Aircraft Replacement Strategy

Massoud Bazargan, PhD Akhila Vijayanarayanan Henry Kosalim Tom Simms College of Business, Embry Riddle Aeronautical University, Daytona Beach

Presentation Outline
Aircraft Replacement Strategy - Introduction Mathematical Model Data Compilation Application Analysis Recommendations

AGIFORS Airline Operations 2011

Introduction
All the forecasts point towards higher demand for air transport: The aviation regulatory agencies (2%-4%) Aircraft manufacturers (3%-6%) Academic studies (2%-5%)

AGIFORS Airline Operations 2011

Introduction
Airlines need a comprehensive plan for future aircraft acquisition/aircraft replacement. Aircraft Replacement strategy involves decisions on when and how many aircraft of different fleet (aircraft type) to purchase, lease and dispose of within an airlines planning horizon.

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Introduction
Average Age of Aircraft in years as of 2010
18 16 14 Average Age 12 10 8

6
4 2 0 Airtran Airways American Airlines Delta Airlines Southwest Airlines United Airlines British Airways Air France Emirates Luftansa Airlines Singapore Airlines

U.S Airlines

International Airlines

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Introduction
Project initiated by two airlines. Some key questions:
When to buy/lease A/C? How many to buy/lease A/C? How many and when to dispose of A/C? Buy or lease? How old is too old?

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Mathematical Model
The literature on aircraft replacement strategy is scarce. Formulated the problem as an integer linear program (see appendix). Objective: Minimize total discounted cost over Planning Horizon by identifying when and what type of aircraft to purchase, lease (including how long) and dispose of.
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Mathematical Model
Relevant Costs: A/C Purchase cost Lease cost Operating Cost Maintenance cost Cost of Operating new fleet Minus Revenue from sales of A/C
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Mathematical Model
Constraints: Aircraft Balance Satisfy future Demand Other side constraints

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Mathematical Model
Parameters (Easy to get):
Planning Horizon: 10 years Delivery lag (aircraft manufactures websites) Future demand:
Base: 1.6% (domestic), 3.3% (international)

Discount factor:
The weighted average cost of capital (WACC) is the rate that an airline is expected to pay to finance its assets. The average WACC is assumed to be around 7.5%

Current fleet and aircraft on order: BTS

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Mathematical Model
Major Parameters (not available!) Airlines do not have or unwilling to provide:
Aircraft market values vs. age Annual Lease prices vs. age Operating cost vs. age Maintenance cost vs. age Cost of introducing new fleet

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Data Compilation
Aircraft values including purchase and salvage prices. Used Collateral Verification (http://www.icollateral.com) and Airfinance Journal (http://www.airfinancejournal.com) databases Various regression analyses conclude:

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Aircraft Market values vs. age for B737-800

Boeing 737-800 Market values versus age
M$ 50. 45. 40. 35. 30. 25. 20. 15.

y = 40.003e-0.052x R = 0.9803

10.
5. . 0 2 4 6 Age of the A/C 8 10 12 14

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A/C Annual Lease Prices

Used Collateral Verification database (http://www.i-collateral.com) provides annual lease payments and aircraft market values for all fleet. Various analyses showed the following logarithmic equation provides the best estimates for annual aircraft lease prices with respect to their market values

AGIFORS Airline Operations 2011

Annual Lease prices for B737-800

Annual Lease prices for B737-800

y = 2.4525ln(x) - 4.8503 R = 0.994

5.00 4.50 4.00 Annual Lease Prices (M$) 3.50 3.00 2.50

2.00
1.50 1.00 0.50 0.00 . 5. 10. 15. 20. 25. 30. 35. 40. 45. 50.

Aircraft Market value (M$)

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Operating cost
Operating cost: All costs related to operating the aircraft including:
fuel, crew, supplies/catering, Landing/parking costs.

Used Airline Monitor database (http://www.airlinemonitor.com).

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Maintenance cost
No data available on maintenance cost versus the age of the aircraft from databases. RAND Corporation (http://www.rand.org) has conducted extensive research into maintenance costs for both commercial and military aircraft. Aircraft age:
New: 0-6 years Mature:6-12 years Aging: 12 years and over

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Maintenance cost index vs. age

1.6 1.4

Aging Mature 3.5% New 17.5% annually .7%

1.2

Cost index

0.8

0.6

0.4

0.2

0 0 5 10 15 20 25 30 35

Aircraft age

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Application
For this presentation we selected 3 airlines with different network sizes and business models.
AirTran Airways (LCC US based) Delta Airlines (Largest airline in the world US based) British Airways (International Airline)

Data on available fleet & orders were compiled from BTS database (http://www.bts.gov)

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Application
Applied the ILP models to the airlines Models have more than 250,000 integer/binary decision variables and 310,000 constraints! All the solutions were obtained in less than 5 minutes on a desktop PC with optimality gaps of less than 0.2% (using CPLEX 11).

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Application
The solutions presented here are based on total discounted cost. They do not include airlines short/long term marketing/competitive strategies.

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Current AirTran Fleet As of 2010

AirTran Airways Average age: 7.9 years
138 aircraft, 2 fleet types

60 50 Number of Aircrafts 40

0 - 5 Years
30 20 10 0 B717 (L) B737 (O) Current Fleet B737 (L)

5 - 10 Years 10 - 15 Years

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Current Delta Airlines Fleet

Delta Airlines Average age: 15.8 years
50 45 40
Number of Aircrafts

744 A/C , 18 fleet types

35 30 25 20 15 10 5
0

0 - 5 Years 5 - 10 Years 10 - 15 Years 15 - 20 Years > 20 Years

Current Fleet

(Excludes Delta connections , third party contracts and stored aircrafts)

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Current British Airways Fleet

British Airways Average age: 12.5 years
35 30 25 Number of Aircrafts 20 15 10 5

229 A/C, Fleet types: 14

0 - 5 Years 5 - 10 Years 10 - 15 Years 15 - 20 Years > 20 Years

0
A318 (O) A319 (L) A319 (O) A320 (L) A320 (O) A321 (O) B737 (L) B737 (O) B747 (L) B747 (O) B757 (O) B767 (L) B767 (O) B777 (L) B777 (O)

Current Fleet

(Excludes Stored and leased out aircrafts)

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Aircraft Replacement Strategy AirTran Airways

Buy
12 10 Number of Aircrafts 8 6 4 2 0

Lease

Sell

Airtran Airways

B737-800

B737-800

B737-800

B737-800

B737-800

B737-700

B737-800

B737-700

B737-800

B737-700

B737-800

B737-700

B737-800

B737-700

B737-700

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Period and Fleet type

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B737-800

10

20

30

40

50

60

70

0 A319-100

A320-200 A330-300
A340-300

Buy

B737-800 B757-200 B767-300ER B767-400ER B777-200ER MD-82 A319-100 A320-200

2011

Lease

Sell

A330-300 B737-800 B757-200 B767-300 B767-300ER B767-400ER B777-200ER MD-88 A319-100 A320-200 A330-300 B737-800 B757-200 B767-300 A319-100 A320-200 A330-200 2014 A330-300 B737-800 MD-88 2013 2012

Delta Airlines

Aircraft Replacement Strategy Delta Airlines (2011-2015)

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A319-100 A320-200
A330-200 A330-300 2015 B737-800 B747-400 B767-300 MD-88

10

20

30

40

50

60

70

80

90

0 A320-200 2016 A330-300

Buy

MD-88 A319-100 A320-200 A330-200 A330-300 B737-800 MD-88 A319-100 A320-200 A330-300 A340-300 B737-700 B737-800 B777-200LR MD-88 A319-100 A320-200 A330-300 A340-300 B737-700 B737-800 B767-300ER B777-200LR MD-88 MD-90 A320-200 A330-300 A340-300 B737-700 2020 B737-800 B777-200LR B787-8 MD-90 2019 2018 AGIFORS Airline Operations 2011

Aircraft Replacement Strategy Delta Airlines (2016-2020)

Lease

2017

Sell Delta Airlines

10

15

20

25

30

35

40

45

Buy

2011

Lease

2012 2013 2014

Sell British Airways

Aircraft Replacement Strategy British Airways

AGIFORS Airline Operations 2011 2015 2016 2017 2018 2019 2020

A319-100 A320-200 B757-200 B767-300ER B777-200 B777-200ER B777-300 B777-300ER B787-8 A319-100 A320-200 B767-300ER B777-200ER B777-300 B787-8 A319-100 A320-200 A380-800 B767-300ER B787-8 A319-100 A320-200 A380-800 B767-300ER B777-300 B787-8 A319-100 A320-200 A380-800 B777-300 B787-8 A320-200 A380-800 B787-8 A320-200 B747-400 B777-300 A320-200 B737-400 B747-400 B777-300 A320-200 B747-400 B777-200ER B777-300 A318-100 A320-200 B777-300 B777-300ER

Observations
Buy/Lease brand new aircraft (age 0); leases (8-12 years); Sell older owned aircraft with average ages of 15 years and older;

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Buy vs. Lease

Percentage of Leased Aircraft
100% 90% 80% 70% % of lease

60%
50% 40% 30% 20% 10% 0% 2010 2011 2012 2013 2014 2015 Period 2016 2017 2018 2019 2020

Delta Airlines

British Airways
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Airtran Airways

% Lease A/C vs. changes in lease prices After 10 years

% of lease vs % change in lease price
120% 100%

80% % of lease

60%

40%

20%

0% -50 -40 -30 -20 -10 0 10 20 30 40 50

% change in lease price

Delta Airlines

British Airways

Airtran Airways

% Lease A/C vs. changes in purchase prices After 10 years

% of Lease vs % Change in Purchase price
120%

100%

80% % of lease

60%

40%

20%

0% -50 -40 -30 -20 -10 0 10 20 30 40 50

% chnage in purchase price

Delta Airlines

British Airways

Airtran Airways

% Lease A/C over 30 years

% of Leased Aircrafts
120 100

80 % of lease

60

40

20

Period

Delta

British Airways

Airtran

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Average age of Leased A/C

Average Age of Leased Aircraft
22 20 18 16 14 Avg Age 12 10 8 6 4 2 0 2010 2011 2012 2013 2014 2015 Period 2016 2017 2018 2019 2020

Delta Airlines

British Airways
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Air Tran Airways

Average age of Owned A/C

Average Age of Owned Aircrafts
16

14
12 10 Avg Age 8 6 4 2 0 2010 2011 2012 2013 2014 2015 Period 2016 2017 2018 2019 2020

Delta Airlines

British Airways
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Air Tran Airways

Fleet Diversity
Number of Fleet
20 18 16 14 12

Fleet Diversity

10
8 6 4 2 0 2009 2010 2011 2012 2013 2014 2015 Period 2016 2017 2018 2019 2020 2021

Delta Airlines

British Airways
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Airtran Airways

Cost Structure
Percentages of cost components over 10 years Total Costs: FL( $B13.6), DL ($B118.9), BA ($B56.7)
80% 70%

60%
50% 40% 30% 20% 10% 0% Purchase Lease Operation Maintenance Keeping Fleet

Delta

British Airways
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AirTran

A/C Market values & cumulative Ops & Mx cost.

Market value and cumulative ops+Maint cost B737-800
60 50 40 M$ 30 20 10

0
0 1 2 3 4 5 Year 6 7 8 9 10 11

Aircraft Market value

Cumulative ops+ Maint

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Break-even points for B737-800

Break-even points

% Increase
40% 35% 30% 25% 20% 15% 10% 5% 0% 0% 1% 2% 3%

4%

5%

6%

7%

8%

9%

10%

11%

Ops

MX

Total

% Reduction

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Recommended Strategies
Leasing aircraft is preferred to buying; Long term leases (longer than 12 years) are not recommended; Older aircraft (older than 15 years) should be replaced; Fleet diversity is not encouraged;

AGIFORS Airline Operations 2011

Recommended Strategies
Operating and maintenance costs are major cost drivers; Airlines will benefit more from operating efficient fleet even if they cost more. These strategies seem to apply to all three airlines with different networks and business models. Cash for clunkers is justified (at least financially)!
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Aircraft Replacement Strategy

Thank You

Q&A

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Appendix Mathematical Model

Index: k i j Index for fleet type (k=1,.., K); Index for age of the aircraft (i=0,..,N), N is the maximum aircraft age allowed; Index for period (j=0,..,T), T is the number of periods (years) in the planning horizon. Time 0 represents current year; Index for lease period (l=1,, ) - is the maximum lease period for fleet type k;

Decision variables: , () () () () Number of aircraft to buy of fleet type k, age i, ordered in period j; Number of leased aircraft of fleet type k, age i, ordered in period j for a lease period of l; Number of owned aircraft of fleet type k, age i, sold in period j; A binary variable taking a value of 1 if the airline has aircraft of fleet type k in period j and 0 otherwise; Total number of owned aircraft in operation of fleet type k, age i, in period j; Total of number of leased aircraft in operation of fleet type k, age i, in period j.

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Appendix Mathematical Model

Parameters: () , () () () () () () () Unit purchase price for aircraft of fleet type k, age i, ordered in period j. (For ordering new aircraft i=0); Unit annual lease price for aircraft of fleet type k, age i, ordered in period j, for a lease period of l; Discount factor for period j; Fixed cost for introducing/keeping aircraft of fleet type k in period j; Unit annual operating and maintenance cost for owned aircraft of fleet type k, age i, in period j; Unit annual operating and maintenance cost for leased aircraft of fleet type k, age i, in period j; Unit salvage value for owned aircraft of fleet type k, age i, in period j; average seat capacity for aircraft fleet type k; Demand for seats on long haul (wide body) flights in year j; Demand for seats on short haul (narrow-body) flights in year j; Average waiting time for delivery of a new aircraft of fleet type k;

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Appendix Mathematical Model

=1 =0 =0

()

()

+
=0 =0 =0

()
=1

, () ,

+
=1 =0 =0

=1 =0 =0

() () () () () ()
=1 =0

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Appendix Mathematical Model

Subject to

=0

() + ()

=0

() + ()

= 1 1 +

, 1

1 +
=1

=0 =1 =1

; 1 ;

1 1

, 1
, () , =0 =0 =1

()
=1 =0

+ , , , , , , ,

0,1

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