Financial metrics like sales, working capital, and asset ratios are popular tools for predicting financial anguish, particularly in industries such as airlines. New research from Vanderbilt faculty Yasin Alan, assistant professor of Operations Management, and Michael Lapré, the E. Bronson Ingram Professor of Operations Management, finds that operational metrics have predictive power as well.
Their study, recently published in Production and Operations Management, finds that airlines with inferior revenue management, lower aircraft utilization, higher operational complexity, and extreme service failures (as measured by delays of 2 hours or more and passenger complaints concerning mishandled baggage) face higher future financial distress.
“Historically, bankruptcy prediction has been a finance topic, so the low-hanging fruit is to look at financial statements and find ratios,” Alan explained. “But those ratios typically mask operations because they are calculated at a very aggregate level. What we’re showing here is that operational metrics can be better predictors of future financial distress than some widely used financial ratios.”
Using quarterly data from 1988-2013 for publicly traded U.S. airline companies, the authors build a model linking operational performance to measure distance to default, an established measurement of financial distress.
The operational factors they selected for analysis are common benchmarks in the airline industry. For airlines, revenue management—the practice of maximizing revenue for planes with fixed seat capacity—involves practices like overbooking, differential pricing, and seat allocation to high-value and low-value passengers. Operational efficiency is measured by fleet utilization (“planes in the air”) and fuel efficiency. Service quality boils down to on-time performance and mishandled baggage, while operational complexity involves fleet makeup (types of planes flown), airport selection, and route networks.
The authors’ model provides the airline industry, the investment community, and regulators a new tool to assess and compare the financial performance of carriers using operational data made publicly available from the U.S. Dept. of Transportation. As an example, the authors analyzed major U.S. airlines from 2005-2013; they found that Southwest was leading the industry in terms of operational performance and financial health and that the bankruptcy probability was sensitive to operational performance for others.
The authors also found that their model outperformed more traditional, financial-based models using the same data set, underscoring the efficacy of operational metrics.
“The superior predictive ability of our model implies that financial metrics do not fully explain the future financial performance of a firm,” Alan and Lapré wrote in the study, “and that operational performance can be a leading indicator of financial performance.”