System Dynamics Approach to Strategic Market Modeling in the Airline Industry
Maliapen M, Ramaseshan B, Quaddus M
Curtin Business School
Curtin University of Technology,
GPO Box Ui987, Perth, WA 6001, Australia
Abstract
The domain of strategic decision making involves very complex issues with action-reaction relationships. In
reality, there are system dynamics-based simulation tools that can help business managers understand the
Sundamental processes of their businesses. In this research paper, we have studied the strategic markets in the
Passenger airline industry for an international city pair between Perth and Singapore. Based on the study of
major players on this route sector, we have attempted to model all the significant market elements and forces that
demonstrate their explicit and implicit behaviours. The model developed in “iThink”, a system dynamics-based
simulation software, provides an interactive capability to the business manager for the exploration of alternative
scenarios so that the decision maker can understand how the pricing or competitive positioning activities of other
players affects the market leader and vice-versa,
1. Background
In recent years, the airline industry has been experiencing growth in market demand, locally,
nationally, and internationally. In particular, the Asia-Pacific sector of the passenger airline
market is growing at nearly 10 percent per annum. The passenger growth on the Perth-
Singapore-Perth sector has been steadily increasing at a phenomenal rate over the last few
years. This has been evidenced in recent years by the increase in frequency of flights by the
national carriers for the city-pair with other new players in the sector. It has brought about
intensive competitive pressure amongst the participants. Therefore, it is vital to understand the
market and its competitive environment, and to use the airline’s competitive advantage to gain
market share and profitability.
In order to preserve confidentiality, we have changed the names of the airlines involved to YQ
Airlines as the main player and SY, IA, and AB as the competitors. We take no responsibility
should these acroymns coincidentally reflect the real players in the airline market. A simulation
mode] for market analysis was developed in iThink, to help airline managers understand and
anticipate the growth in industry and market, and to develop and implement strategies
effectively to attain the defined goals. The process of model prototyping involved planning,
paper prototyping, model building, analysis of the simulation results and providing strategic
assessments of the markets.
2. Airline Country Managers’ Mental Model
It is crucial that airline managers have a thorough understanding of the market demand they
want to satisfy. Aircraft selection, route development, scheduling, product planning, pricing and
advertising are just some of the many decision areas which ultimately are dependent on an
analysis of demand for transport of passengers and freight.
On the contary, aircraft type and speeds, departure and arrival times, frequency of service, air
fares, in-flight service, the quality of ground handling services and other features of supply will
influence demand for an airline’s services. The density of demand, its seasonality, the purpose
of travel, the distance to be travelled will also influence supply and impact on costs. Thus,
airline planning is a dynamic iterative process. New adjustments to supply then takes place to
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meet the changes in demand and the interactive process continues. The more competitive and
unregulated the market as IATA (International Air Transport Association) has made it, the more
are the difficulties of strategic marketing - matching the supply and demand for the airline
managers. Figure 1 shows a summary of the of market drivers for supply and demand.
We can assume that economic
Soictcos growth, political situation, major
Bevo igs
trunk route city type, population or .
more specifically per capita income
— (a socioeconomic characteristic)
. and past industry passenger traffic
nae will be some of the key factors that
aes shape the industry growth for
demand on the Perth-Singapore
l sector. Industry convention and
Seah standards measure of air passenger
Soe vn traffic is defined by one of the
following indicators Revenue
Fine: Mena Model of Aine Mart Amat Passenger Kilometres (RPK),
Available Seat Kilometres (ASK)
or Revenue Tonne Kilometres (RTK) (Transport and Communications Department, 1993). We
also assume that route sector growth forecast for passengers will not outstrip industry growth
forecast.
3. Supply and Demand Drivers in the Airline Market
Market segmentation is invaluable since each market segment has its own characteristic growth
rates and responds differently to variables such as fare changes, economic factors etc. We have
decided to segment the market into the three categories of air travel ie First Class, Business
Class, Economy Class (which includes the discounted fares category). Cost differentiation is
considered the key factor. Porter(1980) describes the five force model and shows that product
differentiation, can be achieved through factors such as distribution channels, frequency and
timing of services, in-flight service and airport customer service. The market segments
correspond to the seat categorization generally used in the airline industry. Understanding the
size and characteristics of each market segment is essential for forecasting demand product
planning, flight scheduling etc and even pricing. (Doganis R, 1993)
Amongst the general factors affecting demand, the price of air transport, the level and
distribution of personal income are perhaps the most significant. Further, the level of economic
activity and trade directly influences the growth of demand for business travel. In the case of
Singapore, a global city state with a 2.6 million population base, it is the affluence and double
digit economic growth that is driving the market demand. Supply and demand do not interact
only through the price mechanism. Various supply conditions such as frequency, seat
availability, departure and arrival times, in-flight service, flight safety record influence the level
of demand and the distribution of the industry demand between competing carriers (Doganis R,
1993). :
The YQ Airline process frame represented in Figure 2 is designed around the 4P’s - product,
place, price and promotion (Assaul. H, Reed. P, Patton. M, 1995). The sub- model pre-supposes
that revenue could be increased by maximising the four-fare price structure. YQ Airlines should
charge more for business travellers because their demand is relatively inelastic to price and
charge less to the price-elastic leisure market using economy and discounted fares knowing that
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it will in turn generate proportionate demand and thereby increase revenue. Fares in our model
are based on a unit price for Economy Class, 1.4 for Business Class, 1.6 for First Class and 0.6
for discounted fares and these ratios can be varied to determine a desirable product mix in the
model.
4, System Dynamics-based Model Design
Process stocks such as the YQ Airline's passenger market share always exist within information
feedback loops. Feedback, fundamentally, determines the behaviour of the real world. There are
two kinds of feedback loops operationalised in our model ie the positive (reinforcing) loop
which generates change or growth such as gain or loss in market share of passengers. The other
is the negative (balancing) loop which acts to negate change which is the “target seeking”
behaviour of the YQ airline's strategies (Risch.J et al ,1995).
enkt graph
mkt table
ie)
target mkt share
mkt promotion
Figure 2 : Structure of YQ Airline Model
Delays can be used to represent the effectiveness of YQ Airline’s Management policy change to
increase the flight frequency from 4 to 8 per week. The desired response such as an increase in
passenger demand might hypothetically take 3 months to filter through advertising before the
full impact of the policy change is realised by the airline. Delays can be represented as
conveyors (Stevenson, 1993). One of the assumptions of the design is that the relationship
between the main player YQ Airline and its competitors’ share (Figure 3) of the market is
modeled as a zero-sum game.
4.1 Simulation Model Validation
The usefulness of the model can only be determined after conceptual validation ie the manager
is satisfied that the business processes are demonstrating expected dynamic behaviours. This
was further validated against historical passenger movement statistics (both RPK and ASK) for
the sector (Transport and Communications Department, Civil Aviation Authority). Marketing
policies work through the interaction of feedback loops which create change and stabilise
performance. It is the simulation tools’ unique ability to interactively support such change for
policy analysis and design that makes it so useful.
5. Strategic Market Assessment
Our analysis of the simulation model results are as follows:
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¢ YQ Airline dominates the Perth-Singapore sector as expected even if its target market share
is deliberately reduced. This is because in terms of qualitative factors such as quality of
service and frequency of service, it is still the preferred airline
¢ YQ's competitors suffer heavily in terms of market share as YQ monopolises the market. In
fact, its growth rate is only contained by the industry growth
¢ shifts and redistribution in the four market segments for YQ Airline due to sensitivities in
cost of air fares when there is heavy discounting by the competitors
Conclusions
little sensitivity to changes in
economic and political factors at
the Perth end of the city pair
indicating that Perth is more of a
leisure destination. Seasonality
affects the market in the winter
months although heavy fare
reductions in the off-peak season
attracts more passengers and
thus counteracts the loss
* passenger market is, however,
affected by destabilising
political and economic factors in
Singapore, showing its
significance as “hub and spoke"
destination for business and
transit travellers.
Based on the scenarios generated by the model, some recommended long term measures for YQ
Airlines are as follows:
¢ to ensure sufficient seat capacity to meet growth demand,
¢ to establish dedicated distribution channels for marketing discounted tickets,
¢ toreduce flight frequencies for this city-pair and use higher capacity aircraft.
References
Assaul. H, Reed. P, Patton. M (1995), Marketing Principles & Strategy, Australian Edn, Harcourt
Brace & Company, Australia.
iThink (1994) , Technical Reference, High Performance Systems Inc, USA.
Stevenson, R (1993) Strategic Business Process Engineering: A Systems Thinking Approach using
iThink, Software Assistance for Business Reengineering, pp 99-118.
Risch.J, Trayano-Bermudez. L, Sterman J (1995), Designing corporate strategy with system dynamics:
a case study in the pulp and paper industry, System Dynamics Review, Vol 11, no 4, pp 249-274.
Transport and Communications Department, Civil Aviation Authority, Air Transport Statistics -
Monthly Provisional Statistics of International Scheduled Air Transport, Years 1984-1994.
Transport and Communications Department,(1993), Domestic Airline Activity Weekly Status Report.
Doganis R, (1993), Flying Off Course-The Economics of International Airlines, Routledge, New York.
Porter, M (1980), Competitive Strategy, New York: Free Press
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