Tips for Comparing Aircraft Operating Costs see more
NAFA member, David Wyndham, Vice President and Director of Business Strategy at Conklin & de Decker, details the process of a Life Cycle Cost analysis and underlines its importance to any aircraft buyer.
What is a Life Cycle Cost analysis and why does it matter when buying a new business aircraft? David Wyndham explains the process…
A consulting client I worked with was evaluating Large Cabin business jets. Initially the client was more concerned with minimizing the operating expenses and less concerned with the capital costs. As long as the acquisition price fitted within their $25m budget, they would be satisfied.
Yet those evaluating business jet ownership should be concerned with more than just the acquisition costs. They should also factor operating costs (variable and fixed), amortization, interest, depreciation, taxes and the cost of capital. Items like depreciation, interest and taxes – for example - can add as much as 60% to the Aviation Department’s costs depending on the value of the aircraft.
Furthermore, you should also consider when the costs occur.
General Methodology for Life Cycle Costing
When analyzing the potential acquisition of a whole aircraft or a share of one, Life Cycle Costing ensures that all appropriate costs should be considered.
The Life Cycle Costing includes acquisition, operating costs, depreciation and the cost of capital. Amortization, interest, depreciation, and taxes also play a part in what it costs to own and operate an aircraft and can be included in the Life Cycle Costing as appropriate.
The first step is to know what aircraft to evaluate. This is achieved with an understanding of the key missions and the technical analysis of all potential aircraft. You need to be sure you are not buying more (or less) aircraft than you need.
There should be no room for assumption in the process. The costs should cover a specific period and take into account the aircraft’s expected value at the end of the term of ownership.
Comparisons of two or more aircraft should cover the same period of time and utilization, ensuring an apples-to-apples comparison is provided.
On the subject of utilization, you are advised to use miles if the aircraft is flying point-to-point and convert each aircraft to hours based on their speed. To have an accurate comparison, you will need to measure performance using the same criteria. Different aircraft fly at different speeds. Using a mile-based measurement accounts for the speed differences between aircraft.
I also recommend that you have a baseline. If an existing aircraft is to be replaced, that aircraft becomes the baseline. If you charter or own a fractional share in an aircraft, then continuation of that charter or fractional share would be the baseline.
The baseline essentially forms a basis for the comparison, establishing whether the new option under consideration costs less than the current baseline or more. If the cost will be more, what is the value of the increased cost?
Net Present Value Analysis
A complete Life Cycle Cost accounts for the time-value of money in a Net Present Value (NPV) analysis. Using NPV enables the differing cash flows from two or more options to be compared and analyzed from a fair and complete perspective.
An NPV analysis takes into account the time value of money, as well as income and expense cash flows, type of depreciation, tax consequences and residual value of the various options under consideration.
When an expense (or revenue) occurs can be as important as the amount of that item. This is useful in the comparison of Cash Buy vs Lease vs Finance options for the same aircraft.
Business aircraft do not directly generate revenue except for the sale of the aircraft. Thus, the NPV results are typically negative.
When comparing negative NPVs, the "least negative NPV" is the more favorable. In other words, if Option A has an NPV of $5m and the NPV of Option B is $6m, Option A has a better NPV.
You may want to run several scenarios. For example, what if you owned the aircraft for five years? How about ten? What if utilization was increased? What is the break-even point to move from fractional ownership to whole ownership? There may be many possible best alternatives when you adjust the important criteria.
Regarding the client mentioned above, we evaluated new and used business aircraft and found several options that were at the top of the acquisition budget had lower total life cycle costs than aircraft with lower acquisition prices.
A Life Cycle Cost analysis is an important decision-making tool, but it is not the answer all by itself. I like to use the term "Best Value" in combining both the capabilities and the costs of the various options analyzed.
Run the numbers and use them in your decision - but remember: Never let a spreadsheet make the decision for you
This article was originally published in AvBuyer on June 25, 2018.
Whole Aircraft Ownership: Is It Right For You? see more
NAFA member, David Wyndham with Conklin & de Decker, highlights the benefits of sole ownership of a business aircraft.
If control over your company’s transportation is paramount, sole ownership of a business aircraft is particularly attractive. With high enough utilization, it is also very cost effective.
As a generalization, when your flying needs come close to (or exceed 200 annual hours), whole aircraft ownership can be more cost effective than fractional, charter or membership programs. Whole aircraft ownership offers the following benefits.
Freedom: With whole aircraft ownership a company has the freedom to select the best aircraft to satisfy its needs. Within safety and operating regulations, that aircraft can be operated as the owner requires.
Customization: When a company acquires its own aircraft, the outfitting of the aircraft can be done to suit its operational and travel requirements.
Options for colors, seating, carpeting materials (and more) are able to be matched to your needs and preferences. The larger the cabin size, the more flexibility there is in how the interior can be configured.
Service Levels: The aviation department personnel are the owning company’s employees. Not only is that company able to shape their training and manage their competence, it can affect how they interface personally with passengers.
The ability to hire the employees that fit the organization can be invaluable, and this service level generates a rapport that is effortless and comforting.
Control: In the US, Federal Aviation Regulations (FARs) allow the most flexibility and opportunity for control to not-for-hire operations flown on behalf of the aircraft owner. A company-owned aircraft that is used in support of the business of the company falls under these rules.
While all aircraft must be operated safely, the sole owner of a business aircraft has greater influence over operations than either a charter customer or a fractional owner. Factors influencing safety and security are within the operator’s control.
A whole-aircraft owner has the highest levels of privacy. You can discuss sensitive business, or leave important corporate documents and personal items on board the aircraft.
Responsibility: With this high degree of control comes an equally high level of responsibility. While the FARs state that the pilot in command is the ultimate person responsible for the safe operation of the aircraft, the owner is responsible for the hiring and training of that pilot. The owner has liability for the actions of its employees, and this extends to the aircraft operation.
The owner can manage this risk via high-quality training and insurance. The crew should be trained to the highest appropriate levels of competence. Maintenance engineers (if applicable) also require regular training.
An individual or company owning or leasing their own hangar is also responsible for ground safety. The owner shares the risk by properly insuring the aircraft and crew.
Managing and directing the detailed operation of aviation activities requires individuals versed in management and Business Aviation - a skillset commonly accomplished either by having an in-house aviation manager/director, or by contracting the management of the aviation operation to a management company.
The Role of Management Companies
A management company can offer a turn-key approach of contracting the function and oversight of the aviation operation. These companies specialize in flight operations.
For a first-time owner of a business aircraft, we usually recommend contracted management for starting the aviation operation. In additional to providing flight crews and functional oversight, the management company can provide economic benefits as well:
- Fuel can be purchased in bulk on behalf of multiple aircraft owners;
- Discounts can extend to maintenance (the management company with multiple aircraft should be able to negotiate discounts for spare parts);
- The management company can purchase insurance for its group of owners at rates that can be lower than for a single aircraft.
While management companies tailor their services to meet an owner’s unique requirements, they typically offer the following oversight:
- Hangaring the aircraft
- Managing the aircraft records
- Hiring and training the flight crews
- Managing the maintenance of the aircraft
- Handling the billing and verification of all variable operating expenses (including fuel, maintenance, etc.)
- Ensuring that all regulatory requirements are met by the aircraft and crew
- Refueling the aircraft
- Cleaning and cosmetic upkeep of the managed aircraft.
Offsetting the Costs of Whole Ownership
If you, as the owner, desire to further reduce your total costs, a management company can charter the aircraft when you’re not using it, provided the firm has authorization under FAA Part 135 (or its equivalent in non US countries).
This relationship is complicated as there are regulatory restrictions governing operational control of any aircraft used for commercial service. The general terms are as follows:
- The aircraft owner pays all the operating costs (fuel, maintenance and other aircraft operating expenses).
- The crew may be billed as salaries or as an hourly fee.
- The aircraft owner gets a set percentage of the charter revenue.
The charter revenue the owner receives should be more than enough to cover the operating costs, but will not be enough to cover all of the fixed expenses, debt service and depreciation. The charter revenue is shared between the charter operator and aircraft owner. Rarely, however, does a chartering arrangement with a management company produce a profit for the aircraft owner.
The relationship with the management company is as much a personal relationship as a business relationship. Communication and shared goals are important. If you want control, fly enough hours and accept the responsibility, whole aircraft ownership can be very rewarding.
This article was originally published in AvBuyer on May 14, 2018.
Avoid Misconceptions About Aircraft Costing see more
NAFA member, David Wyndham with Conklin & de Decker, discusses the costs to owning an aircraft after the initial purchase.
What are some common misconceptions about aircraft costs? David Wyndham details some that he comes across on a regular basis, providing advice on how to avoid them…
Most misconceptions about aircraft cost result from connecting something that we’re familiar with (such as the cost of running an automobile or building a house) and using those as an analogy for the unfamiliar cost of owning and operating an aircraft.
The biggest misconception is focusing too heavily on the acquisition cost, to the detriment of operating costs and asset value over time. Let’s illustrate with an example…
I have a client who has a maximum acquisition budget of $20m. This is a real limit and not one to exceed. There is, however, a possible misconception that can arise if we were to look at Aircraft A (with a selling price of $20m) and Aircraft B ($17m) and conclude that Aircraft B is the less costly option.
The only way to know which aircraft costs “less” would be to evaluate the total costs to acquire, operate and dispose of the aircraft. Two of the major costs that must be factored are the operating costs (including maintenance) and the estimated residual value after a set timeframe.
Hourly Variable Costs
Looking at our current scenario (represented in Table A), Aircraft A has a lower fuel consumption than Aircraft B while the engine maintenance costs are similar. Aircraft B has lower airframe maintenance costs, meanwhile.
Yet even in factoring variable costs, there’s more to consider. For example, Aircraft A flies 8% faster than Aircraft B. The faster aircraft will use fewer hours to fly the same trips form point of origin to destination. Therefore, if Aircraft A flies 400 hours annually, Aircraft B will require 432 hours to cover the same missions.
Annual Variable Costs
Table B sets out the annual variable cost for each aircraft, factoring the required annual hours. As depicted, Aircraft A costs almost 10% less in variable cost per year than Aircraft B.
With both aircraft having about $650k per year in fixed costs, the annual operating budget favors Aircraft A slightly. While not enough to make up the $3m price difference, it does account for about $1m over 10 years. But before we can draw any conclusions, there is more…
Life Cycle Costing
Let’s assume Aircraft A is a popular model and is currently selling better than Aircraft B. Current market values for Aircraft A are being maintained better than for Aircraft B – therefore, after 10 years the estimated value (in dollars and percent) is higher for Aircraft A. Table C represents our ten-year Life Cycle Cost for each aircraft.
Aircraft A costs about the same to own and operate as Aircraft B. Our analysis has shown that making the purchase decision based on acquisition price alone doesn’t tell the entire story.
In the above example, we needed to evaluate parameters beyond the costs alone to determine which aircraft would provide the better value. And once you’ve achieved a solid cost analysis, there are additional factors to consider. Does Aircraft A have better support and a longer range than Aircraft B, for example?
Never let a spreadsheet make a purchase decision for you. And, never just look at a single cost item when evaluating the aircraft that best fits your budget. Aircraft are not commodities sharing essentially the same characteristics, which is why I stress to my clients to look for a best value when making the aircraft buying decision.
Costs are a very important part, but even the total costs do not tell the entire story. For the record, my client has yet to make the final decision on which aircraft to purchase…
This article was originally published on AvBuyer.com on July 16, 2018.