Did you
know that analysts claim that every year 2 trillion dollars is wasted globally
due to poor implementation of strategy? The question is how big is the share of
the airline industry, and what is it that drives the poor implementation of
strategy, pretty visible through increased disruptiveness of air travel and
unexplainable rise in costs?
There
are many reasons for this, but let’s on this occasion focus on the strategic
aspects of operating costs and their impact on operational underperformance.
Traditional
airline costing is among the biggest obstacles to alignment of strategies with
operational reality. It is the by-product of the industrial approach to management
and costing so firmly ingrained in the mindsets that even when a company decides to
introduce the latest technology, no one even thinks about adjusting the approach
to costing to improve the scope and quality of decision making.
So,
what is it that stands so stubbornly in the way of understanding the true
nature of costs essential for successful system management?
At the very core,
it is about departmentalisation of costs set as a standard many decades ago. It
was meant to ease up the budgeting and control processes from the top without
awareness of how much this mechanistic approach affects overall organisational
results. It may have been understandable at the time when this short-sighted idea was conceived. Such costing standards have, however, completely
ignored the intricate nature of costs based on the constantly changing interactions
between data, people, and processes within and outside of an airline. This is
why the gap between strategic assumptions and operational reality continues to
widen, resulting in ‘unexplainable’ drop in operational efficiency and rise in
costs. It deprives strategists from understanding the impact of their decisions
not only on profit, shareholder value and lost revenue, but also on people,
organisation, society and the environment.
Is it
really so difficult to understand that costs apportioned to operational units
without knowing their true origins can turn every decision into an undesired
outcome? This is not only because this information is simplistic, but also
because it is just a historic snapshot of data collected at the time of budget
drafting and some years earlier. As soon as the ‘budget
schedule’ starts to change (normally months before the start of a new
scheduling season), it triggers changes in cost matrix, making the planned
costs even less suitable for decision making. This is how decisions related to
cost savings, network development, aircraft and hub operation, outsourced
services, or investment in additional resources, become stumbling blocks for
improvement in cost efficiency and operational performance.
Let's
look more deeply at what the typical process of cost planning looks like.
It 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.
There
are two major setbacks in this process. The first one relates to the sources of
information used for cost projections 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 the limitations of these functional 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 principles used 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 a flight
cannot operate at optimum flight level, when 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 operational changes. Reducing it at busy airports is becoming more and more
difficult. Still, the fuel-saving programs circulate mostly around these
traditional measures.
Much
bigger potential for reduction of fuel costs, however, 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 and introduce more fuel-efficient ones. 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 cost
output expressed in numbers. Reinstating the connection between numbers and
getting the insight in their origins requires a refined, selective approach. This approach should be based on identifying the cost-critical operational problems, bringing them to
the attention of cost architects that have knowledge and power to fix them, and
finally passing them on to senior decision makers 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 integral parts of the company's organism. When a problem
arises in one part of the body 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.
To
inject more life into the planning processes, upset by limitations of
traditional costing system, senior executives need to be regularly informed
about the cost and quality-critical but avoidable changes in planned operations
and their underlying causes that constantly stress the system. These insights bring profound changes in the way airlines plan and control their
business, resulting in measurable improvement in operational and cost
efficiency.
Being
in a position to experience first-hand the strategic, operational, and
information side of costing problems, I came up with a practical method and
technique that support the creation of missing links between strategy and
operations. It cuts through the complexities and brings new value to this still
unexplored area of airline management, in particular when supported by emerging
technologies.
The basic principles are explained in my book ‘Beyond
Airline Disruptions – Thinking and Managing Anew’ and webinar: Let's Disrupt Disruptions.
