Navigating the skies: The need for digitalization for the cost accounting of small and medium-sized airlines

The airline industry faces constant pressure from fluctuating fuel prices, inflated operating costs, and increasing customer expectations. Small and medium-sized airlines (SMAs) find themselves grappling with intensifying competition from both major network carriers and budget airlines. To stay competitive, SMAs must outpace their larger counterparts by swiftly embracing digitalization to closely monitor and enhance their performance. With options ranging from off-the-shelf solutions to in-house development, the path to digital transformation presents both opportunities and challenges for these SMAs. Digitalizing the cost accounting function will be an essential component for SMAs to expand and develop their operations, taking these to the next level.


The digital imperatives for SMAs

Some of our SMA clients are still relying on their vendors’ invoices to book their costs in their financial accounting system. The drawbacks of such a practice are quite obvious:

Slow cost reporting: Since the cost information is largely dependent on the vendors’ invoices, the top management has to wait 30 to 60 days until the cost information comes from the vendor, goes through the accounting and auditing process, and, finally, arrives on their desk.

Difficult to steer: Slow reporting leads to a lack of awareness regarding route profitability. During peak seasons, this deficiency can prove to be costly. Operating costs – influenced by factors such as landing fees, airport passenger service charges, and en-route charges – are multifaceted. Consequently, the commercial department may allocate more resources to expensive and popular routes, overlooking potentially profitable yet less frequented routes.

Inaccuracy: Since invoices originate from vendors, they generally reflect their interpretation of the contracts signed with the airline. Occasionally, vendors’ understandings may differ from those of the airline. For instance, if the airline ordered eleven business class meals but the catering provider supplied twelve due to human error, the vendor would likely invoice the airline for twelve meals. Theoretically, the airline should still be able to detect this discrepancy by comparing the vendor’s invoice with its own order records. However, in practice, implementation can be challenging, as such mischarges can repeatedly take place. Minor errors often escape the attention of the finance department or station managers, especially when thousands of flights are taking off and landing each month.

The IT solutions

When it comes to embracing digitalization, SMAs are confronted with a pivotal decision: Whether to opt for commercial off-the-shelf (COTS) solutions or embark on the journey of developing their IT solutions in-house.

The in-house solutions: Building bespoke IT solutions in-house offers SMAs a range of advantages. First, it provides the flexibility to tailor the solution precisely to the unique requirements and IT capabilities of the airline. Moreover, self-made solutions can often be more cost-effective, especially in the short term, as they eliminate licensing fees and ongoing subscription costs associated with COTS solutions. From our perspective, the in-house solutions can get a big portion of the tasks done with only about a small fraction of the costs, making them an appealing option for SMAs looking to maximize their profitability.

However, the attractiveness of self-made solutions must be weighed against their inherent constraints. While they offer cost-effectiveness, they often lack the scalability and robustness necessary to navigate the complexities of airline operations. Additionally, in-house development teams may find it challenging to stay abreast of evolving technologies and industry standards, potentially resulting in functionality gaps and inadequate support. Moreover, successful implementation of in-house solutions requires additional IT project management capabilities, adding high stress on the in-house IT team.

The commercial off-the-shelf solutions: At the same time, commercial off-the-shelf solutions offer small airlines a ready-made approach to their digital transformation. These solutions come pre-packaged with a suite of features and functionalities designed to address common challenges faced by airlines. By leveraging COTS solutions, SMAs can expedite their digital initiatives, minimize development risks, and tap into the expertise of established software vendors.

However, COTS solutions also have disadvantages. The primary concern is the significant upfront costs and ongoing licensing fees associated with COTS solutions, which may strain the budgets of small airlines with limited financial resources. Second, COTS solutions often demand a high level of infrastructure readiness not only from the airlines but also from their vendors. Since SMAs may serve some stations with a lagging IT infrastructure, it reduces the effectiveness of the solution. Finally, in most cases, COTS solutions focus on high-value cost items and cannot cover 100% of the variable operating costs.

In conclusion, when embarking on the digital transformation journey, SMAs must find the optimal equilibrium between in-house and COTS solutions. There is no universal solution for the digital transformation in cost management. Instead, SMAs’ top management should collaborate closely with their IT teams to identify and implement the IT solutions that best align with their airline’s unique needs and IT capabilities.

The implementation

Implementing such a digital transformation project is a multifaceted endeavor that requires careful planning, execution, and adaptation.

Data analysis: At the heart of the projects lies the need for extensive data analysis to construct the foundation necessary for successful implementation. When an airline transforms from its current paper/manual-based cost reporting to a digital and system-driven solution, significant effort is required to translate existing contracts with vendors into data formats that can be processed by specific digital systems. For some COTS solutions, the vendors will provide detailed requirements for the information and data format required for their solutions. For the solutions to be developed in-house, functional departments – especially the procurement, finance, and IT departments – have to work jointly to identify and specify the data that are needed for certain solutions and the data format for input and output. These data analysis results will serve as the bedrock upon which IT projects are built.

Solution implementation: The data analysis is merely the first step. The next step is to implement the IT solutions to realize the changes that the SMA intended to take place. For COTS solutions, the process is relatively straightforward, as providers typically possess extensive experience in deploying their systems for similar clients. Detailed implementation project timelines, including training schedules, are commonly provided by these providers. Conversely, in-house solutions present greater challenges. Typically, an external party is needed to act as the Project Management Office (PMO), responsible for coordinating various functional departments, overseeing project progress, and directly reporting to the airline’s top management. Agile project management plays a crucial role in these situations because projects are often developed in multiple phases. Therefore, careful planning of objectives and timely implementation for each phase is vital within this framework.

Training and change management

The digital transformation entails a fundamental shift in organizational processes to align with the requirements of new digital tools and systems. This transformation is not merely a technical overhaul but a fundamental shift in how the organization operates. The users of the systems need to be trained to familiarize themselves with the new IT functionalities and workflows.

For instance, the current tasks performed by accounts payable accountants will undergo a transformation. They will no longer need to process invoices as they did before. Instead, their responsibilities will shift towards reconciling the disparities between the system-calculated costs and the invoices received from vendors. This streamlined process will result in a notable reduction in workload, necessitating the reassignment of some accountants to different roles within the organization, such as the new cost accounting function, which involves continuously updating the system with the latest contract information for different operating cost items. Such organizational changes and personnel training need to be planned even at the beginning of the project.

The benefits

For SMAs, the benefits of this digital transformation in managing their operating costs are quite obvious. With the transformation, cost recognition is almost real-time or near real-time, greatly accelerating financial and management reporting. With such fast feedback from actual operations, top management is able to steer the company much more effectively.

Additionally, through digitalization, much more detailed unit cost and unit consumption data will enter the system. Thus, operating costs can be more easily summarized by flight number, legs, days, stations, and vendors. With these parameters, both the commercial and finance teams will be able to benchmark and spot weaknesses in the existing operation of the airline.

Finally, since the same database can be used for budgeting purposes, instead of relying on traditional average numbers, the cost budget will be more accurate to support the commercial department in planning their network and fleet development. The accuracy of the data will enable more precise forecasting of potential variable costs and the impact of fixed operating costs if certain flights are added, deleted, or changed from the current network.

Concluding summary

In today’s competitive aviation market, it’s imperative for SMAs to carefully oversee their operating costs by embracing a customized digital transformation. This change will significantly boost airline management efficiency. However, the key challenge is finding the right balance between utilizing ready-made COTS solutions and developing in-house ones to prevent potential costs from outweighing the financial gains of this endeavor.

Lufthansa Consulting, with its dedicated digital transformation team, has provided comprehensive support to numerous clients in their digitalization endeavors.
To learn more and discuss how your organization could benefit from Lufthansa Consulting’s expertise in digital transformation, please contact us.

Author: Haihong Xu, Senior Consultant, Lufthansa Consulting