Thoughts on Aircraft Management
Capt. W. Patrick Gordon, M.Sc.
Abu Dhabi UAE
(Accepted by Al Etihad, the leading Arabic language newspaper in the region. It was to be translated and run in their business section but I don't know if that was ever done.)
You’re a high net worth individual and you really don’t enjoy traveling on airlines anymore. You and your family might feel much safer on your private aircraft. Or you might have a successful company. You begin to recognize, in this soft economy, that you and your team need to get around more. It just might be a mistake to quietly await the economic upswing. A more aggressive approach to keeping your business afloat could be required.
Either scenario and you’re at the point where it could make sense to buy your own airplane. You’ve been around long enough to be familiar with the cyclical nature of life and realize that although the economy is presently sluggish there is always an upswing on the way. This is the time to get onto the aircraft ownership ladder. Good, used airplanes are abundant at exceptional prices and it’s always a good idea to buy “low.” Far too many buyers get excited by their good financial fortunes and buy high and wind up selling low. You can’t make up the losses for that in volume. Buying a used airplane is not at all like buying a used car. Unlike a used car, even a used luxury car, aircraft fall under stringent regulatory control that demands excellent and ongoing maintenance. A new paint job and perhaps some interior work can personalize your aircraft, make it sparkle and look like it just came out of the box.
Now let’s look at why you might want to have your own aircraft. Take the time to analyze your perceived mission requirements. How many passengers do you want to carry on the airplane? How far do you want to go? Is London, non-stop, a requirement? Then the next exercise comes in; balancing your budget to your desires. What do you choose to afford, against your perceived mission requirements. You might want to downsize from London, non-stop to, perhaps, London with one stop.
“Beware! Dragons be there,” was applied to the ancient maps over areas that were unexplored lands, oceans and seas. “Beware! Dragons be there,” throughout this entire analysis. There are, literally, hundreds of companies and individuals who will offer help and advice. For many of them, it’s not a coincidence that an airplane they are selling fits your requirement exactly. If you ever, in your life, wanted objectivity and honesty, this is the time. Do not be influenced by a friend or your brother-in-law’s recommendation. They might not be objective enough, or informed enough to be of good value. To complete the purchase to your benefit, the project deserves a variety of expert advice, from a review of the log books to a pre-buy inspection and transfer of ownership, and the probable change in country of registration.
Once the aircraft is purchased, a whole new field of operational management begins. A safe way to proceed would be to negotiate an aircraft management agreement with a reputable operator. That does not mean that the aircraft must, or even should, be purchased through them. They might not have your best interests at heart even though they really should if this arrangement is to work over the long term.
It’s stunning to recognize how many executive airplanes are under individual aircraft management contracts around the world. The numbers can be astonishing, with a few fleets in the hundreds of airplanes within some individual management companies.
Aircraft management contracts can be classed as either “Private” or “Commercial.” In a private management contract, the managing company provides oversight of the aircraft including administrative, regulatory and operational requirements, with the owner paying all costs plus a management fee. The aircraft is not flown for revenue, just for the private use of the owner. This model is desirable to owners who want the ultimate in privacy and security or just want to exercise their complete right to pride of ownership.
One key to the growth of the corporate jet industry, as well as the aircraft management industry, has been the development of the commercial leaseback program. This involves a high net worth individual (HNWI) or a company buying an executive airplane or helicopter for their own use and turning it over to company A to manage for them. When the owner is not using the aircraft, company A has it on their Air Operators Certificate, (AOC). They not only operate it for the owning entity but also generate “offsetting revenue” by chartering it to companies B, C, D, etc.
This type of arrangement provides benefits to both sides of the agreement. The aircraft can generate cost offsetting revenue for the owner that goes towards justifying ownership of the aircraft to themselves, a Board of Directors or perhaps even a financially astute wife, who might still harbor the old fashioned notion that diamonds are a girl’s best friend, not airplanes. Since the owner bears all of the ownership costs, the management company benefits by having access to an aircraft to use commercially without encountering the crippling ownership costs associated with a very expensive piece of capital equipment.
Hourly Direct Operating Costs (DOCs) are calculated. They include fuel, on-going maintenance, catering, over flight and landing charges to name just a few. A revenue margin is then set on top of the total to determine a charter cost per hour. The resulting revenue is shared between the owner and the management company. This revenue, in addition to the management fee, provides a baseline of profit to company A while the owner retains the offsetting revenue previously mentioned to partially reduce the ownership costs. The operative word here is “partially.” Do not be sucked into the idea by an aircraft salesman or management company that the airplane will pay for itself under this arrangement.
Without this type of commercial leaseback management arrangement giving it access to low cost aircraft, company A would find it nearly impossible to generate a profit after adding up all of the ownership costs, now including financing, crew costs, insurance, etc. and then tacking on a profit layer to determine charter pricing. Long-term competition with charter operators, who have little or no ownership costs, would be virtually impossible.
Most income tax environments have provisions for business tax deductions. In that environment commercial aircraft management works well for both parties, as well as the charter flight customer since their resulting charter costs should be lower. However, once this concept is applied to a no income tax environment such as we have here in the UAE some interesting developments take place.
As an aircraft flies more, it’s only logical that the maintenance costs will be higher. Other increases in costs for a commercial management program can be more frequent crew training, insurance and additional wear and tear on the aircraft that must be repaired, again to name just a few. Unless great care is taken in initial negotiations, all of these costs can be at the owner’s expense. Meanwhile the AOC holder, company A, skates by on minimal costs. In this no tax environment, all of these costs come out of the pockets of the owner, not in reductions to end of the year taxes.
Although there are many crossover management functions in the business world, most typical business leaders are not familiar with the complex management specialties required to operate an executive jet in international travel. The regulatory, maintenance and scheduling issues can be daunting. As a result, the actual management of the aircraft, either commercial or private, is well worth considering. However, the owner should be careful to include a cap on the amount of flying allowed by the commercial management company to generate the offsetting revenue. Too much flying and the illusive offsetting revenue is negated by higher costs to the owner.
Reputable aircraft operators have worked out formulas for different aircraft to determine where those break-off points in revenue-generating flights take place. It’s interesting to see that the reasonable and fair amount of flying varies quite widely from one aircraft to another with, in general, the lighter the jet the lower amount of commercial flying time makes sense for the owner. On many airplanes, it’s not fair to the owner to exceed 400 hours per year of commercial flying. On the other hand the Boeing Business Jet (BBJ), originally designed as a workhorse airliner, is quite generous in the amount of time that could be flown on behalf of both the owner and the management company. With a number of very well-maintained business jets, including BBJs, on the market today at attractive prices, it certainly is worth considering owning. Having it managed on either a commercial or private basis can make the ownership virtually trouble free.