© Copyright Forbes 2011 1

2011 Global aerospace outlook

Challenges of an ever-Changing industry

in association with:

© Copyright Forbes 2011 2

• For many airlines, the 2008-09 recession caused them to make some rough decisions, forcing them to

ground planes, pare fleets, consolidate routes, and cut staff. As a result, today they are leaner and more

efficient, and some believe they are competitively stronger.

• Fuel costs remain the biggest challenge airlines are facing. While they take significant steps to mitigate

the impact of fluctuating fuel prices, they are also concerned sudden spikes could play havoc with their profits.

• Fleet executives want more fuel-efficient technology. Despite this pent-up demand, many airlines are

taking a “wait and see” approach to newer airframes as they await what manufacturers will offer and how

they will perform.

• Emerging markets promise the greatest opportunity for growth. While U.S. and European carriers were

dealing with the 2008-09 recession, airlines in other regions were increasing their fleets, number of routes,

and seat capacities.

• There is no end in sight for airline industry consolidation. More than 80% of executives expect to see an

increase in M&A activity over the next five years.

• Lucrative business travelers are a key component of future profitability. In addition, many airlines are

turning to ancillary charges—such as fees for checked bags, food, or in-flight entertainment.

• Operating leases remain the most important area of fleet financing for many airlines. More than half

of respondents said they are leasing 50% or more of their fleets.

Key Findings

today, airlines have little time to lick their wounds, as they face significant challenges ahead.

To gauge the impact of these challenges, Forbes Insights, in association with CIT, a provider of transportation finance, surveyed 136 fleet and finance executives at airlines around the world. The survey identified many concerns that these executives will have to deal with over the coming years. Should they be able to address their challenges, they are poised to return to growth as the economy rebounds.

As it looks to regain its footing, today’s airline industry is trying to keep its balance against fluctuating fuel costs, a desire to boost efficiency, and a marketplace that is forcing

many into consolidation.

The global recession threw a one-two punch at the bottom lines of airlines in 2008-09. Passenger traffic—par-ticularly that of the most profitable business customers—fell precipitously, while fuel costs and other expenses rose. But

© Copyright Forbes 2011 3

short- to mid-term, a development that has made it quite difficult for the airline to plan effectively.

When it comes to fuel prices, “there are just so many question marks,” said the executive. “How long will demand for energy in emerging markets continue accel-erating? Will it continue on a straight line or will it slow down, particularly in China and India?” Similarly, asked the executive, “will the United States continue blocking new exploration or will it implement cap and trade poli-cies?” The answers, said the executive, “aren’t clear.” But one thing is certain, “fuel accounts for [around 20%] of our operating costs.” So if fuel prices rise, “which they are already doing and we’re afraid they’re poised to go even higher,” said the executive, “that’s going to be very bad for the global economy, the global airline industry and for us.”

In fact, survey respondents cited increased fuel costs as the top challenge their companies will face over the next two years, well ahead of issues such as increasing compe-tition, labor costs, or shifting customer demand. (Fig. 2)

A rough ride through the recessionThe past few years were very hard on global airlines. Not surprisingly, leading airlines shifted rapidly into sur-vival mode. For example, more than a quarter of survey respondents indicated their companies had grounded more than 10% of their fleets during the height of the recession, with larger airlines more likely than smaller ones to be grounding part of their fleets. Today, the percent of planes grounded is lower. (Fig. 1)

As a fleet executive with a major European airline explained, “we implemented a survival plan soon after we detected the downturn.” Today, “the action continues, as we recognize that the downturn uncovered a number of short-comings which we now intend to address for the long term.”

This airline’s program centers on developing a more cost-conscious culture. “We want to strip working capital and general operating costs as much as possible, and that requires getting more people involved. People need to understand the issues and the urgency.” Performance metrics, for exam-ple, are being retooled to include greater emphasis on the cost of capital as well as costs in general. “They are putting teeth into the cost measures,” said the executive.

In addition, the program includes paring the size of the airline’s fleet, postponing or canceling orders, reduc-ing cruising speeds to save fuel, and consolidating routes. The company also took moves such as cutting back on workforce hours and is now actively trimming the ranks through attrition. And though economic conditions today are improving, “they are not back to normal,” said the executive. Moreover, “regardless of the extent of the recov-ery, we’ve learned valuable lessons in this crisis—and we will not go back to our old habits.”

confronting fuel costsEven with the recession behind them, many fleet and finance executives noted that their companies face a sig-nificant number of their pressures to their bottom lines. In particular, respondents cited the risk of higher fuel costs and heightened price volatility as a top challenge.

Generally, the consensus is that fuel prices will rise over the long term. Still, according to a senior executive from a large U.S.-based carrier, there is much less certainty in the

figure 1: Percent of fleet grounded

More than 20%

5–10%

0%

11–20%

less than 5%

9

17

18

27

29

2

18

4

31

45

• During the recession • Today

0% 50% 100%

© Copyright Forbes 2011 4

Similarly, 82% said they are extremely or very concerned about fuel supply and costs. (Fig. 3)

It is worth noting that a quarter of respondents said they were concerned about the impact regulatory actions—such as those related to carbon emissions—will have on fuel prices. As the European fleet executive explained, costs related to regulation can create an even greater challenge.

“We can hedge fuel prices, and we do, anywhere from 6 months to 24 months ahead depending on our forecasts and risk tolerances.” However, said the executive, “we have no standard capital market options for hedging regulatory actions which are a de facto fuel price increase.”

the promise of fuel-efficient technologyOne operating hedge against both higher fuel prices and associated regulatory actions may be to improve fleet fuel efficiency. Accordingly, 83% of respondents said their companies are likely to acquire or lease fuel-efficient tech-nology. (Fig. 4)

As the U.S, airline executive explained, “we’ve got orders in place for (a significant number) of 787 Dreamliners, which are extremely energy efficient.” In addition, most of the group’s existing turbine aircraft are outfitted with winglets, while its regionally focused turbo-prop fleet uses advanced technology fan blades. Meanwhile, as Ryanair CFO Howard Millar explained, “given the role

figure 2: What are the most significant challenges your company will face over the next two years?

increased fuel costs owing to rising global fuel demand

increased fuel costs owing to regulatory actions

Decrease in business customers

increased competition from low-cost carriers, charter airlines

Decrease in yields

lack of availability of aircraft

increase in labor costs

increased financing costs

Decrease in overall passenger traffic

increased competition from similar types of airlines

increased aircraft rent

reduced cargo volume

Decrease in charter revenues

53

25

11

38

22

10

29

21

7

27

11

4

4

0% 50% 100%

figure 3: How concerned is your business about fuel supply and costs?

• Extremely concerned• Very concerned• Concerned• Somewhat concerned• Not at all concerned

51%

31%

15%

2%1%

© Copyright Forbes 2011 5

of fuel costs, we would be very interested in more fuel-efficient aircraft.” However, he added, “anything really interesting is probably still a long way off—to at least 2020.”

Even with this pent-up demand for increased fuel effi-ciency, and with some airlines itching to place orders, many airlines appear to be taking more of a “wait-and-see” approach. Just 32% of survey participants said their airlines would be among the first to acquire or lease such next-gen-eration aircraft, while 68% indicated they wanted to wait to see how the new aircraft perform. (Fig. 5)

Why the hesitancy? There may be too many unknowns related to how or when the major aircraft manufacturers will have more fuel-efficient aircraft available. For exam-ple, Airbus COO John Leahy told Bloomberg at the 2010 Berlin Air Show that “the real game-changing technolo-gies in airframes, systems, and engines will come around 2025, 2027.” Delays related to the Airbus A380 and A350 and Boeing 787 Dreamliner may be causing some air-lines to postpone their orders. Moreover, with technology changing at a rapid rate, many airline executives may be concerned that any investments they make in these new aircraft could be overtaken by engine and airframe models that are significantly more fuel-efficient.

figure 4: How likely are you to acquire or lease newer, fuel-efficient aircraft within the next five years?

• Extremely likely• Likely• Neither likely nor unlikely• Unlikely• Extremely unlikely

3%1%

43%

13%

40%

0% 50% 100%

figure 5: What will be your likely actions when a next-generation aircraft becomes available?

we will wait and see how the new aircraft perform.

we will be among the first to acquire or lease the new aircraft.

68

32

In 2010, Ireland-based budget travel specialist Ryanair posted its best year

ever in terms of passengers, up 10% from 2009 to over 72 million. According

to CFO Howard Millar, “there are signs that things are improving. Fare prices

are rising—and that’s always good. And there’s hope for the European

economy and we hope also for Germany in particular.” All of this, said the

executive, “is great news for us.”

But at the same time, there is cause for concern. In particular, the airline’s

profitability is susceptible to higher fuel prices. For a typical airline, fuel costs

represent some 20-25% of operating costs. But for Ryanair, owing to its lean

operations, fuel prices represent a full 40% of cost. “So when fuel prices rise,

it hurts us worse than others,” said Millar.

Through 2011, the executive isn’t worried. For starters, “we’ve already

hedged a substantial amount of our fuel for the next year at prices around

US$75-80 [per barrel]—which looks pretty good right now.” In addition,

said Millar, the carrier “has one of the highest net margins in the industry.”

But should fuel prices continue to climb, “that could hurt us unless we man-

age to offset this with higher yields,” said the executive.

ryAnAir: hedging fuel costs

© Copyright Forbes 2011 6

Greece’s Aegean Airlines and Olympic Air, Ethiopian Airlines, and Colombia’s Avianca-TACA.

Survey respondents overwhelmingly believe that con-solidation will continue in the near future. In the survey, 81% of executives said they believe consolidation will increase over the next five years. (Fig. 7)

As for the nature of where consolidation will take place, there is a wide dispersal of views. Nearly a third, 30%, said consolidation would be along regional lines. Meanwhile, 25% expected consolidation via alliances (cities/routes), 24% expect global consolidation, and 21% said the phenomenon would be most pronounced in emerging markets. (Fig. 8)

In the survey, 46% of respondents said they believe that Boeing or Airbus will deliver a new single-aisle fuselage in 5-10 years, while just 24% said that would happen within five years.

It is worth highlighting some regional differences. U.S. carriers appear more willing to be among the first to lease or buy new technology (38% said they would), especially when compared to European carriers ( just 24% want to be among the first).

Meanwhile, conventional wisdom has been that carriers in emerging markets (those outside the U.S. and Europe) are often not early adopters (and, in fact, often depend on the secondary market for older models), they are now the most willing to be among the first to purchase new models. For instance, in late 2010 IndiGo, the low-cost domestic carrier in India, ordered 180 Airbus A320s valued at more than $15 billion, the largest single order ever placed.

cost drives consolidAtion; consolidAtion drives competitionAirlines must also contend with shifts in the competitive landscape driven by both the emergence of stronger carri-ers and the increasing amount of consolidation.

As they look ahead to the next two years, increased competition from low-cost and charter airlines was sec-ond only to fuel costs in respondents’ list of concerns, cited by 38% of executives. Meanwhile, 27% said they’re concerned about increased competition from airlines sim-ilar to their own.

A key driver of competition is consolidation. According to the U.S. airline executive, consolidation is necessary “in order to trim overcapacity.” This has certainly been the case in North America, where, owing to a slew of mega-mergers and acquisitions, the industry has shifted from relatively fragmented to relatively concentrated. In 2010, Continental merged with United, Delta merged with Northwest, and Southwest Airlines purchased AirTran. Consolidation is also occurring outside the U.S. In Europe, British Airways and Iberia announced plans to merge, and in Latin America, Chilean carrier LAN Airlines will merge with Brazil’s TAM Airlines. Among alliances, the Star Alliance gained several members in 2010, including TAM,

0% 50% 100%

figure 6: When do you believe Boeing or Airbus will introduce new single-aisle aircraft?

within 5 years

within 5–10 years

within 10–15 years

More than 15 years

24

46

27

2

figure 7: Compared to the past five years, do you expect airline consolidation activity to increase or decrease over the next five years?

• Significantly increase• Increase• Remain the same• Decrease• Significantly decrease

15%

4%

67%

14%

© Copyright Forbes 2011 7

What’s pushing this consolidation? Clearly, costs are a primary driver. Growth in M&A and other forms of con-solidation are being set in motion by a need to optimize costs and capacity. And mostly, there is a sense that con-sumers can only be loyal to a handful of carriers. In fact, more than half (54%) of respondents indicated marketing synergies through more routes and stronger brands was what would power this consolidation trend. (Fig. 9)

Looking ahead, there could be other implications to consol-idation. Some airline executives noted that the merged airlines will need to reconcile their larger fleets, which could be having an impact on their short-term purchase and lease plans.

figure 9: What do you believe will be the principal drivers of consolidation activity in the airline industry over the next five years?

opportunities to achieve marketing synergies through more routes and a stronger brand

response to the actions of competitors

smaller carriers needing larger partners to finance growth

need to optimize labor efficiency and cost

need to address overcapacity

opportunities for larger players to acquire assets at relatively distressed prices

opportunities to optimize fleet capacity

need to optimize maintenance efficiency and cost

opportunities for larger carriers to acquire a presence in emerging markets

Greater financial security through larger balance sheet

54

38

20

43

31

19

42

30

39

29

0% 50% 100%

AlohA Air CArgo: Seizing the opportunity in iSlAnd hopping

In Hawaii, there are no roads or railways between the islands. So if you’re having a drink,

eating a sandwich, or handling just about any other food or manufactured item, there’s a

70% chance it was delivered by Aloha Air Cargo.

The cargo-focused carrier has remained profitable in spite of the recession. Doing

so, said president Lee Steele, was no easy matter. The local Hawaiian economy is built

on tourism. So as hotel occupancy rates plummeted, so too did Aloha Air Cargo’s vol-

umes. Consequently, said Steele, “we were very focused on the fundamentals,” in

particular, optimizing the fleet and getting the most out of every run.

Now that tourism is beginning to rebound, Steele is turning his group’s focus to

managing fuel price risks as well as building new business. “We’re too small to hedge

in the financial markets, but one thing we can do is run more fuel-efficient planes,”

said Steele. As such, the group just acquired two Saab 340 turboprops. The smaller,

energy efficient craft also create additional opportunities. “With a big jet, you fear

anything less than a container load,” said Steele. But with the smaller turboprops,

“we’re now able to do more in terms of smaller loads and on-demand needs.”

0% 50% 100%

figure 8: What do you believe will be the most prevalent type of consolidation within the airline industry over the next five years?

emerging market consolidation

regional consolidation

Global consolidation

alliance consolidation

21

30

24

25

© Copyright Forbes 2011 8

according to survey participants, leasing remains the most important form of fleet financing. today, it is generally

estimated that 30-35% of global fleets are leased. in the survey, 54% of respondents indicated that more than half

of their fleets are leased today, and that figure will stay fairly consistent over the next five years.

leAsing is the most importAnt form of finAncing

How important are the following sources of aircraft financing to your company? (% answering extremely important and very important)

operating leasing

bank loans

secured bond structure

Government funding

tax leases

islamic leasing (shariah)

Manufacturer support

export credit loans

65

51

51

39

28

25

24

11

68

58

58

43

30

25

30

16

• Today • Five years from now

0% 50% 100%

• Today • Five years from now

0% 50% 100%

What percent of your fleet is leased?

100%

50–74%

<25%

75–99%

25–49%

11

27

16

24

23

10

23

20

29

18

© Copyright Forbes 2011 9

expAnsion in emerging routesGetting through the recession required some major carri-ers, particularly in the U.S. and Europe, to trim their fleets, reduce their routes, and look for new areas of income. But these actions weren’t universal to the airline industry, as carriers in emerging markets—such as China, India, the Middle East, and Latin America—were expanding. These new markets, in fact, are where many executives believe future growth opportunities lie.

The survey findings bear this out. Some carriers based in the U.S. and Europe took action over the past two years to reduce their costs by paring back the number of planes or the number of routes. While some airlines in the rest of the world (outside the U.S. and Europe) took similar action, many were, in fact, expanding. (Fig. 10) Some examples follow: • Fleet size: Over half of carriers outside the U.S. and Europe

(55%) said they increased their fleet size over the past two years. For U.S. carriers, that figure was 22%, and it was 40% for Europe.

• Number of flights: Again, 55% of rest-of-world carriers said there was an increase, compared to 37% for U.S. car-riers and 36% for European carriers.

• Number of routes: The percent of rest-of-world carriers that grew this over the past 24 months outstripped U.S. carriers by 32 percentage points.

• Seat capacity: 22% of U.S. carriers saw an increase over the past two years, compared to 38% for Europe, and 55% for the rest of the world.

finding wAys to boost revenueGoing forward, airlines expect bottom line growth to come in a range of forms. This includes generally higher fares, an increase in business customers, and increased international traffic—not to mention the lingering benefits from ancil-lary charges enacted during the downturn.

Asked where they anticipate profit growth coming from over the next two years, four in ten respondents cited busi-ness customers (40%), traditionally their most profitable customer segment. (Fig. 11) This was driven by responses of executives from airlines with the largest fleets, where 59% will be depending on business customers to help drive profits.

figure 10: Airlines that saw an increase in the following categories over the past two years

number of flights

seat capacity

number of aircraft

number of routes

37

22

23

22

36

40

55

38

38

55

55

55

• U.S. • Europe • Other regions

0% 50% 100%

© Copyright Forbes 2011 10

One of the most visible changes in the airline indus-try—a clear consequence of the downturn—is that over the past two years, more airlines have been seeking new sources of revenue. In particular, many airlines have begun charging for services that were once covered by the basic fare—including checked bags, food, headsets and other services/conveniences. This “unbundling” trend has been driven by U.S.-based airlines, which, based on the survey responses, are significantly more likely to be adding on these charges.

Overall, about four in ten airlines now charge pas-sengers for food (41%) and their first checked bag (38%), services that they provided for free 24 months earlier. Regional differences are significant. For instance, three-quarters of U.S. respondents said their airlines now charge

• Total • 50+ jets • <50 jets

figure 11: What will be the most likely sources of profit growth for your company over the next two years?

business customers

Fare increase

leisure customers

increased international traffic

increased domestic traffic

ancillary revenues

cargo

charter routes

reduced competition

40

42

31

36

25

20

59

32

28

17

22

39

38

23

41

21

35

20

22

22

21

11

18

25

14

9

11

0% 50% 100%

What Weighs on the minds of fleet and finance executives?

The survey sheds light on the most pressing concerns of airline executives. Executives

are most concerned regarding fuel costs and the need to curb carbon emissions.

Issues such as the need to manage noise levels and industry consolidation, though

still important, are viewed as significantly less worrisome.

• Extremely concerned • Very concerned

How concerned is your business about the following aircraft-related issues?

Fuel supply and costs

regulations to curb carbon emissions

regulations to curb noise levels

shifts in aircraft supply as a result of consolidation

increased use of composite materials

51

21

13

8

10

31

41

29

26

18

© Copyright Forbes 2011 11

for the first checked bag, but just 17% of European respon-dents said that, and 19% of respondents from other regions.

Meanwhile, about half of European respondents (48%) and respondents from other regions (52%) said they have not added any of these ancillary charges for amenities. Just 15% of U.S. respondents said that.

conclusion: A need to control costs Knocked down by the global recession and the resulting dip in air travel, airlines had to look closely at their opera-tions to find areas where inefficiencies and costs could be pared. Today, those tough decisions continue, as airlines look to revitalize their businesses in the face of fluctuating fuel prices, volatile consumer demand, and an unpredict-able regulatory environment.

For many, this means improving their overall efficien-cies. This is taking the form of building fleets with new, more fuel-efficient technologies, optimizing labor costs, and increasing industry consolidation, all while dealing with the effects of greater global competition. It’s not easy. But they believe that they need to put all these parts in place to move to a period of sustainable growth.

• U.S. • Europe • Other regions

figure 12: Does your airline now charge for any of the following amenities that it provided for free two years ago?

First checked bag

blankets/pillows

Food

headsets/entertainment

none

75

7

31

53

52

19

17

30

29

62

10

5

32

48

15

0% 50% 100%

methodology

the information in this report is based on the results of a global survey of 136 airlines executives with fleet or finance responsibility. the survey took place in november and

December 2010. respondents were anonymous.

all survey respondents were involved in general management, finance, or fleet management at an airline. a third of respondents (34%) held c-level or board-level titles,

20% were sVp/Vp/Director, and 13% were fleet managers. Geographically, 43% of respondents were located in europe, 35% were in the u.s., and 22% were from the rest

of the world. respondents also represented airlines of varying fleet sizes: 48% had fleets of fewer than 50 aircraft, 35% had fleets of 50-250 aircraft, and 18% worked for

airlines with more than 250 aircraft.

christiAAn rizy Director

stuArt feil eDitorial Director

brennA snidermAn research Director

bill millAr report author

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