Is the Fractional Jet Business Model Broken?
In a recent article in Aviation International News Online, Chad Trautvetter writes that the fractional jet industry is undergoing a major transformation. He quotes business consultant Brian Foley, who says, “The problem is that the existing business model is geared to rapid growth…So long as fleets expanded, providers could profit by buying new aircraft at discounts and selling them at list price to customers. But now, with fleet size nearly constant, the emphasis must be on making the operational side profitable, or changing the business model altogether.”
Understanding the operating economics of aircraft, I have long wondered when the industry would realize that you can’t sell a product for a profit, then commit to losing all that same profit (plus some) on the service contract after the sale.
The Fractional Jet Programs have been good for our industry. They have brought in a whole new group of users of private jet transportation. The premise that it is a better deal to own a 1/8 share of an expensive asset, spreading the cost of ownership is sound. High utilization of that asset across a number of users to spread the other fixed costs is also a great idea. So far so good – two great ideas, so what went wrong?
The problem was the pricing of the variable part of the service. When I bought a fraction of a jet I got to use it some specified number of hours per year. I paid a variable rate for those hours and paid only when I was occupying the aircraft. I was promised that I would always have an aircraft at my disposal within a few hours notice. Seems simple enough, and it is – for the consumer. Thus the sales guys had an easy job selling the product.
The problems came with the poor guys in flight operations who had to execute the service. What happens when all 16 owners of the same jet want to go flying on the same day? One want to be picked up in Des Moines, IA, but the other 15 owners want to be picked up in 15 other cities. In addition to having 16 different points of origin, the owners have different destinations; so, none of the trips will patch together. Now my head starts to hurt thinking about how you put all that together and make it work both operationally and financially.
As the fractional business expanded rapidly, the providers had to start chartering aircraft from their aircraft management affiliates and traditional air charter companies. It didn’t matter if the cost of the charter was more than the variable revenue received for the flight. The owners had a contract in hand and expected the service. In honoring the contracts, reputable fractional jet companies covered the trips and swallowed the losses (making it up by selling more fractions). The not so reputable companies (or maybe just not so well-funded) went broke.
So where does this industry go now? In this unforgiving economy, there will be some shakeout and turmoil. It will be Suvivor on the island of fractional ownership. The not so smart and under-funded guys will get booted off. The smart guys will fix the broken model by adjusting prices as their contracts turn over innovating and creating a better model. The island will stand firm because the consumers are now hooked on an efficient and pleasant method of travel and don’t want to go back to the airlines.
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- Oct 24, 2009: uberVU - social comments
The fractional industry problems of the last year were seeded in their own success. You had a business model that from the late 1990s to 2007 had almost exponential growth. It was obvious, though by 2007 that the market had become saturated and most of the shares that could be sold, already had. It simply became a fight for market share. The first sign that something needed to change was the offer of the “jet cards” which did not make fractional owners happy since they now saw “renters” on their aircraft and the next sign was the INCREDIBLY high charter and dead head costs that the fractionals were absorbing. Like your article says, as long as the fractionals could sell more shares the money keeps coming in. It becomes almost like a multi-level marketing scheme. The problem now is that there is very little market for new shares on new airplanes while others are divesting. You also have the issue of rapid falling aircraft pricing which is causing havoc in the fractional business model.
I forsee some consolidation in the industry. I read recently that NetJets may merge or absorb the Maquis Jet business and focus more on charter and jet card model. The other 3 players like FlexJet, Options and CitationShares will either have to merge to have some sort of competative edge, or in the case of CitationShares/Air change their model completely. A more direct relationship with each of the airplane manufactuers may also offer some value, but the additonal lift provided only works when business is going well. As of right now no additional lift is needed with each company fighting for its own survival.
Until used aircraft inventory is reduced and prices for new aircraft stablize or begin to rise. The fractional business model will simply not be viable. The key is to continue to show the value of business aviation travel over the airlines. Only a concerted effort by all players can make that point clear.
They are all fairly done. It is hard to make money when you can’t sell enough new shares to compensate for the loss in operations. We felt pretty confident in 2006 that it was the beginning of the end: http://adamwebster.com/2006/07/21/telling_a_great_story/
Selling a service built around an obvious problem fueled the rapid growth, and your right it just makes a lot of sense. However supply chain and logistics must be insane to manage – its almost like the time share industry- yet the assets are always moving. and yea my head is hurting thinking about it as well.
I do believe your correct in saying the ‘Smart Guys’ will get it- I am thinking in networked terms here and the value of small world networks, so this concept can scale- it just should resemble an organic network rather than hub and spoke.
-Kevin