IN FOCUS: MRO consolidation leads to different airline supplier environment

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Airlines are facing a changing maintenance, repair and overhaul market. The sector has been consolidating for some time and continues to evolve.

Various drivers are at work, such as the growing presence of OEMs in the aftermarket and the introduction of new-generation aircraft with different technical and support requirements. But the economic environment and consolidation in the airline business are the main driving forces behind the MRO sector's development. Carriers are a catalyst for change in the aftermarket, as well as being affected by it.

As operators battle with low profit margins and the economic outlook remains uncertain - especially in the mature markets of Europe and North America - there seems to be little prospect for the airline industry to return to a more healthy balance of revenues and costs.

Power-by-the-hour style agreements with all-inclusive service on flight hour-based rates have become popular with airlines not because such arrangements necessarily provide the most cost-effective support, but because they offer financial planning security. With contract periods becoming longer, carriers are trying to hedge their bets and keep costs under control over the long term. But the result is that contract volumes have grown, providing airlines with more negotiating power versus their suppliers.

For the OEMs, this has been an opportunity to build their MRO footprint by sweetening equipment sales with aftermarket support deals. Third-party MRO providers, on the other hand, have responded to the trend by offering similar full-service contracts. But this type of agreement requires sufficient scale in the maintenance provider's business to absorb the risks associated with offering technical services at flat rates over long periods.

Non-technical service

A further trend is that airlines want to pool spare parts rather than buy their own equipment and liquidate existing inventory to improve their finances. This was a central factor in Finnair's decision earlier this year to abandon its in-house engine and component repair activities, and outsource all respective work to Mubadala Aerospace MRO Network member SR Technics in Zurich. The deal included the sale and lease-back of material, including spare engines, to Mubadala financing arm, Sanad.

Such arrangements depend, however, on the financial strength of the maintenance provider. Franck Terner, president of Air France Industries KLM Engineering & Maintenance, says that buying the component stock of customer airlines requires significant investment, even for large MRO groups. He says it can be a challenge to reflect the investment costs in the price for the maintenance services later on.

The company has just started cooperating with Lufthansa Technik for components on Embraer 170/190 series aircraft. The two large European MRO groups have also extended their Spairliners joint venture, formed to provide spare pooling and repair services for the Airbus A380, to regional jets.

While the original purpose was to save resources in light of a small global A380 fleet as it entered service, the Embraer move focuses on a much larger volume of aircraft that has been in service for years, with inventory existing at both MRO groups. By bringing together all their existing Embraer 170/190 component support contracts, Terner says, AFI KLM E&M and LHT can achieve so-called "big scale effects" in the face of growing OEM support programmes.

Airlines are also simplifying their supply chains. Instead of having to manage multiple external partners, such as specialist repair shops, they want to appoint a limited number of MRO providers that can offer a full range of services. "For quite a few years the integrators have been playing a growing role in offering a one-stop shop," says David Marcontell, president and chief operating officer of the TeamSAI consultancy in New York. "While this is not to say that there is no space for specialists, that space is getting smaller."

All these factors conspire to favour large MRO groups that can achieve the necessary economies of scale to provide the services. Airlines that used to maintain their aircraft in house, such as Finnair, are outsourcing the work because they cannot reach the required volume to make their own technical operations as cost-efficient as larger, dedicated maintenance providers and the OEMs.

Economies of scale are not only central to bringing down prices for airframe, component and engine maintenance, but they also generate secondary benefits, such as building up engineering expertise, using data management and administration resources efficiently, and establishing new technical capabilities.

Mixed mode

Air Berlin employs both in-house maintenance capacity and external partners to support its fleet. Airframe base maintenance for its Boeing 737, A320 and A330 aircraft are provided by Air Berlin Technik's facilities in Dusseldorf and Munich, while engines and most components are serviced through other MRO companies.

Despite Germany's high labour costs, Tobias Hundhausen, senior vice-president production and accountable manager at Air Berlin Technik, says that the location offers advantages in terms of flexibility because of the service breadth close to the parent's operational base, covering not just scheduled checks but also modifications such as cabin upgrades and in-flight entertainment installations. He adds that changing agreed fleet maintenance schedules with external MRO providers on short notice can incur penalty payments, which may invalidate an original cost advance. Nevertheless, he admits, that productivity needs to improve "significantly" in future.

The airline wants to decide by the end of 2012 whether to merge its two base maintenance sites. "The more [production] lines are located in one facility, the more flexibility we gain," says Hundhausen. "But the challenge is how to overcome the [current] know-how separation, with the 737s being serviced in Munich and the Airbus types in Dusseldorf."

By mid-2013, Air Berlin also wishes to decide how to source base maintenance in future. If the technical division were to provide only line maintenance and standard C-checks, the latter could be moved to a low-cost location. Hundhausen appears to favour setting up a facility in, for example, eastern Europe, rather than outsourcing the work. "With around 150 aircraft, we could occupy about three production lines. Given this fleet size, I am not sure whether outsourcing will really be more economic."

Air Berlin insists that the strategy is not yet clear and that a continued need for a wide service portfolio may favour a home location. But the airline will outsource base maintenance for the 787, which is to be delivered from late 2015, because of the small fleet size of 15 ordered aircraft and the extended heavy check intervals. After evaluating Boeing's GoldCare aftermarket programme, Air Berlin now wants to cooperate with its largest shareholder, Etihad Airways, to support the type.

The 787 is also set to change Virgin Atlantic's MRO strategy. While it has already focused base maintenance for its existing fleet on a "low number" of MRO providers, Martyn Haines, general manager continuing airworthiness, says: "Our approach for the 787 will probably be more rationalised towards the legacy MRO providers or an OEM."

 

Monopolisation threat

Haines thinks that the consolidation in the maintenance sector is both an opportunity and threat. He values the operational reliability guarantees, which the OEMs provide as part of their aftermarket support programmes, but points out: "Customer service guarantees are nevertheless less mature in the current [manufacturer] offerings."

He adds: "As the OEMs gain strength in the MRO marketplace, we see a worrying trend of monopolisation, as the influence of parts pricing and maintenance data protection restricts legacy MRO providers' ability to compete."

Access to repair manuals and engineering data for new-generation equipment will be a central differentiating factor for MRO providers of new-generation aircraft as the manufacturers are guarding their intellectual property for their products ever more closely to restrict third-party competition. Maintenance companies have to partner either with the OEMs or airlines that can negotiate IP access through their aircraft orders - or a combination of both. But there is much concern that new aircraft, such as the 787 and A350, will reduce diversity and choice in the MRO market.

James Stewart, group chief executive of the Mubadala Aerospace MRO Network, expects a split to go through the MRO industry, where new aircraft platforms will be supported by a small number of global maintenance providers. These MRO firms will also cater for mid-generation equipment, such as the 777 and A330, but be separate from a second tier of smaller maintenance companies supporting older types approaching their sunset period.

The separation will be partly a result of the financial investment needed to establish technical capabilities and provision spare parts, but also the fact that new equipment should offer greater reliability over its predecessors, meaning less maintenance. "MRO providers will not be able to make the economics work on the new platforms unless they have a significant fleet to look after," says Stewart. "So in order to make their investment pay off, they really need to capture a global fleet."

Air Berlin views the MRO industry consolidation as a positive development, because large international maintenance groups could offer a counterbalance to the OEMs' influence. For independent MRO providers, which don't have an own airline or large customer fleets behind them, the situation is set to become more difficult.

"Despite the consolidation in the market for smaller MRO providers, I believe there is still no threat of an oligopoly as in other airline supply areas," says Hundhausen. "Even if there will be five to 10 large global MRO groups in future - it will probably be a few more - we'll still have enough competition."

Unclear future

The outcome of the MRO industry consolidation is not yet clear. While new-generation aircraft will likely change the dynamics as a result of the OEMs' growing aftermarket involvement, current-generation aircraft will continue to require service over the next two decades. In the case of the re-engined 737 Max and A320neo, maintenance providers believe their existing capabilities for the current models can be extended to the new generation without fundamental change.

August Wilhelm Henningsen, chief executive of Lufthansa Technik, views the current industry situation as a transitioning process, where "everything is in a state of flux" with MRO providers and OEMs positioning themselves in the market. "We need to develop a mind-set for this development and look out for opportunities where win-win situations can be reached for both - or multiple - sides," he says. This could be a mixture of different cooperation models with airlines and manufacturers, as "there is no single solution that fits everything". But he says that it is important for third-party MRO providers, to "represent a certain independence. There are so many monopolistic tendencies in the market, which are not supported by the industry and especially the operators. I believe that the airlines must have a choice."

Henningsen thinks there is growing concern among airlines worldwide, which could lead to greater interest in choice between alternative service providers in future. Yet in the current economic climate where airlines battle with low profit margins, he expects that many will make mainly price-led, opportunistic decisions.

Investment remains central for the German maintenance provider's future growth. Although LHT has expanded its network globally over the past two decades, this does not need necessarily mean large greenfield facilities, says Henningsen. But it does include development of new processes, quality assurance, logistics, engineering and in-house repairs. He says the MRO industry is driven by two main factors - airline growth and making maintenance processes more efficient.

International expansion

Expanding its international facility network is a central objective of AFI KLM E&M's strategy. The MRO group wants to open two component repair shops in China next year - one for avionics and the other for large mechanical equipment. The MRO provider is talking to different potential joint-venture partners but has declined to provide more details.

The move is a return to China after AFI KLM E&M became the largest shareholder in the country's avionics repair specialist, Hangxin Aviation Engineering, in 2002. It then pulled out in 2009. "If any mistakes were made - I am not saying we did- they will not be made today," says Terner.

For airframe support, AFI KLM E&M wants to form closer ties with maintenance providers in Asia, where heavy checks for the parent carriers' long-haul aircraft have already been outsourced. "The goal is to develop partnerships with some MROs or airlines with MRO [operations], not just to subcontract D-checks," says Terner. The objective is to set up facilities such as Aerotechnic Industries, its 50:50 joint-venture A320 base maintenance centre with Royal Air Maroc in Casablanca.

Diversification has been the strategy for Sabena Technics. As traditional airframe maintenance became less viable in western Europe, the French MRO provider, which itself is a consolidation product - having emerged from TAT Industries, AOM Industries, the technical arm of former Belgian carrier Sabena and EADS Sogerma - has focussed on servicing military transport aircraft, component support and VIP completions.

In recent years, military aircraft support became the biggest growth driver, now covering roughly 40% of the company's turnover of around €530 million ($687m), says Jean-Luc Fournel, chief operating officer customers.

He is confident the MRO provider will be able to extend its capabilities for the 737 and A320 to the re-engined variants. "[But] the long-term question is, will it be possible for us to access new-generation platforms?"

Establishing the required capabilities will need to be done either in partnership with an OEM or airline. "We already cooperate with Airbus and can imagine that this could be expanded to that category of new aircraft [A350]," says Fournel. But he adds that the MRO company is equally open to a potential cooperation with Boeing.

Fournel dismisses concerns that airlines might be less interested in such partnerships if the required capabilities need yet to be developed, leading to a catch 22 situation where the MRO provider cannot establish the services without OEM support.

He says that it would be possible to build up new capabilities with customer, and adds that Sabena Technics is in talks with A350 and 787 customer airlines about a possible cooperation. But he declines to reveal further details at this stage.