Fractional ownership providers have been hit hard by the industry downturn, but are now battling to rebuild their programmes
These are tough times for fractional ownership programmes. The latest economic recession has left no operator unscathed, but all are anxious to restore their programmes to their former glory. These saviours of business aviation, with burgeoning orderbooks and swathes of loyal customers, once seemed impervious to hard knocks.
Since 1998, the first year when the top three programmes - NetJets, Flight Options and Flexjet - were all operational, the fractional aircraft fleet has leapt from 262 to 846 aircraft, according to US data research group Aviation Data (AvData). The number of shareowners rose by over 300% during the same period, to 4,600 - most of which were new to business aviation when they signed on - and the number of shares has risen by the same percentage, from 1,600 to over 6,400. The fastest period of growth was between 1998 and 2002, however. Then recession hit and fleet expansion and shareholder and share growth continued at a much slower pace.
"Historically, we can draw a number of parallels with the current economic situation," says NetJets vice-president Kevin Russell. Looking back to January 1987, he continues, shortly after fractional pioneer Richard Santulli launched the first programme into a fairly sceptical market, the concept began to grow. Then, four years later, a recession hit and people withdrew. "When the economy started again in 1993, the programme took off. We introduced more aircraft types and began to see growth rates of 35-40% a year."
NetJets has retained an overwhelming lead in the fractional ownership market and in 2003 accounted for 70% of net sales (measured by value), according to NetJets parent company Berkshire Hathaway. The operator's fleet has leapt from 145 aircraft in 1998 to 424 today, which represents 50% of the world's fractional fleet. However, the latest downturn has been a major blow to the market leader and the only provider to have made a profit so far.
According to Berkshire Hathaway, the programme lost $41 million pre-tax in 2003 and another loss is expected this year. "The modest operating profit in the USA is more than offset by a $32 million loss on the aircraft inventory and by continued losses in Europe," says Berkshire Hathaway chairman Warren Buffett. "The $32 million inventory write-down we took in 2003 occurred because of falling prices for used aircraft early in the year."
NetJets bought back fractions from withdrawing owners at "prevailing" prices, says Buffett. "These prices fell in value before we were able to remarket them."
The merger of Flight Options and Raytheon Travel Air in 2002 at the height of the recession has been a struggle, says John Nahill, chief executive of the second biggest fractional ownership operator. A key challenge, he says, has been integrating the two operations and bridging used and new aircraft fleets. "Our attempts to rationalise fleet and introduce new improvements has been at considerable expense to our shareholders." He concedes this is particularly hard during an economic slowdown. Raytheon was forced to increase its holding in the venture in 2003, taking a controlling stake after financial problems at Flight Options. The recapitalisation has included more aircraft, equity and capital, says Nahill. This year Flight Options will remove 25 "old and inefficient types", such as Cessna Citation IIIs and Hawker 800As, and replace them with 25 new-generation aircraft, including the CitationJet, Citation X and Embraer Legacy.
The two companies' merger, coupled with the fleet rationalisation, has pushed Flight Options' fleet to 225 aircraft. "It's been a bloody road, but we have now reached critical mass," says Nahill. He admits a programme can be successful only if it has reached the coveted status of critical mass, where the shareholder base is large enough for management fees to sustain the operation and generate profit without having to sell more shares.
Conversely, Bombardier-owned Flexjet is the only fractional programme that has seen fleet numbers fall. According to AvData, the Dallas, Texas-based operator's decline began two years ago. Flexjet's fleet, then 114 aircraft, slid to 100 in 2003 and only 89 this year. Shareholders have fallen from 636 to 564 during the same period and shares have dropped from 900 to 717.
Mike McQuay, president of Bombardier Aircraft Services, admits Flexjet has gone through a difficult and challenging period over the past two years, but says the programme is now 50% ahead of last year's sales and expects to take delivery of six more aircraft by the end of the year, comprising Challenger 300s and Learjet 40s.
McQuay says that, although the programme has picked up few new sales, it has retained a "high percentage" of renewals. "The models worst hit by the downturn are the Learjet 45 and 31A," he says - types commonly used by less-affluent customers that are hardest hit by fluctuations in the economy. To help boost aircraft utilisation, Flexjet last year introduced its Versatility Plus scheme, which allows owners to place up to 25% of their annual hours into a pool. Owners requiring more hours in a year can draw from the pool rather than borrowing from future years. McQuay says Flexjet is the first fractional to offer an exchange scheme, and the take-up has been strong.
McQuay says the recession has brought a lot of instability to the market. As aircraft prices have plummeted, customers with contracts coming up for renewal have found themselves facing big losses. "We offer owners attractive incentives [high market valuations] to retain their custom," McQuay admits, but Flexjet also realised many owners were keen to extend the contract for two more years. "So that's what we have done. When Flexjet began in 1995, a five-year contract was optimum, but the recession has changed all that."
The grip of recession has forced some owners to reduce their share size from one-quarter to one-eighth or, typically, one-eighth to one-sixteenth, says NetJets' Russell, while others have been forced to downsize to a smaller-cabin aircraft. And it is the high end of the fractional market, which includes the Gulfstream IV and V and particularly the Boeing Business Jet, that has suffered as a consequence. "It's no longer the market place of 1998 and 1999," says Russell. "We initially placed six orders and 18 options for this aircraft [the BBJ]." NetJets did not exercise those options, and Russell says the six aircraft in the fleet are used mostly for "event-related charter work". Lack of interest in the Global Express programme at Flexjet prompted Bombardier to reconsider the ultra-long-range aircraft in its fractional line-up.
Stemming the flow of owners leaving has been a major concern for fractional programmes. Historically, the annual average attrition has been 15%, but the pinch of recession has hit numbers hard. At its peak in 1999, NetJets gained 375 new shareholders and lost 66, says AvData. In 2003 the gap had closed significantly, with the operator gaining 228 shareholders and losing 100. This year NetJets has so far attracted 172 shareholders and lost 79.
CitationShares, the fourth largest fractional provider, has fared well since it began operations in 2001, gaining 69 shareholders and losing only one. Last year the Cessna/TAG Aviation venture gained 113 and lost 14 shareholders and this year has gained 56 and lost 10.
Flight Options and Flexjet, the second- and third-largest programmes, have fared less well, however. Since the merger of Travel Air and Flight Options, shareholder numbers have plummeted. In 2002, AvData reveals, the Cleveland, Ohio-based company gained 134 new shareholders and lost eight; last year it gained 164 and lost 125; and so far this year it has gained 64 and lost 76 shareholders. In 2002, Flexjet gained 116 news shareholders, but about 50% left the programme the same year. But for the past two years the Bombardier subsidiary has lost more shareholders than it has gained. This year, according to AvData, Flexjet has added 33 new shareholders and lost 73.
The introduction of the 25h membership card has thrown a lifeline to the fractionals by offering departing owners a chance to remain within the scheme without the ties and capital expenditure of fractional ownership. NetJets was the first to offer the Fleet by NetJets Card through pioneer Marquis Jet Partners in 2002, and every major fractional has followed its lead.
"The card offers also people an opportunity to sample business aviation and is a good breeding ground for fractional ownership," says Flight Options' Nahill, whose company rolled out its fractional programme, JetPass, in June after introducing it internally last year. "We have had an overwhelming response so far and ouraim is to rank in the top three cardprogrammes in the next two years," he adds. NetJets' Russell says Marquis hassold over 2,000 cards and has a renewal rate of over 90%.
CitationShares' Vector Card has had a promising start since its launch in July, says the company, but Flexjet's joint venture with Delta Air Elite Business Jets, launched a year ago, has had a poor year. "We have not achieved the success we anticipated," says McQuay. "We expected sales to be twice as high as they are." Nahill says there will always be a constant ebb and flow from fractional to charter. "The move up market to fractionals will be relatively stable with less than 50% of card holders realising that fractional ownership is more appropriate for their travel needs."
As the fractionals continue to rebuild their programmes, the landscape for the industry could be very different in the next two years. Some industry observers suggest there will be consolidation, with struggling Flexjet top of the takeover list. Whatever the outcome, fractional ownership and membership programmes will continue to be a major force in business aviation.
KATE SARSFIELD / LONDON
Source: Flight International