Business Economics
The Airline Industry: An Examination of Economies of Scale and Scope
More so than in any other industry economies of scale and scope are vital to the health and well being of the airline industry. Economies of scale ensure that organizations are able to increase output while minimizing increases in cost. Economies of scope ensure that organizations market and distribute their products and services in a manner that is most efficient and most likely to generate increasing revenues and ensure decreasing costs.
The airline industry is face with unique challenges when establishing economies of scale and scope. While most organizations improve economies of scale by growing larger, in many instances this actually contributes to economies of scope in the airline industry. Growing larger often entails increasing an airlines global presence however, a task, which at first glance, may seem cost prohibitive. Fortunately there are a number of measures an airline can adopt to maintain economies rather than facilitate diseconomies of scale.
These techniques include mergers and acquisitions, establishing franchisees, de-regulation, code sharing and more. These tactics and techniques for achieving and maintaining economies of scale and scope are discussed below. Specific attention is also given to the future of the airline industry with specific attention paid to British Airways and their achievement with respect to economies of scale and scope over time.
Economies of Scale And Scope
Economies of scale are often considered the lifeline of an organization, particularly large multinational organizations like those involved in the airline industry. Economies of scale are nothing more than an economic “property of production” that explains what happens to cost when an entity increases the quantity of input by a predetermined amount (Wikipedia, 2005). If costs increases with increasing quantity of input then economies of scale are not created; if costs however increase more than quantity of input diseconomies are created whereas economies of scale are created when cost increases less than quantity of input factors, suggesting an organization is making positive gains (Wikipedia, 2005).
Economies of scale can only exist if a firm’s operating costs increase at a rate lower than the rate of output (Katrishen & Scordis, 1998). The hope in the airline industry including for British Airways has been to create cost advantages through economies of scale. One way to do this is through international expansion (Katrishen & Scordis, 1998).
British Airways has expanded into other countries, opening franchises in European countries and across seas to facilitate better economies of scale. The franchise form of an organization generally enables an organization including an airline industry to achieve the size necessary to create economies of scale (Bronson & Morgan, 1998). Franchisee outlets are in fact favored over independent businesses as they are often considered a method of decreasing unit costs as a “function of increasing unit volume” (Bronson & Morgan, 1998: 33).
Within industries like the airline industry, the volume needed to achieve economies of scale is often almost too high to meet, thus few companies are able to achieve economies of scale without broad measures and international expansion and cost cutting (Katrishen & Scordis, 1998).
Marketing, image-building, personnel specialization and common governance are all factors that can improve economies of scale for a multinational firm like British Airways (Katrishen & Scordis, 1998). Hence many airlines including British Airways spend much time working on branding and image building and marketing their service and product through a variety of techniques. Often economies of scale and scope are realized simultaneously when this process happens efficiently.
Economies of scope are while similar to economies of scale and sometimes confused with economies of scale, quite different. Economies of scale refer more to how efficiently an organization can adjust the scale at which it is producing or providing a given service, whereas economies of scope tends to refer to the actual change in the scope of distribution and marketing related to a specific product or service (Wikipedia, 2005). Economies of scale hence focus on the marketing and distribution of a product or service, which may relate to the organizations size and structure or ability to market specific products and services.
Economies of scale enable measurement of changes in output of single products or services, whereas economies of scope tends to keep track of the changes in the number of various products or services an entity is providing (Wikipedia, 2005). Likewise economies of scale tend to focus on changes that occur on the supply side of operations, including changes that occur in production whereas economies of scope focus on changes that occur with the demand side of production including marketing (Wikipedia, 2005).
Many marketing strategies arise from economies of scope including family branding and product bundling (Wikipedia, 2005). The goal is to reach more people while decreasing costs. This enables more efficient production and advertising for an organization or business entity.
A healthy airline industry is one that is capable of maintaining economies of scale and scope. The airline industry has the potential to prosper more than any other business, yet often struggles to maintain economies of sale. More than 1.25 billion people utilize airlines for travel every year, spending more than $250 annually (UA, 1996). Airlines are a large part of the travel and tourism industry, helping facilitate GDP growth. Most airlines are characterized as having thus making economies of scale more challenging (UA, 1996).
Many structural changes have occurred in the airline industry in recent years. While in the past the industry was dominated by large national organization, more recently many airlines including British Airways have transformed into global organizations through a series of mergers and alliances (UA, 1996). The reasons include controlling rapidly increasing fixed costs and improving access to new markets to improve economies of scope (UA, 1996).
Economies of scope are often related to efficiencies created through sizes within the airline industry though in general business such increase may be associated with improved economies of scale (UA, 1996). In manufacturing for example the costs of producing an extra unit of output may decrease than the average cost of output hence creating economies of scale (UA, 1996). This is not so necessarily in the airline industry however where many costs are fixed. The airline industry has to realize economies of scope when the cost incurred to supply two products simultaneously is less than the costs associated with producing each of these products separately (UA, 1996). The size of the flight network an airline offers often influences these economies (UA, 1996). This means that advertising costs for example would not be aimed at promoting a single route but rather aimed at promoting the entire network of routes a carrier offers, which establishes an economy of scope in the airline industry (UA, 1996). Other methods airlines adopt to realize economies of scope include offering frequent flyer programs that generate loyalty with customers (UA, 1996).
More and more airlines are turning to privatization instead of public ownership, which can help improve economies of scale. Airlines are also gaining economies of scope by achieving alliances, code sharing, block spacing and franchising with other airlines (UA, 1996). Using “code sharing” one airline offers services on another airline but utilizes its own flight codes; for example, British Airways allows consumers to book a flight from Heathrow through to Kansas City, while transferring mid flight to U.S. Air (UA, 1996). This technique is growing in popularity. Not only does the airline profit but so too does the customer looking for schedules that are easily managed and coordinating. Block spacing is another form of this technique where one airline like British Airways can give away a designated number of seats on its flight to another airline (UA, 1996). This airline then markets the seats using its own marketing and advertising methods (UA, 1996).
The airline industry is often referred to as a mature industry, meaning rapid growth in earnings and revenues decline, and growth more closely begins to resemble the GDP or overall growth of the economy in general (Van Bergen, 2004). During the this period of time airlines can still realize positive earnings and a positive cash flow, but usually products and services are not as distinguished as they used to be as they resemble those of competitors too closely (Van Bergen, 2004). Because of this more aggressive competition exists among airline carriers which leads airlines to explore new economies of cope and areas of new or innovative products and services, ones than my potentially raise profit margins (Van Bergen, 2004).
The good news for mature industries including the airline industry is generally they are better equipped to handle economic recessions or downturns than start ups, typically because they have a strong financial foundation with which to endure any temporary economic struggles (Van Bergen, 2004).
Many airlines have to compete vary aggressively specifically related to price in order to generate increasing profits and businesses. A lower cost basis or structure in the airline industry is often the best way for an airline to establish economies of scale. A lower price enables an airline to remain well above the competition.
Economies of scale and scope are vital to the performance of an organization no matter the industry the organization is involved in. An organization can only remain competitive if driven to achieve economies of scale (Bronson & Morgan, 1998). Tactics an organization may adopt to achieve economies of scale and scope will include optimal market coverage, increasing sizes, superior “internal growth” and raised capital (Bronson & Morgan, 1998). Another important consideration for . One might define efficiency as “the ratio of inputs to outputs” (Bronson & Morgan, 1998).
Efficiency of an organization may be measured in various ways including by observation through accounting (Bronson & Morgan, 1998). An organization particularly a franchised business location will continually measure efficiency to ensure they are minimizing costs and saving time to help facilitate economies of scale and scope.
Tactics Businesses Use to Compete to Win in Business Or Survive
Economies of scale and scope are vital to the airline industry. Without economies of scale and scope an airline cannot remain competitive nor generate profits. It is vital that airlines pay specific attention to organizational tactics and methods to ensure economies of scale are maintained. There are several tactics that successful airlines adopt to achieve economies of scale and scope.
Airlines that expand total operations will often realize increasing economies of scale, however much controversy exists as to whether getting larger is an adequate measure for realizing economies of scale and scope in the airline industry (O’Connor, 2001). Many have suggested that airlines that expand in size often increase economies of scope more so than economies of scale. Increasing size is one way that airlines can realize better advertising, marketing and distribution, so this assumption makes sense. However increasing size may also decrease the costs associated with providing additional products or services. Hence the confusion. The matter is at best considered controversial. Airlines adding route branching from existing networks may improve economies of scope or savings because airport personnel and facilities may be in place at the point of origin; this enables costs “to be spread over more units of output” (O’ Connor, 2001: 22).
Other methods and tactics airlines may use to realize economies of scale often involve merging with other airlines (O’Connor, 2001). By doing so an airline may ensure it takes on a more profitable route for example, or improve peak business by merging with a carrier that has peak business during the primary carriers off season (O’Connor, 2001).
British Airway has adopted a variety of tactics to improve its economies of scale and scope. One method they have employed is increasing aircraft fuel efficiency by 30$% in recent years and reducing energy consumption in buildings by 2% every year (British Airways, 2005). The company is committed to expanding its economy’s of scale by providing new airline destinations and cost cutting. British Airways has spent much time increasing their presence in major airports and hubs, securing new slots particularly at U.S. And other major airports (Acumen, 2005).
The company has also worked to open new franchises abroad including ones in South Africa, Denmark and is currently working on with Canadian Airlines (Acumen, 2005). This will help economies of scope by improving British Airway’s brand name while at the same time reducing costs via economies of scale (Acumen, 2005).
British Airways has also begun serving roughly a dozen U.S.. Cities, increasing its international presence and scope of service (O’ Connor, 2001). British Airways has in fact grown to the point where many consider themselves a “mega carrier” growing in size and strength to realize economies of scale (O’ Connor, 2001).
BA has also extended services to distant regions including the East Indies and Asia (O’ Connor, 2001). British Airways also improved its efficiency and economies of scope in 1987 when it became privatized (O’ Connor, 2001). This allowed increasing revenues to be generated, a reduction in deficits, enhanced commercial viability and efficiency and less political interference in the management of the airline (O’ Connor, 2001).
Unfortunately there are often many barriers to economies of scale and scope within the airline industry. As airline companies for example attempt to increase their size through internationalization they also increase their “complexity of operations” and costs associated with managing those operations, which may result in diseconomies of scale (Katrishen & Scordis, 1998; Porter, 1985). British Airways for example launched a new inexpensive airline labeled “Go” in 1998 improving economies of scale while competing for many business oriented clientele (Acumen, 2005). Unfortunately this airline eventually failed which disrupted their economies of scale and scope in the short-term (Acumen, 2005). The expenses associated with and international exposure ultimately resulted in diseconomies of scale.
Conclusions
International businesses are constantly striving to realize economies of scale and scope to remain competitive within their industry. There are a variety of tactics that industries adopt to achieve economies of scale and scope, including increasing their sizes and service offerings. Economies of scale are particularly vital to the health and well being of firms in the airline industry. Often to achieve economies of scale and scope airlines have to cut costs by reducing fares, offering services in international locations, increasing their size and services through mergers and engaging in other brand building tactics.
British airways has adopted a number of these tactics to improve their economies of scale and scope. Many of their strategies have succeed, propelling the airline to mega airline status in the industry. British Airways is often considered a frontline global carrier in part due to its economic success. Of course not all of the tactics the firm has adopted have succeeded in creating economies of scale and scope (for example establishing “Go” as a part of the carriers service). However such mistakes are common and often enable an organization to ultimately grow with time regardless of the industry.
Ultimately the future of the airline industry will depend on its ability to maintain economies of scale and scope over time. In recent years airline agencies have struggled to maintain their stronghold due to a number of factors including economic concerns. Fortunately many including British Airways have pulled through despite minor setbacks such as that incurred with the introduction of “Go.” Often establishing or realizing economies of scale is nothing more than a matter of trial and error in the airline industry.
As time has shown most airlines find ways to face demands and challenges presented with changing times. Some researchers believe in the future airlines might adopt a number of techniques to maintain economies, including raising their capacity per flight (UA, 1996). This may be achieved by utilizing larger aircrafts or by building larger airports and runways (UA, 1996). Technology may also help improve economies of scale by offering more efficient air traffic control (UA, 1996).
As long as airlines like British Airways continue to adapt and conform to changing consumer demands and trends, it is likely they will continue to realize significant success well into the future.
References
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http://www.acumenenterprise.com/Business/Business_Environment_British_Airways_L18237/
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http://www.britishairways.com/travel/crglobalwarm/public/en_gb
Bronson, J.W. & Morgan, C.P. “The role of scale in franchise success: Evidence from the travel industry.” Journal of Small Business Management, 36(4): 1998.
Katrishen, F.A. & Scordis, N. (1998). “Economies of scale in services: A study of multinational insurers.” Journal of International Business Studies, 29(2): 305.
O’Connor, W.E. (2001). “An Introduction to Airline Economics.” Westport; Praeger.
Porter, Michael E. 1985. Competitive Advantage. New York, NY: The Free Press.
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http://en.wikipedia.org/wiki/Economies_of_scope
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Economies of Scale Scope
