Printed headline: The Case for Lower Material Costs
For the last five years, the economics of flying have been good for both airlines and air travelers. During that period, despite rising costs for fuel, airlines have managed to keep the cost of air travel flat on an inflation-adjusted basis—and they have been rewarded with record traffic and profitability.
But all good things eventually come to an end. In our view, the industry cannot sustain this tricky balancing act much longer.
While overall maintenance costs have been increasing over the same five years, billed labor rates have surprisingly slipped slightly on an inflation-adjusted basis. Globally, rates have dropped by 0.6% and 0.7% in North America, based on research from Oliver Wyman Global Fleet and MRO Market Forecasts—a stunning phenomenon, given that demand for labor is increasing and supply is decreasing. The basic law of supply and demand would seem to dictate short-to-intermediate-term increases in wages may be required to attract enough new talent into the industry. Recently ratified, or amended, labor contracts at the major U.S. carriers are the first tangible signs of these rising costs, and aircraft and engine manufacturers, as well as the independent-supplier market, can expect to eventually feel this pressure.
Yet, the MRO community has reported persistently low wage growth, according to Oliver Wyman, which creates an increasing divide between third-party pay for technicians and pay at the airlines for equivalent work. If unchecked, this discrepancy could undermine the health and effectiveness of independent MRO providers.
And if total costs for maintenance are rising while labor rates fall, that also suggests a disproportionate increase in material costs. Once labor rates begin to climb—a trend that will be hard to fight given the competition for workers—airlines likely will turn their attention to rising material costs as a way to counterbalance the wage hikes.
History has shown that when the industry is under significant cost pressure, it employs ever more aggressive cost-containment measures. In the past, this has included the introduction of non-OEM licensed parts manufacturer approvals, significant use of designated engineering representatives and outsourcing to lower-cost countries. While increasing material prices enhances financial results, there is a balance that original equipment manufacturers (OEMs) should consider striking if they want to both sustain profitability in their parts businesses.
Many OEMs already are aggressively pursuing surplus-parts, aircraft-teardown and parts-trading strategies. We expect them to continue to manage their spare-parts businesses through broader deployment of predictive maintenance, maintenance program optimization and aggressive repair development. While some OEMs may worry that these strategies will dilute new parts revenue and margins, they should remember that getting in front of trends and managing their impact rather than dealing with customer backlash is a better approach.
Truly collaborative solutions exist and can be adopted that will produce both tangible cost reductions for carriers and accretive gains for innovative OEMs, perhaps in the form of additional market share. OEMs working for long-term growth for both themselves and their customers already are acting on these strategies and working collaboratively to find the win-win for themselves and their customers.
It is critical for the industry to maintain a vibrant and sustainable independent and airline-affiliated MRO market. Traditionally, this sector has acted as a check on aggressive price escalation, as well as a source of significant innovation, including such advances as alternative repairs and improved repair and check efficiency. A healthy, competitive marketplace benefits all participants and drives more dominant players to innovate. Uncompetitive markets stagnate, prices rise and new entrants emerge that are more disruptive and dangerous than existing alternatives.
To ensure the survival of a diverse MRO ecosystem of both the large and small, airlines and OEMs should consider financial support and executive engagement with independent trade associations like the Aeronautical Repair Station Association as a first step.
Another option is to have larger airlines adopt clauses in their agreements with OEMs and large MRO integrators to guarantee minimum award levels for independent MRO subcontractors—much like the U.S. government does with large procurement programs.
Finally, the airlines and OEMs should recognize that rising labor costs will inevitably put pressure on material pricing to a degree not seen in recent years, forcing them to address the underlying drivers of the price increases. Together, these initiatives will better prepare the industry to remain competitive and assure a robust MRO support infrastructure for a growing aviation industry well into the future.
David Marcontell, general manager of Oliver Wyman’s Cavok division, also is an FAA-licensed pilot and mechanic.
The views expressed are not necessarily shared by Aviation Week.