AlixPartners, the global advisory firm, today released the findings of its annual Asia Aerospace & Defense Industry Outlook. Set against a highly fluid global marketplace for airlines, aerospace and defense manufacturers, and service and maintenance companies, Asia-Pacific remains a profitable region and by 2031 will, among other things, be the biggest airline market in the world, receiving 31% of all new jet deliveries, says the study.
However, whilst strong growth is being enjoyed among airlines and commercial aircraft OEMs, the defense sector globally is shrinking. According to AlixPartners’ study, the defense sector will struggle to make up for reduced revenue growth, while the commercial aerospace sector will benefit from a strong increase in deliveries and will focus on translating that growth into a bigger share of the profit pool.
Commenting on the challenges, CV Ramachandran, Managing Director and Asia Head for AlixPartners, said, “A&D companies need to become more efficient and wring costs out of their operations at all levels. In the defense sector, particularly, companies must diversify their market bases in order to grow both top and bottom lines. They need to identify and exploit those markets with strong growth opportunities.”
Airlines: Asia the Growth Motor
Whilst capacity continues to grow in the global airline sector, companies are still facing pressure on profits because of high fuel prices, the growth of low-cost carriers and pricing competition among new global competitors. Asia-Pacific, however, remains a profitable region for airlines, though margins are being squeezed by a weak cargo market.
With their favorable demographics and growing middle classes, the industry’s center of gravity is shifting from the West to the more rapidly-growing markets of Asia and the Middle East, says the study. Accordingly, airlines in these markets are building up their fleets and placing large orders. By 2031, Asia-Pacific will be the biggest airline market in the world.
Glenn Darwin, Director at AlixPartners commented, “Big changes in operating models are underway in airlines across Asia-Pacific, as the line between low-cost and full-service carriers has blurred. Traditional network carriers have unbundled their pricing to give passengers lower fares, and those carriers are embracing alternative approaches to their full-service models, to drive growth while maintaining premium brand images.”
The study goes on to highlight that low-cost providers, such as Lion Air, AirAsia, and Jetstar, have added new improved services and innovations like live in-flight television. As in Europe and North America, Asia has also seen a number of unsuccessful airline M&A attempts, most recently with AirAsia Japan, the joint venture between AirAsia and All Nippon Airways, which was dissolved after only a year.
“With severe competition, passenger airlines are no longer competing just on price and schedules. They have to differentiate themselves by providing innovative products and service offerings, as well as efficient marketing strategies. Being lost in the mid-market blur could sound the death-knell for airlines that fail to differentiate,” Ramachandran said.
Defense: the Course is Set for the East
Because of budget cuts in Western markets, Asian countries have outspent European NATO countries for the first time, and, says the study, this trend is set to continue.
Compounding this transition, two of the largest developing-market spenders—China and Russia—are effectively off-limits for outside contractors. Defense manufacturers are now fighting to capture the developing markets—primarily India, Brazil and Saudi Arabia—even as Russian and Chinese contractors increase their exports to those markets as well, says the study.
Commenting on the defense sector, Jennifer Li, a director at AlixPartners, said, “Cost cutting is unavoidable for defense manufacturers. Competition for major programs is increasingly a winner-takes-all arrangement, such as combat aircraft in developing markets, so OEMs need to adapt their offerings accordingly.”
Commercial Aerospace: Up, Up and Away
The strongest sector within the global A&D industry last year was commercial aerospace, which accelerated its growth, particularly on the part of OEMs. AlixPartners expects that by 2017, the workload volume of OEMs’ main commercial programs will have ramped up by 45%, with further increases on the horizon.
At the same time, both OEMs and suppliers are translating those gains into improved earnings. Supplier segments—including propulsion, cabin interiors, and components and materials—built on their profit momentum from earlier years, with strong performers such as Precision Castparts, Safran, Rolls-Royce, UTC, Parker Hannifin and Zodiac. Among OEMs, EADS has shown significant growth in EBIT; and other competitors are slowly returning to 2007 levels. Overall, suppliers remain more profitable than OEMs by a gap of nearly five percentage points.
Both Airbus and Boeing are also improving cost efficiencies (and likely enabling further plane orders) and strengthening their supply chain footprint in China through innovation centers, final assembly lines and supplier networks.
It will also become increasingly important to factor in the Chinese state-run aircraft manufacturer Commercial Aircraft Corporation of China (“COMAC”), says AlixPartners. It has already secured a significant order book of hundreds of planes for its ARJ21 and C919 jets. Developing a reputation – real and perceived – for quality product will, however, remain a necessary focus for all Chinese OEMs, says the study.
Supply Chain: Uncertainty
The forecast increase in sales volume is a positive sign, but increased sales will create significant challenges for A&D supply chains, as OEMs increasingly rely on outsourcing to trusted suppliers to improve costs and meet local-content requirements, says the study. For instance, it notes, Japanese companies reportedly account for more than a third of the components to Boeing 787, and Boeing has three Chinese contractors as sole suppliers to select 787 parts. These new programs also involve more-technologically complex designs aimed at increasing aircraft operating efficiency by 15 to 20%.
The current industry supply chain is not entirely ready for this dual challenge of delivering both greater volume and more-sophisticated aircrafts, and in fact, there is a real and growing risk of supply chain disruptions. OEMs are now increasing their scrutiny of suppliers resulting in increased costs.
Ramachandran added, “More and more, OEMs will have to lead operational improvement and streamlining programs at their key suppliers, and tier 1 suppliers will have to develop similar measures further down the supply chain. Consolidation is especially needed in the detailed-parts-supplier segments, and OEMs must actuate that process.”
MRO: Stable Growth but Changing Competition?
AlixPartners expects that airlines will continue to outsource their maintenance segments in greater volume. More broadly, aircraft OEMs are extending their reach into the MRO business. Airbus FHS and Boeing Edge could become major players in the segment in the next three to five years, says the study.
Asia (excluding Japan) already boasts some of the worlds’ top MRO providers, such ase ST Aerospace, SIA Engineering and HAECO, and the region will likely see MRO demand grow in line with the ever-increasing fleet sizes of regional airlines, says the study. Anticipating this growth, both leading international and regional MRO providers, such as Lufthansa Technik, AFI-KLM Engineering & Maintenance, HAECO and GMF Aero Asia, are actively expanding and investing in Asia. Costs continue to increase in Asia. Such pricing differential for Asian MRO facilities is becoming less attractive, says AlixPartners. As a result, Asian MROs are under pressure to achieve further cost savings and efficiency gains while maintaining the highest quality.
There is a clear growth opportunity in the MRO segment, says the study; but to win, operators will have to navigate a dynamic market and compete more and more against OEMs for longer-term maintenance contracts of new aircraft models. Key requirements will be access to capital, willingness to invest long term and a manufacturing footprint with operations close to “the fleet of tomorrow,” including strong coverage in Asia. Some Asian MROs are looking to go up the value chain into new business lines, which includes M&A.
Ramachandran concluded, “The compounding effects of the growing markets in Asia and the Middle East, rapidly-evolving technologies and fiscal strains on mature markets in Europe and the United States could likely lead to instability for the A&D industry over the coming years. Successful companies in the industry must focus on the three key priorities of profitability, diversification and innovation.
“These are sizable challenges, yet they also point to clear opportunities. A&D operators that can get these three areas right can give themselves a clear, competitive edge in this volatile industry.”
AlixPartners is a leading global business advisory firm of results-oriented professionals who specialize in creating value and restoring performance at every stage of the business lifecycle. The firm’s expertise covers a wide range of businesses and industries whether they are healthy, challenged or distressed. Since 1981, we have taken a unique, small-team, action-oriented approach to helping corporate boards and management, law firms, investment banks and investors respond to critical business issues.