Originally Posted by PpruneZeuss
the plagiarized piece of economic fadism posted by PAF.
I think you need to recheck the definitions of a quote and plagiarism.
Sunfish:
Your example is fine as such but consider Relevant Cost if you are comparing operating a Jetstar Aircraft vs. a QANTAS aircraft. I don't think your example really considers mutually exclusive projects. Not to mention the fact that proper analysis of Fixed Costs would not result in the decision you highlight in your example. You're right though that the allocation of fixed costs to specific projects can be a pitfall - however I'm not sure how this applies to the Jetstar / QANTAS example (aka GD performance)
NPV (Net Present Value) is the key. Especially if you consider the Jetstar creation / expansion as a mutually exclusive project to expanding mainline. The highest NPV wins.
Comparing various projects across an enterprise purely on the basis of return is a bad way to do things. It implies that the cost of capital for a particular project (i.e. the risk) is the same as the average for the enterprise. The market demands that the return on equity is based on the risk to that equity. Naturally if QANTAS changes its risk appetite then things change.
What you should be asking is does Jetstar add to the shareholder value of the Qantas group? If it does the next question is which adds more to shareholder value - ploughing resources into Jetstar as opposed to mainline.
All other things being equal - the market opinion of QANTAS (Geoff Dixon, the board et al) is factored into the share price. If that has been rising it either implies that the market is expecting or witnessing increased returns or the risk level of QANTAS as a business has fallen.
Contribution Margins can help when allocating a scarce resource so yes if pilots / aircraft etc can be transferred between the group, Contribution margins (especially during a pilot shortage) may be relevant. However I'd assert that's a short term decision.
For example which route to allocate airframes and crew to in the next few months. The introduction of something like Jetstar is a long-term decision (i.e. Capital budgeting decision). As such NPV is the order of the day.
I think your fascination with Contribution margins is based on some experience you've had with short term resource allocation. Add into the NPV mix sensitivity analysis and Jetstar may look even better.
So in short - no I haven't just discovered "contribution margin" I just don't think it's applicable to capital budgeting decisions. There is a reason why the majority of CFO's use NPV.
It's not a one sided "I love management" perspective. My opinion works both ways. For example I think that any pilot signing onto a 5 year (or even 3 year contract - AWA or EBA) at the moment for a pay rise you would like this year is crazy. Again it comes to risk - the airline can see a near full employment economy (possible inflation) and looming pilot shortage. They are just transferring the risk of these increases to pilots.