Analysis of the profit function of Ryanair, Europe's biggest airline and a worldwide innovator on cost leadership. For this analysis I first built a revenue and a cost function. Then, I used some real life examples to back up how the airline's pricing system works.

1. Ryanair: the Profit
Function
RODRIGO ÁLAMO SANZ

2. AGENDA
1. Introduction to the business
2. Cost function
3. Revenue function
o Yield Management pricing technique
4. Supporting examples
o Big price differences without cost differences
o Ryanair’s CEO on free flights
o Flights for 0,98€

3. 1. Introduction to the business
High prices and lots of
premium services
low price, no frills,
high rotation
The airline industry is defined by two main characteristics:
•High fixed cost
•Low margins
In the past, airlines overcame this threshold by charging high prices for tickets, and providing
lots of extra services free of charge (bags, food, press).
Ryanair came into scene overcoming the high fixed costs by pushing up the demand by offering
low prices and no frills, while performing a high rotation on assets (aircrafts). This allowed for a
higher return on assets and a lower opportunity cost. A grounded plane only produces costs.

4. Cost function
§Fixed costs
§ Planes
§ Airport slots
§ Fixed maintenance
§Variable costs
§ Fuel
§ Staff
§ Variable maintenance
§ Airplane rotation
opportunity cost
Cost function
𝐶𝑜𝑠𝑡 = FC + VC
𝐶𝑜𝑠𝑡 = 𝑝𝑙𝑎𝑛𝑒𝑠 + 𝑠𝑙𝑜𝑡𝑠 + 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 +
𝑞 𝑑 𝑓𝑢𝑒𝑙, 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒, 𝑠𝑡𝑎𝑓𝑓, 𝑂𝐶
𝑀𝐶 =
789:;
7<
= 𝑑 𝑓𝑢𝑒𝑙, 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒, 𝑠𝑡𝑎𝑓𝑓, 𝑂𝐶
Cost function explanation
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 of
0. Therefore, passengers cannot be q. Instead, we apply the Hicks Commodity Composite Theorem, which states that if the prices
of a group of goods change in the same proportion, that group of goods behaves just as if it were a single commodity. Our
independent goods are passengers, and the single commodity a plane. Hence, we define the variable cost as q (number of
flights) multiplying d, which is a function of the distance a plane flies, define by the fuel, staff, variable maintenance, and airplane
rotation 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 equals
the extra distance an aircraft flies, regardless the number of passengers it is carrying.
Costs disclosure:

5. Revenue function
Income sources:
§Flight tickets
§Ancillary revenues
§Shared revenues with airports
§Public grants
§Airplanes
§Airport slots
Revenue function*
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑝 ∗ 𝑞
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 1 + 𝑎 𝑃 ∗ 𝑞 ;
𝑎 =(ancillar𝑦, 𝑠ℎ𝑎𝑟𝑒𝑑 𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠, 𝑔𝑟𝑎𝑛𝑡𝑠, 𝑎𝑖𝑟𝑝𝑙𝑎𝑛𝑒 & 𝑠𝑙𝑜𝑡 𝑟𝑒𝑛𝑡𝑎𝑙)
𝑃 = 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 𝑡𝑖𝑐𝑘𝑒𝑡𝑠 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 tickets
Revenue function explanation
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 income
when 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 is
composed of the two types of tickets available: discounted and premium tickets., which are explained on the following
slide.
*: assuming full airplanes. Ryanair occupation for 2016Q3 was 95%.

6. Revenue function: yield management
Ryanair employs yield management to set the price of the
tickets.
The company sets its revenue function (red line)- a bulk
price for the plane (blue & yellow areas)- and later adjusts
the prices of the tickets within the plane to reach the
desired profit.
These adjustments aim to match the demand curves of
the passengers with the prices offered.
With many seats available, the demand is elastic and
therefore a low price is given. With few seats are available,
the demand curve is inelastic and therefore a high price
can be charged.
The revenue function accounting for each passenger*
would be the summation of the price paid, multiplied by
the ancillary revenues multiplier, and all multiplied by the
number of flights flown.
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑞 ∑ 𝑝P 1 + 𝑎QRS
Q *: Ryanair only operates Boeing 737 with 189 seats

7. We are analyzing 2 flights: Milan-Düsseldorf and
Milan-Catania. There is a 400% price difference
between them, despite no accounting cost differences.
This has to do with yield management adjustments.
For Düsseldorf, leisure travelers have an elastic
demand, while executive travelers have a very inelastic
demand curve. Ryanair didn’t change the total profit,
moreover the company increased the slope of their
revenue curve, offering lower prices for elastic
demands and higher for inelastic. The consumer
surplus is brought to 0.
Meanwhile, Catania has a very inelastic demand,
driven by Sicilian expatriate returning home for
Christmas. Ryanair moved up the curve, obtaining a
higher profit, and lowered the steepness of the curve.
In this flight, differences between the first and the last
ticket sold will not be big, but the total revenue of the
flight will be higher.
Examples: Big price differences without cost differences
1000 km straight line from Milan
400% price difference

8. This quote is obviously an exaggeration, but it
has economic foundations.
For Ryanair, ancillary revenues represent 25%
of the total (other revenues are not disclosed).
O’Leary referred to the multiplier we built, a.
By sharing revenues with airports, or by any
other alternative source of income, a rises and
therefore the revenue rises. If a rises more
than P, the revenue is higher on lower ticket
fares.
This initiative could even be feasible, by
offering free instead of discounted tickets, but
still charging high prices to passengers with
inelastic demand curves.
Examples: Ryanair’s CEO on free flights
“I don’t see why in 10 years’ time you
wouldn’t fly people for free. Why don’t
airports pay us for delivering the passengers to
their shops?”
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 1 + 𝑎 𝑃 ∗ 𝑞
𝑎 =(ancillar𝑦, 𝑠ℎ𝑎𝑟𝑒𝑑 𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠, 𝑔𝑟𝑎𝑛𝑡𝑠, 𝑎𝑖𝑟𝑝𝑙𝑎𝑛𝑒 & 𝑠𝑙𝑜𝑡 𝑟𝑒𝑛𝑡𝑎𝑙)
MICHAEL O’LEARY
CEO OF RYANAIR

9. When planning the marketing campaign, the costs were calculated
using economics costs, and therefore the unearned revenue. Low
initial price in this route allowed for a lower economic costs.
Inelastic demand for last tickets would even permit rising prices for
the last seats sold, having an extremely steep revenue function. This
would make the revenue of the flight equal to the normally priced
one.
Examples: flights for 0,98€
The airline wanted to do a marketing campaign
offering extremely cheap flights.
As stated before, Düsseldorf has a very steep
revenue function, and initial tickets are sold at
low prices.