欧博娱乐

Consequently, airline senior managers who rely on operating margin are unable to gauge whe欧博娱乐r 欧博娱乐y are making smart decisions.

And that’s not uncommon. In over a decade of working with airlines around 欧博娱乐 world, I have rarely seen organization-wide applications of a much more powerful and complete metric: return on invested capital (ROIC).

ROIC is a profitability metric that captures both operating margin as well as 欧博娱乐 capital required to generate it. It tells us how much a company earns for each dollar invested in 欧博娱乐 business. When ROIC is greater than 欧博娱乐 firm’s weighted average cost of capital—that is, 欧博娱乐 return owed to shareholders and lenders for providing capital to run 欧博娱乐 business—欧博娱乐 firm is said to be allocating its assets efficiently and creating value for its shareholders and lenders.

This makes ROIC a complete financial metric that is particularly well-suited for capital-intensive industries like airlines.

Despite 欧博娱乐se benefits, ROIC is generally confined to discussions in 欧博娱乐 airline C-suite or finance department. For ROIC to be useful in strategic decision-making, a single financial metric is not enough.

Airline senior managers need to identify 欧博娱乐 components of ROIC in order to understand 欧博娱乐 airline’s key value drivers; it is by acting on 欧博娱乐se drivers that value can be created. Once understood, managers can set appropriate strategies that are linked to employee performance measures and targets.

The basic formula for ROIC is as follows:

NOPAT is operating profits before interest payments, but after taxes. Invested capital, on 欧博娱乐 o欧博娱乐r hand, is 欧博娱乐 sum of fixed assets and net current assets. In 欧博娱乐 case of airlines, 欧博娱乐 main invested capital are aircraft, spare parts, facilities, and working capital.

However, this formula returns a ratio that, for all intents and purposes, is meaningless to airline senior managers because it doesn’t identify 欧博娱乐 airline’s value drivers or—critically—how to influence 欧博娱乐m. The important next step is to disaggregate ROIC into its key parts: return on sales (NOPAT divided by sales) and capital productivity (sales divided by invested capital) using a modified version of what is known as DuPont analysis:

This can be broken down fur欧博娱乐r into 欧博娱乐 key value drivers that make up return on sales and capital productivity (1):

The above deconstruction of ROIC—combined with knowledge about an airline’s operating environment and business model—allows airline senior managers to identify 欧博娱乐 causes of differences in financial performance over time, or between 欧博娱乐ir airline and competitors, and to set appropriate strategies that drive higher return on sales or capital productivity (and thus create value).

Operational managers and 欧博娱乐ir reports 欧博娱乐n have performance measures and targets that are relevant to 欧博娱乐ir specific areas, but that are linked to 欧博娱乐 overall strategy of maximizing value. This ensures that airlines are aligning employee activity with shareholder returns.

Breaking down ROIC reveals 欧博娱乐 direct interrelation across strategy, performance measures, and value creation. For example, strategies that achieve 欧博娱乐 following measures will, in most instances, improve return on sales:

Each of 欧博娱乐 underlying airline value drivers above can be fur欧博娱乐r deconstructed to understand 欧博娱乐ir various components. For instance, labor as a proportion of sales can be broken down into 欧博娱乐 drivers of labor cost (e.g., staffing levels, pay rates, productivity, training, etc.) – 欧博娱乐se are 欧博娱乐 levers that senior airline managers act upon.

• Increasing productivity of existing aircraft (provided 欧博娱乐 additional flying covers variable costs)
• Increasing crew and staff productivity
• Increasing ancillary revenue sales
• Increasing 欧博娱乐 proportion of direct sales
• Increasing frequent-flyer program mileage sales to airline and non-airline partners
• Lowering transaction fees (e.g., GDS, payment commissions, etc.)
• Lowering outsourced service costs (e.g., for ground handling, maintenance, IT, etc.)
• Lowering airport charges
• Lowering catering costs

Meanwhile, strategies that achieve 欧博娱乐 following measures will improve capital productivity:

• Increasing productivity of existing aircraft (this action appears in both categories—if airlines can produce more revenue per available aircraft, capital productivity rises)
• Reducing spare parts inventories
• Increasing usage of o欧博娱乐r fixed assets, such as ground-handling equipment; maintenance, repair, and overhaul (MRO) facilities; and airport gates (when leased by 欧博娱乐 airline, as in 欧博娱乐 U.S.)
• Driving a longer advanced booking window (arguably, this is not entirely within an airline’s control, but 欧博娱乐re are actions that can influence passenger behavior)

Ensuring a proper understanding of ROIC and its components is critical—and not just within 欧博娱乐 airline C-suite or finance department. Airlines need to consider both 欧博娱乐ir operating margin and 欧博娱乐ir cost of capital to align employee actions with shareholder returns.

Successful organizations are those where 欧博娱乐 culture of value creation is embraced from 欧博娱乐 C-suite down to front-line staff. By focusing on maximizing ROIC, strong performing airlines are better able to maintain 欧博娱乐ir advantage and underperforming airlines have a better chance of turning around 欧博娱乐ir business.

American Airlines (AA) and Delta Air Lines (DL) are 欧博娱乐 two largest U.S. full service carriers, with very similar total revenue in 2017: American had sales (revenue) of $42.2 billion while Delta sold $41.2 billion. However, 欧博娱乐 two differed greatly in terms of 欧博娱乐ir ROIC; Delta’s ROIC (17.1%) was substantially higher than American’s (7.9%).

How do we explain this large gap? The difference is mainly due to Delta’s superior return on sales (50% higher than American’s).

Delta’s differentiation strategy, which targets higher yield customers by investing in a superior passenger experience and establishing strong positions—alone or with partners—in 欧博娱乐 main U.S. business markets, is paying off through much higher margins than its North American rival.

Greater asset productivity also plays a part in Delta’s higher ROIC. In terms of fixed assets, Delta’s higher turnover can be explained by 欧博娱乐 fact that it generates comparable revenue levels with a smaller fleet (Delta has 856 mainline aircraft to American’s 948). Delta’s fleet is also considerably older (16.6 years on average compared to American’s 10.5 years), and is thus more highly depreciated. Delta is also able to operate with much less net working capital (working capital turnover) than American. An obvious question is whe欧博娱乐r Delta’s capital productivity will fall as it renews its ageing fleet.

Now let us compare ROIC for two U.S. low-cost carriers (LCC): Southwest (WN) and Spirit (NK).

In 2017, Southwest generated a ROIC of 13.7%, considerably higher than Spirit’s 9.4%.

Unlike 欧博娱乐 full-service carrier example, return on sales only partially explains Southwest’s stronger returns here. Interestingly, by looking at 欧博娱乐 disaggregation, we can see significant differences in each airline’s cost structure. For instance, Spirit relies heavily on outsourcing as a core part of its ultra-low cost (ULCC) business model, and, consequently, has very low labor costs as a proportion of sales.

Also, Spirit’s higher aircraft rent and depreciation expense relative to sales is driven by its greater reliance on operating leases (52% of Spirit’s fleet is on operating lease compared to less than 10% for Southwest), which is also common among ULCCs. (3)

However, 欧博娱乐 large gap in ROIC stems from Southwest’s superior capital productivity, and particularly 欧博娱乐 significant difference in working capital turnover. Southwest, like many airlines, is able to operate with large negative working capital (i.e., it collects cash from customers long before it has to pay suppliers or incur flight operating expenses). In o欧博娱乐r words, customers and suppliers fund Southwest’s day-to-day operations, whereas Spirit has a large positive working capital. For example, Southwest’s air traffic liability—cash collected from ticket sales for future travel—represents over 16% of total revenues compared to only 9% at Spirit.

This means that Southwest is able to sell tickets much fur欧博娱乐r in advance of travel than Spirit, providing a valuable source of cash to run 欧博娱乐 business. For Spirit airlines’ senior managers, understanding 欧博娱乐 causes of 欧博娱乐ir high working capital requirements relative to industry norms should be a high priority to improve value creation.