OpEd by Nico Buchholz
The bell rang loud and clear when the world‘s mobility came to a grinding standstill within two weeks. No-one initially thought it would be that dramatic when it started but by now the situation is
- for some a required reset (which before they did not know how to start)
- For some a convenient coverup of past mistakes (even if back then some could not have been seen as mistakes)
- For most involved – whole aerospace and economy – a catastrophic event
- For all a severe restriction of mobility
- For some an opportunity and for some a plain disaster
…some people call it a vision, some call it disruption, and some call it innovation and for some, the focus is versatile resilience. The truth will be in between or encompass most of all this. There is insourcing, outsourcing, and resourcing – the success rate, however, depends on the view embraced: is it triggered by a short term balance sheet requirement/idea or does it have a lasting effect on the total cost of ownership? These thoughts apply to OEMs and Airlines alike. As realized by many already during 2019, several industry indicators moved into the red (ASK growth rate, new orders,..).
Let us focus on key elements for success in the aviation world. The airlines – as the only real “cash-in” members of the system – are reluctant to shoulder additional planning incompetence by OEMs and service providers. Whilst in some cases it may be airline self-inflicted, it is true that much on the OEM side has become very unreliable whilst public services in many areas have a huge room to improve – recently there has been only one program (more or less) on time among the OEMs. Even for tolerant consumers, unreliable products are unacceptable. As someone said: “precise reliable prediction is the new currency”.
Slow apprehension to changes or problems – whether among OEMs or airlines, that the concept of economy of scale in terms of aircraft size has been over nearly a decade. A discontinuity of current patterns is required in those areas where tensions are rising. Our industry thrived over the last century on the key elements of Speed, Range, Size, Safety, Technology, and Economics. These created the base of the industry’s growth.
Most of these elements have reached their limit. We need rigid processes, but at the same time, these rigidities lead to mounting tensions in the system. Ideas are needed to find a way forward to enable a conservative industry which is also at the forefront of technology.
We are all consumers, so actually it is not that difficult to understand what is needed. Unfortunately many are caught in a “process cage” and get disrupted by competitors. Smartphones, for example, disrupted our way of doing business.
A simple way to look at disruption is going beyond looking at “can it reduce my cost”? Take 3D printing: it produces complex part assemblies and reduces waste (some parts milled before now see a reduction of waste in the magnitude of 80%).
We need an innovative, but holistic mindset. The A380 is another example of disruption in terms of the production requirements but only an evolution for the operator with limited commercial benefits. This singular focus has now killed this project. This became very visible in 2011, nearly a decade ago.
In the airline world, we can pride ourselves that for example CO2 or NOx has been reduced by 80-90% since the dawn of the jet age. But politics really focuses on noise because that drives the votes. Quietly airlines have opened two new single-aisle city pairs per day in recent times whilst over the last decade long haul direct services grew by 35%. Both were triggered by political global openings but it was mostly due to new better performing single-aisle and twin-aisle aircraft. So it would be fair to say the A220 (triggering NEO and MAX) and the 787 (and later the A350) were disruptors or innovation?
On the OEM side, there will be a lot of replacement deliveries. This is a necessity, so it should not be interpreted as airlines love the aircraft they get as replacements. The old one needs replacing and what is available is better, so let’s take it. Few airlines have the knowledge, competence, financial strength, and guts, to change their operating model. Those who do not have the financial strength will change the way they deploy these aircraft.
Whilst OEM program cycles are measured in quarter centuries, airlines themselves do not have that luxury. As someone put it: the key is “to meet the traveler’s total mobility needs”. The OEMs look at vertical integration in the supply chain to create an upside – decreasing cycle time and inventory. The value potential of this strategy alone is worth 20-40%. Obviously, this most likely remains within the OEM world.
Another buzz word these days is “emerging markets”. The definition shows the challenge: from the point of view in Europe and North America, Africa and Asia are emerging markets. But Asians see Europe and North America as emerging markets. “Emerging” signified by the simple understanding of the source of growth. A standard airplane to go into a market reduces risk, but then the key is also to go boldly and be forthright about why an airline wants to get into a new market.
This is just a small top-level view on opportunities in the value chain without touching on other important stakeholders. Stakeholders like Lessors who hold nearly 50% of the commercial aircraft portfolio or the airports that can disrupt the whole business model.
Customers feeding the system with cash – called passengers and shippers – are becoming more knowledgeable about the options to satisfy mobility needs. Hence be it improvement or innovation or disruption, there is space for all and even a combination. Eventually, consolidation will accelerate as more players start using some of the previously described elements. As ever, the slower ones face extinction.
Considering this all was true prior to the near shutdown of aviation due to the COVID19 virus it comes as no surprise that there is a panic in the Aerospace sector. In our global world logistics for basic needs like nutrition and medicine, aviation is seen as a provider of services. This currently helps our aerospace industry but does not eliminate the requirement for significant and immediate reset requirements.
The virus has simply crystallized the required industry reset. It is not rocket science to state that this – on a smaller scale – happened after Sep11th and other disruptive events. None of these, however, have been the “Mega Black Swan“ as this virus has been.
Looking today into a simplified crystal ball at flight-level 300 provides some thoughts. Airlines, OEMs, and lessors need to rethink their business model.
OEMs have for several years sold into a non-required replacement cycle (at least not to the extent of current backlogs) which now will create many cancellations and deferrals. At the same time, OEMs ask for government support to restart production for a market consisting of fewer airlines with fewer aircraft and a market that needs to find a use for thousands of surplus aircraft.
This will test the standard business cases of a lot of the Lessors as they have to remarket aircraft in a tight market into which they also want to place their new orders without killing residual values due to shortened aircraft lives. But the airlines, as the cash generators of the system, have no surplus cash. So when they restart, many have to rethink business models and the requirement to derisk with smaller, fewer, and older aircraft. It will be some time (fuel price depending) before airlines move to brand-new aircraft which also addresses the environmental topic. The environmental issue will – unlike the Virus – not go away.
All this equipment juggling and decision tradeoffs for a market which maybe 10-25% smaller.
As mentioned previously, the risk (trip cost) versus reward (seat-mile cost) proposition will attract significantly more attention. Airlines, may for a while, act sensibly by not dumping surplus-capacity-filling-fares into the market.
Airbus and Boeing recently brought several new or upgraded models into the market, hence the order glut. There is a risk for Boeing that some 737MAX may actually go straight into a non-operational future. Airlines have learned to radically shrink and adapt their networks. Any growth will keep the lessons learned in mind.
It was visible in this crisis when looking at some established airlines and/or management competencies/experience. Traditional networking tools will cease to be the sole driver of fleet and traffic dimensioning. New business models from within the airline world, but also from some agile providers in the supply chain will dominate the growth rates in our industry. Some management organizations will have a hard time admitting to this. Key questions remain on the sensibility to hub or go direct, including the environmental repercussions (“burning fuel to carry fuel“).
So to conclude this thought piece which does not provide solutions – which some companies and advisors are already working on, let us look at some potential trends:
- Rating agencies may change the way they look at aviation companies (Like potentially adding elements like the value of the network and the fleet structure to name just a few elements)
- Traffic patterns are likely to change – be those route systems, size of aircraft, the utilization of the aircraft with an impact of the MRO industry
- Companies may reconsider what their unique sales proposition really is (example: a simple question of what really makes an airline?)
- Will the focus be on single-aisles or wide-bodies and what impact does fuel price have?
- How will the lessor model evolve when looking at current airline financials?
- How will OEMs and the supply chain adapt to an increased flexibility requirement of the operational units creating the transport space?
Also, it is worthwhile applying a scenario looking back on today from in 2021, but doing this today!
- What is real agility and how much was needed, is flying on-demand coming (back)? What about the total door-to-door network planning concept?
- What did the agile airlines do to foster and cement their success; how did the door-to-door concept work out (tools exist in some boutique companies, but are not part of typical network-management organizations or worse seen as a competitor) and did this generate cash reserves?
- Did the virtual airlines function well as capacity providers globally?
- What does the global employee look like now?
- Did the smart IT systems really deliver?
- Did it help to shift from “improvement“ to disruption?
- Did the environmental constraints really stick only to Europe?
- Which of the forecasted megatrends (globalization, deflation, shareholder value, …) actually are really here to stay?
There is no exact blueprint solution. National interests, as well as different rules, will allow a kick start somewhere whilst others will struggle through a painstakingly long process.
Notwithstanding the length of the shutdown, most experts agree that the rebound will be on a lower level and that it may take anything between 18 and 60 months to get back on track. Domestic travel may come first, international is likely to follow as restrictive measures need more coordination to reopen segments. Asia may open before Europe and North America. North America took nearly three years after the financial crisis to come back, but it did so on a lower yield base and some consolidation.
The supply chain – everybody thinks of Airbus, Boeing and alike, but there are ATC, Airports,… – will look different and no one yet knows how. The US gave $50 billion to the industry…that was likely for a first wave. Will there be more?
European airports could need between €1 and €20 billion depending on how traffic restarts. Will smaller hubs survive or will we see a concentration to the truly big hubs notwithstanding some hub bypassing? And, as usual, after a crisis, there will be some consolidation in all markets – OEM, supply chain, airlines, and others. Where will Africa and Latin America end up?
Finally, there is the obvious question: can we replace some parts of aerospace/airlines with other mobility forms like road, rail, ship? The current crisis is a unique opportunity although in many cases we come back to “Two miles of concrete can give you the world, two miles of rail or road lead nowhere“.
As a consequence, there are several takeaways for respective business segments, but again a non-exhaustive list:
As raised earlier, airlines create cash in the entire commercial aerospace system. Thus the focus is now more on airlines but again, airlines only function with airports and other services. Some airlines have the cash to weather the storm, some don’t. How will states support without distorting competition or even in a competing region?
Cash refund or vouchers – there is a case for both. If my trip was for a one-off event, a voucher is useless.
Airlines are needed for strong trading countries, does that imply a resurgence of large state carriers? If cash would be the measure for survival, should then only WIZZ Air survive in Europe (Bernstein Research gives them the most endurance on cash available)?
Which airline business model is the one for the future – network, low cost? What will traditional transit airlines do? Will network carriers face a slower start than regional carriers or LCCs? What is the impact of residual “baggage” or hedging policies?
Fuel price and environmental considerations are the other leverage unknown or unexploited at this point. And finally consumer behavior: passengers have been accepted all measures as given – lines at security, customs, passport, check-in. Will they therefore just accept another control should there be health control? I would say yes having lived and worked in developing countries in the 80s where all this was standard and having seen the efficiency of the health controls in some Asian countries.
Before the airlines come back, the economy needs to move as aviation is coupled to economic growth. Airlines have been flexible and resilient in the past and will, therefore, find ways to rebuild a network even with the uncertain rules in some markets they operate in.
Large trade connections will drive growth. Business travel will come back but at potentially different yields. The current shutdown has created on the one side, ways to avoid traveling but on the other side, created more desire to travel for meetings and negotiations. As some people would put it: we have moved up the technical achievement chain…from Telex to fax to email to WhatsApp (and alike) to voice-messaging to video-messaging. So will those newly found ways to communicate replace air travel or enhance air travel?
So airlines are here to stay but….
- May shrink in terms of passenger numbers, aircraft and/or size of aircraft if the new baseline for traffic starts at 10-30% below pre-crisis although this might be offset by several bankruptcies in the airline world
- Yields may be lower for a while
- They may need new innovative network planning tools/processes to find cost-efficient paths to restart
- Replacement order (new aircraft) business cases become challenging due to low fuel prices and potentially0available aircraft in the market
- Fleet planning will refocus on the flexibility of assets and the immense value of airline-specific optimized fleet structures
- May rethink their business model on what is truly required
- May have to implement some significant write-offs (impairment) in their books
- Several airlines will go into defacto state ownership, partially hiding past management mistakes
OEMs, larger or smaller Tier1+++ may require the same government bailout as the airlines. Due to the reduction in volume, order books are likely to decrease in the four digit range during their forecasting periods due to overcapacity. Certain aircraft will win on their risk vs reward analysis, be that on cost, profit, and/or environment. Consequently, I expect:
- 2019 production rates and planning for 2020+ will not be seen for some years
- Airbus may lower its production rate on the A320 lines by a double-digit number of aircraft per month, Boeing may restart it‘s 737 production at a rate significantly below the rate at the beginning of 2019.
- Mitsubishi may enter the market at the “right“ time, Embraer and Airbus (A220) products may win some share of the market because of good seat-mile cost and low trip costs (risk)
- The 777X may enter the market too early
- Truly large long haul aircraft will be slow selling for some time; current large units may face earlier retirement with hits into balance sheets of OEMs, airlines, and financiers.
- Used aircraft volumes will place pricing pressure on new deliveries.
- Production system lead times may need further reduction to offer airlines more flexibility.
- With approximately half of the aircraft going to market through the leasing world, lessors may need to adapt their models.
Will have to adapt to lower volumes with the impact of losing some economies of scale whilst at the same time facing price pressure from the OEMs that may have to sell into an even further price-sensitive market filled with an oversupply of aircraft.
To keep the vital air transport system functioning, there will be some vertical integration in the supply chain potentially all the way to the OEMs. As a vital piece of global trade “going-it-alone“ solutions are suboptimal for the airline world when looking at the global system. Politics will fortunately or unfortunately have to play a role to avoid too much bias which may derail some economies we may have to rely on.
About the author:
- Studied aeronautical engineering and management in Germany, the UK, and the USA
- Held senior positions in the Airframe, Engine and airline world from engineering focussed via commercial and supply chain during the last 30 years
- Has lived in several countries globally
- Advised most OEMs on airframe and engine developments
- Had highest employee satisfaction ratings also in difficult years
- Together with his team launched some game changes into the industry whilst also being an early adopter of canceling certain aircraft types
- Advises several companies in the aerospace environment
This presentation represents the author’s opinion based on his professional experience. This does include forward-looking statements when made. For forward-looking statements, there is a risk that they may not be accurate. Readers are cautioned that plenty of factors may affect future growth, results, performance, and market behavior. The forward-looking statements set forth herein reflect and are based on the author’s professional experience up to the end of March 2020 and are subject to change after such date. The author expressly disclaims any intention and assumes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. The forward-looking statements contained in this text are expressly qualified by this cautionary statement.
Photos: Nico Buchholz unless otherwise mentioned
Chart illustrations: Nico Buchholz unless otherwise mentioned