Q&A: Michael Riegel

To become a smarter consumer of business aviation services, believes consultant Michael Riegel, you probably don't need more information- you simply need to better understand and analyze the information you already have. "There's plenty of data," Riegel explained. "It's the interpretation of that data that's lacking. And the business aviation market is now far too complex to be able to just stick your finger in the air and figure out what to do."

That's where Riegel thinks he comes in. "I'm very numbers-driven," he said. "Much of my professional experience has been in strategic and product planning, which requires that you pull in vast amounts of information and interpret it."

For many years, he applied those interpretive skills to helping his corporate employers (see résumé on page 12). Today, however, he works as an independent consultant to approximately 1,700 fractional shareholders and other business jet travelers. He also advises private equity firms, market analysts, and aviation companies, but his heart seems to be with the consumer-advocacy work.

"Consumers have a voracious appetite for the kind of objective service I provide," he said. "I get a great deal more enjoyment out of making sure they make good choices than I ever did in the corporate world."

Perhaps surprisingly, one thing Riegel doesn't particularly like is traveling on private jets. "I took a few flights and just didn't enjoy it," he said. "I found myself getting drawn into conversations with pilots or with people reading too much into the fact that I was on the airplane. It's a busman's holiday. I do maybe half a dozen business trips a year and I find it most restful to just sit in the first-class cabin of American and look around me and marvel at the fact that the airlines are still in business."

What did you learn when you were working in sales and marketing that consumers don't know?

The fractional industry is built, to a very large extent, upon the ignorance of consumers. Providers have preyed upon people who don't understand residual value. They also don't understand which concessions to negotiate for, so it's easy to steer them toward concessions that might not cost the providers very much.

I've seen consumers look at an aircraft type or a Berkshire Hathaway brand and that'll be enough to pull them in. You've got to look more broadly than that. You've got to look in great detail at how you're going to fly and where, how many passengers, for how long, whether they're international flights.

Many consumers never really try to understand what their usage is going to be, so they may purchase the wrong aircraft type, the wrong number of shares or from a provider who offers minimal flexibility. And the industry is now suffering for that.

Because some customers are walking away dissatisfied?

The leading providers aren't doing so badly. The guys like NetJets and Flexjet, who seem to have both good service and reasonable commercial practices, are starting to pull ahead. But they're being dragged by other providers, whose practices have been a bit harsh. I think there's been a fundamental loss of faith in one or two fractional providers.

If we look just at sales, the fractional industry has been very strong. In 2001, which was a record year, the industry sold slightly over 200 aircraft and repurchased about 93. So net, the industry was up about 107 airplanes. In 2005, they sold 180 but they repurchased 157, so the industry was only up 23 airplanes. That's really what has hurt.

You've written that "we regularly see some highly questionable business practices" from major fractional providers. Can you be more specific?

One problem is that providers have been handing out very, very low residual values when people have hit their anniversaries. Two years ago, I would have said most of that problem lies with one or maybe two providers. Today, it's more broadly based. Providers who were taking off 0 to 5 percent [from bluebook values] two years ago are now taking a deduction in the 11 to 14 percent range. The worst is deducting just over 20 percent.

So they're earning more in the short term but they're driving people away.

That's the problem. One of the main providers at the moment seems keen to try to retire a lot of their older airplanes and, when I track the airplanes being retired, many of them have been sold into the wholesale market to brokers. My suspicion is that the provider has been mandated to buy these airplanes back [from shareowners] at a low enough price that they can sell them to brokers to get them off their books very quickly.

The trouble is, the valuations they're handing down are not bluebook retail, not even bluebook wholesale—they're well below that. And shareowners are shaking their heads, saying, "What's going on here? What is fair market value?" I've had folks who've been told, "We want to buy back your 2001 aircraft and put you in another five-year term in the same model 2001 aircraft." They're being asked to pay a substantial premium to move into an aircraft of the same age.

How can the consumer protect himself?

The best way is to select a provider that has had a fair valuation policy. Then take a hard look at the aircraft type to see if it has good residual value. Then see if you can find a used share or something that will help to take some of that early value loss out of the equation.

What besides low residual values is driving some people away from fractionals?

Increasing complexity. Flight Options has just launched a program called Fractional First. I've had a rash of people coming at me in just the last couple of months who've been struggling to make sense of the numbers.

Many of the new programs look on the surface to be more flexible. You know, the idea of having a monthly management fee that moves up and down with your flying looks great, but when we run the numbers, we're finding that the complexity doesn't benefit the consumer. There's a program where the fuel adjustment has become a very large component of the hourly rate. What the provider has done is pass on a lot of the volatility of oil prices to consumers.

An increasing number of program features are forcing consumers to use consultants or attorneys even for something fairly straightforward like a renewal because they're finding it very confusing. Experienced multi-time buyers in the fractional business are coming to me and saying, "I don't know how to convert all these lines of text into something I can actually read and interpret."

You've said that of the 20 or so aircraft types in fractional service, fewer than five represent good long-term investments. Which ones and why?

Well, I'll illustrate with an example of the Challenger 300. I'll say up front that I'm biased, having been the person who led that project. The 300 was purpose-built to operate in a high-use environment. Its economics are very attractive, its appeal is very broad and residual values are holding up very well. The technology's very modern, it's very efficient. It has good range, a good cabin, so it's an impressive all-around package. If you compare how it's selling with airplanes like the Gulfstream 200 and Citation X, it's doing extraordinarily well. The Excel is holding up very well, too—it's got 90 percent five-year residuals.

Sadly, it's tough to find too many other candidates now, but I suspect we'll hear news of some large orders from Embraer and others for airplanes that are going to offer a value proposition that is very compelling. I think they'll usher in another period of updated designs and improved performance, and that's going to be a key to the fractional providers making money.

You and our magazine have both talked about how the card programs are putting pressure on fractional fleet scheduling and about how the fractionals are responding by putting more restrictions on jet cards. Will that trend continue to the point where it really cuts into the popularity of the cards?

It pretty much has to continue. The fractional operations are already suffering. Five years ago, the average shareowner owned about a one-eighth or three-sixteenth share. Today, almost every new buyer is purchasing one-sixteenth shares. So even aside from any card-program activity, providers are wrestling with a higher owner-to-aircraft ratio. If you're going to sell a higher percentage of smaller shares, you have to charge a lot more when you head into peak-demand periods.

That's the first problem. The second is that reliability, maintainability, and efficiency of the airplanes are still critical issues that the industry isn't dealing with very well. And then you have the card programs added into the mix. Even with the restrictions, the card programs can be tremendously damaging to a fractional operation if they're not managed effectively.

You've said you don't see a good fit between the aircraft manufacturers and their fractional subsidiaries. Can you explain?

There tends to be a philosophical difference between how you run a manufacturing business versus how you run a service business, and there hasn't been a great deal of success with one type of business crossing over into the other.

Secondly, there's no leverage. If American Airlines were a subsidiary of Boeing, I doubt American would have a lot of influence over product. Boeing would basically hand them whatever their latest airplane is and tell them to get on with it. If you're a captive fractional program, your ability to dictate terms to the manufacturer is nonexistent because you're not going to be going anywhere else. Because three of the four major providers sit under manufacturers, I think the rate at which products have been improved has been slowed down.

Another statement of yours that caught my eye is that "we may see increasing pressure for a more exclusive form of fractional ownership, one that places the shareowner first and limits provider options." What did you have in mind?

Right now, the fractional industry is begging for someone to start to cherry-pick their better clients. If somebody asked me how to get into the fractional business profitably, I'd say select a small number of aircraft types and don't go with the complexity you see with Flight Options or NetJets. Eliminate an entry-level program, perhaps partner with a VLJ operation so you can focus on the segment of the market that's most profitable, which is below the large segment and above the light segment. You'd probably want a super-light product and a super-midsized. Operate large fleets and focus on people who typically fly 100 or more hours a year.

Fractional providers came to the view that they could be all things to all people. I believe selling a lot of small shares and card memberships has compromised service standards for long-established users. The providers are hurting a lot of the people who made the business what it is.

Will there still be four major providers a few years from now?

I'm not sure we'll see all of the majors survive if Raytheon is successful at selling Raytheon Aircraft Company. It's difficult to imagine how Flight Options would fit into the Raytheon portfolio. Their fleet has shrunk considerably over the last couple of years from well over 200 airplanes-they're at about 150 today. So I could see it going back to perhaps three major players, but I do see a strengthening of at least three or four smaller players sitting underneath those.

How will the advent of very light jets impact the fractional business?

The hope is that there will be some sort of service that would take a lot of the intraregional work off of the low-end fractional fleets. While I don't know how successful VLJs will be, I certainly believe that a lot of folks will find it more attractive to be buying into [air-taxi] programs versus going out and purchasing a share.

But that would take business away from fractionals.

Most of the entry-level jets for fractional providers don't make money. The revenue legs are quite short, the deadhead ratio tends to be quite high, and at the moment at least, none of these airplanes have economics that are radically different from many of the more expensive airplanes.
 

So the VLJs might take the less-profitable fractionals business and leave the providers with the more profitable flights.

Exactly. And my hope would be that one or more of the fractionals would realize this very quickly and dovetail their interregional operations with one or more of these air-taxi providers. If a client needs a 45-minute flight, it is almost certainly going to be a loss-making flight for a fractional provider. If they can find somebody to place that within the VLJ market, it would help to grow the VLJ market and I suspect it would do a lot for the fortunes of the fractional providers.

Do you think a problem could develop when passengers see just how small these aircraft are and perhaps feel uncomfortable flying with just one pilot?

The consumers I see like two pilots and I think they're going to apply very similar standards to the VLJ market—if it's the same consumer base. But maybe there are some people out there who will be willing to look at a different set of standards.

I've looked at enough of the research to have some skepticism about whether the VLJ volume will be up to the level that some people are saying. I think there's definitely room for two or three major players. But the VLJ market seems to be based upon a high level of confidence that the air-taxi market's going to explode. I think there is an air-taxi market out there, but I'm not quite sure "explode" is the appropriate term.