An Analysis of Cost Efficiency Comparison Using a Stochastic Frontier Model - Korean Full-Service Carriers and Low-Cost Carriers -
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With the advent and growth of low-cost carriers (LCCs) in Korea, the aviation market is saturated and competition is intensifying. As costs per unit and break-even ratios are expected to increase, airlines need to strengthen their competitiveness through operational improvements and cost efficiencies. This study investigates the cost efficiency standing of Korean full-service carriers (FSCs) and LCCs and determines factors that affect such efficiency. The stochastic frontier analysis was used to determine cost efficiency. First, the cost efficiency level of Korean FSCs and LCCs was analyzed, showing that FSCs achieve higher cost efficiency than LCCs by 12 percentage point on average as well as a gradual increase in the efficiency level of FSCs over time. The result from the maximum likelihood estimation indicates that an increase (decrease) in available ton kilometers and load factor (available ton kilometers) increases costs of FSCs (LCCs). As a result of the empirical analysis of the cost factors that affect airline operating expenses, I confirm that an increase in wages increases the operating expenses of both FSCs and LCCs. I also find that the lower the flight frequency of FSCs, the higher the operating expenses and that maintaining a higher number of airplanes and a higher level of leverage increase LCCs’ operating expenses.
Abstract
With the advent and growth of low-cost carriers (LCCs) in Korea, the aviation market is saturated and competition is intensifying. As costs per unit and break-even ratios are expected to increase, airlines need to strengthen their competitiveness through operational improvements and cost efficiencies. This study investigates the cost efficiency standing of Korean full-service carriers (FSCs) and LCCs and determines factors that affect such efficiency. The stochastic frontier analysis was used to determine cost efficiency. First, the cost efficiency level of Korean FSCs and LCCs was analyzed, showing that FSCs achieve higher cost efficiency than LCCs by 12 percentage point on average as well as a gradual increase in the efficiency level of FSCs over time. The result from the maximum likelihood estimation indicates that an increase (decrease) in available ton kilometers and load factor (available ton kilometers) increases costs of FSCs (LCCs). As a result of the empirical analysis of the cost factors that affect airline operating expenses, I confirm that an increase in wages increases the operating expenses of both FSCs and LCCs. I also find that the lower the flight frequency of FSCs, the higher the operating expenses and that maintaining a higher number of airplanes and a higher level of leverage increase LCCs’ operating expenses.
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