Swinging The Profit Pendulum
Repairing Maintenance and Fuel Costing
Most airlines allocate maintenance costs and fuel consumption on a per-hour basis for route decision-making. This simple method understates or overstates costs for very short or long segments, and it can lead to errors when calculating route profitability. A better methodology for maintenance is to separate cycle-related costs from hour-related costs, and for fuel to develop a formula based on actual consumption. This improved methodology produces more accurate results and can swing the profit pendulum.
While maintenance engineers utilize the latest tools and technology to fix airplanes, something else is in need of repair. The current process of allocating maintenance costs at the corporate level, where route analysis is performed and fleet allocation and planning decisions are made, is outdated and, at times, inaccurate.
Many corporate analysts do not understand how maintenance is performed, nor do they utilize the best method for distributing maintenance costs fairly across each flight in the network.
Why is this important? After years of negative to slightly positive results, profit margins are finally expected to recover. In fact, they were in the 3 percent to 4 percent range worldwide last year. With such razor-thin margins, mistakes can greatly impact the bottom line. As a result, decisions, such as whether to cancel a flight due to profit performance, must be carefully made.
Unfortunately, these decisions can be ill-advised when based on inappropriate allocation of costs. Maintenance and fuel are areas where cost allocation can significantly swing the profit pendulum of a route.
Departures By Distance
Many carriers operate a mix of long- and short-distance flights within a single fleet type. The dispersion of Lufthansa’s Airbus A321 operations from November 2013 schedules displays that at the extremes, the airline operates stage lengths as short as 156 kilometers (Frankfurt to Stuttgart) and as long as 3,049 kilometers (Frankfurt to Amman, Jordan). The average stage length for Lufthansa’s Airbus A321 operations is 999 kilometers.
Airlines follow a rigorous inspection and maintenance program that must be approved by an airworthiness authority such as the U.S. Federal Aviation Administration or the European Aviation Safety Agency. Under the oversight of these authorities, each airline is required to prepare a Continuous Airworthiness Maintenance Program covering both routine and detailed inspections.
These maintenance programs have evolved over time as more efficient and effective work methods have been developed. Consider the extensive number of scheduled tasks performed when an airplane undergoes heavy maintenance. Many years ago, these tasks had to be completed simultaneously, which removed an aircraft from service for periods as long as several weeks.
However, using approved, modern work methods, these tasks are streamlined. An efficient maintenance program can minimize the time an airplane is out of service, balance the maintenance workload and maximize use of maintenance facilities.
Scheduled maintenance tasks are now grouped into work packages. The concept is called block maintenance or sometimes progressive maintenance. While the maintenance-check letter series of A, B, C and D are still used, checks have evolved to combine work packages.
Maintenance Allocation Best Practices
Both hours and cycles should be considered in as part of a best-practice methodology for maintenance allocation. A new formula for maintenance costs can be calculated by figuring in cycle costs. Maintenance will still be allocated on a block-hour basis; however, the correlation will be non-linear. This will result in a more accurate estimation of maintenance costs for segments that are very short or long compared to a block hours-only allocation methodology.
Activities performed under an airline’s maintenance program include tasks that must be completed at varying intervals, as specifically defined in the program. Work intervals can be based on flying hours, flight cycles, calendar time, and/or a combination of these, depending on the most appropriate parameter of the item maintained. Of the thousands of components and numerous systems on an airplane, each one has a specific maintenance interval. The task of combining these components and systems by the different intervals of hours, cycles and time for cost allocation purposes can indeed be overwhelming.
Typically, maintenance costs are separated into direct and indirect expenses. Direct costs are the expenses associated with the labor and materials required to perform servicing, repair, modification, restoration, inspection, testing and troubleshooting tasks. Indirect costs, or overhead, include maintenance supervision, training and planning; equipment rental; and utilities. Overhead costs do not include capital expenses for facilities, spare parts, test equipment, maintenance tooling and ground-support equipment.
Direct maintenance costs can be broken down into standard groupings with costs distributed approximately as follows:
- Engines (40 percent),
- Components (20 percent),
- Line (20 percent),
- Base maintenance (20 percent).
These groupings can be a helpful guide for developing a more accurate way to allocate maintenance costs.
Maintenance Cost Methodology
The methodology commonly used by most airlines for estimating maintenance costs distributes expenses by block hour. The reason for selecting block hours as the basis for cost allocation is related to manufacturer recommendations for airplane maintenance checks, many of which are performed at specified flight-hour-related intervals. Airline analysts use block hours as a proxy for flight hours since block hours are a more commonly available statistic than flight hours in most airline databases. The difference between the two is that block hours include aircraft taxi time.
Allocating maintenance costs by block hour is a common practice among airlines for simplifying analysis. This approach is adequate when there is not a lot of dispersion or standard deviation from the average stage length (the average distance flown calculated by dividing total aircraft miles by the total number of departures) for a particular fleet type. Flights that deviate significantly from the average stage length, especially short segments such as tag-end flights and long-distance segments, are where maintenance costing issues may surface.
When there is significant deviation from the average stage length of a fleet type, maintenance expenses for short-distance segments are understated using cost-per-block-hour allocation. On the other hand, routes with long stage lengths will have overstated maintenance costs. This is because not all maintenance costs can be measured in block hours. The question, then, is, “How much deviation from the average is significant when calculating costs, impacting the choice of methodology, etc.”?
If the standard deviation is great (i.e., there are a lot of segments that are not close to a fleet’s average stage length), it is a good idea to modify the maintenance methodology utilized.
Maintenance tasks, such as shop visits, replacing or overhauling life-limited parts, flaps, engine-thrust reversers, and tires and brakes, are not related to block hours. Rather, these items wear out during cycles (take offs and landings) or are required to be checked after a certain number of cycles as specified in an airline’s maintenance program. Of course, many less-obvious items require an understanding of maintenance procedures to identify whether their costs should be allocated by hour, cycle or time.
Allocating Fuel Costs
To allocate fuel costs, an airline should use actual consumption for each segment by aircraft type multiplied by the cost of fuel at the uplifted station. If that is not accessible, a more accurate formula should be created to show fuel consumption per block hour using recent historical data. It can then be used for any segment and multiplied by the appropriate cost of fuel at the uplifted station.
Fixing Maintenance Cost Allocation
A best-practices methodology for maintenance cost allocation takes into consideration both hours and cycles. There are two ways to do this. One is to develop two unit costs, one for block hour-related costs, and the other for cycle related costs. The second is to develop a formula per block hour that incorporates cycle costs as well as block hour costs.
The result will be a more accurate approximation of maintenance costs for segments that are very short or long compared with estimates generated by a block-hours-only allocation methodology. The challenge then is to determine which costs are cycle related and which are hour related.
The method for identifying cycle-related and hour-related costs can range from relative simplicity to performing a detailed analysis. Most carriers’ accounting systems provide a breakdown of the major maintenance elements, such as labor, engine and airframe overhaul, and repair costs.
To determine the unit driver of or basis for these costs, analysts should coordinate a review with a maintenance director or maintenance analyst to identify which costs are hour related and which are cycle-related. With a bit of preparation and analysis, these in-house maintenance experts can educate airline management about the fundamentals of cost allocation, as well as provide insights on how maintenance is performed. Equipped with this knowledge, airline analysts can develop an appropriate basis for cost allocation.
One approach is to separate direct labor from other maintenance costs. As a rule of thumb, about one-third of all direct labor, typically line maintenance, involves preparing the plane for its next flight, or cycle. The remaining two-thirds of direct-labor costs are assumed to be hour related.
After labor has been isolated, other direct maintenance costs can be addressed.
A substantial proportion of maintenance expenses, approximately 40 percent, are related to engine performance. The hot section is the chamber in the engine where fuel is continuously burned. When an engine powers a short-distance flight, it produces a disproportionate amount of heat to generate the required thrust compared with the amount for an average, or longer, flight. The heat wears down the engine hot section sooner, thereby driving up maintenance costs.
Engine manufacturers have developed formulas that calculate the engine derate value for each flight to minimize “wear and tear” and subsequently improve engine life and reliability. With this information, the derate value of any flight can be compared with the average value for a specified fleet type. From there, it is easy to use the de-rate value for each fleet type by block hour.
A similar approach is used to allocate indirect costs to cycles and block hours. Simply subtract the percentage of total hour-related direct costs from the total maintenance overhead. The remainder of maintenance overhead is considered cycle related.
As a result of the analysis, three elements are now available for accurately estimating maintenance costs: a rate per hour, a rate per cycle and a formula for the engine derate. The last step is to plot several points based on different block times to create a “cycle-adjusted” maintenance cost per block hour.
The distribution of maintenance costs between hours and cycles should remain fairly constant over time. Therefore, a detailed analysis of cost allocation is only necessary periodically. Rather, maintenance costs should be updated as needed and the maintenance formula adjusted accordingly. For example, if maintenance costs increase by 5 percent versus the prior year, the maintenance curve is adjusted by five percent.
Most airlines allocate maintenance costs on a per-hour basis. This simple method understates or overstates costs, especially for very short or long segments and can lead to incorrect conclusions about route profitability. Comparing the different methodologies for maintenance can produce significant differences in costs. Allocating maintenance using both cycles and block hours produces about one-third more costs for very short segments compared to using a block-hour-only methodology. For very long segments, total maintenance costs are nearly 10 percent lower.
By using a combination of hours and cycles to develop a new maintenance cost-allocation formula, this methodology produces more accurate profitability results compared with those generated by utilizing a constant maintenance cost per hour.
Obviously, maintenance expenses vary widely based on fleet type, age and complexity, as well as labor costs and use of third-party MRO providers. Each airline’s operation is unique, and its maintenance cost-allocation methodology must be carefully reviewed and continually refined to swing the profit pendulum in its favor.
Many airlines allocate fuel costs by multiplying the average fuel consumption per block hour by the cost of fuel at each station. This is usually done when the actual consumption is not known or must be forecast such as for new routes. Similar to maintenance costs, this approach is adequate provided the segment stage length is close to the average for that airplane type.
For networks with a lot of dispersion, this method will create distortions for long- and short-distance segments. Why is that? Airplanes burn far less fuel during taxi compared with climb, cruise and descend. For example, for a flight of 45 minutes, the proportion of fuel consumed during taxi is about 33 percent of the total fuel burned. For a flight of two-and-a-half hours, taxi fuel is about 10 percent of the total consumed. Since taxi consumes much less fuel than when the airplane is flying, the cost per block hour is lower than the average for very short segments and will be higher for long segments.
The best approach to allocate fuel costs is to use actual consumption for each segment (such as from a flight plan) by aircraft type multiplied by the cost of fuel at the uplift station. If that is not available, a more precise formula should be developed to show fuel consumption per block hour using recent historical data. This formula can then be used for any segment and then multiplied by the appropriate cost of fuel at the uplift station.
A Better Method
Most airlines allocate maintenance costs on a per-hour basis. This simple method understates or overstates costs when looking at very short or long segments, and could lead to incorrect conclusions on route profitability.
A better methodology is to separate cycle-related costs from hour-related costs. The reasons are that a significant amount of costs are associated with cycles. Using a combination of hours and cycles can produce more accurate profitability results compared to using a constant maintenance cost per block hour.
For fuel, airlines that use the average consumption per block hour overstate fuel costs for short segments and understate costs for long segments. A more accurate method is to use actual fuel consumption from a flight plan, or if that is not available, develop a formula of fuel burn based on stage length using recent historical data.