Is the Minimum Revenue Guarantee concept the best approach for LIAT?

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Lesroy Browne

By Lesroy Browne

A Minimum Revenue Guarantee (MRG) as perceived by the management of LIAT and espoused by the Shareholder Governments is a concept which is currently employed by some airlines operating from major US and European gateways into some of the Caribbean islands.

The MRG is an Air Service Agreement which is entered into between an airline and a Government.

The agreement is basically for the airline to provide regularly scheduled air services between designated points and, the airline to establish a round trip flight charge or MRG for each service which if not achieved over a stipulated period by the passenger revenues and other ancillary revenues obtained, the Government will be obliged to pay the airline the revenue shortfall or the difference between the total revenues collected and the established flight charge for the stipulated period.

Of course, the actual agreement would be very detailed in respect of the term of the agreement, the definition of air service, the minimum revenue guarantee amount, the revenue calculation, the revenue reconciliation etc. and will also include other relevant legal jargon that is expected to be included in such an agreement.

It was recently reported in several news outlets that the Prime Minister of Barbados told a town hall meeting at the University of the West Indies at Cave Hill that “we need to be able to have a MRG such that once the load factor of particular routes falls below whatever the agreed average is, governments who want to sustain those routes say I will pay the difference between the two as we are currently doing with American Airlines and Virgin Atlantic Airways in many Caribbean countries”.

Earlier this year the management of LIAT wrote to the various Governments of the territories served by the airline to inform them of the planned introduction of a Minimum Revenue Guarantee model as of April 1st 2019; but it is apparent that to date the territories have not confirmed their agreement to the proposal and have not made any payments as requested.

In that same letter the Governments were also informed that LIAT would have no choice but to cut any referenced low yielding flights if the country did not wish to provide the support as proposed.  Cutting flights usually require careful analysis and planning as cutting a flight in the LIAT network that is even unprofitable could possibly make the airline worst off.  Reduction in aircraft utilization would adversely affect the revenues without the necessary corresponding immediate reduction in the costs.  Airlines make money when aircraft are in the air and for various reasons it is sometimes even more beneficial to an airline to operate an unprofitable flight than to keep the aircraft on the ground.

LIAT is currently operating a fleet of ten ATR twin-engine turbo prop aircraft and serving fifteen countries which include Antigua, Barbados, Dominica, Grenada, Guadeloupe, Guyana, Martinique, Puerto Rico, St. Kitts, St. Lucia, St. Thomas, St. Vincent, St. Maarten, Tortola and Trinidad. Of the 15 countries, nine are Caricom member states and one is an associate member state.

The airline operates a linear type configured network which stretches from Puerto Rico in the north to Guyana in the south.  Flight distances on scheduled flights vary from as low as fifty-eight miles (58) between St. Lucia and St. Vincent – the shortest scheduled sector on the network to as high as five hundred and two miles (502) between Barbados and Tortola the longest scheduled sector on the network and most of the flights are multi-sectored flights.  Fares are not based on a standard rate per mile and the operating cost structure varies considerably from country to country. The foregoing is stated to give an indication of the complex nature of the LIAT operation particularly in the context of the implementation of the MRG concept throughout the network.

In the LIAT management letter to the various Governments referred to earlier, the MRG model was based on a MRG threshold that was the same across the network  and was set at the network average yield per seat which was calculated as the weighted average load factor multiplied by the weighted average fare collected across the entire LIAT  network.  That approach would undoubtedly result in a bias against shorter sector flights as shorter flights would require a much higher load factor than the longer sector flights to achieve the average fare criterion.

The Prime Minister of Barbados in the town hall meeting at UWI suggested that an average load factor could be used in the MRG model.  In respect of an average load factor MRG model the varying distances between flights on the network, varying operating costs between two points as well as the fact that fares are not set at a standard rate per mile, a situation can occur whereby a sixty per cent (60%) load factor on one flight can make that flight profitable to operate, but; on another flight with the same load factor, it could be a loss making flight.

Also, If for example, a 60% load factor is set as the minimum load factor and territories would be obliged to pay an amount per passenger for passenger loads below a 60% load factor, how would the MRG apply if on a multi-sector flight from A to B to C, the sector A to B has a load factor of 70%; but only 40% of the passengers on board are actually traveling between A and B.  Would fares have to be prorated so that the first leg of the journey can be given some credit for the non-terminating passengers on the flight or would that sector (A to B) meet the MRG criterion?

Employing either of the two foregoing approaches would not be an equitable approach.  A country like Guyana which is served by ‘long’ sectors with flights from either Barbados or Trinidad would probably achieve the MRG network average yield criterion while countries like St. Kitts and St. Vincent which are served by shorter sector flights would probably end up with most flights not achieving the network average yield.  The concept of the MRG must be based strictly on achieving a set revenue for each flight which is determined by the costs associated with the flight.

The Prime Minister of Barbados also indicated in the town hall meeting that the island-hopping airline’s viability is not the sole responsibility of Caricom even as she declared that sustainable air travel is necessary if the regional bloc is to grow.  She maintained that if the success of LIAT was left in the hands of the shareholder governments alone the regional carrier was doomed. She also went on to say “I trust and pray that we can find common ground for all of the stakeholders because while LIAT 1974 Limited may not be a viable proposition, reasonable, affordable, reliable air travel is the prerequisite for the growth of the region.”

Despite the airlines best efforts by having twelve different persons appointed as Chief Executive Officer (CEO) or acting CEO in the last twenty-five years, profitability has eluded the company.  With LIAT providing a service to nine of the fifteen Caricom member states and one of the five associate member states, Caricom must indeed play a role in the airlines continued existence or the Prime Minister of Barbados statement concerning the airlines future is likely to become a reality.

Each Caricom member or associate member territory which is served by the airline must recognize that it has an obligation and is duty bound to contribute to the continued existence of LIAT for the overall public good and to promote regional growth.  It is in that context I wish to suggest that the best approach for that necessary financial support is for the ten member/associate member territories of Caricom that are served by LIAT to agree to offset any loss incurred by the airline.  The share of each country’s contribution to the ‘offset’ amount should be related to the total available seat miles that LIAT provides either into or out of the particular country.

In other words, any loss incurred by LIAT in any given month would be charged to the ten countries in proportion to the available seat miles that were flown to/from that country for the month.  For the remaining five territories currently served by LIAT which include two US territories, two French territories and one Dutch territory, LIAT can decide if continuing flights to those territories add value to the network operation or not and take whatever commercial decision that is in the best interest of the company, as it may be unlikely that LIAT would get those five territories to provide similar financial support for the services.

The offset model is simple to understand and manage and could be introduced as early as January 2020 to ensure that there is added support for the monies (USD15M) that Antigua is putting into the company.  There is no doubt that creditors are already lining up for monies that LIAT is currently owing, so, the Antigua investment should not be considered the answer to the LIAT situation.

Large sums of monies have been invested in the airline in the past and the airline is still unprofitable.   The way forward must be approached cautiously.  There should be a continued effort to attract new investment in the company while the nine Caricom members and one associate member that are being served by the airline continue with a monthly burden sharing arrangement.  An improved financial situation coupled with a rigorous restructuring program will hopefully put the airline on a secure footing and allow it to provide the reasonable, affordable, reliable air travel that is so important for the continued growth of the region.

(Lesroy Browne is an Aviation Consultant at LB Consulting Services in Antigua and Barbuda. He is a former long serving employee of LIAT and once served as Director Scheduling at the airline)

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