Friday, June 26, 2015

So you want to start an airline (Part 2)

Lets say that you found your ideal hub, you have a good front office team lined-up and a bunch of maintenance guys who seem to know what's what.  What else will need to be done?

(4) Business Plan:  This is the hardest and the easiest, because the revenue analysis is easy -- manufacturers will do that for you!  No kidding, its a service they are happy to render, they will calculate all the routes you want to operate, give you estimates of operating costs (fixed and floating) analysis of maintenance reserves.  In a nutshell they will do the top line.  What they will not do is the rest -- the hard bit.  You have to select your destinations, you have to select your repositioning flights, you have to find airports that want you services (usually smaller airport are very very happy to see you arrive), but try getting a landing slot at a major airport, it could take a while.

In a sense, the best thing to do is start operating in regional and secondary airports (you may even provide a bus shuttle to the main airport -- its cheap and customers [including business people] like that).  The benefit is that slots are usually easily available -- Southwest started that way, could not get LA so then used San Diego (that was small at the time).  At any rate, if you are looking for premium fares its worth working from secondary airport, because they are quicker to get in and out (both for passengers and aircraft) and since your value added is not a hub and spoke model but a single route model business people like to get in and out fast, that has additional value to your premium clientele.

Lenders (and there will be lenders) will want a 7/10 year business plan, but really focus on the next 24/36 months -- the business plan of a start up has to be flexible because YOU WILL MAKE MISTAKES, its a given in this business, errors are common, even among the larger carriers.  You may get a route wrong, because the demand is just not there.  Assume an average range of 450km, that means some flights are shorter, but with a turboprop aircraft that's not an issue (and we assume you are not Middle Easter or Asian that starts-up with A380s or B787), the attractive features of turboprop is that on short flights (less then 60 minutes) they are actually faster than jet aircraft -- because the jets have to climb so much higher.   Over two hours (that's 1,000km) turboprop lose their allure quickly (its the vibrations that get to you).  Anyway, on the 350-450km range you "kill" the car/bus/rail options.  So you find a number of routes that match the density (based on your aircraft selection) and the range -- so that business and occasional travellers will want to use your services, and you start building your route model (that will drive your revenue model, that will drive your cost model).  

The first order of business is determining your break even point.  How many seats need to be filled at what fare to make the operations cash flow neutral (optimise for cash flow not profits -- a private company doesn't "care" about profits, it cares about cash flow).   Airlines used to play ridiculous games with their fares -- until they figured out that it didn't work, in fact it generated worse revenues because passengers quickly figured out how to optimize their ticket purchases.  Now their are two or three fares, depending on the class of travel, or the ability to change date or time of flight.

Once the break even point is determined, a bit of game theory comes in on moving along the fare estimates.  Is there a good (VIP) bus service that is available, what are its frequency -- generally VIP buses are attractive to certain class of business travellers that always go to the same destination on fixed scheduled.  CEO and senior management that fly in and out take a different view.

Getting competitive with other modes of transport require additional analysis, this blog is not the right place to discuss optimisation, but when looking at the competitive environment you have to take all travel time  in consideration (including taxi to airport and security, wait time between flights and overall flight time), its details are simple but the overall modelling is...something else.

There is no doubt that the heavy lifting occurs here.

(5)  Facilities & Costs:  Years ago dealing with a small operator I was having a sane(ish) conversation on the cost of running a particular type of aircraft in a specific jurisdiction (his) and told him that although the aircraft was slightly less expensive to acquire, the fact that the manufacturer had not committed to spare parts depot in the region meant that he would have to hold much larger inventory of spare parts.   This guy had been the CEO for a few years, and when I told him that the "normal" level of spare parts was around 10% of the aircraft cost, but that because of his situation the number would be closer to 20%.  He doubted my impartiality -- that is until the COO got into the conversation and indicated to the CEO that their current spare parts inventory was around 25% of aircraft costs (BTW lots of useless spare parts -- among them 40 seats... who sold them that idea?).  

Although the heavy maintenance is undertaken at one spot, at every airport at which the aircraft lands there has to be some minimal maintenance support -- if for example a flight data computer craps out! These are unavoidable costs. New ultra modern aircraft now have maintenance designated messaging systems where the aircraft is 100% monitored and can tell the maintenance group ahead of time that certain issues will need to be dealt with, but older types don't have that sophistication and really on pilots log (e.g. wipers don't work -- maintenance must fix wipers!).

One issue rarely discussed is the cost of starting a new station; everything from ground crew, airport services, operating fees and maintenance operations (sometimes these can be contracted out), but also advertising, promotions.  People have to know you exists!  Now the internet is great, but it has its limitations (if you are operating via a secondary airport you may not pop on Expedia!).  So, there is a requirement for real PR work, either with HR departments of companies in which you see potential customers or in local publications.  People need to know you exist, tickets are now exclusively purchased online, you need cutting edge web presence (from day one) you need an app that allows frequent fliers to purchase tickets, get boarding passes without even speaking to anyone at the airport, 10 years ago these were nice if we can afford, today they are essential components, and they are not cheap by any measure (if they are to work well).  airlines web sites are not cheap to build... they are actually expensive since they have to be linked to credit card providers, your route network and your booking system, of course there are now standard systems available, still its an expense!

Anyway, these are the low hanging fruits -- lots more is required.

(6)  Aircraft acquisition and leasing:  Believe it or not this is the easiest of the lot.  The first thing to know is that you will acquire, for a time, used aircraft.  Because rarely are new aircraft available. What type of aircraft, how large, these decisions are all part of the planning process, so lets assume you have already decided what size, then you have to negotiate with the manufacturer(s).  Buying aircrafts is like buying cars, the seller does it all day long and you do it once or twice in a lifetime (no jokes) there are things that can be negotiated and others that cannot -- its good to know ahead.  If you lease temporary aircraft from the manufacturer they will provide HUGE amount of support -- this is very valuable, because they want you to stay with the type, they will provide (for a period) a technical representative -- usually a guy that is a "super maintenance professional", they are an invaluable resource.  Manufacturers will provide training for both flight crew and flight attendants (yes they serve drinks 99% of the time, but when trouble arise its always amazing how focused they are -- if properly trained).

Older leased aircraft have many issues, they've had many owners and as many maintenance programs.  Years ago a small start up (actually it was a sub of a very very large airline) insisted that every aircraft be delivered with its copy of the maintenance manual.  The maintenance manual of a typical commercial aircraft had in those days maybe 200 volumes -- each thick binders that needed to be updated on a weekly basis.  These days are gone with ebooks, most manual now are electronic, but not the maintenance log, so what do you do when your leased aircraft has been in Canada, Mexico, India, France, Germany.... the log will be in so many languages with each jurisdiction having its own maintenance rules.  That's an issue (sometime the manufacturer will have translated the maintenance logs or required that the logs be exclusively in English -- something that your own maintenance crew will have to address).

Crew training is also important, each pilot will require type check and recurrent training, the cost of a simulator is $600/h.  If you have 10 pilots, it adds up.

Bottom line the manufacturers will be more than happy to lease you a temporary aircraft, and will support you tremendously during that time.  Fundamentally there is no real different between leasing and owning an aircraft (aside from depreciation), the days of tax leases are over (in 90% of jurisdictions) so leasing is just a tool -- as is owning.  Fleet management can be done either by leasing or owning, and the terms of these lease will very from lessor to lessors.  Obviously owning you aircraft can be fun, but it has to work within the fleet management objectives.

Financing new aircraft is relatively easy:  Export credit agencies and the manufacturer will do 90% of the work.  Only in the US are aircraft financed in the commercial market (and even there...).  Bottom line the cash required to purchase a $10 million aircraft will be about $1.5 MM, the balance will be financed by loans.  Spare part will have to purchased -- manufacturer may agree to some consignments if its convenient for their other business, but the parts may go to other operators when you need them -- that usually another 10/12% of aircraft cost.  

So you need substantial equity if you are going to purchase an aircraft, if its leased the $1.5MM goes away (not the rest) there are other issues as maintenance reserves... anyway details (important). The attractiveness of leasing (for a new airline) is that absence of profits (and even operating losses) reduces the attractiveness of depreciation allowance.  

However, its undeniable that starting an airline (and not just a mom-and-pop one aircraft operation) is challenging and require a substantial amount of capital...all that can be figured out during the planning stage.  

There's another option, buying old used aircraft.  Like old cars there's a reason for the discount! Aircrafts are not like cars, they've got to be in good shape the national aviation administration will have their own rules and requirements.  Older aircraft have a tendency to breakdown more often than newer aircraft.  Some are indeed "one careful owner" but not always.  The upfront capital costs and the fixed leasing or repayments are lower -- but maintenance can really kill you.  Several years ago I worked with a small Canadian airline that acquire a number of F100 at US$1.9MM each (comparable 100 seat aircraft sell new -- like the B737/A319 at around $35 MM each).  These F100s bankrupted the company, because once the engine/avionics were upgraded (total cost of $13 MM per aircraft), they still operated 25 year old aircraft.  That broke down regularly standing passengers...that was a very bad move.

Old used aircraft can be part of your fleet, they just cannot be the core.

Anyway, this is it for now.  There will be a part 3 on Financing & fleet planning in a few days...


Post a Comment

Subscribe to Post Comments [Atom]

Links to this post:

Create a Link

<< Home