Olympic Airways decision to discontinue the Athens – Australia route: Three Questions

In the thread titled “Will it ever be profitable a non-stop service between London and Sydney” that I published in this forum more than a week ago, I promised to our fellow friend Greekdude1 to answer to the best possible three questions that he asked regarding Olympic Airway’s decision to stop operating the services to Sydney and Melbourne from Athens. These questions were the following:

1. Why did they pull out of the market if the load factors were high?
2. Was it more profitable to operate a Boeing B747-200B with 420 seats on a two class configuration or a more fuel efficient A340-300 with 280 seats in a two class configuration?
3. Would an airline discontinue a route if it were unprofitable?

In this thread, I will attempt to fulfil my promise and answer him the above questions. I considered that this topic bears an interest to other members of the forum as well, hence my decision to publish this in the forum rather than sending e-mail to greekdude1 only.

Prior to continue, I must emphasise that given the fact I am no longer a student, I had no access to useful information and resources that I had previously while studying at Cranfield. Therefore, my answers lack of financial and statistical information. For this I apologise in advance. Also, I attempted to answer the questions explaining to the best possible any terms that I have used without being confusing. If I failed to do so and confused you, I apologise in advance. So here we go…

Question 1: Why did they pull out of the market if the load factors were high?

Despite the fact I was unable to find answers to prove that load factors were high on the route linking Athens with Sydney and Melbourne. However, I assume this is correct as the Greek community in Australia has a population of half million people. This high number of the population suggests strong ties between Greece and Australia; therefore a high Visiting Friends and Relatives traffic as well some Business orientated traffic.

Load Factors may be high, however, the profitability of the route does not depend only on load factor. A flight may be full but still may make losses. One must examine also the Break Even Load Factor (BELF). BELF is defined by Clark (2001) as the percentage of capacity filled so that the total costs are exactly equal with the revenues generated. BELF is calculated using the formula “Unit Cost/Yield x 100”.

Unit Cost is Unit cost is the total operating cost the airline makes per Available Seat Mile (ASM) or kilometre (ASK). Note that unit cost is a major determinant factor for airlines when they derive their fare prices. The lower the unit costs, the lower the fares. Otherwise, if fares are still pre-determined by the bilateral agreements signed, the lower the unit cost, the more the profits for an airline. Yield is the average revenue collected per Passenger Revenue Miler (or Kilometre) (Doganis, 2002).

Total Operating Costs are defined as the costs which are directly related to the transportation of passengers and cargo and excludes Interest expenses, Loss of assets, potential loss from affiliates (i.e. other subsidiary companies) and other items like foreign exchange losses. Total Operating Costs are divided to Direct Operating Costs (i.e. the operating costs directly related to aircraft type) like flight crew costs, fuel and oil, en route and airport charges, maintenance costs ownership costs. Indirect Operating Costs (i.e. operating costs that are independent of aircraft type) e.g. ticketing and sales costs, cabin crew costs, station and ground costs, catering costs administration costs etc (Holloway, 2003).

I believe that the BELF was relatively high on the route (surpassing the load factor) simply because the Unit Costs were getting high. I assumed that the yields remained relatively constant or they did not play a significant part to the BELF equation.

Operating costs were high because among other things the service was operated inefficiently in terms of the number of flight and cabin crew groups used. The crews operating this route were having 17 days off per month. Other airlines to the likes of Singapore Airlines allow the crews operating similar flights to have fewer days off per month. Therefore, Olympic Airways was using more crew groups on the route than what others airlines would use. More crew groups means higher wage costs. Are wage costs important though? The answer is yes! Doganis (2001) argues that the flight and cabin crew costs added together accounts approximately (14.3%) of the total operating costs. Given that Olympic Airways was a fully nationalised airline, and given the airline was governed by strong trade unions, suggests that flight and cabin crews used to get higher wages hence increasing further both operating costs and unit costs.

A question that might be formed is “Why didn’t the management of Olympic Airways attempted to make the route more efficient?” The answer is quite simple. Any attempts to reduce the number of crew used would generate an unwelcome response from the strong trade unions that “command” the employees of the airline. Indeed, the power trade union exerts is such that in 1996 they torpedoed the airline’s decision to upgrade the product offered in Business Class by installing sleeper seats (Doganis 2001).

Question 2: Was it more profitable to operate a Boeing B747-200B with 420 seats on a two class configuration or a more fuel efficient A340-300 with 280 seats in a two class configuration?

All Aviation economists argue that the operations costs of an aircraft increase as its size increases. However, the unit costs decreases as the aircraft size increases. In other words, an A319 with 140 seats has lower total operation costs than a B747-400 with say 413 seats. However the B747-400 has lower unit costs than A319-200 simply because the total operating costs is distributed to more ASK than the total operating costs of an A319.

The rule stated above applies to aircraft from relatively the same generation. Therefore, under no circumstances the last paragraph represents the answer to the question Greekdude1 posed. Newer generation aircrafts to the likes of A340-300 might have lower operating costs AND unit costs than an older B747-200.

Therefore, I believe that A340-300 has lower or equal (But not greater) total operating costs and unit costs than the older B747-200. Unfortunately, I was unable to gather exact figures to make calculations to give a clearer answer. However, below I will attempt to highlight the areas which in my opinion the A340 is more efficient than the B747-200B.

Firstly, at the direct operating costs, the A340-300 is more efficient than B747-200B on flight operations costs (i.e. flight crew costs, fuel and oil and aeronautical charges) and at maintenance costs.

Regarding Flight crew costs, Airbus A340-300 has an advantage because it is operated by two flight crewmembers (instead of three the B747-200 is operated by) therefore lower wage costs. The engines A340-300 uses are more fuel-efficient than the older generation engines used on the B747-200B, therefore the fuel costs of the A340 is lower than the B747-200B.

In general terms Landing fees are dependent upon the Maximum Take Off Weight (MTOW) of an aircraft. The higher the MTOW of an aircraft, the higher the landing fees might be. Airbus A340-300 has an advantage, as its MTOW is lower than the B747-200B. In particular, the MTOW of Airbus is 260,000Kg while the MTOW of B747-200B is 377,840kg). Maintenance costs are dependent upon the age of an aircraft. The “younger” an aircraft the less maintenance it may need on components and corrosion repairs. The A340-300’s Olympic Airways operate have a cost-advantage on maintenance than the B747-200 as they were all built in 1999. The B747-200’s Olympic Airways operated were built between 1973 and 1979.

Ownership cost is the only area that the A340-300’s looses the cost-advantage against the older B747-200B. As Olympic Airways acquired the A340’s new they have higher ownership cost than the older B747-200’s as their depreciation and interest cover costs are relatively high. Also, another area which we need to examine is the time period which Olympic Airways acquired the A340’s. In 1999, the aviation industry was at the highest peak of its economic prosperity, therefore aircraft value at the time were higher than what they were in 2002-2003 when the aviation industry was in recession.

Regarding Indirect Operating Costs, the only areas, which I believe A340-300 has an advantage, is on the cabin crew costs and the catering costs, simply because the A340-300 has fewer cabin crew members on board and less passengers.

Summarising the answer of question 2, in general terms aviation economist claims that the total operating costs increases as the aircraft size increases, while the unit costs decrease with aircraft size. However, the rule is only applicable for aircrafts of the same “generation”. A smaller newer aircraft may have lower operating costs and unit costs than an older yet larger aircraft.

Despite the fact, I was unable to retrieve any information to support my answer, I believe that the A340-300 has lower or equal (but not larger) operating costs and unit costs than the older B747-200B. A question that may arise to you is why didn’t Olympic Airways choose to replace the B747-200B with the newer example B747-400, as its unit costs would be lower than the A340-300. However, would B747-400 fit to the market – i.e. would they be operating with satisfactory load factors at all the routes they were assigned and at all times? In my opinion both B747-200 and B747-400 were and would have been large. An aircraft to size of A340 fits better to the markets linking Greece with North America and with Australia.

Question 3: Would an airline discontinue a route if it were unprofitable?

The answer to this question is quite simple if logic is applied. I believe all of you know the answer, as it requires only logic. An airline would never discontinue a profitable route. My answer to Question 1 stated that the route linking Athens with Sydney and Melbourne was not profitable due to inefficiency and bad management of the route primarily in terms of cabin and flight crew.

As the management of Olympic Airways were not in a position to improve the efficiency of the route as the strong trade unions were always “at the corner watching” they were “forced” to discontinue the route. However, bearing in mind the size of the market and the potentiality it has they tried to find other means of serving it. Considering that any attempts to re-launch the route would still be unprofitable as a deja-vu scenario will occur (in terms of inefficiency as this was described in question 1) the management of Olympic Airways concluded that it would be more appropriate to sign a code-share agreement with a foreign airline, which was currently operating the route through a hub-and-spoke network. In June 2003, Olympic Airways signed a code-share agreement with Gulf Air to link Athens with Sydney via Bahrain with a stop to Singapore. I will elaborate more on this agreement in my next thread that will post within this current..

I hope that I kept your attention to the end. I also wish I managed to answer to the best possible Greekdude1’s questions and I managed to address to your interests as well. I am always open for discussion, as this forum is what is about. Therefore, I am open to any comments or additional points or corrections you may wish to add. After all, through discussion, we learn more.

References:

Clark P. (2001) Buying the Big Jets, Ashgate Publications, 2001
Doganis R. (2002) Flying off Course: The economics of international airlines, 3rd edition, Routledge Publications, London, 2002
Doganis R. (2001) The airline business in the 21st century, Routledge Publications, London, 2001
Holloway S. (2003) Straight and Level: Practical Airline Economics 2nd edition, Ashgate Publications 2003, London

Kind Regards