Fuel Category Management at Delta Air Lines (Revisited) by Kelly Barner

Back in May, I wrote a guest post for Procurement Insights about Delta Air Lines’ decision to buy an oil refinery as part of their fuel category management strategy. It is a good example of an ‘out of the box’ or differentiating solution to a spend management challenge that plagues the entire airline industry: the volatile cost of jet fuel.

Just to review a few of the specifics, Delta estimated that spending $150 million to buy the Trainer, PA refinery from ConocoPhillips and investing $100 million to get it back up and running would save them $300 million annually on fuel over a 5-year period. If accurate, this represents a 2.5% savings on their largest category of spend. Delta subsidiary Monroe Energy now operates the refinery and has announced it will come back online as scheduled – ConocoPhillips shut the refinery down in 2011[1] – in September 2012.

In the time since Delta announced their decision, analysts have come out both for and against the strategy, which is obviously not without risk. I admired their willingness to take action, as did Bob Ferrari of Supply Chain Matters, complimenting Delta “for its bold thinking on the possibilities and outcomes of vertically integrating the biggest component of its supply chain.[2]” The actual impact of the refinery will not be felt until the end of 2013 according to a statement Delta’s CFO Paul Jacobson made to the Wall Street Journal[3]. Our interest in this decision goes beyond what the market thinks, what their executives think, and what their shareholders think. We are interested in what this move – and the organizational structure behind it – says about Delta’s philosophy on procurement.

The groundwork for the bold decision to buy a refinery rather than continue to gamble at fuel hedging started four years ago. In April of 2008, Delta Air Lines and Northwest Airlines merged, creating what was at the time the largest commercial airline in the world[4]. In addition to gaining 216 of Northwest’s aircraft, three U.S. hubs and the Northwest pilot’s union, Delta gained the members of their technical procurement and corporate purchasing teams. Several members of those teams are still in place at Delta today. The combination of increased staff, more cash on hand, and larger consumption has afforded Delta new options with regard to their fuel strategy.

Delta has also made organizational changes that reflect the importance fuel has to their competitiveness in the market and their valuation as a public company. “Before the merger, Delta procured jet fuel in much the same way it bought snacks and napkins for its inflight service — a refiner, broker or bank would quote them a price for fuel and they would take it or risk not flying that day.  […] It has moved its jet fuel procurement division into its treasury services department and started to hire traders away from Wall Street …[5]” Delta’s treasurer is a Vice President-level position that reports to the CFO, along with the SVP of Finance & Control, the SVP of Financial Planning, Analysis & Investor Relations, and the SVP of Communications[6].

As with the idea of buying the refinery, Delta seems to have their eye on the big picture when it comes to the positioning of procurement responsibility within the organization. Moving procurement to treasury was not about showing (or withholding) procurement proper respect, but about making sure the fuel category was managed in line with their financial priorities and plans to maximize returns. The basic procurement processes and principles that drive any company’s acquisition of a critical supply are the same as those less strategic categories – in this case, beverage napkins and little bags of peanuts. The key is not the application of process, skills or technology but the impact of the category on the operating effectiveness of the company.

Delta’s positioning of the fuel procurement division brings up the much discussed differences in how direct and indirect spend are handled. Traditionally, operations groups have been reluctant to relinquish responsibility for direct spend categories to procurement, citing the specialized knowledge required to do an effective job. Procurement has pushed back, offering reasons such as overly close relationships with long-time incumbent suppliers and the advantage of a structured competitive bidding process. Delta made the decision to do neither – separating the category from the rest of either operations or procurement and placing them in a position of long-term strategic financial impact.

It will take many more quarters to see whether the risk pays off, but in the short term, Delta is at least taking charge and making purposeful decisions about their critical category management strategies and the organizational changes needed to bring them to fruition.

[1]  Janet McGurty, ‘Delta Air’s refinery turnaround on schedule.’ Reuters: 24 August 2012 http://in.reuters.com/article/2012/08/23/refinery-operations-delta-trainer-idINL2E8JNGKU20120823

[2] Bob Ferrari, ‘Delta Airlines Does Indeed Acquire a Refinery.’ Supply Chain Matters: 7 May 2012. http://www.theferrarigroup.com/supply-chain-matters/2012/05/07/delta-airlines-does-indeed-acquire-a-refinery/

[3] Ben Mutzabaugh. ‘Delta tops Wall Street forecast, but fuel hedges create loss.’ USA Today: 25 July 2012. http://travel.usatoday.com/flights/post/2012/07/fuel-hedges-send-delta-to-q2-loss/811891/1

[4] ‘Delta Air Lines-Northwest Airlines merger’ Wikipedia. http://en.wikipedia.org/wiki/Delta_Air_Lines-Northwest_Airlines_merger

[5] Cyrus Sanati, ‘Delta ups the ante in war against Wall Street.’ CNNMoney: 12 April 2012. http://finance.fortune.cnn.com/2012/04/12/delta-oil-refinery/

[6] Delta Air Lines Org Chart. The Official Board: Updated 7 May 2012. http://www.theofficialboard.com/org-chart/delta-air-lines

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