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Airline direct operating costs and their impact on profitability

IATA recently announced a downgrade of its 2019 outlook for the airline industry – the industry profit is expected to decline further to close to USD 28 billion from the USD 35.5 billion forecasted earlier. The decline can be primarily attributed to rising fuel costs, with overall costs expected to grow by 7.4 percent outpacing the 6.5% rise in revenue.

The rise in the cost structure cannot be blamed only on the fuel price rise though, airline margins are under pressure also due to labour and infrastructure costs. From an airline perspective, a number of these costs are direct operating costs – costs incurred as a direct result of the operation of a specific service – for example, fuel costs and navigation charges. As per some estimates, direct operating costs constitute close to 50% of all costs for network carriers.

This means a few percentage points of savings on these costs can save an airline large volume of money and improve profitability. Conversely, a small percentage of leakage in the form of supplier overbillings can prove to be lethal from an airline financial health perspective.

The challenge of managing direct operating costs

As mentioned above, direct operating costs occur when flights are operated increase as an airline grows their network and fleet. Direct Operating Cost invoices are based on long term supplier contracts with no purchase orders controlling them.

An airline finance team manually captures and map these invoices. But the large volume of invoices and the operational variances make this process difficult. And even though historical trends and averages could be referred to, there is a high probability that a large volume of supplier overbillings go unnoticed and lead to leakages – for services either not delivered or charged incorrectly.

The role of technology

Although a number of these costs are a function of the external environment, technology and process automation can play a key role to ensure improved efficiency in controlling these leakages and protecting margins.

One of these approaches is to automate invoice validation and verification so that each invoice can be validated at a detailed level against operations data and vendor contracts – a 3-way matching. There are challenges here too – all the data sources/files may be in different formats and may require the airline to standardize the process first. This process standardization followed by automation can help an airline to:

  • Exercise complete control over all invoices
  • Facilitate better budget and procurement planning
  • Aid compliance through audit trail

In addition to the above, airlines can leverage the data and insights provided through this process for better purchase decisions and data-driven negotiations with their suppliers.

Conclusion

To initiate any change, it is advisable to identify the low risk areas and implement them first. In case of airlines, fuel contributes significantly to an airline’s direct operating cost and can be taken up on priority. Its advantage being the readily available operations data.

If you liked this post and want to learn more about Fuel Cost Management, download our case study.

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