Thursday, March 20, 2014

Aircraft fleet planning and management - the dark, deep money pit

As we all have heard numerous times in our aviation career: 'How do you become a millionaire? Simple, start with a billion and open an airline.' Oversimplified as it may be, in essence there is some serious truth in this overly utilized speech opener at various trade seminars and congresses. And the one aspect of any operation that has the potential to break your operation even within a few weeks is not mismanagement, a wrong strategy, or even underfunding, it is the one of aircraft acquisition.

Think about it. One way or another 'soft' mistakes and errors, such as a falsely estimated budget, or the wrong skill set of key employees, can be altered in the short to mid term. True, it might not be easy, especially in cases where hard currency is involved, yet in these circumstances there is always light at the end of at least one particular tunnel. It is up to management to find and successfully enter that one tunnel with the light at the end. However, once you committed your investors' hard earned greenbacks on a piece of metal that the manufacturer claims is capable to take to the skies gracefully, safely, and economically, your balance sheet shows a large negative from day one. And with list prices in the high double millions nowadays - total investment in current dollars per aircraft seat has risen over the years - that large negative has the potential not only to become a haunting nightmare but more importantly to close your shop.

Proper fleet planning and subsequent management is therefore not a luxury or a piece of research that only is done with large air operations. It should also not be an exercise only to be done by a few employees. The topic is so important that potentially all divisions within an airline, however small or large, together with aircraft sellers and manufacturers should make serious efforts to come-up with the ideal solution together. After all, the worst case scenario of having the wrong fleet is for the airline to go bust fairly quickly thus threatening each employee's job. And don't think that once you have any aircraft in your fleet, you are able to wrap the airline's strategy around the aircraft type. Despite what regulators like to tell you, aviation still is one of the most ridiculously regulated industries in the world. Even if you are able to find a strategy that works for a particular aircraft within a short time span, no regulator will act fast enough to grant you the necessary permissions to change your business model around in a time frame short enough to defer serious financial implications.

But what exactly is fleet planning and management? And how do you go about it? This article tries to relate my personal experience as upper management with various air operations in a short and concise article. With the limited space I have here available, I do not claim that this article addresses all steps necessary in-depth. However, it should give a succinct overview that, if nothing else, provides you with a good starting point when a fleet change, or a start-up, becomes imminent. Please feel free to tell me if you feel that I missed a major aspect of fleet planning and management. Contrary to what my co-workers might tell you, I do not bite!

Fleet management, as used in this brief, comprises the following integral aspects:

  • Fleet planning and acquisition;
  • Fleet operations;
  • Fleet maintenance; and
  • Fleet disposal.

In order to have a successful fleet management strategy in-place, it is very important to address and implement the topic round-circle. You can have the best aircraft purchase strategy in-place, when you lose big bucks at the end of the aircraft's life-cycle, overall your operations will lose money and your shareholders will be less than happy with your performance. It is also important to remember that fleet management is a continuous process. General markets, and thus your audience, change continuously. Demographics change over-time. Purchasing power will rise or fall cyclically or after sudden spikes. Eve your airline strategy probably changes over-time. Hence your airline's optimal fleet changes continuously. Of course, it is virtually impossible to have the ideal fleet available to your audience at any moment in-time. After all, aircraft, despite its way of procurement, is always capital intensive and thus at least a mid-term investment. However, a suitable mix of owned, leased-back, dry- or wet-leased aircraft according to the airline's strategy will smooth-out, at least financially, most short-termed changes in demand.

Unsurprisingly, and at the very basic level, the main objective of fleet planning is to have at least an efficient capacity equal to demand. Note the word efficient. An A380 easily provides capacity well beyond demand of a regional third-tier route. It does not require an MBA to establish that this solution does not make economic sense, however (although it might make sense to deploy an A380 on such a route for political reasons, for example). Efficient in this sense therefore refers to optimal payload-range, environment, operating and maintenance cost, insurance and legal capabilities. As stated, passenger appeal does sometimes spoil this hard fact research, as can be seen with the Emirates strategy of dispatching B777s and A380s on routes that would make more sense for smaller aircraft. JAL, on the other hand, switched its B744 fleet to B773ERs in order to lower emission output, operating, and maintenance costs.

Ideally, the aircraft evaluation research should be aligned with the following current and future aspects of your operations:

Network - not only own fleet - frequencies flown, which determines the fleet's payload requirements (don't forget to address belly cargo numbers and projections);
Routes flown, including alternates and meteorological assumptions, which determines the fleet's range requirements;
Airport data, such as runway length, obstacle clearance, meteorological conditions, taxiway and apron width and load-bearing factors, terminal capacity, which determines required fleet performance data;
Current fleet and support facilities (incl. logistics and inventory costs), which establishes training and maintenance requirements;
Passenger expectations, which establishes product and IF-service requirements.

This first step within the fleet management research immediately presents you with a problem: it is based on demand models, and as with any assumed model, such a demand model possesses many variables with only a limited accuracy. The market establishes the airline's market share and thus potentially its revenue. However, all these variables are assumed and forecasted and thus prone to - sometimes quite considerable - variations.

We all know that the current success of some of the GCC carriers is based on their central geographical position linked to a low-cost payroll. But what will happen to these airlines' current major fleet orders when (not if) aircraft range capabilities become so sophisticated that stop-overs in the GCC will be no longer necessary? After all, current orders only generate actual deliveries in a few years time by which time new technology will have experienced potentially huge leaps.

There are basically two different forecast models in use today. The top-down model that links forecasted RPM to at least ASM (which again leaves you with the problem that any fleet is a static asset in the mid-term while markets are much more volatile), and the bottom-up model that takes current market data (not only of one's own airline) and starts developing different forecasts based on variables, such as network developments, new market entrants etc. The problem with the latter model is that there is obviously no historic data available for new routes and that small carriers usually do not have the budget necessary to participate in a GDS that is able to provide this data. In order to balance-out the inadequacies of either model as much as possible, one should always strive to combine both models to the largest extent possible.

Cost analysis, i.e. fleet capital costs and operating costs, then is a "mere" accounting problem and can rely on much more reliable data. Not to over complicate matters, capital costs are usually (depending on the individual airline) divided into the following sub-categories:

Capital costs =

Aircraft list price
+ Aircraft options
- Negotiated discount

= Aircraft contract price
+ Agreed price escalation (something that airlines less and less accept)
- Costs of services rendered by OEM "for free"
+ Change orders

= Fly-away price
+ Product / service support (such as training, spare parts etc.)

= Total investment

And as already stated, total investment in current dollars per aircraft seat has risen over the years.

There are obviously a number of other important aspects to fleet management. Powerplant analysis is such a necessary and important research. Life-cycle costs of engines have the potential to contribute up to 50% of total life-cycle DOCs. And one should always have a clear picture on legislation and insurance issues when considering aftermarket parts. As a rule-of-thumb, maintenance cost of engines is the key driver on short-haul operations with take-offs producing the highest stress on the engine's hot section and turbine, and fuel burn is the key driver on long-haul aircraft.

Avionics analysis then has become somewhat less important with new aircraft over the years since the current trend is for OEMs to supply the complete avionics as an integrated package. The advantage with powerplants and avionics is that passengers usually do care to a lesser extent what goes on technically in an aircraft. They very much do like to see the latest cabin and IFE technology but leave the actual cockpit instrument package to the pilots to worry about.

I say it again, however, regulations do tend to get overlooked in any planning process and have the potential to seriously harm your future operations. For the ones that know me personally, the following piece of advice might therefore come as a bit of a surprise: keep a thorough and friendly relationship with your regulatory authority. If not for the sake of you personally, then for the sake of your shareholders and thus ultimately your job! And with that over to you...