Development of a Business Plan to Establish a Private Jet Charter - Essay Example

Development of a Business Plan for Private Jet Charter Embry-Riddle Aeronautical The Private Air Charter Business Opportunity 1.1 Air travel is a fundamental requirement in the US given the geographical spread of the country. For roundtrip distances between 1000 and 2000 miles, over 42% of all travel is by air and for trips above 2000 miles, the percentage goes up to 75% (Duke & Torres, 2005). It is for this reason that each calendar month between 50 and 70 million people in the US take an airplane flight as shown in the chart below (BTS, 2012). The passenger traffic was not significantly different even in the recession years. 1.2 Though the scheduled commercial airlines have done an outstanding job of establishing air connectivity in the US, their coverage extends only to some 500 airports around the country. The adoption of the hub and spoke system by commercial airlines requires most passengers to transit through one of some 70 large airports, adding to the total travel time for most passengers. Most major airline hubs are large and have air traffic congestion and connection times of over 2 hours are needed to provide for potential delays in the incoming flight and the transfer time including additional security screening. An additional issue with the hub and spoke system is the increased probability of mishandled baggage. Due to restrictions on the nature of carry-on bags, many business travelers need to check in tools, instruments and such material and if these do not make the transfer, the business trip itself may become abortive (Copley, 2012). There are over 5000 public use airports in the US that can be accessed by private air charter planes. The reduced travel time due to point-to-point connection, the convenience of flexible departure and turnaround times, the possibility of using flying time for work and the reducing cost differential between commercial plane tickets and air charter rates ( especially when a team of people are travelling together) is driving the growth of the air charter industry. There are over 2,000 registered private air charter companies in the US operating over 15,000 business aircraft with total revenues of over $ 12 billion a year. The overwhelming majority of these planes seat 4 to 8 passengers and have a maximum range of 1,000 miles. Private air charter companies transport between 1 and 1.5 million a year and these aircraft log over 18 billion revenue passenger miles. Contrary to the general impression, only some 3% of these are owned by large corporations (NBAA Fact Book, 2012). Most business aircraft are operated by small entrepreneurs and are typically operations with 1 -2 aircraft. 1.3 Though business travel is often considered the primary market for private air charter operators, the actual usage of private air charters is more varied. The chart below from the FAA General Aviation data for 2010 shows that only 20.5% of the hours flown by small aircraft in 2010 were classified as Corporate or Business use. The largest segment 32.3% was for personal use by people and another 15.7% for instructional use which is for training aspirants for a flying license. Other miscellaneous uses make up the remaining 31.5%. Business related travel will, however, be the primary target market for the proposed air charter company as demand from that segment is likely to remain stable over time whereas the other segments may fluctuate and will require a marketing effort different from that for corporate travel. 1.4 As seen above, the General Aviation industry in the US is very large and is dominated by small entrepreneurs owning 1 -2 aircraft each. Entry into this market as an additional player should not therefore be very difficult. 2. Financial analysis of the business opportunity 2.1 Since an aircraft is a large capital cost item, it is important to do a financial analysis to determine if the business proposal in viable for a start-up entrepreneur. Both the capital costs and the operating costs will, obviously, be determined by the type of aircraft chosen, its means of financing and its utilization. In this section, however, a pro-forma financial analysis sheet is created to define the broad parameters of the feasibility assessment. The data in this pro-forma analysis can be modified once the choice of the actual aircraft is made. 2.2 This pro-forma analysis is based on 2003 data for a Raytheon King Air BE-200 aircraft. This is a popular private jet with over 2,200 in service in 2003 and which has since been replaced by newer versions. This plane is a pressurized, twin-engine turboprop aircraft with Pratt & Whitney engines, which can carry up to 8 passengers and has a range of 603 miles. The typical cabin configuration to seat 6 is shown below. 2.3 The worksheet for the financial analysis of operating the BE 200 turbo-prop aircraft is derived from data from Argus International Inc., a Cincinnati, Ohio based aviation services company. Though the data is 10 years old, the pro-forma helps establish the various elements of cost that need to be considered for selection of the aircraft for the private jet charter operation. These cost elements are discussed below. The cost of the aircraft shown in the worksheet has a very wide range between a high of $ 4.84 million and $ 1.12 million and we have used an average price. We should expect a much narrower range. The cost of business jets in 2011 continue to be in this range with much better performance parameters as we will see later in this report. In the worksheet, the aircraft is financed by a 7 year loan at 5% annual interest rate. Raytheon King Air BE 200 Operating Costs ( 2003) ( in $ )         Capital Cost         Retail Price (High) 4,843,415       Retail Price (low) 1,120,000       Average Price 2,981,708       Annual payments for 7 year loan at 5% interest 490,760       Fixed Costs (annual)         Aircraft insurance 38,747       Liability Insurance ($ 25 million) 8,250       Maintenance Software 5,334       Miscellaneous Services 2,486       Total fixed annual costs 54,817       Periodic Costs         Engine mid-life Inspection 33,200 After 1,500 hours operation Engine Overhaul 245,500 After 3,000 hours operation Paint 29,300 Required after 7 years Interior Refurbishment 72,400 Required after 7 years Modernization / Upgrade 17,270 Required after 7 years Annual reserve to be created assuming 800 hours operations per year 94,971       Facilities Costs (annual)         Hangar / Office space lease 23,674       Misc. office expenses 1,972       Total annual facilities costs 25,646       Staff costs (annual)         Captain Salary 55,754       First officer salary 39,166       Maintenance Technician salary 39,128       Total annual staff costs 134,048       One time costs         Staff training costs ( flight crew) 10,400       Training cost ( Maint Technician) 5,400       Annual cost assuming training costs every 2 years 7,900                 Total Annual Costs 808,142       Cost per hour for 800 hours operations 1,010       Hourly Variable Costs         Fuel consumption ( gallons per hour) 106       Fuel cost 301       Maint. Labor cost 78       Cost of parts 67       Miscellaneous costs 64       Total variable costs per hour 510       Break-even hourly costs 1,520       In place of buying a new plane, there are a number of lower cost alternatives that need to be examined. One is to buy a used plane which could be 30% to 40% lower in cost depending on the market conditions. Another option is to lease the plane from an aircraft leasing company. One other option that needs to be examined is whether a potential corporate customer for air charter in the area that we plan to set up is interested in either leasing out a plane that he already owns or taking part ownership of the plane to get lower charter rates. He will get the benefit of the 10% to 30% depreciation on the value of the aircraft. The annual fixed costs include insurance for the airplane itself (which depends on the cost of the airplane) and a third party liability insurance which has been taken as $ 25 million which is the norm for this class of aircraft. The major item in the periodic costs is the cost of engine overhaul which for the P&W PT6A engines is taken as 3,000 hours of operation. A financial reserve needs to be built up from the operating margins to pay for these. Newer engines from P&W and other manufacturers require engine overhaul only after 8,000 hours of operation. The engine mid-life inspection also, therefore, required only after 4,000 hours of operations. Since provisioning for maintenance is a significant part of the annual costs, the choice of engine for the plane will be influenced by this cost. Engine and airframe manufacturers also offer full service contracts as part of the airplane price. That option can be chosen if it is more economical. The cost of facilities also depends on the location. If the location could be at a smaller general aviation airport that is convenient for the target business travelers, it would be lower in cost than location in a busy commercial airport. The staff costs are based on 2003 average salaries according to the Argus report. Those need to be revalidated for current salaries. The one-time staff training costs pertain to the cot of re-training staff for the particular aircraft that is bought. The worksheet amortizes this cost over 2 years assuming some staff separations and the need to retrain new staff. The major element of the variable costs is the fuel and fuel efficiency will be a major factor in selection of the aircraft. The total break-even operating cost for this aircraft works out to $ 1510 per hour. The air charter rates in 2012 for a Private Jet are between $ 2,000 and $ 4,800 per hour depending on the size of aircraft (Copley, 2012). The operating margin is therefore comfortable. The air charter industry practice is to include the fuel cost in the hourly charter rate and bill all other incurred costs to the customer. These include landing and parking fee at airports, federal taxes, and the cost of hotel and food for the crew if the aircraft remains parked beyond 4 hours at the airport. These costs have not been included in the worksheet (Hellow, 2011). The critical assumption in the worksheet is that the aircraft is operated for 800 hours a year which is a good average for this industry (NBAA Fact Book, 2012). It is clear that if the aircraft operates for fewer hours, the hourly costs would proportionately rise, eating into the margin. The above financial analysis worksheet, as noted earlier, is only a template to be used for filling in the right numbers for the specific aircraft that is chosen. It is also important to recognize that operating with only one aircraft has problems with assurance of service if the aircraft is under maintenance or if there is staff absence. There is therefore the need to build up reserves for a second plane in the first 2 to 3 years of operations. The first major engine overhaul after 3,000 flying hours would cause a major down time. 3. The marketing plan for air charter 3.1 The air charter company needs to have one or more anchor accounts that provide a substantial part of the 800 annual flying hours factored into the financial worksheet. The location for the air charter company should in fact be decided after identifying such potential anchor accounts. The target companies for exploration are large manufacturing or construction companies that are not located close to a major commercial airport. Several large manufacturing companies are located in small towns, for example, in the US Mid-West (example John Deere, Caterpillar) or in Northern New York State (GE at Schenectady). Project construction companies that are involved with building roads or bridges have the need for their staff to travel from their office locations to project sites which are not conveniently accessible from commercial airports. The target customers are not necessarily members of the corporate management or top level executives but mid-level employees in various functional areas. For example, engineers or technicians who attend to field problems need to carry specialized tools and instruments with them, sales or marketing staff that need to attend meetings with customers whose location may not be convenient for a commercial connection or purchasing staff who need to visit suppliers in non-connected locations. An air charter will help such people complete their travel and return to home base saving on time and improving productivity. 3.2 Air charter costs may not be as high as generally perceived. Air Charter should therefore be considered not as a luxury or indulgence but as an affordable alternative. Some typical air charter costs in 2012 illustrate this point (Copley, 2012). Chicago to New York – 2 hours - $ 7,000 to $ 9,000 Chicago to Los Angeles – 3.5 hours - $10,000 to $ 12,000 Miami to Los Angeles – 5.2 hours - $ 15,000 to $ 17,000 3.3 It is useful if two or three anchor accounts can be targeted, each committing to 200 to 300 hours of usage in a year. This commitment works out to an average of 4 to 6 hours a week which is only one round trip from Chicago to New York. For such a commitment, the rates offered could be 10% to 15% lower than the rates for one-off customers. 3.4 Signing up with a corporate account also requires assured service. Since the initial operation of the air charter is with one airplane, there is the need to create a contingency plan to serve the customer’s need if the aircraft is grounded for maintenance or if the flight crew is absent. The contingency plan is to tie-up with another air charter operator either at the same airport or at a nearby airport on a reciprocal basis. 3.5 Once the anchor accounts have been signed, an internet presence and listing with travel agents in the region could help bring in the one-off customers. Particular attention should be paid to the possibilities of aircraft charter on weekends when business travel is unlikely. Some examples are leisure travel to ski resorts or the beach, travel to metro cities and recreational flying. 3.6 As commercial airlines have realized, it is difficult to retain customer loyalty in a service industry. Customer expectations continuously evolve and factors such as on-time departures, cleanliness, in-flight food, ground handling all tend to be taken for granted. For a start-up air charter operation where the avenues for service differentiation are few, this can be a special challenge. 4. Specifications of airplane for charter operations 4.1 The requirements of the targeted key customers would determine the type of aircraft to be acquired. Important questions to be asked of the customer are the number of people on a typical flight, the nature and weight of cargo to be carried, the airports or cities they travel to and the facilities they expect on-board to determine the interior layout. These include telephones, Wi-Fi, projection equipment for meetings, in-flight catering, reclining seats etc. This information will help define the additional features needed for the airplane for landing on dirt strips, for handling prevailing weather conditions and other relevant operational needs. Private Jets broadly classified as Light Business Jets, Medium Jets and Heavy Jets based on their passenger capacity and range (Haining, 2012). Light Business Jets can seat 5 to 8 people; have a range of about 1,000 miles and speeds up to 450 miles per hour. Typical charter rates are $ 2000 to 2500 per hour. Learjet 35, Beech jet 400, Citation Bravo and West Wind are some popular makes of Light Business Jets. A new category named Very Light Business Jets has also been introduced in the market. Medium Jets can seat 8 to 12 people; have speeds up to 590 miles per hour and range up to 3,000 miles. Charter costs for medium jets are in the $2,500 to $ 3,200 per hour. Learjet 60, Hawker 700, Falcon 20 and Citation X are examples of Medium Jets. Heavy Jets are even larger and can seat up to 25 people. They have speeds up to 560 miles per hour, 5,000 miles or larger range and cost around $13,000 per hour to charter. Examples of such planes are the Gulfstream II through V, Boeing Business Jet, Falcon 900 and Challenger 604. 4.2 Once the minimum operational requirements for the key customer needs have been met, the principal consideration has to be the lowest hourly operating cost. Several aircraft brokers and consultant companies provide hourly operating cost comparisons. An extract from one such report is given below. This data is from Conklin & de Decker for 2012 based on their research data base (Conklindd, 2012). These hourly costs show that operating costs have remained substantially constant in over the 10 year period from the 2003 data used in section 2 above and 2012. This is in spite of major increases in fuel costs over this period. Type of Aircraft Variable Hourly Cost ($) Sierra FJ 44 1,760 Beech jet 400 2,519 Nextant 400 XT 1,788 Honda HA 420 1,174 Hawker 400 XP 2,249 Learjet 40 2,171 Cessna Citation CJ1 1,471 Falcon 2000 3,840 Challenger 300 3,152 4.3 Since the first plane for the air charter company is likely to be a used plane, the specifications may need to be compromised to some extent to suit the plane available. In choosing the used plane, particular attention has to be paid to its maintenance records. In particular, the plane’s fitness for uninterrupted service in the start-up phase is critical to the success of the business. 5. FAA Certification 5.1 Air Charter companies and pilots have to be certified by Federal Aviation Administration (FAA). This approval process could take up to a year. The Air Charter Company needs to prepare and submit its operations manuals to comply with the FAA Part 135 rules. These rules include airworthiness standards for the aircraft, maintenance directives including the instruments and tools needed, noise and emission norms for engines, training and medical fitness for crew. Each of these parameters is subject to periodic and unannounced audits. These audits are especially strict for new charter operators (NBAA, 2012). This potential delay is start of operations need to be factored into the business plan. Some steps for mitigation could be the acquisition of an existing charter operator with a license and to employ pilots and maintenance technicians already certified by FAA. 5.2 The International Standard for Business Aircraft Operations (IS-BAO) has been issued by the International Civil Aviation Council as a code of practice business aircraft operators. Certification under the IS-BAO through external auditors is often a pre-requisite for qualifying to provide air charter services to large corporate accounts (Esler, 2004). This certification process also needs up-front time and effort and can be done concurrently with the FAA certification. 6. Competition in the air charter market 6.1 If we apply the Porter 5 forces diagram to the air charter industry, we can see that with over 2000 registered air charter operators; there is intense competitive rivalry within the industry. The bargaining power of the customers is therefore much larger than the bargaining power of the air charter operator and the entry barriers for new entrants is low. The threat of substitute products is essentially from the scheduled airlines offering direct flights to the key customers’ preferred destinations. 6.2 The US however faces a shortage of pilots. At present a total of about 96,000 pilots are employed including scheduled airlines, charters and cargo. 65,000 new pilots are expected to be needed over the next 8 years to cover plane additions and retirements but only 36,000 have passed the FAA Air Pilot examination in the past 8 years (Carey, et al, 2012). This shortage could prevent extension of scheduled airline services to more points and provide continued opportunities for the small air charter operator. 6.3 One major threat of competition is from a company such as Day Jet which was set up to provide on-demand charter planes. The company went bankrupt in 2008 within a year of start of operations due to lack of funding caused by the global financial crisis. The company had a unique business model where they offered a per-seat charter flight with the Eclipse very light jets. The customers had a choice of choosing an available seat on a charter flight the night before departure (Creedy, 2008). With the revival in the US economy, there are good chances of such a model being revived. 7. Summary and Conclusions The starting of an air charter operation is clearly viable financially and is possible for a start-up entrepreneur with a passion for the aviation industry. The principal challenge is in identifying and closing with a few key corporate business travel accounts that can provide an assured base-load for the operations. To find such key customers, it would be necessary to be flexible on the location of the air charter operations. The location should be at one of the 5,0000 General Aviation airports around the US which is located conveniently for access to the key customers. It would be a major advantage if the operation can be started with taking over an existing business jet owned by the customer. This would provide both the low initial outlay and the assurance of the base load. It would also substantially eliminate the threat of competition. An alternative would be to sell the customer on fractional ownership of the airplane which could partially serve the same objective. If such customer participation in airplane ownership is not possible, there is the need to examine if an existing air charter company could be acquired to save on the time and effort in getting FAA certification. Since an airplane is a mobile asset, it would be possible to relocate the operations to an airport near the target customer to win his account. References: 1. Argus Report, (2003). “Aircraft Operating Cost Report”, Argus International Inc., 21 July 2003. (Accessed on 28 Feb 2013 at www.aviationresearch.com) 2. BTS, (2012). “November 2012 Airline System Passengers up 0.8% from Nov 2011”, Bureau of Transportation Statistics, Dec 2012. (Accessed on 27 Feb 2013 at www.rita.dot.gov) 3. Carey, S., Nicas, J. and Pasztor, A., (2012). “Airlines face acute shortage of Pilots”, Wall Street Journal, 12 Nov 2012 (Accessed o 1 Mar 2013 at www.online.wsj.com) 4. Conklindd, (2012). “Aircraft cost summary”, Conklin & de Decker, 2012. (Accessed on 1 Mar 2013 at www.conklinndd.com) 5. Copley, N., (2012). “The reasons to use Private Jet Travel”, Sherpa Report, 23 Oct 2012. (Accessed on 28 Feb 2013 at www.sherpareport.com) 6. Creedy, K.B., (2008). “Day Jet’s Demise”, Aviation Today, 29 Sept 2008. (Accessed on 1 Mar 2013 at www.aviationtoday.com). 7. Duke, J. and Torres, V., (2005). “Multifactor Productivity Change in the air transportation industry”, Monthly Labor Review, March 2005 (Accessed on 28 Feb 2013 at www.rita.dot.gov) 8. Esler, D., (2004). “Toward a Higher Standard”, Business & Commercial Aviation, Oct 2004. (Accessed on 1 Mar 2013 at www.ibac.org) 9. FAA Data, (2010). “General Aviation and Part 135 Activity Surveys- CY 2010”, Federal Aviation Administration, 9 Jan 2012 (Accessed on 27 Feb 2013 at www.faa.gov) 10. Haining, R., (2012). “Types of Private Jets”, eHow, 2012. (Accessed on 1 Mar 2013 at www.ehow.com) 11. Hellow, L.M., (2011). “Private Jet Charter costs …. What is on the Invoice?”, Sherpa Report, 30 Mar 2011. (Accessed on 28 Feb 2013 at www.sherpareport.com) 12. NBAA, (2012). “FAA Regulations Governing Charter Operations”, 2012. (Accessed on 1 Mar 2013 at www.nbaa.org) 13. NBAA Fact Book, (2012). “2012 Business Aviation Fact Book”, National Business Aviation Association, 2012. (Accessed on 27 Feb 2013 at www.nbaa.org) 14. Sherpa Report, (2013). “The reasons to use private jet travel”, 2013. (Accessed on 27 Feb 2013 at www.sherpareport.com) Read More