Cutting Costs

[yourefired]

Here's what I do:

Average gate cost:
Total gate rentals/(#routes*24)

Average cost of gas:
Total projected cost of gas/(#routes*24)

Average lease cost:
Total lease cost/(#routes*24)

Average staff and misc cost:
Total projected staff cost+total project misc cost/(#routes*24)

Average maintenance cost:
Total maintenance cost/(#routes*24)

Average projected total cost=The sum of the above

Average DOP:
DOP/#routes

If average DOP per route is about double average projected total cost, then great, keep expanding. If APTC is more than average DOP, then you'll want to consider cutting costs.

Who said a major in economics is useless?

[dktc]

All I could say is that cutting costs in AM through cutting leases is a waste of time.

If you get 12 million monthly DOP on a 5 million leases, for a plane worth 50 million to buy, you get 7 million out of that lease.

If you buy a plane to replace the lease, you pay out 50 million and still earn 12 million.

If you keep the lease but buy a plane to expand, you pay out the same 50 million, but earn 19 million.

If you use the same 50 million to lease more plane, you get 10 more leased planes, earning a total of 77 million.

Which has a higher profit margin? Replacing the lease.
Which has a lower cost? Replacing the lease.
Which give you more profit? Lease more planes.
Which would help you grow quicker? Lease more planes.

This is the exact reason why businesses mortgage / finance / take out loans. They have higher costs in terms of $$ (and usually % as well), but they have a lot better return on investment, and they don't tie up their cash in one place. Financial leverage is essential if you use return on investment as a guideline, which really, is the only all-round benchmark to use.

Oh, and yourefired, there is no use calculating the average to find a proportion. All you need to do it look at your finance page for the total costs and the total revenue (or if you insist on using DOP, which doesn't make sense from an accounting pov, DOP*24), you could figure out that % you want. (<-- managerial accounting, which is only 9 cr. hr. of my major, always beats economics )


(- The above scenario does not take into account gate rents and salary, because assuming that they are fixed costs, they would take up the same proportion of the revenue in all the planes, and thus do not affect the comparision.
- The above scenario does not take into account maintenance, but maintenance give advantages to leases because the plane owner pays it instead of the operator, and thus further increase the difference in between the cases.
- An assumption on the above scenario is that the leases are actually making money. If they are not, why the hack are you even thinking about keeping them? )

[yourefired]

That's lovely. But if costs weren't such an important part of business, why are so many companies out to cut costs? Hmm? I thought costs didn't matter as long as you're making enough money to cover them.

Speaking of accounting, can we have balance sheets next time? i.e. Assets=liabilities+equity.

PS. By the way, I did take financial accounting. I know why businesses leverage. I didn't say leverage was a bad thing.

[yourefired]

That's lovely.

Simple, right?

Usually people don't understand without some kind of numbers. Don't sweat it though. You are normal :wink:


*comment by dktc: I deleted my post in preparation to respond to yourefired's previous post... but... I was a tag too late obviously. Just want to say that this quote was really a post before *

Here's the thing though: When you make 1 billion euros a month on a 20% profit margin, or 300 million euros on a 67% margin, you're netting the same amount of money, only your 20% profit margin company can only expand so far, while the 67% margin company still has a ways to go in terms of expansion.

[MrOrange]

f costs weren't such an important part of business, why are so many companies out to cut costs? Hmm? I thought costs didn't matter as long as you're making enough money to cover them.

Even if you're making enough money to cover the costs, cutting them is one more way to optimize your profit margins.

[yourefired]

f costs weren't such an important part of business, why are so many companies out to cut costs? Hmm? I thought costs didn't matter as long as you're making enough money to cover them.

Even if you're making enough money to cover the costs, cutting them is one more way to optimize your profit margins.

Exactly. That's what I'm saying. Say a company makes 1 billion euros a month. Say another company makes the same amount. Company 1 has costs of 800 million vs. company 2 which has costs of 500 million. Who makes more money?

By the way, in microeconomics, the cost of the plane minus the going lease rate would be considered sunk, and therefore not considered when making decisions.

What I'm saying is a company that doesn't optimize costs will get to diseconomies of scale SIGNIFICANTLY faster than a company that does. And because I optimize costs, and I keep more of my money, and my profit/expense ratio is actually 2/1, I'm nowhere near reaching diseconomies of scale. Remember MC=MR?

[MrOrange]

Yeah, I was supporting your view in case you didn't notice :wink:

[dktc]

f costs weren't such an important part of business, why are so many companies out to cut costs? Hmm? I thought costs didn't matter as long as you're making enough money to cover them.

Even if you're making enough money to cover the costs, cutting them is one more way to optimize your profit margins.

Cutting costs is to attract investors and to boost share values. Doesn't neccessarily means it is to the companies best benefit. High profit margin = better company = better value of shares + healthier company is a common perception amongst shareholders.

In addition, there are also companies that are not expanding in a rate that is up to par with the expectation of the board / investors, so they have to cut costs to prevent the executives from getting fired.

Of course, then there are the companies that are so large that using rate of expansion to produce return is not going to help much because they have saturated most of their markets. They would have to cut costs to keep the company going (increasing profit).

Of course, your point of saturated market is valid. However, which is more effective? To cut cost when you are rolling in 7 million? or to cut costs when you have 200 million profit? (<- probably more than that even). Even if you look at equalfinality, high ROI then cut costs upon saturation should still trump having high profit margin from the start (ie. high ROI arrival at the finishing point first).

Oh, and as a econ prof said, "Profit is someone's opinion. Cash is a fact."

[dktc]

Exactly. That's what I'm saying. Say a company makes 1 billion euros a month. Say another company makes the same amount. Company 1 has costs of 800 million vs. company 2 which has costs of 500 million. Who makes more money?

It is not that both are making the same amount of money. If you base your theory on that assumption, your theory is already wrong. The issue here is that having a high ROI sacriface profit margin to get higher revenue, a lot higher. As I have illustrated, in eight months, the airline using leverage could have 5+ times the profit of the one replacing the lease to get higher margin. That is not even taking into consideration that the one leasing more planes don't have to wait until he has 50 million to lease the 10 planes at once. He could lease at least one every months, and that compound effect would throw the company aiming to replace the lease so far in the dust. As a result, the assumption that they would have the same revenue would not be valid. The only way to make the above assumption valid is that the company using the leverage is younger than the one with high profit margin, which proofs my point.

[yourefired]

By the way, I do have close to 200 million euros in profit. My revenues are a smidge under 300 million euros. If I were to leverage, I could grow a lot more wildly. But the wave of cost optimizing that's gonna come afterwards is going to be a LOT of work. The top airlines have 3000+ routes. I have 340. If you were to look at it graphically, you have the price curve, the ATC curve, the marginal cost curve, and in a saturated market, the marginal revenue curve IS the price curve.



Let's suspend belief that the price curve is actually above the minimum point of ATC for a moment. It is in the short run. In the long run, on the other hand, that's the graph. I'm at what I like to call cost optimization, and another company that has the same profit with twice as much revenue is a profit maximization which is MC=MR. Because I'm before MC=MR, I still have a ways to go. At the end of the day, I'll make more money.

Cost is handled internally. More revenue can only be achieved by selling more stuff. In a saturated market, which is easier? When I make the decision to buy planes, I consider them a sunk cost in the short run, so it doesn't matter what the cash outlay was. I assume that the money can't be recovered. But what I do see on my income statement is my lease expense going down. For faster growth, yeah, by all means, buy planes and expand, but for sustained, stable growth, cost optimization is necessary every step of the way.

By the way the number one reason startups fail is because their costs were out of control.

[dktc]

I don't think "a lot of work" is something that is concerned by real company :wink:

As for long term, the game round doesn't require long term consideration, nothing serious at least.

I am not saying you aren't making good profit. I am just saying you are not living up to your potential :wink:
And as I have said, profit margin doesn't mean much on its own. If you have a tiny revenue when compared to what you could have, you would still be lacking behind. There is no "at the end of the day in this game". The game rounds end before the end of the day.

When I make the decision to buy planes, I consider them a sunk cost in the short run, so it doesn't matter what the cash outlay was.

That is your challenge. If this were a real business, cash-flow is the most important thing. Cash-flow trumps profit. If you are out of cash for a week, or maybe even a day, you could be done for good, even if you are making a profit. You also need to keep the concept of time-value-money in mind. Cash now is worth more than the same amount of cash later.

The number 1 reason start-ups fail is because of cash-flow. They under-estimated the costs, esp. the incidental parts, and used up too much cash at the beginning. They also over-estimate their takings. The combination of both results in the business running out of cash and going bankrupt. Is the costs "out-of-control"? Could be. But the more practical view is that they have under-estimated their costs (ie. the "control" they set was wrong, as in they estimated 15% costs, but it should be 25%. Of course the costs would be "out-of-control" in that case.)

[yourefired]

When I make the decision to buy planes, I'm usually sitting on more than enough to cover the cost of the purchase.  :wink:

My business model hinges upon me serving and developing a niche market-premium services to be more specific. It doesn't hinge upon wild uncontrolled growth. Thus based on my model it's critical that costs are kept under tight control.

The work isn't a concern because a real company would hire someone to do it.  

My estimates for costs are conservative anyway....at any given moment, I'll tell myself that it's 40% of revenue, and now it's sitting pretty at 34% of revenue and going down. Yes, I could operate on paper thin margins, but I like to have a financial cushion. i.e. if my revenues were slashed by 50% tomorrow, I'd still be making money.

dktc-have you considered the risk management factor also? That having a higher profit margin is actually risk mitigation......running on a 5% margin requires constant growth to be successful. Running on a 50-60% margin does not.

[MrOrange]

Split the thread, moved to General Chat.

[dktc]

Fast growth doesn't mean wild, unorganized.

But anyway, you have admitted that your model does not result in the quickest growth.


To me, keeping costs under control is good, but keeping it under control to a point when it hinders your business, that may leave something to be desired.
Conservative is good, but it should be used in the correct places, such as the evaluation of the lease rate before taking a lease, and the planning of cash-flow. Being conservative on the % is not exactly useful in all cases. It really depends.



(MrO, please move my "just posted" post with the others next time   )

[MrOrange]

Too lazy