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Analyzing turboprop direct operating costs

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The benefits of business aviation services are optimized with efficient and effective cost management featuring as a significant aspect of aircraft ownership and operation.


By Don Van Dyke
ATP/Helo/CFII, F28, Bell 222.
Pro Pilot Canadian Technical Editor

As world economies recover from the effects of the global pandemic, demand for business and commercial turboprops has increased. The accounting system and ownership model under which an aircraft is operated affect the way operating costs should be viewed. Pictured is King Air 360.
Business aviation has 3 current priorities – to provide safe, efficient air transport, to support competitive business reach, and to meet aspirational goals in fostering environmental stewardship. Studies have shown that companies using business aviation as an element of corporate strategy outperform those that don’t.

Professional pilots are asset managers who can apply their knowledge, intuition, and oversight to inform and influence decisions that benefit efficient financial management of business aircraft operations.

Useful concepts of identifying, managing, and minimizing major operating costs of business turboprops (TPs) have been discussed previously in Pro Pilot (Feb 2021, p 38). Since new accounting concepts of aircraft management will be introduced, a brief review of operating definitions is merited.

Aircraft operating costs

Costs related to the use of business aircraft for the provision of air transport are traditionally categorized as non-operating (NOC), indirect operating (IOC), or direct operating (DOC). NOCs are business expenses unrelated to core operations, often provided by the parent organization, and identified as administrative overhead.

Examples include accounting, human resources management, legal, litigation, and restructuring. IOCs are related to core operations. IOCs are not easily traceable to a specific activity or aircraft, and may be incurred for a defined period (or an operating season). Examples include office/hangar rent, leases, utilities, furniture, supplies, equipment rental, and office technology.

And DOCs are variable or fixed expenses which are clearly attributable to a given aircraft type, aviation activity, or product. Each variable DOC (VDOC) changes with the level of an activity (or cost driver) – generally flight or maintenance operations – and are most often expressed as a charge per flight hour. Meanwhile, fixed DOCs (FDOCs) remain constant, regardless of changes in activity.

aircraftHowever, total FDOCs typically increase with organizational size due to related demands of greater infrastructure and support needs. DOCs are easily attributable, but their character may depend on context. For example, flightcrew paid an annual salary are accounted for as an FDOC, while remuneration of contract flightcrew would be a VDOC.

Operators are cautioned against expressing FDOCs on an average per-unit basis (eg, annual aircraft insurance cost ÷ annual flight hours) because it creates the false impression that they behave like VDOCs and that total FDOCs vary with changes in the level of activity.

Total DOCs are VDOCs and FDOCs aggregated for purposes of reporting, comparison (benchmarking), and planning. For operations with one or few aircraft, this is straightforward. The complexities of operations associated with larger fleets or multiple aircraft types make accurate and consistent cost allocation critically important for purposes of traceability and validation.

Depreciation. Depreciation is one of the few expenses for which there is no associated outgoing cash flow. For this reason, depreciation is not usually treated in discussions of DOCs. See Pro Pilot, Oct 2021, p 48 for a related overview of business aircraft depreciation. It is a complex subject, and operators are encouraged to consult resources available through NBAA, JSSI, Conklin & de Decker, and others.

DOCs are the unburdened expenses of owning, operating, and maintaining a business aircraft. Accurate and consistent recording of DOCs is essential to value the benefit of using aviation assets in support of business operations. The example DOCs shown do not include tax or market depreciation.

Financial and managerial accounting

Managerial accounting refers to the practice in which managers receive feedback from accountants to inform and support organizational decisions, planning, and practices.

Financial and managerial accounting systems present and diagnose cost behavior differently – the former reports past performance for a given accounting period, and the latter focuses on the more ambiguous and imprecise future to guide rational decision-making and risk management.

The term “direct resources” (shown in Table 2) may be misleading since it seems alien in discussing the operation of a TP. In our analysis, it simply refers to any variable cost directly associated with operating or maintaining our TP.

Elementary example problems solved with managerial accounting are provided in Figure 1. The utility of aggregating variable and fixed costs separately is reflected in the simplicity of the solutions shown.

Managing DOCs

The Covid-19 pandemic has depressed global air transport – particularly business aviation. The current spike in oil prices associated with ongoing conflicts will only exacerbate these financial consequences.

Although aircraft operators do not accumulate inventory in the traditional sense, the prolonged air transport malaise has resulted in a backlog of charges related to maintenance of airworthiness, sustaining crew qualification, prolonged parking or storage, cabin cleaning, disinfection, associated taxes, and myriad similar expenses.

Low aircraft utilization has increased the effect of these charges on per-flight-hour revenues. Moreover, inefficiencies related to an aging fleet are consequential to the projected decline in new deliveries. Many of these DOCs are extraordinary and result from this extended period of industry lethargy.

Furthermore, many experienced staff have retired or left for other reasons. These circumstances call for ever greater financial vigilance, and for the passionate pursuit of ways not only to minimize expenditure but also to ensure that investments are the product of efficient decision-making. A number of innovations are available to manage DOCs:

• Invoice assurance. DOCs for items like refueling, ground handling services, airport taxes, and navigation expenses constitute significant expenditures, and overpayment of related invoices is surprisingly common. Surveys reveal that 40% of affected invoices cannot be verified but are paid if they are within about 5% of that expected.

Duplicate invoicing is rarely evaluated. Managerial accounting analysis would help to identify both the nature and cause of cost variances from budget, but automation is available to help. The European Commission (EC) CORDIS project offers cloud-based Airsensus software that detects errors in invoices raised by many suppliers at different and sometimes remote airports, often weeks or months after being incurred by a given flight.

Using blockchain technology for transactions, Airsensus monitors charges and avoids overpayments. While the software is initially targeted at airlines, an association could host related services to the consolidated business aircraft market, in the process boosting its competitiveness to reduce the time-consuming manual processes that so far have failed to resolve this problem.

Additional details are available at cordis.europa.eu/article/id/430264-aircraft-direct-operating-costs-heading-into-a-smooth-and-rapid-descent.

table2• Fuel alternatives. With fossil fuels and lubricants representing 30% or more of variable DOCs, the search for alternatives is intense. Sustainable aviation fuel (SAF) is produced from 100% renewable waste and residue raw materials. It is similar in chemistry to traditional fossil jet fuel.

Over its life cycle, its use reduces carbon emissions by up to 80%. Business aviation, original equipment manufacturers (OEMs), fuel producers, academia, airports, and non-governmental organizations (NGOs) are calling upon users to advance use of cleaner and more sustainable aviation fuels.

However, SAF is currently roughly 3 to 5 times more expensive than fossil jet fuel. This keeps the demand for SAF low and affects its production costs.

Production and availability of SAF will not meet demand without the incentive of long-term tax credits. The Sustainable Skies Act, HR3440, was introduced in the US House of Representatives in mid-September 2021, proposing a tax credit which incentivizes blenders to achieve a reduction of at least 50% in life cycle greenhouse gas (GHG) emissions.

It continues through the end of 2031. To date, no further legislative action has been taken. Taxes levied specifically on aviation fuel are a DOC which harms business aviation’s socio-economic contributions to connectivity.

Moreover, they are an ineffective way to pursue environmental goals. Until SAF refueling points become more widely available, many will simply be overflown, eroding the effectiveness of air transport. The costs of diverting simply to uplift SAF could be recovered through tax credits as an incentive for business aviation to patronize SAF resellers, thereby increasing demand. Motivating this requires collaboration among the various trade associations and their members.

• Ownership models. Full ownership, joint ownership, charter, and fractional offer a range of innovative approaches to sharing DOCs. Fractional ownership of aircraft is a particularly interesting arrangement in which multiple owners share the use and costs of owning and operating an aircraft, including managing its attendant operating costs.

formulaThe benefits of fractional ownership include purchase of an undivided interest in a business aircraft with all its tax benefits, fixed monthly costs guaranteed by contract, hourly costs guaranteed by contract, annual hours and total contract hours specified in the contract, guaranteed availability within a specified geographic area and time, no management, maintenance, or employee responsibilities, a guaranteed buy-back plan, and a contract valid for an agreed period of time – usually 5 years.

• Engine maintenance reserves. On delivery, engines represent roughly 20% of new aircraft value. The remainder of the aircraft comprises the remaining 80%. Approaching end-of-life, the ratios reverse, engines accounting for 80% of the aircraft value and the remainder of the aircraft representing 20%.

For this reason, aftermarket maintenance budgeting tends to focus on provisions for engine maintenance, repair, and overhaul (MRO). Maintenance reserves, which typically comprise 34% of variable DOCs, represent significant financial commitment.

By engaging in hourly cost maintenance programs (HCMPs) or predictive aircraft maintenance programs (Pro Pilot, Sep 2021, p 38 and Nov 2020, p 32, respectively), maintenance reserves could be converted from a variable to a fixed DOC, not unlike an insurance portfolio.

While variable DOCs are allocated to the operator of the subject flight, fixed DOCs are allocated according to ownership percentage. By converting maintenance reserves in this way, responsibility for maintenance reserves would be shared among fractional owners. Managerial accounting could then put this accounting transformation to good use in improving DOC management.

• Propulsion alternatives. Lowering DOCs is a goal of developing new technology powerplants as drop-in replacements for installed engines. Hybrid-electric technologies are highly compatible with SAF and hydrogen, as well as advanced engine architectures such as the open fan and other novel engine core designs.

The 1300-shp GE Catalyst is the core of a hybrid-electric propulsion system for the XTI TriFan 600 business aircraft currently under development. All-electric engines require fewer parts than other designs, are emissions-free, and operate with a smaller noise footprint. However, they are limited by the weight and capacity of existing batteries.

Lithium-sulfur (Li-S) batteries are claimed to be lighter and more energy-dense (theoretically by a factor of 5) than conventional lithium-ion (Li-ion) cells. They also operate with a lower fire risk. Using sulfur rather than costly cobalt would net likely cost savings of 30%. The technology, although promising, is not yet sufficiently mature for aeronautical use.

Conclusions

Tracking, reporting, and understanding DOCs is critically important to an aviation department’s financial health, especially as recognition that finite financial resources must be allocated and used as efficiently as possible. Because managerial accounting focuses on internal financial processes, including details of generic overheads, it affords new insights to planning, earlier variance-detection, and activity-based control. The material presented herein only hints at its potential utility in aviation to improve budgeting, performance evaluation, and decision-making. Most importantly, it will lead to lowered DOCs.


Don Van Dyke is professor of advanced aerospace topics at Chicoutimi College of Aviation – CQFA Montréal. He is an 18,000-hour TT pilot and instructor with extensive airline, business and charter experience on both airplanes and helicopters. A former IATA ops director, he has served on several ICAO panels. He is a Fellow of the Royal Aeronautical Society and is a flight operations expert on technical projects under UN administration.