Europe's civil maintenance industry faces overcapacity, pricing pressure and lower-cost challengers, but the market is improving as rationalisation takes root
After several years in the doldrums, Europe's maintenance, repair and overhaul (MRO) market is picking up in tandem with an increase in commercial aircraft flying hours. The competitive environment, however, continues to be fierce. Providers are still some way from being able to command the prices that prevailed at the start of the decade and there is substantial overcapacity in some areas, particularly heavy airframe maintenance.
"Last year in Europe we made budget. Demand is there and the market is alive," says Pierre-Yves Reville, vice-president marketing and sales for Air France Industries (AFI). Following last year's merger between Air France and KLM, the engineering arms of these carriers combined to create the world's third largest civil MRO operation with annual revenues in excess of $3 billion.
It is a slow process, but market rationalisation like this is taking root in Europe. "Supplier consolidation is happening and will continue to happen," says David Stewart of AeroStrategy, a specialist MRO consultancy. "It will occur through acquisitions or joint ventures and when carriers make new fleet decisions and decide not to invest in their own service capability."
In the past 18 months Europe has seen another significant deal in the MRO sector, with SR Technics buying Danish-owned FLS Aerospace. Switzerland's SR Technics, the former services business of Swissair, announced it was buying loss-making FLS, with its large aircraft and spares support operations in Ireland and the UK, in February 2004. The $60 million deal, which eliminated the debts of FLS, was completed in mid-2004.
The integration of the two companies is now complete, says Philippe Erni, executive vice-president marketing at SR Technics. Together they form a business with annual revenues of over $1.1 billion, making it the fourth largest in Europe.
Yet another deal may be finalised shortly, with French MRO company TAT Industries in talks with the administrator of Sabena Technics to take over the Belgian company. "The process of due diligence is completed," says Jean-Luc Fournel, senior vice-president marketing and business development at TAT Industries. The company is tight-lipped about its intentions for the former services division of defunct Belgian flag carrier Sabena, but hopes to conclude the purchase this month.
It has been a tough time for Sabena Technics since its parent went bankrupt in 2001. Overnight the maintenance operation, which was adapted to serving a flag carrier, lost a third of its business. The transformation to a customer-oriented business was a big challenge and the administrator decided not to sell the company immediately, but to revive it to improve returns for the creditors in the long run. However, profitability has been elusive, and despite a major restructuring programme it has remained in the red since becoming independent.
Last year, the bankruptcy of Italian low-cost and leisure carrier Volare, following on the heels of the collapse of Belgian charter operator Sobelair, both large customers of Sabena Technics, put a large dent in the company's progress. That led the operation to make around 10% of its 1,370-strong workforce redundant and take even more drastic restructuring steps, including withdrawing from some unprofitable contracts. The changes seem to be paying off, for although turnover fell by 14% to ?125 million ($160 million) in 2004, the company says it is on course to break even this year.
However, for now such changes seem to have had little effect on overcapacity in the industry, says Walter Heerdt, senior vice-president market and sales at Lufthansa Technik. "There has been consolidation, but capacity has not been taken out of the market. Nobody is really cutting capacity in Europe and there is a tendency in eastern Europe for a capacity increase."
This will mean further tough times, in particular for airframe maintenance, believes Stewart. "The market has massive overcapacity – everyone agrees that is the case," he says. Excess capacity, constant cost pressure from customers and competition from service providers outside Europe are conspiring to keep prices keen.
According to Erni of SR Technics, prices are not even close to recovering to pre-11 September levels and, for some products, continue to fall. "On engines where there is a lot of overcapacity, such as the CFM56, prices are still coming down." In this sector they will not recover until demand picks up around 2007 when a spike in engine overhauls is predicted. In the narrowbody aircraft overhaul market, prices are over 20% down compared with 2000 levels, while widebody prices are 15-20% lower, he says.
This buyer's market naturally encourages carriers to play the field. "It is still a spot market and has been for a while," says AFI's Reville. "There is a lot of shopping around, especially for engine overhauls. There is so much market choice that people are putting bids out for each airframe D check. We have a few long-term customers, but not the majority."
In northern Europe, Sari Kanerva, assistant vice-president at Finnair Technical Services, has detected a welcome shift in emphasis as the market shows signs of recovery. "In the last six months we have seen some companies more willing to do longer contracts," she says. "Previously people were knocking on the door just one week before a heavy maintenance check was needed." Such deals usually need months of planning.
Analysts have long questioned the need for Europe's smaller carriers, like Finnair, to remain in the maintenance business. "There are too many sub-critical mass players," says Stewart. Compared with the struggling US majors, Europe's traditional carriers have not seized the opportunity so far to outsource, he says. "The landing in Europe has not been quite so hard in terms of finances so they don't have the imperative to change."
Many have made major internal changes to boost efficiency and lower costs, but have paused over taking difficult and radical outsourcing steps. "Our strategy is to do as much as we can in-house," says Kanerva at Finnair Technical Services. "We are not big, but we are flexible and independent." Its mission is to support Finnair's fleet and to bring in third-party work.
High labour rates
Kanerva recognises that European MROs, with their high labour rates, have a challenge to compete on price with rivals in Asia Pacific for labour-intensive airframe checks. But, as a recent deal with Dutch cargo carrier Martinair to perform heavy checks on five Boeing MD-11 freighters demonstrates, Finnair can compete. "According to Martinair's assessment, Finnair's offer was the most competitive when, in addition to the fixed price, quality, aircraft turnaround time and our reliability were taken into account," she says.
The determination of carriers like Finnair to remain in the services market means that outsourcing opportunities for the major MRO companies tend to be focused on start-ups, low-cost carriers and leisure operators. According to Heerdt at Lufthansa Technik, "in western Europe more than 50% of the aircraft are flown by eight airlines which have in-house capabilities. That means captive business, which is difficult to target for outsourcing."
High labour costs mean that European MROs will find it tough to hang on to airframe maintenance in the long run, says Stewart. "It's outrageous that Europe is a net importer of heavy maintenance. It will migrate away to eastern Europe or Asia Pacific." Europe's MRO organisations agree that some work will be exported, but not all. "On some market segments we do remain competitive, such as on the smaller four- or 10-year checks for A320s, which are not so labour intensive," says Reville. "There is still an edge for us, mostly due to good flexibility, high-quality work and the ability to design repairs."
But Reville admits that AFI does not chase D-check work on classic Boeing 747s or other older-generation aircraft. "Frankly, it is very difficult to gain customers. We take care of our own fleet and have some long-term customers." Newer-generation widebodies, such as the Boeing 777, are a different story. "An aircraft like the 777 is more or less like the smaller aircraft in relation to the number of man hours needed to perform checks. For instance, a five-year 777 check requires 7,000-10,000 manhours compared with 45,000 manhours on an older 747. We will be able to win customers in these business areas."
The full hangars at SR Technics are testament to the fact that some customers are still willing to pay to have work conducted in Europe. "If you look at the European manhour rate compared with a Chinese supplier, you see a huge difference," says Erni. "But if you compare the package when efficiency comes into the picture, then we are really competitive." One of SR Technics' newest customers underlines this point, he says, with Qantas prepared to fly four Airbus A330s to Zurich for C checks.
But few are likely to invest in new capacity in central Europe. "Our long-term strategy is to perform narrowbody heavy maintenance work where it makes most sense, with SR Technics open to take it to other regions or suppliers if that's what is right for the customer," says Erni. Such a decision has already been taken on its total-support deal with Swiss low-fare carrier Helvetic to support its Fokker 100s. "We found we could not do heavy checks at a competitive price in Zurich," says Erni. Consequently, this work will be subcontracted to other suppliers.
Lufthansa Technik is another looking further afield. "To stay competitive, Lufthansa Technik has anticipated the trend of shifting narrowbody MRO work from central Europe to eastern or southern regions like Hungary or Malta," says Heerdt. The company's services joint venture with Air Malta is preparing to announce the launch of a second line for A320/737 C checks.
The fact that Singapore Technologies Aerospace (ST Aero) is investing in Europe is another indicator that the region is far from finished as a venue for MRO growth. "Overall, we have confidence that Europe will offer many opportunities, and we will invest in Europe where it makes business sense and in line with our strategy," says Tay Kok Khiang, president of ST Aero.
The company started in Europe after buying Airline Rotables, a UK-based spares management firm. "In 2002, we set up Bournemouth Aviation Services [BASCO] to undertake airframe maintenance as part of our strategy to establish a global capability that would enable us to support our customers wherever they need our support," says Tay. That customer base features low-cost carriers such as Malaysia's AirAsia. The cost pressure that low-cost operators exert on the legacy carriers will lead to pressure on their traditional in-source model.
"We believe that model will evolve to one with more outsourcing as airlines strive to reduce costs," says Tay. "BASCO has been building its customer base and demonstrating its ability to deliver on time and with good quality. That is the cornerstone of any MRO, a solid reputation."
ST Aero hopes to cement its name in Europe by winning a total-support contract for EasyJet's Airbus A319 fleet that will eventually number 100 aircraft. The carrier has been discussing new service concepts with several suppliers, with the emphasis on flexibility and a method of continuously maintaining the aircraft. EasyJet has also considered working with a partner to develop a new MRO operation in eastern Europe devoted to its fleet to take advantage of the region's lower labour rates. ST Aero is also looking at expansion in eastern Europe.
EasyJet is understood to be nearing a final decision, with the contenders narrowed down to ST Aero and SR Technics. The latter already has a maintenance joint venture with EasyJet and it supports the carrier's initial A319s. The new deal is significant: it would give ST Aero a stronger foothold in Europe, while one of the major reasons SR Technics bought FLS was to make inroads into the UK's low-cost carrier MRO market.
Source: Flight International