Aviation, Aerospace & Defense

Airline Economics Are Transforming the MRO Landscape
Wave of Outsourcing Subsides, but Airlines Demand More Integrated Services and a Total-Cost-ofOwnership Approach
Oliver Wyman, in conjunction with Aviation Week, recently surveyed 130 airline and maintenance, repair, and overhaul (MRO) provider executives. Respondents represented a global mix of mainline, low-cost carrier (LCC), regional, and mixed-format carriers, primarily from the U.S. and Europe but including other major regions such as Asia, the Middle East, and India. Respondents came from all levels of management, with over half at the director level or above.

Highlights of the Study
MRO spend is almost universally expected to increase, at just over 6% annually over the next five years. Outsourcing of new MRO activities, while still widely popular, has peaked. Work is shifting to low-cost-labor regions as airlines seek deeper cost reductions, limited primarily by the availability of skilled mechanics and technical resources in these regions. Airlines are pursuing the next level of savings, raising demand for maintenance program, reliability, and material solutions to complement the repair work outsourced. To drive further cost reductions, airlines are looking to develop sophisticated materials management solutions, reduce investments in inventory, and improve airline operations and reliability. To manage diverse, geographically dispersed supply chains, airlines are expanding the size and sophistication of their supplier management functions. MRO providers are expanding their geographic reach and capabilities in a bid to become regional and global full-service providers. This expansion is being fueled by acquisitions, with great interest among private equity and other outside (non-strategic) investors. To increase their competitiveness, providers are increasing their investments in technology and Lean, and already have realized substantial improvements.

MRO Forecasts Continue to Grow, but Outsourcing Levels Off
Not surprisingly, survey participants almost universally agreed that MRO spending is expected to increase over the next few years, with growth coming from all major categories. Oliver Wyman estimates that the global market for engine, airframe, and component maintenance will grow at 6% per year, reaching $43.3 billion by 2013 (Exhibit 1). While considerable growth is expected across all maintenance categories, the drivers for growth vary by airline type. Mainline carriers expect increases in maintenance spend primarily driven by aircraft aging, which is estimated to account for 43% of the increase, and price escalation, which makes up the remaining 57%. On the other hand, regional carriers and LCCs expect to see the lion’s share of new spending to come from fleet growth—80% and 87%, respectively. Outsourcing of maintenance activities, a popular trend over the past five years, appears to have leveled off. Only mainline carriers plan to increase the percentage of maintenance spend that is outsourced over the next three years—from 68% to 70%. Over the past several years, airlines across the globe have optimized their in versus out mix, and are now focused on driv-

ing second-order benefits, such as wrapping reliability and materials management services around their core services. Nonetheless, outsourcing remains the predominant choice for nearly all airlines. LCCs, the biggest users of outsourced maintenance services, expect to spend, on average, 80% of their maintenance cost with outside providers.

Airline Capital Constraints and a Focus on Core Operations Have Caused Two Segments to Grow Disproportionately
The wave of outsourcing has likely led to underinvestment in MRO assets by airlines. Oliver Wyman’s survey found that almost 50% of respondents believe that the MRO organization is not a high priority on the investment agenda of their companies despite MRO spending being the third-largest cost category after fuel and labor. Furthermore, almost two-thirds of respondents believe that this lack of financial commitment is adversely impacting company performance, inhibiting growth of third-party business and support of core airline operations (e.g., planning and production control systems to reduce aircraft cycle times), as shown in Exhibit 2. Two factors account for this lack of investment. First, carriers facing further capital constraints rank customer-facing initiatives over other capital investments. Non-essential MRO investments thus slide down the list. Second, airlines are trying to simplify their business by focusing on core operations. Many airline MRO executives struggle to prioritize their requirements within a capital-constrained carrier. As a result, even the most attractive investments may go unfunded. Given this landscape, three dominant airline MRO business models have emerged: Outsource all. This segment is dominated by LCCs, regional carriers, and other start-up carriers, which maintain a virtual base maintenance function with only oversight and management functions housed inside the airline. Many carriers in this segment choose to retain line-maintenance activities within their own operations. This segment is growing disproportionately, fueled by the emergence of LCCs around the world.

Exhibit 1 Survey and model of forecast MRO spending
Maintenance spend forecast
($ billions) $45 40 35 30 8.3 25 13.4 20 15 10 5 0 2008 Engine 2011 Airframe Components 2013 13.2 15.7 18.2 6.5 % 10.7 14.8 6.7 % $32.2 $38.8 10.3 9.7 4.4 % $43.3

CAGR
6.1%

Note: Includes internal and external MRO spend. Source: Oliver Wyman forecast model.

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Exhibit 2 Airline underinvestment in MRO adversely affects performance
Prioritization of MRO for investment
Percentage of respondents answering

Under-investment in MRO
Percentage of respondents who said the lack of MRO investment adversely affects performance

Moderate High Agree

23% 36% 9% 14%
Among lowest Strongly agree Low

27% Not highly prioritized: 46% Under-invested: 59% 36%
Disagree

18%
Among highest

32%

5%
Strongly disagree

Source: Oliver Wyman/Aviation Week & Space Technology MRO Study.

Optimize mix. The second fastest-growing segment includes carriers that selectively outsource across their fleets, selecting lines of business or platforms of repair to retain while outsourcing the majority of the remaining work. Insource and grow and/or divest. While this segment has shrunk, select carriers have made significant investments in their MRO operations to both retain their own work and grow third-party revenue. Some carriers have successfully built extensive, robust third-party revenue from their MRO operations. The natural culmination of this model is the divestiture of the MRO business, typically with the airline maintaining an equity position in the new company.

Impact of the New Business Models on MRO Providers
There are three important consequences of these evolving airline business models. First, a significant portion of global MRO activity is now performed by non-airline providers, creating a strong independent and OEM aftermarket. Second, airline segments that predominantly outsource their maintenance are increasingly seeking integrated offerings from providers. Carriers are increasingly seeking fully integrated solutions bundled under cost-per-hour programs, which provide appropriate levels of risk transfer and certainty. Demand for broader service offerings was highlighted in this year’s survey, with breadth of

Exhibit 3 Importance of supplementary services to airlines
Value of services to airlines
Relative importance, percent answering Reliability management 45% 22% 18% 8% 7%

Materials management/logistics support

25%

46%

18%

11%

Rotables pooling/leasing

23%

36%

15%

15%

11%

Engineering maintenance programs

20%

34%

22%

8%

6%

Technical publications

21%

29%

21%

15%

14%

Project engineering

18%
High

31%
High - Medium Medium

31%
Low - Medium

9%
Low

11%

Source: Oliver Wyman/Aviation Week & Space Technology MRO Study.

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support services ranked similarly to price and turntime in how airlines select a provider. In addition, airlines have become more vocal about the services they value most, including reliability management, materials management, and engineering/maintenance program services (Exhibit 3). And third, the demand for these services and offerings has become truly global, as shown in Exhibit 4. In response, capabilities are growing in domestic markets to meet local needs. Also, disproportionate growth is occurring in lower-cost regions for selected MRO activities to meet international demand (e.g., wide-body airframe maintenance in Asia, narrowbody airframe maintenance in Latin America, and engine maintenance in Europe and North America). Providers clearly recognize these effects and are responding. By 2011, 40% of respondents expect their business model to be defined as an integrated offering, compared to only 28% in 2008. Providers cited several methods for evolving their business designs in both service offerings and geographic presence. Some 32% of providers cited acquisitions as the preferred method of growth, with 25% highlighting joint ventures or partnerships as the chosen path for expanding and growing capability and capacity. These responses support the rapid consolidation occurring in the industry, often supported and initiated by private equity investment.

Within this context, MRO providers face several challenges. First, it is important to identify the appropriate platforms to build or acquire and the regions in which to expand, as missteps can be costly. MROs must target customer segments and regions methodically, understanding that certain business models more effectively serve different segments of the market. Second, with a broader portfolio of service offerings typically comes an increased fixed-cost structure. Companies will be pressed to build scale to maintain or enhance margins. Third, the development of technicians and other technical resources is becoming an acute issue that will constrain the growth of the industry, not simply individual companies. Those companies that address this issue head on will have preferred access to superior talent. Finally, integrating companies and building broader offerings is a complex undertaking, and there are many stories of failed mergers, as promised synergies get lost in implementation. Many MROs understand the basic business model they strive to create, but struggle with how to get there. There are many discrete and substantial investment decisions involved, each with profound long-term consequences. Providers that anticipate and address these challenges successfully will see disproportionate value creation compared to their peers.

Exhibit 4 Diversity of geographical presence
Engine MRO spend
% by region
5% 10% 15% 21% 1% 7% 1% 8% 17% 17% 27% 30% 41% 31% 30% 28% 40% 34% 31% 27% 30% 25%

Airframe MRO spend
% by region
5% 10% 5% 10% 9% 11%

Component MRO spend
% by region
5% 6% 24% 6% 9% 17% 23% 8% 11%

33%

35%

38% 27% 22% 2013 by MRO geographic fulfillment Europe

38%

38%

32%

2008 by operator geographic origination

2008 by MRO geographic fulfillment

2013 by MRO geographic fulfillment Middle East

2008 by operator geographic origination

2008 by MRO geographic fulfillment

2008 by operator geographic origination North America

2008 by MRO geographic fulfillment

2013 by MRO geographic fulfillment

Latin America

Asia/Pacific

Source: Oliver Wyman/Aviation Week & Space Technology MRO Study. Oliver Wyman forecast model.

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The Complexity of a Global Repair Network Creates Added Supply Chain Management Challenges for Carriers
With rising levels of international outsourcing, airlines must manage an increasingly global network of suppliers, which raises various challenges. Respondent airlines that have ventured into emerging-economy regions identify complicating factors that include currency variability, operational oversight, cultural differences, and regulatory requirements (Exhibit 5). MRO providers can effectively address these issues with their international airline customers through solutions such as the following: Pricing agreements in the customer’s domestic currency (balancing currency risk with a hedging program) Putting transparency into operational performance through the use of balanced scorecards with defined Key Performance Indicators (KPIs) and regular reporting structures Working openly and collaboratively with the airline in their dealings with regulatory agencies Providing appropriate language and cultural training to select employees

Airlines also recognize the part they play in more effectively managing their supply base, in particular their international suppliers. Some 82% of airline respondents say their supplier management function has increased in importance in the last three years. Still, at many carriers, the supply chain personnel are too focused on running the day-to-day operation and putting out fires, rather than on more strategic activities like supplier management and supply chain/inventory optimization. Carriers need to strike a better balance to ensure that value doesn’t leak out of the supply chain. Furthermore, 59% of carriers have increased the size of their supplier management function. This data underscores the shift in organizational priority of many carriers and the realization that much of the potential value in new MRO networks lies in effectively managing the global supplier network.

Inventory Management Proves Fertile Ground for Improvements
Nearly 75% of airline respondents believe that their inventory planning processes are insufficient to meet organizational goals, and 95% describe their inventory management capabilities as “basic.” “Material/part availability” is described by 82% of airline respondents as a “significant” or “very significant” challenge, and more than 40% say that parts availability significantly hinders their operations. Moreover, nearly two-thirds of airlines realize that

Exhibit 5 Sources of complexity in managing a global supply base
Sources of difficulty
Percent responding “significant” or “very significant” Currency variability Effective operational oversight Cultural differences Regulatory requirements Customs Technical requirements Language barriers Time zones
Source: Oliver Wyman/Aviation Week & Space Technology MRO Study.

41% 32% 27% 23% 23% 18% 14% 14%

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they hold excessive amounts of slow-moving or obsolete inventory (Exhibit 6). A senior maintenance executive at a major North American carrier commented, “In completing a comprehensive review of our inventory practices, we found that we held too much of non-critical parts and too few critical parts. In optimizing our inventory management practices, we were able to reduce our total investment in inventory and improve service levels.” Clearly, there is substantial opportunity for carriers, MROs, and material providers such as OEMs, PMA manufacturers, and distributors to enhance the effectiveness of the material supply chain. Airlines acknowledge their general lack of expertise in materials management and are willing to partner with providers or other specialized supply chain companies to overcome these deficiencies. Moreover, vendor-owned inventory programs are gaining acceptance as capital-constrained carriers look for means to liquidate their inventory positions; 59% of carriers note that capital constraints have been a substantial driver of their increased focused on enhanced material management. As MRO providers move to become fully integrated service providers, they will be increasingly called on by customers to provide inventory management and materials support functions.

Experience with Lean Techniques Is Producing Significant Value
Regardless of the business model adopted by an MRO provider, operational excellence lies at the heart of success. Lean principles play a key role in achieving better quality, on-time delivery, and lower costs—all attributes core to airline’s MRO selection criteria. Survey results highlight that providers are further down the Lean path than their airline MRO counterparts. Some 41% of airline respondents, compared with 21% of MRO respondents, are not using Lean to their benefit. These responses are consistent with general investment in internal MRO operations by airlines and the propensity for selected airline segments to outsource their MRO activities. Those firms that have made significant investments in Lean are seeing tremendous rewards; these respondents report average benefits of between 25% and 50% in cycle-time improvement, on-time delivery improvement, reductions in rework, reductions in inventory, and increases in labor productivity (Exhibit 7). To be sure, the Lean journey requires substantial investment and fortitude. Respondents note “changing mindsets and behaviors,” “availability of resources,” and “poor or conflicting measurement systems” as the most challenging barriers to overcome in implementing Lean. An integrated, strategic approach is therefore critical.

Exhibit 6 Airline inventory management
Airlines: Effect of inventory availability on operations
Percent of respondents answering 31%+
9%

Slow-moving or obsolete inventory
Percent of airline respondents answering

21 - 30%

27%

High/ inefficient

Hinders 41%
11 - 20%
27%

Enhances 45%
6 - 10%
27%

Sweet spot

Neutral 14%
<5%
9%

Low/risky

Source: Oliver Wyman/Aviation Week & Space Technology MRO Study.

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Exhibit 7 Realized benefits from Lean
Performance improvements at MROs
Reported savings range by percent of respondents

Reduction in cycle time

31%

31%

22%

16%

Improvements in on-time delivery

34%

34%

6%

17%

9%

Reduction in rework

42%

23%

16%

10%

10%

Reduction in inventory

52%

29%

13%

6%

Increase in labor productivity

31%

31%

33%

3% 3%

0-10% Source: Oliver Wyman/Aviation Week & Space Technology MRO Study.

11-25%

26-50%

51-75%

>75%

Shotgun approaches to Lean don’t work. The winners are the ones who are executing disciplined, comprehensive plans that address changes in mindset, are supported from the top and implemented from the floor up. Data from the survey highlights that those that stay the course realize benefits disproportionate to others who have made more modest investments, supporting the old adage “you get back what you put in.” *** This year’s survey clearly highlights that shifts in the MRO landscape that have emerged over the previous four to five years are here to stay. To succeed in this new market, MRO organizations will need to

critically evaluate the effectiveness and relevancy of their current strategies. Central to this evaluation in developing a strategy for global capabilities and supply chain management, plus making focused investments in selected geographies, aircraft/engine platforms, and capabilities. Agility and access to capital will prove critical success factors in moving to quickly develop and expand these global MRO networks. Finally, effectively deploying highly leveraged operational investments, such as Lean, will prove the differentiating factor in profitably meeting ever increasing customer demands. While the evolving market presents great opportunities for MROs, the complexity of decisions and magnitude of risk have never been greater.

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About Oliver Wyman
With more than 2,900 professionals in over 40 cities around the globe, Oliver Wyman is the leading management consulting firm that combines deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation, and leadership development. The firm helps clients optimize their businesses, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is part of Marsh & McLennan Companies [NYSE: MMC]. For more information, visit www.oliverwyman.com.

About Oliver Wyman’s Aviation, Aerospace & Defense Practice
Oliver Wyman’s Aviation, Aerospace & Defense practice works with OEMs, commercial passenger and cargo carriers, MROs, other service providers, and government entities to develop and implement business growth strategies, improve operational efficiencies, and maximize organizational effectiveness. We have successfully completed hundreds of engagements for aviation, aerospace, and defense clients over the past five years, and have consulted to nearly three quarters of the Fortune 500 firms in these sectors. The practice serves the industry worldwide with consultants based in North America, Asia, Europe, and the Middle East. The principal author of this survey is Chris Spafford, a partner at Oliver Wyman. He can be reached at christopher.spafford@oliverwyman.com. For more information on Oliver Wyman’s MRO capabilities, please contact: Roger Lehman, roger.lehman@oliverwyman.com John Seeliger, john.seeliger@oliverwyman.com Tim Hoyland, tim.hoyland@oliverwyman.com Rob Cords, robert.cords@oliverwyman.com

www.oliverwyman.com

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