329- Scott McCartney with "Professor" Doug Parker on Route & Hub Profitability

Summary

Airlines Confidential Podcast

Episode 329: Scott McCartney with "Professor" Doug Parker on Route & Hub Profitability
Date: March 18, 2026
Host: Scott McCartney
Guest: Doug Parker ("Professor," former airline CEO)

---

Episode Overview

This episode dives deep into the complexities of airline route and hub profitability, responding to a listener question about how airlines measure the financial performance of specific routes and hubs. Doug Parker brings his industry expertise — and professorial touch — to explain the real-world mechanics and strategic implications of profitability analyses, with Scott McCartney acting as "the diligent student." Along the way, they discuss Southwest’s strategic retreat from O’Hare, the impact of rising jet fuel prices, Spirit Airlines’ bankruptcy, and a passionate debate about whether business jets pay their “fair share” for use of the national airspace.

---

Key Discussion Points & Insights

1. The O’Hare Capacity Crunch & Southwest’s Exit

[01:23 – 04:47]

• FAA is concerned about potential overcapacity at Chicago O’Hare with both United and American expanding aggressively.
  • “Neither American or United is going to unilaterally agree to pull back. ... There’s not nearly enough capacity at O’Hare for what they both want to do. So something’s got to be done.” — Doug Parker [02:04]
• Southwest pulls out of O’Hare: Cites profitability challenges as a small player in a hub dominated by others; will consolidate Chicago operations at Midway.
  • “As a small player at airports dominated by bigger airlines, Southwest no doubt found it harder to make money.” — Scott McCartney [04:23]
• Southwest is also pulling out of Washington Dulles, preferring to focus on airports where it’s stronger.

2. Industry Updates: TSA Shortages, Persian Gulf Conflict, Spirit Bankruptcy

[05:00 – 10:24]

• TSA labor shortage: Extended waits due to government shutdown affecting screener pay.
• Middle East conflict pushes jet fuel prices:
  • Jet fuel up nearly 65% in a matter of weeks, from $2.40 to close to $4 per gallon.
  • Airlines have tried to increase fares in response, but it’s unclear if those increases will stick.
• Spirit Airlines bankruptcy update:
  • Filing outlines a $300 million term loan and plans to shrink fleet from 214 to possibly under 80 aircraft.
  • No detailed financial projections disclosed yet, delays attributed to jet fuel price volatility.
  • “If fuel prices stay high, it just makes it all that much harder for Spirit, and it’s plenty hard to begin with.” — Scott McCartney [10:19]

3. The Real Impact of Jet Fuel Price Spikes

[10:24 – 12:59]

• Short-term pain, long-term resilience:
  • Airlines struggle to immediately adjust to sudden fuel price spikes.
  • But evidence shows that, over time, the industry adapts — profits were strong even at $100+/barrel oil in 2013-2014.
  • “It takes time to adjust. But if this is the new normal, airlines will get to where they adjust to this.” — Doug Parker [11:29]
  • Main consequence: slower growth, possible shakeout among weaker airlines, fare hikes likely.

---

Deep Dive: Airline Route & Hub Profitability 101 — A Masterclass with Doug Parker

[15:54 – 54:25]

Introduction: Why Route Profitability Matters

• Route profitability is among the most closely guarded airline secrets; vital for managing where and when an airline flies.
  • “If you don’t know how your routes are performing financially, you’re lost as a leadership team.” — Doug Parker [16:45]
• Unlike many financial metrics, route profitability data is almost never seen outside airline walls.

Cost Allocation: Why Airlines Aren’t Like Shoe Stores

[19:04 – 25:00]

• Retail businesses can allocate expenses and revenues per store easily.
• For airlines, every flight uses overlapping resources (aircraft, pilots, crews, ground staff) and involves complex allocation.
• Example: Allocating pilot costs to a DFW–Panama City route is based on aircraft type and fleet-wide block hour costs, not individual pilot salaries per flight.

“Frankly, there isn’t really a single expense you can just pull off the general ledger and attribute to this [flight].” — Doug Parker [23:06]

Economic vs. Accounting Costs

[25:00 – 28:00]

• Airlines often use “economic cost” for management decisions, not strict accounting (GAAP) numbers.
• Aircraft ownership cost: Assigned based on prevailing market lease rates, not what is actually paid, to reflect true economic cost.

Revenue Allocation: The Complexity of Connections and Networks

[29:06 – 34:57]

• Revenue per flight must account for connecting passengers—who may have paid for multileg itineraries, not just one flight segment.
• Credit card loyalty program revenue (from, e.g., Citibank): Allocated to routes based on where points/miles are redeemed.
  • “It’s just a distribution system for seats ... the bank is paying American Airlines to give seats to the bank’s customers.” — Doug Parker [33:19]

The “Network Effect” and the Limits of Fully Allocated Contribution (“FACT”)

[35:19 – 41:50]

• Fully allocated profitability at the route level can be “almost meaningless” due to:
  1. Fixed costs that won’t vanish if a flight goes away.
  2. Network connectivity: Cancelling a route may destroy connecting revenue realized elsewhere in the network.
  • “Some routes live off the beyond revenue they create and they should get credit for that, for that creation.” — Doug Parker [40:14]
  • Example: A Midland–DFW flight may look marginal on its own but brings in lucrative connecting passengers.

Sophisticated Profitability Metrics: VABSO

[43:08 – 46:45]

• Airlines develop several alternate profitability metrics (e.g., VABSO: Variable Allocated cost, Plus Beyond, Net of Spill, Ownership fixed).
• These account for:
  • Exclusion of fixed overhead and aircraft costs (since these rarely change if you remove a frequency/route).
  • Inclusion of connecting revenue (“beyond revenue”), net of displacement (“spill”).
  • The result: Most hub/spoke routes show positive margins on these measures.

“VABSO does reflect the contribution that each individual route’s making to the system. And that’s why you never see an airline significantly reduce capacity in an economic downturn.” — Doug Parker [47:02]

• This explains why airlines typically reduce utilization—not fleet size—in downturns.

Application: Decision-Making & Competitive Dynamics

[48:04 – 53:09]

• Airlines use VABSO (or equivalent) to compare cities and routes:
  • Looking for highest margin opportunity.
  • Focus as much on relative performance and trends as absolute numbers.
• FACT (fully allocated) profit is still used at aggregate levels, especially for an entire hub or the airline overall, but not for single routes.

“It always struck me, ... how much change in a competing service could have on our routes’ VABSO performance... Delta adds one flight in the market that we were in, you know, just, you can just see it, the change in that month.” — Doug Parker [51:18]

• Hubs: Airlines aim for each hub to be fully allocated profitable, recognizing that whole-hub closures could, in theory, enable cost reductions.

Evolution: No More “Development Routes” or “Strategic Losses”

[54:25 – 55:39]

• Airlines no longer keep loss-making routes for “strategic” reasons for long:
  • “If routes are losing money, they get cut these days. It’s a whole different world than it used to be.” — Scott McCartney [55:39]
  • Frequent flyer mileage redemptions are now accounted for, especially as banks are funding so much of loyalty revenue.

AI & Future of Profitability Analysis

[55:39 – 56:15]

• AI may accelerate some calculations but the logic and business context remain critical: “...this is everything I’ve described is not done manually, by the way.” — Doug Parker [55:54]

---

Memorable Quotes & Moments

• “We’re not coming to you this week from O’Hare... O’Hare is getting so crowded… the FAA has told us there is no room for podcasts...” — Scott’s opening joke [00:03]
• “I was not planning on doing a class every time, primarily because I don’t think it’s that interesting to the listeners. ... It requires some work from me and I'm, I've been done working for a while now.” — Doug Parker [15:54]
• “This individual flight is going to show up on a report as break even to slightly negative on a fully allocated basis... the definition of a low-margin business.” — Doug Parker [35:21]
• “Focusing on VABSO... tells our scheduling and revenue management teams what we want to tell them: Given this fleet of airplanes that you have at your disposal, go maximize the contribution they can produce as a system.” — Doug Parker [48:04]
• “No one in their right mind would set up a business this way.” — Doug Parker, on how the US funds air traffic control [68:16]

---

[Mailbag Segment] Business Aviation & “Fair Share” Debate

[57:46 – 69:02]

Listener Adam challenges Scott’s claims about business jets not paying their fair share.

[57:46 – 66:30]

• Adam’s argument: Business jets pay more in fuel taxes per gallon than airlines; with less infrastructure usage, this is fair.

Scott’s detailed rebuttal:

• Airlines pay significantly more per flight to support the airspace—fuel tax is only one (minor) part; the key is ticket taxes and passenger facility charges.
  • Example: One airline flight (737 with 150 passengers) brings almost $2,000 for a two-hour trip into the trust fund; equivalent business jet brings just $110.
  • “If private jets were paying their fair share, NBAA wouldn’t lobby so hard to keep the current system in place... The current system gives them virtually a free ride in terms of air traffic control, and that’s just wrong.” — Scott McCartney [65:36]
• Larger issue: The business jet lobby has been a barrier to US ATC modernization due to funding reform fears.

“Not to go all Bernie Sanders on you, Doug, but the NBAA has tremendous clout in Washington because the people who ride business jets are big donors...” — Scott McCartney [65:43]

Doug agrees, pointing out airlines were even willing to keep business jet costs stable for sake of modernization, but fix-all solutions are tough to enact.

---

Episode Conclusion

Scott closes by thanking Doug Parker for his candid insights and classroom-style explanation. Listeners are encouraged to tune in for the next episode with guest Robin Hayes (Airbus U.S. CEO).

---

Notable Timestamps By Section

• O’Hare and Southwest’s Departure: [01:23 – 04:47]
• Jet Fuel Impact, Spirit Bankruptcy: [05:00 – 12:59]
• Airline Route Profitability Class Begins: [15:54]
• Cost Allocation Analogy: [19:04]
• Aircraft Ownership Costs: [25:00]
• Revenue Allocation and Frequent Flyer/Credit Card: [29:06]
• The “Network Effect” in Profitability: [35:19]
• VABSO & Strategic Network Analysis: [43:08, 46:45]
• Changing Industry Attitudes on Loss-Making Routes: [54:25]
• AI Discussion: [55:39]
• Mailbag “Fair Share” Debate: [57:46 – 69:02]

---

Takeaways for Listeners

• Airline route profitability is complicated. True financial analysis requires sophisticated allocation of costs and “network” thinking that differs dramatically from most other businesses.
• Network effect is everything. Routes that appear unprofitable in isolation may provide crucial connectivity and revenue.
• Airlines typically don't react to downturns by grounding planes—due to high fixed costs and network revenue impacts.
• Business aviation currently pays much less for ATC usage than airlines on a per-flight basis, a sore point in national aviation policy.
• Industry practices and profitability models have evolved; rarely are loss-making routes kept “for strategic reasons” anymore.

This episode is a comprehensive masterclass for airline geeks, industry professionals, and anyone curious about how airlines make (or lose) money on the routes they fly.

Transcript

[A]

Airlines confidential with Scott McCartney is made possible with support from RTX Collins Aerospace, Pratt and Whitney and Raytheon. Connecting and protecting our world. RTX.com infinity flight the leader in Cadet Academy flight training programs infinityflight.com Ontario International Airport in Southern California state SoCal so Easy flyontario.com the executive MBA in aviation at the University of Colorado Denver business ucdenver.edu and by Cirium, the world's most trusted source of Aviation Analytics. Cirium.com we also welcome your business support. Contact us at airlinesconfidential.com welcome to Airlines Confidential. I'm Scott McCartney and we are not coming to you this week from o' Hare International Airport. O' Hare is getting so crowded with flights scheduled by United American that the FAA has told us there is no room for podcasts from o'. Hare. So like Southwest Airlines and Spirit Airlines, we're pulling out. Just kidding about the podcast departure part. Southwest really is leaving o'.

[B]

Hare.

[A]

More on that in a bit. But first, welcome back, Professor Doug Parker. The school bell is about to ring again. Class is back in session and this time we're going to learn about airline route and hub profitability. A listener request this class? I'm looking forward to it just as much as I'm looking forward to the NCAA March Madness Basketball Tournament coming up. Doug, we're going to call this class Market Madness.

[B]

Oh, excellent. Thanks. Thanks, Scott. And thanks for having me back. Yeah, look, I heard your listeners request about how hub profitability is calculated. I said to myself I wasn't going to do another one of these classes. But anyway, as we'll talk about, this is kind of near and dear to my heart given my past. So I thought it'd be fun. And it's also, I think, an interesting and important topic for people that follow airlines. So more on that. But the class does seem timely given the focus that you mentioned that's going on right now at Chicago o'. Hare. There was more news on this. This week the FAA is meeting with the airlines. The city of Chicago, which runs the airport, pushed back on the FAA suggestion that flights be capped lower than the airport's full capacity. So look, it's unclear what the FAA is planning to do at o' Hare other than try to get American United to each pair back a bit of their summer schedules. They don't have slot controls the way Washington, Reagan and the New York airports do. They used to. And the FAA certainly could reimpose slots. I'm not sure what's going to happen here. What I feel pretty certain about is neither American or United is going to unilaterally agree to pull back. And given where they both are, there's not nearly enough capacity at o' Hare for what they both want to do. So something's got to be done, and we shall see.

[A]

Yeah, no, it's really interesting. Nobody's going to say, just kidding, right?

[B]

No, they seem to go up by as much as the other one goes up.

[A]

Yeah, yeah.

[B]

Each time.

[A]

Yeah.

[B]

But.

[A]

But Southwest has made it a tiny bit easier, I suppose, for the faa. Unrelated or not, Southwest did announce that it was leaving O' Hare in June. Southwest started flying O' Hare in 2021 and served 15 destinations from O'. Hare. Starting June 4, Southwest will serve Chicago only through Midway Airport. Curiously, they're. I think they're the official airline of the Chicago Cubs north side, but now flying only from the south side airport. Much closer physically to the White Sox, but the Cubs in marketing and spirit. So all of the 15 O' Hare destinations will be served from Midway. Southwest, interesting. Also said it was pulling out of Washington Dulles effective June 4th. It has only three departures there. I don't think this is about operations and delays and congestion. I think it's about profits and losses. So your lesson is perfectly timed for us. As a small player at airports dominated by bigger airlines, Southwest no doubt found it harder to make money. And so better to focus all of its flying in Chicago and. And Washington on airports where it is strong. Midway in Chicago, Baltimore and Washington. Reagan in Washington.

[B]

Yeah. As we'll discuss, it's really hard to compete against hub airlines in their hubs

[A]

especially, and they're weighing on more and more flights.

[B]

I mean, half, half, half their airplanes are full with connecting traffic. And the airlines that don't have that absolutely cannot compete. Southwest is a different animal. Of course. They're obviously national and can do more. But yeah, I'm sure you're right that over time, Southwest just realized this wasn't use of their assets and they decided to concentrate them where they can do better. In other news, we saw that the Homeland securities restarted global entry. It made no sense that they dispatched. They talked about not doing it, but they apparently had the good sense to restart it. Just as lines are getting longer at airports for government screening because of the funding shutdown, several cities have started to report long TSA lines because of spring break. And there are lots of travelers, of course. And because most more TSA screeners aren't reporting for work because they're not getting paid right now, they're gonna get paid eventually. But a lot of people can't live that way and need to go off and find other things to do. So they, so they don't have as many screeners as they once had, just as, just as loads are ramping up. So anyway, that's, that's a developing situation that doesn't seem to have a ready solution, but I sure hope we get to one soon. Yeah.

[A]

Yeah, I hope so. It really needs to get resolved quickly and for the sake of the economy. The military conflict in the Persian Gulf needs to get resolved quickly, too. Jet fuel prices have gone from about $2.40 a gallon before the US and Israel attacked Iran to close to $4 a gallon at the end of last week, according to the Argus Daily sample of prices in Chicago, Houston, Los Angeles and New York. That's almost a 65% increase, so huge for any airline. Curiously, it seems airlines have been able to raise ticket prices, at least for now. A Deutsche Bank Fair survey, I think this is done weekly, showed some sharp jumps in ticket prices, especially for transatlantic travel and transcontinental trips. Long haul flights consume more fuel, of course, and I think the lack of Lyft through the Persian Gulf takes, I don't know, 10, 20% of long haul international capacity out. And so European airlines and others are probably picking up traffic and maybe able to raise prices because of that. The Deutsche bank survey posted prices for sale, not sold tickets. So we really don't know yet if people are really paying higher prices. Fares, and I'm sure we'll get back into this, aren't, aren't set based on costs. They're based on demand. And so as long as demand is strong, perhaps airlines can cover some of the increased fuel bills they're facing. So let's hope demand stays strong. And the other bit of news last week was filing from Spirit Airlines in the bankruptcy court. Spirit announced its restructuring support agreement and a plan of reorganization. And it was basically the outline of the plan. It seemed to me, as I looked through it all, lacking in numbers, lacking in specifics. But they did outline a $300 million exit term loan facility which would be five years on the term on that at fairly high interest rates. It looked like there were a couple choices in that, but it looked like interest rates above 10%. Spirit requested a confirmation for the confirmation hearing for the restructuring plan for May 27th. So that gives you an idea of the timeline on this. The airline said it was the plan restructures $1.1 billion of outstanding debt and it says it Also said that Spirit, which went into bankruptcy reorganization with 214 point planes, currently down to 125. There's a sale of, I think, 20 of those coming up soon. But Spirit also said in court that it expects to be down to 76 to 80 airplanes by the third quarter of this year. So more shrinking to come. What was not filed was a document of financial projections. Spirit's primary lawyer apparently told the court that those projections are taking longer to put together than they anticipated because of the volatility in jet fuel prices. There was also supposed to be a comparison of what creditors would get if Spirit liquidated, and that wasn't included. This is all in preparation of creditors voting on this reorganization plan so they get to see what. What the alternative would be. Spirit's lawyer said that creditors were raising questions about projected liquidity because of the higher fuel prices and about cash flows in Spirit's reorganization plan. So I just think if fuel prices stay high, it just makes it all that much harder for Spirit, and it's plenty hard to begin with.

[B]

Yeah, I don't have. I don't have anything to add to all your Spirit work, but I do want to talk a little bit about the fuel price situation. I mean, certainly it's a near term issue, and that's in Spirits, you know, living on near term. So a real issue for them. But it feels to me like, you know, the market and analysts over index on this fuel increase and what it means for the industry. What I know is fuel price spikes are really hard to adjust to. It's hard to quickly do what you need to do as airlines to adjust to oil prices that go from $65 to $100 overnight or within a week that can't be offset. But over time, airlines have proven they can be profitable at $100 a barrel. Oil, which I think some of us forget. It feels like we still live as though we're in the old days where, you know, in the 90s, if oil went to $100 a barrel, everybody's filing bankruptcy. Well, in 2013 and 2014, fuel price average for those two years was $104 a barrel.

[A]

Yeah.

[B]

And the airline industry made in those two years about $15 billion pre tax.

[A]

Yeah.

[B]

Which is about what they're making, which is certainly on a. On a inflation adjusted basis, what they're making now. So it takes time to adjust. But if this is the new normal, airlines will get to where they adjust to this. What you'll see is slower growth from airlines than they plan. You'll see some airlines, maybe the lesser airlines, maybe fall to the wayside, but not, you know, not any airline of real size. And the other thing I note is the airlines have prepared themselves for this, given. Given the past, certainly given the recent past with COVID They all have enormous cash balances, enormous amounts of. Of unsecured collateral that could be borrowed against. This is not an issue. Anything close to what we've seen before. And I think over time, you'll see airlines adjust to it with higher fares and less capacity.

[A]

So, so interesting. 2000. I mean, I remember 2008, when baggage fees came in, it was because oil went to $140 a barrel. Right. And got through that. Yeah, sort of.

[B]

Yeah, exactly. And again, it's kind of my point. I mean, I think it really kind of crossed over, like in 2011, 2012 to. But once that was the new normal.

[A]

Yeah.

[B]

We all adjusted to it. Yeah. And we're profitable. And I think if. I'm not saying that it is a new normal. Hopefully it's not. But if it is, we're all going to be paying higher fares and the airlines will. The airlines will figure out it's an entirely different industry than it was, you know, in the 1990s and early 2000s.

[A]

Yeah. It probably does cut into earnings for

[B]

the year, of course. Near term. Near term, without a doubt. Huge impact.

[A]

Yeah. Yeah.

[B]

But I think it's a near term impact, not a long term impact.

[A]

Right. Good. Good. Thanks for that. All right, time now to thank our sponsors who provide the jet fuel for this podcast, if you will. We want to thank Cerium. Cirium offers the most accurate and precise data and analytics to enable airlines to optimize planning, operations and passenger services. The right intelligence drives operational efficiencies, enables you to predict market shifts, and helps airlines respond quickly to maximize revenue, manage costs and seize commercial opportunity. Visit cirium.com for more. And thanks to Ontario International Airport, which is celebrating a decade of local control. Thanks to public support, the local community reclaimed Ont, revived it as a vital gateway in Southern California and ensured the airport is ready to soar even higher in years to come. Visit flyontario.com 10 to learn the story and find out how you can join the year long celebration of how a decade of local control has turned Ont into one of California's fastest growing and most economical airports. Thanks as well to our newest sponsor of Airlines Confidential, the Executive MBA Program in Aviation at the University of Colorado Denver. The Executive MBA in Aviation at CU Denver is the first degree of its kind in the world taught by industry experts and designed for ambitious leaders from across the aviation ecosystem. With classes located at Denver International Airport and week long residencies in Washington D.C. and at airports around the world, students experience a hybrid flexible course structure that balances in person and online classes without career interruption. Go to Business ucdenver. Edu to learn more. And Doug, I have to say I just had my last class yesterday and had two incredibly great guest speakers. One you know very well, Elise Eberwine.

[B]

Oh, yeah.

[A]

Yes. Who we had fabulous conversation. And one I think you also know, Jeff Shane, of course, who the father of Open Skies who came to talk about open skies and regulation and everything else on On Zoom from Switzerland was a fantastic session since, since the last

[B]

time I was on Richard Anderson. And I did one of your classes and. Which I enjoyed. I know Richard enjoyed. It's a great, great group you had there. Smart, smart people with great questions. Intrigued. So anyway, yeah, I enjoyed doing it. And I know what you did, too.

[A]

And that was a fabulous opportunity. We talk about consolidation and you guys were the architects of it. So it was fabulous.

[B]

Good.

[A]

All right. Speaking of class, Professor Parker, the class is now yours.

[B]

Okay, here we go again. As I said in the outset, I was not planning on doing a class. I'm not planning on doing a class every time. My co host now, I promise, primarily because I don't think it's that interesting to the listeners. And also it's, it requires some work from me and I'm, I've been done working for a while now.

[A]

People keep referring back to the first class.

[B]

Okay.

[A]

I think it was pretty valuable.

[B]

We'll see what they think about this one. All right. But anyway, the fact is, while I decided I wasn't going to do it, I did hear on another episode a listener asking, asking you, you know, writing in about how airlines could possibly measure the true profitability of the route system given all the moving parts. And I got to tell you, that was like music to my ears because I started my career long ago working on airline profitability systems. So this is one area where I actually can geek out.

[A]

Yeah.

[B]

And I'm not usually the airline geek, so I'll try not to geek out too much on this. But like I say, this, this I like the topic. I'm happy. I find it interesting myself. Hopefully our listeners will find it interesting as well. The fact is, route profitability is one of the most important pieces of information required to run an airline. If you don't know how your routes are performing financially, you're lost as A leadership team. So we airlines spend an incredible amount of time and effort ensuring the information is right and analyzing the results every month. And what I also find interesting about these reports is that in an industry where there's so much financial and operating data that's made public, much more than other businesses, by the way. Sure. Yeah. No one outside of the airline ever gets to see these critically important route profitability reports. They just, they don't get out. And that's because they're closely held secrets. This is important information and important enough that none of us ever once anyone else, any of our competitors to see it or indeed, you know, the markets themselves. So our listeners are gonna be happy to know that this class is gonna be much shorter than the price the pricing class was because we don't have to go back and review the history here. I learned most of what I'm going to talk about in the late 1980s, but it hadn't changed a whole lot since then. So I should make that caveat up front though. Well, I know the topic pretty well. My knowledge is dated and my memory is foggy and some specifics. So some of our listeners who do this stuff for a living may be able to correct me on some of the details, but I feel really confident that I'm still good on the concepts. Okay, so here we go. Similar rules as the last time. I'm going to do a poor job of pretending as though I'm pretending as though I'm teaching a class in airline route profitability 101. And you're going to do your best to pretend as though you're a student in this class. That means you have to, that means you have to pretend you're not as smart as you really are.

[A]

Oh, no, no. This is. Being dumb on this subject is, comes naturally to me. I know this is really complicated and I know I have no idea.

[B]

Okay. All right, well, we'll see. All right, we'll do your best not to, to at least pretend as though you're in 101.

[A]

Right.

[B]

All right, with those rules, let's call the class to order. So here we go. So let's start by talking about how most businesses go about reporting and analyzing segment financial results. And then we can, we can contrast that to the airline business. I think that's important.

[A]

Yeah.

[B]

So we won't spend a ton of time on this, hopefully. But let's, let's do a little role playing here. Let's suppose you're the owner of a retail chain called Scott Sneaks. Okay. You, Scott Sell high end tennis shoes for men.

[A]

And my slogan is good for the soul.

[B]

See, you're a natural. So, okay. Yes. And by the way, you're killing it. So you now have quickly expanded to 10 stores here in the Metroplex. So you want to assess how each individual store is doing as opposed to just knowing total. What's going on. So how would you go about allocating your company's total revenues and total cost amongst each of the 10 stores so that you can measure how profitable each one is individually?

[A]

Well, I should know the sales per store. Right. For each store. And I know what the costs are to operate each store. That doesn't take into account headquarters and all that. But I can look at each store or I guess, I don't know, would I look at it as revenue per transaction, revenue per sale.

[B]

And no, I'm just talking about just. You just want to get a. You want to take your profits and divide it up amongst these stores. Yeah, you have the answer. It's as simple as that, Right. It really is. Which is we're going to contrast. And I think that's what most people are used to when they talk about profitability and why our listener was thinking, how would I do that in an airline? Because in general, you know, in that situation, in that retail environment, you know exactly what the expenses are related to that store. Certainly the direct expenses, the employees, the employee cost, the employee benefits, all those types of things.

[A]

Yeah.

[B]

And you know exactly what revenues were collected in that store. So you attract the expenses from the revenues. You have this one issue which you, which you described, which is the overhead cost. So you, the CEO of this business, you, you know that, that you're going to allocate some of that to each of the stores.

[A]

Right.

[B]

But if, and you know, the limo you're taking to work because you're now a big shot. Oh, yeah, yeah, Things like that. But you know, a warehouse, if you have to have one, the rent on that warehouse, those things that they're not going to go away if that store goes away.

[A]

So yeah, the marketing costs. I signed Luka Domicik to be the Dallas store rep and he's gone.

[B]

Fair enough. So anyway, so my guess is you would have two measures. You'd say the fully allocated measure, but that measure has a problem in it and that some of the costs, the fixed costs, aren't going to go away. So you'd also look at a variable cost measure, variable profitability. And let's just say for the sake of argument that you're a pretty Efficient operator. So that's 5% of your cost or overhead. So you're going to get really close to these stores and you're going to be able to do it pretty fast with just your accounting guys giving you off the general ledger. Fair enough. That's how that works. That's how it works in almost all businesses around, around the world. Now let's think about how you do the same thing if you run an airline. So before we do that, first, just for definitional purposes, I'm going to be talking about a route, route profitability throughout this. A route, as I'm talking about right now, is a non stop city pair. So if I'm talking about the profitability of DFW to Panama City, Florida, for example, what I mean is the contribution of the three round trip flights per day that American flies between DFW and Panama City, I'll say ECP sometimes that's the city code for Panama City. So airline schedulers will obviously also look at this data by individual flight. But if we're talking about an individual store in our business and how it's doing, we're generally going to talk about how all the flights between those two cities are doing as a whole. Okay, okay. All right, so let's start with costs and then we'll go back to talking about how we allocate revenues. So as you might imagine, this is going to be a lot more complicated than Scott sneaks. Our store has different employees flying in and out of it every day. So there's no, there's no ledger that says, you know, here's what the ECP pilots made. And even the ground employees that work in ECP work flights to different markets like Charlotte.

[A]

Right.

[B]

So we can't charge all the wages and benefits of that airport to the ECP dfw. Frankly, there isn't really a single expense you can just pull off the general ledger and attribute to this store, to this ECP DFW store. So you've got to go through the expenses line by line. And each line gets allocated differently based on a lot of thought and analysis and data. I'm not going to totally geek out on you and go through every one, although I wouldn't mind doing it because it actually is fascinating. They're all different and different. It's the driver of the expense we end up allocating. We always talk about cost per ASM. Almost no costs are driven by ASMs. The only thing I think we actually allocate on ASMs is management costs. The real drivers of cost of Things depending on what it is, either departures or passengers board, depending on what the cost is. But anyway, we're not going to go through all those. We'll just pick one. And the one that's easy to pick is pilots. So if dfw, ECP is your store, how would you go about allocating the cost of all the pilots that flew this route over the course of one month?

[A]

I'd add up the hours because they get paid by. By the hour, right?

[B]

Whatever. Pilot flown hours, that's fine.

[A]

Well, yeah, pilot block hours. It's all right. It's always for. For each flight they get paid either whatever. It's higher of scheduled or actual. Right. Yeah, but so those block hours.

[B]

Yeah, I agree. Yeah, fair enough. So we're going to take. But which pilots are you going to do that with? Because some pilots, some pilots make more than others. You're gonna, you're gonna. You're gonna take the aircraft type, fleet cost, right? Well, no, you're. Yeah, buy aircraft again, this is.

[A]

Yeah, so if it's a 737.

[B]

Yes, exactly.

[A]

Officer.

[B]

Take a 737 fleet cost for the month divided by block hours. That gives you a number. Multiply it by the number of block hours flown that month. Dfwcp. That's it. You got it. Good job. All right. Now, every line of expense is going to go through a similar process with some of them being a lot more difficult than that, but with every time with a goal of accurately assigning all the costs incurred at the airline in that month across each of the 200,000 flights that were flown in that month. Yeah, exactly. In the case of American Airlines. And then interesting, though, I'll also note, the costs that we end up allocating are never going to equal the costs reported in the company P and L for the month, for the quarter or the month. And that's because accounting rules sometimes result in reported expenses that are different than the real economic cost. And what we're trying to do here is it's slight profitability. It's a management tool. It's not an accounting exercise. Yeah. So we want to allocate the economic cost, not the generally accepted accounting principles. Cost. The most notable of these adjustments, and the biggest one is aircraft ownership. You know, in. In the airline, P and L, aircraft ownership spread across aircraft rent. It's in depreciation and amortization. Some of it's an interest expense depending on how you finance the airplane.

[A]

Okay.

[B]

So. And depending on how you finance the aircraft, how the aircraft are financed, two Similar airplanes could have a very different expense trigger on the trail.

[A]

P and L. So right, different, same airplane, different age.

[B]

Right.

[A]

Could, could have completely different costs.

[B]

They could have the exact same airplanes that were manufactured 1, 1, 1 month after the other. And if one of them is, is on an operating lease and one of them is owned, they're going to have a really different cost on the P and L. Yeah. So you don't want to use the actual P and L cost. What you want to do is what, what should you do instead? How would you go about getting an economic cost into our flight profitability system for those airplanes?

[A]

Boy, I think you said 200,000 flights per month. I think I'd take the aircraft costs and divide it by the flight. You need the airplane for that flight or do you want to get finer than that about hours again?

[B]

Yeah, well, we got to get the right number. We just talked about the P and L doesn't have the right number in it. So. Yeah, so we make up a number. Okay, but we make up the right number.

[A]

Yeah.

[B]

So what we do instead is we say what's the market rate for that aircraft if I want to lease one from, if I want what's the, what's the lease rate cost of that airplane? And we're just going to put them all on operating leases basically and say if every one of my airplanes. Because that's the economic cost, if I want to get one more, it's, you know, it's. Again, that's what's, that's a proxy, a good proxy. Much better than the P and L for the economic cost. So we're going to take all the 737 Maxs. Go ask our team if we want to go get 737 maxes on a 20 year lease right now. What's the monthly lease rate? That's what our team plugs in as a cost of a 737 airplane for a month. And then you got to take that airplane, of course. And how many block hours does it produce in a month and put those onto this DFW ECP route.

[A]

So this is, this would mean that you could end up with a different profitability conclusion month to month, depending on what leaves. What leaves. The leasing market is.

[B]

Yeah, they generally don't change that much, but sure, yeah, but yeah, I mean you get, you get their profitability month to month because of fuel prices.

[A]

Yeah.

[B]

So anyways, again, just trying to point out that this is not some kind of oldest. We'll just wing it. People put a lot of thought into this, trying to figure out exactly how to do it. They don't tie it to the P and L. They're looking to show economic costs and get a real profitability of every route. It's not perfect, of course, because we don't have the right, you know, exact information by flight, but it's really, really well done. Okay, so we do that for every line. Now we've allocated the cost. Now let's talk about revenues. How should we allocate the revenue per flight? And I'll start with giving you some information. So let's just start with a single flight. Not a route. Not even. Not just one flight. So let's assume there's a flight today from DFW to Panama City. It's got 140 passengers on it, and on average, those customers paid $500 for their round trip itinerary. Okay with me.

[A]

Yeah.

[B]

So the people on board that airplane have now paid $70,000 in total for their travel.

[A]

Yeah.

[B]

How much revenue should we allocate to that flight?

[A]

So though, each of those tickets has a breakdown of if they're a connecting passenger, what they paid for the ECP leg and what they paid for the prior leg. Right.

[B]

Well, let's. Let's start with it. Fair enough. You're. You're.

[A]

I'm just thinking.

[B]

No, no.

[A]

All I know is ticket breakdown.

[B]

Yeah. Okay, well. Well, there's one. There's one big issue. I told you, it's round trip, and we only wanted to go one way.

[A]

Right.

[B]

Okay.

[A]

Right.

[B]

So we're gonna take 70, 000 divided in half.

[A]

Okay.

[B]

Okay. Everyone paid 500 for a round trip flight.

[A]

Yeah.

[B]

This is just one leg of a round trip flight. So we're already down to 35, 000. Okay, fair enough. Now. Now you're onto a more subtle but really important point, which is a lot of Those people paid $500 not just to fly from DFW to Panama City. They. They paid to fly from Kansas City or Sacramento or Tucson.

[A]

Sure.

[B]

And so therefore, they didn't pay $500 for just that leg. They paid 500 for two legs. Right. And we got to take care of that.

[A]

And we're going to look at the profitability of Tucson as well. So they got to get their fair share.

[B]

Yeah. So anyway, so you're right. So we got to take care of that problem. We'll try and make the math simple here as we can. So let's assume half the passenger. A pretty good proxy, by the way, For. For a US Hub, about Half the customers are connecting on.

[A]

Okay.

[B]

On many flights. So let's assume half those people connected.

[A]

Right.

[B]

And now what you'd really do is what, what the airlines do is they'll go look at. Okay, let's use Kansas City as an example. If someone's flying Kansas City DFW, DFW, ECP, they'll look at the average fair, MCI, DFW, the average fair, DFW, ECP over the month and they'll prorate that $500 based upon which. What those two fares were. So if it was. If.

[A]

Okay, all right.

[B]

We're not going to do that. We're just going to say that they were the same. Okay.

[A]

Right.

[B]

We'll split it in half.

[A]

If Kansas City.

[B]

Kansas City was twice as much. Right. They'll get twice as much of the 500 as ECP. Okay. As.

[A]

Yes. So half of the passengers, you get the full $250 for that leg.

[B]

Half of them. We're only going to get 125.

[A]

Yeah.

[B]

All right. Well done, student. So when you fight through that, that 35,000. Now we're, now we've just taken out rounded the nearest thousand, 9,000. All right, got a fourth of it. So now we're down 9,000. Now then there's another big piece of revenue that's not in passenger revenues that you talk about a lot on your show. Your pundits like to talk a lot about, about how airlines are living off of this revenue. What might that be?

[A]

Well, there are many buckets.

[B]

Okay, well, baggage fees, et cetera. Assume we took care of that in my 500. But you're right, we need to allocate those. Okay, there's a real large one.

[A]

Frequent fire revenue.

[B]

Credit card revenue. Credit card revenue, right, exactly. So that one's big enough that we need to talk about at least for. Even in this example. But you're right, baggage fees would always. Is a big number two. And that would. That's going to. All the ancillaries are going to get allocated actually. Based upon what? On some real data. But anyway. But the big one that I find that we should at least talk about more because I think it's really interesting is the credit card revenues. Now, the fact of the matter is it's not in passenger revenues, but it should be. That's what it is. It's. This is just a distribution system for seats. What's happening is the bank is paying American Airlines to give seats to the bank's customers right there. It's just a distribution system so, so,

[A]

so are you talking about allocating the, the passenger who's on a award ticket or are you talking about in general, the credit card dollars from Citibank? Because I bought my groceries there.

[B]

Absolutely. I'm talking about the $6 billion that comes into American Airlines every year. Yeah, from Citibank.

[A]

Okay.

[B]

A direct payment. Yeah, from Citibank to American Airlines. Yeah, because buying points so they can distribute them to their customers, so their customers can then use them to buy fares. That's what's happening.

[A]

Okay.

[B]

Pure and simple. It's a distribution system that doesn't end up in passenger revenues and it should. So we got to put that in, in this example because it's big enough, we should, we should talk about it. So, and the way you do it is where I think you were getting, the way the airlines will do this is they'll go look at which routes are we, which routes get the most redemptions of miles. So we got to allocate that $6 billion. We're going to allocate it based upon, you know, how many, which, which routes people use their miles on because that's where they're taking up the seats. And that if we didn't give that route that money, they'd be unfairly penalized. So routes like Hawaii would look much worse than they really are because we're getting paid to put those people on flights to Hawaii. Right. And we've got to give that money to Hawaii, not to Des Moines. So anyway, so that's what, so and again, for our example, we're just going to assume Panama City's, it's a leisure market. They probably have some reasonable amount of redemption. People wanted to go there. So we're gonna assume it's kind of the average. The average is a little more than 10% of revenues. If American, if I'm right about America being at 6 billion, they're a 50 billion dollar airline. A little more than 10%. We're gonna add 10% in our example. Okay. Okay. So we'll add 10% of 35, 000. That's 3500 more. Now rounding all this again, we're now at, we took out 9,000 and now we're adding back 4,000. We're at $30,000 of onboard revenue. You with me?

[A]

Okay.

[B]

Yeah. Okay.

[A]

Yeah.

[B]

So that's, so that's, that's what we end up with and we end up with on that flight, that $30,000. I don't know what those fully allocated costs are going to end up to, but I think they're going to be really close to that just based on what I think about a route like this. And at $100, at $100 barrel oil, it's definitely going to be higher.

[A]

Yeah.

[B]

The expenses are going to be higher.

[A]

The definition of a low margin business.

[B]

Exactly. So this individual flight is going to show up on a report as break even to slightly negative on a fully allocated basis. And we'll refer to that as fact. Fully allocated contribution. Right. That's a term that.

[A]

Okay.

[B]

Anyway, I'm used to using all airlines use different acronyms now. But that's what I remember calling it. So that's the fact. Profitability. Now we fought through all that to get to this point. We got a fully allocated profit just like we had for Scott Sneaks.

[A]

Yeah.

[B]

And what I'm going to tell you is here's the rub. The fully allocated profit number for an individual flight or for a route is almost meaningless. I would never look at that. We worked hard. I know. But it's got to be your base point. But I would never look at that number for any decision about increasing or decreasing service on a route. And why do you think that would be? What's wrong with looking at an individual route on a back basis?

[A]

Because it's a big network. It's just one little piece of the network.

[B]

Fair enough. That's right. And how that manifests itself is you're not giving that route. The benefit of the contribution is given to the whole network. That's beyond revenues. When we took those beyond revenues out.

[A]

Right.

[B]

We, we took out the network effect of that route being in place. If, if somebody wasn't able to fly. If we didn't fly to ecp, we wouldn't have gotten that Sacramento to Kansas to, to ECP person. Because we don't have that route. So. Yeah. Although.

[A]

But that's tricky because then that, that flight to Kansas City might have gotten somebody from somewhere else if you didn't have the ECP.

[B]

Okay. You're already moving up to 202. We're coming. It's coming. No, you're right. This is good.

[A]

Yeah.

[B]

You get exactly. That's the real. That's, that's what we'll go through. So. But, but nonetheless you're. What you said is exactly right. The problem with looking at an individual. Right. Enough on a fact basis. There are two problems, one of which we already discussed with Scott Sneaks. There are a lot of fixed costs. Yeah. In that number. So we know that we have that problem.

[A]

Yeah.

[B]

And we have this Other problem, which is the network impact. So we got, we got it. We got to correct for both of those. On the revenue front, we just add back all this beyond revenue that we deducted. If you remember, that was $9,000 we took out of beyond revenue. We just add all that back. Okay, but that's too much. Do you know why that is?

[A]

Well, now you, you're counting more revenue than you actually pocketed.

[B]

No, forget the double counting point. We'll get to that. Okay, but it's just, it's too much even double counting. If I add back that 9,000, I've given too much credit to this route.

[A]

Oh. Because I'm taking up a seat from somewhere else.

[B]

Thank you. Because there's, there's displacement or spill. So that ECP to DFW beyond revenue is taking, displacing some other revenue we could have sold. So if One of those $500 round trip passengers is flying Sacramento DFW ECB, by selling that ticket to them, we lose a seat on Sacramento DFW that we perhaps.

[A]

Perhaps, maybe, maybe not.

[B]

Exactly. Here comes the analysis that perhaps could have sold another customer. We call that spill, which is revenue that we could not collect because we were full or nearly full on the flight already. And this spill or displacement is calculated through some really sophisticated analytical means. People don't just wing this. In my day, we had these things called spill tables that would tell the model how much to deduct based on the probability of displacement given the average load factors in that market, in that Sacramento DFW market and the incremental, the incremental fare levels, because that's what you're going to sell the next, the lowest ticket still to sell, the incremental fare levels of every single route for the month. Now, I imagine since my time there's something even more precise in the coding, but the concept is the same. You have to account for the revenue or connecting passengers displaced on the portion of the itinerary that wasn't in the DFW ECP leg. All right, So I don't know how much the model is going to tell us to take out for spill, But I think $2,000 is probably a reasonable guess and it keeps the math easier, so we'll just use that. So we're not going to add back 9,000. We're going to add back 7,000. Now we're at 37,000 instead of the 30,000 we had in the fully allocated calculation. Okay. Right. It's a big difference. We just added over 20% to the revenues of this flight to the contribution of this flight. And we call this revenue metric is called onboard revenue plus beyond net of spill. Okay, you with me? All right, so this. Now that I want to get to where you started because I have had board members and some airline management people get quite troubled about the use of this measure.

[A]

Yeah.

[B]

And I'm guessing some of our listeners may be already. Because if you're, you know, a purebred accountant, this is really disturbing. What they object to is that we've double counted a lot of the revenue. Just like you said, we most definitely have the $500 paid by that customer flying Sacramento DFW Panama City is now going to get credit net a spill. It's going to get credited to both the Sacramento DFW route and the DFW Panama City route.

[A]

This is what you said about GAP accounting.

[B]

Exactly. But look, that's the true network impact and it's the right way to analyze the contribution of that ECP DFW route to the airline. Because if we cancel Dallas Panama City, we're going to lose all of that $500 of the customer's money, not just the prorated amount of $250. And if we ignore that fact in a hub and spoke airline, we can make some really bad decisions. Some routes live off the beyond revenue they create and they should get credit for that, for that creation. I mean, just this is not a real example, but it can be certainly at times. Think of a market like Midland Odessa, which, you know, short haul route to DFW Southwest is in the market. The local fares are going to be low.

[A]

Yeah.

[B]

But Midland USA also has a lot of oil business and there may be a lot of international travel going in and all of that or much of that is going to flow over Dallas on American. And if all you gave Midland Odessa credit for was their onboard revenue, someone would look at it and think, this route, this route's terrible. We gotta get rid of it. What's wrong?

[A]

Right.

[B]

And in reality, it's contributing enormous amount to the airline. In this example, I don't want to pick on Middle east, it's true. But Roth like this exists certainly from time to time. And you have to look at the full impact on the network before you start messing with routes, particularly in a hub and spoke.

[A]

And in that example, you could see how middle and middle and ought to get credit for some of the business class fare to London that that banker got.

[B]

Right, Exactly. And that's what this does.

[A]

Yeah.

[B]

And yeah, now London DFW is going to get credit for it too. So we have this double county problem, no doubt about it. But if you don't do that, you're going to make some really bad decisions. Okay.

[A]

So I was thinking this really gets more and more hypothetical, but it really doesn't. Right.

[B]

I think it's more real. Yeah, I really do. Again, it takes a while to get your head around this, but once you do, it's more real. So. And again, we'll talk about how you know people anyway. We'll talk about what that means. You can't just go look at zero profitability as the test anymore. It's gotta be something higher than that. Yeah. Okay. So on the cost front, we have the same issue we have with Scott Shops. Some expenses are almost entirely affixed. So we can't assume they're gonna go away. When any individual route goes away for an airline. This includes things like corporate overhead, of course IT development costs which, which are getting bigger and bigger all the time. Non aircraft interest expense. These things can add up to nearly 10% of expenses, particularly since it development costs are growing at every airline. So when we take that out, we call it, just like we did at Scott Shops, we call it the variable contribution, the variable cost contribution. And it results in a better, more accurate picture of what our individual store here is contributing. But unlike Scott Shops, we got another one. Another more significant. It's another significant adjustment to consider to make sure we are really only counting variable costs. Care to guess as to what that adjustment we still need to make is?

[A]

Have we, have we added in the aircraft costs?

[B]

Yeah, the aircraft costs are in this number.

[A]

Okay.

[B]

So. Yeah, all right, you got it. That's right. We. Aircraft costs are in this example view, they're not overhead, they're not anything like that. They're real. They're real cost. So in, in a real, in a, in a, in a normal world, you'd like to say, oh yeah, if, if we get rid of a route, we're getting rid of an airplane and there's. It's variable by the way. I can see you thinking already. Things like pilot costs you can say are fixed but they're not right. If over time, in a short period of time, you can get pilot cost down, pilots retire, we have slow hiring. You can give leaves of people that paid leave people will take. You can manage all the employee cost in a variable basis if you choose to downsize.

[A]

Right.

[B]

But airline, assuming you're going to get out of airplanes is aggressive to say the least because aircraft ownership is almost never really Variable. Airlines like to talk about how they built flexibility into their fleet planning by having a lot of aircraft come off lease each year or how they have a bunch of owned airplanes they can sell themselves a downturn. But if you've noticed, that never happens. And it doesn't happen because one, it's really difficult to return a leased aircraft without planning for that return several months to a year in advance.

[A]

Well, look at Spirit. They had to go to bankruptcy court to do it.

[B]

Yeah, precisely.

[A]

Yeah.

[B]

And two, it's really hard to sell used aircraft in a downturn. So, you know, you can have a lot of used aircraft, but you're not going to be selling them in a downturn. You're going to be fine. So when airlines do reduce capacity or slow capacity growth in a downturn, it's almost always through lower aircraft utilization, not through reduction in airplanes.

[A]

But that raises your cost. That's what we've seen lately at Frontier. They're down to eight hours a day or the aircraft, the costs go up.

[B]

It raises your cost per asm.

[A]

Right.

[B]

It doesn't raise your. My point is those costs are fixed.

[A]

Yeah.

[B]

And because they're fixed. Yeah. You may use the aircraft less because demand's down, but you're not going to return. You're not going to put the aircraft on the ground. Yeah. So. And that's because fleet pans are pretty static for two to three years out. So assuming the ownership expense is going to go away just because we have an aircraft owned, profitable flying is really aggressive and it's a material number. Aircraft ownership costs around about 15% of total cost. So we've already taken out 10% of overhead. Now we got 15%. Now we've reduced our cost by 25%. So this final metric, the one that assumes aircraft ownership to be fixed, is what I always look at and analyze in the variability route, because I think aircraft ownership costs are almost entirely fixed. Now, every airline has different acronyms for these measures and American, I know, has changed theirs from what I grew up with. But I still remember that metric from my past as vabso, which I'm just going to tell you because I'll end up saying it. VABSO is variable allocated cost. So we've taken out all the fixed costs. Okay. Plus beyond revenues. That's the B. Net of spill. That's. Yes. But then net of ownership costs, too. We add back ownership costs and they're, you know, you'll see VAC for variable, you'll see VAB for add to beyond. Anyway, but vabso is the number that we've now gotten to. I've added back the beyond revenue. I've spilled it. I've taken out the fixed cost, but I've also taken out ownership costs. So now if you think about what we've done versus when we had the fact number, which was break even to a small loss, we've added 20% of the revenues by including beyond contribution and we've reduced our expenses by somewhere around 25% by eliminating all the fixed costs, including aircraft ownership.

[A]

All right, ECP's doing better.

[B]

Precisely. Any route flying into hub is going to be nicely profitable as measures. Now, I'm sure a lot of listeners are thinking, well, what's the point of measuring individual route profitability if every route shows up with a nice profit contribution?

[A]

Well, don't you want to compare cities?

[B]

Thank you. Exactly. And that's my answer. First and foremost, it's the right analysis. VABSO does reflect the contribution that each individual routes making to the system. And that's why you never see an airline significantly reduce capacity in an economic downturn. Putting the aircraft on the ground would dramatically reduce their earnings and their cash flow, not improve them. Now, obviously, situations like Covid where there is no revenue, sure, that's a different story. But I'm talking about, you know, I'm talking about, you know, Great Recession. You didn't see anybody grounding airplanes. I'm talking about economic downturns. You just won't see this because of this reason. This is why. Because it would actually reduce the airline's cash flow and earnings. Now, I'll tell you, I've had to explain this. We aren't going to cut capacity in response to an economic downturn or a fuel spark spike argument to a lot of really smart, sure. Successful and skeptical board members over the years because they're all used to manufacturing or consumer products or retail businesses. By the way, I want to go

[A]

back to selling sneakers.

[B]

Yeah, exactly, exactly. And, but they're used to, okay, if we had a down. And they're also not used to the kind of downturns we see in a single business. So they're just kind of stunned when we say, oh gosh, our revenues are suddenly, look, they're going to be down 5%, but we can't get 5%. We can't begin to get 5% of our costs out. And what are we going to do? We're going to do everything we can, but we're probably going to lose 5% of our earnings because I mean, 5% of our revenues and keep our costs the same because we can't do much. And that's frustrating to people in other businesses because they're used to in these kind of downturns, they quickly respond. They'd shut down a plant, slow production rates, close some stores like we would in Scott sneaks to improve cash flow. So it takes them a while to understand that that's not the right answer in our business. And it's not just the relatively high fixed costs. They get that. It's the network, the huge network impact on revenues, particularly for hub and spoke carriers, that is really hard to understand. But anyway, they understand it. Eventually we get through it. But anyway, I'm just pointing out that this is. If people listening are thinking this sounds nuts, they're not alone. People in other businesses think the same thing. But I. I will tell you this is the right way to analyze these routes. And it's why you see the behavior. You see so and here's why. Because focusing on vavso, focusing on tells our scheduling and revenue management teams what we want to tell them. And that is given this fleet of airplanes that you have at your disposal, go maximize the contribution they can produce as a system. And that's what they go do. That's their job. Not to try and worry about the, you know, getting out of airplanes because they can not try and worry about overhead. Go maximize variable plus beyond net a spill, less ownership.

[A]

So is there a VABSO equivalent for a new city you got to make assumptions about?

[B]

Oh, when we start new cities.

[A]

Yeah. Okay. Panama City's not doing so well. Maybe we should start Jacksonville or something. You know, whatever.

[B]

Absolutely. Absolutely. Indeed. That's where. That's where things like these spill we have. There are a group of animals that are looking at new routes all the time. Sure. Primarily international because that's where you really use a lot of assets domestically. I think our team knows pretty well what's going to happen exactly as they add a certain route. But nonetheless, yes, that's. We look at the same exact numbers as we start routes. So anyway. But just because every route happens to have a positive margin doesn't mean we're maximizing the value by any means. And I can't remember the exact babzone margin we would consider adequate because it kind of moves around as economic conditions move. But in general, I recall it being in the 30 or 35% range. You need to have a 30, 35% Babso margin to feel good about those routes. And when individual routes fall below those levels, our team knew we had better alternatives for our existing fleet that hadn't been tapped, so we'd reallocate flying accordingly. Another thing that happens when you focus on the right metric, it makes it easier to see trends in the things that really matter to the network. So we, as you kind of already noted, we'd focus as much on relative performance or on year over year changes or month to month changes in route profitability as we would on the absolute level.

[A]

Sure.

[B]

It always struck me, for example, how much change in a competing service could have on our routes. BABSO performance, that is, you know, Delta adds one flight in the market that we were in, you know, just, you can just see it, the change in that month. Yeah, quickly.

[A]

Interesting.

[B]

And so I got a lot of my best real understanding of what other airlines were doing with their schedules and how we should be thinking about the future by looking at monthly changes in our own individual BABSO routes. And some of that stuff gets hidden if you start using FAQ or if you're not paying attention. And then one last point I want to make is that airlines do, and this will give people some comfort, we do indeed look at fact for two levels of the route network. First, of course, for the entirety of

[A]

the airline, in fact, fully allocated, I'm

[B]

sorry, fully allocated contribution, just the revenues and all the expenses. And for the entire airline. If all those VABSO contributions don't result in an airline that's fully allocated profitable, it obviously isn't working in total. And you got an issue. Airlines also look at fact for each hub because at the hub level you obviously don't have any beyond revenue to add because all the connecting activity is contained within that hub. And the thought is if you did something as big as closing an entire hub, you really could get a lot of the otherwise fixed cost down. Now the reality is there's no way that's true on the fixed cost piece. And doing something as enormous as closing a hub would be almost certainly cash negative and NPV negative, both because of the fixed cost problem and the impact it would have on revenues throughout the whole system. But we always strive to have each hub be fact positive on a standalone basis. We would look at fact as the measure of the hub's profitability in every month. So we certainly do use it, but it's not the right, it's not the right measure for the stores. It's only the right measure at a very high level hub or the airline.

[A]

Would you manage it by saying, hey, we, we need to run more people over? I Don't know, Salt Lake City and, or, you know, you could

[B]

again, the team's doing that through other, through other tools that they see that they, but yeah, yeah, you could get there. But yeah, for the most part it's not, oh, the customer is going to go where the customer wants to go and where the, where the most efficient routing is.

[A]

Yeah.

[B]

And if we start trying to mess around and say let's, let's kind of suppress Dallas on, on, on, you know, Panama City to, to Sacramento and let's try and force him over Chicago where he's going to lose them to somebody who's got an efficient routing. So yeah, very little, it's hard to do anything like that. But yeah, anyway, so that's it. So to our, to our list, to our listener question on how airlines analyze probability by route or hub, my short answer is it's complicated, but it's really important management information. So airline teams spend an enormous amount of time ensuring they're both organizing the data properly and analyzing it intelligently. And it's one of the many things that make our industry unique and therefore it's fun for people like me to talk about.

[A]

Yeah, no, well, I think it's one of the, over time, one of the changes in the industry. Right. I mean, I remember Gordon Bethune talking about when he, when he got into Continental and say, you know, why are we flying that we're losing money. And somebody would say, well, we got it. We got to do Kansas City because it's strategic. And he said it's our strategy to lose money.

[B]

Right.

[A]

I mean, we're not going to do it if we lose the money.

[B]

Precisely. And we, there's people out, they would call them development routes. Yeah, yeah. And on this, back on this frequent flyer point, I remember vividly early American talking about, oh, we fly to Hawaii even though it loses money because that's where people redeem their advantage miles.

[A]

Yeah.

[B]

To which I would think, well, why are we doing that? They're going to redeem them somewhere. Or if you really want to do it that way, it's got to come from some other route. This is a zero sum game. If they're, if they're redeeming their miles there, somebody else is getting revenue they shouldn't have gotten where they earn their miles and we should give that revenue to Hawaii. But it shouldn't be nothing. Now it's much easier because the banks are paying and you used to allocate that to where the redemption is. So. Yeah, so we've learned a lot through all this. But yeah, if routes are losing money, they get cut these days. It's a whole different world than it used to be.

[A]

So is this something that AI is going to change?

[B]

Hey, I could probably do it maybe faster, but I don't. Again, this is everything I've described is not done manually, by the way. This is all now done.

[A]

No, but there are, there are, there's a lot of thinking that goes into it.

[B]

Yeah. Yeah.

[A]

Interesting.

[B]

I don't know. Yeah, my guess is yes. And what could, what could really help is, is doing, I think probably some competitive analysis, which is hard to do because you don't have. There's a lot of competitive information available, but not all the stuff you need to do this really well.

[A]

So, professor, thank you. That was, that was most enlightening. Really was very interesting. All right, thanks, Doug. Before we get to the mailbag, I want to thank RTX for its longtime sponsorship of Airlines Confidential. RTX rallies more than 180,000 innovators around a powerful vision to create a safer, more connected world. With industry leading tools and technology, the RTX Global team works across market leading businesses Collins Aerospace, Pratt Whitney and Raytheon to drive progress for generations to come together. RTX pushes the boundaries of known science and finds new ways to connect and protect our world. Visit rtx.com to learn more. And we want to thank Infinity Flight Academy, the leader in cadet academy training programs, for helping us bring the podcast to you. Whether you're looking to build a custom pipeline or strengthen your existing cadet program, Infinity Flight Academy delivers consistent airline ready results. And for those of you listening who've always dreamed of flying or know someone who has, Infinity Flight has trained thousands of students, many now flying from major airlines around the world. Learn [e-mail] Infinity Flight Academy, where future airline pilots take off. Promotional support provided by the ultimate AvGeek website, theairxiv.net, a vast collection of airline memorabilia, timetables, route maps, rare cabin and airport photos, special flights and more, [e-mail],

[B]

the hub of air transport history. Okay, hang on everybody, because in the mailbag we got one that I think is gonna really set our leader Scott off. So here we go. Adam from Texas writes. Hello, Scott. So it starts nice. I listen to your show every week and have commented to you in the past about various topics with positivity. However, this time won't be that, uh. Oh yeah, you've said multiple times on your show, general and corporate aviation doesn't pay its fair share. As an Airline, corporate and general aviation pilot. I highly all caps highly disagree with this sentence. Jet fuel for non commercial use is taxed at 20 to 1.9 cents a gallon. Airlines pay 4.4 cents a gallon. That's almost five times more with general aviation using less infrastructure besides ATC that requires less money from the ticket taxes airlines pay. I'd say that is a fair share. Someone could write a thesis for a doctorate with the topic of fair share in aviation and I bet it would come out to surprise you. It is fair. Please do some research on this before using this platform to make a statement as bold as what is fair and not fair. I love listening and will continue to do so. Keep up the good work.

[A]

Okay. The steam is coming out of my ears.

[B]

Thanks for that is a nice note. Yes, it's his view. It's strongly help you.

[A]

No, I'm really and I'm really glad he asked because I think this is an important topic. Important for the country. We got some issues we got to settle and this is a really crucial issue. So yes, I did some research at Adam's suggestion. I've done this before, but did it again for this and I'm afraid, Adam, it's going to make my statements even bolder.

[B]

Oh great.

[A]

Okay, first, let's separate general aviation from corporate aviation. I've been specific about business jets, right? This is not Cirrus SR22S or Cessna 172S. Because it's the business jet lobby that has effectively scuttled every attempt to separate air traffic control into a more independent entity. And because business jets very much use the same or close to an amount of air traffic control services as larger jets do. Airports get funding in many ways. Yes. Landing fees levied by weight usually, but also passenger facility charges, concession revenue, parking. Airlines generally pay for the terminals they use based on fuel taxes and landing fees and fixed base operator FBO use rather than terminals, Corporate aviation may well pay its fair share for airport use. That's not where the argument is. The argument is about air traffic control because that's what we're talking about in terms of modernization and most importantly, funding that modernization. There A corporate jet uses much the same service even if it's not talking to a big city control tower. The business jet files a flight plan just like an airline flight. It talks to departure control and uses en route airspace at the same altitudes and spacing as airline flights. It gets sequenced with airline flights in congested airspace, most often talking to a TRACON just like an airline flight. So in terms of air traffic control, the issue at hand, a corporate jet uses close to the same services as an airline flight. So what do they pay? I've got two scenarios what I think are representative scenarios. I looked it up. The most commonly used business jet in the US is the Cessna Citation XL and it burns about 250 gallons of jet fuel per hour. Let's compare a two hour trip. On the airline side, let's use a 737800 with 150 people on board. Not quite a full load, but close to it. As Adam said, the non commercial business jet flight pays federal fuel tax of 21.9 cents a gallon. And that's a total of about $110 for the two hour flight. In terms of fuel tax, the airline pays only 4.4 cents federal fuel tax. 737800 burns about 850 gallons an hour. So only about $75 in federal fuel tax with me.

[B]

Yep.

[A]

But the airline flight also pays federal ticket tax into the trust fund. That's 7.5% of each passenger's fare plus a segment fee of $5.30 per passenger. So let's say the fare is $100 for the two hour flight. We're only comparing one way, but let's make it cheap so we are not skewing the comparison. That means the passengers on the flight paid $1,920 in federal excise tax for the trust fund. Together, the airline flight Contributed just under $2,000. 1995. The corporate flight only $110. Does that sound like fair share? Let's look at a longer flight, five hours. We'll compare a G5, a Gulfstream 5, which burns about 450 gallons an hour with a 737 Max 8, which burns about 750 gallons an hour. 100 gallons an hour less than the 800, by the way. Shows you the benefit of the max. You've got a corporate aircraft that needs more fuel and an airliner that burns actually less fuel than the predecessor model that we were comparing before.

[B]

Okay.

[A]

Fuel tax for the G5 is about $493 and for the Max 8, only $165. But you get those 150 passengers on the Max 8. And since it's basically a Transcon flag flight, five hours, let's say the fare for that leg is $150. Cheap, but we're going to keep it cheap for the comparison. Total $2,648 for the airline flight, $493 for the business flight. Again, five times as much for the airline flight. So, Adam, when you note that non commercial corporate flight pays five times the fuel tax, you're not given the fair share of the tax. In the first scenario, the airline flight paid 18 times as much as the business jet. In the second, it's the airline flight that pays five times as much. Not to get too far into the tax weeds, but I think it's worth noting that there is a federal excise tax that could be applied to private jet flights. But nbaa, the National Business Aircraft association, successfully lobbied to exempt aircraft management companies and aircraft owners, including trusts, which many corporate aircraft are owned by trusts, to exempt all that from the federal excise tax. NBAA brags about this on its website. Aircraft owners qualify for the tax exemption regardless of whether they conduct FL flights under Part 91 Private Aviation Rules or Part 135 Charter Rules. And you know, they qualify for the exemption because they pay the higher non commercial fuel tax. They, they gladly pay it because it's much, much lower than paying the excise tax as the rest of us do. And by the way, you don't really need to do this research. Know the answer to the fair share question. If private jets were paying their fair share, NBAA wouldn't lobby so hard to keep the current system in place. Heck, if they were paying their fair share, private jet owners and their passengers would be demanding better air traffic control service along with the rest of us. The current system gives them virtually a free ride in terms of air traffic control, and that's just wrong. So not to go all Bernie Sanders on you, Doug, but the NBA has tremendous clout in Washington because the people who ride business jets are big donors to politicians. And can history shows, kill initiatives on this issue because they're afraid that if they had to pay for the airspace they use, they'd pay more. They can afford it, as the numbers show. Fair share would mean another a couple thousand dollars per flight at most. But the history has been that air travel in this country has suffered because they aren't willing to pay their fair share.

[B]

Bravo. Bravo. Well done. Look, I don't have. I have nothing to add to that other than to tell you that I was heavily involved in our efforts back in 2016 to get the, the ATC system to be, to be under a much better governance system, and it failed, even with the Republican Congress and administration. Yeah, and we thought we got pretty

[A]

close to the controllers union.

[B]

Yeah, I know. And anyway, yeah. And this was a big part of the Issue. It wasn't all the issue. And the other thing I'd say is, as much as the equity issue is troubling, there's so much value in ATC being reformed that we, the airlines were willing to say, okay, forget it. Just you guys just stay where you are. It was hard to do. It's impossible to do, actually. But we were going to try and figure out a way where everyone was paying about the same. Certainly for general aviation. We made a commitment. So whatever your total payment is, we're going to figure out a way you keep your total payments the same. Yeah, it's much harder for, for the people you're talking about here. And I agree they rightfully should pay, but as you know, that's not the biggest issue. So we need to figure out a way around this. People shouldn't be fighting it. For goodness sakes. It's a national issue. And I appreciate your efforts to continue fighting for.

[A]

Yeah, no, and I would love to see the issue come out. I mean, I think there were. Michael Huerta last week raised a lot of issues with commercial space flights. And what are we going to do about electric vehicles which don't pay a fuel tax? You know, how are they going to pay for their air traffic control services? I would love to see, to see a comprehensive, you know, new system of payment into the trust fund. And more importantly, I'd love to see that money actually get used for air traffic control modernization rather than sit there.

[B]

Yep. I'll tell you that no one running a business would do it this way, that's for certain. And you'd adapt. As things like space becomes an issue, you would change the formula. Yeah. There are inequities. You'd work to fix them, at least over time. No one, no one in their right mind would set up a business this way. And the fact is, air traffic control as a business is really important to business. We're not talking about the safety portion here. No one's talking about taking FAA and making. Privatizing it. We're talking about the air traffic control system and again, and just making it run like a business, because that's what it is and it's really important to commerce in the United States. So that's the way I was thinking about. It's like no one in their right mind as a CEO of a company would set up, would tolerate the structure.

[A]

Yeah, yeah, absolutely. Great point. All right, well, that's all for another edition of Airlines Confidential. I'll be back next week with Charles Duncan in a chat with Robin Hayes, the CEO of Airbus in the US Doug, thank you so much. This has been really grand and I as a student certainly learned a lot. I hope the listeners did as well.

[B]

Great. I enjoyed it, Scott. Hope everybody else did too. Thanks for your time.

[A]

So long.

[B]

Bye. This podcast is produced by mass media infomassmedia.net.