SUPPLY AND

DEMAND FOR AIR

TRANSPORTATION
The air transport industry is a vital component of the global transportation
network. Aviation provides the only means of rapid, long-distance travel,
which makes itessential for the conduct of global business and tourism.
“By facilitating tourism and trade, air transportation generates
economic growth, provides jobs, improves living standards, alleviates
poverty and increases revenues from taxes”
Africa, for example, has long been plagued by
inadequate or non-existent surface transportation, which has hindered
economic growth, but the recent expansion of airline service provided a
springboard forgrowth after decades of stagnation.

Aviation offers a vital link to communities that lack adequate road and
rail infrastructure. This contribution is most apparent
when aircraft deliver life-saving supplies in the immediate wake of
natural disasters.
SIZE, SCOPE, AND ECONOMIC IMPORTANTS
In 2013, the world’s airlines carried over 3.1 billion passengers and 49 million tons of freight.
The aviation industry directly employed some 8.7 million people and contributed $606
billion to the world gross domestic product (GDP).

LARGER THAN In comparison with national

GDP, aviation’s gross product
• Pharmaceutical ($451 billion)
would rank 21st in the world.
• Textile ($223 billion)
• Automotive industry ($555 billion)

Aviation supports some 58 million jobs with a $2.4 trillion global economic impact, or about
3.4% of global GDP.

On the other hand, tourism boosters would argue that tourism supports airline jobs.
 2.97 billion; largest markets are the
United States, the United
Passengers traveling by air Kingdom, and China; 52% of
international tourists travel by air

Air cargo 49.8 million tons

$6.4 trillion in value or 35% of
international trade by value
Jobs 8.7 million direct
18.6 indirect
30.5 induced
Airlines 1,397 airlines
25,332 commercial aircraft in service
3,864 airports with scheduled
commercial flights

AIRLINE INDUSTRY SIZE AND SCOPE

FACTORS DRIVING GLOBAL AIR
TRANSPORTATION GROWTH
Globalization
Many factors drive the growth of world
air travel, but these can be conveniently Globalization broadly refers to
grouped into four categories: the increasing integration of
world economies and
• (a) Globalization societies.
• (b) Demographics
• (c) Liberalization Long-distance trade has existed for thousands of years and
• (d) Factors of production shaped much of world history, but globalization accelerated
after World War II as countries reduced tariffs, subsidies,
and other restrictions on trade in goods and services.

Impediments to foreign investment and the movement of capital were gradually relaxed.
The International Monetary Fund (2010) identified four aspects of globalization:
I.
Trade
The global expansion of each requires extensive
II.
Capital movements
international travel by executives, managers, engineers,
III.
Migration
a host of other business specialists,and laborers.
IV.
Knowledge and technology
In the European Union, for example, laborers commonly travel on Europe’s
EXAMPLES: new low-cost airlines to work in other countries but return regularly to their
homeland.
As the world has outsourced much of its manufacturing to China, India, and other low-wage
countries in Asia, managers need to travel to manage their far-flung businesses.
Components for the Apple iPhone are made in the United States, Europe, Japan, and South
Korea and assembled in Taiwan and China.
Firms throughout the world are suppliers for the Boeing 787 Dreamliner, with the main
components built in the United States, Japan, Italy, Korea, Germany, the United Kingdom,
Sweden, and France and shipped to Everett, Washington, and Charleston, South Carolina.
 DEMOGRAPHICS
Demographic factors—population growth, urbanization, diaspora, and per capita income
—are perhaps the most important factors driving the demand for air travel.

Population growth, of course, expands the potential market for air travel.
Most people have never flown and cannot afford to do so, but the 6 billion people in
developing countries represent a huge potential market.
The world’s poor are mostly subsistence farmers scattered across vast reaches of land. In
recent decades, however, these farmers have been moving to large cities in search of a
better standard of living, and this migration is expected to continue.
Business travel will continue to increase, but discretionary travel from the expanding middle
class with sufficient disposable income to choose air travel for holidays will provide most
passenger growth. As ethnic groups disperse across the world, travel to visit or reunite with
relatives, known in industry jargon as visiting friends and relatives, will also contribute to
leisure travel growth.
LIBERALIZATION
Globalization and demographics drive increased demand for air travel, but liberalization, or
the reduction in rules and restrictions on airline competition, enablesmore supply of air
travel available to consumers.

As the regulation of international air services is relaxed, air services expand, fares
drop, and new airlines emerge.

The largest airlines reorganize their networks and hubs, often in coordination with
partner airlines in global airline alliances, providing more flight frequency and
improved connections.
Airline deregulation spurred air travel growth as airlines provided service according to market
demands rather than what the CAB estimated was required for public convenience and
necessity. Increased competition, especially from new entrant LCCs, reduced prices, inducing
more people to travel by air.
 FACTORS OF PRODUCTION
Liberalization reduces the legal restrictions on the addition of airline service to
meet passenger demand.
The two largest airline expenses are fuel and labor. Fuel prices are volatile and
difficult to predict.
Lack of infrastructure may also restrict airline growth in some world regions.
While high fuel cost, infrastructure, and environmental regulation could
potentially impede airline growth.
Improved technology will partially mitigate all three. Between 1978 and 2013,
airline fuel efficiency more than doubled, and new aircraft models such as the
Airbus 320neo and Boeing 737 Max promise an additional boost in efficiency
that will reduce both fuel costs and lower emissions.
 AIR
CARGO
Growing world trade also increases the demand for air
cargo.
Air freight is much more expensive than competing forms of
land and sea transportation, so air cargo is limited to high-
value–low-volume, perishable, and emergency freight.

Air cargo has grown at anaverage of 5.5% since

1980, but periods of negative growth are also
evident.
 FORECAST IN AIR TRAVEL DEMAND

Long-term forecasts of air transport demand are most important for aircraft
manufacturers because of the lead time and expense involved in developing
and marketing new aircraft.

Airports and airlines also depend on long-range forecasts to accommodate

passenger and freight demand.

The forecast has several important practical applications. It helps shape our
product strategy and provides guidance for our long-term business planning.
 MACRO- FORECASTING
The development of long-range forecasts of air travel demand usually begins
with estimates of GDP, because the two are highly correlated.
As per capita income increases, people tend to
spend proportionately more on air travel.

By examining the chart, it’s evident that world

air travel has grown at roughly twice the rate of
GDP growth over the last four decades.

Airline service typically increases and fares fall as markets are liberalized.
Travelers value a choice of arrival and departure times, routings, non-stop flights,
choice of carriers, and service class, and respond with increased air travel.
How do manufacturers develop forecasts for market
demand?
The annual Airbus and Boeing forecasts include outlines of their
methodologies.
Airbus titles its forecast the Global Market Forecast
Boeing tags its forecast the Current Market Outlook

Several statistical methods generally use regression of historical

market growth against independent variables including GDP,
population growth, urban population density, and oil prices, among
others.
 ROUTE-LEVEL-MICRO-FORCASTING

Many additional factors that influence the demand on individual

routes.
These include:
Historical traffic
Types of passengers
Competition
Prevailing fares

With an estimate of total demand at the route level, the airline must
then estimate the share of that demand, or market share, it can
obtain versus that of competing airlines.
Historical data on the number of passengers and fares in a given
market are usually the starting point for demand estimation and
route planning.
For its own existing markets, of course, the airline will have internal
data.
External data on passenger traffic and fares are available from
several sources.
The Marketing Information Data Transfer (MIDT) is a database that
captures booking information from the major global distribution
systems (GDS).
 Actual sales data, in contrast to booking data, are available for
transactions settled through the Airlines Reporting Corporation
(usually referred to as simply ARC) and the Billing and
Settlement Plan (BSP).

Because direct sales through airline websites and reservations centers

are not captured by any of these databases, the data represent only a
portion of the total market. Data from each of these sources are
processed and sold by several vendors, many of whom do provide
estimates of total traffic and sales.
For the U.S. carriers, the Department of Transportation,
Bureau of Transportation Statistics, makes a 10% sample of
all tickets available to the public without charge.
Many airline economic studies utilize this database.

An airline considering a new route without existing service

will have little or no historical traffic data on which to base
its forecasts. It might rely on market research and expert
opinion, but demand can be at least crudely estimated using
the populations of the two cities and the distance between
them.
Forecast demand is a starting point for airline planning, but it is
subject to considerable uncertainty and error.
A common error has been the failure to differentiate between
underlying demand and past traffic growth that was stimulated by
declining yield (low fares).
Falling prices will increase traffic, especially leisure
travel.
Airlines have frequently overestimated traffic growth and ordered
new aircraft to meet the expected demand.
 PASSENGER
SEGMENTATION
Demand for air travel is derived from the purpose of travel.
That is, passengers do not fly for the enjoyment of flight but
because they need to be in another location for some
reason, be it for business or pleasure.
Economists term this derived demand.

Some markets attract mostly business passengers, whereas

others are dominated by leisure travelers.
EXAMPLE:
The Chicago–New York market, for example,is
predominately a business market.

Flights to Orlando and other Florida destinations are

mostly filled by passengers on vacation.

Similarly in Europe, passengers on holiday will

predominate on routes to the Mediterranean cities.
Depending on the reason for travel, passengers have
different wants and needs.
The airline must tailor its product and pricing to meet
the desires of its passengers. Airlines have traditionally
segmented passengers into two major categories
according to the reason for travel—business or leisure
—but usually develop several
more subcategories (Doganis, 2010).
 BUSINESS
PASSENGER
Business passengers, for example, may beclassified as lower and
higher end.
Passengers traveling for business tend to value flight frequency, non-
stopflights, choice of cabin classes, in-flight service, and flexible,
refundable fares.
High-end business travelers are less price sensitive and often book
flights near the departure date, while the lower-end business
passengers display more price sensitivity.
 LEISURE
PASSENGERS
Leisure passengers are universally divided intothose who are visiting
friends and relatives (VFR) and those on vacation or holiday.
VFR passengers usually have some flexibility in travel plans, book far
in advance, and often select the airline offering the lowest price.
Flight frequencyand amenities are less important.

Leisure passengers display most of the same wants as VFR, but are
usually traveling on vacation or holiday, so the destination appeal is an
important consideration, and their travel days may be restricted by
the days they are off work.
Passenger wants and needs also vary with the length
of the travel.

Many passengers will sacrifice cabin amenities, such

as seat and legroom, for a lower price on a short
segment of less than three hours, but will
demand a higher-quality service on longer flights.
 VARIATION IN
DEMAND
 If an airline does not provide enough capacity to meet
periods of peak demand, it risks losing passengers to
other airlines, a loss known in industry jargon as SPILL.
 On the other hand, too much capacity for the existing
demand results in empty seats (known as SPOIL)
This challenge is daunting, because demand in each market varies
substantially by hour of the day, day of the week, and season, and
with the business or economic cycle.
EXAMPLE
 Business travelers favor morning departures and late
afternoon or earlier evening return flights.
 A flight departing at 7 a.m. may face heavy demand
However, when the aircraft operating this flight reaches
its destination, little demand may exist for the next
departure at, say, 10 a.m.
Similarly, business travelers also travel more frequently
on Mondays and Fridays.
 EXAMPLE
 Both VFR and leisure passengers are less sensitive to the
timing of flights, but often wish to leave on a Saturday and
return on Sunday.

 As a result of these desires, demand mid-week on

Tuesdays and Wednesdays is typically low.

Demand also varies by season of the year

Directional Demand
 This is easiest to visualize with special events such as big
sporting attractions.
 Prior to the event, demand will be high into the host city
and strong leaving the city after the event.
 The result is that with sufficient capacity for the high
demand, flights in the opposite direction will be
wanting.
Directional demand, however, is evident in some markets for
reasons other than special events.
Demand is further complicated by natural disasters; political
upheavals, especially war; and economic crises, all of which
are unpredictable.

The impact of natural disasters from hurricanes, tsunamis, and

volcanoes is usually regional rather than worldwide.
 Traffic falls because of a lack of demand, as well as the
reduction in supply as airlines reduce flights.
 UNEVEN
DEMAND
 If sufficient capacity is provided to meet demand on, say,
Monday morning, then excess capacity is available on Tuesday
afternoon.

 The airline faces the choice of not flying aircraft during low-
demand periods while incurring high ownership costs or
operating those aircraft with lower passenger loads and at
lower prices.
 DEMAND CURVE
 The demand curve is a graphical representation of
the relationship between price and the quantity of
goods or services demanded.
 Not surprisingly, the lower the price, the more tickets
passengers are willing and able to purchase. This
inverse relationship between price and the quantity
of goods sold is known as the law of demand, one of
the most robust principles of microeconomics.
 DEMAND CURVE
In Panel A, ticket price is shown on the Y-axis, while the number of
tickets sold during some period of time is on the X-axis. Not
surprisingly, the lower the price, the more tickets passengers are
willing and able to purchase.
 New Route Example
In 2015, the U.S. hybrid
carrier
Virgin America decided to
enter the San Francisco–
Hawaii market.
Virgin America’s route map of the new routes to
Honolulu and Kahului from its San Francisco base, with
planned additional service from Los Angeles in 2016.
Virgin estimated how much of the already crowded market it
could capture with its new service:

 Specifically, how many passengers it would carry and at

what price.

This estimate depends on the total demand in the market, the

product Virgin America offers in terms of frequency, timing,
and quality, and, critically, the reaction of competitors.
For Virgin’s new routes, the San Francisco to Honolulu
and Kahului city-pairs are only a portion of the
total market Virgin intends to serve, because it
can also offer connecting service from several other
destinations.
Passengers originating in Boston and Chicago will
be able to connect in SFO to flights for Hawaii.
Virgin must be cognizant of the potential reaction of
competitors to its entry into the Hawaiian market.

Airlines vary greatly in their commitment to new routes.

Some, such as Spirit and Allegiant, pull out after a few
months if revenues fall short of expectations, while
others view new routes as a long-term investment that
may take years to fully develop.