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University of Groningen
Technology Operations and Management
Master’s Thesis
Written by: Barran Haunan Supervisor: dr. N.B. Szirbik Co-assesor: dr. ir. D.J. van der Zee
March 2, 2021
Aviation in a Pandemic:
1 Contents Abstract ... 2 1. Introduction ... 3 2. Theoretical background ... 8 2.1 Revenue Framework ... 9 2.2 Cost Framework ... 10
2.3 Revenue and Cost Conditions during the Pandemic ... 11
3. Methodology ... 14
3.1 Selecting case study as the main research design ... 14
3.2 Design Science Research ... 15
3.3 Subject Selection: Garuda Indonesia ... 16
3.4 Data collection and Instruments ... 17
3.5 Data Analysis ... 18
4. Analysis and Findings ... 21
4.1 Interview ... 25
4.2 Expansion of the functional architecture ... 29
4.3.1 Medium term profitability decisions ... 33
4.3.2 Long term profitability decisions ... 35
4.3.3 Critical aspect derived from interview ... 38
5.3.4 Critical aspect derived from functional architecture... 38
5. Discussion... 39
6. Conclusions, limitations of this research, future work ... 41
References ... 43
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Abstract
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1. Introduction
The year 2020 has the seen the world been struck by the COVID-19 pandemic or better known as the coronavirus. The virus which originated from Wuhan, China has spread across the world causing widespread panic among the countries of the world as the new disease took its toll on the world population and with the lack of an effective vaccine. As a result, many countries have imposed strict policies in order curb the spread of the virus, such as mandatory mask wearing, maintaining physical distancing and limiting the number of people in public spaces. A lot of countries have also enacted lockdown protocols with restaurants and bars, shops, schools and gyms closed, and its citizens required, or at least strongly encouraged, to stay home to avoid catching or spreading COVID-19.
With such strict restrictions on movements, many economic sectors have been hit due to the reduction of economic activity. One such sectors is the aviation industry, with an estimated loss of $113 billion according to the International Air Transport Association (IATA) [2]. A large factor in this loss is due to the drop the number of passengers utilizing air travel worldwide, partly due to the lockdown and partly due the loss of confidence of people using air travel, which impacted on the passenger numbers and passenger revenues for airlines worldwide as seen in Fig 1 below.
4 Furthermore, due to the strict COVID protocol governments have enacted all over the world in order to combat the virus, airline has to follow additional procedures in order to be able to carry passengers, such as physical distancing between passengers inside the cabin. This effectively reduces the number of passengers an aircraft can carry as not all of the seats can be occupied which in turn reduces the ticketing revenue for airlines even further, a condition which was explained by the CEO of Qatar Airways, Akbar Al Baker [20].
“After this pandemic, and the usefulness of doing conference calls, video calls, working from home, this will reduce business traffic which is really the bread and butter of our industry.”
“One thing I can tell you, you will pay more to travel. How much more depends on what the government regulation says on the number of passengers I can put in my airplanes”
As the demand for air travel sharply decreased as countries began to close their borders and revenue loss increased from the lack of passengers, many airlines are forced to ground their fleet. With an estimated 62% of the world’s planes being grounded, accounting for more than 16,000 aircraft [3]. The sudden surge of such large-scale grounding of aircrafts brings its own challenges to airlines, as aircrafts needs plenty of work and attention while in storage, from maintenance of hydraulics and flight-control systems to protection from the various external causes such insects, wildlife, weather and etc. The maintenance not only for the exterior but up to the interior of the aircraft.Then there’s humidity, which can corrode parts and damage interiors. Even for the aircrafts that are being parked, it has to be loaded with enough fuel to keep them stable from rocking due the wind as well as to ensure the fuel tanks are well lubricated, a situation quoted by Anand Bhaskar, chief executive officer of New Delhi-based Air Works, a plane repair and maintenance company as a “logistical nightmare’[3].
5 Another glimpse of the situation is given by Ton Dortmans, KLM head of engineering and maintenance, where the airline has grounded 166 out of 204 aircraft in its fleet [11].
“Every seven days, someone would climb into the plane and run the engines for 15 minutes to keep them functional. The air conditioning was switched on to keep the humidity at bay. “And the tyres – well, it’s the same as a car. If you keep a car parked for more than a month, you get flat tires,” Dortmans said.” So, a tug pulled the plane forward and back every month, to keep the wheels and axles in shape.”
The grounding of the fleet for most airlines also meant a lot of pilots have also been
grounded, with many have not been inside the cockpit of an actual aircraft for months. This is a problem for airlines since byregulation a pilot must comply with certain qualifications in order to maintain their pilot license, which involves flying a minimum number of hours and perform three take-offs and three landings every 90 days to stay “current” – to still be
allowed to pilot a plane [11].This is to be proven difficult for pilots, as while it is possible for pilots to maintain their license from the use of a flight simulator, it is currently difficult for pilots to access the simulators due to the lockdowns. Furthermore, even when there is a revival in scheduled flights, the pilots, just like the airplanes, cannot be directly assigned to an aircraft, as they would have to relearn their skills, renew their licenses and be qualified again, a process that can drag on for some months [4].
The pandemic itself also brought attention to cleanliness in aircrafts, with the nature of the virus stressing the importance of good hygiene and being sanitized. Aircraft cleaning has always been part of maintenance for an airline to ensure that the aircraft is in perfect working condition, however with the arrival of COVID-19 this procedure has come into the spotlight. IATA themselves has released a 27-page long publication for the procedure of disinfecting an aircraft, with the aim of not only laying down a standardized procedure to ensure cleanliness during the pandemic period but also reassure passengers in the safety of air travel in COVID times and reinstall consumer confidence [5].
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in air traffic [6], Singapore airlines meanwhile has proposed a novel idea the to turn it’s A380 superjumbo into restaurants which offers people to dine inside from a cost of 37$ up to 440$, depending on the class [7]. Thai Airways is another airline that has come up with a novel idea to come up with another revenue stream during this period, where it offers handbags, pencil cases and tote bags fashioned from recycled life jackets and rafts [8].
Airline also turned to cargo only flights and so called “preighter” operations, where cargo is transported in a passenger aircraft utilizing both the cargo hold and passenger cabin to carry cargo of various types, such as COVID-19 PPE equipment to the doses of vaccine bound for many countries. Airlines such as emirates have begun to setup specialized facilities in order to manage, distribute and transport these vaccines more efficiently [28].
Despite the gloomy effect of the Pandemic, still there is a hope that those grounded aircraft will be back in the sky. There has been noticeable progress in the development of vaccines. The result so far is quite enlightening, with the promising trial reports are beginning to be published [9] and with it, comes the elation that this situation would only be temporary for the industry, with some airlines stating that they would be able to return to pre COVID-19 levels of service by 2022-2024 [10]. Nevertheless, airlines would still have to survive the current pandemic situation, with many taking steps shown in the previous paragraph. Furthermore, due to the pandemic situation there has been an increasing importance in aircraft storage, aircraft and pilot readiness, and aircraft cleanliness shown in paragraphs above as well as the new importance of cargo flights as a new source of revenue stream. However, up till now there is still not enough information to give a clearer picture on what are the important aspects for airlines to survive in this current situation, in short while we may have on how the pandemic impacted the aviation industry and how airlines tried to cope with these changes, there’s no clear indication yet on what is the main driving point for airlines to react, more specifically, what are the processes, activities, and decisions in an operational context for an airline that warranted such response. To summarize this, these are the questions we are interested in finding out in this thesis:
What are the critical operational points airlines need to take into account during this pandemic situation with regards to profitability?
7 This thesis aims to answer the above questions, as such this thesis has been divided into the following sections. First will be the introductions sections, where the background on this research as well as the main research question for this thesis are located. The next section would explain on the theoretical background for this research explaining why the theory is chosen, what is currently missing in the current theory with regards to our research and how do this research would contribute to this field.
Methodology would be the next section covered, where the method chosen for the research (case study and DSR in this case), the subject of this research (the airline Garuda Indonesia), and the reasoning why both research method and research subject are chosen, will be
explained.
The body of this thesis would contain the result from our case study, to see whether the observations made based on the theories and the implications that have been made in both our introduction and theoretical background was indeed correct, that there was a proportional change in an airline’s operational cost structure.
Finally, there is the conclusion and future research section, where the thesis would summarize the findings made in this thesis and listed the key aspects discovered, before finally outlining the limitations of this research, and possible future research that can be conducted from the findings of this thesis.
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2. Theoretical background
To better understand the scientific concepts from the previous section, and how the current operational situation for airlines currently looks like, the design science report by [29] will be used as the initial base for this thesis. The full architectural model from this report is
available in appendix page 43.
Fig. 2a
The thesis indicates that during a pandemic situation there is 4 main functions essential for maintaining control of airline operations during a pandemic as shown in fig 2a above. For this thesis our main focus would be on managing long term assets, which consists of crew
management, fleet management, destinations and profitability, as seen in fig 2b below.
Fig. 2b
Following this, our focus would narrow down again the decomposing function 14,
9 which will be discussed in the following subsections with regards to their pre pandemic measures of performance and the current situation
As this research is focused the effect of the pandemic on both the revenue stream and costs of an airline, it is important to understand both the cost components within the structure itself and the significant cost areas for airlines pre COVID-19. To help us better understand this matter, the theories and findings from [18] would be used as the main guideline, specifically on the list of principal cost categories, and what they contained, which should give a general appreciation on the subject of an airline’s costs. As such the segment of the theoretical background will be split into three different subsections, the cost framework, the major cost areas, and the cost conditions during the pandemic.
2.1 Revenue Framework
For the revenue of an airline, the most often used and important matrix in determining its amount is the Revenue per available seat mile or RASM, it is simply calculated by multiplying the number of seats available on a plane with the number of miles it flies, in which the airline can then determine the most profitable amount of fare, usually by comparing it with the CASM or Cost per available seat mile [11].
There is a standard US patent that demonstrates how this process is done, shown in fig 3 below, sourced from the patent itself [31].
Fig 3. Patented Airline Seat Mile Fare Index Market System and Method.
10 each airline route. An average seat mile fare for each airline route can be calculated, and then these values combined to calculate a multi-route average seat mile fare, from which the airline market index can be calculated. The airline market index can include airline market index contracts having prices and delivery dates as well as options contracts.
2.2 Cost Framework
The first step in our theoretical background is to find out what makes up the airline cost structure. This is important as analysing the costs for an airline is a complicated issue, as the subject of cost itself is not only complex by its very nature, but are also made more difficult by the different terminologies used, such as common cost, separable cost, constant costs, variable costs, fully allocated costs, out of pocket costs, etc. Airline management and transportation economist do not always use these cost terminologies consistently and the classification of a cost one way or another may also depend on the managerial decision being contemplated.
To create a better framework and see how the costs are actually classified in an organized manner, we shall take a look at the accounting categories for airlines created under the Federal Aviation Act of the CAB (Civil Aeronautics Board) and later the DOT (Department of Transportation) of the USA, as a base [18]. The DOT maintained a regulation containing a standard form of accounts, with interpretive rules that airlines were required to follow. The categories of costs can be found on the list below, as well as their components.
- Flying operations: Crew wages and Fuel
- Direct maintenance: Labour and direct cost related to maintenance and repairing of aircraft, including periodic overhauls and other flight equipment.
- Maintenance burden: Overhead cost related to upkeep and repair of flight equipment and other property
- Depreciation and amortization: Depreciation and amortization of the assets owned by the airline
- Passenger service: catering and cabin attendant costs for the airline
- Aircraft servicing: Routine servicing that is not mechanical in nature, this includes the cleaning of the aircraft and landing fees.
- Traffic servicing: Ticketing and baggage handling costs. - Reservations and sales: Booking and airfare costs
11 - General and administrative: General financial accounting activities, purchasing
activities, representation at law, and other general administration not directly applicable to a particular function.
Based on the structure above we can begin to see how airlines generally group their costs, and from the information we have from our introduction, we can also begin to see where the implied shift in operations cost would be based on the airlines focus in storage, aircraft and pilot readiness and cleanliness. For this purpose, the main focus of the shift in costs would be centred on flying operations, Direct Maintenance and Maintenance burden, and aircraft servicing.
2.3 Revenue and Cost Conditions during the Pandemic
As seen in the previous subsections, we now have the two base components to base our research and to put into comparison these base theories in the current pandemic situation. For instance, it is recorded that revenues of airlines have plummeted from the travel restrictions countries have imposed, leading to a drop in ticketing revenue for airlines across the board, as is recorded in fig 4 below from [1].
Compared to previous pandemics, COVID has a more noticeable impact on airline revenues, due to the fact that the disease is far more widespread and is less easily contained as
compared to both the SARS epidemic and the MERS case, in which the airline managed to rebound quickly. As such, calculating revenue from RASM in this case would deliver very low result as there is simply not enough passengers flying in the aircraft and the sudden drop of miles flown by airlines in the current situation.
12 Fig 2, Source: CME Group, [19]
The drop in traffic also meant that/ a lot of aircrew has been grounded, some airlines have even resorted to laying off their staff [6]. Aircraft selection has also changed with airlines no longer purchasing aircraft but instead retiring, selling or grounding of their fleet,
technological advances still play a role however albeit at different aspects from the non-pandemic situation, as airlines now look into solutions into repurposing cargo space, long term storage, etc [11].
13 have no clear information just how much of a change has occurred during the pandemic and if it has shifted the cost priorities for airlines for the foreseeable future.
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3. Methodology
With the nature of the current COVID-19 pandemic situation still ongoing, there are very few academic sources regarding the pandemic’s effect on the aviation sector, with most of the publication still coming in the form of news, interviews and press releases. As such, the academic sources that has talked about the effects of this pandemic in the industry itself has been more focused on coming up with a projected background or an implied theory on what would happen in the near future, and this thesis is no different. With this in mind, our approach for the research design would be a combination case study and design science research, which is used to expand the functional architectural model by [29]. with a subject focus on the National Flag carrier of Indonesia as our main case. The next subsections will now explain on why case study is chosen, why Garuda Indonesia is selected as the subject, the proposed data collection methods and instruments and finally how the data is analysed.
3.1 Selecting case study as the main research design
As mentioned earlier this pandemic situation is still an ongoing occurrence in 2020, and most of the airline’s decision-making process has been reactionary to the pandemic. As such there is already changes that have occurred in the industry with the impact being visible after a very short period. It is this impact that our thesis is focusing to look into deeper and since we will be looking into the effects of this impact on a company, Garuda Indonesia in this case, it is appropriate to use a case study approach in this research.
15 Fig 3, Source: Case Study Research Methods, Bill Gilham, 2000
From the information above, and from our main aim for this research, the methodology that is chosen would be a quasi-judicial/naturalistic case study approach [21]. This method is chosen primarily due to the emergent research design and because the context here is very important in shaping behaviour (airlines reacted to the pandemic, not because they deliberately plan for a recovery plan), and the use of qualitative data in the majority of the analysis.
3.2 Design Science Research
The second methodology approach taken is one from design science research, to showcase more clearly the critical aspects that is discovered and its relations. Design science research is also chosen in order to represent an extension of the design science report by [29]. The extension is done for the function 14 (remaining profitable) as seen in fig 2b previously. For the design science approach itself, the concept is based on DSR for envisaged systems, consisting of 4 phases:
16 However due to the time constraints for this thesis, the DSR will only be conducted until phase 3, with only the first stage of validation conducted during the second interview. All of the representation will be modelled using CORE and displayed in Idef0 diagrams.
3.3 Subject Selection: Garuda Indonesia
As for the subject of our case study, Garuda Indonesia, they are chosen as the focus for our research due to a couple of factors, firstly with a brief explanation on the history of Garuda Indonesia and the development of the aviation industry in its country of origin, Indonesia.
Firstly, the aviation industry has always been seen as a critical means
of connecting the thousands of islands throughout the archipelago. Indonesia is the largest archipelagic country in the world, extending 5,120 kilometres (3,181 mi) from east to west and 1,760 kilometres (1,094 mi) from north to south, comprising 13,466 islands, with 922 of those permanently inhabited. With an estimated population of over 255 million people — making it the world's fourth-most-populous country — and also due to the growth of the middle-class, the boom of low-cost carriers in the recent decade, and overall economic growth, many domestic travellers shifted from land and sea transport to faster and more comfortable air travel. Indonesia is widely regarded as an emerging market for air travel in the region. Between 2009 and 2014, the number of Indonesian air passengers increased from 27,421,235 to 94,504,086, an increase of over threefold [16]. The pandemic has significantly reduced the number of air traffic in the archipelago, however there has been an indication of a rebound for air travel in the country as stated by the President Director of the state-owned airport operator Angkasa Pura (AP) II [23].
“We understand that there are effects of the PSBB (Physical and social distancing) policy on the aviation industry. We initially saw a strong rebound between May and August, but the growth rate started to flatten since then.”
This put Garuda Indonesia in a unique position amongst other flag carriers in the area, as located in Indonesia gives it an advantage in being able to maintain a substantial domestic route which is beginning to recover, something that other large flag carriers have does not have [26].
17 services with the additional health and safety protocol enacted by the government of
Indonesia. He further adds that as the national carrier of Indonesia, Garuda Indonesia should be able to fly after the pandemic is over, so that the airline can have a steady revenue stream once again [16].
In another press release [26], Mr. Erick Thohir also stated that the reason why the
government is backing Garuda Indonesia during this time is to help promote a healthy market within the aviation industry, as there’s only one other major player in the Indonesian aviation Industry, Lion Air Group [15].
“If we pull the plug on Garuda Indonesia now, what will happen is a Monopoly. This is where the BUMN comes into play, to ensure that there is healthy competition within the market and there are times where they have to incur a loss to do so.”
As of now, Garuda Indonesia’s fleet consists of around 142 aircraft and they fly to around 91 destinations both domestically and internationally [17], albeit with the current pandemic situation they have also been forced to take measures, as they have announced grounding over 70% of their fleet [13] as well as laying off 180 of its pilots [22].
3.4 Data collection and Instruments
Based on the reason that has been describe in the section 1.3.2, the data for the case study will be collected from 3 main sources which are
- Publications
- Financial Statements - Direct interview with Garuda
Publications in this regard includes the press releases, news articles, webinars, journals, and videos that is relevant to our research. Due to the still ongoing nature of the pandemic and the limited academic resources on its impact to the industry, these publications will form the bulk of our initial information and our main source of secondary data.
18 Finally, an interview is done in order to both clarify our initial findings found in the analysis of the publication of Garuda Indonesia, and to ask questions derived from the information that was found lacking from both the publications and financial statements we have reviewed.
3.5 Data Analysis
This thesis is aimed to provide Information on how the pandemic shape the operational factors for an airline and what is the insight from the processes which the airlines need to take into account for a better operation management if the same situation happened in the future. Based on that objective, the data that has been collected can be summarized as follows; The analysis of our secondary data sources (financial statements and publications), conducting the first interview, the second analysis from our interview result and finding the key areas, and finally implementing the findings as an extension of the design science report of [29]. The first analysis that is done is based from the publications that we have found; with the findings shown in our introduction section, where it is shown that there is a shift in the priorities for airlines, with regards to cleanliness and storing of aircraft. The finding also implied that there is an increase in the cost with regards to these new activities and one we would like to find out if this is the case. To support this, more secondary data was used to find a suitable academic theory to support this research formulate a base framework as well as the major cost areas in the aviation industry, the discussion for this data can be found in the theoretical section of this thesis.
With our initial findings and base theory established, the next stage is to find out if the implied changes that we anticipated did occur. To do this, an analysis is conducted on the financial statements of several airlines, to provide a background on their current financial situations with special attention being given on the cost components, specifically those regarding storage, maintenance and aircraft cleanliness. The analysis of the financial
statement is also used as the base for formulating the questions for the Interview with Garuda Indonesia, mainly on the information that the research requires but is not shown in the financial statement itself.
19 1. From the financial statement during the year 2020 ending in September, there has been
no recorded ground handling cost for Garuda Indonesia as opposed to the year 2019 ending in September, we would like to learn the reason behind it as well as how Garuda Indonesia characterised Ground handling cost?
2. There has been a noted increase in Salaries, allowance and benefits cost for
maintenance employees, is this increase directly related to the covid-19 situation or was there any other factor behind it?
3. There has been also an increase in the healthcare services expenses of around 7%, we would very would like to know if this is also directly caused by the COVID 19 as well and just what kind of healthcare services the airline provides?
4. There is a very large increase in interest expense cost in the year for the period ending in September 2020 as compared to the same period in 2019, was this an effect of the pandemic or is it unrelated to COVID-19?
5. Given that Garuda Indonesia is a state-owned enterprise and it would be expected that during this time there will be a leniency regarding taxes, therefore we would like to know on why tax expenses has increased instead in this period?
6. There has been a large increase in depreciation and amortization cost from 29 million dollars to 807 million dollars. As this is a substantial increase, we would very like to know on what the reason behind this and whether COVID 19 is also part of the reason?
7. Given one of the focus for this thesis is to determine whether the mass grounding of aircraft would increase the cost of parking for airlines, how did Garuda manage this cost aspect and what cost category would this cost fall into?
8. Aircraft cleanliness (specifically, the cleaning of the exterior and interior for an aircraft) is also one of the key points that has been stressed in our initial findings, however the financial statement did not clearly state on where this activity would fall on the cost category, and as such we would like to know whether there has been a cost increase in this activity and which category would they fall into?
9. In the current condition, are there any external mitigating factors that would help alleviate the operating cost for the airline?
20 11. Given that the industry is predicted to recover in the next 3 to 4 years, and how some
industry names have now come up with possible solutions to better mitigate this situation in the future, (for instance Boeing is currently promoting its “confident travel initiative” which provides solutions on how airlines can protect passengers from virus), how does Garuda plan to position itself for that time. Is there any change in the industry that they would like to happen in the future?
Once the questions have been formulated, the next step involve the interview itself. Here the main goal is to not only obtain the data that was not shown within the financial statement, but also their current cost strategies, new things that they have discovered from the pandemic, and what they foresee, expect and hope for the airline industry in the foreseeable future. The results of this interview would then be added to complete our earlier findings to see whether our anticipated changes did occur, and to also present whether the new key elements found during this research.
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4. Analysis and Findings
The first step in this research would be analysis would then move on to the financial
statements. For the purpose of our research, the main financial statements looked into will be from Garuda Indonesia, Singapore Airlines, and Emirates. Garuda Indonesia is chosen as it is the main subject of our research, while Singapore Airlines and Emirates are chosen to give a competitor’s perspective and as a subject of comparison.
For the analysis itself, we will be focusing on the aspects that has been pointed out in the theoretical framework section on the costs and revenue. For the costs that we will cover, this includes fuel costs, maintenance costs and healthcare costs, whilst revenues are measured as passenger, cargo and total revenue. These are the categories chosen as they are the most relevant in this research.
The results of which can be seen in fig 11, 12, 13 for costs, and fig 14, 15, and 16 respectively for revenues below. Data is taken from [27], [32], and [33] respectively.
22 Fig 12
Fig 13
23 Fig 14
Fig 15
passengers cargo total
revenue 2020 737 181 918 revenue 2019 2551 244 2795 737 181 918 2551 244 2795 0 500 1000 1500 2000 2500 3000 Re ve nu es in $ (m ill io ns )
Garuda revenue changes between 2020/2019
passengers cargo total
revenue 2020 2057 305 2362 revenue 2019 2138 355 2493 2057 305 2362 2138 355 2493 0 500 1000 1500 2000 2500 3000 Re ve nu es in $ (m ill io ns )
24 Fig 16
From the analysis of the financial statements there are several implications that has been found. First, there is a noticeable drop in the amount of operations costs within these three airlines, including in areas that was expected to have a cost increase such as maintenance. There are some possible explanations, firstly for the drop in operations cost can be explained due to the drop in flying operations cost, which takes up mostly by the fuel cost, which has experienced a reduction in both cost and general consumption since there are less planes flying.
Looking at the revenue side, there has also been an observed drop in revenues for the reviewed airlines, with Singapore airline just slightly beating this trend due to their still strong performance in the Q1 period pre COVID-19. But otherwise there has been a downward trend in the number of cargo and passengers transported.
Second, we also found that the financial statements lacked certain cost component that we are interested in finding more details such as the cost of storage, cleaning, and the new protocols implemented by government due to COVID-19. This is an important find because these are actually the relevant factors this research would like find to out, and without any detailed information, another method to find this information must be done, hence why we would conduct an interview with Garuda Indonesia for further clarification.
passengers cargo total
revenue 2020 1271 361 1632 revenue 2019 1234 389 1623 1271 361 1632 1234 389 1623 0 200 400 600 800 1000 1200 1400 1600 1800 Re ve nu es in $ (m ill io ns )
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4.1 Interview
The interview with Garuda Indonesia was done with the president director of Garuda
Indonesia, with two interviews conducted during this process. Note that during the interview, not all of these initial questions are used in the interview due to time constraints, relevancies and the additions of ad hoc questions during the interview. Furthermore, the answers of the interview have been put into a separate note and the interview itself has been recorded. Several important insights which are relevant to this thesis has been found from Garuda’s answer, those of which are shown below.
Question 6: There has been a large increase in depreciation and amortization cost from 29 million dollars to 807 million dollars. As this is a substantial increase, we would very like to know on what the reason behind this and whether COVID 19 is also part of the reason? Garuda’s answer: “The depreciation and amortization cost recorded here reflect the amount of leasing fee monthly to the lessor. This is a large cost component of Garuda since, like most airlines, we did not purchase aircrafts directly from manufactures but instead lease them from these lessors for a set amount of fee per month for a given amount of time, all bound in a contract. The problem is, these contracts were done all pre COVID-19 times when demand for aircraft was very high and to secure our share of the fleet, the contract has a very strict set of requirements. One of these requirements was that in the event that Garuda would like to return these aircrafts before the time is due, Garuda would have to pay a hefty penalty.” “Back then, the decision was considered sound given that we needed the aircraft. But then the pandemic struck and we have to ground over 70% of the fleet, meaning that our capacity has been severely reduced and that our main source of revenue has drastically dropped. At the same time, we still have the normal amount of fee that we have to pay to the lessors, and if we returned the aircraft to them early the penalty is still a lot more expensive.”
“As such this is why our interest expense is still high, since payment is still ongoing despite our lack of flight operations, essentially this is our fixed cost. However, we are working on ways to reduce this cost somewhat by renegotiating our existing contract with the lessors and we are optimistic that we can save up to 30% in cost after we’ve finished negotiations.” Question 8: Aircraft cleanliness (specifically, the cleaning of the exterior and interior for an aircraft) is also one of the key points that has been stressed in our initial findings, however the financial statement did not clearly state on where this activity would fall on the cost category, and as such we would like to know whether there has been a cost increase in this activity and which category would they fall into?
26 impartial compared to our other cost, especially our fixed cost as we have discussed earlier. Furthermore, aircraft hygiene technology is already quite advanced, all our aircrafts have HEPA air filters for instance, which is known to filter over 99.9% of air particulate. These have been standard on aircraft for some time but the pandemic situation made this equipment more important than ever, and it is good to let our customers know that we have these in our airplanes to promote a sense of safety for them.”
Question 11: “Given that the industry is predicted to recover in the next 3 to 4 years, and how some industry names have now come up with possible solutions to better mitigate this
situation in the future, (for instance Boeing is currently promoting its “confident travel initiative” which provides solutions on how airlines can protect passengers from virus), how does Garuda plan to position itself for that time. Is there any change in the industry that they would like to happen in the future?”
Garuda’s Answer: “We expected that the industry will recover within 3 years at the latest, that is by that time people will start utilizing air travel as normal, like it was pre Covid times. In the meantime, however, we will have to endure the current situation and be prepared for when things go back to normal. To do this, we have to change that we approach the business in several ways. Firstly, we need to look at the business right now as a cash management game instead of the normal profit seeking activity, with preservation of our current asset, the reduction of our fixed costs and to find an alternate source of revenue to mitigate the loss of passenger traffic. This is done in Garuda’s part by the some of the steps that we have stated earlier, mainly the renegotiation of our leasing contracts”
From these initial statement from Garuda Indonesia, and from the data that has been gathered prior from the financial statement, it is deduced that there has not been any sharp increase in the airline’s cost structure due to the COVID 19 pandemic and the additional operational activities due to the pandemic. Rather, while it is true that these costs have increased due to the pandemic, their effect is still impartial as a whole to the total operational cost of the airline.
Rather, it is the impact from the drop of passenger traffic and high fixed cost that caused the loss of profit from the airline. From Garuda’s explanation, this high fix cost is attributed mostly to the leasing fee they have to pay to their lessors, which carried a hefty penalty if they decided to return the aircraft to the lessors instead. This is the first important finding from the interview, the information that leasing fee is the cost component with the largest impact for Garuda during this pandemic, which when combined with the reduction of passenger traffic, becomes the major contribution to the airline.
27 factors being put into the renegotiating of these leasing contracts, such as possible fleet composition in the future or any early retirement of their current fleet.
The second point that was discovered from the interview with Garuda was that they expected this situation to last for three years, at which during that period their business focus shifted towards a cash management focus. This is derived from a lot of changes that COVID-19 brings to the industry, from new government regulations restricting movement in the
pandemic, the drop in number of passengers, and high operational cost of the airline. As such, Garuda stated that for this period their main focus is to conserve their cash balance and survive through the challenging period. This is done through, again, the steps they have undertaken above in the aforementioned lessor contract negotiations, but also in finding alternate means to supplement their revenue.
Again, this avenue would be expanded during the second interview to Garuda, focusing mostly towards cargo flights, as part to make this research inline with the work of [29]. The main part of this question is to ask whether Garuda considers cargo to be a viable alternative to bring in revenue, and just how significant do they think that cargo can replace passenger during this pandemic times.
Based on the first interview findings, and to validate the result of the interview with Garuda, A second interview was conducted. This interview is shorter and consists of the following components.
- The validation from the result from the first interview, confirming that indeed for Garuda Indonesia their main issue due to the pandemic is the high fixed cost from the payment to their lessors, dropping passenger numbers causes a sharp downturn in their revenue, and the shift of focus towards cash management in their operations until the industry returns to normal in 3 years’ time.
- Further elaboration on their decision to renegotiate the contracts they have with their lessors, to see if there is an operational factor behind the decision rather than just being purely based on financial reasons.
- The second question focuses on cargo flights, specifically whether cargo flights are considered to be potential substitutes for normal passenger flights for Garuda, and how do they manage the activity so far.
28 was both relevant and valid with what was happening within Garuda Indonesia. For the questions that was asked, the answers are stated in the excerpt below, with question 1 being the focus on fleet composition factors during lease contract negotiations and the second question being about cargo flights.
Question 1: Besides financial reasoning, is there any operational factors taken into account as well in renegotiating these lease contracts such as future fleet composition for Garuda? Garuda’s answer: There is indeed one such case for an aircraft in our fleet, currently in our fleet we have a type of narrow-bodied regional jet, the Bombardier CRJ1000 series of aircraft. Initially we planned to utilize this aircraft to work as a commuter aircraft, where people who worked in one city and live another can use our airline as a way to commute daily between the cities. However, it turns out that this idea is still unpopular with Indonesians who doesn’t see air travel as way to commute between cities yet. As such the aircraft has been underperforming in our service and we planning to phase out the type. The Covid-19
situation merely accelerated this process and we are in the process of returning these aircrafts to the lessors as quickly as possible. So yes, in this renegotiating process with our lessors there is also an operational decision factor as was stated, even if it is merely an acceleration of a process we already planned to do anyway prior to Covid due to an underperforming asset.
Question 2: Are cargo flights now considered to be more of a priority of Garuda? Is there any challenge in conducting this new operational activity?
29 The second interview provides further insight from the findings that was discovered and validated from the first interview. In addition, for Garuda’s case it was clearly stated that the pandemic also affected decision making with regards to airline operations as well, for instance fleet composition for Garuda was affected, if indirectly, by the Covid situation. In which the decision to return an underperforming fleet of aircraft was expedited. It also shows a shift in business focus for the airline, in which for the first time, cargo was deemed more important than carrying passenger, thus diverting away from their traditional business model.
4.2 Expansion of the functional architecture
The interview results bring up several interesting key points within the scope of airline operations, especially in regards to profitability. Translating these points into a design science input is the next step in this research, which is the expansion of the functional architecture model by [29]. These inputs are derived from both the interview result with Garuda Indonesia and the prior secondary sources analysis. The first input that is discovered is that to fly in a pandemic situation, airline rely on a vastly different set of regulations which dictates what can be done. This in turn would affect other operational activities down the line, specifically for the function we would like to focus on, function 14, seen in fig 18.
Second, the interview with Garuda highlighted that the drop of passenger’s numbers as the biggest cause for the drop in revenue for the airline, and as such plays an important role in the for function 14 as well.
31 These new inputs for function 0, carries on to function 1 (manage long term asset) and again as input into the main function for this thesis, function 14 (remain profitable). Function 14 is decomposed into three main parts, long term, medium term and short-term profitability decisions. This decomposition is based from the data that has been collected which suggested that the airline would focus more in a cash management game rather than the usual profit seeking activity as it is currently very challenging to do so in the current situation. It is from this case as well that the thesis focuses more on the medium and long-term profitability decisions compared to the short term one.
The hierarchy and relationship for function 14 is shown in fig 18 and 19 respectively.
Fig 18 141 Medium term profitability decisions Function 1411 Adapt profitability measurements Function 1412 Fleet composition decisions Function 1413 Human Resources decisions Function hier Medium term profitability decisions
33 4.3.1 Medium term profitability decisions
The medium-term profitability decisions, function 141, represent the most important function which was decomposed from function 14. It represents the operational considerations that airline has to take into account during the 3-year period until the industry returns to normal, and involves fleet composition, adapting profitability measurements and human resource decisions.
Sub function 1411, adapting profitability measurements, is the most important sub function due to the airline industry situation now revolve around cash management as mentioned in the earlier parts of this study, and focuses mainly on how to mitigate the cash loss within the financial statement of the airlines through both operations and financial means, such as renegotiating airplane contracts with lessors, or returning aircraft all together as well as determining which personnel are considered essential to the airline. It also provides the potential for providing innovative ideas to stay profitable in the future, and the new financial constraints by the airline.
Sub function 1412, fleet composition decision, represent the operational activity in which the airline would select which aircraft in its inventory would it still fly in the pandemic, with sub function 1411 being a strong input to determine which aircraft is kept in service and which to put into storage, but it also is affected by external factors such as the new flying regulations during the pandemic and the drop in passenger traffic. The output of this sub function consists of the selection of aircraft, which acts as a control for sub function 1411 in
forecasting the new profitability measurements as well as displaying the financial constraints and the long-term profitability decision factor for consideration which is represented by the current operational fleet.
35 4.3.2 Long term profitability decisions
The long-term profitability decisions, function 142, represent the most important function which was decomposed from function 14. It represents the operational considerations that airline has to take into account after the 3-year COVID-19 period, in which the industry returns to normal. It involves offering new products, enacting new processes, and reforming the organization.
Sub function 1421, Offering new products, is the most important sub function for long term profitability decision. It involves airlines coming up with new products in the future as either a new, or supplemental source of revenue stream. This can be in the form of many activities both temporary or permanent, such as the case in Singapore airlines A380 restaurant service, Thai airways repurposing of life jacket and rafts into bags and fashionwear as a novel idea example, or for a more conservative view from our case, Garuda Indonesia opening dedicated cargo routes.
Sub function 1422, enact new processes, is the definition for the collective new
organizational activity from the short and medium long term profitability sub functions, while also having the input of the new requirements from new products, an output of sub function 1421.
Sub function 1423, reform organization, is the final sub function within the long-term
profitability decision, and it centres around the airline undergoing reformation in its structure and operations. It is the broadest in aspect compared to all the former subfunctions, as such it is put on the lowest part within function 142.
38 4.3.3 Critical aspect derived from interview
1. The focus for airlines during the pandemic period is to survive, this is the most critical aspect for airline operations, as such normal operations should be adjusted to this goal. 2. With regards for profitability, the focus for airline should be on cash management and
the preservation of asset, in preparation for an expected industry recovery within three years
3. Alternate sources of revenue should be prioritised in the response to the drastic reduction in passenger traffic, airlines should be active in looking at possible sources of revenue and be ready to change priorities in business operations.
5.3.4 Critical aspect derived from functional architecture
1. The pandemic is of a temporary nature and business will recover after a set period; thus, the airline needs to think ahead on how they can operate as normal after the pandemic
2. The drastic reduction in passenger traffic is to be expected in a pandemic, airline should be prepared in preparing other revenue generating operations to cut the slack. 3. Travel and flight regulations will change during this period, at times the regulations
39
5. Discussion
Several important critical findings can be derived from our analysis, which will be discussed in depth in this segment. These findings, as specified above, comes from both the interview with Garuda Indonesia as well as the ones from the functional architecture.
Furthermore, the trend with these findings is that they are not mutually exclusive, rather there are several critical aspects that are derived from another critical aspect. The relationship between these findings will also be discussed further.
The survival of the airline during the pandemic takes top priority for airline and is the most important thing to keep in mind for airlines to consider when deciding operations during and post pandemic situation.
This might seem an obvious implication, however it cannot be understated on just how important this goal is for airlines during the pandemic, especially with the great reduction in passenger traffic which in turn greatly reduced the traditional income stream for airlines, while operational costs remained high. As such, most airlines, including our interview subject Garuda Indonesia, are experiencing large losses, and the priority now has shifted in ensuring that the airline must survive in this new condition.
Derived directly from this new goal would be another critical aspect discovered from the interview as well, the cash management game. This is an important discovery as it visibly shows the shifting objective for the airline from their normal profit seeking activity to one geared for preservation of assets. A key factor in this shift is also the realization that the pandemic situation will be temporary, with our subject estimating that operations will return to a normal state within three years’ time.
40 A link between these three critical aspects can be traced, with the survival of the airline serving as the key driver to which then cash management is now the main business focus for airline operations and from the situation, other sources of revenues should be considered quickly to mitigate the costs.
41
6. Conclusions, limitations of this research, future work
There are several conclusions that can be drawn from the result of this research, first is that the realization that this pandemic situation is temporary, that at some point things will gradually begin to go back to normal and that airlines should be able to return operating pre COVID-19 times. This is essential, as this meant that airline has to focus on strategy that not only allowed them to survive during the pandemic stage but also transition smoothly when the pandemic is over.
Second in this category would be the drastic drop in passenger traffic. This topic being highly brought up during the interview and identified as the main problem since passengers are the main source of revenue for an airline through the sales of tickets, and when the pandemic struck, with many countries imposing a ban on travel, the number of passengers dropped significantly as well leading to a large majority of the airline’s revenue disappearing. This information should be taken into account as a means for airlines to prepare possible ways to mitigate this issue, such as switching to cargo flights for example.
Finally, there is the issue of everchanging flight regulations during the pandemic. This is considered as the third critical aspect derived from the model as it brings about the
importance for taking account uncertainties that arise during the pandemic, with regulations changing daily and even mid-flight. It is also important to realize that regulations here not only accounts for restrictive measures for flights, for instance a decree by the government for a repatriation flight can cause an airline to fly into a country that’s not part of its destination, which in turn brings the need to schedule, assign and send planes and crew into an airport the crews are unfamiliar with.
42 functions and sub functions, indicating that these aspects added the activity needed in order to operate as an airline profitably for the future.
As stated in the introduction, the end goal for this thesis is to find out how the COVID-19 situation would affect the operational state of an airline, and how it will impact their overall business model in the future in this very challenging situation. It is not designed to find an optimal solution or course of action with regards to the current situation, due to the still recent development of the COVID-19 pandemic at the time this thesis is written.
Instead, this thesis is aimed at being a guideline for possible future researches in the field for finding an optimal solution in regards to the key aspects an airline should focus if a similar pandemic situation would occur in the future based on profitability. As such, this is a limitation of this thesis that has been considered and to find a completely optimal solution would require a separate research to be conducted.
Another limitation of this thesis is the scope of its case study subject as it focuses mainly on the findings from Garuda Indonesia, an international full-service airline which also serves a large domestic market. As such, the findings may not be relevant to other airlines which utilizes a different business model, such as low-cost carriers, or for airlines who serve a purely international route.
As for future research, the critical aspects found in this thesis can open up several new avenues or serves as the base for an expansion into the findings. For instance, it would be interesting to see whether there can be a better way for airline to forecast on just how long the effect of a pandemic would be or is it better to do an internal survey or outsource when it comes to forecasting.
Another possible research avenue can also be focused on regulation, on how airline should prepare or react in an environment in which the regulations can change instantly, or how airlines can influence the regulations in a pandemic, through lobbying for instance.
A research linked to the importance of cash management for the airline during the pandemic, research on the optimal method to achieve this goal, whether be it of operational,
43
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