The Price is Not Right

Written by: Joe Moeggenberg, ARGUS International, Inc.

Business jet charter was born in 1963 with the birth of the  Lear Jet (yes, back then it was two words) and the founding of Executive Jet Aviation in Columbus,Ohio. EJA owned its 20+ aircraft fleet, and charter pricing included not only the cost of flying its trips, but also an allocated portion of EJA’s cost of capital – the aircraft purchase price. Other jet charter companies soon sprang up, each operating company-owned fleets and using a similar pricing model.

But that changed forever in 1967, when Executive Air Fleet (EAF) began offering business jet charter aboard aircraft it managed on behalf of third-party owners, aircraft available when those owners weren’t flying themselves. Now charter clients needed to pay only for the cost to fly their particular trip, without having to pay an allocated capital equipment cost.

Today virtually all of the 850 business turbine aircraft charter management companies in the US use some form of that pricing model; that is, the charter customer pays a rate based only on the cost to fly the trip, without paying the fully-allocated capital cost of the aircraft.

This pricing model is unique to theUS. Charter operators in the rest of the world still own their fleets, and require the charter customer to pay a fully-loaded charter rate, some 25 to 30% higher than US rates. That makes charter flying in theUSrelatively cheap –  and today, perhaps too cheap. The decline in business turbine aircraft charter demand tracks the recent recession, forcing charter operators to scramble in order to stay alive.

Business turbine aircraft flight activity began to slip after peaking in 2007. By 2009, flight activity was down more than 24% from that 2007 high, and remains down more than 19%. Business turbine aircraft charter fared even worse, as 2011 charter flying remained down 27.3% as compared with 2007, down more than 270,000 flights annually.  But there has been no commensurate drop in the number of aircraft available for charter. And so we have the same 4787 aircraft chasing that shrunken market.

A closer look at the charter management model, under which some 80 to 85% of all turbine charter aircraft operate today, illustrates why.

The aircraft owner keeps about 80% of each trip’s charter revenue, to cover the direct and allocated indirect operating costs of the trip. That leaves 20% for the management company to cover all overhead costs: accounting, scheduling, sales commissions (internal as well as charter broker fees), operations and maintenance oversight, and FAA regulatory compliance.

And profit…

In today’s competitive market, many management companies are now charging ridiculously low management fees in order to retain clients. Add to that the downward pressure on charter pricing – the same number of aircraft chasing 27.3% fewer flights – and charter companies are forced to cut corners elsewhere, reducing infrastructure in order to preserve even a slim profit margin.

Add to that the fact that charter brokers are demanding higher commissions, and we find many an operator trying to make a profit by becoming a high volume charter provider. You’re doubtless heard this refrain before: “We lose a little on every sale, but we’ll make it up in volume.”

The net result? No one is making money: neither the charter operator nor its management clients, who are barely covering the direct cost of each trip and receiving little contribution to their fixed costs.

And today that can make charter with the wrong operator a risky proposition.

Let’s take a real world example, drawn from our audit experience. You have a choice between two large cabin, long range Challengers 604s, both in first rate condition and with identical charter rates.

Challenger A has:

• Two young pilots with low total flight time and low time-in-type (specific Challenger experience). They are part-time contract employees, paid on a trip-by-trip basis, and meet the minimum training standard.
• The charter operator provides:
  • Minimum insurance coverages, purchased from a Caymans-based underwriter.
  • Minimal maintenance support.
  • No Safety Management System (SMS) or Emergency Response Plan (ERP)
  • A company without infrastructure,
  • Very little support
  • No dispatch, flight following or customer service

Challenger B has:

• Two professional pilots, with high total flight time as well as time-in-type. They attend recurrent simulator training every six months, and are well-paid, full-time employees.
• The charter operator provides:
  • Complete insurance coverages through a highly-rated underwriter
  • Full time maintenance support
  • An internationally-sanctioned SMS which includes an ERP
  • Complete operations and maintenance support and oversight
  • Full dispatch service, flight following and customer service department

Needless to say, Challenger B has a higher operating cost than Challenger A – and for some very good, but not-so-obvious-to-the-customer reasons.

All charter operators may hold legal FAA charter certificates, but not all charter companies are created equal, nor do they operate to the same standards. Some are content to meet just the minimum required by the FAA.  And it’s curious that business executives who operate their own companies to the highest standards, are willing to compromise their safety by choosing a charter company that operates to lower standards.

You might prefer Challenger A’s price – but would you want to ride it? And would you trust Challenger A with the safety of your family, friends and business associates?

US charter rates have not changed in years, thanks to competitive pressures and charter customers who don’t understand the true cost of safety. The result is that rates simply have not kept pace with increased operating costs.  But higher quality operators need to be able to charge more, to insure continued safe operation – and that means charter customers need to be better educated.

NEXT MONTH- charter pricing outside the US

 

ARGUS  is a specialized aviation services company with global expertise whose mission is to provide the aviation marketplace with the information needed to make informed decisions and manage risk.