Modeling Performance: Measuring and Comparing Unit Cost Competitiveness of Airlines

During the last two decades, the world airline industry has experiences a period of significant structural, institutional and regulatory changes. Many countries have deregulated their domestic airline industries. A series of liberal bilateral agreements have been signed between the U.S. and many European, Asian, and Central American countries. Open skies continental blocs are being formed both in Europe and in North America. Discussions to create a liberalized continental bloc are under way in Asia Pacific. Airlines are facing increasing competition as the deregulation and liberalization advance. Since the economic recession of early 1990s many airlines have undergone painful restructuring in order to survive in this increasingly competitive environment. Therefore, it is useful to measure the consequences of these changes on airline performance.

This chapter (Chapter 38) measures and compares performance of major international airlines in terms of their unit cost competitiveness (see also Chapter 19 for more details on costing). To accomplish this objective, in the first stage the total factor productivity (TFP) of 22 major international airlines is measured, and the sources of TFP dfferentials are investigated in order to compute the residual TFP index, which is a measure of (pure) productive efficiency. In the second stage, a neoclassical variable cost function is estimated, and the variable cost function is used to decompose unit cost differentials of the sample airlines into various sources, including differences in input prices, network characteristics, output composition, and productive efficiency.