By Bill de Decker, Partner, Conklin & de Decker

Fractional ownership's impact on long established aviation departments is a hot topic. It struck us here at Conklin & de Decker that in all the heated discussion some fundamentals are being overlooked.

A graph from our textbook Aircraft Acquisition Planning illustrates the fundamental reason why fractional ownership is, and will, continue to replace some corporate flight departments-cost. What the example in the graph illustrates is that the cost of a fractional program is less than the cost of the in-house aviation department when the annual utilization is less than 300 hrs. In an economy where investors and shareholders demand ever more shareholder value, a company cannot afford to keep an in-house aviation department if an equivalent service can be obtained from a contractor for less. It is called "out-sourcing" and it is a fact of life in today's corporate world.

Historically, senior management and investors focused on ownership of assets and full time employees to control quality, productivity and cost. Today neither ownership of assets nor full-time employees are a necessary prerequisite to maintaining high quality, improved productivity, low costs and the creation of wealth. In fact, experience shows that out-sourcing can decrease costs and allow faster responses to changing market conditions.

This change in thinking has created a generation of managers and investors who are convinced that out-sourcing support services (and even core business functions) makes good business sense. Whole industries have sprung up to provide contract support services such as training, data processing, building maintenance, food services, security, temporary staff, graphics support and programming. Now this trend enters corporate aviation and it aligns itself with current management philosophy.

Does that mean that the traditional corporate aviation department is doomed? Hardly! But to survive many corporate aviation managers will have to change the way they run their flight departments. They will have to become managers first and pilots second. They'll have to take a pro-active role in figuring out how their aviation department can add value rather than being perceived as a financial "sinkhole," (to use the words of more than one CFO). In short they will have to focus on the fundamentals of running a service business in a highly visible, highly competitive environment.

Flight department focus areas

The first step is to know the competition. Much has been written in the aviation press about fractional programs from the pilots' point of view. And most of it dwells on the disadvantages. To sell management on the benefits of keeping an in-house flight department, it is important to look at the advantages of the competition, so you can figure out how to match or exceed them. Put another way, very few sales are made by dwelling on the disadvantages of the competition. From management's point of view fractionals are lucrative for many reasons.

Fig. 1. Here is a cost comparison for charter (line 1), fractional (line 2) and full-ownership (line 3) services. Full-ownership of an airplane becomes cost effective at around 300 hrs of annual use for an efficiently run flight department.

Predictable and lower costs?

Fractional programs have highly predictable costs, with no large or unexpected peaks (like "C" checks and premature engine failures). This makes cash flow planning for the entire five-year fractional term very easy. It also makes CFOs very happy. Remember, the day to day business of a company provides enough financial turbulence. CFOs don't need financial turbulence from a support service. The best way to make your costs predictable is to budget carefully, establish reserve accounts and discuss future, large maintenance expenses with the finance types well in advance of the actual expense.

As shown in Fig. 1, a simple analysis shows that below a certain utilization, fractional ownership will cost less. While that point is different for each aircraft, our experience shows that it occurs somewhere between 250 and 400 hours. Overstaffing, expensive facilities, excessive spare parts inventories and inadequate management will make fractional ownership less expensive at much higher utilizations. Since every dollar spent on the corporate flight department is one dollar less for the bottom line, any program that lowers cost without significantly reducing the level of service will be attractive to senior management.

Hassle-free operations

As American industry has become ever more competitive, layers of intermediate management have disappeared. The remaining managers tend to focus on the company's core business. And they try to get rid of the hassles presented by support services. Out-sourcing accomplishes this by substituting fixed price contracts and performance standards for all the time-consuming details inherent in hiring personnel, arranging insurance, and paying bills for an in-house aviation department. In addition, most CEOs and other senior managers know absolutely nothing about aviation. A contract with a fractional ownership program solves this problem and gives management the service without having to worry about the details. A really good flight department manager should be able to do the same.

Year-round availability

When a corporate aircraft is in maintenance or the pilots are on vacation or training, aircraft services are not available. This can be quite a problem for a small aviation department, particularly if they fly an unpredictable schedule. With a fractional program, the aircraft is available year-round and is not dependent upon planning or supplemental arrangements. Exchange agreements, careful planning and occasional use of charter aircraft can keep this from harming a small flight department.

New aircraft

Most fractional programs use new aircraft. For a company with a limited budget or looking to upgrade an old aircraft, this is an important factor. For example, a half share of a new midsize jet such as a Learjet 60, Citation VII or Hawker 800XP costs between $5 and $6 million. That kind of money will only buy a 15-year old midsize jet. The money spent for a quarter share of a midsize jet will only buy you an old smaller aircraft such as a 15 to 20 year-old Learjet 35A. Let's face it, we all like to ride around in the latest model, but if the money isn't there we can't do it. However fractional ownership programs can put a participating company in a new aircraft.

Disadvantages

While most of the disadvantages have been well covered, there are several on the business side that are worth examining in detail. Some fractional programs do not allow financing of fractional shares. Some require that the number of contracted hours be paid, whether they are flown or not. Most do not allow excess hours without the purchase of an additional share. To sell a fractional share before the five-year term is completed may be much more difficult than selling an aircraft and the resale value of the fractional share is very hard to predict. Even at the conclusion of the five-year period, the resale value is not guaranteed.

Also, there is the highly personalized service available with an in-house flight department. Fractional companies cannot give the same level of individualized attention. They try to compensate with elaborate and thorough procedures, but it is not the same.

Reduction of costs

There is only one fundamental solution to avoid being out-sourced: lower your costs to the point where it is close to the cost of fractional ownership. There are two ways to lower costs. The first is to actually reduce costs. The other is, as shown in Fig 1, to increase utilization.

The first step in reducing your costs is to know what they are. Know what are the variable costs by aircraft. Know what are the fixed costs and what other costs are assigned to your flight department by the finance department in detail. This requires some serious investigation because in many companies department managers are not given the whole cost picture.

For example, you may get a detailed printout of actual costs vs. budget for the flight department. But that often doesn't contain depreciation, cost of capital, corporate general and administrative expenses. However, printouts for the CEO, CFO and other senior executives probably do contain all those other costs, the very costs they'll compare with fractional ownership proposals.

Once you have all the costs, calculate the total cost to provide your department's services. Now you have a number that you can compare with the cost of a fractional program. If your costs are the same or less than an equivalent fractional program, that's great. But what if they're not. What can you do?

Benchmarking your operation

One thing you can do is benchmark your operation against your knowledge of other operations, industry surveys and databases and just good business practices. Items to examine include:

* Cost of fuel. The actual cost, taxes paid, is under $1 per gallon. The difference between that and the price you pay, are the FBO's overhead and profits. One organization we know has incentive awards for crews that average the lowest fuel cost each quarter.

* Heavy maintenance. How many bids did you get on the last heavy engine or airframe maintenance? How hard did you bargain?

* Staffing. Do you have too many people? How does the headcount compare with other flight departments? How do salaries compare with various surveys? Do you use part-time personnel to help with peaks and vacations (very effective) or do you have full-time staff to cover all possibilities (very inefficient)?

* Expenses. How closely are they controlled? Does your staff take advantage of all discounts available to your company?

* Spares inventory. How big is your spares inventory? Does it increase in size each year? If it does, your operation is buying more spares than it needs.

Finance department decisions

You will probably be very surprised to find out what costs the finance department assigns to your department without telling you. One obvious example of this is depreciation. Often the depreciation assigned to an aircraft is the depreciation for tax purposes. For a new Gulfstream IVSP that can be as high as $5 million in one year­ at 500 hrs that adds $10,000 to the cost per flight hr. There is no reason to do this other than convenience, but it sure distorts the cost picture! The best way to tackle this problem is to make some friends in the finance department and ask them. Most likely, they will be glad to help.

Increase utilization

Increasing utilization is a powerful tool to tackle high costs per hour. For the example shown in the graph, at 200 hrs per year, the cost of a fractional program is less than an in-house program. But at 400 hrs per year the cost of an equivalent fractional share is 18% greater than the cost of an in-house corporate aircraft. The reason is that many costs, such as salaries, hangar rent, insurance, lease payments, training costs, depreciation and other overhead are essentially fixed. Increasing utilization means each hour flown bears a smaller share of these fixed costs. And thus the net cost per hour decreases. (Fractional ownership companies realize this only too well. They solve the problem of their high fixed cost and overhead by flying 800 revenue hours per aircraft per year.)

To increase utilization will require a low-key but persistent effort to market your flight department's services to the users and potential users in your company.

Some ways to do this include:

* Find out who does not use the aircraft and why (you will probably be surprised at the reasons given). Then show them how the aircraft can help them.

* Keep up with developments in your company that may require aircraft support and then visit the division/program managers to explain the advantages of using corporate aircraft.

Increasing utilization also means making sure maintenance is set up to make the aircraft available to meet the increased demand. Simply switching to a progressive maintenance plan can increase availability by 3 to 5 weeks per year. Another tool to increase utilization is to reposition the aircraft as required to serve more than one user at a time. And maybe even getting on a Part 135 certificate to get additional utilization and revenue.

By focusing on these fundamentals, one operator we know has doubled annual utilization to over 750 hrs per aircraft over the last 5 years.

Educate yourself

Part of the long-term success formula should include educating yourself on management and business issues. Take NBAA or HAI management courses. Read management books. Read business magazines. Read magazines about your company's industry. In short, develop a perspective about the art and science of running a service business with a big budget and a large capital investment.

In summary, out-sourcing of the corporate aviation department is a fact of life and it will not go away. If your cost structure, as senior management perceives it, is out of line with fractional ownership costs the time has come to take the problem in hand, reduce your costs and increase your utilization. And it is very important to be pro-active in this area.

Complaining will not enhance your business. However, sound management and hard work will make sure that your corporate flight department adds real value to the organization it serves.

Bill de Decker, partner of Conklin & de Decker, has provided impartial, comparable aircraft operating cost and performance data for fixed wing and rotary aircraft since 1989. Conklin and de Decker publishes the Aircraft Cost Evaluator and provides specific operating cost databases. Before joining Conklin & de Decker, de Decker was GM of FlightSafety International's communication systems center.

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