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•	Policy Overview
•	Transportation in Canada Annual Reports
•	Table of Contents
•	Report Highlights
•	1. Introduction
•	2. Transportation and the Canadian Economy
•	3. Government Spending on Transportation
•	4. Transportation and Safety
•	5. Transportation - Energy and Environment
•	6. Transportation and Regional Economies
•	7. Transportation and Employment
•	8. Transportation and Trade
•	9. Transportation and Tourism
•	10. Transportation Infrastructure
•	11. Structure of the Transportation Industry
•	12. Freight Transportation
•	13. Passenger Transportation
•	14. Price, Productivity and Financial Performance in the Transportation Sector
•	Minister of Transport
•	Addendum

Transport Canada

14 PRICE, PRODUCTIVITY AND FINANCIAL PERFORMANCE IN THE TRANSPORTATION SECTOR

Air Transport Industry

Over the past two years, the Canadian air industry has undergone a series of mergers and acquisitions aimed at improving productivity and financial viability through restructuring.

In 1998 and early 1999, both Air Canada and Canadian Airlines International restructured their regional affiliates. Air Canada merged its two eastern regional carriers, Air Nova and Air Alliance, while Canadian Airlines sold one of its regional affiliates, Inter-Canadien, and legally amalgamated two others, Time Air and Ontario Express,Note 5 into Canadian Regional.

As the financial viability of Canadian Airlines and its affiliates became precarious in 1999, further restructuring was initiated. On August 13, 1999, the federal government established a special process to facilitate the orderly restructuring of the airline industry. Further details are presented in Chapter 11, Structure of Transportation Industry.

This section does not analyze the performance of individual carriers in detail, but instead looks at the industry's overall performance. Because of limited data, the industry is taken to be most of level I and II air carriersNote 6 for the purpose of this section. This group accounts for 82 per cent of total industry revenues. In 1998, these carriers generated total revenues of $10 billion, an increase of 7.6 per cent from 1997. However, falling productivity and significant increases in factor prices resulted in a sharp decline in industry profitability.

Price and Output Indicators

In the first six months of 1999, output grew by 2.0 per cent whereas prices increased by 4.9 per cent. In 1998, the aggregated airline price and output levels were affected by a labour dispute at Air Canada and by several external factors, including a severe ice storm in eastern Canada, a weaker trans-Pacific market, stiffer price competition in domestic and international markets, and the replacement of the Air Transportation Tax (ATT) by NAV Canada fees. Overall, in 1998, the industry had an average price increase of 3.3 per cent and output increase of 6.1 per cent.

Part of the price increase was due to the implementation of NAV Canada air navigation fees. Prior to the privatization of air navigation services, navigation fees had been added to the price of air tickets paid by consumers in the form of the Air Transportation Tax, the proceeds of which funded those services.Note 7 Since March 1998, air navigation fees are no longer secluded as a tax but are included in the operating expenses of the carriers, and the carriers in turn recover them through the prices they charge. Previously, the Air Transportation Tax was not taken into account in the analysis of air prices. It is estimated that the new air navigation fees explains most of the price increases of the carriers. But, since these fees replaced the Air Transportation Tax, the net price increase in 1998 was close to zero. Consumers have benefited from the new system. Using 1997 traffic to simulate the differences between the Air Transportation Tax and NAV Canada fees, the air navigation fees, as revised in September 1999, would produce approximately ten per cent less revenues than the Air Transportation Tax.

Table 14-9 shows the effect of navigation fees on air carriers' revenues by sector. On average, the new NAV Canada fees are estimated to have increased carriers' prices by 2.6 per cent. The largest impact was on domestic services, the prices of which rose by as much as 3.6 per cent. The impact is larger on domestic services, since distance on the Canadian territory, a key parameter of the navigation fees, is shorter on international flights.

From 1991 to 1998, output of the airline industry increased by 51 per cent, while average prices increased by only 2.5 per cent. The prices of domestic passenger services rose by 3.4 per cent; once the effect of the NAV Canada fees is accounted for, domestic passenger prices in 1998 were at about the same nominal level as in 1991. This corresponds to an 11.5 per cent decline in real terms and has stimulated domestic demand, which increased by 28 per cent. Transborder is the only market segment that experienced growth in both price and output over this period, by 35 per cent and 98 per cent, respectively. Since 1991, discount fares have largely contributed to the 12 per cent decline of the price of international services outside the US, and to significant demand increases.

Total airline revenues from freight activity have increased between 1991 and 1998 by 14 per cent, while air cargo rates declined by 5.6 per cent. The volume of air freight grew by 21 per cent over the same period. Overall, if air transport prices had grown at the rate of inflation during this period, airline users would have spent $625 million more to travel than they did in 1998, a net saving of seven per cent. However, the inability of some air carriers to align price changes to the evolution of their cost structure was one of the major factors that rendered them unprofitable.

Cost Structure

The cost structure of the industry, in terms of the split between variable and capital cost, is relatively stable, at 82 per cent for variable and 18 per cent for capital. There were, however, some major shifts within the variable cost group during the eight-year period.

Labour costs represented about 24 per cent of total variable cost in 1998, close to that of 1997, but was 3.4 percentage points lower than in 1991. Fuel cost share was around 14 per cent of total in the aviation sector from 1991 to 1997, but dropped to 12 per cent in 1998. Other variable costs as a group (airport and navigation fees, marketing, materials and other expenses) represented a cost share of 46 per cent in 1998, significantly higher than 40 per cent in 1991.

Capital costs as a share of total cost have not changed in 1998. There has been a shift from owned to leased assets. The leasing component within capital costs went from one third in 1991 to more than one half in 1998.

Productivity and Unit Cost Indicators

Between 1991 and 1998, total factor productivity of the airline industry as a whole increased by 27 per cent, with most of the gains achieved in 1996 and 1997. Since 1991, the unit cost of the air industry has declined by nine per cent, half the cost decline observed in the railway industry over the same period. This cost performance was one of the factors that has, since 1991, allowed the major air carriers to keep factor cost increases below inflation and achieve cumulative annual cost savings. By 1998, these savings had reached $1.3 billion, or 14 per cent of the cost base of the airline industry.

In 1998, the productivity of the airline industry dropped by 6.5 per cent, while unit cost increased by 5.1 per cent. This performance explains the decline in profitability of the industry during the year. For instance, after inflation, industry costs increased by $348 million whereas revenues grew by $55 million. The performance of individual carriers, however, varied significantly. Air Canada's productivity was adversely affected by its pilots' strike, while Canadian Airlines was subject to market competition preventing it from passing its cost increases on to users.

With the exception of fuel, all major cost groups (including labour, airport and navigation fees, aircraft rents and marketing expenses) contributed to a 13 per cent increase in total cost in 1998. The productivity decline meant higher unit costs, but industry costs also rose because of exchange rate variations. The devaluation of the Canadian dollar against the US dollar had a significant impact on some large Canadian carriers, as part of their expenses (such as aircraft rents, commissions and other purchased services) were incurred in US dollars. It is estimated that exchange rates had the effect of raising input prices by about two per cent.

Financial Performance

The net cost reduction, after price reductions, between 1991 and 1998 reached $676 million. They were not, however, sufficient to offset the cumulative economic lossesNote 8 of close to $3.3 billion accumulated by the industry over the same period. Such losses, sustained over several years, resulted in the structural changes experienced by the industry in 1999. Figure 14-2 shows cumulative financial losses and cost reductions in the airline industry from 1992 to 1998.

Canadian Airlines accumulated financial losses in 1998 and 1999 of $360 million. These consecutive losses have compromised the viability of the carrier. In December 1999, the majority of the shareholders of Canadian Airlines accepted Air Canada's purchase offer. The performance of Canadian Airlines' regional airlines, for the most part, was also not robust.

Air Canada's profitability was adversely affected in 1997 and 1998 by a labour dispute and several external factors. There was significant improvement in 1999. However, its operating income rose to $503 million, from $144 million in 1998, and its net income reached $213 million, compared with a $16 million loss in the previous year.

In 1998, the total combined revenues of Air Canada and Canadian Airlines, including their affiliates, amounted to just over $9 billion, an increase of six per cent from 1997. Total cost, however, increased by nine per cent. As a result, their average operating ratio deteriorated to 98.7 per cent from 94.6 per cent. Table 14-10 summarizes the financial results for the airline industry.

Lower productivity performance and rising costs were major factors in the sharp decline of the air industry's profitability as a whole in 1998. Furthermore, relatively high debt costs added to net losses for some carriers.

In 1999, total combined operating revenues of Air Canada and Canadian Airlines climbed to $9.8 billion, an increase of seven per cent from 1997. Total cost, however, increased by five per cent. As a result, their average operating ratio improved to 95.3 per cent. Fourth quarter results of Canadian Airlines are estimated.

In 1998, the independent carriersNote 9 as a group also showed a deterioration, with their average operating ratio climbing 3.6 percentage points to 97.6 per cent.