Case Study: Aircraft Leasing
Background
You are the CEO of a large bank leasing company contemplating a strategic move in the product offerings of your aircraft finance leasing group. This group has enjoyed years of success with its main product, full payout finance leasing, but margins have declined from competitive pressures, and the group is pressing to be allowed to move into the related market of aircraft operating leasing, where margins are better. Operating leasing involves much shorter lease terms. It is a certainty that your company will need to reposition each aircraft from its original user to another at least once during your period of ownership. Operating leasing represents a dramatic shift in your expertise needs from a focus on finance and credit analysis to a focus on the equipment itself.
As you sort through the various considerations, you retain the Chesterfield Group to assist in the structure and situational analysis. Their process includes the following.
Strengths
Your experience in finance leasing has built good relationships with the target customer base of airlines. You have a competitive cost of funding. You have the green light from your parent company to examine and pursue growth opportunities. You have much of the needed infrastructure and back office to operate this new business, although not all of it.
Constraints
You lack the expertise relating to the equipment. You need this to decide what types of aircraft will be good ones to buy at various times in the market cycles and what to assume for their residual values at various points in time in order to price your deals. You will also need to physically reposition and/or sell aircraft. Finally, you should know enough about aircraft value trends to enable you to play in the secondary market, buying and selling aircraft subject to leases, in order to manage your exposure to equipment value cycles.
Analysis
You have a number of paths that you can follow, if you want to move forward with this expansion.
- You can just let your aircraft group go ahead and start investing in operating leases with their existing skill set. Amazingly, many companies have done just that over the years with, as you might imagine, uniformly poor results. Apparently, these companies represent a classic case of "not knowing what they didn't know."
- You can hire additional staff with the needed expertise.
- You can buy an existing company with the needed expertise.
- You can outsource, effectively "renting" the required expertise from an existing company with that expertise.
Each of these approaches has advantages and disadvantages.
- Going ahead without the asset expertise involves little incremental short term cost, in money or time, but those are its only advantages. After a few years, other costs of this approach are almost certain to make this one a poor choice.
- Hiring your own expertise will likely be the favored approach, provided that you are committed to grow rapidly to sufficient fleet size to justify this significant addition of staff. For smaller fleets, you will have to make a difficult decision either try to "get by" with some needs covered but not others, or hire a complete staff to cover all the bases but live with a very expensive infrastructure during the ramp up phase. An example of this quandary would be the addition of a professional to estimate residual values. This function exists from the purchase of your very first aircraft, but you would probably still only need the one person with a fleet of 100 aircraft. Amortizing that expert's cost over one aircraft or 100 aircraft illustrates the large economies of scale available in this business. Hiring a few "key" people to get going with the intention of adding other functions as the fleet grows is ill advised because leaving a function out puts the entire enterprise in great danger of making mistakes and, in this business, mistakes tend to be big ones.
- Buying an existing company solves these problems, in that you can bring in a full complement of expertise, together with the fleet needed to cover that overhead. This can be an excellent approach, subject to two caveats. First, an aircraft operating lease company only becomes available for sale very occasionally, so the timing your own expansion will be hostage to the timing of such sale opportunities. Unfortunately, when they do become available, it is often for the wrong reasons, and you will probably be wise to stay away anyway. Secondly, evaluating the prospective acquisition target involves expertise that you don't have in fact, it is the very expertise that you are trying to acquire. You will be at a huge disadvantage in trying to negotiate the price.
- If you can find an existing operating leasing company with a full complement of staff who is looking to leverage up on that expertise beyond the constraints of their own balance sheet to acquire their own additional aircraft, you have the starting place for a Collaborative Business Structure, such as a partnership where both parties invest or a management / outsourcing agreement where you acquire expertise for a fee. Such companies do exist, and the challenge is to structure the arrangement to optimally align goals and avoid conflicts of interest. The Chesterfield Group has many years experience doing just that.
Interestingly, the collaborative alternative just mentioned can also be used in conjunction with the other alternative approaches mentioned above. If you want to build your own staff, you will go through a ramp up phase when the fleet is small, during which time you either have to absorb extra costs from underutilized staff or take risks arising from not filling all the expertise needs from day one. Outsourcing the missing needs to another company can fill that gap, in effect converting the fixed costs of your own staff with a variable cost from "renting" expertise. Using such a collaborative arrangement can also be used to allow you to enter the business and operate profitably, all the while keeping alert for the opportunity to buy an existing company.