Aircraft eet planning a new perspective

Maximising value and competitive advantage

from complex aircraft eet decisions
In the face of extraordinary uncertainty,
airlines are seeking to implement rigorous
yet practical approaches to assessing value
potential from available eet options.
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Contents
Introduction 1
Context 2
The opportunity 5
Realising the opportunity 6
Conclusions 8
Contacts 9
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Introduction
Fleet choices are among the most signicant decisions an airline has to make. Large scale changes to the aircraft
eet, including potentially determining new principal aircraft and engine platforms, will touch nearly every aspect
of the business, from day to day ight operations and customer satisfaction through to nancial performance and
shareholder return.
Growth in forecast demand coupled with the introduction of a wider range of new aircraft frame and engine
choices makes the decision highly complex. At the same time, margin compression and competitive pressures
increases the risk as well as the value at stake.
Comprehensive analysis of the key issues, complexities and uncertainties as well as the risk-return trade-off of
alternative options should be considered so as to assess the impact on the companys nancial performance as
well as operational effectiveness.
Growth in
forecast demand
coupled with the
introduction of
a wider range of
new aircraft frame
and engine choices
makes the decision
highly complex.
Aircraft eet planning a new perspective 1
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Context
Industry characteristics
Recent industry performance as well as economic
uncertainty provides a complex backdrop for eeting
decisions which demands greater focus. Our discussions
with airline executives have identied ten critical issues:
1 Demand growth:
Total international passenger trafc is expected
to grow at an average compound rate of almost
6% from 952 million in 2009 to an estimated
1,265 million in 2014.
The overall trend holds for both international and
domestic travel, with the highest rates of growth
in the Middle East and Asia (Figures 1 & 2).
International freight growth has been even higher
at just over 8% globally with the strongest growth
in Asia-Pacic and the Middle East (Figure 3).
Figure 1 Top 10 Country Forecast for International Air
Passenger Numbers
Millions
2009 2014
Source: IATA, Mintel, Deloitte analysis, February 2011
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Figure 2 Top 5 Country Forecast for Domestic Air Passenger
Numbers
Millions
2009 2014
Source: IATA, Deloitte analysis, February 2011
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India Brazil Japan China US
Recent industry
performance as
well as economic
uncertainty has
increased the
focus on eeting
decisions.
Figure 3 International Freight Volume Growth % from
2009 to 2014 by Region
Source: IATA, February 2011
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2 Margin compression: Prots have historically
been tight across the sector and the increase
in total operating costs threatens to suppress
margins further. Having recovered in 2010 from
the lows of 2009, average regional EBIT margins
declined again in 2011 and are forecast to fall
back further in 2012 (Figure 4).
3 Rising fuel costs: Fuel remains the most
signicant and volatile component of operating
costs and managing this exposure is an increasing
challenge for senior management (Figure 5).
4 Emissions taxes: The extension of the European
and other emissions trading schemes to airlines is
an additional cost burden to international ights.
5 Competitive pressures from increasing
globalisation: The increasing reach of airlines
beyond their domestic markets, particularly
Middle East and Asian players with newer and
more efcient eets, as well as nancial strength
is placing competitive pressure on European and
US airlines with older eets and higher cost bases
(Figure 6).
6 Competitive pressure from evolving business
models: Traditional demarcations between the
business models of low-cost and ag carriers
are blurring as low-cost carriers (LCCs) target
business passengers and ag carriers offer no-frills
services on key routes.
7 Supply-demand balance: With the rates of
deliveries reaching new highs, there is a continued
prospect of excess capacity.
8 Demanding stakeholders: After a period of low
returns and with perceived higher risks in the
industry, investors are demanding a greater return
on investment.
9 Demanding customers: Increasing pressure
from customers for higher service at lower
prices e.g. provision of modern cabin interiors as
part of increased competition for business class
passengers.
10 Responsible business: Industry responding to
calls to reduce the environmental impact of air
transport.
Figure 5 Industry Fuel Costs & Net Prot 2003 to 2012
Source: IATA, March 2012
Net Prot ($billions) Total Fuel Cost ($billions)
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Figure 6 Average Fleet Age in years by Region 2011
Source: IATA, February 2011
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Figure 4 Airline Protability EBIT Margin as % of Revenue
by Region
2009 2010
Source: IATA, March 2012
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Aircraft eet planning a new perspective 3
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The range of
next generation
airframes and
engines being
introduced means
that ranking and
prioritisation of
choices is more
important and
more complex.
New technology, new options
The range of next generation airframes and engines being introduced are expected to provide signicantly
improved fuel efciency, increased exibility especially from new mid-range aircraft, and customer comfort.
This increased range of options means that ranking and prioritisation of eet choices is more important and more
complex. Factors which need to be included on top of the traditional capex versus opex trade-off criteria include:
Delivery timing: The availability of production slots and/or whether OEMs will be able to deliver new aircraft to
schedule (as with the A380 and Dreamliner).
Prospect of newer technology: Determining the optimal timing given expected future technological
developments, including the range of options from potentially newer manufacturers, to ensure that the decision
is as robust as possible and stands the test of time.
Leasing constraints: Fullling obligations and timing restrictions on existing leased aircraft within the timeframe
for commissioning of new aircraft.
Evaluation of optionalities: Incorporating the additional value arising from the greater exibilities offered by
new aircraft in terms of their geographical reach or the split between passengers and freight they can carry.
Availability of nance: Changes in the appetite of traditional nance providers may require access to alternative
sources such as private equity and OEM customer nance.
Brand strength: The comfort, quality and reliability of an airlines eet is becoming more important to brand
strength. The decision to maintain, upgrade or replace is far less driven by pure economics.
These factors provide a more challenging backdrop for long term capital investment decisions generating greater
opportunity to deliver, and also greater potential to destroy, signicant shareholder value.
4
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The opportunity
The strategic direction, and hence value creation,
of an airline is underpinned by a number of key
considerations:
The vision and positioning of the airline versus
available business models.
Securing growth and protability in an increasingly
competitive market, through network planning and
demand capture.
The actions taken to minimise cost base and
maximise returns to shareholders whilst ensuring a
sustainable business model.
Historically, the industry has been characterised by
comparatively less uncertainty around its operating
environment, less volatility around its key cost drivers,
fewer options in respect of airframes and engines, and
higher margins. Consequently the focus of decision-
making has been on operational planning and cost
efciency with less emphasis and analysis required on
eet choices.
The increased strategic importance of the eet
decision, greater range of available options, and higher
uncertainty demands a robust response which enables
an airline to:
Align decision-making more closely with the chosen
strategic direction.
Incorporate the risk and uncertainty around key
decision drivers.
Evaluate any embedded optionalities associated with
eeting choices.
Understand the risk-return prole associated with
alternative choices.
Enable the application of an airlines risk appetite
and balance sheet strength in its decision-making to
optimise the trade-off between risk and return across
a wide range of potential future scenarios.
Implement an integrated approach from decision-
making through to negotiation support.
Based on our discussions with industry executives,
there is a strong belief that future winners and losers
might be dened by the impact of their eeting
decisions on strategic positioning.
Aircraft eet planning a new perspective 5
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There is a strong
belief that future
winners and
losers might be
dened by the
impact of the
eeting decisions
on strategic
positioning.
Realising the opportunity
Maximising value from the eeting decision requires
consideration from three perspectives:
Strategic alignment.
Implementation considerations.
Negotiation support.
Strategic alignment
From a strategic perspective, the airlines key
considerations in respect of eet planning include:
What is the total eet requirement, in terms of the
number and type of aircraft?
Should we maintain or replace our existing eet?
Which aircraft frame(s) and engine(s) should we be
considering?
Airlines are seeking to ensure that eeting decisions
reect economic evaluation on whole-of-life costs,
including the expected residual value of aircraft
disposals, and provide a level of exibility to adapt to
changing circumstances. In addition, the uncertainty
around key input parameters needs to be explicitly
considered to ensure greater transparency around the
risk-return proles for all evaluation metrics.
Implementation considerations
Implementation considerations are also important as
they impact value and risk signicantly and in some
cases may even alter the strategic choices above:
Optimising the phasing of the introduction of new
aircraft.
Minimising implementation costs.
Financing the eet.
Airlines are increasingly recognising that alternative
contract structures might, due to their nancial
and operational implications, impact the ranking of
preferred airframe, engine and MRO concepts.
Negotiation support
It is also clear that signicant value can be derived in
the negotiation process by being able to:
Compare between different manufacturer packages
on a common basis.
Isolate and evaluate the value of individual
negotiation points relative to their cost.
Airlines who achieve premium value in negotiations
display a number of characteristics:
Comprehensive analysis of available packages/
options.
Clear negotiation strategy.
Costing/pricing of key negotiation points e.g.
maintenance contract options.
Ongoing evaluation of strategic alignment and
implementation implications during the negotiations.
Should we maintain upgrade or replace our
existing eet (or combination)?
Strategic drivers:
Competitive pressures.
Target network strategy/ies.
Future passenger traffc on routes.
Market drivers:
Fuel costs & fuel cost volatility.
Carbon costs & carbon cost uncertainty.
Lease length + e.g. part exchange deals.
How do we compare between different manufacturer
packages?
Evaluation of non-comparable offers.
Evaluation of negotiable trade-offs e.g. between cost of aircraft
and MRO contract or extended warranties.
How do we maximise value in our
negotiations with manufacturers?
Granularity to model costs & benefts of different components
of packages.
Flexibility to turn model around quickly during negotiations.
An efcient, effective and competitive eet
How do we optimise the phasing of
introducing new aircrafts?
Bridging requirements between current and future
eet.
Uncertainties in delivery timetables.
Leasing constraints (e.g. max fight hours).
Implementation considerations (see below).
How do we minimise
implementation costs?
MRO set-up and contract.
Retraining crew.
Reconfguring ground services.
How do we nance our aircraft?
Proportion of aircraft purchased versus leased.
Any residual value from disposal of existing aircraft.
Impact of the phasing of aircraft on fnancing.
What is our total eet requirement
(number and type of aircraft)?
Forecast demand (passenger/freight).
Forecast supply-demand balance.
Target operating model (e.g. LCC?,
hub vs point-to-point, O&M outsourced vs
in-house).
Which aircraft frame(s) and engine(s) should
we be considering?
Range of available frame and engine options.
Optimisation of feet portfolio with respect to
network strategy and cost considerations.
Evaluation of options that offer fexibility (e.g.
midrange vs xed routes + charters, exibility
between pax and freight).
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6
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Analysis to support the decision-making
It is widely recognised that new capabilities are required to
support eeting decisions. The key improvement required is
that the analysis needs to better incorporate the uncertainty
in a dynamic rather than static way. This will enable the
uncertainty to be incorporated into the traditional whole
of life evaluation of the upfront capital cost versus the net
present value of the benet of reduced ongoing operating
costs, including retraining and reconguration costs, and the
inclusion of the aircraft disposal value (if owned).
Dynamic analysis will include features such as
Generating a more robust measure of value Using
a risk-return approach which integrates value and risk to
enable better informed decision-making and enhanced
value creation, where:
Key input assumptions such as fuel price are modelled
using a range of fuel prices with associated probabilities.
Being explicit about potential optionalities and the
uncertainty around these. For example, the greater the
uncertainty around an airlines future network strategy,
the greater the option value of using mid-range aircraft
that can serve multiple sectors rather than tailoring
short/long-haul aircraft to short/long haul ights.
This is illustrated in the example opposite.
Optimising the strategic and implementation
considerations An iterative approach helps to optimise
the strategic and implementation considerations, and
enable a coherent and integrated approach from eet
planning through to closing the deal.
There may be instances where implementation
considerations are sufciently important as to rene or
even change the initial view on strategic direction, for
example the value of the MRO contract accompanying
a particular aircraft or particular size of order.
An integrated framework recognises the complexity;
an iterative approach cuts through it.
Finally, the conclusions from both the strategic
alignment and implementation considerations are only
tentative until conrmed during negotiations.
Maximising value from the eeting decision, requires
consideration from three perspectives: Strategic alignment;
implementation considerations; and negotiation support.
It is widely recognised that new capabilities are required to
support eeting decisions. The key improvement required is
that the analysis needs to better incorporate the uncertainty
in a dynamic rather than static way.
Generating a more robust measure of value: A simple illustration continuing
the example of the evaluation of mid-range aircraft
It is more efcient to match short-range aircraft to short-haul ights and
long-range aircraft to long-haul ights than to use a single class of mid-range
aircraft for both. However, where there is uncertainty around an airlines future
ight sectors, mid-range aircraft may be a safer bet i.e. a tighter risk-return
distribution around NPV. This is illustrated in the gures above which enables
management to view the risk-return trade-offs for alternative choices and make
decisions on the basis of risk appetite. In order to generate these outputs, the
analysis must be able to (i) evaluate the eet as it is used on a given route strategy
and (ii) factor in the degree of condence (or lack of condence) around the
airlines expected future route strategy, by identifying the potential range of
future strategies and an expert view of the probabilities of each scenario.
There are other factors to consider. Fuel price uncertainty must also be taken into
account in the core capex versus opex calculation. Might fuel price uncertainty
change the optionality in unexpected ways? Might there even be a strong enough
correlation between future fuel prices and an airlines future preferred network
strategy?
NPV
Broadening the scope of value
and risk drivers may change the
picture further
Route strategy: VARIABLE
Fuel price: VARIABLE
+ correlations between them
Evaluation metric e.g NPV
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On a static view, matching aircraft
to sectors is more efcient than
using mid-range only
Route strategy: Fixed
Fuel price: Fixed
NPV
There is some overlap between
NPVs of both options driven by
fuel price uncertainty
Route strategy: Fixed
Fuel price: VARIABLE
NPV
The efciency of matching is
overstated as there is downside risk
from route strategy uncertainty
Route strategy: VARIABLE
Fuel price: VARIABLE
Aircraft eet planning a new perspective 7
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Conclusions
Fleet choices are among the most signicant decisions airlines make. The greater choice of airframe and engine
options means there is a greater value opportunity. At the same time the challenges facing the industry also
means there is greater risk and a greater impact of not reaching the best possible deal. In order to protect and
enhance value, airlines are seeking to adopt a more robust and integrated approach to decision-making that
better aligns eeting decisions with their long-term strategic direction.
Identifying and incorporating the long-term complexities and uncertainties within the evaluation provides
enhanced understanding of the risk-reward trade-offs, which in turn enables better nancial and operational
outcomes.
8
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If you would like further information about how Deloitte can help you please contact:
Graham Pickett Chris Lynch
Lead Partner, Travel, Hospitality & Leisure Director, Travel, Hospitality & Leisure
01293 761 232 020 7007 9302
gcpickett@deloitte.co.uk chlynch@deloitte.co.uk
Hans-Kristian Bryn Martyn Sullivan
Partner, Strategic Risk Partner, Business Modelling Group
020 7007 2054 020 7007 0808
hbryn@deloitte.co.uk mdsullivan@deloitte.co.uk
Contacts
Aircraft eet planning a new perspective 9
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