Choosing the Right Management Approach: Not as Simple as It May Appear

One decision aircraft owners have to make is whether or not to allow their airplane to be chartered out when they're not using it. On the surface, chartering seems to make good business sense: if the aircraft isn't being used and the crew is available, why not have it produce revenue? As with most financial decisions in private aviation, the answer is not always as simple as it may seem.

Once the decision to charter the aircraft has been made, one major task is determining which type of aircraft management company (the manager) to select.

Most businesses are rewarded for growing revenue quickly and consistently and beating financial projections. Stock prices soar when companies grow quickly, and a business may have a great growth story even when profitability is minimal, because it is gaining market share and stronger profitability is believed to be coming. In many industries, once a company’s annual fixed costs are paid, incremental sales result in higher profit margins.

Aircraft ownership is different. One reason is that an aircraft is a depreciating asset, so generally the more it is flown, the less it is worth when it's sold. The second is that once the aircraft is chartered over a certain number of hours annually, the fixed costs rise because the owner needs to hire an additional pilot or two. This mutes or even eliminates the financial benefit of the additional flying.

While at Embry-Riddle Aeronautical University as a doctoral student, I conducted an unpublished research study, “Aircraft Management Company Selection.” The study used actual management proposals and historic charter performance combined with a Monte Carlo simulation. Five hundred Monte Carlo simulations were run to estimate the number of charter hours each manager would fly per year. Those simulated charter hours were assigned to the financial budgets proposed by three basic managers. The study compared how these managers proposed to staff to fly the hours and how much revenue the flights would produce.

As expected, the high-demand manager’s (HDM) simulation showed the most charter hours each year and significantly more revenue than the other two managers. The medium-demand manager (MDM) showed the second most charter hours while the low-demand manager (LDM) showed the least. 

The financial projections for these simulations incorporated a reduction in the aircraft value based on a factor derived from the value index book for aircraft valuations. This means that the additional hours flown each came at a future cost based on a reduced value for the aircraft.

The key to the study was the different philosophies on aircraft management by the managers. The HDM and MDM both had significant discounts that were offset by their high management fees and staffing costs. Their proposal included additional pilots ready to fly with minimal notice to drive the aircraft’s higher revenue.  The LDM had lower pilot salaries and lower management fees combined with the highest fuel surcharge (which goes directly to the owner as revenue). The LDM’s financials had the lowest revenues in nearly all the simulated financial models.

It is important to understand how managers make their money. The best ones are transparent and disclose how and where they are profiting.  The most transparent managers make their money off management fees and charter revenue only. It's important to note that the managers make the majority of their income off commissions based on charter revenue, which means they make more when revenue increases. When the aircraft flies more, the aircraft declines in value with higher use and there is a need for more pilots to meet the flying requirements. The manager’s commissions are based solely on top-line revenue produced by charter and are not reduced when fixed costs or depreciation increases.   

With those assumptions, the study concluded that 85 percent of the simulated financial models showed the LDM had the best overall return for the owner. The MDM was never the best solution in any of the simulations. The HDM showed as the best financial option only when the HDM produced the maximum number of charter hours while the LDM produced the least. This happened in only 15 percent of the simulations and in real life seems unlikely. It is counterintuitive to assume the HDM is producing the maximum amount of charter in the same year the LDM is producing the least amount of charter. If demand is extremely high in the market, all managers tend to charter more hours.

The most important lesson for an owner looking to hire a manager is that the one that will watch the bottom line the closest without compromising safety will most likely be the one that produces the best financial results. It is easy to be seduced by the manager that will literally double the revenue. But don’t be taken in by the shiny penny—look for managers that will watch over the finances as if it were their own dollars being spent. Remember, managers make their commission off top-line revenue, not profitability.

The managers in the U.S. are some of the best in the world and deserve to be compensated for their efforts and expertise. The best financial result is usually found by determining the staffing levels needed to satisfy the owner’s needs first and then looking at what levels of charter can be accommodated by the staff needed to satisfy the owner’s needs. Remember, chasing charter revenue by increasing the number of staff pilots or hiring contract pilots at day rates just to increase charter revenue generally doesn’t help the owner’s financial situation. Watch the bottom line!