EXERCISE 6-17 (30 MINUTES)

4. The variable cost of filling a seat on an already-scheduled flight is very

small. The number of flight attendants on a flight might have to be

augmented and the number of meals served would have to be in-

creased, but beyond that there would be very little variable cost. Fuel

costs would increase because of the added weight, but not by very

much. Consequently, almost all of the ticket price falls directly to the

bottom line as increased net operating income. This makes airline profits

very sensitive to the load factor. As the percentage of seats filled by

paying passengers increases, profits increase dramatically. The down-

side of this is that if the load factor declines, losses can happen very

quickly.

Airlines have very high fixed costs and very low variable costs, which

gives them a lot of operating leverage. When operating leverage is high,

profits are sensitive because each item sold contributes more to reve-

nue, above fixed costs. Thus, beyond the break-even point, profits grow

more rapidly than they would if operating leverage was low. However, if

the break-even point is not reached, then losses are greater, because a

higher proportion of costs is fixed.