237-Asraf - A Critical Review of Literature On Performance of Airlines - Proceeding PDF

Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
A Critical Review of Literature on Performance of Airlines

Muhammad Asraf Abdullah, Dr. Susila Munisamy and
Dr. Nurulhuda Mohd Satar***
This paper analyses, evaluates, and synthesizes both theoretical and
empirical works on airlines performance across regions in the world
from 1983 to 2012. The focus of this survey lingers around scholarly
literatures pertaining to current controversies in airlines performance
including technical efficiency, allocative efficiency as confined in
seminal work of Farrell (1957) and productivity. Due to inconsistency
of issues focused in past papers pertaining to this area of study, this
paper addresses the issues thematically and not in a chronological
manner. Above all, technical efficiency is the most popular issue well
discussed in the study of performance in the airline business. Among
fresh issue yet little coverage in literatures over the last decades is
outsourcing practice. Topics related to business model, ownership,
and corporate governance are contemporary in nature as they invite
mounting debates recently. Moving on to issue of liberalization from
the aspects of deregulation, open skies policy and alliances- is a
perennial subject in performance study which have impressed many
scholars in the 1990s and 2000s. Other issue which has drawn
greater attention from academics and practitioners in the aviation
industry is labour union which has invited many discussions recently.
Issues on allocative efficiency and productivity are not less important
in literatures as it have attracted researchers attention since 1980s. In
general, views on airlines performance have been sprawling around
multifaceted topics including management, institution and
organizational structure.
JEL Codes: D24, L25, L93
1. Introduction
This paper surveys scientific thought on issues in airlines performance across
regions from 1983 to 2012. The focus of scholarly works since the deregulation of
the U.S. airline industry in 1978 has constantly aimed at benchmarking airlines from
the aspects of efficiency and productivity. Since then, dozens of research in airlines
are centered on how airlines promote efficiency and productivity amidst the rising
competition sparked by moves for liberalization in the air transport industry in both
the United States and the European Union. The importance of the subject matter in
research has substantially increased after terrorist attacks at the World Trade Center
on September 11, 2001 which has adversely effected the financial positions of
airlines across a number of regions in the world.
Muhammad Asraf Abdullah, Department of Economics, Faculty of Economics and Administration,

University of Malaya. Email: asraf_74@yahoo.com
Associate Professor Dr. Susila Munisamy, Department of Applied Statistics, Faculty of Economics
and Administration, University of Malaya. Email: susila@um.edu.my
***
Dr. Nurulhuda Mohd Satar, Department of Economics, Faculty of Economics and Administration,
University of Malaya. Email: nurulhuda@um.edu.my
Chronologically, the focus of research in airlines in the 1980s and 1990s linger
around the issues of rising cost resulted from moves for deregulation in the United
States and liberalization in the European Union. Among the hotly discussed issue is
the allocative inefficiency in the light of opening up of the air transportation markets
in the two regions discussed above. On the other hand, most of the literatures on
productivity in airlines are quite recent with few done before year 2000. An obvious
research pattern in productivity study has constantly focused on determinants of
productivity level and sources of productivity growth.
Bad financial situation in many airlines across regions in 2000s has led airline
practitioners and academic researchers seeking for strategies to improve financial
position of airlines. This reason explains why the focus of aviation studies in 2000s
was procrastinated around the theme of rising operational costs and its solutions
albeit a more in depth investigation at micro level-to involve strategic management
approaches.
Despite critical need to address issues in airlines performance, to our knowledge

there is absence of paper reviewing specific topic related to airlines performance.
So far, survey of papers in the area of transportation economics is too broad which
cover topics in airport and airline economics (Zhang & Czerny, 2012) and transit
economics (Gwilliam, 2008). Hence this paper fills the gaps in research pertaining to
transportation economics.
There are various ways and strategies outlined in scientific literatures to contain the
issue of rising cost as well as decreasing profits including business model;
ownership and control; liberalization (open skies policy, cooperation: airline
alliances); outsourcing; labour union; and corporate governance. This paper starts
with discussion on the development of thought in airlines efficiencies. Next section
will examine issues on allocative efficiency. Section three expounds on issues in
productivity changes and the final section provides gaps for future research.
2. Efficiency estimates and determinants of airlines technical efficiency

Throughout the survey of literature from 1983 to 2012, studies have highlighted
various empirical findings regarding factors affecting efficiency in airlines. These
factors have important impacts on the technical efficiency levels of airline
companies.
2.1 Outsourcing
Outsourcing is not a new phenomenon in the era of increased liberalization today.

Literature on outsourcing activities across firms and industries have been well
documented since the introduction of concept of international division of labour by
Adam Smith in 1976. Many firms tend to outsource some of the activities that they
used to carry in house before. This is among others driven by an economic
reasoning namely the principle of comparative advantage and competitiveness which
was loudly applauded by a highly reputable trade theorist, David Ricardo.
Despite the fact of dozens academic discussions on outsourcing, there are very
insignificant scientific studies focused on outsourcing within the airline industry.
Some of the related studies are deliberated in Rutner & Brown (1999); Al Kaabi et
al., (2007); Rieple & Helm (2008); Durmaz & Adiller (2010); and McFadden &
Worrells (2012). Much of these studies centered on different models of outsourcing,
extent of outsourcing, motivation for outsourcing, and aspects in outsourcing of
maintenance in the airline business. A considerable amount of information and
concepts in these literatures are drawn upon cases of outsourcing in sectors other
than airlines and anecdotal evidences found in airlines magazines and bulletins.
Rutner & Brown (1999); and Al Kaabi et al., (2007) explain activities commonly
outsourced by airlines and outsourcing models respectively. In the former,
outsourcing is categorized as very likely, likely, moderate, unlikely, and very unlikely.
Justification for an outsourcing decision is guided by the works of Quinn (1992); and
Quinn & Hilmer (1994) who suggest that non-core activities should be outsourced to
the most competent suppliers. Non-core activities in this context are described as
activities which are critically important for a business operation but its provisions can
be sourced from third party providers (Gillentt, 1994). In contrast, Al Kaabi et al.,
(2007) discussed models of outsourcing in the context of MRO. The authors
introduced four level of MRO outsourcing namely fully integrated, partially
outsourced, mostly outsourced and wholly outsourced. The basis for decision to
outsource depends on routine nature of the activities. It is suggested that routine
activities like line maintenance can be in-sourced whilst less routine activities such
as engine maintenance may be outsourced. What appears to be similar in both
studies is that outsourcing model is determined by criticality of the activities involved
in the business operation. Study in the latter would be more interesting if it is
extended to investigate the relationship between outsourcing in MRO activities and
efficiency levels of airlines.
The extent of outsourcing in different airline functions is investigated in Rieple &

Helm (2008) who examine decision to outsource by comparing levels of outsourcing
with the principle of transaction cost economics. The finding confirms that an
outsourcing decision does not always conform to what the transaction costs
economics principle suggests. Additionally, the review also suggests a mixed pattern
of outsourcing for airlines in the sample.
There are many reasons motivating firms to outsource their activities. A primary
explanation for this motivation concerning the issue of rising cost is confined in
(Deavers, 1997); and Durmaz & Adiller (2010). The former claims that cost cutting in
terms of low wages is not a mere reason for contracting out of activities but
advantageous of information technology development, risk sharing, increased
concentration on corporate competencies, global opportunities and challenges are
important motivation for outsourcing. In contrast, Durmaz and Adiller (2010) stress
that falling costs are possible through outsourcing of airlines activities which require
high technological knowledge and investment. However, the generalizability power
from the finding may not be applied to all airlines in the air transport market
worldwide as it is based on opinions from a single case airline-the Turkish airlines. In
future, the explanatory power of the finding can be improved by including more major
airlines from different regions in the sample of the survey questionnaire used.
The latest study in the decade explores the aspects of present maintenance
outsourcing practice among airlines including development in global MRO business,
decision for outsourcing, MRO models, and issues in regulatory and safety which
affect outsourcing decision. There is a need to contain rising MRO costs, therefore it
is expected that global maintenance outsourcing is in an increasing trend while
meeting with regulatory and safety standards set by the authority (McFadden &
Worrells, 2012).
2.2 Business model
Business model implies different cost structures adopted by the airline companies in
their operations. An airline may adopt a full service model or a low cost structure in
its operation. The business model adopted by an airline reflects the degree of
flexibility and independency in decision making when an airline facing turbulent
periods which can adversely affect its financial position. The faster the critical
decision is made, the better it is for airlines as they can minimize their losses
incurred from bad business performance.
The role of business model in airlines efficiency is discussed in Vlaar et al. (2005);
Alves & Barbot (2007); Barbot et al. (2008); Lee & Worthington (2010); Assaf &
Josiassen (2011); and Abda et al. (2011). These studies convey that low cost carrier
(LCC) is associated with a high level of technical efficiency compare with full service
carrier. Among the reasons for the high technical efficiency in LCC model is partly
due to the ability of the LCC to lower down their operating costs resulting from lower
average fares and generation of high volume of passengers (Abda et al., 2011). On
the other hand, Vlaar et al. (2005) contended that the sustainable profitability of LCC
is attributed to its fast extraction of value (fast adjustment in the event of changes in
the industry). One of the distinct characteristics of the LCC model is simplicity of its
corporate governance structure which permits the airline to lower cost while making
a faster decision in the event of an emergency (Alves & Barbot, 2007). For
instances, fast decision making by the management to slash routes which deems to
be unprofitable or adjusting other inputs costs in the event of skyrocketing jet oil
prices. This measure ensures airlines remain profitable in surmounting crisis period.
What remains unexamined in the above studies is the degree of outsourcing practice
in LCC business model which may attribute to the successful of the business model
adopted by the airlines. Persistence outsourced of services for activities such as
maintenance, repair and overhaul; catering, cleaning, sales of tickets and the like are
likely to lead to long term gain at the firms end so long that the primary motive for
outsourcing is not driven solely by short term tactic to cut costs down (Deavers,
1997).
2.3. Ownership and control
Types of ownership in airlines business signify the degree of control by particular

individual as shown by the percentage of share a person or a business has in an
airline company. This tells how fast decision can be made during critical period to
save costs. Public ownership of airline implies large size of corporate governance.
Hence, it is likely to slow down the decision making process, as any decisions made
must get the concern from all the board members before it is materialized. On the
other hand, a privately owned airline tend to enjoy a higher degree of autonomy in
terms of decision making, hence making this ownership type more successful than a
publicly owned ones. Other remarkable feature in airline ownership is restriction of
foreign ownership to the minimum to protect national interests. This is particularly
true for majority of the state owned airlines in the world.
The relationship between ownership types of airlines and efficiency were deciphered
in Fethi & Jackson (2000); Backx et al. (2002); Chang et al. (2004); Scheraga
(2004); Carney &Dostaler (2006); Cheon (2007); Barros & Peypoch (2009); Clement
Chow (2010); Sjogren & Soderberg (2011); and Boyd & Hollensen (2012). Studies
on the relationship between ownership types (state ownership vs private
ownership/foreign ownership) and airline performance prior to 2010 uncovered a
rather ambiguous finding to note the absence of relationship between ownership
types of airlines and its efficiency levels. This finding is unravel in Fethi & Jackson
(2000); Scheraga (2004); Carney &Dostaler (2006); Barros & Peypoch (2009); and
Sjogren & Soderberg (2011). The authors argued that what matters in ownership
types is not who owned the airlines but rather the operational objective holds by the
managers (treat the airline as a company) and the identity as well as the interest of
the owner which are more important in determining sustained performance of an
airline company.
In contrast, Backx et al. (2002); Chang et al. (2004); Boyd & Hollensen (2012)
support the notion that privately owned airlines perform better than publicly owned
airlines. The nature of studies conducted by these authors is more towards in depth
investigation on the underlying factors that drives the better performance of privately
owned airlines compare to publicly owned airlines. One of the notable drivers
highlighted by the authors is a high absorptive capacity of an airline resulting from
flexible management style and strong networks, and long term employees
relationship leading to highly competitiveness in family owned airline. In their study,
Chang et al. (2004) pointed that relaxed of ownership and control regulation is
possible so long that important issues- safety, security, economic as well as social
impact of loosening the rule is not compromised. In conclusion, there is no
consensus on whether ownership types affect the performance of airlines. Most of
the findings derived from the quantitative analysis do not support the hypothesis that
publicly owned airlines are inefficient, but the qualitative approach does.
From the discussion above, missing of best practice consideration is omitted by

airline managers. Therefore this issue merits more studies in the future looking at the
importance of best practices on a firms performance. Besides that, future research
may also employ more quantitative approaches in its analysis by extending present
estimation techniques to get a more convincing result in supporting the positive
correlation between private ownership type and profitability.
2.4. Liberalization in air transport market

a. Liberalization/deregulation
It is generally agreed at least by the proponents of free market economy that

liberalization of the air transport market leads to increased efficiency. Liberalization
eases entry barriers imposed on potential and new carriers, therefore leading to high
competition levels among the carriers in the market. In order to attract a high volume
of passengers, airlines have to cut costs so as to arrive at a lower fare otherwise
their passengers will turn to competitors who offer a competitive price.
Since the introduction of the 1978 air transport deregulation policy in the U.S., there
have been increasingly attempts to investigate the impacts of loosening air transport
trade regulation on efficiency and performance of airlines. These studies are
captured in Good et al. (1993); Marin (1998); Fethi & Jackson (2000); Wong & Chen
(2005); Inglada et al. (2006); and Sjogren & Soderberg (2011). Their findings
postulate a direct positive effect from opening up of the air transport market on
airlines efficiency. Despite positive correlations between liberalization and efficiency
of airlines, most of the studies considered periods of observations prior to year 2000
when one knows that liberalization in the air transport market in Asia began only
after 2000. Taking the finding as is without account for temporal issue may result in
misleading policy implication. It may also raise questions on generalizability of the
finding to all regions in the world particularly, Asia.
The rest of the literatures explored different issues of liberalization but still somehow
convoluted indirectly to airline performance and efficiency. For instance, Merkert &
Cowie (2012) stressed indirect effect of air transport liberalization on transaction cost
reduction. The authors contended that managers focus on customers and factor
markets is important to cut costs in the light of liberalization practice in airlines. A
smart airline manager will try his very best to deal in the very right way when liaises
with customers and factor markets. This way will ensure the firm achieved its
objective in cutting the transaction costs. What omitted in this study is an
investigation on variables that may affect the transaction cost volume. This issue is
worth considering if policy implication of the transaction cost is what the researcher
aimed to arrive at.
Starkie (2012) revealed the new form of bilateral service agreement between airline
and airport which consider consumers interests as well as protection of interests of
both airport and airline operator. This initiative will ensure long term commitment
despite avoiding disputes between all parties involved in the contract.
On the other hand, the impacts of deregulation on corporate governance features

were examined in Kole & Lehn (1999). The findings pointed out five interesting
outcomes: (1) concentrated equity ownership, (2) increasing CEO pay, (3) rising
stock option grants to CEO, (4) increased board size. The study also suggested that
changes at internal governance level are costly therefore it should be done
gradually.
An obvious denial of liberalization effect on network characteristics was found in

Daramola & Jaja (2011) who postulated that liberalization of air transport in Nigeria
resulted in dispersed domestic network. This finding challenge the opinion of
proponents in the mainstream studies who stressed that liberalization will eventually
lead to a more concentrated traffic along with few nodes. Future study in this area
may expand the scope of the study to include factors affecting network concentration
and the number of nodes. It is also worth examining the relationship between the
degree of network concentration and the efficiency of airlines. This area of study
would be very interesting as it provide a meaningful finding for policy implication to

all airlines. The validity of conclusion in this study may be further strengthened if it is
possible to check for the effects of various factors that can affect city placement like
political influence, commercial functions and geographical location in future studies.
The degree of liberalization is an issue that matter to raise the efficiency level of
airlines. Therefore, this issue requires a full understanding particularly among
managers who involved in decision making regarding liberalization agreement with
other carriers. Failure to make the right decision on the form of liberalizations which
meets the objective of liberalization of a carrier may result in larger cost implication.
For example, one may choose a multilateral agreement to pursue liberalization
initiative but this may end up with delay in materializing the agreement as it involved
concerns from multiple carriers hence implies a longer time and higher cost involved
in the process. To ensure higher efficiency level, Ehmer (2001) suggested a middle
way liberalization approach that is the contestable market as it ensures flexibility in
decision making hence promoting fast decision making process.
A more in depth study on the effect of liberalization on competition was discussed in

Dobruszkes (2009) who investigate competition at city pairs level. The finding from
this study empirically robust as it considers two different techniques in measuring
international competition at city pairs level. The empirical result from the entropy
technique revealed a contradict finding to that of the mainstream views that
liberalization results in increased competition in air carriers. Additionally, the pattern
of competition found from European sample suggests that number of competition
confines to few routes. Albeit a more caution technique used in the study to estimate
the level of competition, the study seems to have a loophole in the sense that
competition among flights with multiple stopovers were not considered in the study
due to complexity in computing the variables involved.
b. Open skies policy
Open skies policy is a much simpler form of deregulation as it marked a first

approach used in the deregulation initiative in the United States (Button, 2009). In
the move for liberalization of the international air transport market, open skies
agreement have been used as a tool to pursue the initiative of liberalization in air
transport to the level today. It does not convey that the air transport market is free
from regulations but rather it means that some of the obvious issues which were
used to be tightly controlled by the government before are now relaxed for example
the issues of routes served, capacity and service levels, and double approval of
fares to double disapproval. These measures improved the efficiency level of the
carriers involved.
A liberalization move marked by open skies agreement may lead to a more relaxed
restriction on issues like capacity, air fares, routes etc as postulated in Button (2009).
The author agreed that there remain an issue unresolved in the transatlantic open
skies agreement which is the control of states on proportion allowed for ownership of
shares by foreign companies. Airlines may improve this situation by adopting more
than a simple open skies policy approach to assume a broader definition including
free mobility of factor of productions between the parties involved in the open skies
agreement.
The open skies initiative to liberalize the regional air transport market by itself may
not lead to a success mission unless accompanied by freedoms in a broader context
including of all airlines in the region which is comparable to the freedoms granted to
the U.S. Asian region will only benefit from the open skies ties with the U.S. when
the air transport market in Asian itself is not restricted (Kim & Ha, (1998); Tae &
Yeong, (2002)). Failure to liberalize the whole air transport markets in Asia entails
that airlines in Asia are likely to lose to its partner namely the U.S. In a way, there is
a need to form a strong trading block within the region to raise the efficiency levels of
all airlines in Asia before engaging in any open skies agreement with other party who
has a liberalized air transport market (Oum & Lee, 2002).
A major departure between the two studies above is that the former highlighted three
possible solutions for the positive impact of liberalization in the air transport market in
Asia namely the need for fair competition ruling, ensuring network freedom among
airlines in Asian and allocating airport slots for new entrant airlines to ensure they
able to compete with existing players in the market. The later stressed the
importance of institution by forming Trade and transport facilitation committees
which consists representative from each countries involved in the agreement to
provide avenues for bilateral and trilateral negotiations. Both the two studies
provided solutions for greater benefits of the open skies initiative in Asia through the
introduction of a more liberal regulatory environment.
So far research on open skies have been focused on challenges faced by airlines in
open skies agreement and what determines a successful open skies initiative among
parties involved in the agreement. While open skies policies in both the United
States and Europe have met with a success for both regions, there is a need to carry
out more studies to investigate current progress made by Asia as we know that a
more serious liberalization movements only starts lately in Asia. It is also worth
investigating the progress and impediments on open skies movement in South East
Asia nation as we recognize the growing importance of air transportation in countries
like Thailand, Indonesia, Malaysia, the Philippines and Vietnam.
c. Co-operation among airlines
A common form of airline co-operation in the rise of liberalization moves in the air
transport market is an increased tendency to join alliances. This is attributed to
heavy regulations and the desire to form a global network in the air transport industry
as seen in different type of restrictions (legal, political and institutional) for merger
and acquisition in the aviation market.
Airline alliances posed positive impacts on economic welfare, better services due to
better coordination of the airlines connecting traffic, and lower unit costs (Caves et
al. (1984); and Brueckner & Spiller (1994). This indicates a fall in air fare. In addition,
Park & Zhang (2000) postulate similar findings to the two previous studies which
support the positive correlation between alliances and consumers welfare. The
results pointed that increased volume of passenger, reduce average air fare, and
increased customers satisfaction are attributable to increased alliances in airlines.
A little departure from the above studies is shown in Gayle (2007) and Du et al.
(2008). Both studies met with a consensus that code share alliances do promote
competition as can be seen in a fell in price levels and passenger volumes for all
alliance partners. What distinguishes between the studies by the two authors is that
in the former the authors find that there are no signs of price collusion among the
alliance partners, hence suggesting the decision to approve the application for code
share alliance by the members is justified. Whilst the latter find that LCCs entry into a
new market via code share alliance pose a similar positive effect (The Southwest
effect) as is the case of direct entry on the welfares of consumer and producers. The
results in Du et al. (2005) may give an interesting finding if they consider flights with
multiple stopovers instead of just focusing on non stops flight.
Although there was a debate on the negative effect of alliances which was seen as
discouraging competition (Business Week, 2 March 1998), nevertheless this claims
has been proven insignificant as the potential benefits gained from alliances was far
greater than the downside effect of the practice on competition in the air transport
market (Brueckner, 1997). This area may be worth focusing in future research so as
to shed light to present research on airline alliances.
The impacts of alliances on efficiency and productivity of airlines are well discussed
in Barros & Peypoch (2009); and Sjogren & Soderberg (2011). The findings from
both studies did not meet with a consensus where the result in the former support
the notion that alliance affect efficiency in airlines but the latter did not. The two
studies contrast in the techniques used to estimate efficiency. The former adopt a
DEA, non parametric approach, whilst the latter utilizes a parametric-stochastic
frontier approach where both approaches no less than one another as both have
advantages and disadvantages. Both approaches follow extended techniques where
Barros & Peypoch decomposed airlines according to activities or functions whilst
Sjogren & Soderberg use DEA bootstrap to raise the number of observations.
A recent trend in the study on alliance in aviation market do not look at direct
relationship between alliance and efficiency, rather the relationship is viewed from
different perspectives namely: (1) the partial antitrust immunity characteristic of
efficiency (Bilotkach & Hschelrath, 2012); and (2) an appropriate governance
structure in alliances (de Man et al., 2010). The former asserts that claims of
increased efficiency resulted from alliances should not be the ultimate basis of
assessment for granting of antitrust immunity to applicants wishing to form alliances
because the claim in itself is questionable unless followed by proof of incremental
benefits (for example the proof of an absence of anticompetitive practice). The latter
discovers the possibility of having a robust alliance model which gives equal profit
sharing arrangement among the players. An appropriate alliance model will provide a
higher degree of flexibility to airlines when dealing with turbulent periods in their
business cycle, therefore reduce the possibilities of making changes which may incur
high costs to the members.
2.5. Labour union
Union in the airline industry is one of the well established and powerful employee
institutions in an economic organization. Labour union plays an important role in
determining the salary and wage level received by its members. A powerful leader of
a labour organization will materialize the demand for good working condition, decent
salary, and other benefits for its members. Strikes by the labour union will adversely
affect the performance and may tarnish the image of an airline company in just half
day due to the nature of airline business which is heavily capital intensive (Pilarski,
2007). In a way, labour union and performance of airlines cannot be separated. It
may negatively affect the profitability of a business (Kleiner & Freeman); and (Hirsch,
2008) but not to the extent of insolvency (Kleiner & Freeman, 1994).
While there are dozens of research discussing the labour union impacts on business
performance particularly in airlines, the findings in these literatures seem to
conveyed mixed results with some studies showed positive impact of union on firms
performance whilst others contradict. Literatures that agreed with the hypothesis that
union relates positively with organization performance were found in Morikawa
(2010) and Gittell et al. (2004). Although supporting the positive relationship between
labour union and organization performance, what distinguishes between the two
studies is the flow of the relationship examined. The former looked at the direct effect
of union on firms productivity whilst the latter found other intermediate factors which
influenced airlines productivity through union characteristics such as the quality of
labour-management relationship and workplace culture. In their argument, Gittell et
al. asserts that high quality employees-management relationship and high trust
workplace culture are equally important in promoting high performance of airlines. In
contrast, Greer (2009) supports the proposition that labour union has no effect on
airline efficiency. This assertion has its logical explanation because labour union per
se may not bring to detrimental impact on operational performance of airlines but
rather the behavior and actions of its members in the event of high level of
dissatisfaction among workers which leading to strikes (to fight their rights for higher
salary and better work contract) may pose high costs to the airlines. Southwest
airlines is a good example to support this finding albeit a highly unionized employees
(82%), the airline still manage to record decent profits even during downturn periods
in air transport market. Proactive management approach towards labour union
presence and better work environments (equal treatment to all staff, respect and fun)
are among good recipes for building strong foundation in close employee-
management relation as practice by many low cost carriers such as the case of
Southwest in the United States and Air Asia-a successful LCC model in Asias
region.
The role of good human resource practice as deliberated by management style may
also affect the performance of an airline company. Through satisfaction at
workplace, proactive managers in unionized airlines who adopted a good union-
management relationship found that job satisfactions were materialized (Harvey &
Turnbull, 2006). This management feature will motivate the employees to be
productive at work. According to the literature, a good example of feasible
management style is that adopted by a subsidiary LCC in the UK-Go airlines which is
also better known for Centrifugal management approach. This strategic human
resource approach has been translated into satisfactions among its employees.
Other study which convey similar finding is also argued in Gittell et al. (2004) who
contended that high quality employee-management relationship is crucial in ensuring
high performance of airline.
Labour union also plays a dominant role in decreasing unit labour cost (real wage)
through increased productivity level (Alamdari & Morrell, 1997). Results from the
study pointed that unionized airlines in both the U.S. and the EU recorded increasing
nominal wages. There are two major differences between airlines in the EU and the
U.S. First, the increase in productivity level in EU airlines is greater that the increase
in wages but the reverse holds true for the U.S. airlines. Second, falling unit labour
cost in the EU is attributed to increased competition in the airline market, but in the
case of the U.S. decreasing unit labour cost is due to maturity in the labour-
management relation therefore a win-win situation is possible as reflected by the
willingness of employees to receive lower real wage. While in the EU an increase in
productivity is achieved in return of a slightly higher wages.
The relationship between union (organizational feature) and adaptation rate to

changes is deciphered in Nickerson & Silverman (2003). Instead of testing the direct
effect of unionization on the performance of organizations, the authors examine how
organizational features such as investment in specific assets, unionization, entrants
and incumbents influence the rate of adaptation with regards to changes faced by
the organizations. The study stressed that a unionized carrier adapts slower than a
non unionized ones attributing to a high transaction cost (adjustment cost) which
hamper organization response speed towards changes in an organization
environment. This is because fast response towards a change will entail larger
transaction costs hence affecting the willingness of firms to adjust quickly in the light
of liberalization. A firm must weigh whether to adjust, and if it chooses to adjust, the
period for an adjustment to materialize need to be compared to the adjustment costs
incurred so as to ensure the firm is not burdened with substantial costs. The strength
of this literature is that it controls for competition and pre change performance as one
knows that it may influence changes in an organization.
Declining trend in union membership in the private sector in the U.S. was driven by
the increase in competition level (Hirsch, 2008). As is generally understood, a
unionized airline has the capacity and power to negotiate a higher wage which would
result in a relatively higher wage premium than value added generated by the
employees. A highly competitive environment where the union operated may affect
its presence through influences on management opposition, worker sentiment, and
public policies.
The trend in recent studies on unionization tends to focus in the area of human
resource management. Therefore, this area of research merits further investigation.
There is a need to carry a detail study at micro level to investigate how strategic
human resource management approach may lead to good employee-management
relationship, which ultimately leads to higher satisfactions among employees and
increased their efficiency at work. These factors will lead to increased performance
of an organization. A more detail study at micro level in this area deserve greater
attention by cross examining various work environments which deems to lead to
higher efficiency and productivity levels among the employees in an organization.

Besides that, management attitude towards labour union merits more attention as it
relates to the degree of employee satisfaction hence affect the performance of an
organization.
2.6. Corporate governance
Corporate governance provides mechanisms to ensure managers realizing their

obligation in the form of returns to fund providers to compensate their investments in
a firm (Shleifer & Vishny, 1996). Scholarly works on corporate governance have
departed from the impact of corporate governance indicators on firm performance
towards trend in corporate governance approaches across nations.
Direct effect of corporate governance on airlines performance is discussed in Lu et
al. (2011); and Bozec & Mohamed Dia (2007). The former asserts that type of
governance found in low cost carriers is more efficient than full service ones. In the
later, corporate governance features such as the size of board of committee and the
degree of board independency are positively associated with firms technical
efficiency. A major contrast between the two literatures is that the former shows
direct effect of corporate governance variables on efficiency whilst in the latter,
positive effect of corporate governance only seen when market competition is
considered as control variable in the model.
Different airline cost structures are associated with different governance models
(Alves & Barbot, 2007). The authors postulate that low cost carriers adopt a smaller
governance structure than that of full service carriers to achieve cost minimization
objective and faster decision making process. The claim shows that LCCs have a
smaller size of board of committee (senior executives, board member, and board
committee) than the full service carriers have. Other distinctive feature of LCCs
corporate governance is its high coincidence of interest between shareholders and
managers. This literature is extensive in the extent of its analysis whilst taken into
account important factor like different corporate governance mechanisms in Anglo
Saxon countries which may contaminate the findings in the study (Shleifer & Vishny,
1996).
Corporate governance structure in airlines varies with countries of origin. The trend
in airlines governance approach in the U.S. tends to follow the institutional
investment wing or what is called as managerial ownership style (Carney &
Dostaler, 2006); and in China-partial privatization approach (Mar & Young, 2001).
The corporate governance model in Carney and Dostaler is featured by separation in
ownership and control of business whilst in Mar and Young it follows partial
privatization approach. This approach has led to improved efficiency level in the two
Chinese airlines studied. The finding in the latter suggested that an ideal corporate
governance model does not necessarily replicate suggestions outlined in
mainstream literatures but rather customize it with firms suitability. Another
interesting outcome in the study is that both airlines demonstrated good governance
after public listing. These show the positive effect of varying ownership shares of
airlines to public. Despite different corporate governance models adopted in the two
studies, both of them share a similar objective which is to improve their governance
levels hence raising their firms performances.
3. Variations in Allocative efficiency and factors affecting allocative efficiency
The concept of allocative efficiency deals with combinations of right inputs

proportions at the least costs in a production process to achieve a desired level of
output using current technological constraint (Baumol & Blinder, 2003). A profitable
firm is usually allocatively efficient at least in their operation. Any factors which distort
the free movement in prices will lead to inefficiency. Therefore, factors such as
ownership of firm, government intervention in labour contract and prices may
negatively affect firms allocative efficiencies.
Allocative efficiency is an area that requires substantial debates by scholar and

practitioners in the airline business. Although this area is not new in studies of firms
performance, as far as the air transport market is concern, there are little studies
investigating allocative efficiency in airline. The exceptions are literatures in Sickles
et al. (1986); Khumbhakar (1992); Atkinson & Cornwell (1994); and Ajayi et al.
(2010). Sickles et al (1986); and Khumbhakar (1992) postulates that allocative
inefficiency present in both periods, in the pre and post deregulation in the U.S
airline market. The presence of allocative distortions in the above studies may be
related to the fact that air transport market in the U.S. is heavily regulated at least in
terms of control on foreign ownership albeit the massive campaign for liberalization.
The impact of airline size is explained in Ajayi et al. (2010). The author stressed that
large airlines tend to be allocatively efficient when compared with small airlines. This
finding is in line with the result revealed in Barros and Mascarenhas (2005) in their
paper on technical efficiency and allocative efficiency of state owned hotel chains in
Portugal. Barros and Mascarenhas assert that hotel scale does affect their
efficiencies. These literatures suggest that economies of scale plays important role
on the allocative efficiency of an organization. To complement the above researches,
Ajayi et al. (2010) also pointed that the magnitude of allocative efficiency correlates
positively with the magnitude of return on equity.
The presence of allocative distortion in airlines operation due to overutilization of

labour input over capital input is evidenced in Atkinson and Cornwell (1994). In their
study, the authors consider both measures of efficiency (technical and allocative
efficiency). By and large, the literature pointed that issues related to cost are best
dealt with allocative efficiency. It is also concluded that both technical efficiency and
allocative efficiency are equally important and must be considered in studying firms
performance and must be jointly measured. The strength of this article lie on a strong
methodological approach which avoided few issues related to non parametric
approach namely the issues of bias estimate due to the short nature of observation
in cross section data, assumptions of error distribution, and technology.
Methodologically, an obvious pattern detected from the above literatures have

confined to parametric estimation of allocative efficiency. This is probably due to
various assumptions explained in earlier paragraph when one adopts parametric
approach. From the four studies, only Ajayi et al. (2010) use non-parametric DEA
approach in their work. Other commonalities are in terms of data employed in the
study where the sample of airlines used are mostly confined to U.S case whilst in
terms of the length of studies are limited to the periods from 1970s to 1980s. In
general, all the studies above show the presence of allocative distortions in the U.S
airlines in terms of inputs usage.
There is a common gap detected in past literatures where to our knowledge, almost
all studies focus on U.S and European airlines and in most occasions have omitted
airlines in other regions particularly Asia. This region deserves further investigation
as it dominates market shares for both international passenger and cargo segments.
As far as the air transport market is concerned, there are little studies done after year
2000 on airlines allocative efficiency although much of the problems in the airlines
industry assiduously link to unprofitability. These gaps merit more attention in the
future.
4. Determinants of productivity variations and sources of productivity growth
Productivity issues in the airlines sector have drawn the attention of many
researchers recently due to increased competition facing the industry particularly in
the context of international market segment. Current research on airlines
productivity has mainly focused in two aspects: drivers of productivity variations and
sources of productivity growth.
Factors that affect productivity variations in airlines are discussed in Schefczyk

(1993); Truitt & Haynes (1994); Oum and Yu (1995); Oum et al. (2004); Oum et al.
(2005); and Sjogren & Soderberg (2011). Strategic management plays important
roles in contributing to higher productivity level in airlines. An airline manager can
realize a higher level of productivity through reduction in asset sizes which are not
related to aircraft operation (Schefczyk, 1993) or employ larger size of aircrafts
(Truitt & Haynes, 1994). On the other hand, market dynamic as shown by the impact
of liberalization on productivity of airlines is debated in Windle (1991); Oum & Yu
(1995); and Sjogren & Soderberg (2011). These literatures suggest that liberalization
affect productivity of airlines in a positive manner. Windle (1991) makes an important
contribution to liberalization study as he suggests that liberalization must accompany
by increased traffic density in order to close the productivity gaps between U.S and
non-US carriers.
The impact of alliance membership on productivity conveys a mixed result as

detailed in Sjogren & Soderberg (2011) who find no consensus in the relationship
with productivity for both total and aggregated models but Oum et al. (2004) shows a
positive relationship between horizontal alliance and productivity level which is driven
by high level of co-operation between alliance members. Both literatures employ
strong methodological frameworks to estimate productivity level. The former
analyzing productivity in two approaches: aggregated and disaggregated (airlines
activities are decomposed into three models) whilst the latter compute the residual
TFP using regression analysis in Caves et al. (1981 (a) and (b) ) which account for
effects of output characteristics like average stage length and composition of output.
On the other hand, the issue of total factor productivity (TFP) as insufficient indicator
for financial improvement is addressed in Oum et al. (2005) who suggest that unit
cost competitiveness and average yield indexes are used together with TFP to
reflect the true performance of airlines. The authors pointed out that relying merely
on one performance indicator for instance the TFP may give a misleading
interpretation on the actual performance of airlines. Empirically, the study found a
negative relationship between rate of fleet expansion and total factor productivity.
Other interesting area which has invited many studies is sources of productivity
growth. The role of the technical efficiency in explaining a slow productivity growth in
Indonesia is discussed by (Ceha & Ohta, 2000) and Chow (2010). The role of labour
as a source of productivity growth is conveyed in Duke & Torres (2005); and Barbot
et al (2008). What distinguishes between the two literatures is measurement
approaches. The former uses a more reliable measure of productivity or what is
called as multifactor productivity whilst the latter follow the traditional approach.
What seems to be missing in productivity literatures is that there is lacking of study

investigating sources of productivity growth related particularly to airlines in Asia. As
airlines in Asia signed for more open skies agreements with developed countries in a
move to liberalize the aviation sector in the region, there is a critical need to
reinvestigate the implication of the open skies agreements on productivity level and
hence the sources of productivity growth.
5. Areas for future research
The survey discovers several missing areas which are possible to shed light to
current literatures in the scope of airline business. Future research may consider
these areas in order to contain current issues sprawling across airlines performance.
Present studies on business model do not go beyond stating that low cost carrier has
a fast degree of value extraction. The question on factors determining fast extraction
of value in LCC model is yet to be explored. Besides that it is also worth examining
current characteristics of management best practice adopted by LCCs in order to
come with an appropriate policy implication on value extraction.
While acknowledging that liberalization is an important feature that has greatly

influence airlines performance, it is worth to find the empirical link between the
liberalization and ownership and control by foreign firms. This will provide additional
context to existing knowledge in the area of study. Besides that there is virtually no
attempt to investigate whether airlines characteristics (free management style,
strong network and long term employee) related to high absorptive capacity
associated with family owned airline also present in currently successful other
models of airlines (Low cost and full service carriers). Methodologically, quantitative
study on ownership needs to seek for better measurement than present
measurements use to proxy for ownership. Constant searches for appropriate
proxies for ownership variable will lead to more meaningful findings regarding the
relationship between ownership and performance in airlines.
One of the areas in liberalization to study the effect of transaction cost on

liberalization of airlines has overlooked the question regarding variables that may
affect volume of transaction costs. Present papers only look at indirect effect of
transaction cost on efficiency due to liberalization but did not extend the scope to
investigate other issues that may possibly drive affect transaction costs. Another
worth examining area yet unexplored in this context of study is the issue of
applicability of middle way liberalization approach which was concluded as current
trend in airline liberalization merit more investigations to see the link with airlines in
Asia given the different characteristics internally and externally in the regions
airlines. As for airline alliances, further researches are needed in order to arrive at a
conclusive result contending that airline alliances lead to reduction in competition
level. Not only that, the scope of incremental benefits as a basis in granting
application for airlines alliances may be broaden to encapsulate aspects beyond
anticompetitive justification.
As far as the open skies policy is concerned, there are few areas in the study which
are left unchecked. First, to investigate the impacts (economic benefits) to airlines in
Asia due to broader definition of open skies resulting from the inclusion of free
mobility of factor of production for example (how outsourcing of labour, capital,
services in open skies members affect benefits received by parties involved in the
agreement). Is there any association between different models of open skies with
the type of business models or the market structures of particular airlines. It is also
worth investigating recent progress or achievement in open skies agreements
materialized between airlines in Asia to check its readiness to liberalize their market
to the U.S. and the EU regions. Are there any special arrangements needed for
Asian case to fully liberalize its air transport market besides the need to observe fair
competition, network freedom, and allocation of airport slots to new entrants as
suggested in current literatures.
While current literatures in research on outsourcing in airlines acknowledge the

implications of outsourcing on human resource issues such as transfer of employee
to contractual firms, employees loyalty and satisfaction, there is no effort in present
literatures to investigate the impact of outsourcing on quality of human capital in the
outsourced airlines. This factor is critically important because it is generally known
that high quality human capital lead to higher work performance hence is a valuable
asset to a firm. Another area which receives little attention in the study on
outsourcing is the absence of research to link specific area outsourced which
account for a larger portion of operating cost (outsourcing of maintenance, repair and
overhauls activities) to efficiency of airline. Given the unique characteristics of Asian
airlines, it is also interesting to examine what model of outsourcing is appropriate for
airlines in Asia.
Considering a highly performed LCC model as posed in Southwest airlines yet highly
unionized, it is worth investigating and comparing which motivations (monetary
benefits or self-esteem as featured by high work trust culture) matter much in
determining a quality employee-management relationship as detailed in Gittell et al.
(2004). Future research may link the motivations in full service airline and LCC
models with quality employee-management relationship. In the context of airlines in
Asia, it is worth examining various dissatisfactions commonly raised by unions in
order to look at its association with performance. Next, the status of union presence
in the context of Asian airlines and its link with bargaining power and performance
deserve more investigations.
Despite mounting studies investigating corporate governance in airlines, there is

virtually no study examining the association of market dynamics (such as
liberalization and other types of market uncertainties (endogenously or exogenously
determined) with corporate governance practice.
In the context of allocative efficiency, most studies focused on cases in well

developed countries but little efforts made to research the issue in Asian region.
Besides that, other area that is lacking of focus in current literature is pertaining to
factors that affect allocative efficiency. Despite the positive relationship between
economies of scale (size of firm) and allocative efficiency, other characteristics such
as endogenously and exogenously determined characteristics get little attention from
researchers in this area. The link between corporate governance, ownership, firms
objectives and policies of airlines with allocative efficiency deserve greater amount of
studies in the future.
Present studies pertaining to productivity in the airline industry have vastly

concentrated on issues of airline characteristics such as aircraft size, rate of fleet
expansion, and market changes (alliance, ownership, and liberalization). However,
neither the amount nor the detailed investigations are satisfactory at least as far as
the context of the air transport industry is concerned. These gaps imply more studies
are required to complement existing literatures in this particular area. In addition,
sources of productivity growth also lack in attention. Current finding in the study in
this area have confined to traditional concept of input (particularly labour). There is
very little or virtually no study focus beyond the traditional definition of capital to
include human capital in this context. Besides acknowledging that airlines business
is highly capitalized and that aerospace technology evolves very fast, there is
virtually no research attempt to link technological advancement (technological
development) with sources of productivity changes in the airline industry.
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Proceedings of 3rd Asia-Pacific Business Research Conference

25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1

A Critical Review of Literature on Performance of Airlines

JEL Codes: D24, L25, L93

Muhammad Asraf Abdullah, Department of Economics, Faculty of Economics and Administration,

Despite critical need to address issues in airlines performance, to our knowledge

2. Efficiency estimates and determinants of airlines technical efficiency

Outsourcing is not a new phenomenon in the era of increased liberalization today.

The extent of outsourcing in different airline functions is investigated in Rieple &

2.2 Business model

2.3. Ownership and control

Types of ownership in airlines business signify the degree of control by particular

From the discussion above, missing of best practice consideration is omitted by

2.4. Liberalization in air transport market

It is generally agreed at least by the proponents of free market economy that

On the other hand, the impacts of deregulation on corporate governance features

An obvious denial of liberalization effect on network characteristics was found in

would be very interesting as it provide a meaningful finding for policy implication to

A more in depth study on the effect of liberalization on competition was discussed in

b. Open skies policy

Open skies policy is a much simpler form of deregulation as it marked a first

c. Co-operation among airlines

2.5. Labour union

The relationship between union (organizational feature) and adaptation rate to

higher efficiency and productivity levels among the employees in an organization.

2.6. Corporate governance

Corporate governance provides mechanisms to ensure managers realizing their

3. Variations in Allocative efficiency and factors affecting allocative efficiency

The concept of allocative efficiency deals with combinations of right inputs

Allocative efficiency is an area that requires substantial debates by scholar and

The presence of allocative distortion in airlines operation due to overutilization of

Methodologically, an obvious pattern detected from the above literatures have

4. Determinants of productivity variations and sources of productivity growth

Factors that affect productivity variations in airlines are discussed in Schefczyk

The impact of alliance membership on productivity conveys a mixed result as

What seems to be missing in productivity literatures is that there is lacking of study

5. Areas for future research

While acknowledging that liberalization is an important feature that has greatly

One of the areas in liberalization to study the effect of transaction cost on

While current literatures in research on outsourcing in airlines acknowledge the

Despite mounting studies investigating corporate governance in airlines, there is

In the context of allocative efficiency, most studies focused on cases in well

Present studies pertaining to productivity in the airline industry have vastly

Abda,M.B.,Belobaba,P.P., & Swelbar,W.F 2011, Impacts of LCC growth on domestic

Coelli,T.J., Perelman,S. & Romano,E 1999, Accounting for Environmental

Airways/Go and bmi/bmibaby. European Management Journal, Vol.24, No. 5,

Morikawa,M 2010, Labor unions and productivity: An empirical analysis using

Sickles,R.C., Good,D.H. & Johnson,R.L 1986, Allocative Distortions and The

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