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CasereportGroup12
CaseReport
Delta’sNewSong
ByGroup12
2011/3/29
Contents
1.Background
2.Mainissue
3.Problems
4.Analysis
1)High-lowforDelta
2)SimpleRegressionforDelta
3)MultipleRegressionforDelta
4)Conditionsandassumptionsofcostfunctions
5)High-lowforJetBlue
6)SalarycostestimationforSong
5.Solutionandsuggestion
Background
TheentireUSairlinebusinessisfacingthechallengeofoperatingwithinalow-margin,high-fixed-costenvironment.Itsprofitabilityisparticularlysensitivetodecreasesinvolume,eitherfromenvironmentalfactorsorfromcompetition.Moreover,theairlinebusinessislabor-intensive.Laborcostsasapercentageofrevenuesrangesfromalowofabout25percentforthelow-fareairlinestoalmost50percentforthelarge,full-serviceairlinessuchasUnited.Furthermore,formanyairlines,laborunionsarestrong,presentinganadditionalchallengeinthemanagementofcost.Salariesarelargelyfixedintheshorttermforunionizedemployees.Inrecentyears,somemajorairlineshavewonconcessionsfromlaborunionsaboutreducingthestaffandcuttingdownsalaries.
DeltaAirlineisthethirdlargestU.S.airlineinoperatingrevenuesandrevenuepassengermilesflown.Traditionally,thecompetitioncamefromtheotherfull-serviceairlinessuchasUnitedAirlinesandAmericanAirlines.However,inrecentyears,themajorairlineshavebeenforcedtocompetewithlow-cost,no-frillairlinespioneeredbySouthwestAirlines.SalariesareasignificantcomponentofDelta’scoststructure.Deltapilotsarethehighestpaidintheindustry.Meanwhile,itistheleastunionizedofthemajorairlines.Deltapilotsaretheonlyunionizedemployeegroup.Itsflightattendantandticketagentsarenotunderunioncontract.Consequently,theirsalariespresentflexibilityandvariabilityinnature.
InNovember2002,despiteitspreviousfailureinentryintothelow-faremarket,Deltadecidedtoformanewlow-costcarrier,Song,whichistargetedtocompetewithsuccessfulnewcomerJetBlue.
Mainissue
HowcanDeltacreateadifferentcoststructureandbusinessmodelinordertosucceedinthelow-costcarriermarket?
Problems
Deltaisinapositionofevaluatingentryintothelow-costcarriermarket.ThesuccessofDelta’sSongdependsonthefollowingissues:
ØCanDeltacreateaverydifferentcoststructureandanewbusinessmodeltocompetewithJetBlue?
ØHowtopredictfuturesalariesofDeltaandJetBlue?
ØHowtodealwiththestrongworkunion?
Analysis
1.High-lowmethod
Firstly,weidentifysomepossiblecostdriverstoestimateDelta’ssalaries:
availableseatmiles;availabletonmiles;numberofdepartures;revenuepassengermiles;revenuetonmiles.Afterapplyingsimpleregressionusingeachofthepossibledriversandcomparing
andresidualerrorsofeachdriver,wechoosetwomostreasonablecostdrivers:
revenuepassengermilesandavailabletonmiles.
Thesalariesconsistofpaymentstopilots,flightattendantsandticketagents.Theyaredeterminednotonlybythenumberofpassengersandcargoesbutalsothemilesorhoursflown.Infact,milesandhoursarecorrelated.Sowechooserevenuepassengermilesandavailabletonmilesascostdrivers.Revenuepassengermilesisamajorindicatorintheairlineindustry,soit’sreasonabletobeadriver.Availabletonmiles,however,seemsnotsogood.Butaftercalculationwefindthat
oftheformeris0.1764,and
ofthelatteris0.5577.Formoreobviouscomparison,wedrawthefollowingscatterplots.
Thescatterplotbetweenrevenuepassengermilesandsalary
Thescatterplotbetweenavailabletonmilesandsalary
Wecanseethatthelatterscatterplotshowsamorelinearrelationshipbetweenthetwovariables.Fromtheperspectiveofeithernumericalanalysisorvisualjudgment,availabletonmilesismoreaccurateforestimation.Sowechooseavailabletonmilesasthecostdriver.
Lowpoint(3132,1145),highpoint(4029,1514)
Salary=0.4114×availabletonmiles-143.50
Thistechniquehasadvantages:
onlytwodataisneeded,soit’squiteconvenient.It’seasytoapplyandillustratemathematicallyhowachangeinacostdrivercanchangetotalcost.
However,notalltheinformationisused,whichisregardedasinefficient.Becauseitbasescostfunctionononlytwoperiods’costexperience,regardlessofhowmanyrelevantdatapointshavebeenallocated.Inaword,it’slessaccurate.
2.SimpleRegression
Weusesimpleregressiontoestimatethesalarycostwithavailabletonmilesasthecostdriver.Resultsareasfollows:
Coefficients
Standarddeviation
Intercept
-682.643
282.6033
XVariable1
0.551693
0.079698
Salary=0.5517×availabletonmiles-682.64
=0.5577,andstandarddeviationsaremuchsmallerthancoefficients,soit’sstatisticallyvalidandsignificant.
Regressionanalysismeasurescostbehaviormorereliablythanothercostmeasurementmethods,sincethistechniqueusesstatisticstofitacostfunctiontoallthehistoricaldata.Comparedwiththehigh-lowmethodwhichonlycontainstwogroupsofdata,it’sanimprovement.What’smore,regressionanalysisyieldsimportantstatisticalinformationaboutthereliabilityofthecostestimates,whichallowsanalysttoassessconfidenceinthecostmeasuresandselectbestcostdriver.Butweshouldnoticethatonlyonecostdriverisconsidered,soitcan’texplainthevariationofsalariescompletely.
3.MultipleRegression
BecauseofthereasonsmentionedinQuestion1,wechooserevenuepassengermilesandavailabletonmilesascostdriversandusemultipleregressiontoestimatethesalarycost.Resultsareasfollows:
Coefficients
Standarddeviation
Intercept
-1144.55
243.2101
XVariable1
1.051937
0.120829
XVariable2
-72.2955
14.88974
Salary=-1144.55+1.05×availabletonmiles-72.30×revenuepassengermiles
=0.5577,andstandarddeviationsaremuchsmallerthancoefficients,soit’sstatisticallyvalidandsignificant.
Thistechniquetakesmorecostdriversintoconsideration,andtheresultscalculatedaremoreclosetothedatagiven,soit’sanimprovementoverthemodelestimatedinQuestion2.Theaccuracyofestimationthusservesasitstopadvantage.However,itmightbemorecostly,time-consumingandcomplicatedtobeimplementedthanothertechniques.
4.TheusefulnessofanalysisinQuestion1-3
ThecostfunctionsestimatedinQuestion1-3arebasedontheassumptionthatthewagesperhourremainthesameandthereisnoadditionallaborneeded,soit’susefulonlyundercertainconditions.Takingthebackgroundoftheindustryandthecompany’scircumstanceintoconsideration,wethinktheseareimportant:
ØThefirstoneisthatthepresentequilibriumbetweenDeltaandthelaborunionsisnotinterfered.Thatis,endeavorsconcerningloweringpilots’salariestoindustrylevelwillnotbeobstructedbyunionforces,andemployeesotherthanpilotswillnotjoinlaborunionstorequirehigherpayments.Ifnot,adjustmentsoncoststructurewillbefutileandSongwillonlyturnouttobeanotherDeltaExpress.
ØSecondly,noharshregulationsregardingreducingstaffsorcuttingsalariesaretobeformulated.Restrictionsaboutlayoffswilldirectlyleadtoweakcontroloverbudgets,andinturncreatessimilarproblemsashighsalariesdo.Nevertheless,regulationsofthiskindarealmostinevitable.Accordingtoprecedents,largescalefurloughshavealreadybeenblockedoncebyALPA,thuswehavenoreasontoremainoptimisticaslongastherecessionofthegeneraleconomicsstayasafact.
ØThelastpointwecomeupwithisthenewfixedcostcausedbynewsecuritydirectivesaftertheSeptember11terroristattacks.However,sincesecuritycostscanbeexpectedamidthewholeindustry,itshallnotbecomeamajorconcernforSong,althoughourpredictionmodelmayoverallshiftupwards.
Iftheconditionsarenotmet,thecostfunctionswillbelessuseful.
5.EstimatethesalarycostforJetBlue
AccordingtoQuestion1,availabletonmilesshouldbeusedtoestimatethesalarycost.However,availabletonmilesof2002Q3iseccentricallylow.Sowedrawascatterplot:
Inthissituation,availabletonmilesandsalariesarenotlinear.Thescatterplotofrevenuepassengermilesandsalariesisasfollows:
Revenuepassengermilesandsalariesarequitelinear.Weusethehigh-lowtechniquetoestimatethesalarycostwithrevenuepassengermilesascostdriver.
Lowpoint(599.4,16000),highpoint(2016.2,49000)
Salary=23.29×revenuepassengermiles+2038.83
6.EstimatethesalariescostforSonginitsfirstyear
ToestimatethesalariescostofSongisquitedifficultbecausethereisnohistoricaldataforreference.BecauseJetBlueisasuccessfulexampleinthelow-costmarket,weuseitshistoricalsalariescosttopredictSong’ssalary.Forsimplicity,wemakesomeassumptions:
ØSongcanachievethesamerevenuepassengermilesasJetBlueineveryquarter
ØJetBlue’ssalariesarelinearwithtimeseries
Thoughthefirstassumptionisverystrong,thesecondonecanbeeasilyverified.Wenumbereachquarterin2001and2002from1to8,andmakesimpleregressionbetweenthetimeseriesandsalary.
Quarter
Numberoftimeseries
JetBlue’sSalary
2001Q1
1
16000
2001Q2
2
19000
2001Q3
3
22000
2001Q4
4
28000
2002Q1
5
34000
2002Q2
6
38000
2002Q3
7
42000
2002Q4
8
49000
Simpleregressionbetweenthetimeseriesandsalary:
Coefficients
Standarddeviation
Intercept
9571.429
986.5881
XVariable
4761.905
195.3735
JetBlue’ssalary=$4761.91×numberoftimeseries+$9571.43
Thescatterplotofnumberoftimeseriesandsalaryisasfollows:
=0.9900andstandarddeviationsaremuchsmallerthan