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How Decreased Utilization Can "Increase" Costs

by David Wyndham 1. April 2010 16:55
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A user of our cost database asked about the effect of utilization on total cost per hour. His question was with higher utilization do the fixed and total costs decrease on a per hour basis?

First a quick review. Variable Costs are those costs that as activity increases, the total cost will increase but the cost per unit of time will remain constant. An easy example is fuel cost per hour. The next hour you fly will consume so much fuel. If you don't fly, then there is no fuel consumed and thus, no cost.

Fixed Costs are costs that for a given level of activity or period, remain essentially constant. Hangar rent is an example of a fixed cost. You pay so much per year to rent a hangar regardless of how much you fly.

For our discussion, we assumed that Total Cost per Hour was the Variable Cost per Hour plus the Annual Fixed Cost divided by the Annual Hours flown. The example I used was an aircraft with a variable cost of $1,250 per hour and fixed costs of $400,000 per year.

For 200 hours per year = 200 x $1,250 + $400,000 = $650,000 per year divided by 200 hours = $3,250 per hour average.

For 400 hours per year = 400 x $1,250 + $400,000 = $900,000 per year divided by 400 hours = $2,250 per hour average.

You spread the annual costs over more and more hours so the total average cost per hour decreases as utilization increases.

The reverse is also true. Decreasing utilization by a certain percentage will not drive down total costs by the same percentage. If your aviation budget were reduced by 15%, you'd have to reduce flying by a lot more than 15% to make your savings. From our earlier numbers:

400 hours per year = 400 x $1,250 + $400,000 = $900,000 per year divided by 400 hours = $2,250 per hour average.

To reduce our $900,000 budget by 15% to $765,000 by only reducing flight hours, we'd need to reduce flying to 292 hours - a 27% reduction:

292 hours per year = 292 x $1,250 + $400,000 = $765,000 per year divided by 292 hours = $2,620 per hour average.

Also note that our average cost per hour went up by 16%. So if you were tracking that metric too, things would look bad. Decreased flying and increased average cost per hour.

This can result in the "flight department death spiral" of reduce hours, average cost per hour increases, reduce hours some more because the cost per hour goes up, average cost per hour increases again... until at some point the aircraft is sold for being too expensive.

In some cases this cannot be avoided as the company is in dire straits and simply cannot afford the expense regardless. However, as aviation managers you need to be aware of the perception of your aircraft costs and be prepared to both defend and explain them so as to avoid a knee-jerk "the planes too expensive" reaction to reduced flying.

I hate to ask, but have you been there?


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