To Stick or Fold – Dealing With a Not So Successful Airline Acquisition

Background:

Our client was a successful regional airline and contract charter operator. In 2004 they acquired the operations of another airline following that company’s fall into bankruptcy. The operations acquired by our client included their airline routes to a stand-alone regional network consisting of five routes. These operations were collectively loss-making and management were about to make serious decisions about their continuity when they met with Aspirion.

They asked us to investigate the situation and make recommendations about the future retention of routes and a viable network operation. The only problem was we had only three days in which to present our case.

Investigation:

Using the limited data available, we were able to construct a financial model indicating which routes were making positive/negative contributions to fixed costs and which routes might even be making a profit.

All routes were loss-making – the longer the route, the more it lost. However, all routes but one were contributing to fixed costs. From the model we were able to provide a forecast annual loss that was unlikely to please the new owners. We found that each route was caught in a downward trend and no strategies had been implemented by the previous owners to arrest the decline.

Of particular note was the fact that most routes had high fare structures (business travellers) and correspondingly low load factors. The airline had become a ‘boutique business’ that could never make a profit unless serious changes were made. Every route was well below its peak level of passengers – ranging from 12% to 86% down.

Then we compared these routes with other routes of similar distance and population base. This led us to believe that all was not lost. We made a quick assessment of the dynamics of each market to assess what we had to work with and we then formulated our recommendations.

Solution:

We formulated a proposed strategy in three distinct steps:

1. Damage Control
2. Near-Term Growth
3. Long-Term Growth

For the Damage Control Stage, our proposal covered a wide array of changes. First was the recommendation to exit two of the markets. Next was the restructure of fares, which had to change in favour of lower fares and higher loads.

Then there was the extremely low utilisation of aircraft at only 2.8-hours per day. The number and mix of aircraft were the issues behind this problem.

There was also the need to renegotiate airport charges which were driving costs (and fares) higher to the point where the continuation of the service (and the airport revenue base) was at risk. This would increase the mass of each market. We based our projected airport savings on the actual results we had negotiated for a regional airline in another recent project.

Finally, we proposed that the schedule for the remaining three markets should be increased significantly to provide better flexibility for air service users, leading to greater demand. The increased frequency and our advice to the owners to ‘stand-down’ one aircraft increased daily utilisation to 6.9-hours.

We concluded that these changes would cause ‘break-even’ to be reached in 9-months and the full-year of 2004 could possibly be profitable, due to the conservative assumptions we had used.

Unfortunately, as is often the case, the manager felt the proposed strategies were too ‘risky’ and opted to soften them. Nonetheless, he decided to act on our advice and took the following steps:

1. Exit the first two routes, as reccomended and reduce the fleet count from 3 aircraft to 2 aircraft
2. Continue with two of the remaining three routes and focus on pricing and collaborative arrangements with the local councils in order to generate greater demand for the services
3. Whilst we advised that the third route could remain, as we believed it could be operated on a marginal cost basis, the client ultimately decided to withdraw and focus primarily on the two routes mentioned above.

The result of the chosen path was that the operation was quickly restored to profitability. However, the manager conceded that by not following the full list of recommendations the stand-alone network did not reach targeted levels of profitability, already being delivered by the pre-existing business.

Eventually the stand-alone business we sold to another operator and as a result of our recommendations, the client was at least able to extract a small premium on the sale of the business.