,14 11,26
Air Algerie 1,56 1,02 1,32
0
2
4
6
8
10
12
14
Net Profit Margin
Operating ratio
The specification of this ratio from the EBT margin is that this ratio focus on profitability of
the airline operations, and does not include e.g, financial gains or expenses reported in the income
statement.
Looking at the 3 years average reported in the income statement, it is clear that Air Algeria
performance were not stable over years. The revenues generated from operations in 2014, 2015 and
2016 were higher than the costs of operations, this fact generated a value of operating ratio lower than
1 (0.779, 0.989 and 0.982 respectively for the years 2014, 2015 and 2016).
Air Algeria had an operating ratio below 1 during three consecutive years, the best performing
year was 2014 with a ratio of 0.979. A quick benchmarking gives a ratio value of 0.971 for Emirates,
0.915 for Qatar Airways during 2016 while Ethiopians reported a ratio of 0.865 during the financial
year 2015/16.
It is clear from the above that Air Algeria had the worst ratio compared to its peers during
2016.
Return on capital employed (ROCE)
The return on capital employed ratio (ROCE) for Air Algeria during the years 2015 and 2016
were next to zero with a respective value of 0.008 (0.8%) and 0.006 (0.6%). Which means that the
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profit generated in 2016 represented only 0.6% of the total capital employed, the industry average
ratio during 2016 was around 10% (csimarket.com).
This weak performance in term of ROCE is a result of the increasing operating cost caused by
the depreciation of the local currency, knowing that 57% of Air Algeria’s costs are paid in foreign
currency ( Euro and/or Dollars) while only 35% of its Revenues are generated in foreign currency.
2014 2015 2016
Ethiopian 6,21 7,34 10,16
Air Algerie 0,5 0,6 0,7
0
2
4
6
8
10
12
ROCE
Fixed assets turnover
The fixed asset turnover ratio measures total revenue against the fixed assets of the company, it
shows how much revenues assets generate for the company. The fixed assets turnover ratio for Air
Algeria had known a slight and straight increase over years, passing from 0.587 in 2014 to 0.609 in
2015 and then 0.612 in 2016. An asset turnover ratio of 0.612 in 2016 indicates that every $100 of
assets generated $ 61.2 of revenue for Air Alger.
ASK, RPK and Load factor
During 2016, Air Algeria reported a number of 9 333 657 available seats, recording an increase
of 752 322 seat compared to the year 2015, where the number of the available seat was equal to 8 581
355. The international routes represented an offer of 6 233 321 available seats representing 66.8% of
the total available seats, when the domestic routes offered 3 100 336 seats available, representing
33.2% of the total available seats.
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ASK RPK Load Factor
France 4 242 084 520 3 108 337 125 73.27 %
Maghreb and
Middle East
2 514 326 266 1 709 986 614 68.0 %
Europe 1 398 939 654 897 416 244 64.15 %
Long Haul 1 570 253 042 1 100 482 120 70.08 %
Africa 623 962 448 272 596 136 43.68 %
Domestic Routes 1 686 304 389 1 176 125 882 69.74 %
Table 14 Operation performance
The break-even load factor or CASM / RRPK ratio is an important indicator for senior
managers in order to identify the threshold of profitability for the flight, the flight is only profitable
when the load factor is higher than the breakeven load factor.
The load factor is increasing over year for Air Algeria, passing from 64.88% in 2014 to
65.11% in 2015 and then 67.50% in 2016, recording an average growth of 0.23% between 2014 and
2015 and a growth of 2.39% between 2015 and 2016.
The load factor is improving but only slowly. Air Algeria’s performance in term of load factor
in 2016 was at 67.50% , which is high above the African industry average of 54.6% (IATA report
2016) but slightly lower than Ethiopian Airline with a load factor of 68.50%.( Ethiopain's finance
statement 2016).
The table below illustrates the RPK growth, ASK growth and Passengers load factor of Air
Algeria, Ethiopian and the African industry average.
RPK Growth ASK Growth Passenger
Load Factor
Air Algeria 12 % 8 % 67.5%
Africa Industry 8.0 % 6.9 % 54.6 %
Ethiopian 20.0 % 23.0 % 68.5%
Table 15 Air Algeria Growth compared with African Industry Average
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According to Brian Pearce -IATA economics ( June 2016) Africa is the weakest region in term
of performance and load factor, as the last 2 years losses have emerged again due to regional conflict
and the impact of low commodity prices. Breakeven load factors are relatively low, as yields are little
higher than average and costs are lower.
However, few airlines in the region are able to achieve adequate load factors, which average
the lowest globally at 54.6% in 2016.
CASK and RASK
As every airline's operation is unique, it could be misleading to compare the absolute value of
the operating cost between airlines, the most common metric measure for cost is cost per ASK, or
CASK, it represents the cost of flying one aircraft seat for one kilometer. CASK can be measured for
variety of costs such as fuel cost, maintenance cost or crew cost as shown on the table below
providing the breakdown of CASK for Air Algeria.
CASK US Cents
Fuel cost per ASK 1.25
Maintenance cost per ASK 1.27
Crew cost per ASK 0.9
Other operating cost per ASK 2.73
Total operating cost per AS 6.15
Non operating costs per ASK 2.15
Table16 CASK breakdown
The non-operating ASK cost of Air Algeria represented 2.15 US cent which represents 26%
total cost while the operating ASK costs represented 74% of the total cost with a value 6.15 US cent.
The paradox for Air Algeria is when we analyzed its CASK and RASK in foreign currencies
(US Dollars) we noticed that the CASK was decreasing over years from 9.68 in 2014 to 8.6 in 2015 a
8.3 in 2016 and the revenue per available seat kilometers RPK was decreasing over years from in 15.3
in 2014 to 12.4 in 2015 and then 13.3 in 2016.
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In contrary, while the same analysis is done in local currency, it becomes clear that the cost per
available seat CASK were increasing over year from 7.81 DZD in 2014 to 8.66 DZD in 2015 and 9.1
DZD in 2016 at the same time the RASK was increasing from 12.31 in 2014 to 13.42 in 2015 and
13.67 in 2016.
The paradox between the two analyses is due to the depreciation rate of the local currency that
was higher than the growth rate of the airline. In both cases Air Algeria had a RASK value higher the
CASK over the three years of analysis, which a positive point for the airline.
0
2
4
6
8
10
12
14
16
18
2014 2015 2016
US Cents
DZD
Air Algeria revenue per available seat kilometers RASK evolution
0
2
4
6
8
10
12
2014 2015 2016
US Cents
DZD
Air Algeria cost per available seat kilometers CASK evolution
Unit cost comparison needs to be based on a similar average trip length, Air Algeria with an
average length with average length of 1068 km seems to be in the same segment as Ryanair with an
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average length of 1200 km, but the low cost carrier remains the leader in Europe in term of cost
control with a CASK value of 4.7 US Cents in 2016 (aviation.itu.edu.tr).
According to McKinsey, tracking, measuring, and benchmarking costs is most useful when it
inspires action, and that is exactly what driver-based benchmarking helps carriers do.
For example, one company that used this approach found that its cabin-crew complements
were higher than those of its peers. After it quantified the cost across the airline, new inflight service
processes and simpler catering helped it to free up one crew member per flight.
Another critical cost driver, given the high salaries of pilots, is cockpit-crew utilization rates.
To manage costs, some airlines have improved their rostering, developed leaner training programs,
planned their crews more effectively, and reduced the number of pilots in management roles. Driver-
based benchmarking reveals many other insights, as well. One carrier noted that its sales and
distribution costs were more than twice benchmark levels.
A deep, driver-based cost analysis by channels found that cheaper online sales accounted for a
relatively low share of the airline’s bookings and that in some markets it was paying commission rates
higher than its competitors were. Since driver-based modeling clarifies the impact of higher seating
densities, several carriers have used it to reevaluate their cabin configurations.
One airline that did so was inspired to reduce the amount of galley space on its new aircraft so
that it could provide fully flat business class beds to differentiate itself from the competition. Another
key driver - the average daily utilization of the aircrafts. Aircraft - was reported as seven to eight hours
at a fairly typical airline, a large turboprop operator. Best-practice regional scheduling suggests that up
to ten hours of daily utilization may be possible.
5.9.1 Ratios Analysis Summary
The financial performance of operation performance of Air Algeria aims to show the results of
operating performance of the airline, but also enable to generalize those results to see how the
business model of the airline is functioning.
The table below demonstrates the brief answers of the research questions based on the analysis
results.
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Air Algeria Factors affecting the results
ROCE Low percentage and continuous
increase
Low profit generated by the
airline
ROA Stable low percentage Aircraft acquisition policy
instead of aircraft lease
Net Profit Margin Low ratio with slight decrease
in 2015
High cost base plus local
currency depreciation
ROE Relatively low ratio with a
slight decline in 2016
Great part of capital employed
is in US$, while most of
revenues generated are in DZD
Operating Ratio Low with continuously
improved over years
Revenues are higher than costs
PPE turnover Acceptable ratio increasing
over years
High value of accumulated
depreciation
Interest Coverage ratio Good ratio Advantageous interest loan
from a local bank
Table 17 Air Algeria’s Financial ratios Analysis
6. Qualitative Determinants and risks affecting the industry
6.1 Determinants
Several factors influence airlines profitability, recognizing and understanding the underlying
concepts and definitions of the airline industry is essential in order to vouch results and analyses
determinants of profitability. Some determinants of airlines profitability are presented below.
6.1.1 Net Profit
The net result of the AH group shows a high increase (+43% compared to 2015), rising from
1.064 billion dinars in 2015 to 1.525 billion dinars in 2016, benefiting from the result of the subsidiary
Catering AH which registers a net result of 1,699 billion dinars, with an increase of 73% in
comparison with 2015.
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As for the cargo subsidiary accounting two (02) months of activity to its active during the 2016
financial year, it achieved a net profit of about 125 million dinars, mainly generated through its two
cargo transport and consignment activities (see table below):
Year 2016 2015 Variation
Profit/Loss AH
Airline
-306 MDZD 66 MDZD -
Profit/Loss AH
Catering
1 699 MDZD 979 MDZD 73%
Profit/Loss AH
Catering
125 MDZD - -
Profit/Loss AH
Group
1 525MDZD 1 064 MDZD 43%
Table 18 AH Group consolidated results
Except for the for the France routes and some European routes that are profitable , most of the
middle eastern and African routes are causing losses, one of the most unprofitable route is Algiers-
Dubai, causing US$ 10.94 M deficit per year with a negative contribution of US$ 4.54 M per year.
In knowing that the net profits of Air Algerian for the years 2015 was only US$ 10.55, and
then 14US$ in 2016. That may explain in some extent the low profit margin of the airline.
Continue to operate this non profitable to Middle East and Africa is causing a loss of US$22M
per year to Air Algeria (Air Algeria Analytic analysis document).
6.1.2 Load Factor
The acquisition of 8 aircrafts in 2016 (6 Boeing 737/800 and 2 Boeing 737/700), created an
excess in capacity and a relative increase in demand. Increasing capacity does not directly increase
revenues, however, an increase in capacity does create a greater revenue opportunity.
Unfortunately, the load factor remained steady or showed only a slight increase in 2016, the
increase in the total available seats kilometers ASK in the network without pushing up the load factor
makes the unit cost or the aircraft block hour more expensive, causing damages to the airline's
competitiveness.
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For example, Air Algeria is operating four flight a week to Dubai, using an Airbus 330-200
with a capacity of 251 seats, with an average load factor of 54%, the break-even load factor for this
route is 92%, which means that even if Air Algeria fills 230 seats over the 251 seats available, still
will not generate any profit from operating this route.
The France network, is the most profitable for Air Algeria with an average load factor of 73%.
6.1.3 Daily Aircraft Utilization
The unit cost decline as the hourly productivity increases, because crew costs, insurances and
depreciation costs are spread over more units of output. The unit cost continues to decline until the
payload has to be scarified, airlines identify the optimum cost range for each type of aircraft they
operates, it is a range of distance over which its unit costs are uniformly low.
From the table below, we can see that the daily utilization block hours average of AH are far
below the industry average utilization standard of the Boeing 767, Boeing 737 and Airbus 330.
Average world
Industry Hour
Utilization
AH Daily Block
AH Hour
Utilization
A330 12.42 8.25
B767 10.38 1.53
B737/800 9.95 6.35
ATR 72 5.2 5.79
LOOCKED 382G - 1.99
Table 19 Fleet hour utilization
The under utilization of the fleet pushed up the unit cost of the airline and supported the deficit
result of -360 MDZD (Airline AH), the profitability of investment made in aircraft acquisition
requires an optimization of the operation of the fleet to be translated by an optimal production in hour
of flight (HOF), a daily use as optimal as possible and a load factor sufficiently high allow sufficient
profitability.
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The analysis of the productivity of the aircrafts composing AH's fleet revealed that despite the
rapid development of the active fleet, during the period from 2015 to 2016, the main operating
indicators did not reach the performance levels to enable the company to achieve sufficient
profitability. This situation arises from the relatively low level of fleet operation and the over-
dimensioning situation resulting in the immobilization of the Boeing 767 combined with the failure to
meet the demands of the fleet.
6.1.4 Employee Productivity
Here we are going to assess the full time equivalent productivity FTE measured as follow:
Revenue/ employees, number of passengers booked per employees and employees per number of
aircrafts
Air Algeria Aigle Azur Ethiopian Royal
Jordanian
Revenue per
FTE
97.4 K Euros 262 K Euros 129.9 K Euros 157.2 K Euros
Passenger per
FTE
717 2790 550 281
FTE per
Aircrafts
150 110 145 165
Table 20 FTE Productivity
Air Algeria has the lowest revenue per employees with only 94.7 K Euros, while Aigle Azur
has the highest revenue per employee with 262 K Euros, Air Algeria is using one employee for every
717 booked passengers, its performance is far behind Aigle Azur with one employee for 2790
passengers.
6.1.5 Operating Leverage
Another measurement tool is the operating leverage, the degree of operating leverage gives
useful information for the airline company. Higher degree of operating leverage can provide
significantly greater profits when sales are increasing, but higher percentage decreases will also occur
when sales are declining. Higher operating leverage also results in greater volatility in profits.
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High operating leverage leads to higher risk arising from higher volatility of profits and higher
break-even point. On the other hand, the increase in risk provides the potential for higher profit level.
The degree of operating leverage can be measured for a given level of sales by the following formula:
Degree of operating leverage = Contribution / Profit
Applying this formula to Air Algeria , provides an operating leverage of 7.1, this means
profits change by seven times more than the change in sales. Thus, for 10 per cent increase in sales
from $1 million to $ 1.1 million, profits will increase by 71 per cent.
But because of the accounting method adopted by Air Algeria (some fixed costs are
considered as variable costs) the new approximate calculation of the real operating leverage gives 13,
which means that Air Algeria is more vulnerable to the economy downturn and business cycles
swing than it is supposed to be (for 10 per cent decrease in sales, profits will decrease by 130 %).
0
200
400
600
800
1000
1200
0 200 400 600 800 1000 1200
Sales
(Millions of Dollars)
Costs
(Millions of Dollars)
AH GROUP
Loss Area
Profit Area
Total variable
Costs
Total fixed Costs
Figure AH Group variable and fixed Costs
6.2 SWOT Analysis
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The SWOT provides a general summary of the strengths and weaknesses in an analysis of
capabilities and the Opportunities and Threats explored in analysis of environment. This analysis can
also be useful as a basis for generating strategic options and assess future courses of action.
Strengths
 Major airline in Algeria
 High traffic of passengers in the first quarter
of the current year (2018)
Weaknesses
 Other competitors means market share
growth is tough
 Presence of other airlines on international
routes making it difficult to have significant
market share
 Politics intervention
Opportunities
 Expansion of sales
 Strongly positioned in the African and
International market share
 New technology to discover a new markets
 Joining an alliance
Threats
 Increasing Fuel Costs and Labour Costs
 Economy
 Unfavorable Government policies and
aviation regulation
 political instability
Table 21 SWOT analysis
Strengths
One of the major airline in Algeria, Air Algeria is the national airline of Algeria, operates
scheduled international services to 39 destinations in 28 countries in Europe, North America, Africa,
Asia and the Middle East, as well as domestic services to 32 airports.
“(…) for the market share Air Algeria has increased its total passengers transported by 13%
between 2014 and 2017, in terms of operating schedule optimization, Air Algeria has improved its on
time departure rate from only 45% in 2013 to 75% in 2017. The traffic of passengers in the first
quarter of 2018 was higher reflecting these last growths.
Opportunities
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Air Algeria is in the process of aligning its codeshare agreements, frequent flyer programs,
and airport lounge agreements with each of the Sky Team carriers in order to meet Sky Team’s
membership application requirements. They also reported that they applied to join Star Alliance or
Sky Team and also began working in partnership with Lufthansa.
As of September 2012, the company has a 46% market share on international routes; the airline
was the leading operator for flights between Algeria and Spain, and six of ten of its international
routes with highest seat availability served France.
In November 2010, Air Algeria announced and investment for EUR400 million to renew its
fleet, to be launched in 2011. In November 2012, the airline invested EUR600 million for the
incorporation of eight aircraft, two of them freighters, between 2012 and 2016 (Wikipedia).
The new online technologies also provide opportunities for airlines to implement new
strategies to differentiate themselves from the competition and capture market share. In developing on
line sales, it will be possible of capturing a history from this data to connect passengers via Algiers
Hub and to mitigate the mistakes once it traces a profile of the passenger.
Weaknesses
As of December 2013, Air Algeria was 100% owned by the government of Algeria
(Wikipedia). This represents a huge dependence on what the government decides and its influence on
the business for both sides as: favored contracting, suppliers known by them, etc.
This lobby defuses the focus that you see in private enterprises that are worried about being
profitable to their shareholders and be well placed in the market. Difficult development without
making the company fast in decisions because it needs to follow the bureaucracy that can be often
time consuming.
During this slow process within the company, opens the opportunity for other better-off
companies to enter the market with more technological advantages, modern systems, which makes it
more difficult to have a significant market share.
Threats
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The impacts of an increase in fuel costs and/or labor costs are the main threats that found in the
airline company.
Economic factors should not to be ignored, which is really difficult to measure or anticipate as
natural disasters or attacks, as well as financial scandals or loss outcomes that can slow down or
encourage an economy, impacting company costs and decreasing purchasing power affected by these
crises.
Internal and external policy changes could also have a direct impact on business, especially if
the measures imposed by new taxation appear to be a disadvantage to the business segment.
6.3 Risks
The concept of qualitative risk analysis is a fundamental when it comes to the need for the
management team and or the management team leader to take the action at onset or prior to the onset
of the project to adequately and appropriately ascertain the approximate level of risk that so many
exist in regards to the conduction of the given projects or series of projects.
Specifically speaking, the concept of qualitative risk analysis refers to the project related
process of performing a thorough and complete analysis of the overall effect of the complete
analysis of the overall effect of the complete and total set risks in the entirely of the predetermined
list of operations objectives.
The qualitative risks Analysis assesses the impact and likelihood of the identified risks and
develops prioritized lists of these risks for further analysis or direct mitigation. To perform the
analysis it has to identify the risk, including a through description of the risk and risk triggers, it can
be characterized in terms of probability of occurrence and the consequence if it does occur.
The main risks of the airline industry are fuel costs fluctuation, currency depreciation, Labor
cost, economic downturn, political crisis and terrorist attack.
In the Air Algeria ' case, the Airline is currently facing major disbursements, related in one
hand to the financing of its activities, of which a large part is consented in high foreign currency
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combined with a depreciation of the national currency, and from another hand a reimbursement of a
long-term loan of the amount of 30 billion DZD the equivalent of 250 Million Euros (in principal
interest free), contracted in 2010 with the national investment fund for the acquisition of the fleet (07
B737-800 and 04 ATR-72-500) during 2010.
The repayment of this loan started in 2017, the issue faced by Air Algeria was that the local
currency DZD has been depreciated by 52% between 2010 and 2017. Which means that value of this
loan is now equivalent to 45,6 Billion DZD instead of its initial value of 30 Billion DZD.
Despite the aircrafts acquisition by Air Algeria aiming at restoring competitiveness within the
company for a better output both qualitatively and quantitatively, exogenous factors related to its
activity, such as the continuous progression of external charges (costs of aeronautical maintenance,
increase in labor cost and depreciation of the local currency Algerian Dinar, ...), are added to that
constraining operating expenses mentioned. The financial penalizing expenses of the domestic
network altogether causes the deficit of the operating result registered in 2016 and 2017.
The anticipation of the IATA was that owing to the imminent surge in the global prices of fuel,
rising labor costs and the high interest rates, the cost of doing business would go up and hence less
profit margins would be realized. The profit forecast by IATA according to Bottom Line (2017), was
revised down to 33.8 billion down from 38.4 billion which was the estimate in December 2017.
By comparison, in 2017 the profits from airlines globally stood at $38.0 billion. This paper
gives a macro-outlook of the airline industry- it looks at fuel prices and labor costs as 2 major factors
that shape the macro environment for businesses operating in the airline sector and how these factors
are influencing profitability in 2018.
6.3.1 Foreign exchange risk
Foreign exchange (FX) risk, is the risk arising from the airline's exposure to changes in
currency exchange rates. The risk is relevant because of the cash inflow and cash outflow are
denominated in different currencies, as Air Algeria is operating across countries with different
currencies. The local currency DZD has known an important depreciation between 2013 and 2017 as
shown in the table below.
74
2013 2014 2015 2016 2017
1 USD 79.58 80.66 100.59 109.53 117.87
1 EUR 105.93 106.94 111.49 120.77 134.60

Table 21 Exchange rate evolution
Another aggravating problem is that 57% of Air Algeria 's cost are paid in foreign currencies
(US Dollars and/or Euros) while only 35% of its revenues are generated in foreign currencies (US
Dollars and/or Euros).
Air Algeria with a US Dollars deficit must convert additional local currency into US Dollars
each year to cover its Dollars obligations. Such fall in value of local currency had a negative impact
on operating financial performance in local currency terms. This because more units of local currency
needs to be converted into US Dollars to cover the mismatch.
The currency risk can be mitigated to some extent by matching revenues against cost incurred
in those currencies, this can be achieved by developing on line sales and capturing more international
connecting passengers via Algiers Hub. Hedging also provides an efficient way for foreign exchange
risk management.
6.3.2 Fuel Cost
The fuel cost is the second highest component of Air Algeria’s operating cost behind the labor
cost. The fuel expenses, in contrast, are unpredictable and are the item that the airline has the least
amount of control over. Airlines can optimize their operational procedures to realize some fuel
efficiencies, but they do not exercise much influence on the price of fuel.
For more mature and larger airlines, which have sufficient capital and organization breadth to
institute a risk management program, fuel hedging can be of great use in managing fuel price risks.
According to Global Airlines (2017), the first airline reporting cycle has not had an impressive
outlook in 2018. The high cost of fuel has impacted on the projected airline profit for the year. For
example, fuel cost at Delta Airlines Inc. which is one of the largest airlines in the world has increased
by about 20%.
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Since the beginning of the year 2018, the prices of oil globally have been on an upward trend
(BAKER, 2018). This is attributable to the cutbacks by the Oil Producing and Exporting Countries.
Oil prices globally have risen by at least 8% in the period between January and March.
Neuhauser (2018) submits that that the prices of oil account for a significant portion of
expenses of airline service providers and as such is one of the price drivers for the industry. The price
of oil per barrel has gone up $ 73.8 in 2018 representing 12.5% increase. In 2017, the fuel bill for the
airlines globally stood at $18.8 billion.
In 2018, it is projected by IATA that fuel bills will account for about 20.5% of the total costs
of the airlines. In the first quarter of 2018 for instance American Airlines, one of the nation’s major
carriers announced that its ticket prices would increase.
This, they reported was attributed to a 25.8% increase in the company’s spending on fuel. The
price of jet fuel costs 36.5% more in 2018 than it did in 2017.
According to Global Airlines (2017), given the sensitivity of the aviation industry to any
adjustments in the oils prices, a lot of negative effects are already playing out. Major airlines in the
USA for instance including American Delta are suspending flights to various destinations.
6.3.3 Labor Cost
Air Algeria is operating in a low labor cost country, but its labor cost accounts for 22% of the
total cost, nevertheless, , this relatively high average labor cost compared to its regional competitors,
is essentially due to the excessive numbers of employees (8700 employees) , excess employees
responding to government policy to satisfy the national policy to boost employment .
As was already forecast by the industry body IATA, labor costs were expected to rise in 2018.
In 2016, expense on wages stood at 22% of the total cost of operation in the airline industry. The cost
is expected to go up to as high as 30.9 %. According to Hassan & Omido (2018), the global spending
on labor by airlines in 2018 has surpassed that of fuels; the cost of labor trails the list of expenditures
for airlines at an expected 30.9 % against the projected 20.5% for the cost of fuel.
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In North America and in Europe the cost of compensating staff is. As Babic et Al (2017)
reports. In Asian airlines the spending in staff is not as high inherently high
In Asia the fuel price remains a more pressing concern though (CALDWELL, 2018). As part
of the challenge of the cost of labor, a twin challenge of shortage of staff has also been seen by several
airlines despite a growing fleet and more destinations coming up.
For instance, Ryan Air was forced to cancel thousands of its flights in the beginning of the year
because of the shortage of pilots to fly the planes. Big carriers in the airline industry are coming under
pressure from aviation union groups for workers who are demanding better pay for their members. In
France, the Air France is facing 10 labor unions who are demanding at least a 6% rise in the pay of
plot.
As posited Hassan & Omido (2018), the spate of labor disputes has not spared even the Middle
Eastern countries and the United Arab Emirates where industrial action is illegal and labor unions are
not recognized.
Employees working for the Emirates which are the largest carrier in the region are seeking to
have their working conditions improved and their benefits adjusted. Given the fact that the airlines
have been recording huge profits up until 2017, it has given the workforce plenty of market power.
The market power is majorly the factor that is driving the cost of labor.
According to Boehmer (2010), in the USA, the largest carriers American Airlines, Delta and
United UAL are also facing similar labor cost challenges.
They are beginning to feel the effects of the pay increase agreements that they arrived at with
their workers at the close of the year 2017. (SILK, 2016) opines that the cost of labor in the airline
industry is a global problem and is going to significantly reduce the profit margin for airlines in 2018.
American Airlines is coming to terms with the increased spending on compensating its staff.
6.4 Challenges
Regardless of the challenges already discussed in the preceding sections in this paper, the
aviation industry globally has seen some impressive growth indicators. According to « Airlines
77

Industry Profile: China (2017) », there has been an increase in the number of new markets; there has
been an exponential growth in the Chinese market coupled with an increase in the number of Chinese
airlines globally.
A sustained high level of traffic flow has also been recorded despite challenges in oil prices
and labor. A raft of newly developed aviation technology has enabled the tremendous growth in the
number of long haul but affordable flights as well as the launch of new routes (BABIC).
The reason for this success especially in the first quarter of 2018 is because most airlines took
advantage of the projections into the year; they stocked up oil in their stores enough to take care of
their needs well into the year. (KELLY, 2018) suggests that this explains why for most airlines, the
impacts of the high oil prices will only be felt gradually.
As conclusion, it has been covered in the paper, the overall outlook of the airline industry has
not been all bad.
Fuel prices have gone up and labor costs have seen a rise too and in some instances, the
airlines have been forced to take drastic measures like suspending flights. On the contrary, judging by
the year’s first quarter performances posted by a number of airlines, the industry has remained fairly
stable; there has been a rise in the number or airlines internationally, existing airlines have discovered
new markets and new technology has made it possible for airlines to come up with long haul flights
that are affordable to their customers.
A combination of these factors has led to a high traffic of passengers in the first quarter of the
year. Industry players project that the effects of the increase in oil prices may soon change the fortunes
for the industry though
6.5 Risks Assessment
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The risk assessment classifies the identified risks based on probability and severity. It suffices
to judge the risks appropriate to the organization. The focus of the risk assessment lies on the risk
perception and not about exactly estimating the probability.
It is suggested to use a five by five matrix to display the risks in an overview. As part of the
risk management strategy, the Board of Directors sets the risk management strategy based on the risk
policy and decides for each risk whether it is acceptable.
Furthermore, the Board defines the appropriate mitigation strategy. The mitigation process has
to be supervised and controlled. Therefore, it helps to define key performance indicator (KPI) or other
measurable indicators to supervise the implementation process.
Risk Management is not a one-time achievement but a steady and ongoing process. Therefore,
79

The Board of Directors and the Executive Board should at least review the whole risk management
agreement process and the top 10 risks on the updated master risk list on a yearly basis.
This may also include risk-reporting possibilities (KALIA, MÜLLER, 2007). In conclusion, a
mature risk management system, in contrast to an ad-hoc risk management system, which only aims to
comply with legal standards, is an important factor for the success of an aviation enterprise. Risk
management has to become a part of the company's culture in order to unfold its entire potential.
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Risk Title Risk
description
Probability Severity Risk Mitigation
Fuel price
volatility
Increase in
fuel prices
It will
probably
happen
4 Very High Fuel Hedging
Foreign
Exchange
Risk
Depreciation
of the local
Currency
It will
probably
happen
3 High
Capture more
international
customers
paying in
international
currencies
Labor Cost
Continuous
Increase in
labor
Cost
It could
possibly
happen
3 Medium
Firing and
negotiate
voluntary
departure
agreements
with labour
union
Attack Sabotage or
Terrorism
It is unlikely
to happen
5 Medium
Implementation
of ERP plan
Economy
downturn
Airline
cancel
destination
It is to
happen
4 Medium
Market and
business
diversification
Aircraft
accident
Accident
airliner or
chartered
aircrafts
It is unlikely
to happen
5 Medium
Strict
compliance
with safety
standard
Table 22 Risk assessment
7. Discussion
The thesis is based on the analysis of the financial ratios with more focus on profitable
ratios including net profit margin, operating ratio ROA, ROE and ROCE, the analysis was
conducted based on the data retrieved from Air Algeria . The objective was to use financial
ratios of three years period to evaluate Air Algeria 's performance and it was achieved by
analyzing its financial operations.
81

This study can be a reference for general investors who have not had an adequate
knowledge in the airline industry to gain an insight when considering for their investments in
the North African market area.
Fundamentally, the main question in this study is answered through what has been
analyzed above.
It was explained during this study the reasons of the low profit margin recorded in the
airline industry. Despite, the fact that Air Algeria recorded profit during the last three
financial years, investors are unlikely to invest in Air Algeria due to the low profit margin
and low return on equity as well , the profit recorded compared to the huge assets used and
total capital employed remained insignificant and was far below the industry average.
In order to improve its net profit margin , return in equity and return in asset, we
suggest a specific industry analysis, as is the case here , operational determinants of the
industry should be incorporated into financial analysis, it is suggested to have a good
capacity management. The most fundamental reason for the improved levels of airline
industry profitability is better capacity utilization.
The most commonly reported and observed measure of airline capacity utilization is
passenger load factor-how full the aircraft are- but this does not tell the whole story. Global
average load factor have steadily climbed for decades from around 55% in 1970 to around
80% in 2016, meanwhile, however airline profitability has not consistently followed a similar
upward path thought this period.
A full view of capacity utilization needs to include how many hours per day aircraft
are utilized (there is no point in having a full aircraft that only flies a few hours a day) and the
percentage of the fleet that is actually flying and not parked or in storage (is not enjoying high
overall if that full aircraft is flying 24 hours a day but is only one that is in service, then the
fleet is not enjoying the high overall capacity utilization).
In contrast with the broadly upward trend in load factor, daily aircraft utilization and
the percentage of aircrafts in use have both followed a cyclical pattern over several decades.
However following the global financial crisis, daily utilization and the percentage of the fleet
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in use have been on more clearly defined upward path since 2009. At the same time load
factor has also continued to track upwards.
The combination of these three measures of capacity utilization goes a long way
towards explaining variations in the operating margin of the airlines.
Load factor is pushing ever new peaks levels in the airlines industry and appears to
have become the main driver among the three measures of capacity utilization in terms of
their impact on airline profitability.
The use of load factor as a measure of asset utilization efficiency, knowing that the
airlines with increasing load factors are the more efficient airline in using their flight
equipments with the highest daily hour’s aircrafts' utilization average.
Air Algeria is also maintaining a high leverage due to its policy of using loans to
finance its fleet acquisition instead of operational lease, it is recommended for Air Algeria to
take action to avoid high leverage and asset turnover ratio with a small profit margin, it has to
lower its leverage and asset turnover ratio to minimize its loss if it can't improve its profit
margin.
This may require to deplete of the airline's operations by selling the idle assets, replace
fretted fleet by its own fleet, settling part of their debt obviously starting with debt having the
highest cost. The flight frequency on the most non profitable routes should be reduced,
operated differently or the routes closed. However, action on load factors should be carefully
evaluated as reduction on load factor will result in an increase in unit cost exacerbating the
already low profit margin.
The assets portion of the return on assets ROA formula feels the effects of good
supply chain management. Inventory is an asset, so less excess inventory the airline have
sitting around unused, the its total assets and the higher its ROA. Inventory also requires fixed
assets to manage-warehouse space, transportation equipment and so on.
Effective inventory control can reduce the airline's need for these fixed assets and thus
increase ROA. Reviewing the airline's supply chain might even reveal that Air Algeria could
83

save money by outsourcing some inventory management tasks. Supply chain management
isn't just about moving products around, it is also about monitoring the quality and costs of
the product offered to the customers.
As the profit margin and return on equity are very low for African airline industry in
general and Air Algeria more specifically, so in order to these airlines to continue to
provide the social and economic benefits to the society at large by supporting employment
and by connecting isolated regions (specially for state owned airlines like Air Algeria ). The
government should take policy actions and provide support to the airline.
Additional incentives for investors in the industry should be in place to attract and
keep them in the industry including reduction of tax burden on airlines, charges and fees ,
relaxed regulation with due consideration to safety, liberalization and other government
services.
8 Recommendation implementation
8.1 Load factor
The acquisition of 8 aircrafts in 2016 (6 Boeing 737/800 and 2 Boeing 737/700),
created an excess in capacity and a relative increase in demand ,Increasing capacity does not
directly increase revenue, however, an increase in capacity does create a greater revenue
opportunity.
Unfortunately, the load factor remained steady or showed only a slight increase in
2016, the increase in the total available seats kilometers ASK in the network without pushing
up the load factor makes the unit cost or the aircraft block hour more expensive, causing
damages to the airline's competitiveness.
The acquisition plan was probably established on the basis of a traffic evolution
assumption corresponding to a global forecast of world traffic presented by IATA (Air
Transport International Association) which is not specific to AH’s markets.
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Air Algeria’s market is a local and regional small market where more than 95% of the
passengers transported are local with restricted purchasing power compared to the
international market. The excess capacity generated by the acquisition of new aircrafts has
increased the cost base of Air Algeria and decreased its competitiveness as its cost per
available seats has increased and utilization of their aircrafts became more expensive.
Moreover, it started from a reasoning, based on the fleet owned and did not consider
rent possibilities, despite the cyclical nature of the airline industry, which requires a flexible
fleet, especially in a crisis situation.
In order to deal with the over capacity Air Algeria should do:
 Stop operating routes with low load factor
 Increase capacity in routes with high load factor
 Develop new routes with a forecasted high load factor
 Code sharing agreements in order to capture new passengers on its operated routes.
 Operate charter flights out of the scheduled time
 Replace fretted fleet by its own fleet
8.2 Aircraft utilization
The following table shows the average aircraft utilization at Air Algeria and how it
compares with the average aircraft world utilization for similar aircrafts.
Avg World Avg AH
Utilization Utilization
A330-200 12,42 8,25 66%
A767-300 10,38 1,53 15%
B737 NG 9,95 6,35 64%
ATR72 5,2 5,79 111%
%%
Table Block hour utilization
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The jet engines aircraft type used by Air Algeria are significantly underutilized. At
current rates for this fleet and by improving utilization by 25% for the A330 and B 7337 NG,
and by improving utilization by 100% for the B767 can provide Air Algeria additional lift
equivalent of two Airbus 330, eight Boeing 737 NG and 3 Boeing 767.
8.3 Aircraft Availability
Depending on company culture, flight schedule and resource availability, the schedule
tasks can be planned for block checks or an equalized program. Generally speaking an
equalized program will increase aircraft availability. This will be visible by comparing
calendar in service based daily utilization.
A good planning process will ensure a high level of task/check interval utilization
(yield). High yield means reduced maintenance cost within framework of the currently
approved intervals. In case of unforeseen circumstances the application of short time
escalation will prevent equipment out -of-service and associated loss of revenue. Additional
cost reduction can be achieved by controlling planned versus actual man-hours and by
avoiding accomplishing of unnecessary work.
The number of -out of service- days is a major key performance indicator (KPI) that
the aircraft downtime is utilized. Based on the analysis of the calendar and the in-service daily
utilization the table below shows the average number of aircraft out-of-service days per
aircraft. Monitoring this data is another important planning tool.
The out-of-service time also includes days when the aircraft was serviceable, but not
required to fly. Based on this analysis out of the 59 aircraft only 46.01 aircraft were in service.
By improving check performance and aircraft utilization this number can be increased to
make more aircraft available to make revenue (the annual out of service time is based on total
number of out-of-service day for any reason technical or no schedule flight).
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Fleet Daily Fleet Daily Average Equivalent
Aircraft type Calendar In-Service annual out number of
Utilization Utilization of service aircraft in
(hrs/day) (hrs/day) time (days) service
A330-200 7,63 8,33 89,42 6,04
767-300 1,19 1,69 185 1,47
737-800 5,4 8,09 44,7 21,9
737-700 1,6 1,87 162 1,1
737-600 5,2 6,11 33,7 4,54
ATR72 4,98 5,88 85,45 11,5
L-382G 2,16 2,62 182,5 0,5
Total 46,01
Table Fleet Availability
From the above the following actions are recommended:
 Reduce check down time by more productive use of resources and consideration
should be given to include preventive tasks in the maintenance program to minimize
non-routine findings and related materials shortage.
 Improve checks performance and aircraft utilization to increase aircraft availability for
revenue flights.
 Establish KPIs and collect ,analyze data to be able to address a negative trends
8.4 Inventory Management:
Airlines are experiencing pressure to lower labor costs. However, they are also being
asked to reduce cost of maintaining and distributing parts inventory while maintaining high
levels of Technical Dispatch Reliability (TDR) and further reducing aircraft, component and
engine repair cycle times.
As the airline reduce inventory levels of aircraft spares, in turns, its MRO suppliers
must become more efficient and reduce overall repair cycle times. Inventory ownership and
inventory holding has always been used to gauge efficiency. The objective is to hold the
minimum of inventory stock without impacting the operation.
Air Algeria is subject to lengthy export/import cycles which increase the inventory
pipeline and may elevate certain spare inventory levels. WIP (work in process) inventory is a
87

function of, and directly proportional to TAT (turnaround time). If TAT is halved, the
quantity of inventory required to support the maintenance process will be halved as well. The
relationship between TAT and level of spares can described by the following equation:
WIP = f (Daily Demand X TAT)
This equation is true for components as well as engines, it applies to any routable part
which undergoes repair or overhaul. As one can see, if demand is constant and TAT increases,
WIP will also increase, as TAT decreases WIP required to support the same demand will also
decrease.
Surplus inventory occurs for a number of reasons. Including the following:
 Over purchase either at initial provisioning (when the airline takes delivery of new
aircraft) or during the operations.
 Automatic buyback of scrap parts rather than assessing future inventory needs.
 Retirement of some or all of a fleet of aircraft , making the inventory obsolete to the
airline's needs
From all the above our recommendations are the following:
 Implement demand versus actual inventory for engines and components
o Perfect on aircraft checks and scale to engine and components activities
o Review current provisioning levels and right-size existing inventory level
 Establish performance evaluation/recognition process known as MOR (Monthly
Operating Reviews)
o Utilize metrics to evaluate inventory performance
o Supplier On time delivery % versus plan
o Inventory Balance, Spend, turns versus plan
.
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8.6 Unprofitable routes
In the airline industry it is a common practice that an airline continue to operate an
unprofitable route if the contribution generated from this route is positive, in this case the
revenue generated allows to generate some cash to cover a part of the fixed cost of the airline,
but continuing to operate an unprofitable route.
Even if the contribution provided is negative, means that not only the revenue
generated from operating this is not contributing to cover a part of total fixed cost of the
airline but is not covering the variable generated from operating the route itself.
Air Algeria is currently operating numbers of routes that are unprofitable with a
negative contribution the total loss supported by the airline when operating theses route has
reached the value of 22 M US$ as shown in the table below:
ROUTE Revenue
US$ M
Costs
US$ M contributio
n US$ M
Net Profit
US$ M
Alg-dxb-alg 12,9 23,8 -4,5 -10,9
alg-bey-alg 3,2 4,6 -0,6 -1,3
alg-amm-alg 3,7 4,9 -0,3 -1,2
alg-dkr-alg 3,3 9,4 -4,7 -6,1
alg-oua-alg 1,1 3,9 -2,0 -2,8
TOTAL 24,2 47 -12 -22
Table Unprofitable route
The immediate actions we recommend are the following:
 Stop operating the route Algiers Dakar Algiers (potential saving is 6.1M US$)
 Stop operating the route Algiers Ouagadougou Algiers (potential saving is 2.8M US$)
For the Middle Eastern routes it is suggested to continue to operate these routes, as the
Middle Eastern market has a real growth potential, so it is recommend to operate to Dubai
from Algiers four times a week. And while two flights should be operated via Amman and the
89

two remaining flights should be operated via Beirut, by assigning to the routes a different type
of aircraft, which is the narrow body aircraft which is the Boeing 737/800, instead of the wide
body aircraft Airbus 330/200.
This will reduce drastically the operating cost, permitting to reduce the loss caused by
operating the three destinations from 13.3MUS$ to only 3 MUS$ with a positive contribution
of 4.86MUS$ (see appendix for calculation details).
8.7 Labor Costs
The strategies to reduce labor costs or increase labor productivity are the two faces of
the same coin, Doganis (2001) argued that as a consequent of air transport deregulation and
the entrance of new LCCs, a profound change in the nature of the airline industry since 1990
has come the operational arena because, no longer, cost reduction is a short-term response to
declining yields or failing load factors, but it is a continued and permanent strategy when
carriers want to survive in this competitive environment.
The airlines face a strong opposition from well organized labor unions, airlines
managers have always the possibility of transferring services to regional partners, franchises
or alliances and even setting up a low-cost carrier subsidiary. These subsidiary carriers were
created to compete fiercely with the new low cost carriers and followed a similar business
model.
Since the introduction of the low cost carriers, the airline industry has known a new
competitive environment, in order to survive legacy carrier like Air Algeria need to revise
their labor costs downward through various measures which include increasing productivity,
freezing or reducing nominal wages, hiring new labor with lower wages and outsourcing more
non-core activities, such as catering, ground handling and aircraft cleaning and maintenance
8.8 Financial risk exposure
As no company can have full control over economic risks, it becomes crucial for
companies to choose the correct instrument to manage this risks and to react appropriately in
the case of extraordinary events, which may cause damage to the company.
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By observing the trend in the financial risk exposures, in addition to the economic
analysis from the analyst, it shows that the Brent crude oil and jet kerosene price are predicted
to continue to increase.
This is the result of the decrease petrol refinery production, a decrease in the reserve of
the resources, and the fact that the fewer new oil mines have been discovered. Unless a large
vulgarization of a substitute petrol is implemented, airlines industry dependencies on petrol
will keep the price continually increasing.
The Algerian Dinar DZD is also expected to depreciate gradually but continuously.
This, however, stimulates and encourages foreign sales as the airlines can profit from the
currency fluctuation, excluding the increase of actual foreign sales. But on the other hand, Air
Algeria has to pay extra travel allowances or overseas personal expenditures if the Algerian
Dinar DZD depreciates.
However, if Air Algeria operates its foreign transactions, which are based in USD or
other currencies, separately before exchanging them in in and out of Algeria, the swapping
mechanism may help to maximize the airline returns to have strong currency risk exposures.
The ultimate option may be if each country or region is capable of operating by
themselves in terms of self sustaining financially, then it can minimize the risk from the
currency on returns as well.
8.9 Fuel price exposure
Loudon (2004) suggested that short-term cash flows are likely to be directly related to
change in fuel prices due to price change inertia. Revenue responsiveness may initially be
slow due to advance sales, pre-booked seats and so on.
In longer term, much of the price affects are likely to passed on, as all airlines face
similar costs, Carter, Rogers and Simkins (2002) provided evidence that airline cash flows
and share returns are negatively correlated with fuel price changes.
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Airline profitability is reduced by the direct and indirect costs associated with fuel
prices. Since competition prevents an airline from perfectly undoing the impact of changes in
fuel prices by adjusting its fare schedule or seat capacity according to the optimal mark-up,
the fuel price exposure coefficient is predicted to be negative.
The cash flow of an airline is also sensitive to extreme jet fuel price charges when
compared to changes in capital expenditures. Overall, airline exposure to fuel prices is
economically significant, and considerable cost savings would be realized by airlines hedging
in the event of extreme price increase.
From an investment perspective, hedging allows airlines to fund investment when jet
fuel price are high and airline's operating cash flows and values are down. There is a positive
relationship between hedging and value, suggesting that investors view such investments as
positive net present value projects. Airlines have incentive to hedge fuel exposure to protect
their internal cash flow in order to meet future commitments to purchase aircrafts.
Thus, fuel cost levels tend to be negatively correlated with investment in new planes.
Investors see the existence of the hedging premium largely as the result of hedging on capital
investment. Carter, Rogers, and Simkins (2006) found that the value premium associated with
hedging increase with firms' level of capital investment.
These conditions suggest that, if the market expects airlines to invest their marginal
cash flow in positive net present value projects, then investors should place positive value on
the fuel hedging policies of airlines.
Conversely, if investors view such investments unfavorably, hedging would have
negative value consequences (Carter, Rogers, and Simkins 2002). This result implies that that
investors value hedging by airlines when they expect hedging to protect the ability to invest in
bad times. Thus, hedging is regarded as a positive attribute in the investment process of
airline companies.
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Appendix
Costs ALG-AMM-
ALG
ALG-BEY-
ALG
ALG-DXB-
ALG
ALG-BEY-
DXB-BEY-
ALG
ALG-AMM-
DXB-AMM-
ALG
Difference
(Relevant
Costs)
Sales 3,65 M 3,2 M 12,96 M 9,68 M 10,13M
Fuel (1,06)M (0,99) M (7,06)M (1,99)M (1,96)M 5,16 M
Maintenanc
e (1,02)M (1,05)M (3,3)M (2,03)M (2,03)M (1,31)M
Parking/ser
vices (0,07)M (0,07)M (0,4)M (0,13)M (0,13)M 0,28 M
Navigation (0,3)M (0,3)M (1,34)M (0,57)M (0,55)M 0,82 M
Landing (0,21)M (0,23)M (0,7)M (0,42)M (0,42)M 0,3M
Crew (0,71)M (0,7)M (2,6)M (1,3)M (1,22)M 1,49M
Other
Variable
Costs
(0,6)M (0,5)M (2,1)M (1,1)M (1,1)M 1,0 M
Total
Variable
Costs
(3,97)M (3,84)M (17,5)M (7,54)M (7,41)M
Contributio
n (0,32)M (0,64)M (4,54)M 2,14 M 2,72 M
Fixed Costs (0,66)M (0,47)M (5,6)M (3,27)M (3,46)M
Overhead
Cost (0,17)M (0,16)M (0,8)M (0,56)M (0,57)M
Total Costs (4,8)M (4,47)M (23,9)M (11,37)M (11,44)M
Profit/loss (1,15)M (1,27)M (10,94)M (1,69)M (1,31)M 10,36
93

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Africa
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228420001_Airlines_and_their_Focus_on_Cost_Control_and_Productivity
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