Route Pricing and Competition
Let’s say for example, Air M operates Prague to Tel Aviv on an Airbus A319, with a price of € 300 (see Figure 1, Model A):
€ 300, the seated capacity stands at 100%, meaning that all 140+ seats on an Airbus A319 is filled to capacity. What Air M can do is to keep increasing its price until a certain point where the seated capacity starts to drop because of continued price hikes, which in that case is at € 350. After that certain point, the seated capacity drops slowly as less passengers will take that deal. In short, the higher your fare after hitting the optimal price, the lower the demand.
Now, let’s pretend a competitor, called L Airways, starts operating the same route as Air M, this time, with a bigger aircraft–an Airbus A321-200 that can carry 220 passengers (see Figure 1, Model B). Naturally, with that competition, it means that Air M, if they keep the price at € 350, will operate the same route with less passengers on board because L Airways operates with more seats on board. What Air M can do is that it could lower the fare to match L Airways’ fare, say, to € 300, so that it could regain full load on the same flight. In short, the more seats your airline can provide–along with its competitor/s–the lower the fare you can have, translating to higher profits.
Then, we pretend that Air M has no competition on the flight, but has somehow downgraded the aircraft used to operate the Prague to Tel Aviv flight to a Boeing 737-500 to trim costs (see Figure 1, Model C). What that would mean is that Air M has less seats available on board–albeit with faster speed–that it can charge a bit more for its passengers for its premium service. In that case, at the rate of € 350, it will still seat at full capacity until the airline reaches around € 400, after which the seated capacity decreases. In short, matching your route’s demand to your aircraft is crucial to optimizing your profits and seated capacity level.
Now, we get to see the other, more important aspect of the story: profits earned from operating flights (a.k.a. Daily Operating Contribution, DOC). This is very important for us to understand because it shows how much each flight earns on a monthly and yearly basis, as well as showing the effects of competition and changing aircraft from earning profits for our airlines.
Let’s say again, Air M, operating a flight from Prague to London Heathrow on an Airbus A320-200 at a price of € 350:
€ 77,000, a nice profit for a medium-haul flight. It is also interesting to note that although most of the graph shows the positive (green) curve, it also shows the negative (red) aspect of the curve, and I will explain that below. Another thing to note: although fares at the highest possible point may have
€ 77,000 maximum profit, it is perfectly fine to see a route operating
€ 5 above the
€ 350 price and still see profits a bit higher than
€ 77,000 while the seated capacity goes down by around 0.5%. It is also possible that Air M can upgrade the route without any competition in sight: if the airline ups the aircraft used to a Boeing 767-200 for example, it can reduce its fares while earning greater profits because more people will ride the airline. In short, matching your route’s demand to your aircraft is crucial to optimizing your profits.
Some airlines have experimented operating such flights as New York to Miami, Hong Kong to Tokyo, and others with larger aircraft (i.e. Boeing 747) at a fare of
€ 1 to lure even more passengers away from airlines like Air M. There’s definitely a catch to operating such trips at
€ 1 a seat: while your airline may have full load on the flight (see Figure 1, Model A), your operating costs will be higher, such that you need to add the staff, operational, fuel, and layover costs, thus the route may run at a loss rather than a profit (thus the red line shown around the
€ 1 to
€ 60 mark), not benefiting such airlines at all. Operating flights at € 1 a seat can be beneficial as a short-term solution for oversubscribed flights, but, it is a poor long-term profit-making decision.
Let’s pretend a few months later, a competitor named Air Z Express opens the same route as Air M (Prague to London Heathrow). Three scenarios might happen:
- Air Z Express operates the route with a Boeing 757-200, a larger plane (see Figure 2, Model B). What happens is that the profit of Air M operating the same route goes down significantly because Air Z Express operates the route with more passengers on board, thus the airline gets a larger share of the seats and profits. What Air M can do is to match Air Z Express’ capacity, either by upgrading the route to a Boeing 757 (thus increasing profits yet upping costs as well) or by cutting the price using the same aircraft (to around € 300) so that it can have a full load while maintaining good–yet reduced–profits.
- If, however, Air M switches planes used to operate Prague to London Heathrow from an Airbus A320-200 to an Airbus A330-200, it will provide a greater advantage for Air M since it operates a bigger plane. However, one needs to approach this with caution: observe the light green line and curve emanating from the € 300 mark, in which the profits will sharply go down after a certain amount then it falls significantly afterwards. That phenomenon happens because Air Z Express will try to compete with Air M’s prices to serve as many passengers as possible with lower fares. Thus, it is wise to choose what aircraft you operate for your routes: it will determine how much profit it makes, as well as noting the overall operational costs that make up the route.
- Yet another situation arises that Air Z Express, for all reasons, uses the same aircraft as Air M to operate Prague to London Heathrow (see Figure 2, Model B, gold line). What it means is that Air M is directly competing against Air Z Express to make more profits on the same route operating the same type of aircraft. Plus, if Air Z Express operates the route at € 300 a seat (versus Air M’s € 350), it would spell trouble for Air M since it will mean less passengers riding with Air M than Air Z Express. To correct that situation, Air M must either lower the cost to match Air Z Express’ fare, or it can lower the bill to just above the competitor’s fare, so that it can get a decent profit from the trip while maintaining full load on the flight.
In short, to maximize profits, one must be able to adjust both fares and aircraft if needed to optimize and maximize potential profit.
Finally, if Air M continues to operate the route on its own but sees that the route is not making enough profits (see Figure 2, Model C), the airline can increase the fare to around € 375 in about a year so that it could recoup more profits than the previous month or year, thus making it a very profitable route. Same situation applies if the airline is cutting down its operating fleet.
I understand that economics may be a tough subject to discuss when dealing with Airline Mogul flights and operations, but, I hope this supply and demand guide will help you determine the best ways to make your airline profitable and successful in the long run.