Consolidation: The quest to improve operator margins
In this article, Irena Deville, co-founder and CEO of digital purchasing platform Convolus, discusses the consolidation of the business aviation industry, and why that can be good for operators. She will be speaking at the CJI conference in London in January.
Consolidation has taken hold of the business aviation industry over the last four to five years. Large entities such as Lux and Gama Aviation have been spearheading the movement by completing some of the most high-profile transactions, significantly growing the size of their fleet and operational footprint. But consolidation has materialised across regions, operator types and sizes.
To name just a few, and focusing on Europe only, we have witnessed transactions between Wijet and Blink, North 51 and Executive Aviation Services, Flying Group and Jet Management Europe, WaltAir and Hummingbird Aviation, FAI and FlyAlpha, and so on.
BACA’s 2015 Survey suggests that, during 2015, every second business aviation provider transacted an M&A opportunity, considered a specific opportunity, or took advice on M&A options.
So, why are operators choosing this path of consolidation?
For now, the European operator market remains hugely fragmented, with many small and very small operators active. The average European operator manages a fleet of fewer than three and a half aircraft and fewer than 20 operators manage fleets of more than 20 aircraft.
This extensive industry fragmentation stems from its early development. Operating entities were often founded by individuals from an operational background, focused on delivering the best service to a small number of end-users. Only some of these entities mastered the transition to a more business-focused approach to operations, gearing up for growth and operational scale and, following that, reaching critical mass.
At the same time, operators face an increasingly challenging market: management fees are declining and end-user-centric solutions (such as online marketplaces for charter flights) make available flight inventory increasingly transparent and, in turn, render the charter market even more competitive.
It is this highly fragmented, increasingly challenging market that has fostered the spread of consolidation. The consensus is that some level of industry consolidation is necessary for operator margins to finally improve.
But how exactly does operator scale contribute to improved margins?
1 Lower overhead costs per aircraft. Increasingly stringent safety and regulatory requirements, imposed by authorities and auditing companies, drive up operators’ overheads over time. Entities that operate a fleet commercially carry the significant and recurrent costs of an in-house AOC structure.
This cost is fixed to a large percentage, increasing only to some extent with a growing fleet. It is an easy conclusion to come to that the fewer aircraft a commercial operator manages, the more overhead cost it incurs per aircraft.
In the quest for improved margins, an operator therefore has an incentive to grow the fleet to achieve lower overhead costs on a per-aircraft basis.
2 Lower costs for operational input. Simply put, the larger an operator, the greater its power to procure the services it requires to operate its aircraft.
In a fragmented operator landscape, suppliers need to market to a large number of (smaller) operators, which is expensive and offers a small conversion rate. Suppliers are therefore keen to work with large(r) entities that offer the opportunity to meaningfully increase sales, while keeping sales efforts and administration at a minimum. Suppliers with a strategic outlook will also prefer to work with larger operators as they represent a more predictable, contracted source of revenue.
Suppliers can and will reduce their rates for services provided to larger Operators with an increase in sales volume associated with that client. A larger Operator can thus improve its margins by procuring at a lower price point as it grows.
3 Fewer empty legs operated. Currently, a third of all commercially-operated business aviation flights across European skies are empty, leaving the operators to bear the cost. Unsurprisingly, finding a solution to this expensive issue has become the holy grail of the industry.
Consolidation aims to create a network large enough to reduce empty legs to a minimum, or to reach critical mass. The larger an operator’s fleet and the larger its corresponding client network, the better its chances of reducing non-revenue generating flights.
That reduction will have a direct impact on the operator’s margin.
So, consolidation is undeniably happening. And it is likely to positively influence the industry, as it clearly offers the potential of improved margins.
At this point, however, we should ask if and how well operators can reconcile scaling up with offering the high-end, personalised services levels that end-users expect and deserve from them. How large is too large, when clients become yet another “cog in the wheel”?
There is plenty of space in the industry for consolidators operating alongside smaller entities that offer the highly personalised service that many clients want.
It may, however, be time for “boutique operators” to shake up “business as usual” by employing other ways to reduce costs and increase margins, carving a more defined niche for themselves in a transforming, highly competitive industry. One way of doing this could be to offer their clients a unique value proposition, which combines high-end, personalised services levels and a competitive cost base.