At the beginning of 2020 air navigation experts in Europe expected to see a continued traffic growth, further straining the capacity of European airspace.
Preparations were made to distribute the expected traffic to alleviate the pressure on key hotspots. In an unexpected turn of events, as COVID-19 spread across the globe IFR movements in April were 88%  lower than in April of 2019, while the chargeable service units dropped by 87% . This drop in service units placed Air Navigation Service Providers (ANSPs) under an immense financial pressure, not only lowering their revenue, but also affecting their cashflow. This was further exacerbated when four months of airline payments were deferred to the end of 2020 and into 2021. As a result, ANSPs have had to temporarily reduce capacity in line with demand and costs as much as possible - just as all other actors in the aviation industry have done. The crisis the industry currently faces is in stark contrast to the issues ANSPs faced throughout the previous regulatory reference period (RP2, 2015-2019). In those years, traffic growth far outstripped expectations, resulting in staff shortages, which in turn created large air traffic flow management (ATFM) delays, especially in peak summer periods. ANSPs were pushed to accelerate recruitment and seek operational innovation to ease the capacity crunch.
While the situation seen throughout RP2 is entirely different to the issues facing ANSPs now, there is one common denominator: they both require an ability to respond to demand as flexibly as possible, while maintaining the financial resilience of the company. Financial resilience can be defined as “the ability to cope financially when faced with a sudden fall in income or unavoidable rise in expenditure”. The fundament of ensuring this resilience is being able to adjust costs during periods of low traffic. “Cost base elasticity” takes this a step further, capturing the ability to adjust costs in line with demand, whether it increases or drops. In the short term ANSPs are by necessity focused on ensuring financial resilience. In the long term however, it will be beneficial to shift the focus to a more holistic view on cost base elasticity. This elasticity can be achieved through internal, organisational decisions, or by structural changes imposed by regulatory or market reforms. It is this elasticity that I will focus on, as this is the main aspect that is within the control of the organisation..
Organisations can take a series of actions to increase their financial resilience and improve cost elasticity. Opportunities exist across all of the key cost base elements.
The 2017 ATM Cost Efficiency (ACE) Report data shows that for both en-route and terminal costs, staff costs constitute 64% and 68% of the cost base respectively.
Figure 1 Average cost base structure - ACE 2017
In some industries staff costs can be seen as variable costs – they can be flexibly reduced when required, either through redundancies or flexible/part-time employment contracts. However, due to the high level of specialisation and qualification of staff employed by air navigation service providers, staff costs in ATM can be seen as “quasi-fixed”. While theoretically speaking staff can be made redundant, the cost-benefit of such a move is doubtful. This is because re-employing staff with similar qualifications is very challenging, and re-training new staff is both costly and time-consuming. Nonetheless, there are other ways of increasing staff flexibility, such as:
The second largest cost base element is non-staff operating costs, which account for an average of 16-17% of the cost base of a European ANSP. The composition of costs within this category will be relatively fragmented, including a large number of cost lines, which will differ widely across ANSPs. At a high level however, these costs can be divided into three categories: raw materials and inventory, external services and business expenditure.
While a large portion of the raw materials and inventory costs will not be very flexible, there are possibilities for cost optimisation. Within alliances or with cooperation, it is possible to collaborate with other ANSPs to share the inventory and spare parts. This can be achieved across ANSPs who use a similar flight data processing system, or who operate similar CNS infrastructure. An excellent example of such an agreement is the FAB CE limited company, which undertakes joint CNS infrastructure procurements for some or all of its members. This covers the procurement of inventory and spare parts, allowing each individual member to have access to the required equipment while saving money. These benefits are not limited to a given alliance or cooperation. Any ANSP could enter into several such arrangements, depending on the cross-border infrastructure similarities.
Additionally, one could review the spare parts purchasing strategy and ensure that only parts which are likely to fail and would have a significant impact on operations are purchased outright. For other parts ANSPs could look to sign service level agreement contracts with suppliers, ensuring that appropriate parts would be provided in a pre-agreed timeframe, if and when required.
Increasing the number of external services contracts can be cumbersome from a procurement and legal perspective, but can have positive impacts on increasing the elasticity of the cost base. The nature of external contracts is that they can be relatively easily placed on hold or cancelled if a significant change in circumstances is observed. Additionally, external contracts can be more modular, allowing for a more proportional increase (or decrease) of the cost with the required output. In some cases, due to the competitive supplier market, cost efficiencies can also be made through simple outsourcing decisions. Nonetheless, all such external contracts must be sound from a legal, liability and resilience perspective. Adequate service level agreement provisions must be established, along with good supplier trust.
Elements of ANS provision which could be outsourced, leased or covered by external contracts include:
The volume and nature of business expenditure will vary significantly across service providers. As a principle, ANSPs should ensure expenditure is justified and supports the achievement of strategic goals. For this to be possible, they need clarity on their short and long-term strategic goals and objectives, and these must be translated into specific projects to ensure that every activity contributes to the achievement of these goals and objectives. These should be prioritized, to allow to the investment into these projects to be scaled up or down, depending on the external environment and financial standing of the company.
In the short term it is difficult to change depreciation costs which are charged to the users. ANSPs only have control over their fixed capital costs, so they may be able to pause specific capital projects. Nonetheless, this can only be done after careful consideration of the strategic objectives and will also be limited by the supplier contracts. In the longer term, ANSPs could consider strategically developing resilience within their capital infrastructure, a concept discussed in a colleague’s recent blog. Alternatively, ANSPs could review their approach to the financial gearing of the company, where increasing the use of loan financing for the completion of capex programmes could allow them to reduce the organisation’s weighted average cost of capital (WACC), thereby reducing the cost of capital charged to the end user. A shift to using borrowed funds for capital investment can have the benefit of added investment consideration and programme scrutiny, resulting in additional confidence of ensuring value for money.
As well as the actions of organisations, additional cost base elasticity could be enabled by external regulatory changes, such as enabling a wider roll out of ATM Data Service Providers. However, the charging scheme is currently strongly tied to traffic forecasts. To achieve greater elasticity in the cost base, ways should be sought to either strengthen the forecasting processes (no easy task!), or amend the charging regulation to better allow for adjusting output depending on demand. One way would be to reduce the reference period duration, to introduce the concept of scenarios within a performance plan, or to set the unit rates for a shorter period of time in one go.
Creating an elastic cost base is no easy task and can only be achieved if the organisation has clarity over its strategic and organisational goals and objectives. These should be disseminated throughout the organisation to enable informed decision making across all company levels and all projects assessed in their context. This might seem obvious, but it is not always done and can help enormously in creating the right climate for decision-making on costs.
Despite the many challenges, actions can be taken to increase cost base elasticity. From looking at rostering patterns, maximising staff utilisation when their regular duties are disrupted or looking at negotiating flexibility provisions, to investigating cross-border collaboration to streamline some non-staff opex expenditure such as the management of inventory. Capital investment should aim to enable resilience and where possible, external or leasing agreements should also be considered.
But navigating the many options is not easy. One effective way to do this is to engage in scenario planning activities, to consider various significant shifts in external circumstances and how these would affect operations. This would facilitate useful discussion about the changes that would be required, metrics which should be analysed along with what information would be disseminated throughout the organisation and how. A hypothetical discussion about a range of significant external scenarios could also help everyone respond to a crisis, such as the one we are currently experiencing. That will be the topic of our next blog.