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MEMORANDUM

To:

From:

Honorable Edward M. Kennedy, Chairman

Subcommittee on Administrative Practice and Procedure
United States Senate

Dr. John W. Drake, Professor of Air Transportation
School of Aeronautics and Astronautics

Purdue University

West Lafayette, Indiana 47907

Subject: Comments re: A.T.A. study of Consequences of Deregulation of the Scheduled Air Transport Industry

Date: 15 May 1975

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Summary

The ATA model misapplies costs in such a way as to
make more segments appear unprofitable.

• The ATA model probably understates short and thinly
travelled segment yields, thus making more appear
unprofitable.

• The ATA model leaves out all aircraft less expen-
sive to operate than a DC-9-10, thus making more
segments appear unprofitable.

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The $50 billion spent on the Interstate system has
indeed succeeded in providing superior alternative
service over many of the segments enumerated. This
should not be viewed as a catastrophe.

The model used is very questionable for this appli-
cation, for both reasons of oversimplification and
for more fundamental reasons of methodology.

JOHN W. DRAKE • TRANSPORTATION CONSULTANT

Introduction

2

The ATA study referred to concerns the application of a model to the question of profitability of individual segments of the airline route network of the United States. There are a host of questions one may ask about any such study, many of which get involved with fine points which do not, in fact, matter too much. The important thing therefore is to try to address the important questions. These seem to me to be (more or less in order):

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• Does the simulation, as run, use reasonably good
cost data?

Does the simulation, as run, use reasonably good
revenue data?

May the simulation method used be expected to
tive the answers it proports to give (i.e.,
reasonably credible answers re. probable route
abandonments)?

My belief concerning these questions is, briefly: "No," "Perhaps," and "No."

Analysis

Basically the simulation steps flights into the network on a segment by segment basis and computes proported costs of flying and revenue from the services offered. The difference, profit, is used to determine whether to add a flight and where to add it, and thus what and how many routes are candidates for abandonment. Being a difference between two very nearly equal numbers the profit criterion is much more sensitive to errors in either the cost or revenue estimates than they are themselves. Thus the distinct interest in whether or not the cost or revenue

JOHN W. DRAKE • TRANSPORTATION CONSULTANT

3

assumptions used are to be relied upon, since either overly high costs or overly low revenues will quickly turn routes from profit to loss.

Costs

If all costs of operating were proportional to the number of passengers carried or flights flown, airline route analysis would be a vastly simplified matter. However, as in many businesses, costs are very much a mixture of fixed and variable. Furthermore what is fixed in the short run may, sometimes, be variable in the long run. In addition, fixed costs are fixed on a number of levels themselves.*

The ATA in its

*J.E.D. Williams in his excellent book "The Operation of Airliners" (Hutchinson Scientific & Technical, London, 1964) divides costs as follows in his Chapter 12, "The Anatomy of Operational Costs":

Operator's Overheads, A. Those costs which would be incurred whether the particular fleet under discussion existed or not.

Fleet Overheads, B. The costs necessarily incurred by having the particular fleet, whatever its size and whether used or not. Aircraft Fixed Costs, C. The marginal cost of having one extra aircraft in the fleet whether used or not.

Station Fixed Costs, D. The cost of maintaining the basic establishment of personnel and facility at a station.

Sector Costs, E. Those marginal costs of operating one flight on a sector which are independent of how the flight is operated. Hourly Costs, F.

Those marginal costs of flying the aircraft for one hour which are independent of how the aircraft is flown. Hourly costs per flight are computed on the basis of block time, i.e., from the start of taxiing out to the end of taxiing in.

Passenger-hour Costs, G. The costs of providing a passenger with service for one hour not otherwise incurred. For some purposes it is convenient to consider passenger-hour costs as a charge on

revenue.

Fuel and Oil, H. The cost of fuel and oil loaded at the refueling point. Fuel is bought by the gallon and metered by the pound, and produced thrust by the B.T.U. For many purposes (but not, for example, selection of minimum-cost cruise) fuel and oil costs may be considered a part of the hourly variable cost F.

(continued)

JOHN W. DRAKE • TRANSPORTATION CONSULTANT

study treated costs in a very unrealistic manner. As explained on page 4, "marginal" costs were used to select the flight to be added but then "after each flight addition is made.... total operating costs are adjusted to include the additional system costs* [to produce fully allocated costs]." This prorating of fixed costs of all kinds over the variables of all kinds on a percentage basis will permit the model to make incremental decisions in a way which is quite removed from reality. For example, it may in effect by "paying for" 10% or 129% of a DC-9 maintenance base when as a matter of fact for many of the items which make up such a base you simply have one or you don't, thus producing a large fixed and lower variable cost. Rather than being added prorata, major portions of the fixed costs whould be treated by the model simply as they are: fixed, by system, fleet, station, etc. This leads to very much lower marginal costs and a sort of "steady by jerks" behavior of the fixeds. The result is that a model so constructed would have a

Charges on Revenue. Certain costs such as the agent's commission are necessarily incurred by the act of selling a ticket. For the purposes of aircraft operational studies these can conveniently be regarded as a charge on revenue. Reference in this book is always to net revenue, that is, the residual revenue after deduction of items under this heading.

The advantage of this classification is that if values are assigned to A, B, C, D, E, F, G and H it is possible to see precisely how changes in the operation, such as fleet-size, schedule, route-structure, load factor, operating technique, etc., affect the economy of operation. The snag is the difficulty of assigning costs under these headings, but this analysis must nevertheless be undertaken if the operator is to ensure that the operating posture is at maximum profitability.

*fixed costs

†i.e., a big "jerk" when one goes to two DC-9 maintenance bases, opens a

new station, or buys a new type of equipment.

JOHN W. DRAKE • TRANSPORTATION CONSULTANT

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