AIRLINE

Case
6

In 1978, the Federal government deregulated the entire airline industry in the United States,
leaving all companies able to compete for passengers by creating competitive fare structures and
competitive routes. One response by major carriers was to diminish service to the less profitable
markets and create hubs in large cities. Commuter airlines jumped in to fill the service vacuums
left in many medium-sized and small cities. The designation “commuter” and “regional” have
become synonymous as the small airlines fill gaps left by large carriers and create their own mini-
hub operations in medium-sized cities that have lost their major airline service.
The regional air carrier you are taking over is well known to thousands of people living in small
communities scattered throughout the Great Lakes region of the United States. Like other
commuter airlines, the company has been providing air service to cities and towns that were
unattractive to large carriers because of the population size or the limited facilities at the local
airport. You are taking over the airline at a critical point in the business and will have to make
strategic decisions that will determine the viability of the firm. This section provides important
information on the firm and the industry in which you will be competing.
 7

History of the Airline

Your airline was established as a “mom and pop” business by a fixed-base operator to fill the void
when a larger carrier abandoned the region. The airline grew from a fledgling carrier that
transported 2,700 passengers in its first year, to a regional airline serving five routes and carrying
over 20,000 passengers last quarter. The airline has had a cyclical history of profitability, ranging
from small losses to small profits. The present fleet consists of three 19-passenger Beechcraft
1900s, and about nine passengers are needed to break even on each flight. Loads have been from
4 to 15 passengers per flight.
Operating History (Preceding 8 Quarters)
Yield per Yield per
Revenue Fuel Cost
Available Revenue Available Load Net
Qtr. Passenger (Spot/
Seat Miles Passenger Seat Mile Factor Profit
Miles Contract)
Mile ($) ($)
0 4,259,321 8,147,200 0.350 0.183 52.3% $22,234 0.96/1.00
-1 3,976,427 8,147,200 0.375 0.183 48.8% $8,450 1.01/0.99
-2 3,492,145 7,465,400 0.389 0.182 46.7% $3,520 0.99/0.97
-3 2,897,566 7,465,400 0.464 0.180 38.8% ($205) 0.98/0.96
-4 2,680,345 7,465,400 0.500 0.180 35.9% $5,872 0.94/0.94
-5 2,344,965 5,320,650 0.415 0.183 44.0% $2,156 0.92/0.93
-6 2,202,798 5,320,650 0.437 0.181 41.4% $435 0.93/0.95
-7 1,983,388 5,320,650 0.486 0.181 37.2% ($6,310) 0.95/0.96
8

Regulatory Environment

Despite the deregulation of fares and routes, your airline and the industry as a whole tend to be
heavily regulated in several areas. This requires extensive record keeping. Minimum equipment
maintenance schedules are specified and monitored by government agencies. In addition, some
airlines choose a maintenance program in excess of regulatory requirements to decrease
unplanned out-of-service time and to increase safety. This can improve perceived quality, and
may be important for airlines catering to higher end customers.
Minimum levels of pilot training are mandatory and become a cost of doing business. Some small
airlines provide training beyond the minimum level to increase pilot effectiveness. Others fear
that extensive training results in the loss of a greater portion of their pilots to larger airlines.
Aircraft that have more than 30 seats require special certification; moreover, they are required
to have a flight attendant. The paperwork to document compliance with all these regulations can
result in increased staff size. Compliance with regulating agencies is costly to the airlines in terms
of staff needed, paperwork required, and direct costs incurred.
 9

Airline Equipment

Your company has several types of fixed assets: airplanes, ground equipment (i.e., ground power
units, tugs, de-icing equipment, baggage carts, and trucks), maintenance hangars, office facilities,
and computers. In addition, preventive and corrective maintenance require an inventory of spare
parts that may include extra engines. This inventory can tie up significant amounts of cash. Some
fluctuation in equipment and parts occurs based on the size and the composition of the fleet.
Your airline competes with other regional as well as some national airlines for modest numbers
of passengers departing from a location. This smaller market is reflected in the type of equipment
flown. The available aircraft range in size from 19-passenger propjets to 50- passenger fanjets. In
addition, seats can be added or removed to target specific customer segments. Although some
of the equipment dates back to the 1950s, newly developed commuter aircraft contain state-of-
the-art technology in materials, fuel efficiency, noise abatement, and nonflammable cabin
materials. Since there is an abundance of pre-owned equipment available as other, larger and
more profitable airlines “traded up,” the airline has a large choice of aircraft to choose from if
they decide to expand.
The composition of the fleet of any airline may reflect corporate strategy. Airlines may select
from a variety of aircraft to balance customer preferences with operating costs. Although airlines
may maximize revenue by acquiring aircraft tailored to each route, flying many types of planes
results in high costs, as the maintenance department has to stock more parts and train mechanics
to work on a larger variety of aircraft. Pilot training costs are increased as well.
Passengers have a definite preference for cabin-class service (i.e., flight attendants and stand-up
head room), and a slight preference for jet aircraft (versus propjets, which are in wide service).
Smaller aircraft work well on shorter routes, making it economical to provide the convenience of
multiple flights per day for commuter traffic. Larger, faster aircraft are better for longer routes,
especially in resort and foreign markets. While the Beechcrafts have served the company well so
far, the airline will have to diversify its fleet to expand service to new markets and control costs.
The table below provides a description of the aircraft available in Airline, along with costs.
10

Fuel Efficiency
Maintenance
Seats

Rating
Cruise
(min/ Lease per

Miles
Max.
Daily
MPH

(M$)
Cost
Aircraft Type normal/ Quarter Description
max)

Small and a bit noisy, but

15 economical for short,
Beechcraft Prop-
19 268 1800 $2.0 $80,000 10 1 frequent runs. Not cabin class
1900 jet 21 aircraft and should not be
used for luxury service.
Similar in size to the
Beechcraft but offers cabin
14 class service. Good choice for
British Aero Prop-
18 253 1800 $2.2 $82,000 5 7 short routes where frequent
31 jet 20 flights are required and
passengers expect a bit more
comfort.
A medium-sized aircraft at
the high end of the
24 turboprops. Works well for
Embraer Prop-
30 294 2000 $3.1 $132,000 7 6 normal and discount flights,
Brasilia jet 33 but luxury passengers much
prefer the quieter and faster
ERJ135.
A medium-sized workhorse
for regional airlines. More
28
Saab Prop- economical to operate, but
34 272 1800 $3.4 $144,000 6 5
340 jet 37
slower and noisier than the
similarly sized Embraer
ERJ135 jet.
A medium-sized jet, quieter
and faster than the
31 turboprops, but may be more
Embraer
Jet 37 400 2400 $4.3 $184,000 3 2 expensive to operate on
ERJ 135 40 short hauls. Luxury
passengers look for carriers
using this jet.
Ability to transport more
passengers than other
38 turboprops, at a lower
Aerospatiale Prop-
46 300 2000 $4.4 $185,000 8 8 operating cost than a jet.
ATR42 jet 50 Good choice for discount
airlines flying foreign and
resort routes.
Regional jet providing size,
42 speed, and comfort for your
Canadair
Jet 50 450 2400 $5.8 $240,000 2 4 passengers. Works well on
CRJ100 54 longer routes, such as the
foreign and resort routes.
Note: Ratings are from 1 to 10. Aircraft with higher maintenance ratings are more expensive to
maintain. A fuel efficiency of 1 is the least efficient at cruising speed, but aircraft with low fuel
efficiency ratings may still be cost-effective on short routes.
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Markets and Routing

Your firm currently serves five of seven different types of routes in the Airline environment.
These are designated A, B, C, D, E, F and R, and each has its own unique set of associated
characteristics in terms of geographic location, flight distance, demographics, and level of
demand. In addition, each route starts with a different level of competition. Route types A–D all
start with two competitors. Route type E has just one firm serving its population, a temporary
monopoly position for the firm. The table below provides a summary of the route types, initial
demand, and the number of competitors at the start of the simulation.
Route Characteristics
Qtr. 0
Qtr. 0
Daily Round
Market Number of
Seat Trip Description
Type Competitors
Demand Miles
in Market
Per Firm
From your hub to a medium city with light
A 40 2 600
manufacturing and service businesses.
Service between 2 medium cities. One has many
B 36 2 400 service businesses, and the other, a military
base.
From your hub to a bigger regional hub that has
C 38 2 340
many heavy manufacturing firms.
From your hub to a medium city that has a major
university and extensive business services, with a
D 38 2 360 stopover halfway out from the hub at small but
growing technology cluster. For simplicity, fares
are the same to either destination.
From your hub to a medium city that has a new
E 40 1 400
and growing industrial park.
Estimates indicate that current service is not meeting demand on these routes, and there is room
for growth if more convenient flights, better service, and more favorable pricing are offered.
However, sales for individual firms will fluctuate depending on economic and competitive
conditions. As more companies come to market with different pricing, schedules, and amenities,
the market may become saturated. You'll want to monitor this as competitors add routes and
schedule more flights.
In addition to serving cities in the region, your firm has the opportunity to offer service to two
new types of markets—foreign (F) and resort (R). The foreign market provides you with the
opportunity to become an international carrier. The route goes from your hub to a foreign city
12

that has a diversified industry and tourist trade. Any cabin class aircraft would be ideal for the
route, but the Beechcrafts should not be used. Demand is expected to be between 30 and 60
seats per day for each firm.
The resort market represents major resort and recreation areas popular with people in the
region. Resorts are currently served by charter flights operated as tours, but it is thought that the
regional airlines can develop demand if they provide sufficient fare sales to compete. In addition,
resort customers expect cabin class service, so the Beechcrafts should not be used. Sales for each
firm are projected to be from 40 to 50 seats per day.
While passengers prefer nonstop flights at convenient times, there may not be sufficient demand
to provide direct flights on all routes and cover fixed costs. Instead, regional airlines generally fly
routes terminating in larger cities such as your hub, where passengers can make connections with
major airlines. In addition, regional airlines may provide direct service (on the same plane) to a
hub city, but make one or more stops along the way, as your airline does with the D route. The
route map below may help you visualize the available markets and their relationships. This map
only shows the routes for one hub in one region. At the beginning of the simulation, there is one
region for each pair of firms, and each region has two hubs that connect the same cities.
Route Map for Airline Firms

R
C

F 340 miles
600 miles

420 miles

Your Hub 400 miles E

B
360 miles
400 miles 600 miles
D Stopover

D
B A
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In addition to expanding service within your region, you also have the opportunity to add a hub
in a new region and start servicing a new set of routes. Adding a new hub costs $250,000 for
facilities and equipment, which will add $5,000 to depreciation expense each quarter. You will
also need to acquire new aircraft to serve routes in the new region, since aircraft can only be
used in a single region during a quarter.
14

Flight Scheduling

Airplanes do not generate revenues when they sit on the ground. Therefore, utilization is a
variable that can affect successful operations. A typical aircraft can be flown for 10 to 14 hours a
day, which allows for overnight maintenance and an average of 10 to 12 legs per day. This
calculates at 1800 miles flown per day per aircraft for the airline’s current fleet of Beechcraft
1900 aircraft.
The number of flights per day is a crucial factor to the success of an airline. Too few flights prompt
prospective passengers to drive to the nearest competing hub and too many can be too costly to
maintain. With the exception of the resort and foreign runs, it is not practical to fly only one or
two round trip flights per day into a market; there would be no passenger loyalty and the cost to
maintain a station there would be prohibitive. The careful balancing of flights and seats on a
route is an important decision for your firm as the passenger load factor (number of paid seats
divided by total seats) is a major driver of success. At current prices, the break-even point for a
flight is a load factor of about 50%.
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Fares and Marketing

Airline fares are one of the more complex pricing systems in the free enterprise world. All airlines
post a standard fare for each portion of a route in the Department of Transportation listings; this
is known as the “Y” fare. These fares are set artificially high and are used as a baseline for
discounts and to calculate portions of tickets that are issued in conjunction with other airlines.
Last quarter, the firm charged 35 cents per seat-mile-flown for its fare. However, the airline is
not very profitable at that level, and managers believe that fares could be increased one or two
cents without much decrease in demand.
Airlines develop promotional fare packages from time to time to introduce new service or offset
sluggish demand. In Airline, fare sales of 1/3 off can be offered for one, two, or three months.
Promotional fares stimulate demand but reduce revenues, sometimes creating a loss for that
route. The competitive market is very reactive to fare changes; thus fare reductions tend to be
copied by competitors and the benefits to a single airline are short-lived.
Fare prices must also align with a company’s overall strategy. Thus, pricing as a low-cost airline
may help stimulate demand, but one must also watch expenses very carefully. Pricing as a luxury
/ high-end airline may improve your margins, but only if the service provided is seen as enough
of a benefit to be able to charge a higher price without hurting demand. Positioning your
company to provide improved service will also require an upgrade to your fleet as customers will
not see your small Beechcraft 1900s as a luxury flying experience (insufficient seating, no toilet,
no cabin service).
Airlines spend a significant amount of money to attract passengers. A unique aspect of this
industry, however, is that much promotional activity is directed toward online travel services,
travel agents, and other specialists who dispose of extra seats. These sources are responsible for
75% of the tickets sold.
Last quarter, your firm spent $2,500 on promotional and $2,500 on advertising activities; this is
a very minimal amount. As your fleet increases and you expand into new routes, you will need to
budget substantially more. Promotions include packaged vacations, incentive plans for travel
agents who sell large numbers of tickets, frequent flyer programs, familiarization (FAM) trips for
travel agents, etc.
Airlines advertise through a variety of media: print, television and radio, and internet. Firms
trying to attract the business traveler will use different media than those that target the casual
traveler. Some firms participate in customized “in-flight” magazines placed on board the aircraft
to enhance and promote their image. Your firm has not been producing an on-board magazine
for your passengers; the cost for this would be $500 per aircraft per quarter in addition to your
normal advertising budget.
16

Your firm does not have any sales force now because of its small size. However, as you grow you
may want to add salespersons. The cost of each salesperson is $12,000 per quarter, which
includes the employee’s salary, travel allowance, and fringe benefits. You will also incur an
automatic $3,000 fee for each sales person hired to cover hiring expenses. Airlines employ a sales
force to act as a go-between to promote business with corporations and travel agents. One
advantage of building a sales force, in addition to increased sales, is the possibility of greater
volume of direct sales to corporations and tour promoters, thus lowering the amount paid as
commission to intermediaries.
Social responsibility is an important aspect of any business. A firm has responsibility to many
“publics” in addition to its stockholders: employees, suppliers, creditors, competitors,
government, the local community, and the natural environment. The firm has never budgeted
funds for social responsibility, but you may choose an amount and an area where funds are to be
used.
 17

Operations and Organization

A significant cost to airlines is the operation of “stations” in the airports. The station provides
boarding, baggage handling, and ground services to the passengers and aircraft. A well-run
counter is important for both corporate image and maintaining employee competence. Opening
a station for a new route incurs a one-time charge of $10,000. This charge is in addition to the
depreciated cost of the hub for the region.
Flight operations include crew cost; dispatching and weather services; baggage, mail, and cargo
handling; and aircraft ground handling. Maintenance is the cost associated with servicing the
planes. Passenger service includes the cost of the reservation and ticketing service, ticket
counters, terminal baggage service, and rental of terminal passenger areas.
Fuel is one of the most unpredictable expenses incurred in operations. Fuel can be purchased
either on the open market (as needed at various airports) or on a three-month contract at a fixed
rate. The contract price can either be somewhat higher or lower than the “spot” price at the time
the contract is negotiated, depending on the forecasted price of fuel for the next quarter. Your
fuel has been purchased on the open market in the past. Fuel prices over the past eight quarters
are shown in the table below.
Fuel Prices (last 8 quarters) *
Quarter 0 -1 -2 -3 -4 -5 -6 -7
Average Spot 0.96 1.01 0.99 0.98 0.94 0.92 0.93 0.95
Contract 1.00 0.99 0.97 0.96 0.94 0.93 0.95 0.96
*Note: Fuel prices in the simulation will not equate to prices in the “real world” but have been set
in relation to other simulation variables.
Your airline is organized into four small departments: marketing, human resources, operations,
and finance. There is little overlap between the areas, and employees must have specialized
training as required by regulatory agencies.
Organizational Chart

President

Human
Marketing Operations Finance
Resources
18

These departments handle all functions, including setting fares, promotion, compensation,
training, flight scheduling, maintenance, passenger service, and asset management. For regional
operators, creating an efficient organization is difficult and costly in terms of personnel. Those
airlines that are dual designators with major airlines may receive services such as ground
operations or computer information systems as part of the agreement. Remaining autonomous
is expensive in terms of organizational design and attracting passengers.
Currently, your company has 81 employees, an average of 27 employees per aircraft. Because of
its small size, the salaries and wages of employees have been below the “market” for airline
employees of national and major airlines. Station personnel are frequently paid minimum wage;
this salary differential holds true for pilots and ground crews. Thus, they have become a training
ground for the larger airlines, with relatively high employee turnover (12% or more) causing
additional expense to the airline. Strategies used by other regional airlines to counteract this
problem:

• Encourage a sense of ownership in the company through stock options and profit-
sharing. Employees are called “managers” of the position they hold (e.g., a ticket agent
becomes a customer service manager).
• Design jobs of ground crews to include rotation through several types of positions.
• Develop clearly defined “career paths.”
Historically, your company has been passive about the turnover problem and views it as a cost of
doing business. However, as the airline expands, the cost may have a greater impact on the
bottom line, and the problem will need to be addressed.
 19

Financing

Assets are financed through several channels. Aircraft may be leased or purchased. Leasing
provides advantages to an airline that does not have cash available for a loan down payment,
does not have sufficient collateral, or wants to use a specific type of equipment for a limited
period of time. Airplane leases may be either operating or, if selected by your instructor, capital.
Operating leases do not appear as assets on the balance sheet and do not increase the value of
the company to its owners. A capital lease appears as an asset and as a long-term liability on the
financial statements.
Financing options available for purchasing aircraft include a conventional loan and issuing stock.
Loans require down payments plus some assurances to the lender (collateral) that the payments
can be made. The typical loan period is 10 to 12 years. Issuing stock may require increased
dividend payments and can dilute shareholder value.
Fledgling airlines frequently need a line of credit to finance current assets and meet ongoing
expenses (working capital). This is usually handled by a line of credit (demand notes) that ranges
upward from 2% over the prime interest rate. As with other businesses, an inability to meet
current expenses can be the downfall of an otherwise solvent commuter/regional airline. The
risks in acquiring all of the necessary funds are higher, but a well-managed company may be able
to finance purchases for a lower cost of capital by issuing stock.
20

Reports

Each quarter your team will have access to reports to assist you in making your decisions.
Company reports include an income statement and balance sheet as well as other internal
reports. Analysis tools are integrated into decision pages to help with evaluating route
profitability, scheduling aircraft, and projecting cash flow. Market reports provide competitive
information on the industry and can help in deciding which markets to enter.
The income statement shows the airline’s revenues and expenses over a period of time. Revenues
come mainly from ticket sales to passengers, with adjustments made for commissions and
refunds. The largest portion of expenses is direct flight expense, which includes flight operations,
fuel, maintenance, and passenger service. Historically, direct flight expenses have represented
approximately 65% of gross revenues, so these four items are clearly very important to monitor.
There are two other major expense items to watch. First is the cost of owning or leasing the
planes. This cost will show up as either a lease payment or depreciation (plus interest expense if
you’ve financed the planes using a loan). The second is overhead, such as the general and
administrative expense, which will increase as your fleet expands. Other expenses, such as
marketing and training, correspond directly to quarterly decisions. A summary of the income
statement for the quarter preceding your takeover of the airline is shown below.
Income Statement
% of Gross
Item Value
Revenue
Gross Revenue $1,490,761 100.0%
Commissions $135,659 9.1%
Refunds $119,260 8.0%
Net Revenue $1,235,842 82.9%
Direct Flight Expense $993,276 66.6%
Marketing Expense $36,000 2.4%
Depreciation $48,750 3.3%
General & Administrative $110,260 7.4%
Total Operating Expense $1,188,286 79.7%
Interest Expense $10,500 0.7%
Profit Before Tax $37,056 2.5%
Less Income Tax (40%) $14,822 1.0%
Net Profit $22,234 1.5%
The balance sheet provides a summary of your firm’s assets, liabilities, and equity. It “balances”
because assets must equal the sum of liabilities and equity. Examples of assets are cash,
receivables, aircraft, and equipment. The total cost of aircraft owned is shown, along with the
cumulative depreciation of the aircraft. Aircraft are depreciated at the rate of 1.75% of their
 21

purchase cost per quarter, while depreciation of facilities and equipment for each hub is $5,000
per quarter. Receivables are revenues that have been booked, but payment has not yet been
received. They represent about 40% of quarterly ticket sales. Liabilities include accounts payable
and loans. Accounts payable is the amount owed to suppliers and payroll taxes collected but not
yet paid to the government. Equity consists of the original value of stock issued, along with
retained earnings. Unlike the income statement, which shows results over a specified time
period, the balance sheet is a snapshot of your business at a particular point in time. The balance
sheet as you take over the airline is shown below.
Balance Sheet
Account Value Account Value
Cash $85,785 Accounts Payable $344,070
Accounts Receivable $596,304 Loans $444,000
Parts Inventory $25,419 Total Liabilities $788,070
Aircraft Cost $2,500,000
Less Depreciation $800,000 Common Stock $1,687,500
Net Aircraft $1,700,000 Retained Earnings $31,938
Net Facilities/Equipment $100,000 Total Equity $1,719,438

Total Assets $2,507,508 Total Liabilities & Equity $2,507,508

The income statement and balance sheet provide an overview of the financial health of the
company. Managers use them to identify potential problems in the business. Correcting
problems will require taking a closer look at additional reports. The cash flow statement,
operations, sales, and fleet status reports are internal reports that help management make better
decisions. The cash flow statement shows the sources and uses of the firm’s cash. A healthy
company will have positive cash flow generated by core operations, though a negative cash flow
as a result of investment in the company could be a sign of future growth.
The operations report provides critical information for evaluating the performance of your airline.
Along with quality and reliability ratings, it contains the following important measures:

Measure Description
A measure of airline “production” calculated as
Revenue Passenger Miles
passengers per flight × number of flights* × route miles
The capacity to carry passengers, calculated as:
Available Seat Miles
seats per flight × number of flights* × route miles
A measure of how well aircraft are being utilized. It is
Passenger Load Factor
revenue passenger miles ÷ available seat miles
Yield per Revenue Passenger Calculated by dividing Gross Revenue (on the Income
Mile Statement) by Revenue Passenger Miles.
22

Yield per Available Seat Mile

This is Gross Revenue divided by Available Seat Miles.
(YASM)
Cost per Available Seat Mile Total expenses (including commissions, refunds, and
(CASM) interest) divided by Available Seat Miles.
*Note: In the simulation, there are 80 flying days per quarter, so the calculation uses the number
of daily flights times 80.
The company sales report provides sales and load factor information for each route the airline
serves. Use it to assess the effectiveness of fare sales and to evaluate the profitability of individual
routes.
Several reports are available to provide competitive data and information on the business
environment. Some information, such as the industry news on the dashboard and the financial
summary report provide publicly available information and are available at no cost. Other
information, such as the operating statistics, sales, and marketing reports must be purchased.
Each quarter, as you make decisions for your airline, you should take advantage of the analysis
tools on the decision pages. For example, when scheduling be sure to monitor the total miles
flown for each aircraft type so you are not over- or under-utilizing aircraft. Also when scheduling,
estimate the number of passengers required to break even by using the route profitability tool
for each route. Analysis of your human resources decisions will give you an idea how changes in
compensation policy will impact costs. Analysis of your financing decisions will help ensure you
raise enough capital to meet the needs of expansion and don’t run out of cash.
 23

Strategic Options

The owners of the airline believe that they are at a crossroads. In an environment of increasing
competition in their own routes and the opportunities in new markets now available, there was
no question that their business was about to change dramatically. Staying on the same course
was unlikely a path to success. While they do have access to capital markets for either a loan or
issuing stock, they are concerned about the risk associated with taking on debt or the dilution
effects of selling stock on shareholder value.
The decision was important enough to get some advice from a consultant, Dr. Peggy Golden, who
was a certified pilot and had been the CEO of a small but successful commuter operation. After
several days of studying the situation, Dr. Golden met with Jerald Smith, current president of
your airline to report her findings. (Editorial remark: Later these two wrote the simulation and
subsequently were married.)
“I have studied your flight operations, finances, and marketing strategies and can find strengths
and weaknesses in each area. My greatest concern is that your aircraft are not the best type for
the 600-mile routes and that you are not taking advantage of some markets that are wide open,”
commented Dr. Golden.
Smith replied, “I am aware of this, but the FAA has had us under scrutiny lately. Our oldest
Beechcraft needs updated instruments and radios. In addition, one aircraft is 18 years old, and
all were purchased used. The oldest one is beginning to be costlier to maintain at this point. You
can see how maintenance problems with their associated costs and the weather have kept us
from flying at an optimal level. We have cash problems that are exacerbated by overhead costs.
We need a certain level of support personnel to maintain a three-aircraft fleet; however, we
could add two more aircraft at little or no additional overhead cost.”
The president continued, “There are markets that are not currently being served in our area and
I think we could lease a couple of new aircraft. But it takes from 6 to 12 months to get to the
break-even point in a new market, and we just don’t have the working capital for that. I suppose
that if we tightened our belts and tried to get some short-term credit at a couple of banks in the
small cities we serve, we could do it. We can’t grow because of our slim profits, and because we
can’t grow we can’t improve our profit picture. It seems like a vicious circle."
“I have evaluated the two options that are available to you,” said Dr. Golden. “Taking out a
significant loan has the potential to provide enough cash to improve your maintenance program
and add a substantial amount to your working capital. This would make your firm much more
attractive to a leasing company, and you would be able to lease some additional aircraft. In fact,
there are aircraft manufacturers who have been aggressively selling pre-owned aircraft that have
been traded in for new planes; I think they would be able to offer you good leases. Right now the
24

going rate for a pre-owned, newly refurbished British Aero 31 is $2.2 million and the quarterly
lease is $82,000.”
Smith responded thoughtfully, “Yes, having a few hundred grand would sure get us out of the
hole, and we would be able to take advantage of some markets that are opening up. Giving up
some ownership position through selling common stock just sticks in our craw a bit. On the other
hand, there would be no interest payments to make each quarter, which would lower financial
risk and improve profitability.”
“If we keep the airline, what kind of strategies would you suggest?” asked the president.
Golden responded, “The possible strategies are about the same regardless of who owns the
airline. The crucial thing is to maximize the use of your equipment and serve markets that will
provide you with a greater than break-even load. You may have to give up some markets to which
you have an emotional attachment because you have served them for such a long time.
“The airline can remain small, and the owners can have fun and some sense of satisfaction out
of it. They are both in their mid-50s and in excellent health. The airline does have a positive cash
flow, and the owners are making a decent living. On the other hand, there is potential for growth
in the industry at this time. If the airline expands, the organization will have to change in order
to accommodate this new strategy; this would adhere to the strategic-planning principle of
creating a structure that aids in implementing a new strategy. Some commuter airlines are
looking outside their traditional business for new ways of generating revenues. Package freight
services and junkets to ski resorts provide revenue beyond passenger service.”
Smith replied, “Although we are using our Beechcraft 1900s on a 300-mile route, there are better
planes for the longer routes. In addition, passengers on junkets and vacation runs prefer more
luxurious aircraft than we currently own.”
“That is correct,” Golden agreed. “Some of the new ideas might require larger aircraft, such as
the Canadair CRJ100, Saab 340, or Embraer Brasilia.”
Smith looked out the window of his office at a plane being serviced and replied, “Well, thanks for
taking a look at our operation and giving us your opinion. There’s a lot to consider.”
Golden gathered her papers from off the desk and said, “It was nice meeting you. Good luck on
whatever direction you decide to go.”
 25

Next Steps

The owners are confident you will make the right choices as you take over management of the
airline. The first task is to give your airline a name. Be sure to plan a course of action before you
begin; then coordinate your decisions to implement the plan, monitor the results to make sure
you are on track, and make adjustments as needed. Keep in mind that maintaining the current
course is not an option in this competitive environment, while expanding too quickly can cause
severe cash flow problems. Best of luck in running your airline!
26

Summary of Decision Variables

A summary of simulation variables is provided below and should be used as a reference aid when
making decisions in Airline. Along with each decision variable, this summary includes suggested
limits, costs, other factors, and general parameters of the simulation.
Decision Variables
Decision Description Value Ranges
Select a fare structure (discount, normal, luxury)
Fare 28–31, 35–40, or 48–51
and fare per mile in cents.
Cabin Food Level of food service on the plane. Cost of
none, $1, $2, or $5
Service service is per passenger.
Promotion Spending on promotion in the quarter. (This is
0–99,999
Budget separate from fare sales on routes.)
Advertising Spending on advertising for the quarter. 0–99,999
In-flight Customized magazine to promote the airline’s
Yes/No
Magazine image. Cost: $500 per quarter.
Salespersons Add sales force to promote the business. Cost
0–4 (negative to fire)
Hired per salesperson is $3k to hire, $12k a quarter.
In region: yes/no;
You start in one region but may expand to
marketing effort: 0–100
Regions others. Establishing a hub in a new region costs
(sum over all regions is
$250k, which is depreciated $5k per quarter.
100%)
Quality and Enter spending on a quality program and
0–100,000
Training employee training.
0–7% above norm; no
Increase compensation above industry average
Compensation bonus, stock bonus, or
for all or select employees.
profit sharing
Basic maintenance is required, but increase at Level 1, 2 (+$2,500), or
Maintenance
additional cost to improve reliability. 3 (+$3,500)
Fuel can be purchased on the spot market, All spot; half spot, half
Fuel Contract
under contract, or a mix. contract; or all contract
Purchase or lease up to 8 aircraft of 2 types per
Aircraft Aircraft type, number
period. Purchased aircraft are depreciated at a
Acquisition (0–8), purchase/lease
rate of 1.75% per quarter.
Change number of seats in aircraft for a fee, and
Aircraft seat layout (discount,
move to different region if you’ve entered more
Change normal, luxury), region
than one.
Dispose of aircraft at any time. Costs $50,000 to
Aircraft
cancel a lease. Purchased aircraft disposed of at Keep or Dispose
Disposal
book value at a cost of 1% of value.
 27

Choose routes to serve and fare sale (1/3 off) for aircraft and fare sale
Routes
each route. Costs $10k to enter a new market. (none, 1, 2, 3 months)
Social Choose from among nine causes to support in 0–100,000 plus area
Performance the community. choice
Enter amount of capital needed and shares will
Stock Sold 0–5,000,000
be sold at current stock price to raise amount.
Pay cash dividend or optional stock dividend. 0–1,000,000 cash and
Dividend Paid
Cash dividend cannot exceed profit for quarter. yes/no stock
Short-term loan is interest-only; enter negative None to available credit
Loans value repay to repay. 2% of long-term balance or negative value up to
repaid automatically. balance
Extra cash can be invested in a CD for the
Certificate of
quarter. Investments do not renew 0–1,000,000
Deposit
automatically.
Special There may be other one-time or on-going Choices vary by special
Decisions decisions. decision.