Mercer Study Reveals Growth Opportunities in Airline Maintenance, Repair, and Overhaul

DALLAS, TEXAS, April 18, 2005 -- If you think that rising fuel prices are the only thing airline executives are preoccupied with these days, think again. Faced with unrelenting cost pressures, they must also continue to pay heed to other strategic questions that have a major bearing on their businesses such as aircraft maintenance, repair, and overhaul (or MRO for short).

The worldwide commercial aircraft MRO market is reportedly estimated at around $37 billion annually, with as much as half of all U.S. carriers' MRO work now performed by outside vendors here and overseas. The chief beneficiary of the growing tendency of airlines to outsource maintenance of their aircraft have been airline-operated and independent MRO providers, two-thirds of whom expect to see increased revenues over the next three years, according to a recent study conducted by Mercer Management Consulting.

(Mercer surveyed 55 MRO and airline executives in February and March of this year and released its research findings at the 2005 Aviation Week MRO Conference and Exhibition in Dallas, Texas.) Peter Walsh, who is a managing director and head of Mercer's global aviation and aerospace consulting practice, observed that there are four principal factors driving this optimism. Walsh explained that despite a global aviation downturn, there has been a general increase in global air seat miles (an industry measure of capacity). The industry has seen increased growth by low-cost carriers, which traditionally outsource a significant portion of maintenance. Carriers that have traditionally "insourced" maintenance are refocusing themselves on core competencies and sending non-core work to third-party providers. And, finally, the aircraft fleet overall is aging, requiring more maintenance.

Airline executives surveyed by Mercer confirmed the optimism displayed by MRO providers. Nearly all intend to increase outsourcing or keep it constant. Contrary to quality concerns that may have held back outsourcing growth in the past, most of the airline executives reported that outsourcing resulted in increased quality or the same level of quality. Only a few reported a decrease in quality.

Commenting on the drivers of outsourcing from the airlines' perspective, Roger Lehman, a director in Mercer's aviation and aerospace practice, said: "Network and low-cost carrier business models are both under pressure, with all looking for cost- and efficiency-driven solutions as pricing power remains elusive against a backdrop of rising fuel costs. Network carriers are increasingly looking to outsource non-core, uncompetitive lines of work, and many newer low-cost carriers are coming out of maintenance 'honeymoon' periods on major bodies of work like heavy airframe and engine overhauls."

Strategies for capitalizing on growth

The Mercer research suggested a number of strategies that MRO providers can employ to capitalize on this anticipated growth. Some of these strategies include creating lean, low-cost operations that generate value for customers, shareholders, and employees, while allowing providers to meet the challenges of low-cost competition in emerging markets. Others involve taking advantage of customer demand for new or customized offerings with innovative financial options to expand existing customer relationships and develop new ones.

Most MRO providers plan to grow through expanding share of wallet with existing customers. To do this, delivering on individual customer needs such as customer service and low cost, while at the same time meeting the "ante" of high quality, is a must. Andrew Schmidt, a director in Mercer's aviation and aerospace practice, commented: "There's still opportunity for MRO vendors that don't have the strongest market presence, provided that they meet quality and cost standards and inspire trust."

A strategy that many MRO providers plan to pursue is becoming a full-service integrator (i.e., moving away from niche service provision) and working closely with customers to develop new or customized ancillary services. Nearly all survey respondents stated that they plan to expand their service offerings in the next three years primarily through building new capabilities in house, but also through mergers/acquisitions and partnerships.

Ancillary services that offer the greatest potential for MRO vendors are those where they are less aligned to delivering on the most important needs of their customers. Examples include materials management and reliability management services, which ranked high in the survey in importance but low in vendor performance. Creative risk and financial options also have a great deal of appeal for customers. "Capturing full value from these services will be key," said Lehman, who added that "winning MROs will develop robust costing and pricing capabilities that will allow them to profitably price service offerings."

Most MRO providers are continuing to focus on productivity improvements, with over half of the survey respondents having delivered double-digit annualized cost savings through continuous improvement programs, which Mercer's Schmidt said is "consistent with what we have observed among our own clients." Strategic sourcing, lean redesign services, and people engagement have yielded the best results for over half of the survey respondents-better results even than labor negotiations or traditional cost-cutting measures.

According to Mercer's aviation experts, the MRO supply chain represents one of the richest areas for performance improvement. In their assessment of survey respondents' supply chain practices, they looked at 18 measures of supply chain excellence and found the majority of respondents operating at the highest level of performance in less than half of those measures. While most organizations have achieved high performance in areas such as purchase order policies and setting performance metrics, the consultants maintain that there is considerable performance enhancement possible in most other areas.

"Most respondents have a long way to go to achieve desired supply chain performance, even in basic areas like materials management," said Schmidt. "But the need for improvements is particularly pronounced in higher-order areas such as supply chain strategy or forecasting and planning." He noted that nearly half of the survey respondents do not employ advanced inventory allocation and status tools, and only a quarter employ centrally coordinated supply chain processes and decision support systems.

The globalization imperative

Airlines are more willing than ever to look outside North America and Europe for MRO solutions, preferring traditional providers and known brands with proven emerging market records. Four in ten survey respondents indicated that they are sourcing or will source airframe work to Latin America and Asia, and more than half said they will source engine work to Asia.

"With labor rates in Latin America and Asia less than half those in the United States and Western Europe, MRO providers based in the high-cost regions must embrace globalization opportunities quickly to remain cost-competitive and effectively serve global alliances," said Walsh.