A decades-old system for cost classification inherited from industrial era still dominates management practices across the airline industry. Airlines continue to use this system partly driven by collective inertia and partly by the lack of alternative solutions that take organisational complexity and uncertain market conditions into account. To avoid the undesired consequences of these practices senior executives need to become aware of the true unreported origins of changes in planned costs, especially those unknowingly created at corporate and strategic levels.
Traditionally, costs derived from financial reports are statistically distributed to business units in order to be calculable at functional levels and easy to control. This practice ignores the fact that costs are more than just numbers - they are nonlinear, interrelated, and consequently cannot be measured in a conventional way. This is why answers to questions related to true effectiveness of cost saving measures, route network, aircraft and hub operation, outsourced services, or investment in additional resources, remain stumbling blocks for improvement in cost efficiency and operational performance.
Answering these questions by using cost apportioned to operational units without knowing its true origins turns the decision making into a very risky process. Not only because this information is simplistic, but because it is just a historic snapshot of data collected at the time of budget drafting. As soon as the ‘budget schedule’ starts to change (normally months before the start of a new scheduling season), it triggers changes in the cost matrix, making the planned costs even less suitable for decision making.
This may, at least partly, answer the question why airlines with long established practices make so many changes in planned operations once the season starts. We have seen traditional and even some low-cost carriers incurring significant losses in cost, revenue, and reputation by reducing the planned operation due to planning and strategic errors described as ‘overexpansion’, ‘overstretched capacities’ or ‘to avoid more operational problems’. What were the causes of such serious misjudgements resulting in change of decisions made just several months ago? How many of these changes and related losses were associated with wrong evaluation of disruption risks, or poor understanding of system limitations. How much does the cost planning process contribute to this situation?
Let's see how the typical process of cost planning looks like.
'The typical process of cost planning starts with projected traffic, cost, and revenue for the coming year. The company’s finance director then sets a target figure for net results including the necessary return to shareholders. This is further broken down into management units and transmitted to senior directors, responsible for squeezing the savings out of their respective departments. The initial figure may be adjusted several times during the year. There are reviews after the IATA slot coordination meetings and regular refinements in the light of information received on forward bookings, interim revenues, and yields. These adjustments can result in even tighter cost controls. The intense cycle of setting targets and searching for further departmental cuts is giving an early warning if a director is going to exceed the budget. If this happens, there are generally negotiations between the director and the CFO’s office to reach a satisfactory result. The process could be tightened further if necessary, using various management techniques’, as described by a senior manager of a major hub airline.
There are the two major setbacks in this process. The first one relates to the sources of information used for cost projection for the coming year based on too many assumptions. The second is the management aspect of cost control. Led by the nature of traditional cost information, managers put too much emphasis on cost control of departmental performance rather than on interrelated problem areas. As unforeseen problems start to emerge, senior directors have no other choice but to put even more pressure on middle managers and, through them on other staff to save more. The next round of ‘unexpected’ events includes the reset of targets, and continual search for new cuts from already well squeezed departmental cost - good for justifying efforts, but not good enough for improving business performance.
How can we overcome limitations of these costing practices?
Take the fuel saving measures as an example. The process is usually assigned to the Flight Operations department. There is a whole set of measures aimed to minimise fuel consumption on the day of operation. They include things like flying at optimum speeds and flight levels, fuel tankering policies, careful weight and balance control or flying the ‘cost efficient’ air routes (not necessarily the shortest ones). In reality, however, most of these principles cannot be applied. Fuel consumption will be increased every time when flight cannot operate at optimum flight level, ATC diverts the aircraft to a longer route or puts it on hold over a busy airport, and in many other situations. According to industry research, about 10% of fuel consumption is attributable to changes in operational performance. Reducing it at busy airports is extremely challenging. Still, the fuel-saving programs circulate mostly around these traditional measures.
And, as sown below, fuel costs are not just dependent on price and operational issues. There are many immeasurable impacts that cause the rise in fuel costs:
As we can see, much bigger potential for reduction of fuel costs comes from inside the airline. It comes from people who decide which airports and routes to fly to, which aircraft can best serve these routes, how many hours it should fly, when to replace old aircraft or introduce a new aircraft type. Then, there are schedule creators that have to make all these ideas workable by balancing requirements coming from many different sides inside and outside of an airline, people who negotiate fuel prices, repair and maintain the aircraft, provide service to passengers, and many other specialists and generalists – the cost architects.
The impact of this process of creation and preparation for service delivery remains invisible to senior decision makers focused primarily on tabular form, good for accounting and general management purposes but not sufficient to manage the business.
Reinstating the connection between these numbers and their origins requires a refined, selective approach based on identifying the cost critical operational problems that include elements of service quality, bringing them to the attention of cost architects that have knowledge and experience needed to fix them. An then, to finally pass it on to senior executives who can balance their acts to achieve what is best for the organisation.
The same principle can be applied to every area of business management. Costs allocated to departmental units shouldn't be an obstacle if we don't stop there. Departments are the integral parts of the company as an organism. When a problem arises in one part and its root causes are not identified, the treatment applied to the wrong part will harm other parts of the body and weaken the organism.
This reminded me of the case of a European Airline where crew shortages were being reported as a cause of costly disruptions for about four months, starting at the beginning of the new season. The C-Officers decided that saving the company's reputation surpasses the investment in additional crew and, sometime later, 24 new crew members joined the company. To cut the story short, as there were no signs of improvement, the top team required a more thorough analysis of the root causes of problems. The analysis showed that crew shortages were only the last in the chain of causes triggered mainly by problems related to unscheduled aircraft maintenance, which was the result of tight schedules, which appeared to be the consequence of strategic requirements for increased aircraft utilisation over tolerable level. The sunk investment could have been avoided if the magnitude of disruption costs and associated causes of problems were diagnosed at an early stage.
To inject more life into the planning processes, troubled by limitations of traditional, outdated costing and overall information system, senior executives need to be regularly informed about the cost and quality critical but avoidable changes in planned operations and their root causes, but only those that require their attention. This is what sets the opportunity for changes in the way airlines plan and control their business. The results: measurable improvement in operational and cost efficiency and simultaneously, better passenger experience.
For this to happen we need integrators, people with wide and deep knowledge based on diverse experiences, those who lead, connect others, who can spot emerging problems and organise actions to prevent them from happening. They have the ability to see new opportunities for improvement and for expansion. Their skills to translate the systemic pain points into the language spoken in boardrooms and inspire collective actions aligned with core values is indispensable.
This new process is described in more details in my book 'Beyond Airline Disruptions - Thinking and Managing Anew'.
