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Monday, May 1, 2006

Aftermarket Outlook

David Evans, Editor

Out of the Crisis of Costs, Opportunity

The problem with predicting the size of the aftermarket industry is that it depends heavily on the price of fuel. Crank up the price of fuel and the aviation industry takes a dive, and with that plummet goes the aftermarket industry. Then again, hold the line or slightly decrease the price of fuel and the aftermarket industry is looking at a viable environment.

The aftermarket industry might be described as the maintenance and upgrade activity on an airplane after it leaves the factory. As Dr. Morris Cohen, founder and chairman of the board of MCA Solutions, a decision support company specializing in aviation, said, "We are dealing with capital intensive products, airplanes, that are in service for many years. They have to be maintained and repaired over an extended period of time, and at the same time there is pressure on the industry to cut costs." (See p. 9 for related story on MCA Solutions.)

The big three costs, he said, are fuel, labor and maintenance. "The question is how do we keep flying at the lowest cost?" he said. "The maintenance and repair side is a major cost driver, and that represents an opportunity to improve performance and cut costs," he said. "The fundamental problem is that you've got a piece of equipment that costs millions of dollars; it has to be kept flying, and it has to be done safely."

Or, as one wag quipped, "An airplane is the most expensive piece of machinery that goes higher than a 12-story building."

Having said this, the Federal Aviation Administration (FAA) provides virtually no insight into the size of the aftermarket industry. What it does do is provide estimates of the overall health of the aviation industry. Its latest projections, for years 2006-2017, show that the industry is very sensitive to the price of fuel. As FAA Marion Blakey says in the introduction to the forecast, "We face challenges, but ... we're confident that the future holds promise."

"The future" she talks about is over the long term, not short term. As in the case of Pentagon weapons planning, the "outyears" always look better, budgetarily, than the near term, with lower costs to buy and operate glitzy new weapons platforms. Put another way, the aviation industry in the FAA's forecasts looks much healthier in future years than it does, say, next year. Consider the price of oil, which is expected to decline in future years despite recent increases. The FAA forecast says:

"[The] OMB [Office of Management and Budget] forecasts the price of oil ... to increase by 15 percent in 2006 following the 40.5 percent increase in 2005. The cost of oil is expected to decline by between 0.6 to 2.5 percent annually between 2007 and 2012 and then rise by just over 2 percent for the balance of the forecast period."

The rosy scenario

By this means, both the transport category and general aviation segments of the industry are expected to grow during the forecast period. The FAA's optimistic forecasts are also based on the lack of a successful terrorist attack on aviation, and the absence of "major contractions" of the industry through bankruptcy, consolidation or liquidation.

This last may be optimistic, given the parlous economic straights of the commercial airline industry. Consider that legacy carrier Delta Air Lines is in bankruptcy, and low-cost start up carrier JetBlue Airways has been losing money, despite a relatively new fleet of aircraft and outsourcing of maintenance (see AM, March 2006, p. 14). Both carriers, among others, have been afflicted by high fuel costs. The FAA clearly regards high fuel costs as a major risk to its forecast:

"Higher fuel prices cost U.S. commercial air carriers $9.6 billion in ... 2005, essentially wiping out the significant improvements made by the legacy carriers in reducing their operating costs. The legacy carriers, which currently account for 62 percent of the industry's domestic capacity and carry 52 percent of the industry's domestic passengers, are at most risk from higher fuel prices. If oil prices (and jet kerosene prices) had stayed at 2004 levels in 2005, most carriers ... would have been profitable. This years forecast assumes $54/barrel oil in 2006, falling gradually to under $51/barrel by 2010. With oil prices in the $50-$55 range, it is unlikely the industry will return to profitability in 2006."

"In a high oil price scenario, the potential exists for major supply disruptions/dislocations and/or increased passenger inconveniences, either of which could significantly lessen capacity and passenger demand and reduce competition in many markets. In a $70/barrel plus scenario, supply disruptions would most likely occur through liquidation and/or further contraction of mainline carrier route structures."

In other words, high fuel prices are quite likely the norm, and carriers must look to reducing labor and maintenance costs to achieve or preserve profitability. This imperative lies behind the airlines' pugnacious efforts to pay less for labor and to cap maintenance costs.

Up but aging

Regarding general aviation (GA), the FAA says it relied heavily for its forecasts on "discussions with industry experts." According to the forecast, general aviation manufacturers shipped 2,606 aircraft on 2005, a 10 percent increase over 2004. But as Clint Crookshanks of the National Transportation Safety Board (NTSB) noted at a recent symposium about the aging general aviation fleet, "Airplanes coming off the production line are not reducing the average age of the GA fleet."

He pointed out that there are presently an estimated 210,000 GA aircraft in the U. S. fleet, with an average age of 35 years. By 2020, he said, the average age will by 50 years. "So we're not affecting the average age of the fleet with new production."

Various speakers at this symposium lamented the lack of maintenance, the poor maintenance, and the bad maintenance that compromises the safety of many GA aircraft. "We are beginning to provide type-specific training for mechanics," said Neil Probarz of the American Bonanza Society. Whether that will be enough to assure the safety of the aging GA fleet is an open question.

John Goglia, a former member of the NTSB, pointed out that in 2004 "we produced 6,400 A&P [airframe and powerplant] mechanics; 10 years ago we produced about 14,000." This reduced number of mechanics is going primarily to the airline industry, not to the maintenance of GA airplanes. Thus, at a time when GA airplane structure, wiring and other components is likely to come under increasing scrutiny (and FAA mandates), there are going to be fewer A&P technicians to do the work.

Rotary wing needed

With respect to helicopters, Rolls Royce predicts for the 2006-2015 period that some 10,900 turbine rotorcraft will be delivered worldwide, a slight increase. However, most are military. Scheduled civil helicopter service is likely to remain a niche market; the real growth is likely to be in emergency relief operations. As the Rolls Royce survey recounted:

"When Hurricane Katrina hit the South coast of the U.S. in August 2005, helicopters were ... first to the scene, performing medical evacuation missions and bringing in much needed supplies. Paramilitary and military rotorcraft provided a range of capabilities, including search and rescue, heavy lift delivery and law enforcement, but civil-owned helicopters were also heavily utilized, highlighting the importance of the commercial fleet during disaster relief."

Interestingly, according to Rolls Royce, high oil prices are good for helicopters that support offshore oil exploration:

"Studies have shown that the helicopter market as a whole tends to benefit from higher oil prices, due to the effect of increased hydrocarbon exploration. Given continued instability in the Middle East and the resurgence in deepwater oil exploration, the outlook for the offshore helicopter market is expected to increase."

It may be the only segment of the aviation industry to benefit from higher oil prices.

Rationalizing maintenance

For the rest of the industry, there will be continued pressure to contain labor and maintenance costs. Kevin Michaels, a principal with AeroStrategy, a management consulting firm, said the maintenance industry is more efficient today by some 30 percent. That's for transport category aircraft, based on the maintenance, repair and overhaul stockage per airplane, today compared to 1997. Presently, about $2.5 million per airplane inventory is stocked, compared to $3.6 million in 1997.

Among the factors behind this trend to greater efficiency, Michaels said, is the application of "enabling technologies," in addition to the emergence of third-party logistics suppliers. Michaels estimated the commercial maintenance, repair and overhaul (MRO) market will grow to $55 billion by 2015, up from $38 billion today (see box, right).

We present here highlights of two enabling technologies. One, provided by Cohen's company, is called "Service Planning and Optimization (SPO)," which determines the optimal deployment of support resources, such as spare parts and repair capacity, to support a fleet of aircraft to achieve flying hour requirements in the most efficient manner. The system is known in the military as Performance Based Logistics (PBL). Analogous to "power by the hour" arrangements for engines, part of the payment for logistics support of the airplane is based on use of the airplane - in other words, the time it is not in maintenance.

"SPO aligns the incentives of the maintainer and the operator," Cohen explained.

Part of the methodology behind SPO is determining what will break and/or require maintenance. "It's analogous to high stakes gambling," assessing what will require maintenance, Cohen explained. Making the right bets are required if operators and providers are to prosper.

"Because labor is so expensive, more operators are opting for outsourcing. However, when maintenance is outsourced, "managing the flow of materials and parts is more complicated, so we need to improve the management of these resources," said Cohen. "You have to track down to the piece-part level."

"Our SPO software answers the questions about what parts should be stocked, and where?" Cohen said. "The objective is to maximize the uptime of the aircraft at the lowest cost." According to a paper on PBL authored by Cohen, the value of PBL has been shown in military programs. For the F/A-18 strike fighter, the U.S. Navy had a PBL contract with Boeing and achieved 85 percent aircraft availability compared to 67 percent for those managed under traditional programs. Also being applied to Lockheed's F-35 Joint Strike Fighter, PBL is just now seeing application in the commercial sector, as in the SPO software offered by Cohen's company. Over the coming years, such software could significantly improve the efficiency of the supply chain. In civilian application, PBL often goes by the title "broad component support" or "total aircraft support." Both terms are likely to be in increasing vogue as further efficiencies are wrung out of maintenance.

Retrofitting efficiency

As an example of efficiencies achieved in upgrading airplane systems, consider the flat panel displays Innovative Solutions & Support (IS&S) has installed in ABX

Air (formerly Airborne Express) B767s (see box below). The two companies have teamed together to obtain a supplemental type certificate (STC) on the B767. The flat panels replace the old "steam gauge" instrumentation.

"I sent a challenge to our engineering department about six years ago," said Geoff Hedrick, chairman and chief executive officer of IS&S. "No custom glass; use commercially available glass. Put it into the cockpit without forced air cooling, and reduce the cost by a factor of 2-4."

According to Hedrick, the turnkey cost is about $250,000, or well under the $1 million typically required to upgrade the cockpit displays. The company has provided about 50 sets of hardware and has orders for 200 more. "We're seeing incredible interest in this upgrade and believe 30,000 airplanes are eligible," said Hedrick.

Mike Glover, in charge of IS&S flat panel programs, said the display retrofit takes about four days. "Our goal is to get it down to under two days," he vowed.

He described the retrofit as "removing 20 part numbers and installing four flat panel displays." Glover said the new installation saves 200 pounds of weight, only 45 wires were added to the airplane, the new displays provide more information, and "an order of magnitude reliability improvement," Glover said.

Hedrick recounted that the flat panel satisfied the most stringent military requirement and the same part number applies to military, commercial and general aviation. The next step, he says, is to enable customers to standardize flight decks across various fleet types. In other words, he wants to achieve further efficiencies, and his retrofit kit, by the way, is in keeping with the SPO concept, as the time to install it decreases and as ever more components are standardized and yield greater reliability.

Thus, while fuel costs are prompting the industry to look for ways to decrease maintenance costs, these two innovative programs show how that can be done.


The key MRO market trends:

  • Escalating PMA (parts manufacturing authority) parts and DER (designated engineering representative) repairs.
  • A shift to supplier-owned inventory. Suppliers owned just 25 percent of the MRO supply chain inventory in 1997. By 2004, the percentage of supplier-owned inventory increased to 39 percent - an increase of nearly 60 percent.
  • There is growing involvement of third-party logistics suppliers. This is evidenced by recent announcements of blockbuster deals. For example, the 10-year deal for Aviall to own, distribute, and manage CF6-50 and CF6-80A spare parts, the value of which is pegged at $3 billion.
  • The MRO sector will continue to globalize, with more North American heavy maintenance going overseas.

    Getting more efficient

    AeroStrategy's analysis suggests inventory worth $44 billion (book value) is now held in the air transport MRO supply chain. But in whose hands?

  • Airlines, with $26 billion in inventory at maintenance bases and line stations, hold 61 percent.
  • MRO suppliers hold nearly $9 billion, or 20 percent.
  • Distributors and redistributors account for 3 percent
  • Parts manufacturers - EOMs, PMA manufacturers, and raw material suppliers - own 16 percent.

    Worth noting is that this inventory nominally valued at $44 billion supports an active air transport fleet of nearly 17,000 aircraft - the same valuation, without adjusting for inflation, as 1997 when the air transport fleet was roughly two-thirds as large. That means $3.6 million of inventory was available for each aircraft in 1997 compared to $2.5 million today.

    Clearly, a decade of ongoing overhaul of the industry has made the commercial aviation MRO supply chain vastly more efficient.

    Source: AeroStrategy

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