Airlines are doing a great deal of soul-searching over whether they should expand or contract in maintenance, or even get out of the field altogether, as the industry pursues a relentless drive towards new business models.
Cost pressures have long been bearing down on airline maintenance budgets. And along the way carriers have faced tough decisions over how far to retain or outsource their own in-house operations. In the present climate, such choices have become impossible to ignore as the major carriers take a long hard look at their business model.
"Since 11 September, there has been a step change in terms of trying to get more cost-effective by using opportunities to simplify our business," says Alan McDonald, director of engineering at British Airways, echoing the views coming from many airline overhaul units.
Maintenance is not only a major expense, making up around 10% of airline operating costs, but it is one which has been on the rise over the past few years. This year's Airline Business maintenance rankings suggest that the trend continued last year. Despite reduced flying toward the end of the year, the 2001 spend appears to have risen by close to 6%, based on an analysis of some 30 leading mainline airline groups - a selection which accounts for more than half of industry revenues.
Outsource rise
The ranking also hints at the extent to which outsourcing has become part of the solution. The figures suggest that the leading airlines are putting out some 36% of their total spending to third parties, led by the USmajors which are regularly putting out more than half of their work. Only Delta Air Lines has kept a substantial majority of work in-house.
Derek Cridland, engineering director at Cathay Pacific Airways, which is also heavily outsourced, concedes that maintenance units have already been under pressure to "do things differently", moving from a pure-engineering approach to "one based on a more business-orientated approach."
The original equipment manufacturers (OEMs), and particularly the engine makers, have been keen to take a lead in building third-party businesses. Together with the mighty Lufthansa Technik and Air France Industries (AFI), they dominate the ranking of airline maintenance operations all with annual revenues over $1 billion.
Behind these lead players come a series of airlines and independents, some of which at least are pushing to reach that top tier. Air Canada, Alitalia, Delta and KLMall have ambitions to drive their third-party businesses towards the scale of the German and French leaders. Like Lufthansa Technik, however, the trend has been to remodel the units as standalone businesses in order to set them free to pursue third-party growth. SRTechnics was another early mover and now finds itself as a fully-fledged independent after the collapse of Swissair. Sabena Technics has been left in a similar position after the collapse of its parent group. It too is conducting business-as-usual as an independent pending any decision on a new owner.
In Asia too, SIA Engineering was hived off from the airline parent a couple of years ago and others have followed in turning their maintenance overhead into a profit centre.
This summer, Air Canada joined them, establishing its Technical Services Division as a profit centre under the leadership of Robin Wohnsigl. "Three years ago, we made a conscious decision to be in third-party work, and not just use it to fill vacancies or holes in our product line," he explains. Technical Services was formed in July and will have revenues of around $200 million in third-party work this year, a 50% rise over the past two years.
In general, third-party work has suffered in the wake of last year's crisis, but is expected to recover strongly over the longer term, argues AeroStrategy Management Consulting (AMC), a specialist in the sector. Its latest forecast calculates that the global maintenance market is likely to total around $34 billion this year, marking a fall of $2.5 billion from the high point of 2000.
Flying hours plunged and the active fleet fell by over 1,000 aircraft in the six months following 11 September. However, AMC forecasts that maintenance spending will average 5.3% annual growth over the next ten years to hit $57 billion by 2012.
Increasingly, the market is being divided up into two strong groups - the major airline maintenance operations and those of the OEMs - with independent providers apparently being squeezed in the middle. Although many airlines are turning to the OEMs for support, mainly in engine and component sectors, airline departments believe that they have some inherent advantages too. "The fact we are an operator helps," says Pierre Yves Reville, vice-president for marketing and sales at Air France Industries. "We have seen airlines switching from the OEMs to our airline-orientated support."
A key factor is that the arrangements are more a "transfer of know-how", where there is little upfront investment from either side, says Reville. It has deals where AFI assists an airline to develop its competency in technical support, and in exchange the carrier sends engines and components to be overhauled by the maintenance arm of the French carrier.
Spares inflation
Whether the operation is an in-house maintenance department or a carrier with an outsourced business model, the goal remains to make savings wherever they can be found. But some areas seem beyond their control. One key issue, which Cathay's Cridland likens to "a thorn in our side", is the constant price escalation from OEMs for their spare parts. In engine maintenance the cost of spares and material represent 60-70% of the total overhaul cost of an engine, so it is easy to see why this is a crucial issue.
While there are many joint ventures and partnerships between airlines and OEMs that attempt to deal with this issue, there continues to be tension between the two parties, explains Gene House, managing director of United Services, a division of United Airlines.
He admits that airlines can sometimes be their own worst enemies. When choosing aircraft components in the first place they squeeze the lowest possible price out of the OEM, which then must make its profits over the lifetime of the component through spare part sales. This is a tried and tested cycle, but one that House believes "has to be broken".
Cridland agrees on the issue of dealing with the OEMs: "It is very much on our radar screen. You tackle it by being pretty brutal. Different airlines have varying success, but it is an issue the industry as a whole has really got to tackle." He adds that OEMs have to be "dragged" to the table to discuss it.
In their defence, engine manufacturers claim that profits from the spares business are crucial if they are to make acceptable returns on their massive upfront investment in new technology. Giveaway prices for new engines, they argue, are only possible due to the stream of spares revenue that follows. Stephen Heath, president of International Aero Engines, says that manufacturers are happy to rethink the business model, but that airlines might have to be more realistic in accepting a higher initial purchase price. However, few airlines have "the discipline" to balance the initial capital and future maintenance costs in this way, he argues.
Without such a rethink in prospect, carriers are seeking other routes toward cost control. The use of cheaper Part Manufacturing Approval (PMAs) components - non-OEM manufactured, but FAA-approved spare parts - is a growing trend. Lufthansa Technik has a 20% stake in US firm Heico, one of the largest makers of PMAs, and is a pioneer in their use. It says they can offer savings of 20- 60% over OEM list prices.
"We are aggressively seeking out PMAs and alternative sources of material," says Ray Valeika, Delta Air Lines senior vice-president, technical operations. Delta also seeks to reduce costs by locking the OEM into "material-by-the-hour" agreements, where the price of parts is fixed per hour used by the carrier.
Power-by-the-hour
Power-by-the-hour deals, where carriers pay a fixed price per flight hour for the maintenance of systems and components, are growing in popularity. BA, for example, has now transferred over half of its engines to such deals, including the GE90, Rolls-Royce Trent and IAE V2500. Fixed rates help to address the spares price escalation issue, and take the uncertainty out of introducing a new engine type- such as BA's difficult experience with the GE90.
"The most powerful advantage is very predictable costs," according to Gene House at United. However, there must be a clear understanding of costs from each side to ensure both are happy they have signed a fair deal. "They can be a good thing if done wisely, and they can be a lazy way of shopping," he says. "The best possible arrangement is a competitive time and material rate between two people who trust each other."
Although Delta has several power-by-the-hour deals, Valeika too sounds a note of caution. "By its very nature power-by-the-hour eliminates competition because the major OEMs take over those processes. It inhibits other people from entering the business, and further isolates the market into fewer players."
Nevertheless, the consensus is that power-by-the-hour will become even more commonplace. This thought has gained currency as carriers have become increasingly determined to rid themselves of surplus spares, which sit on shelves waiting to be used, tying up millions of dollars. "We are doing everything to reduce inventory," states Valeika.
Delta is undergoing an "incredible IT renaissance" to transform its maintenance and materials management environment. "We are seeing productivity improvements on maintenance that will knock your socks off," he says, with gains of 25-30% over the entire maintenance process. For instance, better planning and stock control has meant that Delta has avoided the need to purchase $70 million-worth of inventory this year.
BA has a target to reduce its parts inventory by 25%to £450 million ($700 million) over two years, says McDonald, as part of the carrier's Future, Size and Shape project released in the wake of the 11 September crisis. Although the market for spares is depressed, it has already managed to cut its inventory by £20 million so far this year. Spares holdings can also be cut as BA rationalises its fleet.
However, the attention to the fleet goes much further than reducing the number of types or sub-types operated - a topic close to the heart of BAchief executive Rod Eddington, himself an engineer by training. "Rod was very clear with us, he wanted us to stop modifying the aircraft so frequently," says McDonald.
BA has had a mindset where once it bought its aircraft it would develop and improve them to its own specifications. It has had design authority to produce its own repairs for parts and components. "Now on all fleets we try and minimise the number of modifications that are not industry standard," he explains. "It is about taking more off-the-shelf aeroplanes, and resisting - other than safety or reliability modifications - changing them." BA is already doing this with its Airbus A320s, with the last 40 all built to the industry standard.
BA is among the carriers working towards maintaining its aircraft according to the manufacturer's Maintenance Planning Document (MPD). This is the manufacturer's standard guide to how to service and maintain its aircraft. "It's about consistency and simplicity, and doing things at standard planned intervals," says McDonald.
Following this model means it is easier to move aircraft in and out of an airline's fleet without having to perform costly maintenance to bring it into line with the MPD. The initiative will save millions of dollars every year over the lifetime of an aircraft, he says.
Standard aircraft
The push to standardise aircraft, equipment and maintenance methodologies is essential, but a tough nut to crack, says House at United Services, and will require the co-operation of carriers through their alliance partnerships and those of the OEMs.
McDonald states such efforts are already under way. "We are aligned as the engineering directors of oneworld," he says, adding that the alliance will use its collective purchasing power to push OEMs in this direction. "Our relationship with manufacturers will be based on a need to get more standardisation [of equipment] across aircraft types and within similar types of aircraft."
So while it would be fine for an OEM to specify two different manufacturers for a sub-assembly such as a pump, the parts should be interchangeable. Today the spares for items such as pumps too often require different spares holdings. Multiply this across the entire aircraft and the maintenance cost and complexity becomes bewildering.
Although it is a major shift in policy for OEMs, they are "engaged" with the airlines on the issue, says McDonald. "They would be pleased to see us buying the same equipment, as it would make life less complicated for them too."
As carriers explore every avenue to increase efficiency and tackle costs, some are asking the fundamental question of whether maintenance is a business they want to be in at all. For some the answer may be no, but the decision to out-source faces resistance from labour. For example, in the USA, Continental and Northwest Airlines have been criticised by their mechanics unions for transferring aircraft maintenance work out of the country.
Most of the major US carriers have built up huge operations to service their fleets, and argue that periodic outsourcing is a natural part of their business. Northwest's policy, for instance, is to focus its in-house resources on newer aircraft, while outsourcing work on older ones, especially those nearing retirement. Hence its deal with Singapore's independent ST Aero for work on McDonnell Douglas DC-10s.
Despite union efforts, management is likely to seek more flexibility to put work where it can find the best deal. For non-unionised Delta - which "doesn't have a labour issue" and claims a 10-15% cost advantage over other North American airline maintenance operations - this will be in-house, says Valeika.
"The key is to offer people an opportunity and not a threat," he says. "We reward our people for being productive by in-sourcing work which gives them greater job security." For instance, in August it signed a deal worth $1 billion over 10 years to bring in-house GECF34 engine work from two of its Delta Connection subsidiaries.
A strong relationship with its unions and a common interest in growing the business has been a major factor in enabling Air Canada to spin off its maintenance operation, says Wohnsigl: "Labour understands the long-term viability of the business is crucial and dependent on being competitive in the marketplace." Whatever other changes may take place in maintenance markets, sharper competition looks assured.
Source: Airline Business
