MARK PILING LONDON
Europe's airline maintenance repair and overhaul (MRO) organisations are entering a consolidation phase as they debate whether to expand the business or to abandon it altogether
Europe's major airline maintenance, repair and overhaul (MRO) groups seem to fall into two camps. There are those that have a stable business plan and clear strategic direction - Air France Industries (AFI) and Lufthansa Technik. Then there are those with unresolved strategic questions (KLM); major restructuring pending (Alitalia and Sabena Technics) or shareholder difficulties influencing future decisions (SR Technics).
Although they might all be at different points in their development, the airline MRO operations generally agree on one thing: there will be major strategic realignment in the industry over the next few years, as airlines decide if MRO is a core part of their operation or something to be outsourced. Key to this decision will be whether they view MRO as a business in which they need a partner - be it another airline or an original equipment manufacturer (OEM) - or a parent with the deepest of pockets to buy other suppliers, to become a true global player.
Europe has a multitude of serious players among the top global MRO organisations. However, only three airlines have MRO companies that can claim to be top-tier groups: AFI, Lufthansa Technik and SR Technics.
For KLM, the failed link-up with United Technologies - the parent of Pratt & Whitney - was designed to give it the strength to join the industry's elite. The deal, first revealed in March 2000, was designed to expand their aftermarket relationship to provide a full "nose-to-tail" aircraft, component and engine maintenance service. "It will be a strategic watershed [for the industry]," said Peter Somers, KLM Engineering & Maintenance executive vice-president, just days before the deal collapsed. "Several OEMs and airline MROs have co-operated in various areas, such as engines, but there has been no deal where all services are being brought under one umbrella organisation."
And there still is no such deal. KLM and UTC ended their talks because their "goals are too divergent". No-one who was party to the talks disagreed that what they were attempting to create was ambitious and complex, but there were problems with antitrust issues in the USA and with labour in the Netherlands.
It is a bitter blow for KLM, which "felt like the pattie inside the burger bun", according to Somers, sandwiched on the one side by OEMs gobbling up each other, and on the other by airline consolidation and alliances, all coming together to create larger organisations with greater purchasing power. It was for this reason that it decided to seek a partner. The plan outlined a trebling in its $800 million turnover over three years through expansion and acquisition. It would also create a business that could handle the entire MRO needs of small to medium-sized airlines or even an entire fleet of, say, 50 to 100 Airbus A320s or Boeing 737s from a larger carrier.
Now KLM has to go back to the drawing board. According to Somers, the basic fact remains: "If we are to survive, we need to reposition ourselves. To broaden our portfolio and deepen our scope of operations, we must find a partner."
A question of trust
A similarly sized airline MRO - Alitalia - feels much the same way. "In the medium- to long-term we cannot be independent. Consolidation is a way to survive, especially against the big OEMs," said Enrico Sposato, head of marketing & customer support at Alitalia's technical operations.
Under Alitalia's reorganisation, new chief executive Francesco Mengozzi has already identified the technical operations department as one of its five core divisions. Initially, this is the first step to the MRO operation being given the freedom to decide its strategy, regardless of the ups and downs of the parent. The next step is for technical operations to become a separate entity, a move Sposato expects sometime in 2002.
Then the company would be able to seek a partner. But, unlike KLM, Alitalia is nervous of becoming involved with an OEM. "We don't look too favourably on the big steps into the MRO market from the OEMs. Their target is to squeeze the market from another side," he said. "I would prefer an airline partner. Being tied in with an OEM will not give us the market access [we seek]."
The obvious partner could be AFI now that Alitalia has become a member of the SkyTeam alliance. However, it is too early to say if this is the direction it will take and what the synergies are between them. For instance, the two companies compete on GE CF6 engine overhaul and on A320 airframe maintenance, but don't overlap on MD-11/DC-10s and Boeing 767s.
Perhaps because of its significantly larger industrial presence, AFI is far less wary than its SkyTeam partner about working with OEMs in suitable markets. It is second only to Lufthansa Technik in the airline MRO field, and has an aggressive expansion strategy - particularly in the higher profit margin engine and components overhaul areas. It has built up what Alain Bassil, executive vice-president, describes as "frontline positioning" in Airbus and Boeing aircraft maintenance markets, focusing especially on Airbus A320/A330/A340 component support, A320 airframe overhauls, Boeing 747 airframe overhaul and 777 fleet support.
Its 777 role has been forged in partnership with Boeing, while it is working with Airbus on supporting its A319 Corporate Jet and with GE on the GE90 engine. AFI's policy is to grow via the partnership route - or organically - rather than by investing heavily in buying other MRO operations, explains Pierre Yves Reville, vice-president for marketing and sales.
Another SkyTeam partner, Delta Air Lines, is becoming an increasingly important piece of AFI's partnership network thanks to its TechOps division. The two operations have little overlap in the overhaul field and have begun to make joint offers to carriers to conduct complete aircraft, engine and component support.
The operations are working together for the first time on an aircraft type in offering support for the Boeing 737 Next Generation (NG), and have talked about having a joint brand for their MRO activities, says Reville. Talks have also been held with fellow SkyTeam carrier Korean Airlines about co-operation in MRO, and it is likely that talks with Aeromexico will not be far behind.
Global networks
What AFI is steadily doing is building up a global network to compete effectively in the growing open market for MRO business, which it estimates has risen from 15-20% to as much as 40% of total MRO work over recent years. It is one of the players seeking to take part in the consolidation that seems inevitable in the near future. "There will finally be five or six major networks worldwide, and our aim is to be one of those," says Bassil.
The airline MRO that is closest to having a true global network - and also the largest in terms of revenues - is Lufthansa Technik, now in its sixth year as a standalone company within the Lufthansa Group. "Our presence in regional markets is a cornerstone of our success. It enables us to produce as regional providers," says chairman of the executive board of Lufthansa Technik August Henningsen.
Its regional network is not complete, however, as it still only has a limited presence in the USA. While it is looking for acquisition opportunities, it will probably not buy one of the major operations. "I'm interested in making a sizeable step and to see if our services are what people expected, and then let it develop, instead of buying [a lot of new capacity and having it sit idle]," said Henningsen. As for the timing of this next step, the only comment he makes is "soon".
Whatever the Lufthansa Technik move is, it will be independent of OEMs. The company is seen as the airline MRO champion, standing up to the manufacturers. "You can have the feeling that from time to time the OEMs are more looking for [monopoly situations]," he said. "It is very important that we keep competition and competitiveness in the MRO market."
Co-operation on MRO came early after the formation of the Star Alliance, he explains. Lufthansa Technik, United Airlines and Air Canada have founded a business to sell their surplus materials, both to the partners and to outside customers. As a separate legal entity, Lufthansa Technik has the flexibility to move swiftly on such matters, and with similar independence moves under way at the MRO divisions of other Star carriers, it will be easier to find more collaborations. "We are working on dedicated programmes through which we will know if either we or our partner airline sees synergies for co-operation," says Henningsen.
Swissair crisis
While AFI and Lufthansa Technik have solid strategies, wholeheartedly backed up by the parent company, the troubles of Swissair must have influenced its subsidiary SR Technics, the third largest airline MRO.
This is a point on which its president Dr Hans Ulrich Beyeler refuses to be drawn. During Swissair's recent half-yearly results press conference, chief executive Mario Corti revealed that the carrier was selling its ground handler Swissport and airport retailer Nuance to help it meet its debt reduction targets. For Beyeler, the fact that Corti did not even mention SR Technics among other businesses that are being considered for sale shows how key the overhaul company is for the strategy of the airline.
For Beyeler, it is more or less business as usual. "So far we have not cancelled any investment project or course of action due to the Swissair situation," he says, adding that the group is continuing to build a new engine test cell at its Zurich base, and is expanding its engine shop there too.
With Swissair desiring an in-house MRO operation, and with the Swissair fleet too small on its own to sustain an economic MRO organisation, it has long been the strategy of SR Technics to play the industry game of going global, he explains. "I want to be a sustainable global provider. For that we need a limited number of excellent service provider operations, preferably in some form of partnership."
But forming these over-arching partnerships, as KLM and UTC have witnessed, is proving extremely hard. There are plenty of examples of partnerships in specific sectors, such as engines and airframes, but the often-discussed wholesale deals are not yet coming to fruition.
"The whole consolidation process is taking a more difficult and complex route," says Beyeler. "We have had many strategic discussions, but, despite the best will and efforts, it is very hard to come to an agreement." Some of the influences at play are the emotional attachment that airlines have with their MRO operations; the harmonisation of what are complex businesses; and the role of labour relations, which may restrict the freedom of some airlines to outsource MRO, he explains.
The efforts of SR Technics to form partnerships with airlines in Africa and Asia illustrate the difficulties perfectly. Beyeler will not comment on any specific projects, but MRO joint venture proposals between SR Technics and South African Airways, and SR Technics and Cathay Pacific - first announced over 18 months ago - have come to nothing so far.
But it does seem that the issue of control is central. "How do you manage this type of divestment, and how to do you manage somebody giving up control to a joint venture or an outside partner? It is a very tricky question," he states. "While technically it is relatively simple to put a case together, the reality of control is much more difficult to reconcile."
Manufacturer link
While SR Technics is finding it hard to sign up airline partners, it has found no such difficulty in sealing a deal with an OEM to take a core step needed to move its strategic vision forward. It has teamed with Rolls-Royce to form a joint Trent engine support company that will help SR Technics increase its engine overhaul capacity from 250 to more than 400 shop visits per year, says Beyeler.
"We have found a novel arrangement and I am very confident it will work. Rolls-Royce is not a shareholder in our shop; we will team up for Trent overhauls in specific markets - Europe and Africa. The first thing I said to them is "I am not helping you monopolise that'," he says. "The deal enables meto do the same arrangement with anyone else; that is clearly defined. AndI am not committed to exclusively providing (customers) with spares from Rolls-Royce."
For Peter De Swert, president of Sabena Technics, the present industry upheaval and strategic re-evaluation is no surprise. "It is a symptom of things that have been happening for at least three years. There is a big fight between the airline MRO shops and the OEMs whereby the manufacturers have discovered MRO as something that repeats itself, has higher margins compared with making products, and can give them serious leverage on spares parts."
His company is engaged in its own upheaval as it is being sold as part of Sabena's efforts to finally become profitable. De Swert does not know who will buy Sabena Technics, but he concedes that at some point the operation would have had to find a partner anyway as it is too small to survive on its own. Two years ago Sabena Technics took the decision to move out of the higher-risk (because of the amount of infrastructure needed to support it) widebody MRO market, preferring to concentrate on developing a full support package for the narrowbody 737NG and A320s.
Both Henningsen and De Swert sound a note of caution to those who think MRO can be a cashcow business. "It is a growing market, but do not over-estimate it," says De Swert, who believes that growth is less than 5% per year. "Especially in Europe, margins are extremely low because of high wages and fierce competition."
It is too simple to see the MRO market growing at 6% a year in line with aircraft deliveries. As aircraft, engines and systems become more reliable, the increase in the amount of MRO services required for the number of aircraft being added to the fleet will be in the order of 2.5-3% per year, states Henningsen. He feels most shops can cope with such increases through productivity improvements, rather than building new MRO shops.
Despite such warnings, the MRO market is attractive both to the airlines that want to stay in it, and the OEMs. As in other fields - such as ground handling and in-flight catering - consolidation will take its course. However, it is likely to be a tortuous and complex route.
Source: Airline Business
