Understanding the commercial aerospace industry sometimes benefits from stepping back and looking at it from a distance. This chart shows that the average domestic air fare, when adjusted for inflation, has continued to decrease in recent years.
This next chart enables us to step back even further for more perspective. The recovery in 2009 is driven by ancillary fees (those bag fees).
These two charts provide industry watchers with what may be the single most important driving force in commercial aerospace. Air travel has become, and is continuing to be relatively cheaper every year. We would suggest that everything about the industry be viewed through this prism. The airline industry is fundamentally a commodity product in which the low cost producer wins. When coupled with the perishability of the product, as an empty seat can never be re-sold, the drive for lower costs impacts the entire supply chain.
Because airlines need to relentlessly provide more seats at continually lower costs of production, the industry supply chain behind the airlines must also to follow the same path. Every company that provides products or services to the airlines must also relentlessly work to cut its costs. And since fuel costs have been rising steadily in recent years, even more pressure is placed on the remainder of the supply chain.
The Impact on Airframe OEMs
One interesting take away from examining the big picture is the implications for the two big aircraft OEMs. They have the largest amount of capital at risk, and the largest labor forces in the industry. Keeping the price of new aircraft (and operating costs) low is critically important to airlines, and the OEMs have dramatically increased both their productivity and held the ground with inflation-adjusted aircraft prices in recent years.
A decade ago, there was a great difference between the final assembly lines at Boeing and Airbus, and the difference in the number of personnel between the highly automated Airbus factories and older Boeing factories was quite noticeable. Today, both companies are at the forefront of automation, and both Airbus and Boeing are moving towards an even greater deployment of robots. While such devices may have a significant up front cost, they will not incur the long-term costs of labor. No holidays, no pensions and no health care premiums. And they never get tired or take the weekend off.
Boeing provided an example of how compelling the impact of robots is on the 777 wing painting two weeks back.
The compelling benefits shown in the chart above resulted from simply painting the 777 wings using robots instead of the traditional, more labor intensive, methods. Of course, the real benefit is consistency, as the production output from the task is the same every time, for as long as the system runs. Every factory manager has dreams of consistent, high-quality output. The CFO loves the fact that savings mount daily.
Consider the impact from a people and shareholder point of view. Airbus and Boeing have different core shareholders – EADS’s core shareholders are nations within the EU. These nations want their ROI measured in providing and protecting a highly skilled and well paid labor force. Such shareholders provide EADS with fabulous flexibility because EADS executives do not have to worry about the next quarter’s numbers to the same degree as their counterparts at Boeing, which does not have government shareholders. Consequently Boeing has to deliver sparkling financial performance every 90 days or risk scathing feedback from Wall Street, which they have recently experienced through the multiple 787 challenges. Opinions vary on which model is more efficient or better, but both companies are run rationally by their management teams to satisfy their shareholders and stakeholders.
From a longer-term perspective, each model has different characteristics. EADS, through Airbus, is able to offer its customers more stable production rates than Boeing can. Airlines love stability and predictability. Moreover, EADS/Airbus can offer very competitive pricing because its shareholders are not dividend focused. Remember the primary dividend for EU nations comes by way to well paid, high skilled citizens paying high taxes.
Boeing has had a fractious relationship with its labor force. As orders wax and wane, Boeing shrinks or swells its labor force. As with EADS, their labor force is also highly skilled and well paid. Boeing’s unions are legendary and may be among the most powerful in the US. Boeing’s use of an expanding global supply chain could be seen as a part of the attempt to gain even greater labor and cost flexibility.
The force driving change, lower yields, will make the future for both OEMs more complicated. Neither business model can drive down production costs without making fundamental structural changes in their processes and skill-set. But robotics and automated manufacturing will provide an interesting alternative. Boeing benefits from using robotic production because it provides them with a predictable cost structure that can (literally) be switched off when necessary to adjust to the cyclical market. The improved production efficiencies and lower costs are delightful additional benefits.
EADS cannot flex its workforce in the EU so easily. So having factories outside the EU, in China and Mobile, Alabama, provide an excellent place where to grow or slow production – while keeping EU plants humming at a predictable pace. It also helps that EADS made sure it went to a location (Alabama) that is “right to work” friendly, as did Boeing with South Carolina. Location and automation are two factors working against the union efforts to maintain jobs and a strong labor force. Both OEMs are trying to build in as much flexibility as they can to ensure they deliver products to customers as competitively priced as possible.
The Next Generation and the Talent Shortfall
But there is another twist to make it even more interesting. We are seeing a global shortage of skilled aerospace engineers. The shortage looms even more as older engineers retire. There are thousands of aerospace engineers at Airbus and Boeing who hail from all over the world as contractors to help alleviate the shortage. Airbus is moving its design facility to India – taking the jobs to where it hopes the people are.
We have seen the aerospace industry become thrilled over tenths of a percentage improvement in fuel burn. Why? The answer is because we have reached the pinnacle of current technologies, and needs another breakthrough to achieve another level in efficiency. But paradigm shifts are disruptive, and the aerospace industry must manage disruption because it operates in a more fine balance than ever. Which is why Boeing is working future programs as derivative models. It is a much safer play. MAX, for example, is way less risky than a new CFRP (carbon fiber reinforced plastic) airplane. For Airbus, neo is also a low risk way to push the envelope.
We believe one has to watch the single aisle market closest because this is where the two big OEMs have the highest demand, and the most capital at risk. These programs are the money-makers and bellwethers for the industry, and the OEMs will protect their franchises with every tool available. The current advantage of the big two is economies of scale — as amortizing development cost over 42 aircraft per month is easier than over the 10 or 15 units per month that Bombardier or Embraer plan to produce.
Even with substantial scale economies, Airbus and Boeing will need to relentlessly cost-cut to keep aircraft prices in line with inflation. Watch for growing robotics deployment at Boeing and Airbus (which has deployed a lot in its Hamburg A350 factory already). The key challenge will be their ability to develop creative ways to work around looming engineering and skilled labor shortages. And looming in the distance is China, armed with massive funding and endless patience. The need for continuous improvement is just that – continuous. Until the next disruptive technology arrives, execution and cost-effectiveness will be the driver of profitability at the OEMs.