Monday, 1 December 2014

How to Overcome Limitations of Traditional Costing Practices

A decades-old system for cost classification and reporting inherited from industrial era still dominates management practices across the airline industry. Airlines continue to use this system partly driven by collective inertia and partly by the lack of alternative solutions that would empower decision makers with understanding of true origins of operating costs, essential for making informed cross-functional decisions of strategic and operational nature.

Traditionally, costs derived from financial reports are statistically distributed to segmented business units in order to be calculable at functional levels and easy to control. This practice ignores the fact that costs are more than just sums of numbers - they are nonlinear, interrelated, and consequently cannot be measured in a conventional way. This is why answers to questions related to true effectiveness of cost saving measures, route network, aircraft and hub operation, outsourced services, or investment in additional resources, remain stumbling blocks for improvement in cost efficiency and operational performance.

Answering these questions by using cost apportioned to operational units without knowing their true origins turns the decision making into a pretty risky process. This is not only because this information is simplistic, but also because it is just a historic snapshot of data collected mainly at the time of budget drafting. As soon as the ‘budget schedule’ starts to change (normally months before the start of a new scheduling season), it triggers changes in cost matrix, making the planned costs even less suitable for decision making.

This may, at least partly, answer the question why airlines with long established practices make so many changes in planned operations once the season starts. We have seen traditional and even some low cost carriers incurring significant losses in cost, revenue, and reputation by reducing the planned operation in the middle of scheduling season due to planning and strategic errors described as ‘overexpansion’, ‘overstretched capacities’ or ‘to avoid more operational problems'. What were the causes of such serious misjudgements resulted in change of decisions made just several months ago? How many of these changes and related losses were associated with wrong evaluation of disruption risks, or poor understanding of system limitations. How much does the cost planning process contribute to this situation?

Let's see how the typical process of cost planning looks like.
'The typical process of cost planning starts with projected traffic, cost, and revenue for the coming year. The company’s finance director then sets a target figure for net results including the necessary return to shareholders. This is further broken down into management units and transmitted to senior directors, responsible for squeezing the savings out of their respective departments. The initial figure may be adjusted several times during the year. There are reviews after the IATA slot coordination meetings and regular refinements in the light of information received on forward bookings, interim revenues, and yields. These adjustments can result in even tighter cost controls. The intense cycle of setting targets and searching for further departmental cuts is giving an early warning if a director is going to exceed the budget. If this happens, there are generally negotiations between the director and the CFO’s office to reach a satisfactory result. The process could be tightened further if necessary using various management techniques.' (Described by a senior manager of a major network carrier)

There are the two major setbacks in this process. The first one relates to the sources of information used for cost projection for the coming year based on too many assumptions. The second is the management aspect of cost control. Led by the nature of traditional cost information, managers put too much emphasis on cost control of departmental performance rather than on interrelated problem areas. As unforeseen problems start to emerge, senior directors have no other choice but to put even more pressure on middle managers and, through them on other staff to save more. The next round of ‘unexpected’ events includes the reset of targets, and continual search for new cuts from already well squeezed departmental cost - good for justifying efforts, but not good enough for improving business performance.

How can we overcome limitation of these costing practices?

Take the fuel saving measures as an example. The process is usually assigned to the Flight Operations department. There is a whole set of principles used to minimise fuel consumption on the day of operation. They include things like flying at optimum speeds and flight levels, fuel tankering policies, careful weight and balance control or flying the ‘cost efficient’ air routes (not necessarily the shortest ones). In reality, however, most of these principles cannot be applied. Fuel consumption will be increased every time when flight cannot operate at optimum flight level, ATC diverts the aircraft to a longer route or put it on hold over a busy airport, and in many other situations. According to industry research, about 10% of fuel consumption is attributable to changes in operational performance. Reducing it at busy airports is becoming more and more challenging. Still, the fuel-saving programs circulate mostly around these traditional measures.

Much bigger potential for reduction of fuel costs, however, comes from inside the airline. It comes from people who decide which airports and routes to fly to, which aircraft can best serve these routes, how many hours it should fly, when to replace old aircraft or introduce new aircraft type. Then, there are schedule creators that have to make all these ideas workable by balancing requirements coming from many different sides inside and outside of an airline, people who negotiate fuel prices, repair and maintain the aircraft, provide service to passengers, and many other specialists and generalists – the cost architects. The impact of this process of creation and preparation for service delivery remains invisible to senior decision makers focused primarily on cost output expressed in numbers. Reinstating the connection between numbers and their origins requires a refined, selective approach based on identifying the cost critical operational problems, bringing them to the attention of cost architects that have knowledge and power to fix them, and finally pass it on to senior decision makers who can balance their acts to achieve what is best for the organisation.

The same principle can be applied to every area of business management. Costs allocated to departmental units shouldn't be an obstacle if we don't stop there. Departments are integral parts of the company's organism. When problem arises in one part of the body and its root causes are not identified, the treatment applied to the wrong part will harm other parts of the body and weaken the organism. This reminded me of the case of a European Airline where crew shortages were being reported as a cause of costly disruptions for about four months, starting at the beginning of the new season. The C-Officers decided that saving company's reputation surpasses the investment in additional crew, and some time later 24 new crew members joined the company. To cut the story short, as there were no signs of improvement, the top team required a more thorough analysis of the root causes of problems. The analysis showed that crew shortages were only the last in the chain of disruption causes triggered by problems with aircraft maintenance, which was related to tight schedules, which appeared to be the consequence of strategic requirements for increased aircraft utilisation (a bit over tolerable level). The sunk investment could have been avoided if the magnitude of disruption costs and associated causes of problems were diagnosed at early stage.


To inject more life into the planning processes, upset by limitations of traditional costing system, senior executives need to be regularly informed about the cost critical but avoidable changes in planned operations and their root causes. This will bring profound changes in the way airlines plan and control their business resulting in measurable improvement in operational and cost efficiency.

Friday, 21 November 2014

The Tragedy Of The Last 10% or How Far To Go With Cost Reduction

Here is the latest Seth Godin's blog post 'The tragedy of the last 10%' . 

'In a competitive market, if you do the work to lower your price by 10%, your market share grows.

If you dig in deep, analyse, reengineer and make thoughtful changes, you can lower your price another 10%. This leads to an even bigger jump in market share.

The third time (or maybe the fourth, or even before then), you only achieve a 10% savings by cutting safety, or quality, or reliability. You cut corners, certainly.

The last 10% costs your workers the chance to make a decent living, it costs your suppliers the opportunity to treat their people with dignity, and it costs you your reputation. 
The last 10% isn't worth it. We're not going to remember how cheap you were. We're going to remember that you let us down'


As for the airline industry, the second step is far from achievable. This is not because airlines don't try to dig in deep, analyse, reengineer, and make changes, but because their access to the right cost information is limited. Not to mention self induced complexity and uncertainty that only exacerbate the problem. 

Related:



Thursday, 20 November 2014

What Is Your Definition of Efficiency?

According to Investopedia, 'being efficient simply means reducing the amount of wasted inputs', which raises the following questions: 
  • What are our wasted inputs?
  • If we don't know what they are (typical for complex organisations) how do we measure efficiency?
  • How do we make and measure real improvements? 
All these assuming that the above definition is right.

In real world companies tend to use definitions that better suit their need to make things look better than they really are – at least for a while.

What is your definition of efficiency?


Related post:


Monday, 27 October 2014

What Do Disruptions And Chauffeur Knowledge Have In Common?

Chauffeur knowledge is making its way into business dictionaries following a story told by Charlie Munger during his talk about what went wrong with Enron.

After winning the Nobel prize for Physics in 1918, Max Planck went around Germany giving talks. His chauffeur heard the talk so many times that he had it by heart, and so one time, he asked Max Planck if he could give the address. Planck agreed, they changed places, and the lecture came off famously. But then came the question time, with the very first question being one that the chauffeur had no hope of answering. The chauffeur replied: ‘Never would I have thought that someone from such an advanced city as Munich would ask such an elementary question! I'll let my chauffeur answer it.'

If you are a decision maker in an extremely busy airline environment, and are expected to think and act fast, to be persuasive but unable to commit time and effort to understand the topics, the chances are that you can easily slip outside of your circle of competence, the zone of chauffeur knowledge and source of not so obvious causes of disruptions. This doesn't have to be as bad as it may look like as long as you can recognise when you are outside this circle and are open for inputs from those with real knowledge. 

Distinguishing between those with real and chauffeur knowledge in real life is difficult. Here are some hints.




How big is your circle of competence and how often are you out of it?

Thursday, 16 October 2014

Recovering Disruption Losses Caused By Third Parties



This time the problem and the solution are described in Recovering Disruption Losses Caused By Third Parties as a SlideShare Presentation and contains some additional information. Hope you'll find it useful.    

My Renewed Website is Online!

I have just launched a renewed website Beyond Airline Disruptions. It is designed to promote my business activities focused on unlocking hidden potential for cost saving and improvement in airline profitability.

We at Beyond Airline Disruptions are helping airlines to understand why their plans do not work on the go. We identify, analyse, model, and measure the true cost and causes of operational disruptions in order to minimise their impact on airline financial and operational performance and assist airlines in recovering disruption losses caused by third parties.
                                                   
Visit Beyond Airline Disruptions to learn more.


Wednesday, 1 October 2014

Why Do the Existing Cost Saving Projects Have Little Chance to Succeed and What Can Be Done About It

Never before has there been so much hype about cost saving, and never before has there been less evidence of it. We often mistake knowing the inexhaustible volume of reported data for understanding the costs, forgetting that it is not just facts that are important, but the intertwined threads and people that connect them to their ever-changing origins.

To find out more follow this link to my SlideShare presentation 'Managing Costs We Don't Understand'.

Saturday, 26 July 2014

Disruptive Overconfidence

We systematically overestimate our knowledge and our ability to predict – on a massive scale. The overconfidence effect does not deal with whether single estimates are correct or not. Rather, it measures the difference between what people really know and what they think they know. What’s surprising is this: experts suffer even more from overconfidence than laypeople do. If asked to forecast oil prices in five years’ time, an economics professor will be as wide of the mark as a zookeeper will. However, the professor will offer his forecast with certitude. 
("The Art of Thinking Clearly", Rolf Dobelli)



Tuesday, 22 July 2014

Can ‘Happiness Blanket’ Really Improve Passengers’ Experience?

British Airways has started trialling a hi-tech blanket – known as the ‘happiness blanket’ – which uses neuro-sensors to measure the electrical fluctuations in the neurons of passengers’ brains, and changes colour depending on their state of mind.' 

Frank van der Post, British Airways’ Managing Director, Brands and Customer Experience, commented: “This is the first time this technology has been used by any airline to help shape how service is delivered onboard an aircraft.” He explained that the happiness blanket “is another way for us to investigate how our customers’ relaxation and sleep is affected by everything onboard, from the amount of light in the cabin, when they eat, to what in-flight entertainment they watch and their position in the seat.”

Wouldn't this 'happiness blanket' be more useful to measure the mood of (potentially the same) passengers experiencing disruptions on ground? Or at least, to protect them against cold if needed.

Wednesday, 16 July 2014

One Way of Solving Big Problems

Have you ever asked someone who doesn't know much about your business, even a child, how they see the solution to the problem you've been stuck on for some time? The chances are that their uncluttered, freer thinking will resonate more closely with the right answer. You may be surprised what they can come up with.

The only effort you have to make is to explain your big problem in a simple way so that even a child can understand it. The effort put in simplifying it will often present you with the answer you were eagerly searching for, but couldn't hear from the noise of cluttered data and other unnecessary inputs.

Monday, 7 July 2014

Risk vs Uncertainty and How to Make Better Predictions

Predicting the company's future has never been trickier than today. In the age of accelerating changes, even the most comprehensive annual reports could be misleading and cannot serve their purpose.

We can make predictions more reliable by understanding the difference between risk and uncertainty. Companies that are able to make this distinction usually perform better than others. In practical terms, they are more capable of narrowing the gap between plans and reality and can tolerate uncertainty with greater ease. 

'Risk means that the probabilities are known. Uncertainty means that the probabilities are unknown.
On the basis of risk, you can decide whether or not to take a gamble. In the realm of uncertainty, though, it’s much harder to make decisions. The terms risk and uncertainty are as frequently mixed up as cappuccino and latte macchiato – with much graver consequences. You can make calculations with risk, but not with uncertainty. The 300-year-old science of risk is called statistics. A host of professors deal with it, but not a single textbook exists on the subject of uncertainty. Because of this, we try to squeeze ambiguity into risk categories, but it doesn't really fit.' 
'This confusion contributed to the chaos of the financial crisis in 2008.’    
(‘The art of Thinking Clearly’, Rolf Dobelly)

Even if we learn how to differentiate between risk and uncertainty we still need to transform this understanding into practical decisions. To do that, we need to acknowledge the existence of self-induced uncertainties and learn how to 'read' them. Operational disruptions could be a good starting point as a measure of airline ability to cope with unknown. Being able to grasp even a bit of this knowledge can sometimes make the difference between business survival and demise. This is at the core of my work.

Monday, 30 June 2014

The Cost Of 'Delay-Repay' Promises

This month was marked by two interesting strategic moves towards compensating air and rail passengers experiencing delays.

While air passengers can expect to be able to claim compensation through the courts for flights delays that happened as long as 6 years ago, rail passengers are promised an automatic refund for journeys delayed by 2 minutes or more (3p per minute for delays between 2 and 29min - more afterwards).

Let's go back to reality.

Air passengers have almost zero chances of taking advantage of this regulatory 'improvement' as airlines struggle to track records even for day-old 'cases'. Which is why CAA advises disrupted passengers 'to lodge their claim as soon after the flight as possible'. No extra costs for airlines from this promise. Guaranteed!

As for train passengers, the reality check to be carried out by National Express c2c trains will tell if the multi-million investments in stations and additional trains will pay off and keep this joyful promise alive. Not to forget the potential burden of £100 million in compensation for delays that passengers in Britain miss out to claim each year.

Which of these promises would you trust more as a passenger?