According to Aengus Kelly, CEO and Executive Director of aircraft leasing and finance company Aercap, “the single biggest issue between the aircraft manufacturers (OEMs) and the airlines is ordering too many airplanes—everything else is noise and irrelevant”.
“If you have too much capacity, it doesn’t matter if you’re flying a Boeing 787 or an Airbus A350,” he says. “If you’re flying from nowhere to nowhere with no one on board, you’re not going to make any money.”
Kelly believes too many airlines are fixated on massive growth plans. While this looks impressive on the day of the deal, they may soon realize they have over-ordered.
This is not necessarily an over-order in the number of aircraft but, more likely, in the delivery timetable. “You might be able to take 50 airplanes, but whether you can take them over four years is very different from whether you can take them over 10 years,” says Kelly. “And if you take them over 10 years, the pricing gets out of whack because of OEM escalation clauses.”
The crux of the dilemma is lack of negotiating experience. Most airlines will sit down to negotiate a transaction with an OEM every five or six years. The person on the other side of the table is doing it every day.
“Unsurprisingly, there’s one winner 90% of the time; that’s what you would expect,” says Kelly. “The focus on ownership costs of the airplane pales into insignificance against the amount of cash you will burn if you have an airplane that you don’t have the traffic to fill, or that you have to sell for deeply discounted prices.”
There are about 40 airlines in the world that operate more than 100 aircraft, and another 50 operators with fleets of 50-100. In the past year, orders of 50 or more aircraft have been placed with Airbus and/or Boeing by 10 airlines and three leasing companies.
Kelly is confident that the airplanes on order will all be delivered. “But will they be delivered in the timeframe that they were originally ordered?” he asks. “No, I don’t think they will. There are deferral discussions going on all the time with the OEMs.”
Philippine Airlines (PAL) recently deferred the delivery of some of its Airbus order, following an assessment of market requirements.
Jaime Bautista, PAL President and Chief Operating Officer, described it as “a win-win for both PAL and Airbus. We were able to get what we want and they were able to get what they want.”
In 2015, PAL will take delivery of five A321s, down from the original target of 10. The remaining 33 aircraft ordered from Airbus are scheduled for delivery through 2024, and not 2020 as originally planned.
While the PAL case may be a win-win, Kelly thinks the relative profitability of OEMs and airlines reflects an inherent imbalance in the industry. “There’s a certain amount of profitability in the aviation complex,” he says. “If the OEMs get more than their fair share, then someone else is giving up more than their fair share. The instrument that transfers that wealth is an airplane, and you’re either paying too much or you’re buying too many of them.
“A lot of airlines have done very well and they’ve been very smart and very aggressive at the right times,” he says. “But the numbers speak for themselves in the profits of the two parts of the aviation chain. Most of the time, the relationship between the OEMs and the airlines is fine. But the root of the problems, when they do occur, is over-ordering.”
New aircraft program delays also affect the relationship from a financial standpoint. “We’re seeing more cancellations recently than ever before,” says a report from Air-Insight. Nearly 14% of Airbus and Boeing orders were cancelled in 2014. Late programs have included the Airbus A380 and A350XWB, the Boeing 787, and the Bombardier CSeries. “With delays in deliveries and OEMs not meeting contractual obligations, it is much easier for an airline to recapture progress payments made to OEMs,” says the report.
Late entry into service can create significant issues around the fleet plan. Aercap had a customer that had Boeing 767s on lease from the company, which was planning on changing to Boeing 787s when the 767 lease expired. But the 787 program was delayed. As a result, the customer had to extend the 767 leases for another 12 months.
Kelly admits “you’ve got to pay a big number if you want it for 12 months, because I could move the airplane to someone else for five or six years”.
Degrees of difficulty
Numerous other elements feed into the OEM-airline dynamic. Different degrees of difficulty in the relationship could be fostered by a problem with the seat manufacturer or a problem with some buyer-furnished equipment products. In such a situation, airlines do not have the commonality that they want in the layout of the passenger cabins and this, in turn, could raise costs or alter scheduling plans.
Then there’s the question of maintenance, repair and overhaul. When new aircraft are delivered, larger airlines usually have the sophisticated maintenance and technical teams needed to manage advanced technology models. For a smaller airline, it’s far more of a challenge. The consequences are significant. “It’s the same as a bad debt for a bank—if the dispatch reliability is running at 92% then you have 8% losses,” says Kelly.
The various after-sales packages now available can seriously affect the dynamic between the two partners.
Airbus Senior Manager, Martin Fendt, says “it’s a big, big operation for the OEM” to maintain relationships with the customers and make sure their aircraft are performing exactly as expected. “It starts with development of a new aircraft—industry focus groups, understanding what the market wants within the capability of the supply chain, technology readiness levels,” he says. “Then we thoroughly demonstrate and validate everything we had promised to deliver for the airlines once the design was frozen.”
This is followed by in-service introduction, where any issues are closely monitored and ironed out. “As the aircraft enters service, inevitably there are teething things, and that’s why we have people at every stage to take onboard all that feedback from the operator as a centering service, and then to liaise internally with the program or customer service or the sales team to make entering service as smooth as possible.”
Paulo Cesar Silva, President and CEO, Embraer Commercial Aviation, says his company also does everything it can to understand the requirements of its clients. “We are in business to sell aircraft, but we also need to understand our customers and how their aircraft will be deployed.”
Silva says the advent of new technology is driving new designs. But the company is careful not to over-spec an airplane, and believes in incorporating technology only when it adds value.
“The obsession with cost may sound repetitive, but you need only look at the drop in real passenger fares over the years to understand that airlines need to find ways to cut costs, to carry the proliferation of lower-yield traffic,” he says.
“For the past few years, carriers have been overhauling their operations—outsourcing, automating, simplifying. As they replace their ageing fleets, it’s only natural that new aircraft deliver even lower costs. Unfortunately, that low yield-low cost dynamic is something of a vicious circle.”
All manufacturers are under pressure to lower costs associated with maintenance tasks and spares inventories, according to Silva. “We’ve responded to this in a number of ways, including our spares pool program that minimizes up-front investment in high-value repairable items,” he says. “The program saves on repair and inventory carrying costs, reduces warehouse space, and virtually eliminates the need for repair management resources.”
“We’re continuously engaging with our customers to know what is working, and what isn’t, with the airplanes. We’re keenly aware of how the airplanes are performing operationally and, of course, financially.”