December 2010Oliver Wyman
Airline operators face a difficult question: Should the airline take the opportunity to refresh our fleet by signing on for close-to-ready new aircraft, such as the Bombardier C-series? Should the carrier wait for Airbus and Boeing to potentially upgrade the engines of their venerable work-horse products, the 737NG and A320 families of aircraft, which may be launched late in 2010? Should the airline steer clear of reengining entirely and instead wait for Airbus and Boeing to develop a completely new narrowbody?
On the surface, making re-engining decisions may seem a lot like making any fleet strategy decision. But when it comes to re-engining, the decision process presents a few wrinkles. Of course, a cost benefit analysis occurs in either situation; however, operators (as well as owners, lessors, and financiers) must place a greater level of emphasis on the trade-off evaluation. These trade-offs include the potential benefits of re-engining including increased fuel efficiency and engine reliability against the possible costs such as more complex engine maintenance or if fuel prices increase or decrease significantly, and a decrease in valuation of their older fleet. Moreover, uncertainty surrounds the re-engining situation. The 2010 Farnborough Airshow, where many new programs are launched, came and went without any firm decision from the airframe OEMs on the topic.
A cost-benefit analysis of re-engining will yield different insights for different operators, depending on their unique business circumstances (such as current fleet configuration and business model). Using a disciplined approach that outlines and quantifies the risks inherent in a re-engining effort, each company can properly manage the risks and uncertainties. In this white paper, we draw on our extensive stores of data, our analysis of past re-engining programs, and our considerable client experience to reveal the nuances behind the re-engining decision and offer recommendations for approaching it.
Let’s start by taking a closer look at the re-engining programs currently on the horizon.
Re-engining programs on the horizon
Airbus and Boeing are both examining CFM’s Leap-X and Pratt &
Whitney’s Geared Turbo Fan (GTF) engines, which are ready for near-term
adoption by airframe manufacturers. These engines promise approximately
12%-15% fuel-burn improvements over their predecessors in
addition to maintenance-cost reductions. The engines have already been
selected for in-development programs, which for the first time in decades
are starting to present Boeing and Airbus with significant competition in
the 100-plus seat narrowbody sector. Competitors include the Bombardier
C-Series (powered by the GTF) and the Commercial Aircraft Corporation
of China, (COMAC) C919 powered by the CFM Leap-X.
The re-engining programs that Airbus and Boeing are considering would
involve fitting a new engine to the existing aircraft with minimal other
changes. As previous re-engining programs show, this still involves significant
engineering work and cost. However, the goal is to improve aircraft
performance significantly while reducing development timeframes
and costs. Press reports suggest that Airbus will offer the GTF and Leap-X
as additional engine options, rather than as full replacements for the
CFM56-5 and V2500-A5 currently powering those aircraft, and Boeing will
offer the Leap-X for the 737NG.
As mentioned earlier, making re-engining decisions is more complex
than making ordinary fleet selection decisions. For traditional fleet selection
choices, most carriers use a Total Cost of Ownership approach that
takes into account not just the purchase price of an aircraft, but also the
cost of owning, operating, and disposing of it. However, this approach
usually pits two or more new aircraft against each other, rather than
comparing in-operation aircraft with proposed new aircraft. Moreover, it
does not consider the impact of a newly developed aircraft on the current
fleet’s value or the pros and cons of ordering the current versus the
To make the wisest possible re-engining decision, operators must go
beyond the usual fleet selection process and weigh three crucial considerations:
(1) fuel-burn reduction and future fuel prices; (2) changes in engine
reliability and maintenance costs; and (3) impact on current fleet values.
Key to this analysis is quantifying these potential impacts—a frustratingly
difficult feat for most operators. With an eye toward attaching numbers to
the three considerations, we evaluate five re-engining programs launched
since the 1970s in the next section of this article and then show how our
findings can be applied to the current re-engining dilemma.
Five re-engining programs
As a normal course of business, engine OEMs create upgrade options
and new versions during each product’s lifecycle. Occasionally an engine
OEM, with an airframe OEM or another partner, will offer a new engine
for a current aircraft. These offerings generally fall into two categories:
retrofits for existing aircraft and new engines for new production aircraft.
Retrofits are more common in military programs, but are quite rare
in commercial applications with the CFM56-equipped DC-8 being the
notable exception. In this study, therefore, we concentrate on the second,
more common, category to draw lessons from past programs.
For the purpose of the analysis, we identified five aircraft re-engine/ upgrade examples that could provide insights for evaluating today’s
options. These examples span a range of time frames and narrowbody and widebody types. Exhibit 1 (click to enlarge) summarizes the programs, including technological changes that accompanied the efforts as well as the range benefits gained from the new models.
How did these new aircraft perform compared with their predecessors in terms of fuel burn, engine maintenance, and aircraft valuation? Let’s look.
If we assess fuel consumed per block hour for US operators of these aircraft, we find a median reduction in fuel burn of 9.5% in the new aircraft. (See Exhibit 2, click image to enlarge) This fuel burn decrease ranges from a low of 5.6% for the 737-300 over the 737-200 to a high of 9.8% for the MD11 over the DC10-30. In this context, press reports of 15% fuel-burn reductions for the reengined 737 and A320 (before dilution from the extra weight of the new engines and modifications) appear consistent with previous programs.
This 9.5% median fuel-burn reduction isn’t surprising: The programs
would not have gone forward if the OEMs had been unsure of the benefit.
What is perhaps different for today’s scenario is the price of fuel consumed,
or not consumed. Since 1991, the average price paid by US airlines
fluctuated between $0.45 per gallon in Q1 1991 and $3.74 per gallon
in Q3 2008.
As Exhibit 3 shows, fuel prices and variability have changed more dramatically in recent years. While no one can foresee precisely what fuel prices will do in the medium and long term, carriers can (and should) use a fuel risk management strategy to arrive at educated estimates and include them in their decision-making process.
US regulations require airlines to submit detailed financial data, including maintenance costs, to the Department of Transportation, which publishes the data in what is commonly called Form 41. Still, comparing aircraft engine maintenance costs across generations of aircraft presents
difficulties: The costs rise as an aircraft accumulates flight hours, but
they don’t do so in a smooth fashion that lends itself to a standard formula
(such as when costs are adjusted for stage-length).
To allow for a robust comparison, we plotted the annual engine maintenance
costs for the programs shown in Exhibit 1 on a per-flight-hour
basis against the average aircraft age for the time period 1991-2009.
Reporting for the A320 program blends data for the older and newer versions, so a comparison was not possible. For example, the 737-300 fleet had an average age of approximately 5 years in 1992 and a total engine maintenance cost of $99 per hour in 2005 dollars. The 737-700 fleet had an average age of about 5 years in 2007 and a total engine maintenance cost of $108 per hour in 2005 dollars. Exhibit 4 shows how these costs have changed as the fleets age over time.
Because of the staggered timeframes covered by the data set, it is not possible to create comparable full-lifecycle graphs for all generations of aircraft in our study. However, there is enough overlap and history to show that engine maintenance costs rose from the 737-200 to the 737-300 and decreased from the DC10-30 to the MD11. Cost changes wereinconclusive in the other two examples.
Despite this ambiguous picture, the increased interval of flight hours between scheduled shop visits is unequivocal, and impressive. (Engines usually follow a four visit overhaul program.) Exhibit 5 illustrates this progression for the engines powering the three generations of 737s in our study. This trend holds true for widebody aircraft as well.
Unlike fuel-burn improvements, a reduction in engine maintenance costs
is not necessarily a given with the re-engining programs on the horizon.
Maintenance costs will rise or fall depending on whether this next generation
of engines continues the progression of increased on-wing life and
how shop-visit costs change when they do come off-wing.
It is difficult for operators to forecast these parameters because, unlike
fuel prices, they vary across companies, depending on mission profile
and maintenance program. Operators can estimate the likeliest impact
of re-engining on maintenance costs by applying a risk analysis exercise
similar to the one we use to help clients model engine-services agreements.
(These agreements are sometimes referred to as Power-by-the-
Hour or PBH.) However, airlines have moved far beyond the PBH metric in
complexity and now seek to place risk with those best equipped to manage
it. For example, in engine services arrangements, the airline agrees
to a certain thrust range limitation on the engine while the engine OEM
agrees to the time-on-wing target.
For the purposes of this article, we’ve framed this as a simple twodimensional sensitivity analysis, which examines how much maintenance costs and fuel prices could move before putting fuel-savings benefits at risk. (See Exhibit 6.) To state it another way, when does the potential benefit become too small to warrant the risks outlined in this article?
As Exhibit 6 shows, the per-flight-hour benefit is uniformly positive. We found a 9.5% reduction in fuel consumption (737-700 improvement over the 737-300), a fuel price range reflecting the high and low points of the last 10 years, and engine maintenance costs flexing up or down 15%. At a 5.6% reduction in fuel consumption, the benefit is positive except for the worst scenario. Obviously, this exercise is sensitive to the starting values, which may be different for each carrier.
An often-voiced fear among owners, financiers, and operators is that a
re-engined 737 or A320 would make the current fleet (both with substantial
install bases) less attractive and, therefore, would reduce its value.
This is a serious concern, as loans, structured debt, and other financial
instruments that back the financing of aircraft are all built on assumptions
about the continuing value of the underlying aircraft. Additionally,
many of the business and financing plans of these constituents count on
future financing transaction being backed by the existing aircraft. Any
impairment of fleet value would reduce the owner’s financial flexibility.
Yet our study of the five re-engining programs suggests that the introduction of an improved aircraft variant does not have a significant
Oliver Wyman has deep, international experience in all segments of aviation, including airports, airlines, service providers, MROs, OEMs, and investors. The Aviation, Aerospace & Defense Practice has consulted to nearly three-quarters of the Fortune 500 firms in these sectors, as well as to major airports around the world.
*The views and opinions expressed in the guest columns are those of the author