AV I AT I O N S TAT I S T I C S

Variance analysis can help airlines

improve their competitive edge
An analytical process known as variance analysis is valuable in understanding why an airlines actual
and projected revenues and costs are different, thereby highlighting ways to improve the bottom line

ICAO SECRETARIAT

INCE the dawn of air transportation, there has been an exponential

increase in the number of passengers and routes flown, currencies used in
transactions, fare types and discount levels, to name just a few areas that generate
complex data. Such an overload of information can make it difficult for a manager to identify ways to improve airline competitiveness. This is why a systematic
data collection process is required to
highlight information of value, with support from a management tool known as
variance analysis.
Variance analysis has myriad forms that
range from simple to complex, but its basic
principle is simple: compare the actual revenue or costs with budgeted or same-period figures to ascertain variances. Once
known, the reasons for these discrepancies
are determined in such a way that managers are empowered with the right information to address deficiencies, if any, and
to make decisions that enhance the airlines
competitiveness and improve its profitability. Variance analysis is thus the set of procedures adopted by managers to help them
understand the sources of variances
between sets of comparable data.
The reasons for variances between
actual and targeted capacity may be
found in one or more factors, among
them flight cancellations and rescheduling, unscheduled aircraft maintenance,
unanticipated changes in equipment,
unexpected block speeds, en-route and
airport congestion, unforeseen payload
restrictions and unplanned changes in
payload configurations.

NUMBER 1, 2007

The basic document from which revUnderstanding what underlies variances

enue data is collected is the passenger
in capacity makes it possible to track traffic
ticket, with revenue being generated at
changes related to each route group and
the time of travel. The calculation must
the impact of such changes on revenues,
account for commissions, adjustments for
costs and profitability. Analysing the effects
interline claims, special discounts, and so
of traffic growth facilitates decisions on the
forth. It also takes into account sales in
optimal deployment of capacity. Addressing
foreign currency.
variances in block speeds will also help in
Many airlines use specific software to
minimizing fuel burn and operating costs
account for their revenues. The end prodwherever practicable.
uct of the process is statements of passenAn example of variance analysis at the
macro level, which in
2005 versus 2004
Operating
Operating
Operating
this case focused on
revenues ($ billion) expenses ($ billion) result ($ billion)
the worlds sched2005
413.3
409.0
4.3
2004
378.8
375.5
3.3
uled airlines in 2005
Variance in $ billion
+34.5
+33.5
+1.0
and 2004, is illustratDue to change in:
ed in the accompanyTraffic (revenues) and
capacity (expenses)
+18.6
+17.4
+1.2
ing table. The adjaUnit revenues and unit costs
+15.2
+15.6
-0.4
cent figure shows
Differences in exchange rate
+0.7
+0.5
+0.2
some
individual
costs, expressed as a percentage of
24
Costs as a percentage of total
total operating expenses, related to this
22
operating expense, 1999-2005
global analysis. As shown, the share of
20
fuel costs increased from 11 percent of
18
total operating expenses in 1999 to
16
around 19.5 percent in 2005. Airlines
Fuel
14
responded to this challenge by using
12
Distribution
technology and improving processes to
10
Passenger service
reduce some controllable costs, notably
8
that of distribution and, to a lesser
99
00
01
02
03
04
05
extent, passenger service costs. (See
Example of variance analysis: changes in operICAO Journal Issue 5/2006, pages 10ating revenues and expenses, 2005 vs 2004
11 for more details concerning the vari- (scheduled air carriers of ICAO member States).
ance analysis presented in the accom- The figure illustrates specific costs expressed as
a percentage of total operating expenses.
panying table and figure.)
ger revenues covering different route
groups for comparable time periods.
Revenue variance analysis
These statements simply show whether
Managers are often presented with revthere has been a positive or negative
enue figures spanning comparable perichange in revenues on different routes,
ods. It is crucial for the manager to disand of course overall passenger revenues
cern why the variances in revenues occur
for comparable time periods. They do not
so that steps can be taken to enhance revaccount for variances, and the informaenue generation.
Percentage

A. SAINARAYAN

19

AV I AT I O N S TAT I S T I C S

Jim Jorgenson

tion they contain is not helpful in deciding

not a win-win situation; to apply this stratdevelop for each route group, since there
how to boost revenues. To understand the
egy, the airline must project the currency
is an impact on its competitiveness, profreasons for revenue variances, it is necesexchange rate for a specific period and
itability and planning process.
sary first to determine the variances that
must be prepared to accept a negative
After accounting for the impact of
stem from currency exchange transacimpact if this prediction turns out to be
exchange fluctuations, variance in revtions, yield and traffic developments.
grossly inaccurate.
enues can be broken down further for
Even without the use of hedging, an
each fare class and type, based on changes
To some extent, variances in revenues
airline will still find it necessary to pinin commissions and special discount rates,
can be traced to transactions involving curand the real increase or
rency exchanges, moreso
decrease in air fares. Such
for airlines that operate
an analysis will help deterinternationally. Sales transmine whether steps taken
actions are performed in
to increase yields or traffic
multiple currencies, but
are bearing results, or
are converted on a regular
need to be reviewed.
basis to the home currency, according to the periTraffic variances can be
odic rate of exchange
further analysed to account
adopted by the airline.
for the increase or decline
in capacity offered, and the
Variances in the level of
real growth in traffic relatbookings between compaed to changing load factors.
rable periods, when conA variance in traffic figsidered in light of differures may be misleading
ent currencies representsince this could occur as
ing a portion of total sales
Using variance analysis, an airline can exercise cost control and obtain a
on a route, indicate to true picture of the cost of its efforts to increase revenues and profitability a result of an adjustment
in capacity offered vis-what extent the revenue
point how much of the variance in revvis the comparable periods. Usually an
growth or decline was caused by fluctuaenues for a particular route group is
increase in flight frequency will boost
tions in the currency exchange rate. When
caused by currency exchange rate fluctumarket share, provided there is no corremajor foreign currencies are a critical
ations, as such information can provide
sponding growth in capacity offered by
component of revenues in a route group,
the air carrier with a competitive advancompetitors on the same route. Similarly,
the airline must decide whether the
tage. If an airline finds, for example, that
flight cancellations and service withdrawimpact of currency exchange fluctuations
its home currency on a specific route is
al will lead to a traffic decline. It is therewarrants currency risk management. If so,
depreciating against an important foreign
fore necessary to isolate the traffic variseveral alternative approaches to managcurrency component on the same route
ance related to changes in capacity and
ing currency risk are available.
When an airlines revenues are denom(usually bookings made for the return
arrive at true traffic variance attributable
inated in a foreign currency, in effect it
leg), it can increase profitability by adoptto load factor changes, while comparing
holds assets valued in that currency. One
ing a short-term strategy focused on the
equivalent capacities for comparable periway to manage the economic risk inherappreciating foreign currency. If, howevods. The real variance in traffic, after
ent in this situation is to establish a natuer, the long-term trend points to a
excluding the impact of capacity adjustral hedge by arranging long-term financdepressed home currency, with the cost
ments, needs to be determined for differing in the currency concerned, and
of the home currency not rising commenent fare classes and types for the route
undertaking currency trades, especially if
surately with the level of depreciation, the
group concerned.
the airline foresees that revenues in forairline might decide to benefit from this.
Variances cannot be traced simply to
eign currency will form an integral part of
yields or traffic developments. To achieve
It could decide to lower fares in the
its long-term strategy. If financing is not
appreciating foreign currency, thus
effective revenue management and optideemed appropriate, forward contracts
mize revenues through better inventory
increasing market share on the route
or currency put or call options may be
management, variances should be looked
concerned. Such an action would put
considered. Whats important is that the
at in a holistic manner, considering all
pressure on the competitor to match the
airline weigh the benefits of hedging.
price in order to retain market share.
continued on page 34
Simply put, the goal is to reduce variFor a number of reasons, it is clear that
A. Sainarayan is a Statistical Officer employed in the
ances in future cash flows and improve
an airline needs a currency reporting sys- Economic Analyses and Databases Section of the Air
the airlines ability to plan. But hedging is
tem and analyses of variances as they Transport Bureau at ICAO headquarters, Montreal.
20

ICAO JOURNAL