16
Price, Productivity and Financial Performance in the
Transportation Sector
Air Transport Industry
In 1997, the Canadian airline industry generated revenues of
$11 billion, an increase of 9.6 per cent over 1996.
Air Canada, Canadian Airlines International (CAIL) and their
affiliates accounted for 72 per cent of industry revenues and
form the basis of the productivity analysis of this section. Large
independent operators such as Air Transat, Canada 3000, Royal
Air and Westjet produced about ten per cent of industry
revenues and are included in the analyses of market structure,
price and output changes, cost structure and financial performance.
In this section, Air Canada, CAIL, their affiliates and large
independent carriers will be referred to collectively as the airline
industry. Other carriers, mostly Level III and Level IV, have
the remaining 18 per cent market share of industry revenues. Their
activities are not included in this analysis.
In 1997, approximately 89 per cent of the industry's
operating revenues come from passenger transportation services.
Cargo accounts for 6.7 per cent, and the remaining 3.8 per cent
came from other flying services and incidental air transport services.
Domestic passenger services accounted for almost 48 per cent
of the passenger market, a share that was once close to 56 per
cent in the mid-1980s. Transborder and overseas markets have made
gains in terms of percentage points, but the relative gains of
transborder markets have been more significant.
Figure 16-18 illustrates the breakdown of airline revenues
in 1997.
The share of passenger charter service reached 11 per cent
of total passenger revenues in 1997. This share has varied between
nine per cent and 12.5 per cent since 1986. Charter
activities are available only in some of the highest density domestic
markets as well was in popular destinations in Europe and Central
America.
Charter services are attractive to consumers because their
prices are lower than prices for scheduled services. In fact,
in each market, charter services yield lower revenues per passenger-kilometre
than scheduled services.
Figure 16-19 compares the yields of charter and scheduled services
by market, standardizing the yields to neutralize the effect of
stage-length differences.Note 21 In domestic and transborder
markets where the market share of charter services is small, scheduled
services generate revenues per passenger-kilometre at least twice
as high as charter services. In overseas markets where the role
of charter services is much more significant, however, scheduled
services generate more revenues per passenger-kilometre, but the
gap is reduced to less than 75 per cent.
Price and Output Change
From 1986 to 1997, the prices of domestic services increased
by 32 per cent, a rate of 2.6 per cent per year. Prices have
also increased every year, except for a pause in 1992 and from
1995 to 1996, when market conditions and/or renewed competition
caused prices to fall by seven per cent.
Air transportation demand tends to evolve as a function of
price changes and economic conditions. For instance between 1986
and 1993, the price of domestic services increased by 18 per cent
in real terms, and demand dropped by nine per cent. From 1993
to 1997, prices fell by 12 per cent and demand surged up by 30
per cent.
From 1986 to 1997, prices for international services declined
in real terms, and demand more than doubled. During this time,
transborder services were the most dynamic international market,
despite price increases of some 20 per cent during the
last two years. Demand was stimulated by economic conditions and
the introduction of new services that resulted from the "Open
Skies" bilateral air agreement between Canada and the US.
In other international markets, much of the stimulated demand
came from lower prices. Since 1986, the increased usage of discount
fares has contributed largely to the 20 per cent decline in real
terms of prices for international air services outside the US.
Turning to freight, airline activity has been volatile since
at least 1986. During this time, revenues declined for seven years
and increased for seven years. Revenue growth has also been modest
in this market segment, with prices declining and output increasing
at less than two per cent per year.Note 22 These factors
suggest that Canadian carriers have not been participating in
the fast-growing flow of trade by air, leaving this market to
be captured by foreign carriers.
Overall, however, revenue performance in the air industry was
strong between 1986 and 1997. Revenues rose every year, except
between 1991 and 1993, at an annual growth rate of 5.6 per cent.
From 1986 to 1991, the major source of revenue growth was higher
prices, as output rose by only 1.6 per cent per year. From 1991
to 1997, the reverse occurred, as output grew annually by 5.9
per cent and prices declined by 0.1 per cent.
During the first half of 1998, the prices of both domestic
and international air passenger services were firming up. Despite
these price increases, domestic demand continued to grow, lifted
by a strong economy. While demand for transborder services continued
to be strong, however, the market for other international services
was soft, due to a weaker trans-Pacific market during the second
half of the year.
Estimates suggest that half of the price increases that occurred
in early 1998 resulted from the internalization of air navigation
fees by the airlines. At one time, these fees were added to the
price of air tickets in the form of the Air Transportation Tax.
In addition, during the second half of 1998, unused capacity
in the trans-Pacific markets was transferred to other markets,
precipitating stiffer price competition. The situation was also
intensified by the end of the Air Canada pilots strike, as the
company tried to win back its customers with seat sales.
In the end, the airlines' net yields for the new navigation
fees fell sufficiently to offset the increases recorded during
the first part of the year.
Table 16-29 shows price and output annual percentage changes
in the airline industry from 1986 to 1997, looking closely at
the changes in 1995/96, 1996/97 and 1997/98.
Efficiency Indicators
In 1997, airline labour costs amounted to less than 23 per
cent of industry costs, down considerably from 1986 levels. Employment
increased by eight per cent over the same period. This
growth, however, was uneven. Employment peaked at 48,000 during
a period of rapid increase between 1986 and 1990, then fell for
four consecutive years to return to its 1986 level. In recent
years, employment has picked up again, increasing by 10 per cent.
Figure 16-20 compares costs in the airline industries in 1986
with costs in 1997.
Labour productivity rose by 38 per cent between 1986 and
1997. These gains were achieved after 1991 because labour productivity
fell by eight per cent between 1986 and 1991. Unit labour costs
were lower in 1997 than in 1986. During the last three years,
unit labour costs have dropped by 16 per cent, which equals 5.5
per cent per year.
Table 16-30 compares various efficiency indicators for the
major airlines, Air Canada, Canadian Airlines International, and
their affiliates, including employees, labour costs and productivity
changes, from 1986 to 1997.
Fuel costs represented close to 17 per cent of total cost in
the aviation sector in 1997. In recent years, the fuel cost share
has risen, due to increases in domestic fuel prices. Fuel efficiency
gained 18 per cent in the airline industry. As for labour,
much of these gains have been recent. Other notable operating
expenses are: marketing at 12.5 per cent, landing fees at three
per cent, and food and beverage costs at four to five per cent.
Capital costs are on the rise in the airline industry, accounting
for 17 per cent of industry costs. This reflects the impact of
fleet renewal in the late 1980s and early 1990s. Per unit of output,
the value of all fixed assets has increased by 41 per cent
in real terms since 1986. The effect of this increase was moderated
by reduced capital costs.
Total factor productivity in the airline industry reached a
low in 1991, registering at 13 per cent below 1986 levels. Since
then, productivity has risen by 28 per cent, with particularly
strong performance in 1996. In 1991, unit costs in the air transport
industry were 32 per cent higher than in 1986, but they have declined
since then by 14 per cent between 1991 and 1997.
The performance of the airline industry can be segmented between
the two major Canadian carriers, Air Canada and Canadian Airlines
International, and their affiliates, the regional airlines. As
Figure 16-21 shows, their productivity performance followed basically
the same trend. The exception is 1997, when a strike occurred
at the regional airlines affiliated with Air Canada.
However, the performance of the regional carriers in relation
to the larger carriers has been lagging since 1991. In that year,
the productivity growth of the two groups of carriers was basically
the same, while in 1997, the productivity of the regional carriers
was 22 per cent below that of the larger carriers.
Impact of Productivity
Table 16-31 shows estimated cost savings from productivity
gains for major carriers, Air Canada and Canadian Airlines International,
and the users of their air services. The table covers 1992 to
1997.
Carriers' cost savings equal the difference between the actual
costs of the carriers and the costs they would have incurred if
their unit cost had increased at the same pace as the economy
as a whole. Such a formulation was used to measure the impact
of lower prices increases on carriers' revenues.
Between 1992 and 1997, strong productivity performance allowed
the major air carriers to achieve cumulative annual savings. By
1997, these savings reached $2 billion or 15 per cent of
the airline industry cost base. The carriers passed on some
40 per cent of the cost savings to the users in the
form of lower prices. Instead, the carriers used the savings to
make up for their poor financial performance during the early
1990s. In 1998, lower efficiency gains and higher input prices
are expected to affect these gains.
Financial Performance
The profitability of the two major airline corporations, Air
Canada and Canadian Airlines International, has tended to fluctuate
from one year to the next. Figure 16-22 shows trends in their
costs and prices, which help to explain some of the volatility
in their profitability since the late 1980s.
Between 1989 and 1991, the carriers' unit costs rose sharply,
significantly above price increases. While costs started to decline
in 1992, prices were also depressed due to recession. Their profitability
started to improve in 1994, resulting from price increases and
cost reduction measures. In 1996, intensified competition in the
industry depressed prices. However, this was somewhat offset by
further cost reductions. Benefiting from the strong performance
of the global economy, the combined revenues of Air Canada and
Canadian Airlines increased sharply with strong growth in both
output and prices during 1997.
Table 16-32 highlights the financial results of the air transport
industry from 1990 to 1998.
The financial results of Air Canada and Canadian Airlines reflect
their price, cost, output and productivity performance over the
past decade. In the early 1990s, operating expenses exceeded operating
revenues, with an average industry operating ratio at 102 per
cent.
In 1997, Air Canada and Canadian Airlines generated a combined
total operating revenue of $8.6 billion. Their operating profits
rose to $465 million and average operating ratios improved to
94.6 per cent, approximately four per cent lower than in 1996.
The large independent carriers also showed improved profitability
in 1997.
In 1998, the profitability of Air Canada and Canadian Airlines
was adversely affected by a number of unexpected events, including
the ice storm in eastern Canada, the economic crisis in Asia and
the pilot strike at Air Canada. Partial data from other large
airlines also indicated a deterioration of profit margins during
the year.
Despite several negative internal and external factors, combined
total corporate revenues of the two major carriers amounted to
$9.1 billion, an increase of eight per cent over
1997. Both domestic and US transborder revenues showed strong
growth, but international passenger revenues declined, particularly
on Pacific routes.
Total operating expenses of these two airlines increased by
ten per cent in 1998, higher than their revenue growth. As
a result, their average operating ratio deteriorated to 98.7 per
cent. Higher navigation fees were transferred to users in the
ticket prices, but higher labour costs and the weaker Canadian
dollar drove costs even higher. Lower Canadian currency exchange
rates against the US dollar contributed to higher costs because
aircraft fuel, rent and materials are partly paid in US currency.
In order to restore their profitability, both Air Canada and
Canadian Airlines have announced a number of initiatives to be
implemented during the coming year, including fleet capacity rationalization
and workforce reduction. For instance, Air Canada plans to reduce
1,275 employees by February 1999 and a further 450 by the
end of 1999, representing a 7.5 per cent reduction in workforce.
Canadian Airlines' main strategies include gaining more market
shares through new customer services and forging strong global
alliances with other airlines.
Capital Expenditure
From 1986 to 1997, capital expenditureNote 23 in the airline
industry amounted to $1.2 billion per year. In constant dollars,
the net assets of the airline industry increased much more rapidly
than output growth during this time.
Table 16-33 illustrates the variability of capital spending
in the airline industry. The periodic variation in capital expenditures
is partly due to the life cycle of flight equipment. Capital spending
of less than $400 million a year in the mid 1980s climbed to $2
billion per year from 1988 to 1992 . In the period following,
1993 to 1995, capital spending was more than halved. Since 1996,
airlines' capital spending has picked up.
The two major airlines' total capital expenditures increased
significantly in 1998. As traffic growth has slowed down, however,
capital spending on flight equipment is expected to decline in
1999.
Air Transport Industry
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NOTES:
21
The average stage length flown by an airline in a market was
estimated by dividing, for the said market, total annual passenger-kilometres
by the number of passengers.
22
Exercise caution in interpreting these results because the quality
of the available data is limited.
23
Includes acquisition of fixed assets, owned or leased, excluding
land, by all airlines.
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