Economies of scale drive Xojet business model

 - September 28, 2006, 4:19 AM

It’s one thing to find a new way of doing business. It’s quite another to make it work. Paul Touw, founder and CEO of Xojet (pronounced exojet) in San Carlos, Calif., believes he has done both.

In 2001, after acquiring a Citation X for his own use, he created Xojet in response to what he saw as “inefficiencies” in the traditional means of aircraft management and operation. Under the Xojet umbrella Touw designed a new business model. As a former aerospace engineer, Silicon Valley software entrepreneur and active pilot, Touw figured he had the tools to make it work.

Early last year the company officially launched that business model, called Fleet Exchange Ownership. Today, Xojet’s Fleet Exchange Ownership program has six Citation Xs, each flying on average about 1,100 hours annually, and Xojet revenues for the first half of this year totaled 2.5 times revenues for all of last year.

The inefficiencies that Touw saw in traditional business aircraft operations, said Xojet chief marketing officer Nick Solinger, were “no economies of scale, no leverage in fuel or insurance or parts purchasing, and little or no focus on delivering efficiency to the aircraft owners.”

He said key to the new business model is the elimination or minimization of old inefficiencies, the creation of new efficiencies and emphasis on economies of scale.

Xojet’s Fleet Exchange isn’t a fractional program, though at first glance the casual observer might see it as one, and it isn’t a traditional on-demand charter operation, despite some similar elements. Nor is it block charter or a card membership plan.

While fractional and card program fleets comprise 7 percent of the jets in the U.S., said Solinger, the other 90 percent are typically in one- or two-aircraft fleets managed by in-house flight departments.

Fleet Exchange allows Xojet customers to buy an interest in Fleet Exchange equivalent to half or 100 percent of a Citation X, at prices similar to what the manufacturer charges. As of late August, Fleet Exchange had six customers with a whole-airplane or half-airplane interest.

The buy-in comes with access to any aircraft in the Fleet Exchange program up to 600 flight hours a year. Owners pay per occupied hour to use any airplane in the fleet. There is guaranteed availability, with no peak days or blackout periods. Owners are also entitled to benefits of tax depreciation as they would normally from aircraft ownership.

A fractional ownership program, explained Solinger, is an ideal product for the person who flies 25 to 200 hours a year. When people fly more than 200 hours a year, he said, they begin to opt for ownership “because the cost of fractional ownership doesn’t go down with volume. Our focus is on corporate users, flight departments and individuals flying more than 200 hours a year. Our owners are averaging more than 300 flight hours a year.”

It’s a matter of economies of scale. “You can’t be everything to everybody, and with that in mind, we ensure that all our owners have similar needs. Customers with a lot of different needs would create a strain on the business model,” said Solinger.

“There are also tremendous economies of scale to having a fleet made up of the same aircraft types,” said Touw. It allows Xojet to take advantage of considerable savings in such areas as crew training, insurance, aircraft parts and fuel. In fact, he said, “Our costs are running about 27 percent below the industry average.”

Fuel is of particular interest. For example, for the month of July, Touw said he found the average price of jet-A for business aviation operators to be $4.08 a gallon. For that same period, the airline JetBlue was paying $2.06 a gallon.

To realize its own economy of scale with regard to fuel, Xojet bases aircraft only at smaller airfields near major destination airports, where fuel costs are lower and it can negotiate a still lower price.

Passengers heading to New York City might be dropped off at Teterboro or another metropolitan airport, but the airplane is then immediately repositioned, at no cost to the user, to New Castle County Airport in Wilmington, Del. There, Xojet has an agreement with aircraft management specialist Aeroways for fuel, which in late August was a few pennies over $3 a gallon, considerably less than the national average of nearly $5 a gallon.

New Castle serves all of Xojet’s Northeast operations. Other bases include the company’s headquarters at McClellan Airfield for Northern California and Van Nuys Airport in Los Angeles serving Southern California.

“Each airplane is its own independent operating unit,” said Touw, explaining that customers rarely fly out and return on the same airplane, which maximizes the amount of time the airplane is in the air. “We recently had a customer who flew from Renton [Washington] to Washington, D.C., on a Friday and returned on Monday. [Between] the time he was dropped off in Washington, D.C., and picked up for his return trip, that airplane flew 22 hours with other customers.”

To meet the maintenance demand of such high utilization, Xojet returns its airplanes to its McClellan Airfield base in Sacramento, Calif., for progressive maintenance. The maintenance center works on a 24-hour shift rotation, primarily at night, maximizing aircraft availability during the day, when demand is highest. “The added cost of doing maintenance at night is vastly outweighed by the benefits of having all the airplanes available and flying during the day,” he said. The company also has a maintenance center at its New Castle location.

Asked whether the Fleet Exchange business model is working, Solinger said that, even putting more than 1,000 hours a year on the airplanes, “We have 99.37-percent dispatch reliability.”

To preserve that record, Xojet plans a five-year service life for its Citation Xs. This, said Solinger, is about half the average age of an airplane in the on-demand charter industry.

The Citation X Makes Sense
Xojet’s Citation X fleet currently totals six aircraft owned outright, or operated on behalf of a customer, and a managed Falcon 900 available to Fleet Exchange owners when longer legs are required–such as Los Angeles to Honolulu or New York to Paris. Touw expects the company’s Citation X fleet will total 10 airplanes by year-end.

The choice of the Citation X made sense, said Solinger. “It has coast-to-coast range: Los Angeles to New York an hour ahead of anything else with up to six passengers.” He also noted that for a mission of two hours or more, the Mach 0.92 cruise speed offsets the higher direct operating costs. And he pointed out that the cabin is at the high end of the midsize business jet class.

“Because it’s flying 15 percent faster, it becomes cheaper to operate,” said Touw. “And even if you slow it down to its long-range cruise speed of Mach 0.88, it has by far the lowest fuel consumption over that distance.” He further noted that the Rolls-Royce AE3007C1 is a “commercial-grade” engine that also powers Embraer’s regional jets.

While the Citation X fleet might be the most visible, and perhaps the most glamorous, it is not the only airplane Xojet operates under the Fleet Exchange business model. The company also has five King Airs and a Premier IA in a regional program covering the West Coast. The Premier might seem to be an anomaly, but Solinger pointed out that the airplane nevertheless fits into the regional version of the business model almost as precisely as the King Air, and he added that the cockpit of the Premier IA is so close to that of the King Air that “it allows us to easily rate pilots in both.”

Xojet has plans to launch another King Air/Premier IA fleet to cover the Northeast, “probably later this year.” Also at some point in the future, Touw plans to add midsize and ultra-long-range heavy-iron business jets to the company’s fleet.

Aware that from time to time, an owner in the Citation X program might need some regional hours or an owner in the King Air program might have occasional need for something faster with longer legs, those in both programs have access to airplanes in the other.

 “But we won’t go into very light jets. There’s no proven business model yet, and after running the numbers, I’m just not sure it’s going to be that successful,” said Touw.

To further ensure maximum use of its Fleet Exchange aircraft, Xojet also offers an hourly lease/membership model for companies or individuals who don’t benefit from the depreciation benefits of ownership. These customers fly with guaranteed availability, but with a simple lease model and flexible contract membership. “Like our ownership model, it’s designed for high-volume use,” said Solinger.

Solinger added that about half of the company’s total capacity is taken by on-demand customers who pay by the hour and by the trip. The airplanes are available to these customers on a first-come, first-served basis, “but once we’ve booked a trip, it’s guaranteed.” The business model, said Solinger, allows the company to adhere to a fee structure similar to “and sometimes much less than” that of traditional charter on one-way flights. Xojet works with charter broker CharterX of Portland, Ore., to fill aircraft on empty flight legs.

He may have doubts about the very light jet, but he voices no such doubts with regard to Fleet Exchange at a time when business aviation is experiencing strong growth. “Forecasters are predicting a 10-year boom in deliveries,” he said, “and not all of those buyers are going to be wealthy people keeping the airplane in a hangar and available just for the occasional trip. Most of them are going to be business people looking for ways to optimize their investment.”