Ryanair:theProfitFunction

RODRIGOÁLAMO SANZ

AGENDA1. Introductiontothebusiness2. Costfunction3. Revenuefunctiono YieldManagementpricingtechnique

4. Supportingexampleso Bigpricedifferenceswithoutcostdifferenceso Ryanair’sCEOonfreeflightso Flightsfor0,98€

1.Introductiontothebusiness

Highpricesandlotsofpremiumservices

lowprice,nofrills,highrotation

Theairlineindustryisdefinedbytwomaincharacteristics:

•Highfixedcost

•Lowmargins

Inthepast,airlinesovercamethisthresholdbycharginghighpricesfortickets,andprovidinglotsofextraservicesfreeofcharge(bags,food,press).

Ryanaircameintosceneovercomingthehighfixedcostsbypushingupthedemandbyofferinglowpricesandnofrills,whileperformingahighrotationonassets(aircrafts).Thisallowedforahigherreturnonassetsandaloweropportunitycost.Agroundedplaneonlyproducescosts.

Costfunction§Fixedcosts

§ Planes§ Airportslots§ Fixedmaintenance

§Variablecosts§ Fuel§ Staff§ Variablemaintenance§ Airplanerotationopportunitycost

Costfunction

𝐶𝑜𝑠𝑡 = FC+VC

𝐶𝑜𝑠𝑡 = 𝑝𝑙𝑎𝑛𝑒𝑠 + 𝑠𝑙𝑜𝑡𝑠 + 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 +𝑞 𝑑 𝑓𝑢𝑒𝑙,𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒, 𝑠𝑡𝑎𝑓𝑓, 𝑂𝐶

𝑀𝐶 = 789:;7< = 𝑑 𝑓𝑢𝑒𝑙,𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒, 𝑠𝑡𝑎𝑓𝑓, 𝑂𝐶

Costfunctionexplanation

We depart from the prototype cost function.

Then, we identify which magnitude turns costs variable. To do so, we calculate the marginal costs of a passenger, with a result of0. Therefore, passengers cannot be q. Instead, we apply the Hicks Commodity Composite Theorem, which states that if the pricesof a group of goods change in the same proportion, that group of goods behaves just as if it were a single commodity. Ourindependent goods are passengers, and the single commodity a plane. Hence, we define the variable cost as q (number offlights) multiplying d, which is a function of the distance a plane flies, define by the fuel, staff, variable maintenance, and airplanerotation opportunity cost.

To check our findings, we calculate the marginal cost, deriving the cost on q. The result is the marginal cost of Ryanair that equalsthe extra distance an aircraft flies, regardless the number of passengers it is carrying.

Costsdisclosure:

RevenuefunctionIncomesources:

§Flighttickets

§Ancillaryrevenues

§Sharedrevenueswithairports

§Publicgrants

§Airplanes

§Airportslots

Revenuefunction*

𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑝 ∗ 𝑞

𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 1 + 𝑎 𝑃 ∗ 𝑞 ;

𝑎=(ancillar𝑦, 𝑠ℎ𝑎𝑟𝑒𝑑𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠, 𝑔𝑟𝑎𝑛𝑡𝑠, 𝑎𝑖𝑟𝑝𝑙𝑎𝑛𝑒&𝑠𝑙𝑜𝑡𝑟𝑒𝑛𝑡𝑎𝑙)

𝑃 = 𝑝𝑟𝑒𝑚𝑖𝑢𝑚𝑡𝑖𝑐𝑘𝑒𝑡𝑠 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 tickets

Revenuefunctionexplanation

We depart from the prototype revenue function.

We built a multiplier, a, which includes all sources of revenue which are not tickets. The multiplier elevates the incomewhen any of the alternative revenue sources is higher.

As for the remaining component of the function, P*q, q equals the number of flights, as in the cost function. P iscomposed of the two types of tickets available: discounted and premium tickets., which are explained on the followingslide.

*:assumingfullairplanes.Ryanairoccupationfor2016Q3was95%.

Revenuefunction:yieldmanagementRyanair employs yield management to set the price of thetickets.

The company sets its revenue function (red line)- a bulkprice for the plane (blue & yellow areas)- and later adjuststhe prices of the tickets within the plane to reach thedesired profit.

These adjustments aim to match the demand curves ofthe passengers with the prices offered.

With many seats available, the demand is elastic andtherefore a low price is given. With few seats are available,the demand curve is inelastic and therefore a high pricecan be charged.

The revenue function accounting for each passenger*would be the summation of the price paid, multiplied bythe ancillary revenues multiplier, and all multiplied by thenumber of flights flown.

𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑞 ∑ 𝑝P 1 + 𝑎QRSQ *:RyanaironlyoperatesBoeing737with189seats

We are analyzing 2 flights: Milan-Düsseldorf andMilan-Catania. There is a 400% price differencebetween them, despite no accounting cost differences.This has to do with yield management adjustments.

For Düsseldorf, leisure travelers have an elasticdemand, while executive travelers have a very inelasticdemand curve. Ryanair didn’t change the total profit,moreover the company increased the slope of theirrevenue curve, offering lower prices for elasticdemands and higher for inelastic. The consumersurplus is brought to 0.

Meanwhile, Catania has a very inelastic demand,driven by Sicilian expatriate returning home forChristmas. Ryanair moved up the curve, obtaining ahigher profit, and lowered the steepness of the curve.In this flight, differences between the first and the lastticket sold will not be big, but the total revenue of theflight will be higher.

Examples:Bigpricedifferenceswithoutcostdifferences

1000kmstraightlinefromMilan400%pricedifference

Thisquoteisobviouslyanexaggeration,butithaseconomicfoundations.

ForRyanair,ancillaryrevenuesrepresent25%ofthetotal(otherrevenuesarenotdisclosed).

O’Learyreferredtothemultiplierwebuilt,a.Bysharingrevenueswithairports,orbyanyotheralternativesourceofincome,a risesandthereforetherevenuerises.Ifa risesmorethanP,therevenueishigheronlowerticketfares.

Thisinitiativecouldevenbefeasible,byofferingfreeinsteadofdiscountedtickets,butstillcharginghighpricestopassengerswithinelasticdemandcurves.

Examples:Ryanair’sCEOonfreeflights“Idon’tseewhyin10years’timeyouwouldn’tflypeopleforfree.Whydon’t

airportspayusfordeliveringthepassengerstotheirshops?”

𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 1 + 𝑎 𝑃 ∗ 𝑞

𝑎=(ancillar𝑦, 𝑠ℎ𝑎𝑟𝑒𝑑𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠, 𝑔𝑟𝑎𝑛𝑡𝑠, 𝑎𝑖𝑟𝑝𝑙𝑎𝑛𝑒&𝑠𝑙𝑜𝑡𝑟𝑒𝑛𝑡𝑎𝑙)

MICHAELO’LEARY

CEOOFRYANAIR

When planning the marketing campaign, the costs were calculatedusing economics costs, and therefore the unearned revenue. Lowinitial price in this route allowed for a lower economic costs.

Inelastic demand for last tickets would even permit rising prices forthe last seats sold, having an extremely steep revenue function. Thiswould make the revenue of the flight equal to the normally pricedone.

Examples:flightsfor0,98€The airline wanted to do a marketing campaignoffering extremely cheap flights.As stated before, Düsseldorf has a very steeprevenue function, and initial tickets are sold atlow prices.