Nov 12, 2005
Low and Slow
Source: Flight Intl'

Fractional aircraft ownership has lost some of its gloss as the providers struggle to be profitable. But as a way to use business aviation, it is here to stay

Five years ago fractional ownership was the darling of business aviation, bringing new owners into the industry by the hundreds and building manufacturer backlogs to record levels. Then came 9/11 and the US economic downturn, and fractionals proved they were as locked to the cycle of corporate profits as whole aircraft ownership.

Now, almost 20 years after the fractional industry was created, it is being regarded with caution, and in same cases suspicion, as it struggles to achieve and sustain profitability. While the business aircraft manufacturers are seeing their sales and orders rising rapidly, the fractionals have yet to show a similarly robust recovery.

Promises made in the heady days of the late 1990s and early 2000s, when new owners signed up in their hundreds, are coming home to roost as a bow wave of contracts comes up for renewal. Share owners’ experience with the service provided is proving key to whether they renew, switch providers or exit fractional ownership altogether.

“It’s the day after the party,â€￾ says Bob Knebel, vice-president sales for Bombardier’s fractional subsidiary Flexjet. “Customers are coming to the end of their contracts and asking if was worth it.â€￾ The cost per hour may have risen a bit more than they expected, he says, while aircraft residual values have not held up. “Most decide it is worth it for the service and safety standards; others do not.â€￾

Shifting emphasis

The downturn proved “fractional ownership is in lockstep with whole aircraft ownership in terms of residual value and customer activity being cyclical with the economyâ€￾, says Knebel. “Fractional was placed on a pedestal, and it has disappointed in some respects.â€￾ As fractional growth has slowed, and for some providers gone into reverse, the emphasis has shifted from chasing share sales to operating profitably.

“During the irrational exuberance in the late 1990s, nobody had a grip on the cost of running the business,â€￾ says Knebel. “Cash and customers were pouring in, competitors were growing furiously – it was a marketshare grab environment.â€￾ Fractionals fought for customers by offering concessions such as extra hours and guaranteed upgrades. “The impression is these do not cost much, but they do,â€￾ he says. “Every little element pitched into the deal costs money.â€￾

Such incentives came home to roost as share sales slowed and the operating costs revealed themselves. The second largest fractional, Flexjet, believes it is the only one the “big fourâ€￾ to be profitable. Certainly NetJets, the largest and longest-running of the four, is not. Parent company Berkshire Hathaway has reported NetJets suffered a net loss of $47 million in the first six months of this year as shortages of aircraft caused by peaks in customer usage incurred high costs for charter back-up.

Efficiency drive

Operating efficiently is becoming paramount. “Fractional ownership is random-access on-demand transportation,â€￾ says NetJets president Bill Boisture. “We operate over 400 aircraft of 14 types for over 5,000 owners in the USA…and it is not until 17:00 each day that we know where we will use those aircraft tomorrow. The aircraft are constantly floating, except for maintenance.â€￾

Flexjet has invested in a software program called Optimizer that it runs before each day of operations to position aircraft and crews, and credits the system with making it the most efficient operator in the industry. “We are the leanest company,â€￾ says Knebel, pointing to Flexjet’s “sold-to-in-serviceâ€￾ ratio – a measure of excess capacity – of 94-95%. This compares with the industry-wide average of just over 70% estimated by investment analyst UBS.

“Our operating performance is better than anyone else’s,â€￾ says Knebel. Flexjet is the only fractional to guarantee an owner will be “offloadedâ€￾ to a chartered aircraft no more than 5% of the time. “And the number of times we leave a customer on the ramp is zero – something our competitors cannot say.â€￾

Such measures of service performance are becoming important as owner contracts come up for renewal. Flexjet reached that point first because the manufacturer-owned programme was structured to force owners out of their aircraft after five years so as to rotate the fleet. Market reality and the “worst residuals in historyâ€￾ led to contracts being extended to seven years, to give residual values time to improve.

Despite this, Flexjet has lost customers. “Of the contracts that came to term this year, we have retained 83%,â€￾ says Knebel. Of the 17% that exited the programme, “70% left because of underutilisationâ€￾, he says. “They jumped in at too high a level, did not consume all of their hours and left a great deal of value on the table.â€￾

Flexjet retained some customers by moving them to smaller shares or aircraft, but this adversely affected a measure UBS calls “churn ratioâ€￾ – a rolling 12-month ratio of the of shareholders lost to shareholders gained. Historically, according to UBS, the industry average is 0.2 - one lost for every five gained – but it had climbed to 0.66 by June, with estimated churn ratios of 2.35 for Flight Options, 1.19 for Flexjet, 0.58 for NetJets and 0.12 for the newest and smallest of the big four fractionals, Cessna-owned CitationShares. UBS notes Flexjet’s churn ratio has improved significantly. “We lost a lot of contracts when we proactively downsized customers,â€￾ says Knebel, who believes NetJets and Flight Options are entering “darker timesâ€￾ as their longer, seven- to 10-year contracts come up for renewal.

Quality key

Quality of service is expected to be a key to whether owners renew their shares, exit the fractional market or go to another provider. So far this year, Knebel says, Flexjet has lost four owners to competing fractionals for reasons including price point and availability of a specific aircraft. Over the same period, he says 18 owners have been captured from other programmes because of Flexjet’s service performance and reliability – helped by having a young fleet of manufacturer-supported aircraft.

Operating a fractional is like running an airline without a schedule. Knebel says the ideal model is Southwest Airlines – operate a limited number of types from the same manufacturer, all under warranty. Where NetJets operates 14 types from four manufacturers, Flexjet has five, all from Bombardier. CitationShares also has five, all Cessnas. Meanwhile, Flight Options, the third-largest fractional, admits it has struggled because it operates too many older aircraft of too many types.

Now majority-owned by Raytheon, Flight Options has launched a three- to five-year “future fleetâ€￾ modernisation that will reduce the types it operates from 12 to four – all new or less than five years old – to provide profitability and long-term viability. “Newer aircraft have better reliability, lower maintenance costs and will dramatically improve our consistency,â€￾ says Cameron Gowans, chief marketing office. “We don’t need four light jets. We will have a larger fleet of Hawker 400XPs, and the customer will know the aircraft will show up.â€￾

Flight Options captured a large share of the fractional market by offering lower-priced shares in used aircraft, and also competed by offering more hours – a business model that was ultimately self-destructive as older out-of-warranty aircraft are more expensive to operate. “Growth was the fractionals’ primary goal for the first few years,â€￾ says Gowans. “Now the industry is transitioning to a business model that is viable for the long term, not just quarter-to-quarter based on shares sold.â€￾

Some of Flight Options recent moves – such as offering buyers of a 1/32nd share in a new Hawker 400XP an extra 25h a year for free – are reminiscent of its early tactics, but Gowans says they are designed to give customers the incentive to modernise. “We are looking for ways to bring people out sooner and into the future fleet.â€￾ There is some urgency: Flight Options’ losses increased in the first half of the year due to higher charter expense caused by aircraft downtime and customer demand, forcing Raytheon to pump in another $50 million of equity in August.

Charter costs are of concern to fractional providers. Part of the problem, Knebel believes, is the runaway success of card programmes that subdivide the shares and increase demand on the aircraft. “Card sales are out of hand,â€￾ he says. “Instead of 16 people sharing an aircraft there are 32, and the ability to operate efficiently is a function of the number of people trying to gain access to the aircraft.â€￾

Marquis Jet, which sells access to NetJets’ fractional fleet through its 25h Jet Card, says it has around 2,000 active card holders – about half the more than 4,000 cards UBS estimates have been sold industry-wide since 2001. Industry watchers believe that demand from card customers is behind NetJets’ struggle with aircraft availability. CitationShares halted sales of its Vector card this year to limit demand on its smaller fleet. Knebel believes the “sweet spotâ€￾ for cards is about 7% of shares.

A substantial number of those Flexjet customers who have left the fractional programme have gone to cards because they underused their shares, Knebel says. Gowans, meanwhile, says Flight Options’ JetPass card has succeeded in bringing customers into fractional ownership: “They try it for 25h, then move up to a share.â€￾ The company’s 75:25 programme, which for a 1/8th share provides 75h a year in one aircraft type and 25h in another, has also been a success, he says, adding that the key to managing demand on the aircraft lies in the availability guarantees. “The 75 and the 25 have different access conditions.â€￾

Tailored service

Programmes such as 75:25 and others the fractionals have introduced recently, like expanded service areas and ferry-fee waivers, are signs of an industry becoming more sophisticated. “In the past we just offered a 1/16th or a 1/8th share. Now we know what the customer needs we can offer a more tailored package,â€￾ says Gowans. “And we have a much better handle on the costs.â€￾ The ability to calculate the cost of providing any new service or incentive is key, says Knebel.

Despite its difficulties, the fractional industry is still growing, albeit more slowly, and it is still bringing new owners into business aviation. About 30% of the owners signed up by Flexjet this year have never been in a fractional before, which is a “pleasant surpriseâ€￾, says Knebel. Now all the industry has to do is make money. “Everybody has a long way to go,â€￾ he says. “The focus is on execution, and not on growth.â€￾