Risk Management of Blue Star Airlines - Term Paper Example

Risk Management The European Airline industry is a dynamic industry that changes its trends in accordance to general European economy. The over all air transport market in Europe is expected to grow substantially in the comings years. The international air transport association along with few leading bodies like AEA and ATI estimate that number of international scheduled passengers traveling between countries in Europe will grow from 233 million in 1999 to 302 million in 2005, reflecting an annual growth rate of 4.9%. By contrast, the low fare segment of the market is expected to grow at a significantly higher rate. It is estimated that low-cost airlines which carried 6.3% of all domestic and international passengers with in Europe in 1999 will increase that to a share of 16-18% by 2005 making them a for formidable unit in the Europe air travel market. (European Airline industry-strategies for the new Millenium-sky Tech Solutions accessed from the website www.skytechsolutions.com and Global Market Forecast, The future of flying, 2006-2025, (2006), November, Accessed from the website www.airbus.com). Now it has been evident that aviation market in Europe has been increasing especially for low-cost carriers and therefore our airlines Blue Star will be started as soon as possible to take the advantage of booming air travel market. The proposed airlines "Blue Star" is willing to start operations from Vienna (Austria), whose location is more central to Eastern Europe and have the potential to cover Baltic nations (Estonia, Latvia & Lithuania), Poland, Czech & Slovakia, Hungary, Italy, Croatia, Germany etc. The next important fact that founding partners of the Airlines are from three nationalities and around 45 years of age with 15 years of experience in managing an airlines which will prove successful in the long run. Another important fact that airline is starting with 10 same size/carrying capacity and most probably the same type of planes. It becomes easy to handle / upkeep the same type of plans for pilots and other staffs. It any reduce turnaround time and reduce maintenance expenses and training costs. An important fact in starting Blue star is that it is leasing those airports and concentrating on those destinations which are not expensive due to their landing fee or heavy traffic and where national carriers make competition more intense. The most important fact that airlines proposed that its starting capital of $ 100 million consists of only 50% from borrowing in which bank borrowing/short term is only $ 25 million and rest 25% is through long-term bonds. By adopting this method, airline ensures that instant debt-service has to be kept at minimum. These are the above five important facts, which Blue star kept in its mind to start with and will prove to be successful in the long run. The next important step is to choose the first 10 destinations, where the passengers' flow is maximum and risk of bad weather; security or political stability is at minimum. In Europe Most of the airlines are trying to operate in the east. Due to integration of Europe, Vienna is the place / hub for most of the airlines in central Europe joining West Europe and Eastern Europe. The Baltic nations, Russia, Ukraine and Belarus are the new found destinations where low-cost airlines trying to reach out. Most of the passengers from Western Europe are (Businessman) moving in the Eastern Europe market exploring new opportunities where as persons living in Eastern Europe moving Western Europe to find new job oppourtunities. So Blue star has to choose its all the ten destinations keeping in mind the passenger's availability. Three Baltic nations are at first place. They have to start with three airports namely Parnu in the Estonia, Liepaja in Latvia and Kaunas in Lithuania. In choosing the three airports we had not taken the respective countries main airports i.e. Tallinum, Riga and vilnius due to airline policy to lease those airports have low leasing costs and potential competition from major carriers as well as more waiting time. Now apart from these three destinations other destinations will be Gdansk & Krakow in Poland, Kosice in Slovania, Pardubice & Ostrava in Czech, Hannover and Dortmund in Germany and Debrecen in Hungry. These 10 proposed destinations which has been initially covered by Blue star are the most politically stable countries have booming economics, minimum security risks etc. These places are almost less prone to weather catastrophe. Now if we develop a business model for Blue star for the 1st year taking all the considerations, which has been provided in the case study and on the basis of average (80% capacity), above average (90% capacity) and below average capacity (70%), taking the ticket prices at $ 250 for one way trip we will find the following position: Revenue @ 90% capacity @ 80% capacity @70% capacity Fare $ 70.2 million / month $ 62.4 million / month $ 54.6 million/month Expanses Lease charges $ 35.1 million 31.2 27.3 (@ 50% of total Revenue) Fuel @ $2/ gallon (For 10 $ 20.0 million 20.0 20.0 Million gallon) Salary $ 2.5 million 2.5 2.5 Mechanical Breakdown $ 0.1 million 0.1 0.1 (Taking one breakdown/ year approx.) Short term dept Service $ 2.5 million 2.5 2.5 @ 10% on $ 25 million Computer & Communication $ 8.0 million 8.0 8.0 System Lease $ 68.2 million $ 64.30 million $60.4 million Insurance @2% of Revenue $ 1.5 million $ 1.25 million $ 1.0 million (Current Prevalent rate) $69.7 million $ 65.55 million $ 61.4 million If the airline will develop lease hold location which costs of $ 1 million / airport it needs additional $ 11 million and self-communication/computer system needs $ 30 million. So in total it needs $ 41 million. From the initial capital of $ 100 million we can easily meet out the expenses on communication system and lease hold locations so after deducting the lease cost of computers it will decrease the expenses effectively by $ 7 million which ultimately provide us the leverage to operate at average capacity and without increasing the ticket prices. One of the surveys conducted by U.S department of commerce shows that almost 33% passenger's first criteria for choosing an airline was Ticket prices. The other three criteria ware convenient schedule (17%), frequent flyer (14%) and non-stop flight (4%). These four criteria almost decide the 75% passenger's airline selection. So if Blue star has to operate at its average or above average capacity it has to keep its ticket cost at lowest. Recent trends in airlines insurance industry shows that airline fleet value increased by 11% and passenger's numbers rise by 12% but the insurance premium has been fallen by 15%. In Europe, low cost carriers have the lowest insurance cost per passenger $ 0.794 (which is less than $ 1 per passenger). In a survey it has been found that insurance risk management budget for the airline industry has been fallen down to 1.6% of total revenue in 2007 compared to 2.1% of total revenue in 2005. So if we take the trend of current aviation (airline) insurance industry we can take maximum 2% of the total revenue earned by Blue Star as the largest insurance premium. Taking insurance premium @ 2% costs almost $1.5 million / month. As we earlier analyzed that if we increase the ticket prices or kept it at a higher end then the number of passengers decreases. At the initial phase of starting an airline it is advisable to keep the passenger ticket prices at the minimum, which has been fixed at $250 one-way. We have already analyzed that if the ticket prices has been on $250 one-way and capacity utilization is 80% then we can match our expenses with revenue. So in my opinion the most suitable price should be $250 one-way. Blue Star's main objective will be to establish itself as Europe's leading low-fare airline operating frequently point-to point flights on short haul flights, mainly our of regional and secondary airports. The heart of its strategy will be based on providing the no frills-service with low fare, design to stimulate demand, particularly from budget conscious leisure and business travelers, who might otherwise have used alternative forms of transportation, or might not have traveled at all. The Blue Star's goal will be to be profitable on new routes from their inception, by pitching their fares to below enough to attract new customers but high enough to provide a satisfactory operating margin. No frills services will allow blue star to prioritize feature important to its clientele, such as frequent departures, advance reservations, baggage handling and consistent on time services. Simultaneously this eliminates non-essential extras included advance seat assignments, in-flight meals, multi class seating, access to frequent flyer programme, complementary drinks and other amenities. These practices drastically cut down the cost. Similarly to reduce turnaround time is one of the areas, which can cut cost for the airline and utilize its planes more efficiently. Normally the business travelers attracted by frequency and punctuality despite often less conveniently located airports and the absence of pampering. Blue Star using single type 130 seat aircraft, which may be Boeing 737-200, which is most widely, used commercial aircraft. Due to use of single type aircrafts, airline will be able to obtain spares and maintenance services on favorable terms, limit costs of staff training and offer flexibility in scheduling aircrafts and crew assignments. So Blue Star fleet must be of single type aircrafts. Though Blue Star outsourced it's catering services but to cut costs it must outsource/contract out aircraft handling, ticketing, baggage handling etc. EU directives forbidding ground handling monopolies at European airports will enable blue star to continue to negotiate economical contracts in the highly competitive environments. Blue Star must launch it's website. This will affect on cutting costs on staff, agents commission and computer reservation charges and will significantly contribute to airline growth. This will also decrease marketing and distribution costs drastically. Blue star must adopt the philosophy of managing well in good times to be ready for bad times. By remaining lean and mean and keeping cost under control, Blue star will sail through comfortably. Before starting any new destination Blue star must send its planners from marketing & sales, promotion, Public relations & advertising to study and prepare demographic data. After taking all demographic information, Blue star may sponsor any big event in that area and advertise all its highlights including lowest fares. This attracts passengers. Risk management departments major responsibility is to identify the entire major / minor risks and in care of any eventualities, they have a plan to mitigate the risk. Blue star has to be cost leader. Its low price strategy will create a new market. Blue star Risk management department has to develop a cross-functional, lean and short haul setup cost may be high so to reduce the cost, Blue star risk management team has to focus on reducing turnaround time. The quick turnaround will be facilitated by excellent coordination among various functions-Pilots, flight attendants, gate agents, ticketing agents, operation agents, ramp agents, baggage transfer agents, mechanics, fuelers, aircraft cleaners and caterers. This make more efficient use of aircrafts less time to checkout even airport congestion worsened and security regulations become stricter- one of the major risk in schedule flights is delay due to weather and operational. Risk management team must make sure that efficient flight dispatch system should work properly and delays must be minimized. Risk management team must use the fleet of 10 aircraft of younger age (average age around 6 to 10 years) and deploy efficient maintenance team to minimize delays and cancellations due to mechanical problems. Though Blue star have a stand by arrangement but it has to be informed in 3 days advance, which held the operation for next three days. So in the event of emergency maintenance team efficiency will pay. Risk management department must concentrate heavily on extensive training to all pilots', flight attendants and Mechanics so in case of any emergency, Blue star can substitute the aircraft, reschedule flight crews or transfer mechanics quickly. With only one type of aircraft, managing spares inventory and record keeping becomes simpler. Exclusive use of single type aircraft helps Blue star to negotiate better deals. Another important task for risk management team is to manage / mitigate the risk of increase in fuel prices. It may be fitted with all its aircrafts of oil saving devices. Different cost cutting practices should be promoted and finally if necessary fuel costs must be hedged. Risk management team / departments first duty is to develop an approach to be prepared for all possible scenarios. They always have at least 2-3 scenarios for every possible eventuality. They have to prepare the employee that if they are in Airline business they have to be ready all the time and act fast otherwise someone else is ready to do. It has always been understand that airline industry is risk prone but if we consider the catastrophe as a percentage of whole operations it comes to negligible. Mainly the aircrafts are prone to different risks. Weather conditions and accidents or flight delays / cancellation due to weather is one of the commonest risk. Due to weather, delays / cancellations of flights directly affects the revenue of Airline. After 9 /11 incidence in US, the terrorist threats are one of the major risks. Though after the incidence no such another incidence has occurred anywhere but the risk due to terror threat perception has increased security costs and insurance cost for the airlines after 2001. Due to terror threat perceptions, loss of life as well as of planes, have severe impact on the airlines. Fire; crash on ground mostly during landings and destruction in air are the type of risk on life of passengers and the aircraft. Now potential to mechanical snag may also crash airplanes on the ground or destruction in air. So Mechanical problems and maintenance of aircraft must be done regularly and properly. Now due to windstorms or fire or crash on ground not only airplane or passengers but the airports also gets damaged. Now for the Blue star, any damaged caused to airplane or airport property has to be paid by airline, therefore direct financial implications fall on the Blue star. It has been stated time and again that financial position of Blue Star is not strong enough to mitigate such catastrophe, so risk management dept. of Blue Star has to work continuously and relentlessly. All the perils have the potential to destroy or harm airplanes as well as airports. It directly affects the airline revenue. Catastrophes and Mechanical glitches are one of the commonest risks in airline industry. Here we assumed that at least one mechanical difficulty will occur in a year and it will take atleast 10 days because of 3 days notice period and further one-week rectification time. For this time, if we calculate 3 days revenue loss @ 80% capacity and add one week lease cost of another plane @ $ 1,00,000 / per day, we will find that it cost to Blue Star around $ 1.324 million / per mechanical fault. So taking atleast one such mechanical fault in a year it becomes costly for the airlines. Risk management department must take care of these difficulties and try to minimize because a simple fault cost heavily and reduce profit of Blue Star. Now if we analyse the losses i.e. losses due to natural calamities, mechanical faults or any other terrorist activities we find that after the incident of 9 / 11 these type of glitches coming down and most of the airlines taking care of these type of faults seriously because one such fault not only have potential income loss to airline but it also affects its credibility in the air travel market. From the safety point of view, 2007 so far stands out from recent years in terms of high number of fatalities, hull losses and liabilities. In 2007 from Jan. to September, compared to the same period of last year, there have been nearly 80% more fatalities, the value of hull losses is around 18% higher and the value of liability losses has doubled. The relatively high level of global losses has been driven by a high number of incidents in specific countries, rather than a general change in overall safety trend for the industry. Given the number of successful take off and landing countries to grow, it may be that by the end of the year 2007 will still prove to be relatively safe overall (Aon Airlines insurance market review pre-2007 accessed from the website www.aon.com). No matter how technologically advanced the industry becomes, aviation still involves a high level of potential risks, even though there are a relatively low level of incidents (The emerging airline industry done jointly by Kearney A.T. and the society of British aerospace companies (2003) Accessed from the website www.atkearney.com). Employee compensation costs are typically the most important component of total airlines costs. Blue star must control these costs through a performance related pay- structure. There has always been a major risk related to key people replacement costs. In any airline there are several key people who plays pivotal role in operations planning etc. often they shift around and to find their replacement is also a cumbersome process and involves cost. Promoters are there in Blue Star as a key person. If any of the promoters wants to withdraw the investment he has done in the airlines is at risk and to find out its replacement is not an easy job. The remaining employee in the Blue star are mainly pilots, flight attendants etc. The three top managers appointed by Blue Star are the key persons who are most probably from Marketing, Operations and Finance. Replacing these managers may have high replacement cost. These three managers are in a controlling position in Blue Star, so finding another persons like these key persons is not an easy job. Airline has to invest some money to find out the people like them and then to train him/her according to the needs of the airline. In the mean time the productivity loss is also included in replacement cost. If a person to be replaced, another person search, selection recruitment, induction training and time to reach the level of previous key person and its productivity loss, all costs to airline and it will be the replacement cost of the key person in the airline. Every crisis cost heavily to the airline. In one way it directly affect revenues and the replacement cost on the other hand require more investments in the operations. In general a major crisis, which almost all the airlines faced, was the 9 / 11 incident. During this terrorist activity airlines grounded for several days and then after the no. of passengers drops drastically. This was a major crisis all over, the world. Most of the airlines faced huge losses in the year 2000. But even then some of the airlines that planed their crisis management team well came out from the crisis successfully. During the crisis, most of the airlines retrenched its employees to be remaining profitable or to survive. Though this crisis was so big that governments supported and provide financial support to mitigate the problem. The role of crisis management team is to act swiftly incase of crisis and find out the ways to solve the crisis. Every airline must have a crisis management team, where the persons deployed assess the risks in advance and if the risk cannot be avoided, then they must have several plans to minimize the impact of these crises. Now for Blue Star, if any type of major crisis, such as terrorist activities or air crashes may occur in the future, crisis management team must plan all the details to perform in such a way that impact of crisis could be minimized. It needs systematic analysis of all potential problems, its overall impact on airline, financial, operational and on its image. Most of the minor crises like wartime, fuel prices fluctuation, Union-management relationship etc. has to be taken care of through proper risk assessment and ways to solve the risk to minimize the impact on airline revenues. If we evaluate the Blue Star financial statement we can easily observe that at an average capacity of 80%, it hardly achieve break-even. So if any type of unwarranted risk or catastrophe occures, airline will be in great financial crisis. Blue star initial infrastructure investments are hardly met, and if we add to this with at least one month operational cost, its hardly sufficient. So Blue Star must have strongest risk management programmes because it cannot bear any risk, which directly affect its revenue increase cost of operations. If we consider only one major Mechanical difficulty we can easily assess its impact on operational cost of Blue Star. So looking at the financial structure of Blue Star, we could easily assess that if any not anticipated risk occures, then airline will be in financial difficulties. Finally we come to the conclusion that starting an airline to especially targeting Eastern Europe business travelers and making Vienna as hub to Blue Star is the right choice due to its location and potential for passengers. Blue star will be a low-cost carries so the ticket prices will be the main attraction for passengers. Though the financial, revenue earning for the airline @ 80% capacity and at $ 250 one-way ticket only reaches up to break-even level, considering most of the recurring expenses but if any further risk may arise, for that our airline financial position is not sound enough to mitigate the problem. Apart from geographical locations of Vienna, the next important is the starting locations for airline services. Most of the locations have been selected in Eastern Europe Baltic Nations and nations earlier remained under Warsaw Pact or Soviet Union control will be targeted because of opening of economic and their integration in EU. Airline operation is largely a high-risk prone, high cost investment industry. So initial investment and provision for risks such as fuel prices, competition, Natural calamities, terrorist activities etc. have not been sufficient. So Blue Star is an airline, which starts without sufficient funds. To mitigate the risk airline has to adopt cost cutting techniques where possible and to keep its structure mean & lean. There are several ways to reduce costs. When airline starts it needs plane lease, airport lease, landing fees etc. and choosing the airports which are well connected through roads & rails and not for away from international airports and where landing fee & other charges are not high is one of the major cost cutting technique. As being a low cost carries Blue Star has to adopt point-to-point short haul operations so that it could reduce its turnaround time. Airline has to use single type of aircrafts so that its employee training will become easy, cost effective and staff could be interchangeable in case of emergency. Airline has to look at the prevailing insurance market and its rate. After 9 / 11 incident it was at the higher side but the premium rates are coming down nowadays. So keeping close eye to insurance and negotiate the premiums properly and for long complete coverage because it has not the financial ability to mitigate any type of aircraft distraction risks will be the next important aspect to which airline has to look at. It has been estimated that any aircraft destruction replacement will take at least 6 month so the revenue loss and alternate arrangement cost is as high as $ 54 million (approx.) and also the human life and cost of aircraft as well. So Blue Star cannot bear the destruction or permanent loss of even a single aircraft. Again Blue Star has to manage its human resource properly because the employee specially the controlling key persons replacement involves high cost to airline. So utmost care should be taken to reduce the possibility of key person's loss. In the present solution one of the weaker area is the pricing of ticket. Blue star is a low cost airline and prices of tickets plays an all-important role in passengers' decision making for an airline. So due to constant increase in fuel prices which in my case has been calculated at $ 2 / gallon increase in future must be hedged. Insurance costs partial transfer to customers has to be analyzed in the long run. In the present case, we have taken the capacity at an average rate, 80% but still it is on the higher side. So keeping all these factors ticket prices has to be increased. Keeping close eye on market growth and all other factors airlines could be started with in a month time because oil prices are rising and airline should sign a contract with oil company after renegotiating prices for at least next 6 months to 1 year if possible. The renegotiation on prices for long-term will help airline to reduce its oil bill. In the future airline has to develop strong relationships among employee, managers, unions and suppliers and enable the airline to be extraordinarily in cost cutting and improving customer satisfaction. Airline must emphasize on effective coordination, proper communication, safety, and on-time performance. It must create a lean organizational structure and eliminate inflexibility. Employees are motivated enough to take on & challenge conventional wisdom and keep coming up with improvements. References: 1. Global Market Forecast, The future of flying, 2006-2025, (2006), November, Accessed from the website www.airbus.com on 15th December 2007. 2. Airline insurance market review, pre renewal session 2007, Accessed from the website www.aon.com on 16th December 2007. 3. European airline industries strategies for new millennium, Accessed from the website www.skytechsolutions.com on 14th December 2007. 4. The emerging airline industry done jointly by Kearney A.T. and the society of British aerospace companies (2003) Accessed from the website www.atkearney.com on 13th December 2007. Read More