Major Industry Trends
This report covers the entire aviation industry, including the airline and aerospace sectors. It focuses upon the civil sector of the aerospace business. The military sector is included in the separate sector profile on Defense.
The Economic Cycle and Aviation
The civil aviation industry is highly cyclical, being extremely sensitive to the economic cycle. In times of economic hardship, people simply fly less often than they do in the good times. In addition to being hostage to the economic cycle, the airline industry is struggling with two major factors, namely fuel costs, which seem to be on a perpetual path upwards, and the need to “green up.” As the Economist (2012) has pointed out, the world’s airlines operate on the tightest of margins, and the least ill wind can push even the most established players into administration or bankruptcy.
However, necessity, as the old saying has it, is often the mother of invention, and the big engine manufacturers that target the sector, such as Pratt & Whitney, Rolls-Royce, and GE, along with several innovative competitors, have all been looking to design more-efficient, leaner engines that use less fuel per mile and that are generally quieter, putting them comfortably inside the industry’s latest noise abatement measures.
Connectivity is undoubtedly one of the biggest trends in the sector, with airlines racing to re-equip their cabins to provide passengers with internet capability and telephone connectivity while in flight. Another development that has already made great advances in the business aviation sector, where price is often not an overriding consideration, is opening up the cabin management system (CMS) to the new “bring your own device” world. Major equipment providers such as Honeywell are already giving customers the option of using their tablet PCs, iPads, and iPods to watch movies and to interact with the entertainment resources on board. With commercial airlines, this trend will affect first-class cabins first, and will probably be slower to filter down to premium and economy-class cabins.
Interestingly, while supersonic flight came to an end in commercial airline operations with the demise of Concorde in 2003, the business aviation world has a couple of players that are going flat out to try to bring both supersonic and hypersonic jets to market. Aerion is partnering with NASA to overcome the design issues involved in producing a supersonic business jet that will be capable of cutting hours off a long-range journey such as New York to Tokyo. Another company, HyperMach, now headquartered in the United Kingdom, is working on what would be the first hypersonic business jet. HyperMach CEO, Richard Lugg, reckons that his revolutionary hybrid electric and jet-fuel turbine engine will take his SonicStar aircraft with 24 passengers from London to New York in 55 minutes. These are exciting developments and show that the dream of supersonic and hypersonic flight has not died.
The current state of the global commercial airline business continues to be difficult at best. One of the deep structural issues that the industry faces is that it is very difficult to take overcapacity out of the sector while so many national airlines are propped up in various ways by government subsidies. What happens in other industries faced with overcapacity, namely a spate of mergers and takeovers, along with some high-profile failures, has all sorts of systemic barriers to overcome in the airline sector. This arguably prevents the market from functioning the way competitive markets should function.
By way of example, two of the biggest mergers in recent years, the merger between Air France and KLM, and the merger between British Airways and Iberia, were both accomplished through holding companies, with the result that both parties to the merger stayed largely independent of each other and could continue to be national in character. Part of the problem is that for an international airline to fly between two countries, the airline requires the bilateral agreement of both governments. This either involves the country concerned requiring a stake in the incoming airline or requiring reciprocity from that airline’s government for its flag carrier. So far, no solution to this problem has been found and the only way in which the airline industry can seem to be truly global to its millions of passengers, is via alliances between airlines. These alliances allow baggage forwarding, through ticketing, and a multi-country network, which gives them an international flavor even as all the participants retain their domestic links.
The global airline industry has made a multi-billion-dollar loss in seven of the last 12 years. There is scarcely a major airline that is immune from potential bankruptcy, apart from the Gulf airlines, which are all cash-rich and expanding their businesses. Any sector with a profit margin of 3% or under is living on the edge. In fact, on December 13, 2012, the International Air Transport Association (IATA) announced that the net post-tax margin for the industry as a whole will barely amount to 1.0% for 2012 and 1.3% for 2013. That is such a wafer-thin margin that even a modest spike in fuel costs could tip the industry into yet another annual loss in 2013. In any event, IATA estimates that the industry needs a profit of between 7% and 8% to recover the cost of capital deployed. That does not look on the cards any time soon. IATA director-general Tony Tyler said in December 2012 that it seems likely that the world’s airlines will return a profit of US$6.7 billion in 2012, which represents a downward revision of IATA’s October 2012 prediction of US$7.5 billion. This amounts to just US$2.25 for every one of the 2.97 billion passengers carried in 2012, not much of a profit margin for a multi-billion-dollar sector.
Despite the thin-to-non-existent profits, passenger numbers continue to grow. In fact IATA points out that, despite high fuel prices and a slowing world economy, airline profits and cash flows held up at levels similar to 2006, when oil prices were US$45 per barrel lower and the world economy was growing at 4.0%.
Commenting on the numbers, Tyler said: “With global GDP growth close to the ‘stall speed’ of 2.0%, and with oil at US$109.55 a barrel, we expected much weaker performance. But airlines have adjusted to this difficult environment through improving efficiency and restructuring. That is protecting cash flows against weak economic growth and high fuel prices.”
General Aviation—The Scale of the Business and VIP Jet Market
As the international industry body, the General Aviation Manufacturers Association (GAMA), points out in its compilation of statistics on the sector (GAMA, 2012), the corporate and private jet sector is responsible for getting on for two million jobs worldwide and generates billions of dollars in revenue. This “general aviation” (GA) sector is defined as encompassing all aviation other than military and commercial aircraft, and includes everything from two-seater trainers to intercontinental business jets such as Bombardier’s Lear 850 or the Gulfstream 650. There are more than 320,000 GA aircraft worldwide, and more than two-thirds of these are based in the United States, the world’s largest GA market by far.
GA contributes more than US$150 billion to the US economy annually and employs some 1.265 million people. GA aircraft fly some 35 million hours annually in the US and carry around 166 million people. There are nearly 4,000 paved GA airports in the United States open to business jets. By contrast, there are just 500 commercial airports. At a stroke, this highlights one of the major reasons for the continued use of business jets by corporates and high-net-worth individuals. Even in the United States, there are a large number of town and city pairs that are not on commercial airline routes and that would require road trips of more than an hour or two for travelers to get from their desired destination to a commercial airport. In the emerging economies of India and China, business aviation has an even stronger case to make.
General aviation has always had to struggle against the public (and political) stereotypical view of private jets as toys for the super-rich. As the National Business Aviation Association (NBAA) points out in its “No Plane No Gain” campaign for 2012 and 2013, legislation follows perception, so the sector has to wage a constant struggle to avoid penal taxes being imposed, which would damage growth and jobs in the sector. One of the perennial ideas pushed by US politicians from time to time is a GA usage fee tax of US$100 per flight. When you consider that a corporate with an eight-seater jet will do at least 300 hours flying time each year, or around 30 trips with six to eight managers and executives flying to meetings with clients and suppliers, that amounts to 30 times 6 times 100, or a tax on the company of US$18,000. To a multinational such as Walmart, which works its corporate jets hard ferrying generally mid and low-level managers, buyers, and supplier relationship representatives out to the regions, the tax on the business would not be trivial.
The NBAA commissioned the research house NEXA to report on business jet usage by S&P 500 companies. It found that, between 2003 and 2009, users of business aircraft outnumbered non-users by three to one, and that users typically used business aircraft to drive increased revenues, profitability, and efficiencies. Business aircraft users outperformed non-users on several important financial measures for the period 2003 to 2007. On a market-cap-weighted basis, annual growth in revenues was 116% higher for users, earnings growth was 434% higher, and average annual EBIT growth was 83% higher. According to GAMA, more than two-thirds of all the hours flown by general aviation are for business purposes, and this includes all the leisure hours flown by small propeller and turbo-prop two-seater and four-seater aircraft.
Airbus and Boeing Growth Predictions for Sales of Commercial Aircraft
Despite the very thin profit margins experienced by commercial airlines worldwide, passenger numbers are continuing to climb. In its latest industry forecast for the period 2013–20, Boeing notes that passenger numbers for 2011 rose 6% above the figure for 2010. Boeing expects world passenger traffic to grow at 5% annually for the next 20 years. Air cargo traffic actually shrank slightly in 2011, down 2.4% on the figure for 2010. However, Boeing argues that emerging-market economies, with their hunger for goods and their thriving export engines, will foster a continuing need for air cargo, which Boeing expects to grow at an average annual rate of 5.2% up to 2031.
Taking these two facts into account, Boeing is forecasting a long-term demand for some 34,000 new airplanes to 2030, with a total value of US$4.5 trillion. “These new airplanes will replace older, less-efficient airplanes, benefiting airlines and passengers, and stimulating growth in emerging markets and innovation in airline business models,” it says. The bulk of new orders, some 23,240 airplanes, will be single-aisle regional jets, reflecting growth in emerging markets such as China and India. The larger, twin-aisle segment of the market, which currently has an approximately19% share of today’s fleet, will increase to 23% by 2031, Boeing says. These planes tend to be the intercontinental jets, so their arrival will foster the continuing globalization of trade and travel.
Airbus sees new-build demand for 2031 rising to 28,200 passenger and freight aircraft, somewhat down on Boeing’s figures. Traffic growth between advanced and emerging air transport markets will run at an average annual rate of 5.1%, it says. This is ahead of the average global growth figure of 4.7%, and not far off the 6.6% growth anticipated for flights between emerging markets. Airbus also thinks that around 42% of all the aircraft larger than 100 seats in size will be delivered to carriers in the EU and North America.
Aircraft makers are focused on reducing fuel consumption, and operating costs in general, in the battle to win orders from airlines. Fuel costs, which can account for 50% of an airline’s operating costs, can make or break an airline. Boeing says that its 787 Dreamliner cuts fuel use by 20%, thanks to new engines, and the use of lightweight, composite materials. Meanwhile, Airbus says that the A380 is the first long-haul aircraft to consume less than three liters of fuel per passenger per 100 km, a rate comparable to an economical family car. It claims that the A380’s efficiency and advanced technology result in 15–20% lower seat-mile costs than those of competitor aircraft. Fuel-efficient engines and the use of advanced composite materials have played a vital role in reducing the A380’s operating costs. The airframe is made up of some 25% composite material by weight, while the Airbus A350XWB, which entered production in 2010, utilizes around 50% composite material.
Boeing and Airbus are also engaged in developing alternative fuels. Engine-makers Pratt & Whitney, Rolls-Royce, and General Electric are all involved, and momentum is being maintained, even though oil prices have fallen considerably from their mid-2008 peaks. IATA has a goal of 10% alternative fuels by 2017 while, in the United States, the Federal Aviation Administration is encouraging the use of new fuels. Several flights have already taken place using biofuels. In April 2010, for example, the Boeing F/A-18 Super Hornet, nicknamed the “Green Hornet,” carried out a biofuel-powered flight and became the first US Navy fighter to be powered by a biofuel blend. The Navy noted that the F414 engine performed as expected during the 45-minute flight, and indicated “the aircraft did not know the difference between the bioblend and its traditional fuel source.”