The third party maintenance, repair and overhaul business will consolidate further as the dominant companies seek greater economies of scale and airlines turn their attention back to improving costs.
If you were asked to name the landmarks of the aircraft maintenance and overhaul industry over the past year, you might struggle to come up with a reply.
FLS Aerospace bought TEAM Aer Lingus; General Electric (GE) continued to grow through acquisition; and the shortage of skilled engineers continued. These are all obvious answers. But the truth is that the maintenance market has been fairly uneventful.
With good reason. When times are good, efficiency and productivity in the aircraft hangars are hardly top management priorities. The major airlines have continued to do much of their routine maintenance in-house, contracting out the smaller fleets or the heavy D checks. The smaller and start-up carriers have relied on the independents to provide a turnkey solution to their maintenance needs.
But this static picture is changing. Like every other industry, the airframe, engine and components maintenance, repair and overhaul (MRO) business is looking for the bigger profits to be gained through economies of scale. Customers, meanwhile, want the same level of service for less. In a global third party market worth more than $25 billion a year, consolidation is the logical outcome as more mergers take place like that of FLS and TEAM.
"There is no reason why this industry should be any different from other markets," says FLS' chief executive Vilhelm Hahn-Petersen.
While the major airlines still do most of their own routine maintenance, contracting out a relatively small amount, the choices will get tougher as new generation aircraft like the Boeing 777 are introduced. New equipment means expensive new tooling and inventory assessments, at a time when the first major D check is years away. The new aircraft and their components are also more reliable, making the maintenance investment hard to justify unless there is a sizeable fleet. Those carriers that want to do their own maintenance on the new types, or compete in the third party market, will need deep pockets. "If they continue to make small, incremental, investments, they will not gain market share and will lose out. If they can make the investment, then they have a chance," says Hahn-Petersen.
Andrew Todhunter, a principal with The Canaan Group consultancy, agrees that the amount of work contracted out is likely to increase with the new types as some marginal players choose not to invest in the latest equipment. "The change will come over time. It has already started to kick in, but it's very gradual," he says. Few carriers have invested in engine capability for the 777, says Todhunter, adding that this is likely to foster more outsourcing deals or selloffs.
The sale by British Airways (BA) of its engine overhaul operation to GE and the transfer of its landing gear concern to Hawker Pacific are cases in point. Colin Matthews, managing director BA aircraft engineering, says the airline should not resist an inevitable industry evolution. Engines represent between a quarter and one-third of BA's maintenance and overhaul activity, but GE is "tremendously aggressive in doing a high quality job in this area", says Matthews. He adds that the Hawker Pacific deal gives BA a state-of-the-art facility for its landing gear. "As technology changes, you might have trouble justifying your investment based on your own volumes," he explains.
Such arguments have faded into the background as airlines have enjoyed record profits. But when the economy turns down, cost-cutting will be back with a vengeance, along with the contentious issues of how to allocate maintenance costs and how much to contract out. Indeed, the heavy losses are often to be found on the maintenance side of the airline business, a fact reflected by a recent Lufthansa Technik (LHT) survey of 800 senior engineering and finance airline managers. Over 90% of respondents said that MRO costs will exert a growing influence on their airlines' profitability.
A few leading carriers in third party maintenance worldwide (see chart) have turned their maintenance operations into profit makers, but elsewhere the picture is often the reverse. The industry is littered with examples of airlines that have tried to get into third party maintenance in a big way only to pull back later. The US carriers all did this in the early 1980s and most now do comparatively little third party work. In Europe the push came in the mid-1990s. While LHT, Air France Industries and Swissair's ST Technics have built themselves into world leaders, others, like BA and TEAM Aer Lingus, were less successful. In Asia most of the successful major third party providers are joint ventures involving airlines (see P58).
One of the reasons for the failures is that third party maintenance is a completely different discipline to in-house work, says John Hansen, vice-president technical at consultancy Avitas. "You really have two different businesses that you have to manage separately. You can't just bring someone else's aircraft in between yours. You have to have a different system." Morten Beyer, chairman of Morten Beyer and Associates, agrees. Some US carriers, like Delta and United Airlines, perform a small amount of third party work, but their union agreements mean they are not particularly cost-effective, he says. Nor are they geared up to deal with maintenance needs that differ from the core airline's standards. "They can do a C-check every day and a D-check every week, but if they get anything out of the ordinary they fall to pieces," he says.
BA had big ambitions in 1996, when when BA Engineering became a separate profit centre and aimed to generate 50% of its business from third party work. Two years on, the engineering division has been merged back into the core airline and BA recognises that the third party business is a different ball game. "Our ambitions in terms of scale are significantly lower, but not in terms of our ability to be profitable," says Matthews. BA now focuses its third party business on component overhaul and aircraft line maintenance away from the home base. In these areas its third party business accounts for as much as 40% of BA Engineering's activity, says Matthews. Its components business is avionics based, but the carrier plans to develop its business further in pneumatics and hydrolics.
The odds were always stacked against TEAM Aer Lingus making it in the third party sector because of the low level of investment Aer Lingus was able to make over the last four years. The terms of its recapitalisation agreed with the European Union imposed funding restrictions during its restructuring. TEAM was a standalone company with a large capacity for heavy maintenance and had big third party ambitions. While it did improve its efficiency and financial performance in the last three years of its existence, lack of investment resulted in a failure to win sufficient market share.
During the same period the largest players in the third party maintenance market have grown bigger. LHT has the largest third party operation of any airline in the world, accounting for 44% of its overall business, turning in a pretax profit of $56 million in 1997 on revenue of $1.8 billion. Air France is a close second with revenue of $1.5 billion, while SR Technics recorded a pre-tax profit of $45.5 million on revenue of $731 million. The major airline players are closely tracked by the largest US and European independents: Aviation Sales and BFGoodrich in the USA; Sogerma of France; Singapore Technologies and Danish-owned FLS Aerospace. In Asia the biggest airline players are Cathay Pacific's sister venture HAECO and AMECO, LHT/Air China's joint venture.
The original equipment manufacturers (OEMs)have continued to expand their maintenance activities, but remain coy over numbers. GE has the largest maintenance concern, and probably ranks above LHT in revenue. However, engine overhaul is only 30% of LHT's activity.
Pratt & Whitney and Rolls-Royce are also very active in the third party market. R-R has a number of joint ventures but will neither divulge revenue figures nor separate civil aircraft engines serviced from its military business. While the airframe manufacturers have paid little attention to maintenance, few doubt that, once its production and merger difficulties are over, Boeing will fulfil its stated goal of expanding its presence in this market.
The OEMs are also very competitive in the components market, which accounts for 19% and 21% of the businesses of LHT and SR Technics respectively. FLS has identified components as a major growth area and leases $250 million in rotables to its airline customers. Its components services have grown from around 15% of turnover to 50-60%. This competition looks set to increase in avionics, where a major market share battle is in full swing between OEMs Honeywell and Rockwell Collins (see P61).
Some marginal players in this market have already gone down the outsourcing road. Austrian Airlines, part of the Qualiflyer grouping, has closed its heavy maintenance operation, recognising that it will never have a major third business. All of Austrian's heavy maintenance is now done by Shannon Aerospace, a joint venture between Qualiflyer partner Swissair's SR Techniks and LHT. Air France, SR Technics and LHT each do heavy maintenance on one of Austrian's Airbus A310s. Austrian continues to do all the base maintenance, including the C-checks, on its fleet and now barely employs 700 people for its 40-aircraft fleet compared to 1,000 staff for just 20 aircraft 10 years ago.
At present, however, most major carriers are determined to keep as much in house as possible. In the USA, this has been re-inforced by a tightening of oversight by the Federal Aviation Administration, which expects each carrier to police its third party providers. "The FAA tells the airlines 'you are responsible and if you do anything wrong, we will come after you first'," says Beyer. There is also typically a lot of union resistance to a significant amount of work being contracted out. As a result, most US majors prefer to keep control and mainly use third parties during their busiest periods. The exceptions are Southwest Airlines, which contracts out all but basic line maintenance, and to some extent, America West.
Maintenance costs in the USA are among the industry's highest and vary enormously according to the number of older aircraft in the fleet. Maintenance accounts for 8% of total costs at Delta Air Lines, 15% at Northwest Airlines and even more at TWA.
The picture in Asia is similar. The economic downturn and reduction in aircraft fleets has caused an overcapacity crisis that is likely to push third party rates down (see P57). But many airlines still want to acquire more maintenance capability and remain full-house operations. Only time will tell whether the Asian downturn will reverse this trend.
In Europe, third party companies like FLS believe, that in the long term, a recession would be good for business. More carriers would reevaluate their maintenance costs and there would be more outsourcing and greater opportunities for consolidation, believes Graham Springthorpe, marketing manager for FLS. FLS provides a turnkey or integrator approach to maintenance, known as Prime Maintenance Operation (PMO). This means it can meet an airline's entire maintenance needs leaving the carrier only to manage the process.
At present only low-cost start-ups like go and easyJet use PMO but Hahn-Petersen believes there is the potential to go further. "How do industries develop? Is it because there is demand or because the innovative suppliers shape the market? It is one of our goals to shape the market," he says.
FLS is dwarfed by its two largest airline competitors, LHT and Air France, but its acquisition of TEAM has enabled it to double in size and become Europe's largest independent airframe maintenance operation. Post-merger FLS is looking at ways to restructure the company and improve economies of scale by concentrating core airline types at central locations and giving local support where needed.
Meanwhile, LHT, Air France and SR Technics continue to expand their market share. LHT was spun off from the main airline into a separate profit centre in 1995. Germany is a relatively expensive labour market but LHT's strength lies in offering "bundled" maintenance - the ability to do engine, airframe and component services, says Canaan Group's Todhunter. LHT has automated wherever possible to cut labour costs, he adds. LHT has also benefited from major carriers tending to put turnaround times and quality well ahead of price. "The most cost effective solution is a high quality one and high quality means you do it right, once," says BA's Matthews.
Air France Industries, a division of Air France group but not a separate profit centre, is a world leader in Boeing 747 maintenance. SR Technics, spun off from the core airline under the SAir Group umbrella in 1997, is also targeting the high quality market with an even greater focus on airframe overhaul turnaround times.
While maintenance costs and efficiency are not at the top of major airlines' agendas now, these issues will return to the forefront. When they do, some marginal players can be expected to relinquish market share to the major players and OEMs.
Source: Airline Business
