Efficiency and Survivability of New Entrant Airlines
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Journal of the Eastern Asia Society for Transportation Studies, Vol. 6, pp. 752 - 767, 2005 EFFICIENCY AND SURVIVABILITY OF NEW ENTRANT AIRLINES Jinn-Tsai WONG Chun-Nan CHEN Professor and Chairman Supervisor Institute of Traffic and Transportation Business Development Office National Chiao Tung University China Airlines 4F, 114 Chung Hsiao W. Rd., Sec. 1, Taipei, 13F, 131 Nanking E. Rd., Sec. 3, Taipei, Taiwan 100. Taiwan 104. Fax: +886 (2) 2349-4953 Fax: +886 (2) 2514-5814 E-mail: [email protected] E-mail: [email protected] Abstract: On November 18, 1987, the Ministry of Transportation and Communications, Taiwan, announced an ordinance allowing new airlines to be established and routes developed. Taiwan’s air industry thus saw a lot of change. This paper explores the outcomes of airline competition and survivability resulting from the liberalization policy through a research on the relative efficiencies of Taiwan's domestic airlines. The result shows that all of the new-entrant airlines had difficulty in using their inputs efficiently in their initial stage of operations. However, their scale efficiencies improved year after year. The incumbent airlines’ efficiencies were also improved. This implies that competition between the carriers resulting from entry relaxation was indeed intensified and thus performances were improved. In addition, because of the un-removable barriers of competition, most new entrant airlines indeed experienced the life cycle challenge: growth, decline, and collapse. All the newcomers except UNI Air, a subsidiary of EVA Airways, disappeared. Key Words: efficiency, survivability, DEA, entry relaxation policy 1. INTRODUCTION The rapid economic growth of Taiwan in 1980s had resulted in high domestic air travel demand. The incumbent airlines were unable to expand the capacity effectively so as to meet the market demand. As a consequence, the average load factor of air transportation reached as high as 82.2% in 1987. Passengers were denied booking frequently during the peak periods. Therefore, on November 18, 1987, the Ministry of Transportation and Communications, Taiwan, announced an ordinance allowing new airlines to be established and routes developed. It was the so-called “Taiwan’s open sky policy.” In fact, it was not an open sky, but an entry relaxation policy. After more than 20 years of regulation, Taiwan’s air industry thus saw a lot of change. Originally, only four airlines (China Airlines, Far Eastern Air Transport, Formosa Airlines, and Taiwan Airways) operated in the market. After the inauguration of the entry 752 Journal of the Eastern Asia Society for Transportation Studies, Vol. 6, pp. 752 - 767, 2005 relaxation policy, new entrants such as Great China Airlines, Makung Airlines (UNI Air), and China Asia Airlines (U-Land Airlines) joined the market one after another. In 1997, there were ten airlines in the market and the average load factor dropped dramatically to 66.5%. As of now, one has ceased operation completely; three has been merged and two operate exclusively international flights. Only four airlines survive in the domestic market. Since 1991, despite an average flying time of around only 40 minutes, airlines have successively introduced relatively large airplanes, such as A320 series, MD 90 series and Boeing 757 series etc., into Taiwan’s domestic markets, especially on those routes with strong demand (air freight in the domestic market is extremely low and can be ignored). Under the entry relaxation policy, airlines are devoted to expanding routes and flight capacity. However, the limitations of airport capacity, slot availability and limited price freedom have restrained the airlines’ development and thus, possibly, their performance and survivability. It is therefore interesting and worthwhile to explore the effects of the entry relaxation policy. With this background, the focus of this paper will be on the competitiveness of Taiwan’s domestic airlines through exploring their relative operational efficiencies. Efficiency variation for each airline during 1984-1998 and efficiency difference among airlines are analyzed. Also studied are the changes in efficiency resulting from technology and productivity improvement due to the entry relaxation policy. 2. METHODOLOGY Traditionally, methods such as financial ratio analysis and partial productivity measures (Windle and Dresner, 1992) were used to evaluate airline performance. However, using financial ratio analysis and partial productivity measures raises the problem of which ratios should be selected. Selecting a representative ratio among numerous ones is not only difficult but also crucial. In addition, the value of the ratio is often affected by such matters as company’s scale, operating type and scope. Bailey, Graham, and Kaplan(1985), Burning and Hu(1988), Antoniou(1992), Oum and Yu (1998), have adopted an airline’s profitability as an indicator to evaluate its operating performance. Most of them assumed that some specific variables are correlated with profitability, and regression analyses were used to test the correlation. Using profitability to evaluate an airline’s operating performance has its drawbacks. Airlines in Taiwan were regulated by the government before 1987, and were not allowed to enter/exit markets and adjust their operations at will. As a result, some airlines were unprofitable for a long period, but were nevertheless not allowed to exit the unprofitable market. These airlines thus are not fairly judged on their financial performance. 753 Journal of the Eastern Asia Society for Transportation Studies, Vol. 6, pp. 752 - 767, 2005 Frontier functions have been used to measure the efficiency of firms. Data Envelopment Analysis (DEA), which involves mathematical programming, is one of the principal methods used to estimate the frontiers. The production frontier and relative efficiency for each decision-making unit (DMU) is evaluated through the linear programming technique (Boussofiane, Dyson, and Thanassoulis, 1991). It is a non-parametric technique based only on the observed input-output data of firms and does not require any data on the input and output prices. Golany and Roll (1989) presented an application procedure for DEA analysis. Charnes et al. (1994) have also surveyed the state of the art and its numerous applications. Despite its drawbacks (Coelli, Rao, and Battese, 1999; Tofallis, 1997; Charnes, Gallegos, and Li, 1996), due to the flexible feature and its various advantages (Sengupta, 1999; Lewin and Minton, 1986), DEA was widely used in a variety of research including the area of transportation (Oum and Yu, 1994; Parker, 1999; Chapin and Schmidt, 1999; Sarkis, 2000; Scheraga, 2004). Though aware of the limitations of conducting a DEA analysis, considering the data availability, and information being derived from the analysis, we chose to adopt DEA in this paper to analyze the airlines’ relative efficiencies so that their competitiveness and survivability could be judged. To measure separately technical and scale efficiency, the constant returns to scale model, proposed by Charnes, Cooper and Rhodes (1978, 1981) and variable returns to scale model, proposed by Banker, Charnes, and Cooper (1984) are both employed. For detail, please see Coelli, Rao, and Battese (1999). 3. DATA Data Envelopment Analysis (DEA) evaluates a firm’s efficiency on the basis of the associated inputs and outputs. The exclusion of an important input or output can result in biased results. As a consequence, selecting correct variables, which can properly represent the inputs and outputs, becomes very important. Those considered in this paper are: 3.1 Inputs z Carrier’s Assets : including office buildings, airplanes, engines, hangers and the associated facilities, etc. z Labor Expenses:expenses for all kinds of employees, including the wages of flight crews, maintenance personnel, and other company staff. z Fuel Expenses:expense of aircraft fuel. z Maintenance Expenses:expense of equipment and material for repairing and maintaining aircraft and other physical assets. 754 Journal of the Eastern Asia Society for Transportation Studies, Vol. 6, pp. 752 - 767, 2005 3.2 Outputs z Operating Revenues:including the revenues from scheduled and non-scheduled flights. z Available Seat Kilometer (ASK):the sum over all flights of their available seats multiplied by the associated distance. z Revenue Passenger Kilometer (RPK): the sum over all flights of their revenue passengers multiplied by the associated distance (used only in sensitivity analysis). The main focus of this paper is on efficiencies of Taiwan’s domestic airlines, and thus excludes China Airlines (CAL), EVA Airways (EVA), and Mandarin Airlines (MDA), which operate international routes without domestic markets feeding for them. The separation of the industry into international and domestic sectors has proved to be appropriate since different structural characteristics of the frontiers emerged for each sector (Charnes, Gallegos, and Li, 1996; Oum and Yu, 1994). Thus, only airlines operating in the domestic markets are examined in this study. They are: Far Eastern Air Transport (FAT), Trans Asia Airways (TNA), Formosa Airlines (FAC), UNI Air (UIA), Taiwan Airways (TAC), Great China Airlines (GCA), and U-Land Airlines (ULA). The total number of DMUs is shown in Table 1. Table 1. Period of Data Collection and Number of DMU Airlines Period of data collection Number of DMU FAT 1984~1998 15 TNA 1988~1998 11 FAC 1984~1988 15 TAC 1986~1997 12 GCA 1989~1997 9 UIA 1989~1997