The traditional airline organisational structure is rapidly changing under competitive and cost pressures. The shift towards airlines reducing their involvement in non-core support functions is accelerating as they increasingly focus on their core business of providing capacity and selling seats. This is now obvious in many operational areas, but nowhere are the changes more fundamental than in aircraft maintenance and engineering (M&E).
M&E is among the largest of airline functions, generally involving more than 10 per cent of both employees and assets of major airlines. The monolithic airline structure of the regulated past was able to accommodate this function without penalising the airline unduly. But this old structure, much of which has survived into the mid-1990s to a surprising extent, is finally in full retreat as airlines pursue a more lean, nimble and cost-effective organisational profile. In today's airline world, non-core functions like aircraft M&E are business impediments rather than assets and are increasingly severed in some way from the core business.
Outsourcing M&E entirely has long been the obvious strategy for many startup carriers, but the established majors and state airlines still often decide that it is neither desirable nor practicable to shed so much fixed investment and so many employees. Instead, many of the world's largest airlines are now restructuring the M&E function as separate subsidiaries or profit centres, hoping to cut costs, boost third-party revenues and broaden the scope of the operation. Four of Europe's largest airlines are in the process of creating or spinning off new M&E subsidiaries, bringing the total number of such carrier daughter companies to eight at the last count. Adding joint-venture offspring brings the total to 12 (see box).
Examining the status of these ventures will help clarify the viability of the M&E subsidiary as a management model, and determine whether this trend is merely a passing management fancy or the way of the future.
A cursory examination of the candidates shows some obvious regional factors at work, on top of aspects unique to individual players. The earliest innovators - Cathay Pacific and Aer Lingus - predate the trend, owing the establishment of separate M&E operations chiefly to local factors. Cathay's sister company Haeco, for example, was formed as part of a family of interlinked businesses in the manner favoured by most Hong Kong business empires. With one exception, all the remaining and most recent activity has been in Europe. The exception is Singapore Airlines, which has long prided itself on being ahead of the game.
The concentration of this rush of activity in Europe is perhaps understandable; the continent is in the midst of its deregulation process. But the pressure of this process is largely absent elsewhere in the world, explaining the relative lack of such maintenance reorganisations in Asia-Pacific (outside the established players in Hong Kong and Singapore) and in Latin America, the Middle East, Africa, and other developing regions.
Streamlining
Under this logic, it is surprising that restructured and repositioned M&E operations did not also spring up in North America, where deregulation first took hold. Part of the explanation for this apparent anomaly may lie in US labour laws and customs, which make the dismissal of employees easier and less costly and have allowed much greater streamlining over almost two decades of deregulation.
For example, Continental Airlines and America West have in the past year addressed the problem of securing more cost-effective M&E by electing to reduce their internal maintenance operations dramatically and to outsource most of the work. This form of radical surgery is probably not available to the majority of airlines elsewhere.
Another recent barrier to change in North America has been partial employee ownership at three of the seven largest US airlines. This may not prove to be in the interest of the airlines in the longer term, as none of the part-employee owned airlines seem ready to consider any actions which put short-term job security at risk, even though they may enhance corporate health in the longer term.
But the most likely explanation of the absence of the aircraft M&E spinoff in the US is probably the fact that deregulation happened there nearly 20 years ago, before this organisational model became a widely accepted option. In the event, this may turn out to be one area in which the Americans can learn a lesson from Europe and Asia.
In analysing the current M&E spinoffs as management models, one key differentiating factor is their age. At a robust 46 years old, Hong Kong's Haeco is older than all the remaining ventures combined. The only other M&E spinoff which existed before 1990 is Airmotive Ireland. Four of the ventures on the list began operations after January 1995, and two more are slated to begin at the start of next year. This shows that, while the concept of the M&E spinoff is not new, most of its current incarnations are very new, and the momentum for more players seems to be building.
Another distinguishing parameter is the nature and degree of these ventures' separateness from the parent airline. Again Haeco stands apart in this respect, with just 25 per cent owned directly by Cathay Pacific and a slightly larger share owned by Cathay's parent, Swire Pacific. The remaining 48 per cent of the company is owned by unrelated parties, including a public shareholding. As a publicly traded company with interlocking but separate ownership by the airline, Haeco has not only the freedom but also the obligation to operate at arm's length from both Cathay and the other airlines related to Swire Pacific.
These 'related' airlines provide Haeco with between 60 and 65 per cent of its revenue, and they certainly benefit from volume discounts. However, more than most of the other ventures, Haeco has been able to achieve the desired 'equal prioritisation of customers' which is essential to success in the third-party market. Haeco's managing director John Slosar is well aware of the problem: 'Taking care of the base customer and simultaneously looking for third-party work don't mix very well. The base customer tends to use all the capacity you have available.'
If Haeco's core customers do not enjoy the priority claim on capacity which they would gain if Haeco were an internal division, the balancing benefit is that they do get truly market-based pricing, because Haeco has no priority claim on the maintenance work needed by these core customers; they can go elsewhere. This tradeoff may have some disadvantages for both parties, but it is the balance which most of Haeco's more recent imitators are now trying to achieve.
The engine maintenance operation Airmotive Ireland, with 15 years of operating history, has also achieved considerable operational separation from its parent company Aer Lingus. Its airframe sibling, Team Aer Lingus, has been trying to follow the same path, but has been seriously set back in its bid for independence by high-profile and costly labour strife. Irish rival Shannon Aerospace has a great deal of operating independence, but this is a special case in that it did not evolve out of the maintenance operation of a single airline in the first place.
Offspring
The more recently inaugurated ventures at Lufthansa, British Airways and Air France are each wrestling with this issue of the degree of independence from the parent airline. Both Lufthansa and BA have defined three-year 'weaning periods' during which the maintenance offspring are meant to learn to survive without the direct support of the airline parent. The idea is that during this weaning period, the proportion the spinoff's business which the airline guarantees to provide declines in each successive year. From the fourth year there is no guarantee at all.
In their weaning periods the M&E spinoffs must move towards market-rate pricing, which in both cases represents a fall of about 30 per cent in the cost of its individual services to its customers, including the parent airline. Team Aer Lingus has shifted to market-rate pricing in its dealings with Aer Lingus, taking a serious hit to revenue in the process.
The Air France and Sabena operations are at the other end of the independence spectrum. Both Air France Maintenance (AFM) and Air France Industries (AFI) remain profit centres - or more realistically 'result' centres - rather than true subsidiaries, with no 'weaning' processes or moves to market-rate prices yet forced on them. Among other things, AFM serves as the maintenance planning department for the airline, and there is no prospect that it could ever become truly separated from the core. AFI, on the other hand, is clearly further from the centre, as is shown by the fact that its core customer is AFM rather than Air France directly. Separate subsidiary status for AFI is certainly more conceivable, although there are no plans for this at the moment.
Sabena Techniks was also reorganised as a profit centre, although again there is only a limited degree of separation from the parent company. However, in this case it seems that the disadvantages of independence outweighed the advantages. A source in Sabena Techniks says the arguments over internal pricing between Techniks and Sabena simply negated any perceived benefits of independence, and the profit centre structure was very quickly scrapped. The name Sabena Techniks has survived, but the organisational structure is simply that of an internal division.
Transparency
Why is the degree of separation so relevant, and even significant? Most executives of the M&E spinoffs give the following reasons:
First, separation provides true cost transparency, which is necessary to force upon the organisation the difficult changes required to achieve true cost parity with the marketplace. From senior management to the shop floor, a stand-alone company operating in the market is much better able to avoid red ink than an internal division exceeding its budget. As a subsidiary, there are fewer excuses to hide behind and fewer other people to blame for poor results.
Second, separation allows for a more truly market-oriented stance. Brian Philpott, director of engineering at BA Engineering, says: 'In the old days [as a cost centre], if the BA work declined, we just had the guys paint the hangar. It wasn't really our problem. Now, it's a crisis, and we scramble for outside work.' Building and sustaining a strong base of independent third party-business, rather than treating it as a sporadic in-fill if internal demand falls, is an essential tactic for a spinoff but can be very difficult to achieve for a cost centre.
Instead of orienting towards the core customer's needs and selling off the excess capacity when necessary, an organisation with an independent perspective surveys the entire market it can serve, and makes its investments according to where it sees opportunities. It seems to be hard for an M&E operation to make investments specifically designed to serve the third-party market within the psychological and organisational straitjacket of an internal division.
Third, raising the independent capital needed for such investments, and making alliances based upon the needs of the maintenance operation rather than those of the parent airline, are virtually impossible as a non-separated cost centre. Without an independent, audited balance sheet, the internal maintenance operation is wholly dependent upon its parent for capital.
Any alliances are also likely to spring from the relationships set up by airline parent, which will preclude any tie-ups with rival airlines or with operations linked to them. Allways Airways may be an excellent codesharing partner for the parent airline, but it may not be the ideal partner - or even customer - for the maintenance organisation, which may be better served by doing business with Everywhere Airlines, Allways' bitter rival.
Also, an alliance's full effectiveness may require a purchase of shares in Everywhere's maintenance operation, or a sale of shares to Everywhere's maintenance arm. But this would require both M&E operations to be separately constituted as subsidiaries. For the maintenance function to maximise its own prospects for growth and alliances, it requires the flexibility and control over its destiny which a separate corporate entity entails.
This, at least, is the creed of those M&E spinoffs which have achieved maximum separation and exploited it effectively. Not surprisingly, executives at Team Aer Lingus and Sabena Techniks, which have had less success with this strategy, are less willing to embrace it wholeheartedly. Their defence is that the precise mode of organisation is of little intrinsic significance, and that it is the actions of management, regardless of the structure, which make the difference between success and failure.
Boundaries
In separating any non-core function from the airline parent, the drawing of clear boundaries is the often the biggest challenge. With M&E operations in particular, the primary issues are how to deal with long-term engineering and maintenance planning, and the more short-term needs for light and line maintenance.
In any delineation of core and non-core airline functions, M&E planning obviously cannot be divorced from the core, and cannot be outsourced. For the airline to deal at true arms' length with a maintenance vendor - even a wholly owned subsidiary - these functions need to be internal to the airline. They are also vital if a spun-off vendor of M&E services to other airlines is to be managed efficiently.
Segregating
This is exactly the model which has evolved at Cathay and Aer Lingus, the airlines with the longest history of dealing with M&E subsidiaries. Air France has adopted the novel but essentially similar approach of segregating its maintenance functions into two entities - those which are essential to the airline, now residing in AFM which deals with the airline's planning and engineering, and those which can be devolved, now in AFI.
At BA Engineering, Lufthansa Technik and ACE, however, the planning and engineering functions have gone with the spinoffs rather than remaining with the airline. Time will tell, but it remains unclear at this stage how the airlines could allow the spinoffs to become truly independent when the airlines have retained no 'buying competence' of their own.
A similar boundary issue arises in the area of light and line maintenance. These functions seem further removed from the core than planning and engineering, but a valid argument can be made that both parties are better served if these functions remain within the airline. From the airline's point of view, they are a key contributor to reliability, and hence a factor in competitive differentiation. From the spinoff's point of view, there is only a relatively small true third-party market for these services at the destinations served by the airline and its maintenance organisation. If the core customer is to be almost the sole customer, there is little advantage in spinning out this activity.
Haeco and Aer Lingus have both left light and line maintenance within the airline, while Air France has placed them with planning and engineering in AFM. BA and Lufthansa, on the other hand, have placed them within the spinoff. It will be interesting to see which strategy, which set of boundaries, survives the test of market pressure and proves the most effective for the airline and the bottom line.
The debate over how best to deploy the M&E function in the modern airline is sure to continue well into the next millennium. It is clear now that the concept of maintenance spin-offs is gaining momentum, and that the spate of new arrivals in the mid-1990s is unlikely to be the last.
Best business practice
Curiously, the way ahead may be most clearly signposted by the oldest player in the list, Haeco. Its element of publicly held equity, its large proportion of third-party business, its close but truly arms' length relationship with its core customer, its recent moves towards geographic dispersion, and its joint venture offspring with other airline and non-airline partners, offer a rich menu of choice for best business practice.
The aim is deceptively simple - a business strategy in which airline maintenance operations can survive and prosper in harmony with, but not shackled to, their parent airlines. It asks maintenance managers to change themselves from corporate bureaucrats into aggressive entrepreneurs, while workers on the shop floor are no longer the enemies of competitiveness but essential weapons in the battle for business.
This route, of course, is not for everyone. Many, possibly most, airlines will choose to preserve the traditional corporate structure more or less as it was before deregulation, and many of these reactionaries will make this choice for good, valid reasons at the time. But times change, and we shall see whether they are among the survivors of the consolidation which will inevitably follow true deregulation.
The M&E spinoff players
ACE (Aeroplex of Central Europe): This operation is a 50:50 joint venture between Hungary's airline Malev and Lockheed Martin. ACE was created in 1992 and incorporates Malev's entire maintenance and engineering department.
Air France Maintenance and Air France Industries: These are separate profit centres, with AFM providing engineering, maintenance planning, and light/line maintenance to Air France almost exclusively. AFI provides heavy airframe and engine maintenance to the parent airline (via AFM) and to third party customers. They were set up in March 1995.
BA Engineering: The operation was reorganised as a profit centre in April 1995. It is primarily an airframe maintenance operation, in that BA's primary engine shop had been sold previously to US aero engine maker GE. BA intends the operation to become a full subsidiary in two years.
Haeco (Hong Kong Aircraft Engineering Company): The oldest of the maintenance spinoffs, and the most truly separate from its parent. Founded in 1950, Haeco is a public company in its own right, with just a quarter of its stock owned directly by Cathay Pacific. It provides heavy airframe and engine maintenance to related companies and third parties.
HAESL (Hong Kong Aeroengine Services Ltd): Another child of Haeco, HAESL will provide engine repair services in a new facility in Hong Kong to be equally owned by Haeco and UK engine maker Rolls-Royce. HAESL is projected to begin operations in January next year, at which time the current Haeco engine shop will be closed.
Lufthansa Technik: The Lufthansa subsidiary was created in January 1995. It provides the full range of maintenance services to its parent airline and third parties.
Sabena Techniks: Formerly a profit centre within Sabena, it was reconstituted in the early 1990s as an internal division once again. Sabena is now allied with Swissair, and further changes are likely.
Shannon Aerospace: First created by aircraft lessor GPA in partnership with Lufthansa and Swissair, Shannon Aerospace began operations in 1991. After the withdrawal of GPA, Lufthansa and Swissair elected to keep the venture alive by shifting some of their narrowbody airframe work to Shannon away from their home country bases.
SIA Engineering: The subsidiary of Singapore Airlines was founded in 1992, providing full maintenance to SIA and third-party customers.
Swissair Technical Services: This currently operates as an internal division, but becomes a separate subsidiary from the start of next year and will provide a full range of maintenance services to Swissair and third-party customers.
Taeco (Taikoo Aircraft Engineering Company): This joint-venture heavy airframe maintenance company began operating in Xiamen, China in April. It is 40 per cent owned by Haeco, 30 per cent by Chinese interests and 10 per cent each by Cathay, SIA, and Japan Air Lines.
Team Aer Lingus and Airmotive Ireland: Twin subsidiaries of Aer Lingus, providing heavy airframe and engine maintenance respectively. Airmotive was created in 1981, with the Team operation set up 10 years later. The majority of their business is external.
Source: Airline Business
