Jerome Bouchard
The new business model that could emerge would be separating change ownership of the aircraft from its usage and we can call it uberization.
Narrator
Welcome back to the velocity podcast. We are joined again by Jerome Bouchard and Ken Aso as they continue their conversation around the recovery of the aerospace industry post COVID-19. We invite you to listen to the previous episode if you haven't already done so. Thank you and enjoy the show.
Jerome
Hello and welcome back to Velocity Podcast. You are joined here again by myself, Jerome Bouchard and my colleague Ken Aso. We are both partners at the management consulting firm, Oliver Wyman. Great, to be speaking with you again today, Ken.
Ken Aso
Hi Jerome. Yes, very happy to be continuing this conversation. We've got some great interesting topics to cover today. If you haven't already, had a listen to the previous episode. We were having a discussion around the aerospace industries recovery from COVID-19, the current state of the industry and then how it may potentially take up to five years to recover. Today we will now have a discussion about new business models and the implications on the MRO aftermarket. Jerome, what is your view in terms of the kind of decisions that OEM's and suppliers will need to make around production and models.
Jerome
I think some drastic evolution are actually required. First of all, in terms of production rate and operational model for production. What we mean by that is maybe some simplification are expected. Today the aerospace in Europe is quite complex from a logistics standpoint. For instance, with a lot of exchanges between several countries. So maybe the COVID-19 helps rationalizing the industrial system overall. I think another part will be, of course, an impact on asset and footprint of aerospace. There would be some difficult trade of that will need to be made. There will be some factory, unfortunately that may be shutting down, but at the same time maybe in the mean time. I'm a firm believer in relocation of some of the aerospace activity specifically in the system area back to Europe or let’s say a high cost country in general. And the last consequence will unfortunately be on the organization side. It's very sad to say, but we have seen already some lay off plans in the aerospace industry, hopefully, with the support of the government, of the big OEM’s, of private funds we will we limit the social damage but there will be for a momentary time, maybe two to three years but downsize, to be expected in aerospace industry.
Ken
Yeah, there's going to be some painful steps. I think about specific models as well. The A380 is one, where there's been significant discussion about retiring those are playing some decisions, around new airplane production. The ability of the A380 to be a viable aircraft and to fill the aircraft but thinking about the Boeing portfolio as well. There's the 777x that is going through its development and certification process. That's, of course, been pushed back on a couple of occasions, but there are signs that some air carriers are questioning whether they're ready to take delivery expensive, new airplanes. Think about some of the sub models like 737 Max 10, very low orders for that model derivative and not as efficient as the Airbus product, the orders for the smaller and mid-sized 737max are very strong, but around the edges. Question about 747’s, of course, it passed for passenger service that is being raised out for cargo. It's still a quite useful airplanes, but it's a very low rate of production. And so, will Boeing need to sacrifice production relative to 747 and as they're making painful, cost-cutting decisions, are there similar model decisions that are of us will be faced as well?
Jerome
Yes, that’ll definitely be some very difficult decision on Airbus project policy. You mentioned A380 that was already planned to stop in term of production but the acceleration of exit of the airline fleet is now a reality. Unfortunately, for this aircraft that I love you, if I may say so. But there will be as well a question mark for Airbus. If you take a look at this researching, for instance, will there be a real space in the market for this researching? If you compare rates to its Big Brother, the 350, which is more recent, as a better range, better performance that if you look as well at the 321XLR, this research program may be, well a squeeze in between those two more recent and maybe more adding aircraft. So it's future maybe under question, the new Ace research new. So, with a better engine and a bit more performance may still have a small market share, but we are clearly seeing a fade out of this particular program.
Ken
Yeah, there just may be the need to retrench in terms of the models, especially to support lower rates of production and lower orders. Hey Jerome, we talked a lot about Airbus and Boeing. What about the other aerospace firm, do you have any thoughts on Comack, Embraer and others?
Jerome
Yeah. I can talk about HCR, HCR and other European manufacturer. Well, we are feeling quite proud of situation because this regional aircraft so trouble props are resilient, in fact to the decrease on the airline demand because they are small modules maybe they have a lower level of consumption. And they need lower maintenance cost compared to a 737 or A320. But the airlines that are operating them are even more agile than big airlines. Normally, HCR operators are, let's say, 3-6 aircrafts and maybe operating in some remote part of the world like Philippine Islands or Desert in Africa, they have a very fragile business model, and the order book has drying over the last month for HR and the capacity to produce an aircraft has also drastically reduced probably from let's say 80 aircrafts last year for almost probably down to 20, 30 this year.
Ken
Of course, it's been really interesting to watch the Boeing, Embraer, JV, CATA. It made a ton of sense for the portfolio to be, the also get some benefits out of the very strong, engineering capabilities, and then obviously following Airbus’ success in working with them Bombardier in the C Series. There was a portfolio hole there for Boeing, very disappointing to see that due to COVID-19 that JV didn't move forward. And so there's a lot of questions right now whether Embraer can survive on their own? Will they seek a partner? Can you continue to stay private? And I think at the rate of production that they have on the commercial side, it's really going to be a decision for the Brazil government to decide whether they want a strong national aerospace industry. Of course, there's benefits both on the commercial and defense side to have those dual capabilities. But it's likely that the government will need to step in and support Embraer with funding to continue through the COVID-19 crisis over the next several years until the commercial side can stabilize. It's interesting to see other countries stepping in and expressing interest. But also Jerome, we're seeing that as we move into the 2020s. Now, there's really a rise in the level of trade concerns rise of regionalization and nationalization. And in terms of the government's stepping in, there's a real question of that, 2000’s, 2010’s trends of globalization. So, will other countries be able to step in and support Embraer. I don't know if that'll happen. It’s a very good product line for Embraer, but frankly, it’s the question of whether they have the scale to be able to manufacture and if they can meet the cost and cost points that they need to hit. For Comack, it’s also very, very interesting as well. The C919 is a pretty good product and China has the ability to support that product. They’re well over 30% of the narrow body market. And so, from that standpoint, it's a good airplane for domestic routes. There are some questions about international trade relationships, import-substitution. The Chinese market could choose to utilize the 919 for particularly domestic routes. I think the question is whether production can meet the demand or if those airlines will continue to need Boeing and Airbus airplanes to support their growth and maintaining those fleets. But I think there have certainly they’re to stay and pretty good airplanes as well. They have a market.
Jerome
So, they do have a market with connection but for me, it remains a true question mark. This is a question everybody is asking me, you know, what about Comack? What is the future of this company? Will they benefit of, let’s say, relatively weak positioning of Airbus and Boeing during the crisis? Or will they be affected as well by this crisis? For me, it's from your very tough question to answer. I do believe like you Ken, that the strength of Comack, of course, is the national domestic market of China and we are seeing already a very strong sign of recovery in this market. And, of course, this restart may question, capacity of some manufacturer to capture that grows or that recovering but at the same time I'm afraid that Cammack is too much focus on this particular internal market and that their partners especially on the engine side may also suffer from the crisis, and de-prioritize likely the help to Chinese manufacturers overall leading to a more difficult situation.
Ken
That's a great point. And I think it also underlines the fact that its easy to design, produce and launch an aircraft, but to produce its scale and hit those cost points and to have the supply chain integrated that’s another level of maturation in the development of a model, in the development of the aerospace firm. And certainly, those are real questions. Absolutely Jerome. Let's talk now about the MRO Aftermarket for those who are listening to the podcast that aren’t as familiar, the aftermarket. This is really about supporting the aircraft after it has been delivered. Everything from engineering, spare parts, maintenance of the aircraft's, modifications that you make of the aircraft over its 30-year lifetime is all to do with the aftermarket. And as we look at the aftermarket the state of the aftermarket. It's funny before COVID-19, Oliver Wyman pushed out its annual MRO forecast, where we predicted MRO services globally would be over 90 billion dollars in total size. And now, since COVID-19, we forecast that to be less than half of that, frankly about 43 billion dollar in size, which will clearly threaten the survival of many of the aftermarket suppliers, and we've been seeing in the news that there have been some closures of facilities. But again, this is very early days, there's many more to come. In the US Jerome, we’ve seen the US Cares Act support with funding through the end of the third quarter of this year. But beyond that there is uncertainty, but really what's going to happen thereafter is a question. We do know that over the next ten years, through 2030 the MRO market will recover. But over that 10-year period of time, there's going to be about a hundred fifty billion dollars less in revenue than we originally forecasted early part of this year
Jerome
And that's a massive evaporation of the business. But to come back to the root cause of the massive drop you mention from the ninety plus billion as a market size for MRO down to forty-three. I believe this is directly co-related to all of these aircraft that are parked and the temporary decrease and service fleet. But, I'm assuming Ken, that there will be also opportunity related to early retirement, for instance. Could you tell us more about that?
Ken
There's the opportunity for a private equity to support the MRO industry and participate in a space where there's going to be sustained growth post COVID-19, but they're certainly readying for activity to support many MRO providers and provide capital and liquidity. We're also seeing that the materials market which has been around 60%, 2/3 of the total MRO Market largely been controlled by the original equipment manufacturers and alternative solutions that are lower cost have struggled to gain market share were talking about PMA part, DER repairs and use serviceable material, but because of the sheer number of aircraft that are being accelerated for retirement. There's a significant potential for the rise of use serviceable material, a lot of older airplanes or also seeing some midlife airplanes that are being staged for potential part out that could support the rise of use serviceable material. And so if there is opportunity for them to have the liquidity, the capital to control those airplanes for part out that could drive a shift towards the growth of USM, certainly from the standpoint of many airlines. They prefer USM because it is OEM material. It's just used material that has been restored. And so, you can get a discount associated with that. Something they're quite interested in seeing today, given their cost pressures.
Jerome
But the question is are the OE’s interested as well in these use serviceable material trends? Do you have a prospect on that?
Ken
Yeah. I think carriers are, partly because they just want cheaper solution and USM can provide that. And the second thing is it is original OEM product. And so particularly with those air carriers that put a premium on that or for least airplanes where the return provisions require OEM product. Those are important factors. So we think that the USM market will go from high, single-digits penetration rate for all material and grow from 12-13 percent-plus over the next several years. Are there other examples of business models Jerome, where you think there will be opportunity in this environment for them to grow?
Jerome
I believe a new business model that could emerge would be separating the ownership of the aircraft from its usage and we could call it uberization, if you wish of aircraft. But I quite convinced that in order to place a new aircraft in the market for our OEM’s. But also for leasers to actually encourage the airline taking on aircraft will have some sort of extended-releasing packages that will also cover services such as maintenance why not flight operation support, or even when proposing crews, as well. So that airline can eventually focus on their core value added, which is actually flying the aircraft and less taking care about the maintenance or the acquisition aspect. But, what about you Ken, do you see even innovation or breakthrough in the MRO market.
Ken
I think the focus so much is on low cost, and I think there's constrain on capital to deploy for new innovations. And so, I wonder how much will be invested. I do think that digital continues to be a very high priority investment, one that can drive new breakthroughs in Innovation, but also simultaneously drive more efficiency in terms of the assets to deployed and capital deployed. So, I think investments in analytics, in digital will continue to be funded to support the MROs and certainly the larger OEM’s, larger MRO’s are making those investments. I do like your idea though Jerome about the uberization simply because we talked about the risk of whitetails being produced. You want to put those assets to work. Don't want them to be sitting idle for too long as well, and given the fact that air carriers will want to variablize there costs, they may be interested in having certain portions of their lead by the drink. I think that's an interesting model one to watch.
Jerome
And if we take a step back now, and close the loop now that we are seeing all the steps of the aerospace and chain. What are your perspective towards 2030 Ken? Are you still optimistic about this sector?
Ken
For all of the challenges right now and certainly, this is profound. This is still a sector that bounces back in aerospace and air travel. I'm very optimistic over the long-term passenger travel both for business and for leisure as the economy's recover across the world. Think by mid-decade the industry will be back on their way towards building 30,000 aircraft, 35,000 aircraft fleets by the end of the decade. We estimated in our original forecast approaching 39,000 aircraft. I don't know if it'll be like that, but certainly growth relative to now, 35,000 aircraft, which will be an opportunity for a lot of growth across a number of different regions, companies and business models. Well, I think that's all the time that we have for today. Jerome. Thank you for an interesting discussion and the opportunity to share our transatlantic news on the state of the industry.
Jerome
No. Thank you Ken. And if our listeners would like to further deep dive into one of this area, please write to us. Please get also to our website for more information than the document we were mentioning during this podcast.
The Velocity Podcast is brought to you by management consulting firm Oliver Wyman. Please email us or tweet us if there is a topic you would like Ken and Jerome to explore further. We also invite you to subscribe so that you'll be notified when the next episode goes live.
