MIT Sloan School of Management

Time-Critical Management of AOG

(Airline on Ground) at Latin Airlines
by Maria Soledad Jeria and Robert M. Freund

Robert M. Freund

AOG
It is now 19:30 hours on Tuesday, January 13. The AOG (Airline on Ground) desk of the
Santiago Maintenance Center at Latin Airlines has just been informed that the aircraft CML19
has been designated AOG due to a thrust reverser failure. (The thrust reverser is comprised of
two components: the support assembly and the transcowl, see Figure 1.) The support assembly of
the thrust reverser on the left engine on the CML19 has failed, causing the AOG.

Support
Assembly

Transcowl

Figure 1: Pylon and Nacelle System

Aircraft CML19 is part of Latin Airlines fleet of Boeing 767 aircraft. (Each aircraft is assigned a
unique identifier of three letters and two numerals.) When an aircraft is designated AOG, the
aircraft is not airworthy and all flights assigned to that aircraft are cancelled until the problem(s)
causing the AOG are solved. This is distressing to any airline company, since the gigantic cost of
modern passenger aircraft (on the order of $100 million for long-haul aircraft) makes it too
expensive to keep extra aircraft in reserve in case AOG situations arise. All passengers on all
flights assigned to the aircraft must be re-booked to other flights at the airline (or on competitor
airlines) and/or be enticed to voluntarily delay their travel plans (with free tickets on future
flights), all resulting in revenue and reputation losses.

Latin Airlines
Latin Airlines (LAC) is the leading airline in Central/South America. With headquarters in
Santiago, Chile, LACs routes cover most of South America internationally, plus domestic routes
in Peru, Argentina, and Ecuador. LAC also has a cargo division that operates six Boeing 767
cargo aircraft with a hub at Miami International Airport. LAC is part of the One World airline
alliance that includes American Airlines (AA), Qantas, Iberia, and Japan Pacific among others.
Participation in One World brings numerous benefits to LAC as they pursue an aggressive
expansion program. These benefits include up to 5% discounts to LAC on last-minute airfares
paid to One World airline companies if LAC needs to re-book its own passengers on other One
World carriers (due to oversold or cancelled flights, for example). LAC currently flies two types
of aircraft on long-haul passenger flights: Boeing 767 and Airbus A340, and two types of aircraft
for short-haul passenger flights: Boeing 737 and Airbus A319/320 (Airbus A319 and A320 are
considered to be the same aircraft, they have only a slight difference in capacity.)

Exhibit 1: Typical Last-minute Roundtrip Airfares for Santiago-Miami

Business Class Coach
Latin Airlines $6,930 $2,750
American Airlines $6,500 $2,600

The Boeing 767 passenger fleet shares routes with the Airbus A340 on Santiago-to-Los Angeles
and Santiago-to-New York routes. The Santiago-Miami route is mostly covered by the Boeing
767 and the routes to Madrid and Frankfurt are covered by the Airbus A340.

The Santiago-Miami route has been experiencing very healthy seat occupancy rates: 70% (of all
seats) in coach and 80% in business class, compared to 65% in coach and 50% in business class
for the nearest competitor. The high occupancy rates are all the more encouraging in light of the
fact that the average airfares at LAC for coach and business class are 10% higher than
competitors. This is partially attributable to positive customer reaction to direct flights to major
American cities and LACs reputation for superior in-flight services. But it also is due to LACs
innovative revenue management software algorithms that automatically and dynamically adjust
fare classes and seat inventory to extract the most revenue per seat. Average roundtrip airfares
for Santiago-Miami are $1,350 for coach seats and $6,300 for business class seats.

Aircraft CML19
Aircraft CML19 is part of the passenger Boeing 767 fleet, which has seen an increase in seat
occupancy in the last two years. The average configuration of a 767 has 28 seats in business and
185 seats in coach. The passenger 767s average 4,500 to 5,000 hours of flight-time per aircraft
per year. The average flight leg time (from takeoff to landing) of the passenger 767s is 5.1
hours. A 767 passenger aircraft normally burns 1,669 GA/FT (GA= gallons; FT= Flying Time)
of jet fuel. The price of jet fuel at this point in time is $3.00/GA.

The CML19 intended flight schedule for the week is shown in Exhibit 2.

Exhibit 2: CML19 Flight Schedule

Date Departure City/Time Arrival City/Time Flight
th
Monday 12 Miami 20:30 Santiago 6:55 MIA-SCL 063
Tuesday 13th Santiago 21:55 Miami 4:20 SCL-MIA 067
th
Wednesday 14 Miami 20:30 Santiago 6:55 MIA-SCL 063
Thursday 15th Santiago 21:55 Miami 4:20 SCL-MIA 067
Friday 16th Miami 20:30 Santiago 6:55 MIA-SCL 063
th
Saturday 17 No flight No flight No flight
Sunday 18th Santiago 21:55 Miami 4:20 SCL-MIA 067

LAC has two daily flights from Santiago to Miami: SCL-MIA 067 departs at 21:55 and SCL-
MIA 077 departs at 23:00. Both aircraft return from Miami the following night and arrive in
Santiago the following morning, with the same time difference. LACs current key competitor on
this route is American Airlines, which flies two similar aircraft daily to Miami at approximately
the same time.

AOG Passenger Costs

An aircraft AOG means that all flights assigned to the aircraft are cancelled until the AOG has
been lifted. LAC must re-book all passengers on all flights covered by the affected aircraft either
on other LAC flights or competitor flights, and must cover ticket costs as well as schedule-related
hotel, taxi, and meal costs for all affected passengers.

In the last five years of re-bookings of LAC passengers, roughly 70% of business class
passengers are re-booked to other flights (LACs or competitors) the same night, while the other
30% are enticed to delay their travel for 24 hours with a coupon for a free roundtrip business class
ticket usable in the next 6 months. (80% of LAC business class passengers are members of the
LAC-Elite premium flyers program.) Business passengers that opt for the 24-hour delay are
assigned a personal taxi and are taken to a hotel suite, and LAC pays hotel, taxi, and meal costs.

Roughly 50% of coach passengers are re-booked to other flights the same night, while the other
50% opt for the 24-hour delay with a free roundtrip coach ticket coupon. (15% of LAC coach
class passengers are members of the LAC-Elite program.) Typical incidental costs are shown in
Exhibit 3.

Exhibit 3: Typical Hotel/Taxi/Meal Costs Per Day

Business Class Coach
Taxi/Van Service $30 $10
Hotel $150 $75
Meal Vouchers $100 $45

CML19 AOG Solutions

A quick check reveals that neither LAC nor any other airlines in South America have either a
support assembly or an entire thrust reverser in inventory. (All airlines share spare component
inventory information and there is an established spot-market for components among the airlines
themselves in order to promote efficient industry-wide operations.)

The thrust reverser is a component that is changed every 9,000 cycles (one cycle is one takeoff
and one landing). The thrust reverser is made up of two components, the transcowl and the
support assembly. The manufacturer, in search of more flexibility, has begun a design initiative
to produce interchangeable support assemblies between different fleets. However, since this is a
current initiative, there is only a 35% to 50% probability that support assemblies of different
fleets will fit perfectly and hence are interchangeable. There is no way to know in advance, this
has to be checked on the aircraft when the component is installed.

Purchasing a new thrust reverser is always an option; the AOG staff has a 30-day-old quote of
$2.1 million FOB Miami from one of their Miami-based maintenance suppliers. The supplier
would deliver the component within 12 hours of receiving the purchase order, with a 5%
surcharge to cover the cost of expedited transportation and service. The newly purchased
reverser would only fly until the current reverser is fixed. It is estimated that fixing the current
reverser would cost approximately 15% of the purchase price. After the current reverser is fixed
the new reverser would be taken off the wing and put into re-sale on the aircraft component
market. The last time LAC purchased a component and put it into re-sale it took more than two
years to sell it. The depreciation of this type of component is linear over 10 years with a zero
salvage value at 10 years; LAC uses a weighted average cost of capital of 10%.

The AOG desk has contacted two potential exchange suppliers: ARCSolutions and Bennett Cargo
Sales (BCS). (An exchange supplier will supply a new/rebuilt component and will take
ownership of the failed component, which they will then repair, at their own expense, and then
put into re-sale.) ARCSolutions offers the transcowl and the support assembly together for $1
million, and Bennett Cargo Sales (BCS) offers the support assembly alone at a price of $500,000.
Because of the volume and facilities needed to transport either or both components, the
transportation to Santiago would have to be done through LAC Cargo.

ARCSolutions is located in Tulsa, Oklahoma. LAC Cargo has a daily flight from Miami to
Santiago at 21:00, arriving in Santiago the next day at 5:30. If the component reaches Miami
International Airport by 20:00 there will be enough time for it to be loaded onto the flight; if not
it will have to wait an entire day in Miami for the next cargo flight. Upon arrival in Santiago the
component will have the necessary time to be exchanged with the damaged one and CML19 will
be able to fly that night (if scheduled).

There are two options to transport the component from Tulsa to Miami:

1. Transport by land. The component would be trucked to Miami. Because of daylight

restrictions, truck loading in Tulsa can only take place from 7:00 to 17:00 hours (Tulsa time).
It takes approximately 1 hour to load the truck. The trip from Tulsa to Miami typically takes
10 to 11 hours; however, because of congestion and traffic delays there is a low likelihood
that the trip would take more than 11 hours, making it impossible to load the component onto
the LAC Cargo flight that night. When pressed further on this, it was estimated that this low
likelihood was in the 20% range. The total transportation cost would be $3,000.

2. Transport by air. There is a flight that leaves Tulsa at noon and reaches Miami
International Airport one hour later. The cost would be $65,000.
Bennett Cargo Sales is located outside of Paris, France. LAC Cargo has a daily flight from
Madrid to Santiago at 22:00, arriving in Santiago the next day at 5:30, which would leave plenty
of time to have CML19 operating that night. There is a flight from Paris to Madrid at 14:00
reaching Madrid at 15:30, leaving plenty of time for LAC Cargo to load the component onto their
flight. The cost of transportation from Paris to Madrid is $70,000. If the support assembly does
not fit, this would be known by 19:00 Santiago time on the day it arrives. In such a case, BCS
would take it back and return 2/3 of the purchase price (but LAC would still have to pay the
transportation cost to return the support assembly to Paris.)

Decision Strategy
A viable decision strategy, complete with sensitivity analysis as appropriate, needs to be
presented to the VP of Operations within two hours in order to have CML19 flying as soon as
possible while keeping revenue and customer goodwill losses to a minimum.

Note: Here are Some Things to Keep in Mind:

1. Santiago time is two hours ahead of Miami (in January).

2. Miami is one hour ahead of Tulsa.

3. All ticket prices are for roundtrip fares.

4. Consider revenues and costs in a two-cycle context. This is the flight pair Santiago-to-
Miami and back to Santiago.

5. You can ignore the effects of taxes in your analysis.

6. Assume that passengers that opt to delay their departure by 24 hours will receive a
coupon for a free ticket in their fare class (coach or business class). Since the coupon has
restrictions, consider the effective cost of the ticket coupon to Latin Airlines to be 50% of
the highest coach airfare for coach passengers and 70% of the highest business class
airfare for business passengers.

7. Assume that Latin Airlines owns all of its aircraft, and that the useful life of the aircraft is
20 years.

8. Assume that last-minute airfares are typically the highest priced airfares.

9. Assume that the market depreciation of aircraft components is the same as the accounting
depreciation.

10. Assume that the one-way ticket price is equal to one half of the price of a roundtrip ticket.

11. According to Wikipedia, FOB is an abbreviation for Free On Board (an alternative term
is Freight on Board). The term FOB (often seen as f.o.b.) is commonly used when
shipping goods, to indicate who pays loading and transportation costs, and/or the point at
which the responsibility of the goods transfers from shipper to buyer.

12. International Flight schedules cannot be changed without two weeks notice.
13. If you have questions on the arithmetic of asset depreciation or the use of the weighted
average cost of capital, please ask a knowledgeable classmate or the TA.

14. You should assume that the AOG desks decision process takes at least one hour.