When an airline replaces an aircraft type in its fleet, some costs change immediately while others do not change at all. So why are the fuel bill and the rent of the head office building not put in the same basket? In this lesson we examine, step by step, what cost is, for what purposes airlines use cost information, how ICAO classifies costs as operating and non-operating, direct and indirect, the leasing options for acquiring aircraft, fixed and variable costs, and unit cost indicators.

Note on the period: The cost shares and sample amounts in this lesson belong to the period in which the source was published; the current situation should be followed from the official sources of the relevant institutions.

What will you learn in this episode?

• To define cost and list the five uses of cost information in airlines
• To distinguish operating costs from non-operating costs and explain why this distinction matters
• To explain ICAO's classification of direct and indirect operating costs and the criterion it uses
• To explain the components of direct operating costs and make a simple annual depreciation calculation
• To compare wet, operating and finance leases
• To explain the components of indirect operating costs, fixed and variable costs, and unit cost indicators

Summary of this episode

1. What is cost and why is it measured?

Definition: Cost is the monetary value of the production factors a business spends to obtain the goods or services that are the subject of its activity. In a broader definition, it is the monetary amount of the resources used, or planned to be used, to carry out the business's functions and keep it going.

Why is it measured? Managing an airline successfully depends on two questions: how can costs be reduced and how can revenues be increased? To reduce costs, they must first be measured and classified according to suitable criteria.

Five uses of cost information:

• determining profit or loss for accounting rules and taxation,
• monitoring the cost efficiency of functional departments (for example maintenance or passenger services) and comparing them with industry averages,
• investment decisions such as how many aircraft of which type to buy or whether to open a new route,
• operating decisions such as which points to fly to, with which aircraft and how often,
• setting ticket and cargo prices.

Is a single classification enough? No. Different purposes require different classifications; no cost classification is sufficient on its own.

Why the ICAO classification? Because ICAO member states report their airlines' cost data to ICAO in a standard format, the ICAO classification is used as the basis for international comparisons.

2. Operating and non-operating costs

First criterion: ICAO first looks at whether the cost is related to the air transport activity.

Definition (operating costs): Costs related to the transport activity (operating costs).

Definition (non-operating costs): Costs not related to the transport activity (non-operating costs). Their main items are:

• expenses arising from retiring, replacing and selling aircraft,
• interest on debts and loans,
• losses from affiliated companies,
• losses from exchange rate differences.

Why does this distinction matter? Comparing airlines only by net profit can be misleading. Example: An airline in financial difficulty can show a profit by selling its aircraft; however, this does not mean that its transport activity is run efficiently. A proper comparison is made with operating costs and revenues.

3. Direct and indirect operating costs

Criterion: The basic criterion ICAO uses to classify operating costs is whether the cost varies with aircraft type.

Definition (direct operating costs): Costs that vary with aircraft type (Direct Operating Costs). Example: Fuel cost is a direct operating cost because it varies with aircraft type, and even engine type.

Definition (indirect operating costs): Costs that stay the same even if the aircraft type changes and are common to all flights (Indirect Operating Costs).

Why is it useful? This classification is especially useful in fleet planning: since indirect costs are independent of aircraft type, direct operating costs are used when comparing two aircraft types, and it can be estimated in advance which expenses will change, and how, when the aircraft type changes.

Shares: According to the ICAO data in the source, in 2005 about 54% of scheduled airlines' total operating cost was direct and 46% was indirect operating cost; the values of the two groups are usually close to each other.

4. Components of direct operating costs

Three groups: Direct operating costs consist of flight operations costs, maintenance and depreciation.

Flight crew expenses: Pilots' salaries, training, accommodation, insurance and benefits are in this group. Why do they depend on aircraft type? Pilots are mostly type-rated for a single aircraft type, and wide-body pilots are usually paid more. Cabin crew expenses, however, fall not into this group but into passenger services.

Fuel and oil expenses: They have the largest share within flight operations costs. Fuel consumption depends on many factors such as flight length, altitude and speed, aircraft weight and wind, so it is hard to calculate precisely; oil expense is very small compared with fuel. According to the 2005 data in the source, fuel and oil expenses made up about 22% of total operating cost; this share changes from period to period depending on fuel prices.

Insurance expenses: They cover insurance against the risk of aircraft being damaged on the ground and in flight, and liability insurance.

Aircraft and flight crew leasing expenses: When an aircraft is leased together with its flight crew, this is called a wet lease. In a wet lease the rent can be high because it also includes the aircraft owner's depreciation; in return, the lessee's depreciation expense stays low.

Maintenance costs: They consist of the labor, material and management expenses of all kinds of maintenance activity. Because maintenance is a field of expertise in its own right, some airlines buy maintenance from specialist organizations (outsourcing); the fees paid to these organizations are also tracked under maintenance expenses.

Definition (reliability): The probability that aircraft systems perform their functions for a given period. The main purpose of maintenance is to keep reliability at the desired level.

Definition (depreciation): Depreciation is reflecting the purchase value of the aircraft by spreading it over its useful life as expenses. It is a fixed cost because it exists whether the aircraft flies or not.

How is annual depreciation calculated? The residual value at the end of the aircraft's life is subtracted from its price and the remaining amount is divided by the depreciation period. Example: An aircraft that costs 200 million dollars with its spare parts, with a depreciation period of 16 years and a residual value of 10%, has a residual value of 20 million dollars; its annual depreciation is (200 − 20) / 16 = 11.25 million dollars.

Leasing options: Leasing is also common in acquiring aircraft.

• Operating lease: it is short-term, and the aircraft is returned to the leasing company at the end of the contract.
• Finance lease: it is long-term, and ownership of the aircraft passes to the lessee at the end of the contract. The depreciation expenses created by a finance lease are also tracked in the depreciation group.

Comparison (types of lease): In a wet lease the aircraft comes with its crew; in an operating lease the aircraft is used for a short time and returned; in a finance lease the aircraft belongs to the lessee at the end of a long term.

5. Components of indirect operating costs

Airport and air navigation charges: Charges paid for the runway, apron, terminal and similar services according to the aircraft's weight and the time it uses them, and air navigation charges paid according to the distance flown in the airspace.

Why are the airport charges paid by passengers not an airline cost? Because the airline is a bridge that collects them with the ticket price and passes them to the airport operator or the state.

Station expenses: They cover the staff, equipment and building expenses of ground handling for aircraft, passengers, baggage and cargo at the airport, and the expenses of private lounges.

Passenger services expenses: They consist of cabin crew, catering, flight delay and cancellation expenses, and passenger liability and accident insurance. Why are cabin crew expenses indirect? Unlike pilots, cabin crew can work on different aircraft types, so these expenses are considered independent of aircraft type; however, since the number of crew depends on the number of seats on the aircraft, some airlines track them as a direct cost.

Ticketing, sales and promotion expenses: They cover commissions paid to agencies, reservation systems and credit card companies, call centers and advertising expenses.

General, administrative and other expenses: General expenses that do not fall into the other groups.

6. Fixed and variable costs

Why a separate classification? The direct–indirect distinction is useful when comparing aircraft, but it is not enough for decisions such as increasing frequency or changing the structure of a route. For these decisions, one looks at whether the cost varies with the volume of output.

Definition (fixed cost): Expenses that are not affected by available seat kilometers in the short term and exist whether flights are operated or not. Examples: rents, depreciation, the fixed part of pilot salaries, maintenance expenses independent of use, and most indirect costs. Fixed costs are related to fleet size and can only be reduced in the medium or long term.

Definition (variable cost): Expenses that change with the amount of output and can be avoided in the short term. Example: If a flight is cancelled, the fuel expense, fees paid by flight hour, flight-related maintenance expenses, catering and airport charges disappear.

Its result: Since fixed costs are independent of the amount of output, airlines try to lower unit cost by using their aircraft as much as possible on revenue flights instead of keeping them on the ground.

Short-term decision: An airline that wants to cut costs in the short term can remove routes whose revenue falls below their variable costs from its network, or reduce frequency on these routes.

7. Unit costs

Definition: Unit cost is found by dividing total cost by a measure of the amount of output. It is calculated to measure cost efficiency, compare airlines and allocate costs to specific flights or routes.

Commonly used indicators: cost per flight or per landing and takeoff, per flight hour, per block hour, per revenue passenger kilometer (RPK) or available seat kilometer (ASK), and per passenger.

How are direct variable costs allocated? It is easy. Example: Fuel cost per block hour is multiplied by flight time; for an aircraft whose fuel cost per block hour is 3,000 dollars, a 2-hour flight costs 6,000 dollars in fuel (fictional calculation).

Why is maintenance tracked with two measures? The wear of some parts depends on flight hours, while that of others (such as landing gear) depends on the number of landings and takeoffs.

How are indirect costs allocated? It is harder; usually the passenger kilometers produced by the flight are used as the basis.

In short

Airline costs are classified first by whether they are related to the transport activity, then by whether they vary with aircraft type. Flight crew, fuel, insurance, maintenance and depreciation are direct operating costs; airport, station, passenger services, sales and administration expenses are indirect operating costs. The fixed–variable distinction and unit costs guide managers in frequency, route and pricing decisions.

Key concepts

• Cost: The monetary value of the production factors a business spends to obtain goods or services.
• Operating costs: Costs related to the air transport activity.
• Non-operating costs: Costs not related to the transport activity, such as aircraft sales, loan interest and exchange rate differences.
• Direct operating costs: Costs that vary with aircraft type; flight operations expenses, maintenance and depreciation.
• Indirect operating costs: Costs independent of aircraft type and common to all flights.
• Reliability: The probability that aircraft systems perform their functions for a given period.
• Wet lease: Leasing an aircraft together with its flight crew.
• Operating lease: A form of acquisition in which the aircraft is leased for a short term and returned at the end of the contract.
• Finance lease: A long-term form of acquisition in which ownership of the aircraft passes to the lessee at the end of the contract.
• Depreciation: Spreading the purchase value of the aircraft over its useful life as expenses.
• Fixed cost: A cost not affected by the amount of output in the short term, existing whether flights are operated or not.
• Variable cost: A cost that changes with the amount of output and is avoidable in the short term.
• Unit cost: Cost found by dividing total cost by a measure of output such as flights, block hours or passenger kilometers.

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Sources used:
Gerede, E. (2016). Havayolu işletmelerinin maliyet yapısı ve verimlilik göstergeleri. E. Gerede ve A. E. Demirci (Ed.), Havayolu Yönetimi (4. Ünite) içinde. Eskişehir: Anadolu Üniversitesi Yayınları.

📚 Academic Use Note: This content is a supporting learning resource prepared with reference to a published course text; it does not replace textbooks, lecture notes or your instructor's teaching. The sources to be used for exams and assessments are your course's official curriculum and the sources recommended by your instructor. The simplifications and interpretations in the narration are for teaching purposes; TT Institute Academy cannot be held responsible for any consequences arising from possible errors, omissions or outdated information. The cost shares and sample amounts in this lesson belong to the period in which the source was published.

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