First, the good news. Global airline yields and traffic growth are on the upswing and have contributed to a significant expansion of aggregate industry revenue to approximately $470 billion in 2007. This is a welcome development after years of staggering financial losses. The bad news is that airline costs, led by a doubling of fuel prices, are increasing at 4%-5% per annum and will reach $450 billion, resulting in a paltry 3% estimated operating margin, according to IATA. Finding new ways to control costs after years of belt-tightening is the central challenge confronting airline procurement and supply chain executives.
Consider fuel, which at 20%-25% of a typical airline's cost structure (and in some environments up to 50%) is a critical driver of financial performance. Hence, airlines attack fuel consumption from many angles, of which four are key. First and most simply, many have endeavored to pass on fuel price increases to the consumer via surcharges. Second, airlines micromanage the operation to reduce fuel burn, e.g., more aircraft towing, less APU usage and even monitoring of individual pilot performance on managing fuel. Third, airlines have become more sophisticated in fuel hedging and associated policies. And finally, after many years of aborted efforts, the airline alliances have started to leverage aggregated buying power with respect to the basic purchase of fuel.
There are numerous challenges and opportunities in procuring maintenance services. Integrated maintenance packages, which combine MRO services, inventory management and engineering, are an increasingly popular approach allowing airlines to simplify operations and free up capital from investment in nonproductive inventory. However, procurement of integrated maintenance packages requires a different skill set and approach. Relations with suppliers become much closer and interdependent, such that contract, supplier and service-level management skills are more important.
Furthermore, cost transparency is vital to ensure that competitive costs are being delivered. A second issue related to maintenance procurement is how to leverage an increasingly global supply base. To what extent should procurement look to suppliers in low-labor-cost regions to reduce costs? In heavy maintenance, for example, many airlines are now sourcing from East Asia and Latin America -- locations that were off the radar screen just five years ago. Another emerging cost-containment tool is the use of PMA parts. Current penetration is just over 2% of the $15 billion spent annually on maintenance materials but is growing rapidly. The entry of a major OEM (Pratt & Whitney) into the fray promises to expand cost-saving opportunities. Airlines must determine whether to attack OEMs by aggressively embracing PMA parts usage or to create airline-OEM material supply partnerships. Complicating the PMA issue is the reticence of lessors to allow PMA parts installation.
The other most significant cost item is ground handling. This activity is labor-intensive and in many regions heavily unionized, which makes cost restructuring risky. However, many airlines consider it noncore and are making moves to outsource. Lower cost is driven by labor productivity and economies of scale at airports, so this does provide advantage to the larger suppliers (many times the airport itself or the local carrier). The outsourcing trend by startups and low-fare carriers has also facilitated the growth of a number of large global players such as Menzies and Penauille/Servisair.
Finally, inflight services (air navigation and airport fees), which account for nearly 10% of the industry's cost structure, have also come under scrutiny as more airlines seek to negotiate better commercial terms and expand service provider accountability.
Procurement and supply chain have always been the most demanding (and often under-appreciated) functions in airline organizations. The challenges and opportunities outlined here point to the increasingly strategic role they will play in airline operations. Indeed, effective procurement and supply chain practices will separate winners from losers in an increasingly competitive and global aviation industry.
By Kevin Michaels and David Stewart of AeroStrategy, a management consulting firm devoted to aviation and aerospace aerostrategy.com.