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Operational
The operational performance of performance of
UK airlines: 2002-2007 UK airlines
A. George Assaf
University of Massachusetts-Amherst, Amherst, Massachusetts, USA, and 5
Alexander Josiassen
The Centre for Tourism and Services Research (CTSR), Victoria University, Received 13 January 2009
Accepted 2 November 2009
Melbourne, Australia
Abstract
Purpose – The purpose of this paper is to measure the efficiency of UK airlines in light of all the
recent industry challenges.
Design/methodology/approach – The study measured the technical efficiency of airlines through
the innovative data envelopment analysis (DEA) bootstrap methodology.
Findings – Results based on a sample of recent input/output data indicated that the efficiency of UK
airlines has continuously declined since 2004 to reach a value of 73.39 per cent in 2007. Factors which
were found to be significantly and positively related to technical efficiency variations include airline
size and load factor. The paper also highlights that factors such as increase in oil price and fierce
market competition were also potential inefficiency determinants.
Practical implications – The findings of this paper provide a fresh link between airline
performance and the current industry characteristics. UK airlines also have a major role in the
European and international aviation sector, and thus a reflection on their efficiency could be of interest
to private and public policy makers.
Originality/value – The paper focuses on a recent period and thus provide a fresh efficiency
assessment of the airline industry. The study also extends the limited literature available on UK
airlines.
Keywords Airlines, Performance management, Data analysis, United Kingdom
Paper type Research paper
1. Introduction
Recent industry reports from the UK and international airline associations have
warned that airlines currently face a threatening period of major financial losses
following the last four years increase in oil prices. The predicted global loss in 2008
was around $2.3 billion and latest figures from the International Air Transport
Association (IATA) also indicated that the financial losses could even exceed the $6
billion dollars in the near future if oil prices stay high (Robertson, 2008a). The president
of IATA described the global situation as “desperate” and indicated that in early 2008
around 24 airlines have gone out business. Figures from the US, for example, indicated
that in the first quarter of 2008, United Airlines lost around $537 million, American lost
$328 million, and Northwest lost $191 million (Wilber, 2008; Robertson, 2008b). Other
airlines such as Continental and JetBlue have also suffered major losses. In the UK, Journal of Economic Studies
Vol. 38 No. 1, 2011
airline analysts expected that airlines might face considerable challenges in the near pp. 5-16
future. British Airways for example predicted a profit reduction of £250 million in 2008 q Emerald Group Publishing Limited
0144-3585
(Robertson, 2008b). DOI 10.1108/01443581111096114
JES In the literature, the link between performance and profit was well established. It is
38,1 hypothesised that with a sharp drop in profits only the high performing airlines will
survive. Airlines are currently adopting cost-reduction strategies and IATA predicted
that airlines will be forced to increase their prices in the near future (Fleming, 2008).
Thus, the need for high performance takes an additional importance within the current
market challenges.
6 In this study, we were driven by all the above-mentioned factors and the major aim
was to reflect the efficiency standing of UK airlines in light of all the recent market
challenges. Another aim of this study was to determine those factors that explain the
sources of efficiency variations between airlines. We focused on UK airlines because of
their international market power; however the findings could also be generalised to
reflect the link between performance and current industry characteristics. The
methodology used in this study also aimed to improve the accuracy in modeling the
performance of airlines. We introduced the innovative data envelopment analysis
(DEA) bootstrap methodology. Traditional methods used in the airline and airport
efficiency research were the traditional DEA or stochastic frontier analysis (SFA). One
of the major limitations of DEA is that it is a deterministic technique and thus does not
account for measurement error in deriving the efficiency measures. SFA was again
subject to criticism, as it requires a pre-specification of the functional form in the
estimation of cost or production frontier technologies. SFA also requires larger sample
size than DEA. On the other hand, it is possible with the DEA bootstrap to keep the
flexibility of DEA and also obtain statistical properties of the efficiency scores. Data
used in the analysis range from 2002 to 2007 and covered 15 airlines. More details on
the literature, methodology, variable used, results and discussions are provided in the
next four sections of the paper.
2. Literature review
Studies on airline frontier models are generally limited and outdated and clearly
indicate the need for additional evidences and implications on the efficiency
characteristics of the airline industry. None of the available studies has focused purely
on UK airlines, but many studies have analysed the performance North American
airlines and in some cases compared the performance of European, and Asia Pacific
airlines. North American airlines usually appeared to be the most efficient (Oum and
Yu, 1995). In a recent study, it was also confirmed that US and European airlines were
more efficient than Asia Pacific airlines (Barbott et al., 2008).
In general, most studies have also followed traditional approaches in the analysis of
efficiency. However, in most cases these studies have addressed the limitations of
simple partial productivity measurements by incorporating multiple inputs/output as
well as environmental variables in the analysis of efficiency. Some of the most common
input/output variables are illustrated in Table I. The more common environmental
variables are the average load factor and airline size, which in most cases have been
found to play a positive role in improving airlines performance (Caves et al., 1984;
Coelli et al., 1999). Other variables in the same category are float characteristics like the
average speed and size of aircraft.
Some of the methodologies used in these studies include the traditional SFA model
(e.g. Caves et al., 1984; Baltagi et al., 1995), the DEA-based Malmquist approach
(Barbott et al., 2008), and the traditional DEA models (Good et al., 1995). As mentioned
Operational
Study Inputs Outputs Other variables
performance of
Coelli et al. (1999) Labour, capital TKA Load factor, aircraft capacity UK airlines
Ahn et al. (1997) Labour, materials, fuel Revenue Load factor, aircraft size
Good et al. (1995) Labour, materials, planes Revenue Load factor, network size
Baltagi et al. (1995) Capital, labour TKA Load factor, aircraft size,
hubs, mergers 7
Cornwell et al. (1990) Labour index, materials, TKA Stage length, service quality,
energy, capital expenses seasonality Table I.
Schmidt and Sickles (1984) Labour index, materials, TKA Size, load factor Overview of existing
energy, capital expenses studies
before, all these methodologies suffer from common limitations. The main limitation of
DEA is that it is a non-statistical technique and thus treats all measurement error as
sources of inefficiency, while the main limitation of SFA is that it requires a
pre-specification of the functional form in the estimation of cost or production frontier
technologies. In this context, the use of the bootstrap approach in this study is therefore
considered an innovation as it takes into account the limitations of both the DEA and
SFA methods. The findings are consequently expected to be more accurate and as a
result provide a more solid ground for policy implications. More details about the
advantages of the bootstrap approach are provided in later sections.
3. Data
The data selection process started with a detailed review of the existing studies in the
literature. Guidance from experts in the area was also helpful in confirming the list of
variables selected. Data were collected directly from the “Civil Aviation Authority” and
consisted of 15 major UK airline companies during the period 2002-2007 (90
observations). The authority collects data using the same criteria of the International
Civil Aviation Organisation (ICAO).
On the output side, two variables are used namely, “TKA” or tonne kilometres
available and total operational revenues. TKA is a reflection on two airline outputs:
passenger service and cargo operation and is calculated by multiplying the number of
tonnes available for the carriage of revenue load (passengers, freight and mail) on each
flight by the flight distance. The “total operational revenues” (sum of aeronautical and
non-aeronautical revenues) was also used in previous studies (Ahn et al., 1997; Good
et al., 1995), and is strong indicator of overall performance. On the inputs side three
inputs were selected namely labour expenses (total expenditure for the salaries and
allowances of all employees), aircraft fuel and oil expenses (includes fuel,
de-mineralised water and water methanol consumed), and aircraft value[1] (total
financial value of aircraft minus depreciation).
In order to account for the sources of efficiency changes, we have also regressed
DEA on two environmental variables, namely load factor and airline size. Load factor
(defined as the ratio of performed tonne-kilometres to available tonne kilometres) was
used to account for the environment in which the airlines operate. As mentioned in the
literature review, this variable was used in several related studies (Coelli et al., 1999;
Ahn et al., 1997), and it is considered as a measure of market demand. Airlines
operating with a high load factor coefficient would expect to have a stronger demand,
JES and thus consequently a higher production/efficiency. The identification of airline size
38,1 was based on the percentage share of each airline in the total kilometres performed by
all UK airlines[2]. It is hypothesised that larger are more productive, as these airlines
usually possess stronger economies of scale and more flexible access to technology and
innovation. The descriptive statistics of all variables are listed in Table II. In the next
section we describe in detail the methodology used in the paper.
8
4. DEA and the bootstrap
4.1 Data envelopment analysis
DEA is one of the most popular methods to estimate technical efficiency (for some
applications refer to Barros, 2004; and Goncharuk, 2007). It aims to define a frontier
envelopment surface for all sample observations. The frontier is a representation of all
the efficient firms. Firms that do not lie on that surface can be considered as inefficient
and an individual efficiency score will be calculated for each one of them. The output
oriented DEA efficiency estimator d^i can be simply derived by solving the following
linear programming:
( )
Xn Xn Xn
^ ^
di ¼ max d . 0 di yi # yi l; xi $ xi l; l ¼ 1; l $ 0 ;
d^i ;l i¼1 i¼1 i¼1 ð1Þ
i ¼ 1 . . . n airlines
d^i ¼ zi b þ 1i ð2Þ
where zi is a vector of management related variables which is expected to affect the
efficiency of firms under consideration and b refers to a vector of parameters with
some statistical noise 1i . A popular procedure in the literature is to use the ordinarily
least square (OLS) regression to estimate this relationship. However, as described in
Simar and Wilson (2007), this might lead to two main problems. First, the of efficiency
scores estimated by DEA are expected to be correlated with each other, as the
calculation of efficiency of one firm incorporates observation of all other firms in the
same data set. Therefore, direct regression analysis is invalid because of the
dependency of the efficiency scores. Similarly, in small samples, a strong correlation is
expected between the input/output variables and environmental variables, therefore,
violating the regression assumption that 1i are independent of zi .
To overcome these problems we use in this paper the double bootstrapping
procedure, proposed by Simar and Wilson (2007), in which the bootstrap estimators are
substituted from the estimators in the regression stage to calculate the standard error
of the estimates. The procedure produces, with bias corrected estimates of d^i valid
estimates for the parameters in the second stage regression. For more details on the
bootstrap procedure used in this stage refer to Simar and Wilson (2007).
6. Conclusions
The study has introduced the DEA double bootstrap methodology to measure the
technical efficiency of UK airlines. The results could generate a starting point for policy
makers at the different airlines by providing them with a comprehensive figure on their
level of scale and efficiency standings. The results can be used as an incentive to target
operational deficiencies and seek new areas of efficiency improvements. However, the
management of different airlines is also strongly encouraged to adopt a benchmarking
management procedure in order to perform a continuous evaluation of their
performance against operational strategies and to make the necessarily corrective
actions. It is also possible to validate the results of this study with some qualitative
case investigations of the major airlines involved, so future strategies taken by these
airlines in response to the current industry trends can be identified. The results can
also be used for international benchmarking purpose. For example, several studies
have looked at the efficiency of US and other European airlines, and each of studies
provides an efficiency score on key airlines in these countries. Thus, it is possible for
UK airlines to compare their average efficiency score with those international airlines
that share similar characteristics.
The efficiency estimates indicated that the performance of UK airlines experienced
strong increase between 2002 and 2004, while from 2005, the average technical
JES efficiency started to decline to reach its lowest level in 2007. In this paper we have also
38,1 employed a second stage estimation to explain the variation in technical efficiency
scores. Factors such as load factor and airline size were found to be significantly and
positively related to technical efficiency. The paper discussed that the decrease in
efficiency of UK airlines might be due to factors such as increase in oil price, intense
market competition and drop in load factor. For small airlines the impact of these
14 factors might have also been stronger as they usually suffer from weak economies of
scale.
Notes
1. Some other studies have also used the number of planes as a proxy for capital input. In this
study we the aircraft value as data on the number of planes are not consistently available for
all airlines. Ahn et al. (1997) have previously used aircraft value in assessing the efficiency of
US airlines.
2. Note that we followed the “Federal Aviation Administration”, and we defined large airlines
as those having 1 per cent or more of national enplaned passengers.
3. A production function is said to exhibit constant return to scale (CRS) if a proportionate
increase in inputs results in the same proportionate increase in outputs. The variable return
to scale (VRS), on the other hand, does not assume full proportionality between the inputs
and outputs.
4. The results reported in this paper are the VRS results; however we have also estimated the
CRS model in order to determine the return to scale (RTS) properties of the different airlines.
Fore more details on how to calculate RTS refer to Coelli et al. (1998). An airline is said to be
operating either at decreasing returns to scale (DRS) if a proportional increase of all input
levels produces a less-than-proportional increase in output levels or increasing return to
scale (IRS) at the converse case.
5. These are variables that are neither inputs nor outputs but are used to mainly explain the
variation in the efficiency scores.
6. Simar and Wilson (1998) recommended the use of 2,000 bootstrap iterations to obtain reliable
bootstrap estimates.
7. It is possible to include oil price in equation (3) as a potential determinant on technical
efficiency. However, it is theoretically known that an increase in oil price affect the cost
structure of airlines and this is more related to the concept of allovative or cost efficiency.
The relationship between technical, cost, and allovative efficiency is expressed as follows:
cost efficiency ¼ technical efficiency £ allocative efficiency. So, it possible that oil price
affected indirectly technical efficiency through its direct impact on cost and allocative
efficiency. For more details on each type of efficiency refer to Coelli et al. (1998).
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Corresponding author
A. George Asaf can be contacted at: assaf@ht.umass.edu