Understanding Allocations

As discussed in previous articles, expenses are organized into cost centers in the general ledger. Consequently, Flight Profitability teams have to determine how to allocate those expenses to individual flights. Understanding some of the challenges associated with this process will help as we dive deeper into the costs section.

Allocations are not unique to Flight Profitability. They are present in everyday life from how much screen time we decide to give our kids to how we use money to distribute our scarce resources (yes, we go deep in these articles!). There are essentially two things to keep in mind when it comes to any allocation: 1) determining the right mechanism or driver to use and 2) understanding the by-product and incentives of using that driver. 

Drivers & Incentives:

The right allocation driver ensures the right incentives are in place which in turn creates the right outcomes. In the Bible, King Soloman chose to physically divide a baby equally between two women, each of whom claimed to be the child’s mother. At first glance, not the best of methodologies but in the end, no babies were harmed, and one that got to the right outcome.  

Before determining an allocation methodology, it is really important to understand what drives the expense. Let’s think through a few different approaches to allocating call center expenses.

What if we choose departures as a driver? This would result in all flights regardless of their size (seating capacity and passengers) having the same amount of expenses allocated to them. Consequently, a 50-seat regional jet and a 300-seat widebody would get the same amount of nominal expense. This doesn’t seem fair given that there will likely be more passengers on the bigger aircraft calling the res center than the smaller one. This methodology could incentivize network planners to eliminate marginal regional flights while potentially adding more widebody ones.

What if you were able to get a call log for all the calls handled in the call center and could determine how many calls were associated with each flight? That seems like a pretty accurate approach.

There’s a couple of challenges with that methodology. The most important being that it would introduce a significant amount variability in the results for one-time events. For example, if a particular flight had a maintenance delay one day (i.e., lots of people calling the reservations center) it could depress profitability considerably.

Ultimately, though one needs to understand what drives call center expenses. It’s probably not departures and it likely isn’t just in time “day of” events. More probable (at a very high level) is that a workforce planning group estimates the number of passengers that will be calling based on the number that will be traveling which is in turn based on a future schedule.

In Conclusion:

Using the wrong allocation methodologies can significantly impact results and ultimately lead to the wrong business decisions. It’s easy to get a false sense of security when working with allocations as most people tend to validate allocations by checking to see if the total expense equals the allocated expense. How one allocates expense can significantly alter the distribution of an airline’s profits potentially resulting in a distorted view of an airline’s network and cost structure.

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