University of Chicago
Type of paper: Thesis/Dissertation Chapter
North South Airlines
BACKGROUND OF THE COMPANY
Northern Airlines merged with Southeast Airlines to create the fourth largest U.S. carrier in January 2008. The new North–South Airline inherited both an aging fleet of Boeing 727-300 aircraft and Stephen Ruth. Stephen was a tough former Secretary of the Navy who stepped in as new president and chairman of the board. Peg Jones on the other hand is the vice president for operations and maintenance.
DEFINE THE PROBLEM
Stephen’s objective is to gear the company’s financial performance towards stability and continuous growth. This made him concern that the aging fleet of Boeing 727-300 aircraft’s maintenance cost may impede realization of this goal.
The significant difference in the reported B727-300 maintenance costs (from ATA Form 41s) both in the airframe and engine areas between Northern Airlines and Southeast Airlines made him to probe through Peg Jones’ assistance on determining the quantitative and graphical report of the following : Correlation of the average fleet age to direct airframe maintenance costs Linear relationship between the average fleet age and direct engine maintenance costs
CASE FACTS AND INFORMATION (INCLUDING LIMITATIONS & CONSTRAINTS)
In addition to the aging formulas below, Peg constructed the average age of Northern and Southeast B727-300 fleets by quarter since the introduction of that aircraft to service by each airline in late 1993 and early 1994 respectively.
TOTAL FLEET HOURS = TOTAL DAYS IN SERVICE X AVERAGE DAILY UTILIZATION
AVERAGE AGE OF EACH FLEET = TOTAL FLEET HOURS FLOWN # OF AIRCRAFT IN SERVICE
AVERAGE DAILY UTILIZATION = TOTAL FLEET HOURS FLOWN
TOTAL DAYS IN SERVICE
In getting the average utilization, Peg used the actual fleet hours flown on September 30, 2007 from Northern and Southeast data, and dividing by the total days in service for all aircraft at that time. The average utilization for Southeast and Northern were 8.3 and 8.7 hours per day respectively. In addition, available cost data including the average fleet age were calculated for each yearly period ending at the end of first quarter.
Business asset depreciation depends on the cost of asset and its useful life. What is distinct about aircraft depreciation is that each component of an airplane is depreciated at different rates and depreciation methods. The North-South Airline problem for this instance may also be resolved by using depreciation methods as follows: straight line with salvage value method = Asset Cost/ Useful Life The advantage of using the straight line method involves the ease of calculating the annual depreciation amount.
The disadvantage of using the straight line method is that this method does not consider the rate the asset will actually depreciate in value. Declining balance method = Remaining Asset Value x Depreciation Rate The advantage of using this method is that it accelerates the depreciation recorded early in the asset’s life and thus reduces the taxable income and the taxes owed during the early years. The disadvantage is that the method can be applied only when there is a residual value of the asset.
quantitative method/s employed and the solution to the problem
Northern Airlines Data
Southern Airlines Data
Southeast Airline—airframe maintenance cost:
Cost = 4.60 + 0 (airframe age) = 4.60
Coefficient of determination = 0.39
Coefficient of correlation = 0.62
Northern Airline—airframe maintenance cost:
Cost _ 36.10 _ 0.0025 (airframe age)
Coefficient of determination _ 0.7694
Coefficient of correlation _ 0.8771
Northern Airline—engine maintenance cost:
Cost _ 20.57 _ 0.0026 (airframe age)
Coefficient of determination _ 0.6124
Coefficient of correlation _ 0.7825
Southeast Airline—engine maintenance cost:
Cost __0.671 _ 0.0041 (airframe age)
Coefficient of determination _ 0.4599
Coefficient of correlation _ 0.6782
DEPRECIATION USED = SAFETY
The units of production method involves determining the cost to depreciate and dividing that amount by the estimated production units the company expects to manufacture over the life of the asset. The advantages of using the units of production method include the ease of calculating the annual depreciation amount and that the depreciation is matched to the production quantity. The disadvantage of using the units of production method is that this method assumes the asset will depreciate evenly over its productive life.
The graphs below portray both the actual data and the regression lines for airframe and engine maintenance costs for both airlines.Note that the two graphs have been drawn to the same scale to facilitate comparisons between the two airlines.
Northern Airline: There seem to be modest correlations between maintenance costs and airframe age for Northern Airline. There is certainly reason to conclude, however, that airframe age is not the only important factor.
Southeast Airline: The relationships between maintenance costs and airframe age for Southeast Airline are much less well defined. It is even more obvious that airframe age is not the only important factor—perhaps not even the most important factor.
Overall, it would seem that:
1. Northern Airline has the smallest variance in maintenance costs, indicating that the day-to-day management of maintenance is working pretty well.
2. Maintenance costs seem to be more a function of airline than of airframe age.
3. The airframe and engine maintenance costs for Southeast Airline are not only lower but more nearly similar than those for Northern Airline, but, from the graphs at least, appear to be rising more sharply with age.
4. From an overall perspective, it appears that Southeast Airline may perform more efficiently on sporadic or emergency repairs, and Northern Airline may place more emphasis on preventive maintenance.
Ms. Young’s report should conclude that:
1. There is evidence to suggest that maintenance costs could be made to be a function of airframe age by implementing more effective management practices.
2. The difference between maintenance procedures of the two airlines should be investigated.
3. The data with which she is presently working do not provide conclusive results.