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ACE CASE STUDY

Air cargo and the economic slump

Air cargo volumes have slumped in the first part of 2009.  BAA said that its total UK cargo shipments
had fallen by 21.4 per cent during February 2009 compared with the same month a year ago to
119,984 tonnes.

Some airports fared much worse than this average.  Cargo weight (on which cargo fees are charged
by airports) at Gatwick and Glasgow fell by over 50%.

The reason?  Leaving aside the bad weather in February 2009, quite simply the reason is the
reduction in global demand for freight.  Retailers, wholesalers and other distributors in the UK are
reducing the quantity of stocks held in the supply chain (destocking = fewer goods imported using
freight) and exporters are finding that demand from customers outside the UK has fallen.

The statistics illustrate how an economic downturn can result in significant changes in the physical
flow of goods around the economy. Bad news for airports, freight forwarders and the myriad of
other businesses that make their living from handling air cargo.

Charging for Cargo

One important aspect of the OCR 2880 case study (ACE) is the revenue generated for the airport by
cargo.  So how does an airport charge for cargo flights?

The airline actually carrying the cargo charges its customer based on the total weight flown.  The
customer will typically be a “freight forwarder” - in effect a middleman that arranges airfreight for its
own customers, consolidating various freight requests into a smaller number of consignments to
load onto the aircraft.

For the airport, cargo revenue is generated based on the total weight of the aircraft landing and
taking off.  That total weight includes both the aircraft AND the freight on board.

So how is the weight priced?  The case study airport ACE is based on East Midlands Airport, so let’s
look at how they charge for cargo.  There are three key elements:

A standard “runway charge” -of £1.75 per tonne; paid by all cargo aircraft.  That is the minimum
price.

In addition, the airport charges a supplement for cargo aircraft that want to arrive or depart at
certain times:
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Daytime - Shoulder Supplement £1.55 per tonne (levied on arrivals and/or departures between
0601-0700 or 2101-2329 local time)

Nightime supplement - £2.33 - £2.85 (depending on noise band of aircraft), levied on arrivals and/or
departures between 2330-0600 local time

For flying cargo into and out of ACE during the night would be approximately three times the price
that is charged for a daytime operation.

Revenues by Activity

The June 2009 case study for OCR A2 Business Unit 2880 (ACE) is closed based on a real business
(East Midlands Airport).  We’ve dug out some of the detail behind some of the data presented in the
case study as a way of helping students develop their thoughts on the strategic issues facing the
business.  Here is some information on revenues:

The case study points out that, in 2008, total revenues were £54 million [line 8].  For East Midlands
Airport that was actually the figure for the year ended 31 March 2007 (the date is not significant in
terms of how students should address the case).  In the chart below, we show the breakdown of
revenues by each of the four main income categories:

Cargo and passenger-related aircraft charges are combined in the accounts of East Midlands Airport. 
Together they represent around £30m of turnover (just under 60%).

Car parking, as suggested by the case, is also a substantial revenue earner.  Of the £54m revenue,
around £10m comes from car parking charges (just under 20%).

Concession income from retail outlets is also substantial, at around £10m (2again, a little under
20%).  As the chart shows, this was the fastest growth area in the last year.

“Other income” includes property rents and other charges for other businesses that use the airport
location and facilities.
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Regional airports suffer from the downturn

It seems there is a dispute about whom or what is to blame for the downturn.

The airport operators blame low-cost airlines for squeezing costs (isn’t that why passengers like
them??).  The low-cost airlines blame the airports for adding extra charges which have to be
absorbed by either passengers or the airlines.

All highly relevant to OCR 2880. Remember that ACE’s passenger volumes are dominated by low-
cost carriers (we know this because of the absence of belly-hold volumes).  The competitiveness of
the airport is an important issue when an airline determines where it flies to and from.

Calculating the Traffic Growth

The OCR 2880 case study has some data tables which encourage students to consider the historical
and projected growth rates of activity at ACE.  It is easy to get these percentage calculations wrong,
and to draw some potentially misleading conclusions…

Both Table 2 (cargo and mail tonnage) and Table 4 (projected air traffic movements) look at the
growth of ACE traffic over a period of time.

Table 2 looks at the historical growth in non-passenger tonnage from 1996 to 2008.  Both cargo and
mail have grown substantially over that period.  But what is the annual percentage growth?

One commercial analysis of the case says the annual growth in cargo is 16.8% and mail is 12.9%.  This
is calculated by simply dividing the difference between the final 2008 value and the starting 1996
value by the number of years covered (12). Is that the correct answer?  No.  It takes no account of
the nature of compound growth.  It significantly inflates the actual growth rate in cargo and mail
tonnage. That calculation is just an arithmetic mean.  Not very helpful.

The correct percentage growth to calculate is a “compound annual growth rate” (often shortened to
“CAGR").  CAGR is widely used to describe the growth over a period of time of some element of a
business, for example revenue, units delivered etc.  That is the right approach to the growth rates
achieved historically by ACE, and also provides a basis for evaluating the projected growth up to
2016 in Table 4.

So, for Table 2, the correct CAGRs for the growth in cargo tonnage are cargo (9.6%) and mail (8.1%). 
As you can see, quite a difference.

The projected CAGR for cargo up to 2016 is 5.6%.

Using this data, a student can begin to make some sensible and accurate comments about the
realism of the objectives set by the business
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Why build a railway line when a bus will do?

One of the strategic choices facing students in the OCR 2880 case study is a potential project to build
a railway line linking the ACE airport to the national rail network. Here’s what the real-life airport
behind the case study has actually done when faced with the same challenge.

The business in question is East Midlands Airport.  Back in 2007, planning permission was finally
given for Network Rail to build East Midlands Parkway, a new “green” railway station which has been
built one mile from junction 24 of the M1 motorway and next to the A453 that connects
Nottingham, to the M1 and East Midlands Airport.

How has East Midlands Airport responded to the new station?  Build a spur link directly to the
airport?

No.  It has taken a much cheaper, simpler option.  A short 15 ride on a regular shuttle bus service
brings passengers directly to the terminal

East Midlands Airport is pleased to announce that a dedicated shuttle bus will operate between the
new East Midlands Parkway Station and the Airport from 26 January 2009 – the station’s first day of
opening.

The new service has been created and funded by a close working partnership between East Midlands
Airport, East Midlands Trains, Nottingham City Council, East Midlands Development Agency (emda)
and East Midlands Regional Assembly, making it easier for passengers to access the Airport by rail
and bus.

Funding was also secured from Derbyshire, Nottinghamshire, Leicestershire, Northamptonshire and
Lincolnshire County Councils and Leicester City Council.

Operated under contract by Premiere, the ‘Rail link’ service will run every 30 minutes, 7 days a week
from 7am to 11.30pm, using low floor vehicles supplied by Nottingham City Council. The ‘Rail link’
timetable coincides with train arrivals and departures, reaching East Midlands Airport in up to 15
minutes. The new dedicated shuttle service will complement the existing Skylink bus services which
connect the Airport to Nottingham, Derby, Leicester and Loughborough.

Penny Coates, Managing Director, East Midlands Airport, said, “We are delighted that the Airport
will be served by a dedicated bus link from East Midlands Parkway Station, from the first day of
opening. This new service will help deliver our promise of ease for the passenger and create better
commuter links between the airport and the rest of the UK. We hope this will encourage more
passengers to reach us by rail.”

East Midlands Regional Assembly member Nick Rushton, deputy leader of Leicestershire County
Council, said, “I’m delighted that this new bus link and rail station are being launched, to help more
people travel to the airport on public transport. The regional assembly helped to secure agreement
on this service and get the funding together.”

David Horne, Commercial Director for East Midlands Trains, said, "The opening of the new station
on 26 January really will represent a significant milestone for the East Midlands region. For a new
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station to be successful and to attract new passengers it is vital that good transport links are
available. We are therefore extremely pleased to be working with partners in the region to deliver
this vital new bus link between the station and the airport."

Sounds like a smart move to me.  It avoids a substantial investment risk and minimizes the loss of
lucrative car parking revenues.  Yet it still provides an environmentally-friendly service for customers
who wish to travel to the airport via the rail network.  If demand proves greater than expected, then
simply add more shuttle buses to the service. Like so many things in business strategy, think KISS -
“keep it simple stupid”!
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The Air Executive proposal

A likely question on the forthcoming OCR A2 Business Unit 2880 exam paper will ask students to
evaluate the proposal from Air Executive to run scheduled business flights from the airport.  The
exam paper was written at about the same time as a very similar airline was setting up - and failing -
operating out of Luton airport…

Students who attended our AQA Unit 1 Intensive Revision Workshop will be familiar with the case of
Silverjet.  The Silverjet story is very similar to the fictitious Air Executive airline which OCR have used
in their Business Strategy case study.

So what lessons or pointers might OCR students take from Silverjet?

The most important would be a simple one - that the viability of a premium business class airline
operating out of a regional airport has to be called into question.  Particularly one (like Silverjet and
Air Executive) planning to fly on the highly competitive transatlantic and UK/India/China routes.

Four businesses, including Silverjet, all tried this approach during 2007 and 2008.  All failed -
spectacularly.

Silverjet calls in administrators

Business airline Silverjet has gone into administration after financial problems forced it to suspend
all its flights, leaving passengers stranded.

The cancellations left about 7,000 UK and 2,500 non-UK customers needing to make alternative
plans at short notice.
The firm said other airlines were not obliged to honour unused Silverjet tickets and advised
passengers awaiting return flights to make their own plans.
It is the latest carrier to run into trouble over the soaring cost of fuel.
Over the past few months, rival business airlines Maxjet and Eos have both gone out of business
while other carriers are struggling.
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For sale

Silverjet said it was "with deep regret" it has appointed administrators.

"The Silverjet team has worked exceptionally hard to try and turn this situation around, however
with the time available, we were unable to secure the funding required to continue our operations,"
said Lawrence Hunt, Silverjet's former chief executive.
Silverjet administrator Begbies Traynor said it was negotiating a potential sale of the business with
"interested parties" and urged potential suitors to come forward, but shareholders are unlikely to
benefit, according to Silverjet.
"A number of interested parties have already been in contact, ahead of our appointment as
administrators, and we are confident of achieving a sale given the attractions of the company," said
Mark Fry, partner, Begbies Traynor.
He considered that the carrier's unique position as the last business class-only transatlantic airline
operator underpinned its potential as a going concern, given adequate funding.
Silverjet operated two daily services between London Luton and Newark Liberty International
Airport, which serves New York City, and one between Luton and Dubai.
The average cost of a return fare was £1,000

Stranded passengers

Both outgoing and incoming flights between Luton and Newark were cancelled on Friday, as was the
outgoing flight to Dubai.
The last service departed from Dubai at 0730 BST
Passenger Mark Silk arrived at Luton shortly after 0800 BST to board a Silverjet flight to New York
with his mother and said he was initially "stunned by how good the service was".
But 10 minutes after they checked in their luggage, he said: "The same people who checked us in
came back to us shaking, one of them was crying."
"They apologised... they'd just heard the news."
He said the founder and former chief executive Laurence Hunt had personally apologised to the
affected passengers already at the airport.
"He was looking very disappointed, which must be an understatement for how he was feeling," Mr
Silk added.

Compensation
For other passengers booked on later flights, a notice taped to the door of the Silverjet departure
lounge was the first word they received of the travel situation.
"We hope to be able to bring you our very 'sivilised' flying experience again", the message
concluded, angering some passengers who were not amused by the choice of words.
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UK customers that have booked just an airline ticket from SILVERJET FACTS
Silverjet are not eligible to claim a refund from the CAA's Air Fare: London to Newark/Dubai £1099
Travel Organisers' Licensing (ATOL) scheme. Number of aircraft: Three Boeing 767
But those who paid by credit card are urged to contact their
Number of seats: 100
credit card companies to see if they are eligible for a refund,
Seat size: 6ft 3in flatbed
or check any travel insurance policy taken out about airline
insolvency cover.
Customers who booked flights and chauffeur drive or valet parking and those who booked flights
through a travel agent are protected under ATOL.

The CAA said passengers returning to London from New York or Dubai should make their own flight
arrangements home with other carriers and apply for reimbursement afterwards.

Cost pressures

Shares in the carrier were suspended earlier this month when

it failed to obtain a critical $5m (£2.5m) loan.
But as recently as last week Silverjet said it would continue its
services as scheduled but warned that it needed to secure
additional funds urgently.
At the time, it said it was in discussions with a number of
parties looking to invest in the firm.
Silverjet started services in January 2007 and operates three
aircraft. Lawrence Hunt apologised to
Airlines across the board are struggling to deal with rising cost passengers but many were not happy
pressures, many of them having to raise fuel surcharges and start charging for services such as
checking in bags.
Aviation analyst Laurie Price told the BBC that the soaring cost of jet fuel was a "serious problem" for
airlines, particularly business airlines.
"You can see the difficulties they are in. It's going to be very difficult to operate a single-product
model," Mr Price added.
At the other end of the spectrum, budget airlines are also being squeezed.
Oasis Hong Kong, which operated daily flights between London and Hong Kong, applied to go into
liquidation in April.
Low-cost short-haul airlines Easyjet and Ryanair have both warned recently that profits will be
significantly lower in 2008.