With all Stage 2 aircraft to be banned from operation in the US by 31 December 1999, and in Europe by 1 April 2002, something must be done with the worldwide fleets of up to 5,000 narrowbodied aircraft, mainly Boeing 727-100s and -200s, 737-200s, and McDonnell Douglas DC-9s. The widebody aircraft are less of an issue with only some early 747s and DC-10-30s not meeting Stage 3 regulations.
New aircraft are not cheap. At the top end, the list price for the B747-400 is $148-177 million - not many airlines make that much profit in a year, points out Avitas. Smaller aircraft are cheaper, but are usually required in larger numbers.
One alternative to replacing ageing fleets with new aircraft is taking on used, but not necessarily old aircraft, which with refurbishment can cost about half the price of a new aircraft. Hushkitting is a cheaper alternative still, at $1.75-2 million for a DC-9 and $3 million for a B737-200 Nordam heavyweight kit. Reengining the aircraft is more costly than a hushkit, with prices ranging from $4-8 million, depending on the equipment involved.
In the past year three carriers in particular have weighed up the options. Finnair opted for used MD-80s to replace its 17 DC-9s at a cost of $20 million per aircraft. Northwest decided to hushkit and refurbish its 100-plus fleet of DC-9s, a decision which it says will save $1.4 billion over 10 years. Air Canada was to have gone down the hushkitting route, when its chairman Hollis Harris was persuaded that new aircraft could be a 'cash neutral' option. The carrier then ordered 25 A319s.
Finnair's decision to opt for three to four year old MD-80s was made in the mid-1980s, but due to the recession it was forced onto the back burner, says Pekka Valimaki, managing director of Finnair's domestic subsidiary Karair and the chairman of the committee which re-examined the question of fleet refurbishment last year. 'We are now continuing according to the original plan, but we did consider all the possibilities,' says Valimaki.
Arguably, the choice between new and old aircraft is now more delicate than ever, as technological advances in new aircraft have slowed down and more ways have been found to keep older aircraft flying safely. While cost is the ever-present primary issue, commonality with the rest of the fleet is also important as many carriers are trying to realise the benefits of fleet rationalisation.
Cost dilemma
Inevitably, there is the classic dilemma between capital costs and operating costs. An older aircraft will be more expensive to maintain than a new one, but clearly the new model will be more of a burden to the balance sheet. However John Vitale, director of asset valuation at Avitas, says that these days there is less financial proof to support buying new aircraft. 'Replacement economics are very difficult to prove on paper. The one variable is fuel. There is a point when the purchase price of used aircraft will decline to compensate for the advantage new aircraft have on fuel.'
But with maintenance, fuel and labour costs all coming down in price the economic advantage of new aircraft lessens, says Vitale. Indeed, when Finnair looked at the operating cost of all of the aircraft under consideration, Valimaki says there was only a 2 per cent difference between any of the options. This includes operating costs, fuel, crew, spares, landing fees, but not the overhead.
However, once the capital costs were added in the difference became quite clear. With the modifications Finnair will make to the MD-80s that it acquires, the cost per aircraft will be $20 million. This compares with for example $40 million for an A319, says Valimaki. And this does not include interest, which at 10 per cent per annum adds some $4 million to the price of each new aircraft.
Valimaki acknowledges that all the manufacturers were keen to offer good deals on new orders, but even with discounts Finnair was unwilling to commit. 'The discounts are limited. You can get a maximum of 10 per cent or so but this does not change the whole picture. I can imagine that sometimes there are situations where they like to offer very rock bottom prices, but that didn't happen in our case,' he says.
Common fleet
In opting for the used MD-80s Finnair achieved capital cost savings and, equally important, a common narrowbodied fleet. Common-ality was a major issue for the carrier, says Valimaki, since flight crew, cabin crew and maintenance staff will already be familiar with the aircraft.
Finnair's hangars are already equipped to deal with the MD-80s, whereas if, for example, the A319 had been purchased, modifications would have been necessary. Doubling the size of the MD-80 fleet does not require the carrier to double its spares holding. In fact Valimaki says only a 30-40 per cent increase will be needed.
The common fleet also allows flexibility in the allocation of the aircraft at the last minute, with no need to worry about having the right crew available. 'We have the flexibility to change the aeroplane at very short notice. Today with the DC-9s and the MD-80s, if we change the aircraft we have a problem with the pilots,' he says.
Aircraft size was a major factor. The various 100-seat options were not appropriate; Finnair wanted a 120-140 seat aircraft to suit its intra-European routes, which do not require high frequencies but will support the larger aircraft. This underutilisation of an asset favours buying used aircraft, says John Vitale. Lower utilisation means fewer penalties on fuel or maintenance, where new aircraft win. In contrast, new aircraft need to be fully utilised to amortise the capital cost.
Other options
Re-engining the DC-9s was one option for Finnair, but the price tag on re-engining, adding new cockpit systems, and a cabin refurbishment of its existing DC-9 fleet, was about $20 million per aircraft. Contrasting this with a new aircraft at $25 million or the used MD-80s at $20 million, Valimaki says it made more sense to opt for the aircraft that in 10 years' time would not be 35 years old.
Hushkitting was not a viable option for Finnair, whose DC-9s are mostly -40s and -50s, rather than -30s. Finnair was not satisfied with the performance levels that the current hushkits for the -40s and -50s produce.
For some carriers there is a perception problem with hushkitting or re-engining, points out Stephen Rimmer, director at Curtis & Company. 'Some carriers and investors look at a DC-9-32 and say: "It is worth $2 million and a hush kit is worth $2 million. Is it really worth doing this?"
Certainly the manufacturers would support this sceptical view. 'Hushkitting may look attractive in the short term, but it is investing a substantial amount of money, yet reducing the efficiency of the engine and only just arriving within the noise limits,' says Airbus.
John Vitale at Avitas believes this is the wrong way to look at the situation. 'Many people measure the additional investment of refurbishment. What is important is that they need that aircraft to put their product on the market. The analysis of "my aircraft is worth $1.2 million and re-engining will cost $6-8 million" is irrelevant,' he says.
Hushkitting benefits
Northwest decided the cost benefit of hushkitting its 100-strong fleet of DC-9s outweighed any potential range and fuel performance disadvantages. The net present value saving to Northwest is estimated to be $1.4 billion over 10 years. The cost of refurbishing with the hushkits is set at $5-6 million per aircraft over 10 years; 40-50 per cent of this cost will come in the first three years, the remainder being increased maintenance and systems upgrades on the aircraft.
The carrier knows this is a short-term solution, but says it has not closed the door on future options. 'The payback comes in the next two or three years versus the cost of buying new,' says Northwest. 'But five years down the road, if we get a good offer from the manufacturers we have not foreclosed from making that decision.'
Acknowledging it will take a hit in terms of aircraft performance, Northwest says that for the routes the DC-9s operate on this is not a major factor. And with fuel prices so low, there is currently little to worry about at present. But Northwest is aware of the devastation in the airline industry caused by the spike in fuel costs during the Gulf war, and says it did do the calculations in relation to potential fuel costs. 'In testing the sensitivity we figured that fuel prices would have to double and stay at that for quite some time before it would be cost ineffective to use the hushkitted DC-9s,' says the carrier.
Vitale points out that carriers like Northwest do not necessarily have the financial flexibility to make ideal fleet acquisition choices. This impacts on the fleet plan. 'You choose the asset on the merits of that asset. How you finance that choice is the next decision. But some airlines do not have a strong enough balance sheet to do this and the decision is made backwards,' says Vitale.
In the end the availability of finance is a critical issue. Despite the lower cost of buying used aircraft, some airlines will have difficulty finding the funding for older aircraft, says Rimmer.
'In some cases people are making equipment change decisions and have to go with new aircraft because of the availability of funding. Japanese leverage leases, manufacturer guarantees, US export credit leases - these are all only available to new equipment,' he says.
With hushkitting at one end of the financial spectrum of possibilities and new aircraft at the other, re-engining and buying used are the 'mezzanine level of fleet renewal' says Vitale. Federal Express and UPS have reengined their 727s, which solves the fuel efficiency and range performance problems that hushkits may have, but also places a greater financial burden on the carrier.
Air Canada was to have been the North America launch customer for McDonnell Douglas' DC-9-X refurbishment programme. With the potential to win modification business for other carriers worth $12 million per aircraft, Air Canada said this was the best option.
Most manufacturers were anxious to prove otherwise, and it was Fokker that eventually came up with the numbers to show the exchange could be done on a 'cash neutral basis', according to Harris.
Price was right
The contract was eventually won by Airbus Industrie, with the carrier ordering 25 A319s. Commonality certainly played a part in this decision, as Air Canada was already an Airbus customer with 34 A320s. But Harris also insinuated that the price was right. While coy about actual figures, Harris has said that an assumption that Air Canada got one-third off the list price on average for its A319 deal is 'not so far-fetched.'
Manufacturers clearly want to encourage new sales. Each will argue in turn that it is in the carrier's best interest to invest in a new aircraft which will have a greater residual value and a longer life.
However a senior executive from one manufacturer says: 'If it is an existing customer and it is a choice of extending the life of our aircraft or switching to the competition, the answer is clear.'
Commonality, flexibility and, above all, price are the driving forces behind the fleet decisions being made today. With airlines returning to aircraft types that they already operate, it seems in many ways the fleet decisions for the future have been mapped out historically. 'I think they [executives] do spend lots of time on these decisions. The wrong aircraft type can bust an airline very quickly,' Vitale says. This is a fate that carriers will be keen to avoid.
Source: Airline Business
