Strategically integrating an airline's Scheduling function in a Revenue Management Framework

In a series of blogs, Sum evaluates and researches the big question "How to Save Air India". In the first part of the series integrating the scheduling decisions of an airlines in a revenue management framework is discussed. The framework discussed below is general as it applies to all the airlines. Specific references and the case as it applies to Air India will be discussed in the next blog.

Scheduling is a means of matching consumer demand with supply. An airline’s flight schedule defines its core product and is a key determinant of its profitability. Scheduling determines where and when the airline will fly, and what aircraft capacity and types to assign to these routes. Customers make their purchase decisions based primarily on the schedule – the routes, days of operation, departure times and connections the airline offers. The time-sensitive business customer looks for convenient, consistent and high- frequency departure times particularly at the beginning and end of the work day and work week; the leisure customer may be more concerned with the availability of routes to exotic destinations or convenient connections between flights. Aircraft equipment types and age may also influence customer demand. Some customers have preferences, particularly on long-haul flights; others may have related safety concerns. Another factor that customer may consider is service delivery.

Maximizing profitability is the primary goal of airlines. Scheduling is the means of matching supply (aircraft seat capacity) to passenger demand. Airlines try to improve their profit margins by creating a schedule that will attract as many customers as possible in a wide variety or origin & destination (O&D) markets.

By ensuring that proper capacity is assigned to the right markets at the right times. Airlines can meet or exceed their financial targets. This may involve considering new route opportunities or looking for more profitable ways of deploying aircraft within the current route network. Many different groups and departments provide input at different points to ensure that the optimized schedule is also feasible and efficient.

There is a wide range of opportunities and threats in the marketplace that can affect both the development and management of the schedule. Airlines compete in a complex dynamic environment. They must continue to monitor the schedule up until the time of departure and may need to adjust capacity in response to external influences raging from mundane to crisis situations. These might include shortfalls or excesses in anticipated customer demand, special events, economic upturns or downturns, natural disasters, pandemics, terrorism and war. Those airlines that can respond quickly and effectively are at a competitive advantage.

Most of the major carries operate extensive hub-and-spoke networks. A hub system allows an airline to enter markets and offer access to more destinations. Without the combined traffic from the other stations, the airline would not be able to operate these flights. In a hub-and-spoke network a passenger can fly Chandigarh to New York by connecting through the hub in New Delhi. There is not enough passenger traffic between these two cities to warrant non-stop direct service between them. However, with a hub-and-spoke configuration, passengers originating from Chandigarh, Licknow, Jammu, Amritsar, Varanasi, Jaipur etc can all conect at the hub in new Delhi to the flight to New York.

To maximize when developing and optimizing the airline schedule, it is important to adopt a network-based perspective. A leg-based approach would concentrate on local point-to-point traffic with minimal connection opportunities. This provides only and isolated view of each flight. It doesn’t consider where the passengers connecting to the flight are coming from or where the passengers connecting from the flight are going to. Although an airline schedule is composed of flight legs, airline products and revenues are based on passenger O&D markets. A network or O&D based approach optimizes the total network by combining direct point –to-point traffic with connection traffic. It maximizes profits by looking at the big picture of how each flight in the network affects the traffic on the rest of the network.

Schedule banks are specific time periods in an airport hub city during which a large number of arrivals and departures are timed to connect with each other. This combination of arriving and departing aircraft within a window of time is done to maximize connection opportunities.

Timeline and Organizational Perspectives

Developing and maintaining an airline schedule is a dynamic process extending over a long period of time that involves many people in different departments across the organization. The processes involved in network planning, schedule development, and capacity adjustment occur at different points in time and at different levels within an airline’s organizational structure.

• Long-term strategic planning by top level management;

• Medium –term planning and schedule design by the network planning group; and

• Short-term management by the current schedule group.

Keep in mind that the specific organizational structures, division of duties, and points of time when the schedule off between groups will very from airline to airline.

Corporate strategy and financial targets are communicated downward; information on historical and current performance and forecasted demand is reported upward and across the organization. It is the responsibility of the network planning group to determine how to distribute capacity in the different O & D markets and create the schedule. Given this scheduled capacity, the revenue management group implements seat allocation and pricing strategies to achieve corporate revenue and traffic targets. As the date of departure approaches, the current schedule group makes capacity adjustments in response to actual booking levels and changes in market conditions.

Core Schedule

An airline’s schedule is displayed in the computer reservation system 12 months in advance. It is desirable to work with a rolling core schedule that is consistent through the year. Flights are added to the schedule for the peak periods when demand increases. The core framework basically remains intact from season to season.

This type of open-ended, yet consistent, rolling schedule has a number of advantages. Frequent air travelers prefer a consistent predictable schedule. It also provides stability in the future booking schedule. Group bookings often happen very early in the booking cycle and should be based on a schedule that is as close as possible to final. Other branches within the airline can use the schedule for budgeting and planning purposes.

Ideally, an open-ended rolling schedule should be 70 to 80% accurate in terms of departure times and capacity.

Schedule Design Parameters

From a commercial standpoint, there are a few core requirements you need to have when designing a schedule. You want to be able to provide hourly flights in key markets and have both business & economy cabin seats available in competitive and business markets. Other commercial constraints may be a result of particular market characteristics or contractual obligations. For example, flights to Florida from Canada need to be timed the cruises. Some airlines have contractual obligations to transport cargo in certain (mostly international) markets.

There are a large number of operational constraints that must be factored into the schedule. These include maintenance requirements as well as airport configuration, capacity and issues. There are also certain regulatory bilateral agreements between countries that result in operational constraints.

You must also factor in minimum turn times, crew rest, possible ground handling issues and curfews when determining departure and arrival times. When an aircraft arrives into a station it needs to stay on the ground for a minimum set time.

There are also limitations to that can be used in certain markets. This may be due to bilateral agreements with countries that may restrict the type of aircraft used. These agreements sometimes also dictate how often you can fly to a certain city or country. There may be runway length, gating or slot issues at various destinations that affect the type of aircraft you can assign to a flight or when you can aircraft in you can assign to a flight or when you can arrive or depart.

Asset Mispricing: Inefficient Markets or Investors’ behavioral biases

Asset Mispricing: Inefficient Markets or Investors’ behavioral biases

Let me begin by asking you a question. How good a driver you are?  Most of us reply, above average to this question, does this mean we are overconfident of overoptimistic when doing a self assessment? There are two main implications of this analogy in investor confidence; Investors take bad bets because they fail to recognize that they are at an information disadvantage and they trade more frequently than is prudent, which leads to excessive trading volume.

LTCM members promoted their firm as an exploiter of pricing anomalies in global markets. But they accumulated huge loss over a period of time due to bad bets worsened by leverage. The basis of LTCM investment mythology was benefiting from markets mispricing, so does its failure suggest markets are indeed efficient or is it that Investors’ errors are the cause of mispricing?

Effects stemming from investor’s behavioral biases:

Winner Loser Effect

• Investors who rely on representativeness heuristic become overly pessimistic about past losers and overly optimistic about pas winners and that this instance of heuristic driven bias causes prices to deviate from fundamental value. Specifically pasty losers come to be undervalued and past winners come to be overvalued. But mispricing is not permanent over time the mispricing corrects itself. Then losers will outperform the general market, while winners will underperform
• In traditional finance, losers will be associated with higher returns because they are riskier than the average stock.

Effects stemming from conservatism

• Analysts who suffer from conservatism due to anchoring and adjustment do not adjust their earnings predictions sufficiently in response to the new information contained in earning announcements. Therefore they find themselves surprised by subsequent earning announcements. Unanticipated surprise is the hallmark of overconfidence
• Conservatism in earning predictions means that positive surprises tend to be followed by positive surprises and negative surprises tend to be followed by negative surprises

Effects stemming from Frame Dependence

• Does frame dependence have an impact on price efficiency?
• Answer is a strong yes, in the past loss aversion caused investors to shy away from stocks, therefore stocks earned very large returns relative to risk free government securities
• People might be less tolerant to risks whose magnitude is smaller than those described in the preceding question. When stake is smaller, people actually become more tolerant of risk not less tolerant.
• House money effect - After a market run up, the house market effect kicks in, raising investors’ tolerance for risk and lowering equity premium.

Departure from Fundamental Value: Short Term or Long term

• Heuristic driven bias and frame dependence can cause prices to deviate from fundamental values for long periods. There is more volatility in stock markets and bond markets than would be the case if prices were determined by fundamentals alone
• Prices move away from fundamental value for long periods but eventually revert

How behavior affects investing decisions ?

If you transfer a dollar from your right pocket to your left pocket, you are no wealthier. It is a matter of form whether a person keeps a dollar of wealth in the right pocket or in the left pocket. The form used to describe a decision problem is called a frame. Form is irrelevant to behavior. However behavior reflects frame dependence. While taking decisions we tend to form different frames in our mind and the way these frames are formed define our response to the problem.

 

Loss Aversion is a heuristic which is closely integrated with the way people behave while taking financial decisions. An example can be ‘Get evenitis’ disease or trying to get even when faced with a loss.

Faced with a choice between a guaranteed loss and a gamble to lose more or loose nothing, the investors will choose later as they hate to lose and by picking a gamble they hope to get even. Even if gamble is not risk averse; their behavior exhibits loss aversion. Two decision problems together constitute a concurrent package. Most people do not see the package. They separate the choices into mental accounts.

 

Investors prefer certain frames to other, a principal known as Hedonic Editing. People prefer guaranteed gains over gamble where they might get less – this exhibits a risk averse behavior. People also prefer gamble (with a probability to lose more or lose nothing) to guaranteed losses – this exhibits risk seeking (loss aversion) behavior. People are not uniform in their tolerance for risk, it depends on the situation. Some appear to tolerate risk more readily when they face the prospect of a loss than when they do not.

 

In case if sequential investing, people have tendency not to net their two gains (of two separate and sequential transactions) but to net losses. The added attraction of experiencing gains separately inclines people to be more willing to gamble. The term frame dependence means that the way people behave depend on the way their decisions problems are framed. Hedonic editing means that they prefer some frames to others. In a financial context, hedonic editing offers some insight into investor’s preference for cash dividends. When stock prices go up, Dividends can be savored separately from capital gains. When stock prices go down, dividends serve as a silver lining to buffer a capital loss. This is frame dependence; investors feel comfortable choosing a portfolio of stocks that feature high payouts and spending those dividends

How to solve the problem of under recoveries on LPG?

How to solve the problem of under recoveries on LPG?

Under recoveries on oil and gas in India remains one on the biggest drag on the fiscal deficit and it accounts for bleeding balance sheets of oil and gas marketing companies. By official estimates under recovery on a LPG cylinder is around Rs.300. Energy prices remains one of the most contentious issues in the public domain and it is one of the yardsticks people use to measure the performance of the governments. Recent price rise of LPG and Diesel have made the media and opposition parties go on the offensive against the government, even when government is taking a sound economic decision.

 

The problem here is that there LPG is heavily subsidized and the government in subsidizing it is incurring a fiscal hole in its balance sheet. LPG is one of the efficient sources of energy and is better than burning charcoal or wood for house hold cooking. Government started subsidizing LPG when the economy was relatively backward in terms of using efficient sources of energy for household cooking and allied purposes and the use of LPG was encouraged by means of subsidizing it to provide an affordable and clean energy solution. As the economy and incomes grew, government failed to make a reality check and alter the subsidies it was offering on LPG and other energy products and bring it in line with rise in incomes. Any benefit passed on to the general public in terms of price concessions becomes politically sensitive and ‘vote back’ politics prevent even minor tinkering with price rises. The subsidies continue to swell and government coffers continue to bleed.

The solution to under recoveries is not as radical as it is thought to be. Offer one unit of LPG gas (in this case a cylinder) per family or per connection at the current subsidized rate. Increase the price at an incremental rate for increase in usage (such as charging higher prices for 2nd, 3rd cylinders and so on). The fall out for such incremental prices might be an increase in demand for the number of connections and that need to be managed by implementing strict controls and checks. In such a case LPG subsidy will be capped and relatively within bounds.

 

A reform of distribution network of LPG products also needs to compliment incremental pricing mechanism. The leakage of subsidized LPG which is meant for house hold use to commercial and industrial uses undermines the basic purpose of subsidizing the household fuel. For those who feel, the discussed pricing mechanism will increase inflation; please be assured elimination of deadweight loss and reduced subsidies will increase spending on social sector projects and decrease inflation in the medium and long run.