Management Accounting - MAJORAIR - Assignment Example

? Contents Question 3 Network Management 4 Marketing 6 Sales 8 Service Delivery 9 Country Manager 11 Finance Director 12 Question 2 15 Appendices 18 Appendix 1a: Given Data - SMALLAIR Winter 2011 / 12 18 Appendix 1b: Given Data - Aircraft info. Winter 2011 / 12 18 Appendix 2 – Turnover (Winter 2011/12) 19 Appendix 3: Costs (Winter 2011/12) 20 Assumptions on cost and profitability 21 Appendix 4 21 Profitability per route (winter 2011 / 12) (before proposed changes) 21 Potential Turnover per route at full capacity 22 NETWORK MANAGERS PROPOSAL 23 MARKETING MANAGERS PROPOSAL 28 SALES MANAGERS PROPOSAL 32 SERVICE DELIVERY MANAGERS PROPOSAL 34 COUNTRY MANAGERS PROPOSAL 37 Part B - Management Accounting Question 1 The finances of SMALLAIR are in good shape but have faced some crucial fiscal challenges in some important areas, particularly in regards to the profitability of some routes and the capacity factor of some planes on other routes needed a higher load factor to enhance profitability and reduce costs. Taking into account the advice given out by the proposals of the Function Managers there is a need for a partial overhaul of the companies working practice and corresponding adjustments need to be made to its business model with an overall aim of ensuring as smooth a transition as possible in the aftermath of the acquisition of the company by MAJORAIR. What should also be considered by the board is the long-term strategy of what market should be the focus in terms of both location (established versus expanding) and passenger type (low cost versus high end and discerning), as well as the risks posed by each of these approaches. In regards to the accounts for the season Winter 2011/12 Overall profitability for the season stands at ?148,201,205 It will be important to benchmark the overall profitability of the proposals against this figure to establish which offer would be the most attractive to the company. Another important figure to look at would be at which moment in the season the proposals meet the breakeven mark. There are two ways of looking at this figure. One is to look at which moment in time the costs are covered by simply deducting overall costs against turnover as a point in time (for example: costs are covered between months 3 & 4 and from that point on all revenue can be considered as profit.) Another is to deduct what percentage of each sale is allocated to cover the costs spread out over the entire season or year. Figures for the yearly turnover are not calculated in this analysis because of the uncertainty of passenger numbers for the summer months. In regards to Load Factor there is some room for improvement Gatwick – Washington (AM) – 77.97% Load Capacity (55.14% of total available seats) Gatwick – Washington (PM) – 88.44% Load Capacity (28.26 of total available seats) Gatwick – Boston (AM) – 79.44% Load Capacity (57.9% of total available seats) Gatwick – Boston (PM) – 84.5% Load Capacity (50.88% of total available seats) Gatwick – Seattle (AM) – 55.78% Load Capacity (34% of total available seats) Gatwick – Seattle (PM) – 77.57% Load Capacity (63.16% of total available seats) As the accounts stand there is a surplus that can be reinvested or paid out to shareholders as part of a dividend but before either of these can occur I will be analysing the proposals set by the Functional Managers in regards to an investment strategy. Some of them are long-term investments, several of them are speculative and some of them deal with short-term fixes. I will be assessing them on immediate changes to profitability, projected impacts of capital expenditure feedback (for both the immediate fiscal year and for long-term cost reductions through investments) and what impact each proposal has on the current business practice used by SMALLAIR. Network Management In the first instance, this is the proposal I would want to present to the board as I agree with the recommendations of the proposal in a number of ways. Firstly, the Washington PM flight is the most efficient at load capacity with 88.44% of seats taken for each flight but the route is only maintaining a quarter of the total seats available for London to Washington (maximum load capacity for this route in terms of available seats on a 767 would be 28.26%). It is therefore very important to the profitability of the airline that this high capacity plane is changed to a 747 with the revenue neutral switch (in terms of operating cost) occurring with the Seattle AM flight, in order for overhead costs to be minimised and profits to be maximised. The flight to Seattle is only operating at 55.78% of Load Capacity and would only experience a slight net loss of passengers if switched to a smaller plane, although the savings per flight in Specific fixed costs (?16,000 per flight, or ?288,000 per season) combined with the 33% saving on Variable Cost per aircraft/KM (?8,760 per flight or ?1,576,800 per season) would help alleviate this reduction. Also factored in should be the ?5 extra variable cost per return passenger differential between travelling on a 767 over a 747 (although due to the switch this would be almost revenue neutral. It would also be expected that an increase in 5% Load Capacity of the Washington PM route would more than make up for the shortfall lost by the switch, especially as the route is currently more profitable by ?167,860. Working out the turnover is difficult as there is no information as to what proportion of passengers are expected to travel in the relevant classes (first, club or traveller) so, assuming that proportions will stay as they are it can be taken that a 5% increase on route 1 pm would be across the board and a 20% decrease would likewise occur on route 3 am on current figures. Total revenue before costs taking into account the proposals and predictions of 5% increased passenger numbers would be as follows: Previous Year Increase/(Decrease) Current Year WAS. AM ?41,887,310 ?2,095,123 ?43,982,433 WAS. AM ?27,968,625 ?2,867,067 ?30,835,692 BOS. AM ?42,062,400 ?2,103,173 ?44,165,573 BOS. AM ?25,396,230 ?1,270,373 ?26,666,603 SEA. AM ?29,824,650 (?1,133,337) ?28,691,313 SEA. AM ?45,599,400 ?2,277,375 ?47,876,775 Overall turnover for this proposal is: ?222,218,389 This is an improvement on turnover from winter 2011/12 of: ? 9,479,747 Considering the time value for money, the revenue of next winter shall be discounted at a rate of 10% as that is the interest rate of borrowing. We shall see then see the next years NPV at ? 8,617,090 (previous year profit * discount fact @10%). This shall lead to a combined present value of 18,096,837 of the project over the span of two years. Hence break even shall be achieved over the span Marketing The aims of the Marketing Manager are more speculative than the Network Manager as they are based on a two year projection (for increased sales) and for a 5 year write off period for the costs of refits to all 6 planes used due to the depreciation of the assets. This would mean that there would be ?42,000,000 in capital costs or ?8,400,000 per year. This money would need to be found from within the company’s yearly budget then claimed back later as expenses meaning that while there is no long-term fiscal burden there is an accounting concern that capital first has to be allocated out of profits before it can then be claimed back. ?8,400,000 per year allowance in write off costs means that after one year there is still ?33,600,000 on the company’s books. These figures should be compared to the depreciation costs which the refit is aiming to compensate for. The question would be when these planes are due for their next refit. That time frame would determine the time frame against which to benchmark these refits. Say for example that the 747 fleet was refitted two years ago. Refitting them in time for the following winter season would bring the effective refit period up meaning that the unrecovered depreciation factor of those refits would have to be added to the current refit cost projections. In regards to the projected sales increases for the upcoming next 2 years the projected 40% increase in First Class and the 50% in Club Class tickets would contribute ?9,965,810 and ?46,951,673 respectively to revenue. This looks impressive but has to be figured out over a two year period meaning that a one year projection of increased revenue from ticket sales would be half this amount. When the advertising costs combined with the capital costs of one year for the retrofit are included then it results in a net loss of ?12,400,000. This may be only temporary due to the money that can be written off for capital costs but I would be hesitant to bring this to the board as it stands at the moment unless the difference between refitting planes and the depreciation cost can be brought down to a smaller percentage or that less can be allocated for the advertising budget. The effect on profits of these two actions could be a turnover of above ?91,232,185 in forthcoming years (assuming current data on passenger numbers) but are only projected figures so should be treated with caution. The accuracy of these projections should be questioned. What information are they based on? It seems unlikely that a refit coupled with an advertising campaign would actually produce these increases in traffic. In addition How would the extra passenger numbers be accommodated on existing planes? The only routes that could accommodate this increase in traffic would be Washington morning (First & Club class); Washington afternoon (First class) and Seattle (First & Club class). As the project proposal is based on two year period, this is where NPV, CPV and ARR models come in really handy. Although all the proposals have considered the time value aspect due to the finance managers comments of meeting breakeven by next year. A loss is to be incurred on projection of this proposal. The NPV aspect shall not improve the aspect. ARR shall also reflect on the negative aspect due to the loss. Sales The Sales Manager’s Report represents a more short-term approach to boost numbers in First and Club class when compared to the Marketing Manager and the smaller amount needed (1 million pounds) does make it appear to be a more attractive short-term investment for the board. However, I would advise that this proposal should be taken into account alongside the Marketing report as together they offer a longer-term strategy to boost numbers in the targeted area of First and Club class seats; both have a greater increase in profits when compared to their increased costs. The attempts to increase load factor to 90% for Seattle AM flights and Boston AM Flights the Seattle Flight should be prioritised due to its current actual seats to available seat percentage share of only 56%. The turnover of the ?250 tickets if sold to all Seattle AM passengers in traveller class with a load factor of 90% as predicted would generate ?23,814,000 in revenue compared to the current ?21,162,900 that is currently being produced. As the finance director wants to meet a break even over the next two years. We shall have to use the NPV method to calculate the next year revenue. The present value of the revenue shall be then place at ?21,646,926, that is, a touch higher than that of the previous year. This shall result in a positive CPV, which reflects a positive aspect of the project. Undoubtedly routes will be more profitable if load capacity is increased. My primary concern with the sales proposal is that more than the stated 25% of consumers, predicted to use the cheaper tickets would result in the target of 90% load capacity being reached, perhaps without a similar profitability in selling the reduced price tickets. Another concern is whether the cheaper traveller class tickets will result in a fuller traveller class section and little increase in people taking up the First or Club class seats. For this reason while I would suggest to the board that they should agree to the reduced price ticket to be available for the Seattle morning flight as this should meet with the longer term aims of improving this route from its minimal current market share) and the Boston route should not be quite so generous (or less than the discount offer) for as it currently stands it is operating at 79% of full potential (as well as being a more mature route) compared to the 43% of the Seattle morning flights full potential, suggesting that this route is the only one of the 6 routes that is of significant concern to long-term profitability projections. Questions that decision makers would want answers to would include the following What will customer reactions be to being bumped up to Club Class - Especially if they have to pay the difference? Proposal 1 would mean having to bump 11,949 passengers up to Club Class. If there was no extra charge to these passengers this will result in 11949 satisfied customers but it would mean a cost in variable revenue of ?358,470. What % of seats are available at the reduced price? Service Delivery The proposals presented by the Service Delivery Manager are a series of small scale proposals designed to reduce costs and drive up efficiency of resources and labour costs. Proposal 1 suggests that ?5 can be saved per first class ticket, ?4 per club class ticket and ?2.50 for a traveller class ticket. Taking the predicted lost passenger numbers into account, the total savings for this would come to; ?80420 for 16084 First Class tickets; ?262000 for 65500 Club Class tickets and ?1,132,935 for 453,174 Traveller Class tickets, making a total saving of ?1,475,355. Were this prediction incorrect and passenger numbers not affected the savings would be; ?92,030 for 18,406 First Class tickets; ?262,600 for 6,500 Club Class tickets and ?1,130,435 for 452,174 Traveller Class tickets with a total saving of ?1,485,065 Proposal 2 would result in a 1 pound saving per passenger meaning a saving of ?536,079 for flight operations. Proposal 3 would save 1000 pounds a day based on 4 x 747s' flying meaning that during a season of 180 flights there would be a ?180,000 per season or ?360,000 per year saving. When the three totals are combined they would come to somewhere between ?221,144 (If there were no change in passenger numbers) and ?2,191,434 (If the predicted loss in passenger numbers proved correct), resulting in a net loss when compared to a 2% decrease in ticket sales of ?823,341.20 (?3,013,454.20 = 2% of a ?150,672,710 total). Due to these proposals making a loss based on the projected decrease in ticket sales and passenger numbers I would be hesitant to submit this proposal to the board unless there can be a projected decrease in sales of no more than approximately 1.5% of ticket sales (which would equate to a ?2,260,090.65 pounds decrease in ticket revenue). Again considering the time value for money and applying NPV may further increase my hesitance in considering the proposal and going for a submission. If a loss is already being incurred the NPV for next year is deemed to be even worse, hence the CPV shall prove the proposal to be unfeasible. However, if the 5% projected increase does occur by the next year then I would be willing to forward these cost cutting proposals too. Country Manager The proposals of the Country Manager operate as an incentive to boost long-term premium passengers in First and Club class. This strategy is in keeping with the primary reason behind the takeover, that of boosting load factor on these routes and in particular the two higher end types of travel. The biggest differential in ticket prices when compared to full-fare is in Traveller class, where they pay on average only 75% of what a full fare costs (and compared to 92% of full fare for First and 80% for Club) but this class of passenger is at highest load capacity of all three classes. In order to boost the uptake of First and Club Class passengers I agree with the idea but not with the level of discount being offered to Club Passengers as ?800 discount rate is already ?325 below average which would result in a total loss of ?21,287,500, based on the predicted 65,500 passengers paying this reduced price as suggested in the country manager’s report. Any promotion which requires a reduction in revenue as a lost leader should undergo strict scrutiny. It should be clear that income is greater than overheads, therefore a clear understanding of the breakeven point is necessary and the relationship that the margin of safety plays in the cash flow of the operation. A promotion such as this is too costly for the company to afford therefore I wouldn’t suggest it goes before the board. Even with the projected uptake of 2000 Traveller passengers taking up this offer (revenue of ?1,600,000), and the 3% of upgrades for Traveller class (difference of ?500 from average price being paid by 13,565 passengers coming to ?6,782,610 in total), the lost revenue from average fare paying passengers would be difficult to justify. Another problem posed by this promotion is that customers will be reluctant to accept a price hike to pre promotion levels so there are sustainability levels and marketing questions related to this. How long is the promotion planned for? If this is s limited availability offer then it should be expected that the passenger numbers would return to a normal level again following the promotion. How do you keep these passengers if they have simply come to the company because of the attractive price on offer, once the price returns to normal? For the proposal to boost First Class numbers I would be more inclined to favour this to be presented to the board as the knock on effects of moving 600 passengers up to First Class would result in more space being available in Club class which might encourage more Traveller class passengers to pay for the upgrade. The accumulative effect would result in more tickets being available for Traveller class which is the highest class in terms of load capacity, and something that should be maintained, though caution should be urged in case Club class becomes over-subscribed and First class is not at the same capacity as pre-takeover times. Finance Director In regards to the note from the Finance Director I would suggest to the board that using an interest rate of 10% for expenditure on aircraft when projected sales increase in the North American market is projected only at 5% and should be reconsidered. Using this as a method of financing would result in a year on year loss to the company and should be avoided, except as a last resort to perhaps fund a refit as suggested by Marketing. For the ?100,000,000 in maximum capital expenditure this should not be a problem as the largest costs incurred over the next season would be the refit of the planes for ?42,000,000. While this amount will remain on the balance sheet for 5 years it can be written off as expenses meaning it will not have any long-term impact on profitability and would be tax deductible. The finance director’s note serves as a limit on expenditure but as I am approaching the proposals from the Functional Management with caution except where there is an immediate increase in profitability, then the cap on spending doesn’t necessarily apply. I would see the main concern with the finances as being to boost revenue through a combination of network changes and some new marketing and sales proposals but the total advertising costs would be only ?6,500,000 so when combined with other total capital expenditure there is only a potential total of ?51,500,000 for all new purchases and costs. There is another aspect to these limitations imposed on the financial constraints which is the possibility of purchasing new aircraft to accommodate an increase in passenger numbers. This may be necessary in the future as certain routes are nearing capacity and will continue to do so in the immediate future. As expenditure on aircraft can be financed at 10% per annum then it would be necessary to evaluate profitability of larger aircraft carrying more passengers against this possible loan for possible purchase of aircraft plus 10% interest to service the debt. Taking the example of the marketing managers proposal into account, ?91,232,185 turnover is unachievable without more passenger carrying capacity. Therefore larger planes would be needed which would mean a combination of possibly reshuffling planes around and purchasing larger aircraft this is truly when the ?100 million and subsequent 10% per annum borrowing would come into play. Question 2 The two most influential pieces of literature on the subject of creating a business perspective that I utilised for the analysis of the Functional Managers in question 1 are ‘The Risk Society: towards a new modernity’ (1992) by Ulrich Beck and ‘Nudge: Improving decisions about health, wealth and happiness’ (2009) by Richard Thaler. Together these helped me to sort out my view on short-term impacts and long-term strategies when looking into the takeover of SMALLAIR by MAJORAIR and how to distinguish between the risks and opportunities. The importance of these two theorists for establishing a comprehensive analysis are the ideas of risk and negation of all potential risks through effectively analysing what these risks could be. In regards to Thaler it is important to understand what can be achieved through small scale changes as opposed to comprehensive and systemic changes to a company's operating procedures. The concept of a nudge is important in the modern world as stock prices can fluctuate to a great degree if it looks as if a company is making too many expensive changes at once. By enacting the smaller changes first then monitoring the effects, as Thaler suggests, this risk can be averted. The most important idea I gained from Beck’s ‘The Risk Society’ is that it is our instinctive tendencies that determine our behaviour and this allows us to look at the issues in front of us with a high degree of caution based on our understanding of the matter. In terms of the business decisions involved in this airline takeover and the impact of the Functional Management proposals it meant that I was approaching all six contributions with a critical perspective on what short-term risks would be involved with sending their proposals to the board for ratification. Beck introduces the reader to the idea that all decisions have a risk element behind them and that our ability to predict and respond to these risks, in a business sense, results in success or failure. After going through with Richards and Stewart (2003), “principles of corporate fianance”, the Net present value model gave me an insight about future returns. It helped me understand the importance of time value of money. It is sensitive to future cash inflows hence provides a better view on the feasibility of a project. Along with NPV the ARR model may be used as a tools but as compared to NPV is not that reliable as it does not consider the value aspect of a cash flow. Thaler, in ‘Nudge’ influenced my thinking in another way. The main idea of his book is the power to persuade through simple means. Translating this to the proposals from the functional Managers meant that what I was looking for from them was the smallest change in operating practice to lead to a bigger increase in firstly load factor and then in profits. This is why I was very willing to put forward the proposals from the Network Management, a small fix involving changing type of aircraft from an under-capacity route to one where load capacity was much higher, but not from Service Delivery, as the measures they were suggesting were more complex and have a larger knock on effect in terms of ticket sales. There were another three articles that I found interesting for my financial analysis. These were Chapter 4 from Coombs and Jenkins’ ‘Public Sector Financial Management’ (2002) which provided a useful oversight into the importance of budgetary constraints and long-term expenditure and revenue estimations. Another useful source was Drury’s ‘Management and Cost Accounting’ (2000) as it helped me to better understand the importance of factoring in all expenditure into a budget and how crucial the idea of controllability is for keeping down costs and highlighting potential areas for revenue increases. The third article that I found useful was Otley’s ‘Performance management: a framework for management control system research’ from Management Accounting research (1999, 10 pages 363-382) which introduced me to the key principles that I used in my financial analysis of the takeover deal. These were about measuring, controlling and developing a strategy to assess the current financial performance for SMALLAIR by looking at its accounts for one season. Appendices Appendix 1a: Given Data - SMALLAIR Winter 2011 / 12 Route info Washington Boston Seattle Return flights leaving AM PM AM PM AM PM Aircraft Type 747 1 0 1 0 1 1 767 0 1 0 1 0 0 Distance (KM) 5240 5240 5901 5901 8760 8760 Potential Market: Passenger Seats (000's) 252 270 240 150 408 220 Seats Available First 6480 3600 6480 3600 6480 6480 Club 26640 15120 26640 15120 26640 26640 Traveller 105840 57600 105840 57600 105840 105840 Total one way seats available 138960 76320 138960 76320 138960 138960 Actual seat Numbers. First 3251 3375 4416 2580 1550 3234 Club 11920 8100 17664 11610 5426 10780 Traveller 93190 56025 88320 50310 70543 93786 Total one way seats 108361 67500 110400 64500 77519 107800 Net ? return fare First 1360 1360 1145 1145 1650 1650 Club 915 915 880 880 1125 1125 Traveller 285 285 243 243 300 300 Appendix 1b: Given Data - Aircraft info. Winter 2011 / 12 Aircraft Type 747 767 Tot. seat capacity First 18 10 Club 74 42 Traveller 294 160 Total 386 212 Range (KM) 13250 9095 Flight Crew 2 2 Cabin Crew 16 9 Variable cost per passenger (?) First 105 110 Club 75 80 Traveller 45 50 Variable cost per aircraft KM (?) 3 2 Specific fixed cost / return flight (?) Engineering / maintenance 8000 5000 Crew 6500 5000 Catering 1500 800 Total 16000 10800 Aircraft depreciation & other overhead Cost for 6 month season (?000's) 5000 4000 Total flying days in year 360 Projected growth (Winter 2012 / 13) 5% Appendix 2 – Turnover (Winter 2011/12) Actual seats * Fare for route WAS. AM First 3,251 ? 1,360 ? 4,421,360 Club 11,920 ? 915 ? 10,906,800 Traveller 93,190 ? 285 ? 26,559,150 Total ?41,887,310 WAS. PM First 3,375 ? 1,360 ?4,590,000 Club 8,100 ? 915 ? 7,411,500 Traveller 56,025 ? 285 ? 15,967,125 Total ?27,968,625 BOS. AM First 4,416 ? 1,145 ? 5,056,320 Club 17,664 ? 880 ? 15,544,320 Traveller 88,320 ? 243 ? 21,461,760 Total ?42,062,400 BOS. PM First 2,580 ? 1,145 ? 2,954,100 Club 11,610 ? 880 ? 10,216,800 Traveller 50,310 ? 243 ? 12,225,330 Total ?25,396,230 SEA. AM First 1,550 ? 1,650 ? 2,557,500 Club 5,426 ? 1,125 ? 6,104,250 Traveller 70,543 ? 300 ? 21,162,900 Total ?29,824,650 SEA. PM First 3,234 ? 1,650 ? 5,336,100 Club 10,780 ? 1,125 ? 12,127,500 Traveller 9,3786 ? 300 ? 28,135,800 Total ?45,599,400 Total turnover for winter 2011/12 = 212,738,615 Appendix 3: Costs (Winter 2011/12) Route Actual seats Variable cost Total Variable costs / passenger Variable cost /KM *180 days Fixed cost / return flight *180 days WAS. AM First 3,251 105 341,355 (5240km*?3)* 180 (16000 * 180) Club 11,920 75 894,000 Traveller 93,190 45 4,193,550 Total ?5,428,905 ? 2,829,600 ? 2,880,000 ? 11,138,505 WAS. PM First 3,375 110 371,250 (5240km*?2)*180 (10800 * 180) Club 8,100 80 648,000 Traveller 56,025 50 4,482,000 Total ?5,501,250 ?1,886,400 ? 1,944,000 ? 9,331,650 BOS. AM First 4,416 105 463,680 (5901km*?3)*180 (16000 * 180) Club 17,664 74 1,324,800 Traveller 88,320 45 3,974,400 Total ?5,762,880 ?3,186,540 ? 2,880,000 ? 11,829,420 BOS. PM First 2,580 110 283,800 (5901km*?2)*180 (10800 * 180) Club 11,610 80 928,800 Traveller 50,310 50 251,550 Total ?3,728,100 ?2,124,360 ? 1,944,000 ? 7,796,460 SEA. AM First 1,550 105 162,750 (8760km*?3)*180 (16000 * 180) Club 5,426 75 406,950 Traveller 70,543 45 3,174,435 Total ?37,444,135 ?4,730,400 ? 2,880,000 ? 11,354,535 SEA. PM First 3,234 105 339,570 (8760km*?3)*180 (16000 * 180) Club 10,780 75 808,500 Traveller 93,786 45 4,220,370 Total ?5,368,440 ?4,730,400 ? 2,880,000 ? 12,978,840 Assumptions on cost and profitability The dataset provided covers the winter season therefore 360 flying days divided by two = 180 flying days. The information is given for flights leaving Gatwick and no sales figures are provided for the USA to Gatwick journeys. Flight times to the destinations vary between 8 and 10 hours. (Google search - Question: How long does a flight take from Gatwick to destination X?) Allowing for stopover of 1 to 2 hours before returning to Gatwick these planes would do 2 journeys in a 24 hour period. It is therefore feasible to calculate the given data by 2 to accommodate this in an attempt to work out the true profitability of the various planes however there would probably be discrepancies with passenger numbers on return flights. To gain a true picture of the profitability of the planes would require more accurate data from US sales. Therefore calculations have been made on 180 days of flying and on the dataset provided. Costs have been provided on the basis of return journeys as have the fares however the passenger numbers are for one way journeys only. The assumption is made that all one way seats are sold for return journeys and that figures from US sales are categorised as different routes and that all costs as well as depreciation costs against return journeys would be calculated against this route despite them covering both outward and return legs. It is important to calculate both outward and return journey passenger numbers against relevant fare prices (Which for US passengers would be in $US) and calculate these totals against costs for true profitability figures. In other words it is assumed that the UK cost centre is recovering costs and depreciation against its routes out of Gatwick while the US cost centres would calculate their profitability (Ground staff, US employees etc) free from Aircraft costs. It would be interesting to know which cost centre would accommodate refuelling of aircraft in the USA. Appendix 4 Profitability per route (winter 2011 / 12) (before proposed changes) Turnover - (Total costs Fixed + Variable + Depreciation) Route Turnover Total Fixed costs Depreciation Total WAS. AM ? 41,887,310 ?11,138,505 ? 5000 ? 30,663,805 WAS. PM ? 27,968,625 ?9,331,650 ? 4000 ? 18,632,975 BOS. AM ? 42,062,400 ?11,829,420 ? 5000 ? 30,227,980 BOS. PM ? 25,396,230 ?7,796,460 ? 4000 ? 17,595,770 SEA. AM ? 29,824,650 ?11,354,535 ? 5000 ? 18,465,115 SEA. PM ? 45,599,400 ?12,978,840 ? 5000 ? 32,615,560 Overall profitability for season ?148,201,205 Potential Turnover per route at full capacity Class Passenger Numbers Fare Turnover WAS. AM First 6,480 1,360 8,812,800 Club 26,640 915 24,375,600 Traveller 105,840 285 30,164,400 138960 63,352,800 WAS. PM First 3,600 1,360 4,896,000 Club 15,120 915 13,834,800 Traveller 5,760 285 1,641,600 24480 20,372,400 BOS. AM First 6,480 1,145 7,419,600 Club 26,640 880 19,923,200 Traveller 105,840 243 25,719,120 138960 53,061,920 BOS.PM First 3,600 1,145 4,122,000 Club 15,120 280 4,233,600 Traveller 57,600 243 13,996,800 24480 22,352,400 SEA. AM First 6,480 1,650 10,692,000 Club 22,640 1,125 25,470,000 Traveller 105,840 300 31,752,000 138960 67,914,000 SEA. PM First 6,480 1,650 10,692,000 Club 22,640 1,125 25,470,000 Traveller 105,840 300 31,752,000 138960 67,914,000 Totals 644,640 29,496,7520 Passenger Efficiency/Plane Route WAS. AM WAS. PM BOS. AM BOS. PM SEA. AM SEA. PM Capacity Rate (%) 77.97 88.44 79.44 84.5 55.78 77.57 (Actual Seat Numbers / Seats available) * 100 Of total available (%) A 55.14 28.26 57.9 50.88 34 63.16 (Total one way seats available / potential market seats) * 100 Of total actual tickets (%) B 43 25 46 43 18.99 49 Differential - B/Ax100=% 77.98 88.46 79.44 84.51 55.85 77.58 (B/A) * 100 Efficiency (%) Washington 83.22 (Total actual seats) / (Total seats available) * 100 Boston 81.98 Seattle 66.72 Actual % of seats First 3 5 4 4 2 3 Club 11 12 16 18 7 10 Traveller 86 83 80 78 91 87 (Actual seat numbers / Total actual one way seats available) * 100 Available % of seats First 4.7 4.7 4.7 4.7 4.7 4.7 Club 19.2 19.8 19.2 19.8 19.2 19.2 Traveller 76.1 75.5 76.1 75.5 76.1 76.1 (Seats available / Total one way seats available) * 100 NETWORK MANAGERS PROPOSAL Passenger numbers for forthcoming winter season on actual passengers carried. (5% increase in passenger numbers without change in plane type on routes) Then multiplied by net return fare price: (Current Actual passengers carried + 5%) * fare price = ? Turnover WAS. AM: First - 3,251 + 5% = 3,414 * ?1360 = ? 4,643,043 Club -11,920 + 5% = 12,516 * ?915 = ? 11,452,140 Traveller - 39,190 + 5% = 41,150 * ?285 = ? 11,727,750 Total - 108,361 + 5% = 113,780 Revenue = ? 27,822,933 WAS. PM: First - 3,375 + 5% = 3,544 * ?1360 = ? 4,819,840 Club - 8,100 + 5% = 8,505 * ?915 = ? 7,782,075 Traveller - 56,025 + 5% = 58,826 * ?285 = ? 16,765,410 Total - 67,500 + 5% = 70,875 Revenue = ? 29,367,325 BOS. AM: First - 4,416 + 5% = 4,637 * ?1145 = ? 5,309,365 Club - 17,664 + 5% = 18,547 * ?880 = ? 16,321,360 Traveller - 88,320 + 5% = 92,736 * ?243 = ? 22,534,848 Total -110,400 + 5% = 115,920 Revenue = ? 44,165,573 BOS. PM: First - 2,580 + 5% = 2,709 * ?1145 = ? 3,101,805 Club - 11,610 + 5% = 12,191 * ?880 = ? 10,728,080 Traveller - 50,310 + 5% = 52,826 * ?243 = ? 12,836,718 Total - 64,500 + 5% = 67,725 Revenue = ? 26,666,603 SEA. AM: First - 1,550 + 5% = 1,628 * ?1650 = ? 2,686,200 Club - 5,426 + 5% = 5,697 * ?1125 = ? 6,409,125 Traveller - 70,543 + 5% = 74,070 * ?300 = ? 22,221,000 Total - 77,519 + 5% = 81,395 Revenue = ? 31,316,325 SEA.PM: First - 3234 + 5% = 3396 * 1650 = ? 5,603,400 Club - 10,780 + 5% = 11,319 * ?1125 = ? 12,733,875 Traveller - 93,786 + 5% = 98,475 * ?300 = ? 29,542,500 Total - 107,800 + 5% = 113,190 Revenue = ? 47,879,775 Passenger numbers for forthcoming winter season (with 5% increase in passenger numbers and change in plane types on routes with resulting predicted new passenger numbers) WAS. PM = Current passenger numbers + 5% First: = 3,375 + 5% = 3,544 Club: = 8,100 + 5% = 8,505 Traveller: = 56,025 + 5% = 58,826 SEA. AM: = Current passenger numbers - 3.8% First: = 1,550 - 3.8% = 1,491 Club: = 5,426 - 3.8% = 5,220 Traveller: = 70,543 - 3.8% = 67,862 Turnover with changes: WAS. PM = Turnover + 5% (increase from 25% to 30% for next season) First: = ? 4,819,840 + 5% = ? 5,060,832 Club: = ? 7,782,075 + 5% = ? 8,171,179 Traveller: = ? 16,765,410 + 5% = ? 17,603,681 Total = ? 30,835,692 SEA. AM = Turnover - 3.8% (decrease from 19% to 15.2% for next season) First: = ? 2,686,200 - 3.8% = ? 2,584,124 Club: = ? 6,104,250 - 3.8% = ?5,872,288 Traveller: = ? 21,162,900 - 3.8% = ?20,358,710 Total = ?28,691,313 Predicted potential market (with 5% increase in passenger numbers) = Current potential market + 5% = (252,000 + 270,000 + 240,000 + 150,000 + 408,000 + 220,000) + 5% WAS. AM: = 252,000 + 5% = 264,600 WAS. PM: = 272,000 + 5% = 285,600 BOS. AM: = 240,000 + 5% = 252,000 BOS. PM: = 150,000 + 5% = 157,500 SEA. AM: = 408,000 + 5% = 428,400 SEA. PM: = 220,000 + 5% = 321,000 Total = 1,709,100 WAS. PM: (Total one way seats ? by Potential market seats) * 100 = 25% of market share. Therefore: 30% of current Potential market = 270,000 * 0.3 = 81,000 expected new passengers after change (working on todays figures) SEA. AM: (Tot one way seats ? Potential market seats )*100 = (77,519 ? 408,000)* 100 = 19% of market share. Therefore: 408,000 *0.152 = 62,016 expected new passenger numbers = 15.2% of market share (without market expansion of 5% in passenger numbers.) Previous SEA. AM - New SEA. AM = 77,519 - 62,016 = 15,503 reduction in passengers because of change. (based on current figures before 5% growth in passenger numbers. Plane capacity: (Total one way seats ? Total available)*100 SEA. AM: = 55.7% load capacity (Currently without changes or market increase) WAS. PM = 88.4% as above SEA. AM: = 101.5% (New figures with changes to plane type) WAS. PM = 48.57% as above Overall turnover for routes after changes and expanded passenger numbers = ?43,982,433 + ?30,835,692 + ?44,165,573 + ?26,666,603 + ?28,691,313 + ?47,876,775 = ?222,218,389 Variable costs with increased passenger numbers and proposed changes: New passenger numbers * variable cost per passenger WAS. AM: First 3,414 * 105 = ?358,470 Club 12,506 * 75 = ?937,950 Traveller 41,150 * 45 = ?1,851,750 WAS. PM: First 3,544 * 105 = ?372,120 Club 8,505 * 75 = ?637,875 Traveller 58,826 * 45 = ?2,647,170 BOS. AM: First 4,637 * 105 = ?486,885 Club 18,547 * 75 = ?1,391,025 Traveller 92,736 * 45 = ?4,173,120 BOS. PM: First 2,709 * 110 = ?297,990 Club 12,191 * 80 = ?975,280 Traveller 52,826 * 50 = ?2,641,300 SEA. AM: First 1,491 * 110 = ?164,010 Club 5,220 * 80 = ?417,600 Traveller 67,862 * 50 = ?3,393,100 SEA. PM First 3396 * 105 = ?356,580 Club 11,319 * 75 = ?848,925 Traveller 98,475 * 45 = ?4,431,375 Total = ?26,382,525 ((Fixed costs after proposed changes + (Variable per KM * Route distance)) * 180 days WAS. AM: ((16000 + (3 * 5240))* 180 = ?5,709,600 WAS. PM: ((16000 + (3 * 5240))* 180 = ?5,709,600 BOS. AM: ((16000 + (3 * 5901))* 180 = ?6,066,540 BOS. PM: ((10800 + (2 * 5901))* 180 = ?4,068,360 SEA. AM: ((10800 + (2 * 8760))* 180 = ?5,097,600 SEA. PM: ((16000 + (3 * 8760))* 180 = ?7,610,400 Total: = ?34,262,100 Depreciation of aircraft: 747 = 4 * 5000000 767 = 2 * 4000000 Total = ?28,000,000 Profitability of proposal: = Turnover - (Variable costs + Fixed costs + Depreciation) = ?222,218,389 - (26,382,525 + 34,262,100 + 28,000,000 = ?222,218,389 - ?88644625 = ?133,573,764 MARKETING MANAGERS PROPOSAL Advertising: ? 4,000,000 charged to profit Refit 747 plane: ? 8,000,000 write off as depreciation after 5 years Refit 767 plane: ? 5,000,000 write off as depreciation after 5 years Advertising: ?4,000,000 charged to profit Refit 747 plane: ?8,000,000 write off as depreciation after 5 years Refit 767 plane: ?5,000,000 write off as depreciation after 5 years Total refit costs: 747 - ?8,000,000 * 4 planes = ?32,000,000 Total refit costs: 767 - ?5,000,000 * 2 planes = ?10,000,000 Total refit costs = ?42,000,000 Refit costs written off over 5 years = ?42,000,000 / 5 = ?8,400,000 per year Refit costs for year divided by 2 (Summer & Winter seasons) = ?4,200,000 write off for the season. 747 Depreciation over 5 years (winter season figures only) = 5 * ?5,000,000 = ?25,000,000 767 Depreciation over 5 years (winter season figures only) = 5 * ? 4,000,000 = ?20,000,000 Fixed Costs 747 plane: 4 Routes per day * 360 days = 1440 flights per year * 16000 total fixed costs = ? 23,040,000 + (5000 * 2) (Depreciation * 2 for 360 days) = ? 23,050,000 fixed costs in a year Fixed Costs 767 plane: 2 Routes per day * 360 days = 720 flights per year * 10800 total fixed costs = ? 7,776,000 + (400 * 2) (Depreciation * 2 for 360 days) = ? 7,784,000 fixed costs in a year Variable cost / KM for 360 days (747plane: ? 3 / KM) WAS. AM = (5240 *3) * 360 = ? 5,659,200 BOS. AM = (5901 * 3) * 360 = ? 6,373,080 SEA. AM = (8760 * 3) * 360 = ? 9,460,800 SEA. AM = (8760 * 30 * 360 = ? 9,460,800 Variable cost / KM for 360 days (767 plane: ? 2 / KM) WAS. PM = (5240 * 2) * 360 = ? 3,772,800 BOS. AM = (5901 * 2) * 360 = ? 4,248,720 Total variable costs for all routes = ? 38,975,400 Variable costs per return passenger: (with 40% increase in passenger numbers) Total passengers on plane type in class type for season of 180 days * Variable cost--per passenger for that class. = 747 plane for season - First Class = (4551 + 3186 + 2170 + 4528) * ?105 = ?1,830,255 = 767 plane for season - First Class * ? 110 = (3612 + 4725) * ? 110 = ? 917,070 = 747 plane for season - Club Class * ? 75 = (11920 + 17664 + 5426 + 10780) * ? 75 = ? 3,434,250 = 767 plane for season - Club Class * ? 80 = (12150 + 124515) * ?80 = ? 2,365,200 Revenue First Class: = actual seats + 40% * Fare for class by route 747 WAS. AM = (3251 + 40 %) * 1360 = ? 6,189,630 767 WAS. PM = (3375 + 40%) * 1360 = ? 64,626,000 747 BOS. AM = (4416 + 40 %) * 1145 = ? 7,078,390 767 BOS. PM = (2580 + 40 %) * 1145 = ? 3, 580,500 747 SEA. AM = (1550 + 40 %) * 1650 = ? 7, 471,200 747 SEA. PM = (3234 + 40 %) * 1650 = ? 4, 135,740 Total: ? 34, 881,190 Revenue Club Class: = actual seats + 50 % * Fare for class by route 747 WAS. AM = (11920 + 50 %) * 915 = ? 16,360,200 767 WAS. PM = (8100 + 50 %) * 915 = ? 1,117,250 747 BOS. AM = (17664 + 50 %) * 880 = ? 23,316,480 767 BOS. PM = (11610 + 50 %) * 880 = ? 15,325,200 747 SEA. AM = (5426 + 50 %) * 1125 = ? 9,156,375 747 SEA. PM = (10780 +50 %) * 1125 = ? 18,627,840 Total: ? 93,903,345 Against winter 2011/12 revenue from club class: ?46,951,673 Total = 34881190 + 93,903,345 = ? 128,784,535 (Turnover in 2 years) Therefore: Total revenue - Total costs = Total turnover in 2 years - (Total Variable costs + Fixed costs + Depreciation) = Profit in 2 seasons time = ? 128,784,535 - (? 1'830,255 + ? 917,070 + ? 3,434,250 + ? 2,365,200 + ? 23,050,000 + ? 7,784,000) = ?128,784,535 - ?37,552,350 = ?91232185 Profit in 2 years Passenger numbers over 2 seasons: (40% increase in First Class passenger numbers) = Total Actual First Class seat numbers + 40% = 25,768 First Class passenger increase across all routes (50% increase in Club Class passenger numbers) = Total Actual Club Class seat numbers + 50% = 98,250 Club Class passenger increase across all routes SALES MANAGERS PROPOSAL 1) SEA. AM: Limited availability fare of ?250 for Traveller Class to increase load factor by 90 % 2) BOS. AM: Limited availability fare of ? 200 for Traveller Class to increase load factor by 90 % Advertising expense: ? 1,000,000 25 % of people travelling on these routes will take advantage of this offer. It is assumed that this 25 % is from the existing Traveller Class. 1) SEA. AM: Load factor = (Actual Available) * 100 First = (1550 6480) * 100 = 24 % Club = (5426 22640) * 100 = 20 % Traveller = (70543 105840) * 100 = 67 % Total = (77519 138960) * 100 = 56 % Revenue of SEA.AM Traveller at 90% capacity at proposed price of ?250 = (Available Traveller seats * 0.9) * 250 = (105,840 * 0.9) * ? 250 = 95,256 * ?250 = ?23,814,000 Current Revenue of SEA. AM Traveller at present capacity & fare price = 70,543 * ?300 = 21,162,900 Therefore: 90% (Predicted new load factor) - 56 % = 34 % increase in overall passenger numbers on this route needed to meet targeted predicted load factor. Therefore: Total one way available *0.34 = 47246 new customers needed to meet predicted load factor. Unoccupied seats in existing Traveller Class: = Total Traveller Class available - Actual Traveller = 105840 - 70543 = 35297 Spare seats on Traveller Class Load Factor: = (Actual Traveller Class Total one way seats available) * 100 = (70543 138960) * 100 = 50.76 % Actual load factor for Traveller Class on Total Carrying capacity of aircraft. Therefore: From the 47,246 new customers - only 35,297 of them would be accommodated in Traveller Class. Therefore: 11,949 passengers would have to be bumped up to Club Class. Potential loss in variable costs if upgraded passengers are not charged accordingly = 11,949 * (75 - 45) = ? 358,470 2) BOS. AM: Load Factor = (Actual Load factor Total Available) * 100 First = (4,416 6,480) * 100 = 68 % Club = (17,664 26,640) * 100 = 66 % Traveller = (88,320 105,840) * 100 = 83 % Total = (110,400 138,960) * 100 = 79 % 90% - 79 % = 11 % increase in passenger numbers Therefore: Total one way available + 11 % = 15286 new customers needed to realise prediction. Total Traveller Available - Actual Traveller = 10548 - 88320 = 17520 spare seats on Traveller Class SERVICE DELIVERY MANAGERS PROPOSAL 2% reduction in overall passenger numbers (warning by marketing) = 536080 * 0.02 = 10722 less passengers. At the current lowest fare of ?243 = ?243 * 10722 Therefore: Minimum Lost Revenue at max discounted fare price ? ?2,605,446 Cut catering costs by 10% = Total (passengers * relevant cost per class) - 10% So: First Class total catering cost = ((3,251 + 3,375 + 4,416 +2,580 + 1,150 + 3,234) * ?50) - 10% = (18,406 * ?50) - 10% = ?920,300 - 10% = ?828,270 (Saving of ? 92,030) And: Club Class total catering cost = ((11,920 + 8,100 + 17,664 + 11,610 + 5,426 + 10,780) * ?40) - 10% = (6,500 * ?40) - 10% = ?2,620,000 - 10% = ?2,358,000 Saving of ? (262,600) And: Traveller Class total catering cost = ((93,190 + 56,025 + 885,320 + 50,310 + 70,543 + 93,786) * ?25) - 10% = (452,174 * ?25) - 10% = ?11,304,350 - 10% = ?10,173,915 (Saving of ?1,130,435) New catering cost for winter season = ? 13,360,185 (Total saving of ?1,485,065) Saving for full year = ?1,485,065 * 2 = ?2,970,130 Ground handling charges of ?10 per return flight cut by 10% Total one way seats - ?9 = (108,361 + 67,500 + 110,400 + 64,500 + 77,519 + 107,800) * ?9 = 536,079 * ?9 = ?4,824,711 for winter season (Saving of ?536079) Doubled for year = ?964,942 (Total saving of ?107,216) Cut cabin crew on 747 (?250 reduction per flight) = 4 flights per day * 360 days flying per year = 1440 flights per year * ?250 = ?360,000 saving (assuming that flights return on the same day) Therefore: Total savings proposed for 360 days flying = Min. Lost Revenue - (Catering + Ground handling + Cabin Crew) = ?2,605,446 - (?2,970,130 + ?107,213 + ?360,000) = ?2,605,446 - ?3,437,343 = ?831,877 Potential profit against absolute minimum priced discount fare. So - against average fare price for Traveller class: ?300 New Min. Lost revenue would be: 10,722 passengers * ?300 = ?3,216,600 - ?3,437,343 = ?220,743 Potential profit against average Traveller Class fare. And against Average First class fare: ?1650 New Min. Lost revenue would be: 10,722 passengers * ?1650 = ?17,691,300 - ?3,437,343 = ?14,253,957 Potential LOSS Most lost fares would probably be from First & Club Class passengers. Therefore: Dividing 10,722 passengers between First & Club classes and calculating the average fares: First: = 5361 * ?1650 Club: = 5361 * ? 1125 = ?8,845,650 lost revenue = ?6,031,125 lost revenue Against suggested savings of ?3,437,343 = ?11,439,432 Potential LOSS And against an even spread between all classes based on average fares: First Club Traveller = 3574 * ?1650 = 3574 * ?1125 = 3574 * ?300 = ?5,897,100 = ?4,020,750 = ?1,072,200 Potential LOSS of: ?7,552,707 COUNTRY MANAGERS PROPOSAL Average fares to full fares as percentages: (Average fare / Full fare) * 100 First: ?1650 (Full fare ?1,800) = 92% Club: ?1125 (Full fare ?1,400) = 80% Traveller: ?300 (Full fare ?400) = 75% Half of tickets sold on SEA. AM & SEA. PM are sold in the USA = Actual seat numbers ? 2 = (First ? 2) + (Club ? 2) + (Traveller ? 2) First: = (1550 + 3234) ? 2 = 4784 ? 2 = 2374 Club: = (5426 + 10780) ? 2 = 16206 ? 2 = 8103 Traveller: = (70543 + 93786) ? 2 = 164329 ? 2 = 72165 Total = 82642 Most club passengers on AM flight moved to First Class Boeing 747 capacity: First: = 18 * 180 days in season = 3,240 Club: = 74 * 180 days in season = 13,320 Traveller: = 294 * 180 days in season = 52,920 Actual numbers in First on AM flight = 1550 for winter season Actual numbers in Club on AM flight = 5426 for winter season Capacity of first - actual seats occupied on first = 3,240 - 1,550 = 1,690 free seats Full fare paying Club class - upgrade to first = 1690 * ?1400 = ? 2,366,000 Future first class paying full fare reduced to 20% of current number = (1550 + 3234) * 0.2 = 957 full fare paying for first class. = 957 * ?1800 = ? 1,722,600 2000 extra passengers to club fare = 2000 * ? 800 = ? 1,600,000 Actual Traveller class - 3% (upgrading to Club discounted fare) = (70,543 + 93,786) - 3% = 164,329 - 4,930 = 159,399 Traveller class for next season Next season traveller class * average fare = 159,399 * ?300 Revenue next season Traveller class = ? 47,819,700 Discounted fare ?800 for Club class * number of passengers travelling in club class next year. = ? 800 * (2,000 new customers to class + (current number in Club - those moving to first on automatic upgrade) = ? 800 * (2,000 + ((5,426 + 10,780) - 1,690) = ? 800 * (2,000 + 16,206) - 1,690) = ? 800 * 16,516 = ? 13,212,800 Full fare for club for those upgrading from the USA only = Half total club class passengers * Full Club Class price = 8103 * ?1400 = ?11,344,200 Promotional campaign ? 500,000 Sales revenue for next season on this route: = 2000 New passengers @ discounted Club fare of ?800 + 20 % of potential capacity for first class @ full price of ?1800 = (First * Fare) + (Club * Fare) + (Traveller * Fare) = ?11,344,200 + ?13,212,800 + ?47,819,700 +?16,000,000 +?1,722,600 + ?2,366,000 = ?92,465,300 However this is assuming that the full number of passengers are purchasing their tickets from the UK but half of them are purchasing from the USA. Current sales revenue for this route: = Actual numbers * Net return fare First = (1,150 + 3,234) * ?1,650 = ?7,233,600 Club = (5,426 + 10,780) * ?1,125 = ?18,231,750 Traveller = (70,543 + 93,786) * ?300 = ?49,298,700 = ? 74,764,050 Read More