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Production & Operations Management


Production & Operations Management


Yield management originated with the deregulation of the U.S. airline industry in the late 1970. Effectively managing capacity is a challenging aspect of the airline business. Emirates airlines also use the industry wide concept of Dynamic Pricing. This assignment will discuss Emirates Airline's focus on the revenue perspective of capacity management i.e., yield management in an effort to improve the airline’s performance. It will also discuss the key concepts of capacity management, impact on the airline industry and challenges faced in capacity management. Critical analysis on a few functions and trends of capacity management alongwith capacity fluctuations will be discussed with appropriate recommendations. Break even point and best operating levels will also be discussed briefly.

Emirates Airline is the world’s fastest growing airline. Currently the fleet of Emirates is 66 aircrafts. By 2012 the figure is likely to go up to 169 aircrafts. Presently the airline is serving 77 destinations around the world, New York and Christchurch being the latest additions. Primarily in the business of carrying people from one place to another, the market of Emirates covers almost the entire globe and if Emirates currently does not serve a destination then it enters into strategic partnerships and alliances with other carriers which also increase capacity for the airline.

Effectively Managing Capacity- The Perishable asset

In the airline industry, plane seats are referred to as inventory. If the plane leaves the gate with empty seats, this inventory cannot be stored and is lost. If an airline can minimize the inventory waste, then it can operate more efficiently. Yield management determines the load level to try and maximize revenue. Hotel rooms and cars at a car rental company also form a similar sort of perishable asset. From an Emirates perspective the management of capacity is twofold- Operations- wherein the focus is on maximum utilization of existing resources, while maintaining on-time departures and convenient flexible schedules confirming to best aviation safety and service standards and secondly Revenue-wherein the focus is on maximization of revenue being a trade off between flexible capacity and the existing capacity constraints. Low cost airlines are making a big impact on the profit margin of large carriers so in the uncertain environment and injection of private airlines in the aviation business increasing, the subject of profitability management becomes ever more important. The term yield management has been coined in the airline industry and its objective is to manage the product inventory in such a way as to maximize revenue. The intelligent use of the yield / revenue management concepts and principles is to increase profitability in service industries.

One of the greatest potentials for profit improvement comes from improved management of airline's capacity (seat inventory). A typical airline's annual seat inventory is worth over $ 1 billion. Hence a mere 1 % improvement in the effective utilisation of inventory would be worth a $10 million annually.

(Source Managing Uncertainty- Airline Business Magazine)

Capacity can be defined as the maximum level of value-added activity over a period of time that the process can achieve under normal operating conditions. (Slack et al 2004).

Markets determine the way organizations need to manage capacity. If the market is strong the organization could be working at peak output and still not able to meet the demand whereas if the market is strong then most organizations try to evolve a new product or enhance the product thereby slowing the supply effectively managing capacity.

Capacity planning if managed effectively can result in maximizing revenue and profits.

An appropriate balance needs to be maintained between capacity and demand which can generate high profits and customer satisfaction but getting an imbalance will result in potentially disastrous consequences.

Capacity planning can be both strategic and tactical.

Strategic Long term Capacity Planning

Strategic capacity planning is an approach for determining the overall capacity level of capital-intensive resources, including facilities, equipment, and overall labor force size. (Slack et al 2004).

If you cant Measure it you cant Manage it. As a company Emirates carefully plans the growth of the company. The current fleet size will be almost doubled in the next six years and also Emirates would have their first full freighter aircrafts. All these is carefully planned and managed by the Emirates Groups strategic Planning department manages strategic capacity planning. An effective monitoring system is in place which uses passenger feedback, market research and surveys to identify potential growth or change opportunities. E.g. Emirates flights to Bombay were operated in only a two class configuration but market research identified the need to include first class on the sector. By changing the class of travel in the aircraft Emirates was able to improve on their yield. Similarly new stations on the routes are planned as per the delivery schedule of the aircrafts E.g. With the introduction of the Airbus A340-500 in the EK fleet, passengers were now offered a option of directly flying to JFK thereby eliminating the need of a stopover in London and also at reduced time and cost. Long term capacity planning improves supply chain processes to isolate vendor delivery risks, which may potentially impact revenue.

Tactical short term Capacity Planning

Due to demand fluctuations, capacity may be adjusted by swapping aircrafts around which would enable the output to be flexed for a short period, either on a predictable or on a short notice. Operations managers can decide how to manage the capacity of the aircraft in the medium term, which could range from 2-18 months or even short term.

Emirates analyses the route performance periodically and conduct audit (with Market Research) and evaluate the cause for non-performance to review drivers such as demand, pricing structure, competitor activities.

This enables the airline to react to market changes immediately to realize revenue opportunities, reducing financial risk and operating costs.



Figure 1: A definition of capacity planning & control

(Source- Slack et al, 2004, Operations Management Fourth edition)

The term capacity implies an attainable rate of output but says nothing about how long that rate can be sustained. The concept of best operating level is the level of capacity for which the process was designed and is the volume of output at which average unit cost is minimum When the output of the facility falls below this level (underutilization), average unit cost increases, as overhead must be allocated to fewer units. Above this level (over utilization), average unit cost increases. (Refer fig 2)

(Source: http://www.pom.edu/p304/ch8ppt/sld001.htm)

Under utilization over utilization

Utilization is a key measure of performance for an airline industry. Capacity utilization rate reveals how close a firm is to its best operating point, i.e., design capacity.

(Source - http://www.hn.psu.edu/faculty/lsinger/blog/chapter7.pdf)

The best measuring tool for an airline “Best Operating Level” is to calculate the airlines fleet or capacity utilization. Currently Emirates airlines has the highest fleet utilization in the industry. Whereas the industry average of fleet utilization is between 7-11 hours a day, Emirates aircrafts are utilized for about 13.3 hours a day which is very high by the industry standards. If the capacity is over utilized, the maintenance cost, staff overtime, in other words production costs would rise and there could be a compromise in quality of the product and safety. Safety is paramount in Emirates and the advantage Emirates has over other competitor airlines is that the average age of the fleet, the industry average is about 160months emirates has an average of 46 months which help in keeping the costs substantially lower. (Refer fig 3)

(Source- Emirates Annual Report 2003- 2004)

Over the last year Emirates has also managed to get the break-even seat factor down to 59% from 64% which is also a measure on how well the capacity is utilized. The break-even seat factor is the minimum seat-factor required to cover the operational costs. The average seat factor is 73.4%which indicates that Emirates is operating at the optimum level, and is constantly looking to improve this level by reducing costs and other strategies. (Refer fig 4)

(Source- Emirates Annual Report 2003- 2004)

Often, though, organizations find themselves with some parts of their operation operating below their capacity while other parts are at their capacity 'ceiling'. (Slack et al 2004).

Due to bilateral agreements and government regulations there is a restriction on the number of flights that can be operated to a particular country E.g. India. This prohibits the company from using its inventory (seats) to the maximum and has to operate below capacity. Other factors which could also induce capacity constraints are airport facilities like runways, parking stands, etc E.g. when the A380 is introduced in 2006 though Emirates on that single aircraft will be able to sell about 600 seats it will be restricted as the A380 will not be able to fly to all airports around the world due to runway and parking stand limitations.

How Capacity Management affects the airline industry

In an airline industry the objective of the intelligent use of capacity management is to generate revue to the maximum. Revenue Management (RM); sell a seat to the right type of customer, at the right time and for the right price. It is the science of manipulating available capacity to meet market demand in order to maximize revenue. Revenue is the total money out of a market for a given flight or a set of flights. It is the day-to-day monitoring and control of seat availability in each fare group on each flight to ensure that total revenue for that flight is maximized.

(http://www.horand-vogel.de/members/moreym.asp)

YM is very well suited for service firms, and a few characteristics that make yield management efficient are:

If capacity were flexible, there would be no need for a tradeoff. If airlines could add or remove seats there would be no need for capacity management.

The airline must seek a trade-off between maximum load factor and highest paying passengers. A good comparison would be between the time-sensitive business person and the price-sensitive customer. Such a strategy allows airlines to fill seats that otherwise would be empty.

In the airline industry, plane seats are referred to as inventory. If the plane leaves the

Gate with empty seats, this inventory cannot be stored and is lost. If an airline can

minimize the inventory waste, it can operate more efficiently.

The tradeoffs occur when the question arises should the ticket be sold early at a discounted price so you guaranteed a sold seat or wait till the last time and hope a higher fare paying passenger arrives. If all tickets were sold at once, the right tradeoff would be a fixed figure.

Historical data can be used to analyse the traffic pattern during the year. In peak

Season, the airline can increase its revenue by increasing the fare on its tickets and in

low season, it can increase capacity utilization by offering low prices.

(Source – Strategic Revenue Management training handbook – Emirates Airline, 2001)

Functions of Revenue Management: (in relation to Emirates Airline)

RM plays a key role in achieving the Emirates business strategy for profitability, with decreased operating costs and increased revenues. (Refer fig 5)

Figure 5: Emirates Business Strategy for Profitability

Forecasting demand fluctuations enables an airline to plan their capacity more efficiently. The ability to forecast accurately is an enshrined principle of Revenue/Yield management. (Raeside 1997; Glover et al 1982).

The most errors occur in forecasting resulting sometimes flights going with seats not sold or resulting in an overbooked situation. Based on the forecasts operational managers try to make informed decisions with regards to usage of aircraft types, scheduling, and maintenance (Refer fig 6)

Figure 6: Variance forecast Vs Actual data

The above graph gives an analysis of the forecast variance Vs actual data. Emirates flight EK502 variance is -12seats 120 days before departure and on the day of departure its +4 seats. Effectively managing the variance in the life span of the flight will result in higher incremental value.

In Emirates, Passenger Revenue Optimization System (PROS) is used to forecast final bookings and boarding’s on day of departure. PROS system tells airlines how many seats to sell at each price. (Refer fig 7)

Inventory

Figure 7: The working of PROS System

(Source – Houston Chronicle - Business Finance & Markets magazine)

Capacity management systems manage this uncertainty of passenger behavior using mathematical models to balance risk of denied boarding with the revenue loss due to empty seats. Historical data helps in analyzing the trends of variance and helps in arriving at an optimal overbooking solution with minimal error factor. If the calculations go awry then the airline has to face huge costs in re-booking, accommodation etc.

ORG DES BKNG NOSH NOSH % BKNG NOSH % VAR

DXB BOM 15146 917 6 13673 1360 10 -4

The above statistics is a sample of the no-show percentage for different sectors. The variance fluctuates at different times and for different sectors. Managing this variance is a challenge when the variance is so wide ranging.

Dubai being an expatriate city there are clearly identified periods during which the traffic is at it is peak and other periods the traffic being a bit low like the seasonal holidays etc. Clearly with the number of stations that Emirates now serves the transit traffic is about 60-65% of the total load. Emirates Revenue Management comes into play only when demand exceeds capacity and during low demand period. Revenue management then uses pricing tools and other business strategies to simulate the market. Revenue managements block a certain number of seats at each fare on each flight (Refer fig. 8). Enough seats are protected of the higher priced seats for the last minute traveler. The allocation is constantly reviewed and changes to the allocation considering the demand. All this is done with the sole objective of increasing revenue.

Wherever possible, to exploit increased demand, higher capacity aircraft are deployed to improve revenue. Alternatively, where the demand is lower than the capacity on a given date, smaller aircraft if available is used to reduce direct operating costs.

Reducing operating costs and increasing revenues by capturing excess demand is the key to Revenue Management. Emirates airline revenues for year 2003-2004 were close to 13.3 Billion AED and Revenue Managements contribution is estimated to be approx. 3.5 % to 4 % of this revenue.

Revenue Management Tactic: Address short-term fluctuations first with price, then with capacity. (Robert Cross, 1999)

EK 502 30AUG MON VFL DISPLAY FOR FLIGHT LEG FORECAST



ROUTING DXB-BOM



PHY CMP PRS CLS NOW

DATE LEG CLASS CAP BKD FCT BKD AVL

30AUG DXBBOM BD-F 12 10 11

ID-F 10 2

ID-Z 0 0

ID-A 0 0

ID-O 0 0

BD-J 42 30 35

ID-J 30 16

ID-D 0 2

ID-C 0 2

ID-I 0 0

BD-Y 183 113 131

ID-Y 10 106

Figure 8: Sample of the different booking classes in the Emirates Reservation System

(Source – MARS Emirates Booking System)

All the airlines have different pricing structures and policies. The earlier you buy a ticket the cheaper it is the later you buy a ticket the more expensive it becomes. A similar policy is followed by Ryan Air and Southwest Airlines and many other low cost carriers.

This is also known as discount allocation. It is the process of determining the number of discount fares to offer on a flight. The ratio of discount Vs full fares are not fixed during the reservation period and are moved appropriately as the departure date approaches.

To introduce itself in the airline market a low cost carrier from Sharjah is offering special discounted rates. The tickets are no-refundable, non-exchangeable, and valid for a fixed period (month). Instead of the regular price of AED 650 the discounted price offered is AED 450 for a round trip fare. The aircraft used has a capacity of 150 all economy class passengers. Past data analysis showed that the demand for full fare tickets follows a normal distribution with mean of 60 and a standard deviation of 15. Let Cu be the average cost, i.e. the cost associated with reserving too few seats at full fare. Co for the overage cost, i.e. the cost associated with reserving too many seats at full fare. Cu is the lost opportunity of additional AED200 i.e. the difference between full and discounted fare. Therefore Co = AED450 because we assume the extra seats reserved for full fare passengers can now only be sold at a discount.

Where f is the demand for full fare tickets and x the number of seats reserved for full fare passengers. The critical fractile value P(f




Bibliography:
Bibliography


1. ‘N. Slack, S. Chambers, and R. Johnson, Pitman’ –“Operations Management, 2004” – 4th edition

2. Emirates Group Annual Report 2003-2004

3. Raeside 1997; Glover et al 1982

4. http://www.pom.edu/p304/ch8ppt/sld001.htm

5. http://www.hn.psu.edu/faculty/lsinger/blog/chapter7.pdf)

6. Bradford handouts, 2004

7. ‘Robert G Cross’ – “ Revenue Management, 1997”

8. EK Strategic Revenue Management training handbook – Emirates Airline, 2001

9. Interviews and discussions with Yield Management’s managers, trainers and controllers, Emirates Airline.

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