A Case Study on Cost Estimation and Profitability Analysis at Continental Airlines Essay

Words: 8987
Pages: 36

A Case Study on Cost Estimation and
Profitability Analysis at Continental Airlines

Francisco J. Román


In 2008, the senior management team at Continental Airlines, commanded by Lawrence Kellner, the Chairman and Chief Executive Officer, convened a special meeting to discuss the firm’s latest quarterly financial results. A bleak situation lay before them. Continental had incurred an operating loss of $71 million dollars—its second consecutive quarterly earnings decline that year. Likewise, passenger volume was significantly down, dropping by nearly 5 percent from the prior year’s quarter. Continental’s senior management needed to act swiftly to reverse this trend and return to profitability.
Being the fourth largest
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Relative to other industries, airlines are a very difficult business to manage. In particular, they are exposed to tremendous risks brought by volatility inherent in their business model, as they deal with high fixed costs, labor unions, instability in fuel prices, weather and natural disasters, passenger safety, and security regulations. These aspects bring a large burden to airlines’ cost structures. Moreover, competition within the industry is fierce; the proliferation of discount carriers, such as Southwest Airlines and, most recently, Jet Blue, and the end of fare regulation in 1978, has hindered airlines’ pricing power and their ability to spur revenues. For these reasons, cost containment is a critically important aspect of profitability in this industry.
In order for Continental to restore profitability in this harsh environment of weak demand for air travel, it must be able to contain its operating costs, especially its massive fixed costs, which are visible in several ways. For example, salaries for pilots, flight attendants, and mechanics, as well as aircraft leasing costs, are typically fixed, varying little with shifts in passenger volume. Because fixed costs typically embody the amount of operating capacity of a firm, they are commonly referred as “capacity” costs. Since fixed costs do not self-adjust to fluctuations in passenger volume, the only way in which they can be decreased (or increased) is