Working Through the Downturn

By Perry Flint
Air Transport World, November 2009, p.28

THE COMMERCIAL AVIATION MAINTENANCE, REPAIR AND overhaul sector has taken it on the chin over the past 12-18 months as business withered and price competition intensified in the face of what IATA has described as the worst downturn in airline history. As carriers have parked planes and reduced utilization, demand for MRO has plummeted, a situation expected to continue at least into the middle of 2010, say some analysts.

According to AeroStrategy, which cites OAG data, airline industry block hr. fell 3.8% in the first nine months of 2009 compared to the same period in 2008. US carriers, which account for more than 33% of the total, flew 8.4% fewer block hr. this year compared to last year. Because they typically operate older and thus more maintenance intensive fleets than their counterparts in Europe, Asia and the Middle East, the impact on MRO activity is even greater.

"The percent of airplanes that came out of the market does not reflect the percent of the workload that came out of the market," confirms R. Gene House, Executive VP and CMO of Greensboro, N.C.-based Timco Aviation Services. AeroStrategy expects that on a global basis, MRO spending will fall 5% this year to $41.8 billion from $44 billion in 2008, which itself was a 2% drop from the $45 billion spent in 2007. MRO spending will not return to 2008 levels until 2011. The Oliver Wyman consultancy sees 2009 maintenance spending (excluding line maintenance) decreasing $2.4 billion or 7% to $31.9 billion compared to 2008.

Worse Than 9/11

No two crises are the same, but with one notable exception the consensus among those interviewed by ATW is that the current downturn is more difficult than the one that occurred following 9/11 in terms of its impact on the MRO sector.

"Both were obviously quite terrible," says Chris Spafford, a partner with Oliver Wyman. "In Sept. 11 there was a massive immediate shock . . . But on the MRO side there wasn't a mass amount of capacity taken out of the industry. This is a far more protracted economic slowdown. It started off with extremely high fuel prices which caused airlines to ground older aircraft, primarily narrowbodies, so from an MRO perspective it took extremely heavy-maintenance aircraft out of the market and a large number of them." The economic crisis that followed "drove further decreases in capacity and further flight hour reductions."

Finally, he says, "the rebound appears to be very, very extended," adding, "2010 will look a lot like 2009 from a market perspective. It will be another challenging year for MROs."

"I believe this downturn is worse than 9/11 in magnitude," comments SR Technics CEO Bernd Kessler. "Parked airplanes are approaching 3,000. That's a higher number than after 9/11." He also points out that the world economy continued to grow in the aftermath of 9/11. Although some economists believe that the recession technically is over, he says this is not the case for aerospace. "I believe that in particular the upcoming winter period is going to be very, very difficult for all of us."

Singapore Technologies Aerospace President Tay Kok Khiang thinks that "there is a subtle difference between what happened after 9/11 and this time around." Following the former, "we saw a very rapid parking of very old aircraft [such as] 727s [and] 737-200s . . . Now this time around some 5% of the global fleet is parked [including] newer aircraft, and of course these are the aircraft we support and are the backbone of the aviation fleet."

An Exception

Interestingly, Lufthansa Technik Senior VP-Marketing & Sales Walter Heerdt takes a contrarian view, stating that from the perspective of the industry's largest player the earlier downturn was more severe. "When I'm looking into sales activities and what we have in the sales pipeline, I really do not see a very big change from the time before this crisis," he says.

Company financial data appear to support this assertion: LHT's revenue from third-party MRO activities rose nearly 14% in the first half of 2009 compared to the year-ago period--although this in part may be attributable to the absorption of Swiss International Air Lines' technical operation--whereas revenue climbed just 5% between 2002 and 2001 and fell 2% between 2003 and 2002. LHT continues to expand. This year it has opened additional lines and/or stations at Milan (LHT International), Malta (LHT Malta) and Sofia (LHT Sofia). LHT Switzerland opened a VIP cabin interior shop.

Nonetheless, Heerdt is in an agreement with his counterparts that "we are seeing tremendous price pressure." LHT's operating result fell 8.9% in the 2009 first half and Lufthansa Group cited "greater client pressure on pricing" as one reason in its report for the period. It also bluntly criticized "airlines' unsatisfactory payment practices, including outright defaults."

"I've been in this industry for 25 years and this is probably the most intense price pressure and pricing situation I've seen in the marketplace," Kessler says. House believes that as outsourcing has accelerated over the past decade, airlines "have become more sophisticated; they've got more professional sourcing people partnering with the technical people."

Defer, Delay, Destock

Beyond the intense pricing pressure on MRO organizations, House and others identify a more powerful trend: Airlines simply are doing a lot less maintenance. "This is the issue of the day for most of these MRO suppliers," says Michaels. "Deferred maintenance and destocking is what is really reshaping their world even more than the 4% [block hr.] capacity reduction."

"We're seeing the impact not only owing to the reduction in the number of aircraft that are flying but the remaining aircraft that are flying are in many cases flying less hours and cycles," says Delta TechOps VP-Marketing and Sales Jack Turnbill. For customers on comprehensive support programs "where they pay a power-by-the-hour type rate [as opposed to time and materials], if they're flying less hours there is an impact on the revenue generated," he notes.

Airlines also can burn through existing inventory rather than paying to repair or overhaul parts, a costly long-term strategy but one that preserves cash in the present. AeroStrategy estimates that the industry is holding $44 billion in parts and components dedicated to the MRO supply chain, an amount that "is larger than current MRO spending." Carriers control 61% of this inventory, according to the consultancy, and MRO suppliers 20%. Aero-Strategy notes that between 2002 and 2003, US airline capacity declined 4% while carriers' maintenance spending plummeted 12%. This year it expects a 6% fall in fundamental MRO demand from airlines to translate into a 10%-15% reduction in revenues for overhaul and repair services and a 15%-25% decrease for service parts. The trend is self-correcting but can be painful to suppliers in the near term. "You can get away with it for awhile, but it affects dispatch reliability. Eventually you've got to restock," Michaels says.

Survival Strategies

With revenues shrinking, MRO providers are downsizing, accelerating introduction of lean concepts, developing new business opportunities and services, entering long-term relationships with OEMs and establishing facilities or partnerships in lower-cost regions of the world.

House says that getting costs down immediately is crucial: "You can talk to somebody about a five-year process improvement plan and you'll get heads nodding up and down about how wonderful it is, but nobody's really paying much attention to that. They are looking at what we can do to get expenses out of the next quarter."

Kessler says SR Technics began managing for the approaching downturn in early 2008. He has introduced Continuous Improvement into the company. SRT is controlling head count tightly and has reorganized its corporate structure and reduced top management from 13 people to five. It also made the decision to close its Dublin facility, which was engaged primarily in heavy maintenance, with the loss of 1,100 jobs. It has cut 335 from its Zurich workforce and 90 at Stansted. Furthermore, he says it is in the final stages of selecting a location on the periphery of Europe to establish a narrowbody MRO facility where it can take advantage of lower labor costs.

SRT also is "finding creative innovative ways to repair parts" and is establishing a repair development engineering group. In cooperation with its Abu Dhabi-based parent Mubadala Development Co., it is creating a leasing venture in the emirate primarily focused on components. The unit "will offer customers liquidity through sale/leaseback of components," says Kessler, with SRT handling the repair management.

Tay says "keeping costs low has always been a modus operandi" at ST Aerospace. It manages the peaks and valleys by using contract workers as well as fulltime employees and is introducing shorter work weeks and reduced hours. Like SRT, it is a "strong adherent of kaizen," having introduced the Japanese CI program 12 years ago. Its leading position in the passenger-to-freighter conversion business also helps, such as its 757 deal with FedEx that will keep ST Mobile Aerospace Engineering in Alabama busy through at least 2015. And it is the only company actively doing 767 conversions. ST Aerospace has been careful in pursuing growth opportunities as well. "If you look at the last 3-5 years, the focus has been on low-cost areas around the world," he says, citing its ventures in Panama, Shanghai and Xiamen, and its landing gear venture with Iberia in Spain.

Tempe, Ariz.-based StandardAero introduced reduced work weeks and furloughs but is growing. Like SRT, it is owned by a deep-pockets Middle East investor, in this case Dubai Aerospace Enterprise. The company's diversified portfolio, with activities in government/defense and business aviation as well as regional and helicopter engines, acts as a natural hedge in a downturn, says President and CEO Rob Mionis.

"We are seeing some softening--more than softening I guess--in business aviation and also the turboprops. At the same time our regional airline business and military business are quite up year-over-year, so it's balancing them out a little bit."

Last month StandardAero broke ground on a major expansion of its facility in Winnipeg in order to begin overhauling CFM56-7 engines. This represents its first foray into the large commercial engine market and follows on an $850 million three-way deal with GE Aviation and WestJet announced at the Paris Air Show under which it will maintain the Calgary-based LCC's 737NG engines for 12 years and become a "GE-designated fulfillment center" for CFM56-7Bs, committing to purchase parts and material from GE and work with it to develop repairs. The agreement builds on the company's longstanding relationship with GE covering the CF34.

If You Can't Beat Them

The deal is symptomatic of the evolving role of OEMs, particularly engine-makers, in the MRO aftermarket as they embrace long-term partnerships with existing service providers rather than exclusively developing their own networks of repair facilities.

"I'll be very frank that the MRO engines and components business is largely an OEM business in the sense that whether the OEM does it himself or not or through a partner, he still gets the sales in material, which is the bulk of the cost," Tay explains. "And on the airframe side, having hundreds if not thousands of direct workers is not the preferred direction for most companies. So hopefully what we saw in the last three years is a gradual shift in the OEM direction into trying to foster a network in partnership with what they perceive to be the stronger MROs." ST Aerospace, for example, has extensive relationships with GE (CFM56-3, -5, -7) and Honeywell (avionics and mechanical systems), among others.

Through its parent Mubadala, SRT is forging relationships with GE and CFM International. At the Paris Air Show, Mubadala and GE completed their "strategic partnership" announced last year under which GE provides technical support and services to SRT and its other maintenance company, Abu Dhabi Aircraft Technologies, including technical and corporate training support, comprehensive material support and the granting of licenses to service certain GE engines. Separately, CFM is supporting the partnership for CFM56-5s. Rolls-Royce also has partnered with Mubadala, launching a joint venture to provide on-wing care for Rolls operators in the Middle East through ADAT.

Locked Out

As OEMs and MRO companies turn to partnerships, those on the outside may be challenged, particularly if they lack a deep-pockets owner or investor or captive airline, says Spafford. "My perspective is that the business model of the absolutely truly independent MRO [is] an extremely challenging and difficult one going forward . . . They can absolutely perform the best service, have the best customer care, the best quality, some of the best turn times. That is all great but everybody else is doing that as well. Everybody is implementing lean. Everybody is doing CI. That's not a differentiator like being able to bring $100 million in capital to the table and say, 'I'll buy out your parts and finance them. I'll do all your initial spares provisioning so you never have to.'"

Turnbill cites TechOps' size--it is managing more than 800 airplanes in the combined Delta and Northwest fleets--that "allows us to provide better products for MRO customers as well. We compete with the OEMs in the MRO market but we're also one of their largest customers." He adds, "we realize that we've got to look globally to realize our long-term objectives and we're looking at opportunities in Asia, in the Middle East, as well as Latin America."

Thus even as MRO shops remain cautious about the present, they have an eye out for the future. "We have seen that every 5-7 years we have a cycle and this is another cycle and we have put our strategy on growth and we will stick to this strategy," says Heerdt. "We are going ahead with all our plans and we continue to recruit and train people," Tay states. "All the initiatives that we are undertaking will continue, because they are very important to making sure that we position ourselves very strongly when the recovery comes."

Kessler, however, adds a note of warning: "I always tell my people, don't expect that the so-called good old times are coming back. That's not going to happen at all. This enormous pressure in the marketplace is going to continue."

ATW

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