Aviation MBA: the short form at Northwestern U

 - May 7, 2008, 11:23 AM

Many business gurus believe knowledge is power, but the ability to transform that wisdom into action is the real measure of success. With just that goal in mind, 17 general aviation business leaders–CEOs, presidents, CFOs and operations managers–gathered at Northwestern University’s Transportation Center recently for the Strategic Management for Aviation Service Firms conference. The three-day seminar was cosponsored by the National Air Transportation Association.

Jay Franke, the transportation center’s assistant director and the first commissioner of aviation for Chicago mayor Richard Daley, opened the conference with a poke at the industry: “General aviation business people are too nice. Many of them did not get into this business to make money, and that is simply the wrong motivation.” Other conference speakers, Franke said, would focus leaders on the goal of making money–lots of it–by using conference experiences to reinvent aspects of their organizations with a strong emphasis on measuring and reshaping business financials.

Back to Class

Dr. Aaron Gellman, the center’s former director and a well known airline analyst, who was actually the conference’s final speaker, could well have been a primer for what was to follow in the days ahead, just a few days before the first anniversary of September 11 and with a still-slumping economy. “I’m an optimist,” he said. “Things are looking up for GA.” Gellman took great delight contrasting the GA industry innovation he’d experienced at AirVenture 2002 with the weak airline sector.

Although September 11 offered some companies an “excuse to use business aviation,” Gellman said, “those excuses have been transformed into solid reasons to continue using it. If the Eclipse 500 can be built at the quoted price, there will be a revolution in favor of FBOs. The sky is the limit.”

Reinforcing balance-sheet basics, Franke started with an in-depth look at a case-study acquisition of a small mom ’n’ pop FBO. After reviewing fact sheets, our class was asked to role-play as the CEO of Lazy Eight Aviation and decide whether to acquire mom ’n’ pop’s place, employees, assets and debts, or walk away from the deal. We’d also need justifiable arguments to our banker, a man with a five-minute attention span. Since we–and our families–also knew mom ’n’ pop personally, walking away from the deal was sure to cause some additional pressure, especially since mom ’n’ pop were desperate for money.

Students broke into groups of five with a mere 45 min to decide on the acquisition. The group I followed combed through every aspect of the profit-and-loss statements and other paperwork, which offered some cleverly hidden gems such as a lease for unused land. The group strategized. Could the land be developed into an office park, providing valuable passive revenue for the acquiring FBO? Would this acquisition fit with the overall company strategy? Could the two differing employee cultures be successfully blended? Should we assume the outstanding debt or dump it back on mom ’n’ pop? One unanimous and disappointing decision was to shutter mom ’n’ pop’s flight school, with no thought given to where future pilots–Lazy Eight’s customers–would come from.

Other groups’ solutions varied widely. Some rejected the purchase outright for fear of local competition, while others gave the purchase thumbs up with a million-dollar price tag. Still others wanted to take it off the old couple’s hands for no money down. Franke reiterated the need for professional metrics and analysis to highlight how many factors can influence business value, beyond fixed assets, receivables and debts, a concept that some GA executives admitted might still be in its infancy.

Bala Balachandran, the Kellogg distinguished professor of accounting at Northwestern, offered an engaging explanation of complex cost accounting and why, in light of the financial scandals at Andersen, Tyco and Enron, “accounting was once again sexy.” Times have changed as decisive thinkers–other than MBAs– with analytical skills such as accounting, have stepped to the front of the line to solve real business problems. Balachandran confirmed, “You can be profitable in a down economy. Now is when managers should be planning what to do when business picks up and, even more important, how they’ll measure their success.”

“The key to success is customer profitability, not product profitability. Success is also the result of developing long-term customer value. But you must ask the right questions. For example, are accounts receivable assets or liabilities? Are accounts payable assets or liabilities?” Balachandran believes the Chinese have the best common-sense answer: “They have one arm for accounts payable and another for receivables. They just hope the receivables arm is longer.”

Balachandran said cash flow is the measure of a company’s success and suggested that unit costs and revenues are not black and white. Overhead costs are questionable numbers often determined by an allocation percentage, rather than by true cost. “Cutting costs can often deliver bigger returns than additional sales volume. But when margins are tight, you need a couple of different measurement tools to verify this. Activity-based costing, for example, measures the cost of a specific product and does not spread costs out across an entire company overhead pool. This maximizes profit by clearly identifying what product or service is really making money.”

Executives should use their management team’s strengths and make an investment back in their company, such as leveraging existing capacities to develop new products and services, rather than grab immediate cash profits. He reminded students: “You cannot be excellent at everything, but you must be good at product innovation, operational excellence and customer loyalty, while demonstrating a core competence. Focusing on what customers want in the long haul is a strategic tactic. Look at who is already doing it right–the Nikes, the Home Depots, the FedExs. If you want to be the leader in 25 years, spend the money to be good at all disciplines, but excel at one. This is about taking the time to think the process through.”

Think Like an Entrepreneur

“Every businessperson is an entrepreneur and should think like one,” said Steven Rogers, the Gordon and Llura family professor of entrepreneurship and clinical professor of management at the Kellogg school and leader of the institution’s entrepreneurial finance program. Speaking on business valuation, he reinforced Balachandran: “It is imperative that you understand basic finance. Simply saying I have someone who does my accounting is not good enough. If you can understand small financials you can understand big ones.

“Making decisions with incomplete data is also the sign of an entrepreneur,” he said, explaining that valuation is an auction based on what people will bid, which is often much different from what people believe a business is worth. An important measure is gross margins–revenues minus the cost of labor and materials–which equates to cash flow, the true indicator of business value. “If you need an accountant to understand that, you’re in trouble,” he said.

A 90-percent margin, for example, indicates a company receives a 90-cent profit on ever dollar it brings in. Rogers believes a benchmark of any industry’s gross margin is a necessity. Although he offered no GA margin examples, he did give a few exhilarating benchmarks from other industries, including Amazon.com, 38 percent; Starbucks, 40 percent (70 percent on espresso); and Microsoft, a whopping 92 percent. The downside of fat margins, however, is that they invite competition.

Some business valuation tips include realizing that value comes from cash flow. “Ask why a company is being sold. Base acquisitions on revenues, never net income, since small business owners often hide income to lower tax liabilities. Simple valuation guidelines consider approximately three to five times cash flow, or two times the gross margin.” Check that revenues are growing faster than accounts receivable. Good managers must know how their customers pay and be bulldogs about getting paid.

“Don’t be a sucker because you are afraid to ask for your money,” Rogers said. “Nurture the relationship with your customer’s accounts-payable people and have a system in place that initiates action if you don’t get paid. A company’s two largest customers should not account for more than 20 percent of revenues.”

Dean Harton, president and CEO of Piedmont Hawthorne Aviation, spoke about FBO acquisitions: “Have a plan for why you want to buy. Most large acquisitions are a failure because the acquiring company can’t meld the corporate cultures.” Common acquisition problems include not doing due diligence before the closing, choosing the wrong financing and not being sure of the value of the business. “You have to kiss a lot of frogs to find a prince,” Harton joked.

Echoing Rogers’ earlier comments, Harton said, “The price the owner sets for his business often has very little to do with the actual value of the company. You don’t need to know how to produce all the financials, but you need to have a good handle on what they’re telling you.”

Guide to Negotiating

Most people find conflict interesting. A popular session at the conference was negotiating multi-party deals, taught by Leigh Thompson, the J. Jay Gerber distinguished professor of dispute resolution and organizations at the Kellogg School of Management. He said, “The best transfer of negotiating skills comes from real-world experiential learning.”

Students then broke into groups and role-played stakeholders–the union, environmental activists, state bureaucrats, competitors and the feds–in a deepwater port-construction project. The rules were simple: students should score as many points as possible for their own agendas, any way possible. Lying was permitted.

“Negotiation can be terribly egocentric,” Thompson cautioned. “When things don’t work out, people say it was the economy or the other guy’s fault. When they’re successful, it was due to their superb negotiation skills and brilliant thinking. But neither result helps you look at a situation more effectively.”

Harborco, a fictitious construction company, believes the port could generate substantial profits within 10 years. But the environmental league is opposed to anything that threatens the ecosystem. The unions want to see their members get all the jobs, while the other ports worry about losing business. The feds have the deep pockets to subsidize building, but are tight with a buck. The governor is eager to promote local development.

After a spirited debate, student stakeholders unanimously trounced their CEO’s first proposal. Four yes votes were needed to build the project. The second attempt improved everyone’s lot. It called for building a mix of industries near the port, while maintaining the environment, no union job preference, a $3 billion loan and $150 million to keep the other ports happy. The vote: four to one against. Now the environmentalists might be flexible if Harborco improved the environment. The feds might go for $2 billion, but the ports needed at least $300 million. The governor and the union reps walked out into the hall for a quick sidebar, followed by the CEO and the union rep. This time, the vote was three in favor and two opposed. Progress!

Eye contact gave away some strategies during continued negotiations that, on the surface, seemed cordial and swift. Most parties appeared confident, but the feds wouldn’t budge past $2 billion. With three yes votes in his pocket, Harborco’s CEO seemed to be close to a deal. The final results were delivered in the classroom and much to the CEO’s shock, the vote was still three in favor and two opposed. His last-minute back-room deal had come unglued. One stakeholder, it seemed, maxed out on points if she derailed the deal. No one had considered that possibility.
“When negotiations are too calm and people appear too self-assured, something is probably wrong,” Thompson said. She queried students about other possible negotiated outcomes for the port deal. Most people agreed there were four or five. The number was actually 55, demonstrating just how narrow people’s vision can become when too focused on the outcome.

“If you can’t win,” Thompson suggested, “work out a good BATNA, or a best alternative to a negotiated agreement. Signal what you can be reasonable about. Negotiate a package rather than individual issues.” To illustrate the point, Thompson paired students at their desks holding hands, arm-wrestling style. The goal was to win as often as possible. Some squirmed and struggled. The real winners, however, simply alternated wins with their partners demonstrating that both could win. “Negotiation is win-win. You can’t win all the time, but you can sometimes.”

In closing, Gellman stressed that a major challenge facing FBOs is how to maintain new-generation aircraft. “The Eclipse 500, for example, will require a very different maintenance repair and overhaul program from what is used today.” He warned: “Even if the Eclipse is never delivered, it gives you a good idea of what is coming. You need to get ready now. Expect more dealers to be taken out of the sales mix, as Mooney did. Aviation insurance is experiential, not actuarial.”