Aircraft Valuation in Volatile Market Conditions: Guiding Toward Profitability and Prosperity (Management for Professionals) [1st ed. 2022] 3030824497, 9783030824495

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Management for Professionals

Bijan Vasigh Farshid Azadian

Aircraft Valuation in Volatile Market Conditions Guiding Toward Profitability and Prosperity

Management for Professionals

The Springer series Management for Professionals comprises high-level business and management books for executives. The authors are experienced business professionals and renowned professors who combine scientific background, best practice, and entrepreneurial vision to provide powerful insights into how to achieve business excellence.

More information about this series at http://www.springer.com/series/10101

Bijan Vasigh • Farshid Azadian

Aircraft Valuation in Volatile Market Conditions Guiding Toward Profitability and Prosperity

Bijan Vasigh David B. O’Maley College of Business Embry-Riddle Aeronautical University Daytona Beach, FL, USA

Farshid Azadian David B. O’Maley College of Business Embry-Riddle Aeronautical University Daytona Beach, FL, USA

ISSN 2192-8096     ISSN 2192-810X (electronic) Management for Professionals ISBN 978-3-030-82449-5    ISBN 978-3-030-82450-1 (eBook) https://doi.org/10.1007/978-3-030-82450-1 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

This book is dedicated to the memory of my father, Majid Vasigh. He was beloved and respected by all who knew him. Bijan Vasigh I dedicate this book to the memory of my grandfather, Mr. Hussein Dehmand. I am also grateful to my wife Elnaz and my parents Morteza and Rabeeh. Farshid Azadian

Foreword by Chris Tarry

Whilst to the customer the business of an airline may appear to be very straightforward, in that it safely moves passengers and cargo from an origin to a destination, it is in fact dependent upon range of suppliers of products and services. Furthermore, as we have seen in the past and particularly since the early part of 2020, and will indeed see again in the future, the industry is susceptible to external events whether in previous cases, terror attacks, oil price rises or financial crises, or most recently a pandemic. What should also not be beyond any doubt is that the rules of economics apply to the airline and wider aviation business in the same way as they do to any other. Against a background where statistical models of any type work because the cells are appropriately connected, there is also an overwhelming need for assumptions and expectations to be reasonable across all activities whether market growth or the future value of an aircraft; generalisations in any business are dangerous but appear particularly so in this wider industry; managerial illusion and, worse than this, delusion are not unknown in the aviation industry. Furthermore, the adage that how your business does in the good times will determine how you will do when the going gets tough also applies and where there was no shortage of evidence even before the onset of COVID-19. Whilst it is possible to treat an airline as a number of business activities where the two main areas are capacity provision or asset management and operations, the inescapable fact is that making the “wrong” capacity decision may not only have a fundamental impact on the financial performance of the business but one that could be “catastrophic”. Simply put, whilst two airlines may have certain similarities, where management may describe the airlines as operating in the same segment, for example “low cost”, and they may to a greater rather than lesser extent fly the same equipment, their financial performance may be quite different. At the simplest level, an aircraft in effect represents moving floor space, which generates cash flows and which has an associated operating cost, which will in part be determined by the airline’s own costs, and in addition an ownership or “right of use cost”, which will be dependent on a range factors between own or lease, and which will need to be allocated/amortised across the aircraft’s operations. However, one thing is beyond any doubt whatsoever is that making a bad or indeed the wrong decision here could well place the airline at a significant disadvantage to its competitors over a

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considerable period of time – it is impossible to understate the importance of this decision alone. The extent to which these cash flows are “sufficient” and ideally but not always or often result in a financially sustainable performance also depend on a number of factors both internal but also external. In this respect, the actual financial result of any business represents the outcome of large numbers moving in different directions where there is a need to identify the key ones and also to understand what causes them to move in which direction and why. It is in respect of this fundamental need that this very practical book should be a “must read” not only for those embarking on their career not just in airlines but also aircraft finance too. It is also very timely given the extent of the current dislocation across the sector. This is something that summed up in the title as the decisions made and actions taken at the present time, when for many airlines the key focus is on cash, will impact not only on survival for a number of not only airlines but others in the aviation sector now but will also determine the extent to which they might become financially sustainable, an outcome which even in more normal times would be seen as a very significant achievement. What we should also be clear about is that in due course, as airlines move through restart and recovery, demand will then start to grow again, although this will not be evenly spread. The main difference for the airline industry is likely to be on the supply side, and here this book’s subtitle “Guiding toward profitability and prosperity” acts to underline this. Founder of CTAIRA and Visiting Professor of Aviation Strategy Coventry University Coventry, UK

Chris Tarry

Foreword by Kenneth M. Dufour

For decades I have enjoyed working with Dr. Bijan Vasigh at Embry-Riddle Aeronautical University’s O’Malley College of Business. Dr. Vasigh is recognized as the “go to” expert in the aircraft finance and aerospace industry. This aircraft finance book focuses on the complex financial global airline industry in a postpandemic world. There are many challenges and opportunities in this very dynamic, constantly changing industry. This book exposes the readers to the always evolving global aircraft industry, especially pre-COVID and post-recovery within the airline industry. Dr. Vasigh and Dr. Azadian’s practical and logical approach should be required reading for anyone not only in their aviation career but for any student in an airline or finance collegiate program. We have worked together on many aircraft, finance, and leasing valuation analyses. Our collaboration has developed information that offers both logic and a unique perspective of these complex topics. Understanding how to value aircraft, machinery equipment, and hangars as well as other aviation assets is critical to aerospace business operations today as well as into the future. Additionally, forecasting the future values for these assets is a critical business/finance support function. Dr. Vasigh and Dr. Azadian present fresh as well as time-tested insight and perspectives to these aerospace business segments. This aircraft finance book explores the new opportunities and challenges for the global environment in a post-COVID-19 marketplace. It presents updated information for aerospace professionals, financiers, aerospace consultants, attorneys, maintenance technicians, and students alike. A comprehensive analysis including aircraft valuation, leasing, and finance including banks, credit agencies, and various capital markets affecting the international marketplace is provided. The user of this edition will be exposed to and learn the language of aircraft finance as well as airline management. Readers will benefit from this and have this textbook as a primary reference in their libraries. Member of the Board of Trustees Embry-Riddle Aeronautical University Daytona Beach, FL, USA

Kenneth M. Dufour

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Preface

It may not be an exaggeration to say that we are observing one of the most volatile eras of air transportation in the modern age. Never before, even in the heat of the September 11 attacks or the financial crisis of 2008, the aviation industry experienced such financial hardships with an uncertain future. A few years ago, when we embarked on writing this book, many airlines were blessed with high demand that persisted despite the high fares, inherited from earlier financial crises. In 2018 and 2019, IATA reported the average net profit of airlines as 6.2 and 5.8 dollars per departing passenger with an average load factor of about 82% (one of the highest load factors in decades). In the light of positive prospects for the industry, some airlines were contemplating or negotiating their fleet expansion and actively adding new city pairs. The situation, however, has changed dramatically as the COVID-19 pandemic spread like wildfire across the globe and grounded aircrafts worse than 9/11. In the course of few months, the revenue-generating assets of airlines were reduced to cost liability with the occasional opportunity for cargo transportation as the lifeline of many airlines. The topic of discussion has changed from growth, expansion, and pilot shortage to survival as the sky was cleared from planes. The $5.8 average net profit of airlines per departing passenger for 2019 dropped to a loss of $71.7 for 2020 as IATA estimated the return on investment for the airlines to be −18.3%. Nevertheless, as the quest for a vaccine succeeded, the travel demand jumped abruptly as people who suffered from prolonged isolation seek to travel. Once more, airlines were hopeful for a strong market and high yield, despite the increasing cost of operations. Airplanes were called back to service and thus recovered some of their value. At the time of writing this text, the prospect of recovery is still unclear as the hopes of a return to normal status are overshadowed by the widespread Delta variation of the COVID-19 virus. Contemplating the event of the last few years highlights the cyclic, unpredictable, and volatile nature of the aviation industry. It shall serve as solid support for the dire need for understanding aircraft financing and proper planning to assure profitability. In this book, we strive to provide a foundation for aircraft financing and elaborate on the process of valuing commercial and general aviation aircraft. The book offers a myriad of numerical examples and industry cases to assist practitioners and consultants while it reviews and discuss the foundational theory behind the practice to assist readers with academic interests.

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We start with a brief review of the evolution of the aircraft manufacturing industry in Chapter 1. This chapter should help readers see the aviation industry’s transition from post-WWII to modern times by highlighting the success and faultier stories of various aircraft manufacturers and airplane models. We hope the insights provided in this chapter facilitate a better assessment of the prospect of the industry and airplanes as it is needed for proper valuation. Chapter 2 summarizes the general and technical characteristics of most common commercial aircrafts, including some popular but out-of-production variations. Throughout the book, aside from the chapter on general aviation, we tried to address all categories of airliners, including wide-body, narrow-body, and regional jets. Chapter 3 reviews the key measures used to assess aircraft’s financial and operational efficiencies. Correct understanding of these measures is crucial for the next step in appraising an airplane and estimating its financial performance toward its operator’s profitability. To put the measure into perspective, we offered the latest estimates of the efficiencies on various aircraft in operation and compared the airplanes for different factors. Similarly, Chapter 4 reviews the fundamental concepts of aircraft valuation and dives into the theoretical bases of asset valuation methodologies. Various numerical illustrations and case examples from practice were utilized to facilitate understanding the concepts and demonstrate the calculations. The book addresses some of the most common methods for aircraft valuation and discusses the key definitions, including useful life, obsolescence, hedonic price, and value. Using the foundation established in previous chapters, Chapter 5 takes the readers through a step-by-step process of valuation of commercial airplanes. We use a numerical case study based on airplanes of Boeing and Airbus as the dominant players in aircraft manufacturing. Case studies that span across the chapter demonstrate step-by-step how various influential revenue and cost factors on an aircraft’s value are identified, measured, and accounted for toward the final estimation of the value. A discussion of value trends over time and volatility of value due to external triggers and changes in the cost and revenue factors is provided. Before the pandemic, an aging A320 aircraft could be sold for between $6.5 million and $7.5 million, compared with about $2  million today. The long pandemic travel restrictions have extended recovery trajectories for wide-bodied aircraft following the significant hit during the pandemic. Chapter 6 focuses on sources of capital for aircraft financing. We discuss equity and debt financing and provide an overview of bankruptcy and financial distress. The chapter concludes by reviewing the cost analysis and management of the crew. Chapter 7 introduces and reviews financial instruments that utilize aircraft as assetbacked securities. We discuss credit rating and risk assessment along with a comparison of various aircraft secure bonds and their pros and cons. We allocated a separate chapter to general aviation. Even though the foundation of aircraft valuation is the same for general aviation and commercial aviation, there are specific issues that demand additional attention when it comes to general aviation. Unlike commercial aviation, where aircraft are revenue-generating assets for operators, in general aviation, the primary purpose of owning and operating an

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airplane may not be directly tied to revenue generation. We provided an overview of the appraisal process and report writing requirements in this chapter and presented some of the more prominent databases for aircraft data and price estimates in general aviation. Chapter 8 also presents a technical overview and background of more dominant general aviation aircraft. In Chapter 9, we elaborate on aircraft leasing and financing. As volatility in demand increases and certainty on the prospect of the industry decreases, airlines shift more toward leasing, allowing them to reduce their risk exposure and expand the cash access. We discuss the benefit of lease versus buy and review various lease classifications. A methodology for assessing the value of a lease agreement from the perspective of both lessee and lessor is presented. Major leasing companies and a summary of lease aircraft fleet and characteristics are provided for readers’ reference. Chapter 10 addresses another critical tool in airline managers’ arsenal. The success of an airline’s highlight depends on acquiring the right airplane for their business model and applying them correctly with the goal of airline profitability. Therefore, this chapter reviews the key factors that must be considered for aircraft selection and their performance evaluation. Chapter 11 discusses the special issue of obtaining financing through credit agencies that facilitate the transaction between manufacturers and buyers. Such an option may be available to buyers through various agencies who indirectly seek to ease the export of aircraft by their domestic manufacturers. This book and its practical approach to aircraft valuation and financing assist practitioners and academicians in making better and more informed decisions. Daytona Beach, FL, USA

Bijan Vasigh Farshid Azadian

Acknowledgments

Air transportation is undeniably the center of international trade and finance, and without it, there would be no growing economy. The writing and development of any book is a long and trying endeavor. Much of the material included in this book was initially formulated in response to the need of the industry to develop aircraft valuation methodology. As authors, we received a lot of assistance and encouragement from a number of individuals. First, we would like to thank Chris Tarry, Ken Dufour, Kelly Ison, Graham Deitz, Husam Fanashe, and Peter Agur for their support. Additionally, many Embry-Riddle Aeronautical University graduate students also helped prepare and gather information for this manuscript. We owe a special debt to graduate assistants Tianyi Hui, Luman Liu, Andrea Lopez Jimenez, Nicholas Pombo, and Nidhi Trambadia. Several friends and colleagues made written contributions to the first draft that brought this book to life. We are particularly grateful to Reza Taleghani, Darryl Jenkins, and Paul Mifsud. We particularly acknowledge our friends and families who supported us in this endeavor. We also thank Lorraine Klimowich and Shobha Karuppiah at Springer Publishing, who encouraged us and helped to deliver a quality manuscript. Any mistakes in the book are attributed to the authors, and we will be grateful for reader feedback.

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Contents

1 The Globalization and Evolution of the Aviation Industry��������������������   1 1.1 Early Contributions to Commercial Aircraft Manufacturing��������������   3 1.2 Overview of Commercial Aircraft Industry����������������������������������������   6 1.3 North America������������������������������������������������������������������������������������   7 1.3.1 Boeing Aircraft Company ������������������������������������������������������   8 1.3.2 McDonnell Douglas (1967–1997)������������������������������������������  18 1.3.3 Lockheed Corporation������������������������������������������������������������  21 1.4 Western Europe Aircraft Companies: Evolution and Constellation��������������������������������������������������������������������������������  25 1.4.1 Airbus Industries��������������������������������������������������������������������  26 1.4.2 Fokker (1912–1996)����������������������������������������������������������������  33 1.5 Russia and Eastern European Countries ��������������������������������������������  35 1.5.1 The Early Years ����������������������������������������������������������������������  37 1.5.2 Russian Aircraft Manufacturers����������������������������������������������  38 1.5.3 The 1960s��������������������������������������������������������������������������������  41 1.5.4 The 1970s��������������������������������������������������������������������������������  43 1.5.5 The 1980s��������������������������������������������������������������������������������  44 1.5.6 The 1990s–Present������������������������������������������������������������������  45 1.6 Asia-Pacific ����������������������������������������������������������������������������������������  49 1.6.1 Commercial Aircraft Corp. of China (COMAC)��������������������  52 1.7 Regional Jet Market����������������������������������������������������������������������������  53 1.7.1 Empresa Brasileira De Aeronáutica, S. A. (EMBRAER) ������  54 1.7.2 Bombardier Aerospace������������������������������������������������������������  58 1.7.3 Mitsubishi Aircraft Corporation����������������������������������������������  61 1.8 Summary ��������������������������������������������������������������������������������������������  63 Bibliography������������������������������������������������������������������������������������������������  64 2 Aircraft Variants and Manufacturing Specifications ����������������������������  67 2.1 Introduction����������������������������������������������������������������������������������������  68 2.2 Boeing’s Commercial Aircraft������������������������������������������������������������  70 2.2.1 Boeing Existing Fleet��������������������������������������������������������������  70 2.2.2 Boeing Out-Of-Production Fleet��������������������������������������������  79

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2.3 Airbus Commercial Aircraft���������������������������������������������������������������  84 2.3.1 General Characteristics of the Fleet����������������������������������������  85 2.4 Mcdonnell Douglas’s Commercial Aircraft����������������������������������������  94 2.4.1 General Characteristics of the Fleet����������������������������������������  95 2.5 Lockheed Corporation������������������������������������������������������������������������  97 2.6 The Commercial Aircraft Corporation of China (COMAC)��������������  99 2.6.1 General and Physical Characteristics of the Fleet������������������ 100 2.7 Regional Jets �������������������������������������������������������������������������������������� 101 2.7.1 Embraer���������������������������������������������������������������������������������� 101 2.7.2 De Havilland Aircraft of Canada�������������������������������������������� 106 2.7.3 Mitsubishi Heavy Industries (MHI)���������������������������������������� 108 2.8 Summary �������������������������������������������������������������������������������������������� 111 Bibliography������������������������������������������������������������������������������������������������ 112 3 Aircraft Financial and Operational Efficiencies ������������������������������������ 113 3.1 Airline Fleet Composition������������������������������������������������������������������ 114 3.2 Single Factor Ratios���������������������������������������������������������������������������� 117 3.2.1 Aircraft Technical Performance Ratios���������������������������������� 119 3.3 Operating Ratios �������������������������������������������������������������������������������� 127 3.3.1 Fuel Efficiency������������������������������������������������������������������������ 127 3.3.2 Aircraft Utilization������������������������������������������������������������������ 132 3.3.3 Average Stage Length ������������������������������������������������������������ 133 3.3.4 Breakeven Load Factor ���������������������������������������������������������� 138 3.4 Financial and Operational Performance���������������������������������������������� 141 3.4.1 Aircraft Financial Performance Through Financial Ratios Analysis ���������������������������������������������������������������������� 141 3.5 Comparative Analysis of Efficiency���������������������������������������������������� 148 3.5.1 Narrow-Body: Boeing 737NG vs. Airbus A320 �������������������� 148 3.5.2 Wide-Body: Boeing 777-200ER vs. A330-300���������������������� 157 3.5.3 Regional Jets: CRJ 900 vs. EMB 175������������������������������������ 159 3.6 Summary �������������������������������������������������������������������������������������������� 162 Bibliography������������������������������������������������������������������������������������������������ 162 4 The Foundation and Economics of Aircraft Valuation�������������������������� 165 4.1 Introduction���������������������������������������������������������������������������������������� 166 4.2 Definition of Value and Price of an Asset ������������������������������������������ 168 4.2.1 Base Value������������������������������������������������������������������������������ 169 4.2.2 Current Market Value�������������������������������������������������������������� 170 4.2.3 Future Value and Securitized Value���������������������������������������� 170 4.2.4 Parts, Salvage and Scrap Value ���������������������������������������������� 171 4.2.5 Forced Sale, Liquidation and Distress Value�������������������������� 171 4.3 Depreciation and Obsolescence���������������������������������������������������������� 172 4.3.1 Economic Useful Life ������������������������������������������������������������ 174 4.3.2 Economic and Functional Obsolescence�������������������������������� 176

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4.4 Approaches to Valuation �������������������������������������������������������������������� 178 4.4.1 Cost Approach for Valuation�������������������������������������������������� 178 4.4.2 Revenue Approach������������������������������������������������������������������ 180 4.4.3 Sales Comparison������������������������������������������������������������������� 180 4.4.4 Applicability of Valuation Approach�������������������������������������� 182 4.5 Economics of Aircraft Valuation�������������������������������������������������������� 182 4.5.1 Time Value of Money and Estimation of Discount Rate�������� 183 4.5.2 The Weighted Average Cost of Capital ���������������������������������� 184 4.5.3 Methods of Investment Assessment���������������������������������������� 187 4.6 Summary �������������������������������������������������������������������������������������������� 195 Bibliography������������������������������������������������������������������������������������������������ 196 5 A Step-By-Step Methodology for Commercial Aircraft Valuation: Case Study of Boeing and Airbus ������������������������������������������������������������ 197 5.1 Introduction���������������������������������������������������������������������������������������� 198 5.2 Intricacy and Resourcefulness������������������������������������������������������������ 199 5.3 Aircraft and Data Selection���������������������������������������������������������������� 202 5.3.1 Boeing Aircraft����������������������������������������������������������������������� 203 5.3.2 Airbus Aircraft������������������������������������������������������������������������ 203 5.4 Sources of Revenue���������������������������������������������������������������������������� 204 5.4.1 Passenger Revenue������������������������������������������������������������������ 207 5.4.2 Cargo Revenue������������������������������������������������������������������������ 208 5.4.3 Ancillary Revenue������������������������������������������������������������������ 209 5.5 Aircraft Total Cost Structure�������������������������������������������������������������� 211 5.5.1 Direct Operating Costs������������������������������������������������������������ 213 5.5.2 Indirect Operating Costs �������������������������������������������������������� 216 5.5.3 Non-operating Cost���������������������������������������������������������������� 217 5.6 A Model of Aircraft Valuation Decisions Based on Net Present Value Calculations������������������������������������������������������ 218 5.6.1 Theoretical Aircraft Value vs. List Price�������������������������������� 220 5.6.2 The Trend of Aircraft Values�������������������������������������������������� 222 5.7 Aircraft Value Volatilities�������������������������������������������������������������������� 225 5.7.1 Fuel Price Sensitivity�������������������������������������������������������������� 226 5.7.2 Passenger Yield Sensitivity ���������������������������������������������������� 228 5.7.3 Other Factors Sensitivity�������������������������������������������������������� 228 5.7.4 Elasticity �������������������������������������������������������������������������������� 228 5.8 Summary �������������������������������������������������������������������������������������������� 229 Bibliography������������������������������������������������������������������������������������������������ 230 6 The Principles of Long Term Financing and Effective Cost Management�������������������������������������������������������������������������������������� 233 6.1 Financing Capital Spending and Sources of Capital�������������������������� 234 6.1.1 Capital Structure �������������������������������������������������������������������� 237 6.1.2 Common Equity���������������������������������������������������������������������� 237 6.1.3 Preferred Stock����������������������������������������������������������������������� 238 6.1.4 Common Stock Valuation ������������������������������������������������������ 239

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6.1.5 Methodologies of Valuing a Company’s Stock Price�������������� 240 6.1.6 Debt Financing������������������������������������������������������������������������ 244 6.2 Bankruptcy and Financial Distress ���������������������������������������������������� 251 6.2.1 Chapter 7: Straight or Liquidation Bankruptcy���������������������� 252 6.2.2 Chapter 11: Reorganization Bankruptcy�������������������������������� 252 6.3 Strategic Cost Management���������������������������������������������������������������� 253 6.3.1 Financial Crew Cost Analysis������������������������������������������������ 254 6.3.2 Operational Crew Cost Analysis�������������������������������������������� 255 6.4 Rules of Thumb���������������������������������������������������������������������������������� 261 6.5 Summary �������������������������������������������������������������������������������������������� 261 Bibliography������������������������������������������������������������������������������������������������ 264 7 Aircraft Secured Bond Transactions and Securitization������������������������ 265 7.1 Aircraft Secured Bond Products �������������������������������������������������������� 266 7.1.1 Asset-Backed Securities���������������������������������������������������������� 269 7.1.2 Equipment Trust Certificates and Pass-Through Certificates������������������������������������������������������������������������������ 272 7.2 Bankruptcy Protection Issues�������������������������������������������������������������� 275 7.2.1 Chapter 11 Bankruptcy Reorganization���������������������������������� 276 7.2.2 Chapter 7 Liquidation ������������������������������������������������������������ 277 7.3 Aircraft Lease Securitization�������������������������������������������������������������� 278 7.3.1 Aircraft Lease Portfolio Securitizations��������������������������������� 278 7.3.2 Enhanced Equipment Trust Certificates���������������������������������� 284 7.3.3 Tranching�������������������������������������������������������������������������������� 288 7.3.4 Liquidity Facility�������������������������������������������������������������������� 289 7.3.5 Cross-Default�������������������������������������������������������������������������� 289 7.4 Credit Rating Agencies ���������������������������������������������������������������������� 290 7.4.1 Standard & Poor’s ������������������������������������������������������������������ 290 7.4.2 Moody’s Investor Service ������������������������������������������������������ 291 7.4.3 Fitch Ratings �������������������������������������������������������������������������� 291 7.4.4 Altman Bankruptcy Index������������������������������������������������������ 292 7.5 Summary �������������������������������������������������������������������������������������������� 293 Appendix������������������������������������������������������������������������������������������������������ 294 A7.1 Rating Scales for Long-term Corporate Obligations ����������������  294 A7.2 Moody’s Rating Scale for Long-term Corporate Obligations Defined ������������������������������������������������������������������  294 A7.3 Standard and Poor’s Rating Scale for Long-­term Corporate Obligations Defined ������������������������������������������������������������������  295 A7.4 Fitch’s Rating Scale for Long-term Corporate Obligations Defined ��������������������������������������������������������������������������������������  295 Bibliography������������������������������������������������������������������������������������������������ 296 8 General Aviation Aircraft Manufacturers and Appraisal���������������������� 297 8.1 General Aviation Industry ������������������������������������������������������������������ 299 8.2 General Aviation Aircraft Manufacturers�������������������������������������������� 300 8.2.1 Manufacturers Operating in the Global Business Jet Market�������������������������������������������������������������������������������� 301

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8.3 Appraisal Standards and Requirements���������������������������������������������� 315 8.3.1 American Society of Appraisers (ASA)���������������������������������� 317 8.3.2 The International Society of Transport Aircraft Trading (ISTAT) ���������������������������������������������������������������������������������� 318 8.3.3 Appraisal Company Requirements ���������������������������������������� 318 8.4 General Aviation vs. Commercial Aviation Appraisal Methods �������� 318 8.4.1 Aircraft Bluebook Values�������������������������������������������������������� 319 8.4.2 Scope of Appraisal������������������������������������������������������������������ 321 8.5 Diminution or Impairment of Value Assessment�������������������������������� 325 8.6 Fixed-Base Operators�������������������������������������������������������������������������� 327 8.6.1 Scope of Operations���������������������������������������������������������������� 328 8.7 Summary �������������������������������������������������������������������������������������������� 329 Bibliography������������������������������������������������������������������������������������������������ 329 9 Aircraft Leasing and Finance ������������������������������������������������������������������ 331 9.1 Commercial Aircraft Leasing Industry ���������������������������������������������� 332 9.2 Physiognomies of the Aircraft Leasing Industry�������������������������������� 336 9.2.1 Advantages of Aircraft Leasing���������������������������������������������� 337 9.2.2 Disadvantages of Aircraft Leasing������������������������������������������ 340 9.3 Lease Classification���������������������������������������������������������������������������� 342 9.3.1 Operating Lease���������������������������������������������������������������������� 343 9.3.2 Financial (Capital) Lease�������������������������������������������������������� 345 9.3.3 Cross-Border Aircraft Leasing������������������������������������������������ 348 9.3.4 Sale and Leaseback ���������������������������������������������������������������� 348 9.3.5 Leveraged Leases�������������������������������������������������������������������� 351 9.4 Dry and Wet Lease������������������������������������������������������������������������������ 351 9.5 Financial Considerations for Aircraft Leasing������������������������������������ 354 9.5.1 Buy vs. Lease Analysis ���������������������������������������������������������� 354 9.5.2 Evaluation by Lessee�������������������������������������������������������������� 355 9.5.3 Evaluation by Lessor�������������������������������������������������������������� 357 9.6 Business Jets Market and Fractional Ownership�������������������������������� 360 9.7 Major Commercial Aircraft Leasing Companies�������������������������������� 361 9.7.1 General Electric Capital Aviation Services (GECAS)������������ 362 9.7.2 AerCap������������������������������������������������������������������������������������ 362 9.7.3 Avolon������������������������������������������������������������������������������������ 363 9.7.4 BBAM Aircraft Leasing & Management�������������������������������� 363 9.7.5 Nordic Aviation Capital���������������������������������������������������������� 364 9.7.6 SMBC Aviation Capital���������������������������������������������������������� 364 9.7.7 Industrial and Commercial Bank of China Leasing���������������� 364 9.7.8 DAE Capital���������������������������������������������������������������������������� 365 9.8 Summary �������������������������������������������������������������������������������������������� 368 Bibliography������������������������������������������������������������������������������������������������ 368

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10 Evaluation and Fleet Selection Process���������������������������������������������������� 369 10.1 Fleet Planning and Aircraft Selection ���������������������������������������������� 370 10.1.1 Operating Environment������������������������������������������������������ 373 10.1.2 Fleet Assignment���������������������������������������������������������������� 376 10.1.3 Market Forecast and Route Analysis���������������������������������� 378 10.1.4 Analyzing the Competitive Dynamic���������������������������������� 379 10.2 How to Choose the Right Airplane? ������������������������������������������������ 384 10.2.1 Criteria for Aircraft Selection Process�������������������������������� 386 10.2.2 Detailed Aircraft Performance������������������������������������������ 389 10.2.3 Cost Factors������������������������������������������������������������������������ 391 10.2.4 Payload Vs. Range�������������������������������������������������������������� 393 10.3 Modeling Techniques and Issues������������������������������������������������������ 397 10.3.1 Assessing Aircraft Profitability – Cost Components���������� 398 10.3.2 Assessing Aircraft Profitability – Revenue Components������������������������������������������������������������������������ 400 10.3.3 Sensitivity Analysis������������������������������������������������������������ 402 10.4 Summary ������������������������������������������������������������������������������������������ 403 Bibliography������������������������������������������������������������������������������������������������ 404 11 Aircraft Acquisition Trough Export Credit Agencies ���������������������������� 405 11.1 Introduction�������������������������������������������������������������������������������������� 406 11.2 Aircraft Export Credit Agencies ������������������������������������������������������ 408 11.2.1 Export Credit Agencies Throughout the World������������������ 410 11.3 Cape Town Convention (CTC)���������������������������������������������������������� 417 11.3.1 Export Credit Agencies (ECA) Financing and the Cape Town Treaty�������������������������������������������������� 418 11.4 Aircraft Sector Understanding (ASU)���������������������������������������������� 419 11.4.1 Grandfathered Transactions������������������������������������������������ 422 11.5 Financing Alternatives Utilizing ECA Support�������������������������������� 423 11.5.1 How Aircraft Financiers Utilize the ECA Guarantee to Lower Borrowing Costs�������������������������������������������������� 423 11.5.2 Loan and Bond Instruments and Structures������������������������ 424 11.6 Summary ������������������������������������������������������������������������������������������ 428 Bibliography������������������������������������������������������������������������������������������������ 429 Appendixes���������������������������������������������������������������������������������������������������������� 431 Glossary�������������������������������������������������������������������������������������������������������������� 447 Index�������������������������������������������������������������������������������������������������������������������� 457

1

The Globalization and Evolution of the Aviation Industry

The commercial aviation industry is one of the most vital industries, which affects with great influence, by supporting about $2.7 trillion of the world’s gross domestic product (GDP).1 Even though the airline industry overall is a relatively competitive market, there is little competition among supply chains; airports, aircraft manufacturers, and jet engine manufactures. An aircraft is usually made up of more than a million parts, and aircraft manufacturers rely heavily on a complex web of hundreds of suppliers providing everything from engines, fuselages to seats and avionics. Among major suppliers of Boeing, China’s Xian Aircraft Co. makes some 737 vertical fins, and Japan’s Mitsubishi Heavy Industries provides the wing’s inboard flaps. Many of the Dreamliner’s other suppliers are based overseas in countries  The Air Transport Action Group (ATAG), Montreal, 26 September 2019.

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© The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 B. Vasigh, F. Azadian, Aircraft Valuation in Volatile Market Conditions, Management for Professionals, https://doi.org/10.1007/978-3-030-82450-1_1

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1  The Globalization and Evolution of the Aviation Industry

including Japan, Italy, Korea, Germany, the United Kingdom, Sweden and France. One of the best ways for aviation companies to succeed in times of rapid (but unpredictable) international growth is to build and cultivate global partnerships with forward-thinking and reliable suppliers, logistics and technology providers. The industry receives significant attention from policymakers and industry analysts. Nowadays, the commercial aircraft industry is dominated by two very strong companies, primarily due to high barriers to entry, intellectual property, and high degrees of operational and financial leverages. The aircraft manufacturers primarily depend on the aircraft demand from airlines, which make up the bulk of the major markets for operators. In total, Airbus delivered 863 aircraft to 99 different customers in 2019. Airbus received gross orders for 1131 new planes. In contrast, Boeing delivered only 380 planes; it is the lowest total since a 57-day strike shut down production in 2008. Boeing’s deliveries continue to deteriorate in the aftermath of two 737 MAX deadly accidents and the subsequent grounding of the fleet.2 Boeing delivered 157 planes in 2020 as its 737 Max crisis was intensified by the COVID-19 pandemic. During the same period, Airbus delivered 566 planes to customers, a 34% drop from the year before.3 The development of new commercial aircraft requires a massive initial investment in labor, capital, equipment, and technologies. Historically, this has led to the formation of large, consolidated firms with financing from both public and government sources. For example, the total development cost for the A350 was more than $15 billion, with one-third financed by European members of the Airbus consortium. France, Britain, Germany and Spain have all invested heavily in the A350 program. In the case of Boeing 787, the total cost for development and manufacturing has been around $32 billion.4 In the past, there were several aircraft manufacturers, including Ford in North America and Junkers in Europe, from the early 1900s through the late 1980s who made significant contributions to the industry. The market has undergone considerable consolidation in the past two decades and especially more recent years, resulting in the emergence of a relatively stable duopoly for narrow and wide-body commercial airliners: the Boeing Company in North America and Airbus S.A.S in Europe. In this chapter, we will present a brief history and overview of the product offerings of the major commercial aircraft manufacturers. We have structured the remainder of the chapter as follows:

2  Defense and Security Monitor. Airbus and Boeing Report January 2020 Commercial Aircraft Orders and Deliveries, February 17, 2020. 3  Boeing’s 2020 aircraft cancellations worst on record, despite December Max orders. CNNB January 12, 2021. 4  The Seattle Times, September 24, 2011.

1.1  Early Contributions to Commercial Aircraft Manufacturing

3

Early Contributions to Commercial Aircraft Manufacturing Commercial Aircraft Manufacturing North America • Boeing Aircraft Company • McDonnell Douglas • Lockheed Western Europe • Airbus • Fokker Russia and Eastern European Countries • The Early Years • Russian Aircraft Manufacturers • The 1960s • The 1970s • The 1980s • The 1990s–Present Asia-Pacific • Commercial Aircraft Corp of China (COMAC) • Mitsubishi Aircraft Corporation Regional Jet Market • Embraer • Bombardier Aerospace • Mitsubishi At the end of the chapter is a summary for this chapter review and a selected bibliography for further study.

1.1

 arly Contributions to Commercial E Aircraft Manufacturing

The commercial aircraft industry requires a very large investment to develop and manufacture fuselage, engines and avionics. Rising disposable income, living standards, lower average ticket prices result in an increased demand for air travel for both business and leisure purposes. Exogamous shocks may also significantly influence this growth. The economic impact of COVID-19 has been tremendous to the aviation industry; Airbus delivered 566 aircraft in 2020, significantly short of 863 last year. The COVID-19 outbreak has also hit airports around the world hard, and as of August 2020, European airports estimate to have a $38.8 billion loss in revenue in 2020 due to the pandemic. Many aircraft manufacturing companies have gone out of business or merged with other peers. This industry is littered with the reminiscence of unsuccessful commercial aircraft endeavors. The series of three-engine Ford Trimotor aircraft produced during the 1920s and 1930s were classic planes of the era. The Lockheed L-1011 was a wide-body aircraft that entered into commercial operations following the launch of the Boeing 747 and the McDonnell Douglas DC-10. However,

4

1  The Globalization and Evolution of the Aviation Industry

Lockheed later withdrew from the commercial aircraft business due to low sales.5 Subsequently, in 1997, McDonnell Douglas was facing a financial crisis forced to merge with its rival, Boeing.6 The Burgess Company (1910–1918) and Curtis, Inc. was the first licensed aircraft manufacturer in the United States. Burgess merged into the Curtiss Airplane and Motor Company Curtiss in 1916, and Curtiss acquired all Burgess assets. In the early 1920s Henry Ford and his son Edsel, along with a group of 19 other financiers, invested in the Stout Metal Airplane Company (1922–1936). Only 6 years after the Wright Brothers’ first flight, the first Ford/Van Auken airplane, powered by a Model-T engine introduced in 1909. It would not be until 1927, however, that Ford would enter the commercial aviation arena with the first of the 4-AT series Ford Trimotors, also referred to as the “Tin Goose”. Previous Ford manufactured aircraft, like the model 2-AT “Air Transport” had been used by Ford itself in shipping auto parts, mail and personnel back and forth between Denver, Detroit and Cleveland. The Ford Trimotor was the first plane primarily designed to carry passengers instead of airmail. This aircraft could carry 14 or 15 people, possessed a cabin high enough for passengers to walk without stopping and had room for a flight attendant.7 The Tin Goose’s three engines made it possible to fly as high as 3 miles at a speed of about 130 miles per hour, and its sturdy appearance and Ford name had a reassuring effect on the public’s perception of flying (Ingells, 1968). The Trimotor had a range of approximately 500 miles and was not capable of crossing continents without refueling. Ford, unlike his cars, did not manufacture the engines for these airplanes (Exhibit 1.1).

Exhibit 1.1  Ford Trimotor, 1929

 Greenwald, J., J. Hannifin and J. Kane. Catch a Falling TriStar. Time December 21, 1981.  Boeing. Company, Boeing Chronology, 1997–2001. 7  Donald, David, ed., the Complete Encyclopedia of World Aircraft. New York: Barnes & Noble, Inc. 1997. 5 6

1.1  Early Contributions to Commercial Aircraft Manufacturing

5

From 1926 through 1933, there were 199 Ford Tri-motors built.8 The Trimotor sales dropped from a peak of 86 a year in 1929 to only two sales in 1932.9 The Ford Motor Company ceased manufacturing this aircraft in 1932 (Larkins, 2004). The end of Ford’s contribution to commercial aircraft manufacturing was likely due to a combination of various issues. Amongst, the tightened market, the economy of the depression era, the overall loss incurred in the production of the airplanes, the diminished need for a three-engine aircraft, an increased need for a faster and more economical design for airline use, and Henry Ford’s diminishing interest caused by the deaths of three test pilots in crashes. In Europe, Junkers (1895–1969) was a major German aircraft manufacturer. Junkers manufactured some of the best-known aircraft over the course of its fiftyplus years in business. Junkers is a name that quickly became associated with great aerodynamic and structural advances in aircraft in post-World War I Germany. The company was founded by Hugo Junkers. In 1919, Junkers began designing the aircraft that would not only become the world’s first all-metal airliner but also the forerunner of all commercial transport aircraft. The single-engine, low-wing, cabin monoplane was of particularly small dimensions since it was necessary to work within the onerous restrictions diligently forced upon Germany. It was in production for 13 years and in commercial use for about 20 (Kay & Couper, 2004). Junkers produced the F13 commercially; the aircraft was made entirely of duralumin and designed to be dismantled into sections for easy shipment to export markets.10 The F13 first flew on 25 June 1919. In fact, the first order for an F13 came from an American businessman John Larsen who planned to sell it as a JL6 in North America. A total of 322 F13s were produced, mainly between 1923 and 1925, and most went into service in Germany and Russia (Kay & Couper, 2004). Junkers was absorbed within Messerschmitt-Bölkow-Blohm (MBB) and the Junkers seazed operation in 1969 (Exhibit 1.2).

Exhibit 1.2  Junkers F-13

 Herrick, Greg A. The Amazing Story of America’s Oldest Flying Airliner, 2004.  Russ Banham. The Ford Motor Company and the innovations that shaped the world. 10  The J13 is an alternative designation for the F13. 8 9

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1  The Globalization and Evolution of the Aviation Industry

1.2

Overview of Commercial Aircraft Industry

With a short dash down the runway, the machine lifted into the air and was flying. It was only a flight of twelve seconds, and it was an uncertain, wavy, creeping sort of flight at best; but it was a real flight at last and not a glide. —Orville Wright, on the first flight of a heavier-than-air aircraft.

As the historical data on the commercial aircraft industry shows, a few major companies influence the entire industry. Today, the market presents a very tight duopolistic, or at best, an oligopolistic market structure due to very significant barriers to entry. Since the merger of Boeing and McDonnell Douglas in 1997, the two major players, the Boeing Company and Airbus Group, dominate the industry. The commercial unit makes mid-range jets of up to 150 passengers, which compete directly with the Airbus A220. Subsequent to these agreements, the Airbus-Boeing duopoly dominates 99% of the large plane market. In July 2018, Boeing, in response to Airbus’s partnership with Bombardier regarding the then named C-Series aircraft, entered into a memorandum of understanding (MOU) for a partnership 80/20 with Embraer for its commercial aviation interests valued at $4.75 billion. For Boeing, this was to give momentum to the smaller size of its aircraft portfolio that competes directly against the renamed A220 family from Airbus. It also provides engineering capabilities to work on the new potential Boeing products that are under development, such as the New Midsize Airplane (NMA). For Embraer, this gave more marketing power for its new E2 family of aircraft. It passed shareholder approval in early 2019 after some back and forth on national control and interest grounds for the Brazilian government. In April of 2020, Boeing abandoned the deal to buy 80% of Embraer’s commercial aircraft business for 4.2 billion, stating that the Brazilian company did not satisfy the necessary conditions of the agreement.11 Aircra deliveries by manufacturer - global aircra fleet 1999-2019

2,000 1,500 1,000 500

Boeing

11

Airbus

Bombardier

 Forbes. Boeing-Embraer Deal Collapses, April 25, 2020.

Embraer

Others

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

0

1.3  North America

1.3

7

North America

World aircraft manufacturing was, and to a large measure, continues to be, dominated by North American manufacturers. After World War II, four prominent players emerged in the business of building commercial jets: Boeing, McDonnell, Douglas, and Lockheed. McDonnell and Douglas eventually merged in 1967, and the combined entity remained a long-standing competitor to Boeing until its ultimate merger with Boeing in 1997. Lockheed merged with Martin Marietta in 1995, and the combined entity later refined its focus to primarily military aircraft manufacturing (Sandler & Hartley, 2007). Both Boeing and Lockheed Martin compete for American defense contracts. The U.S. government is the single largest customer for Boeing and brought in almost 31% of the company’s revenue in 2018. That is why Airbus had claimed that Boeing uses its defense division to cross-subsidize its commercial airline development. Boeing and Lockheed dominated the North American aircraft manufacturing landscape both in terms of civilian and military aircraft. Together with McDonnell Douglas, Boeing was a world leader in commercial aircraft manufacturing into the 1980s, when Europe’s Airbus Industrie evolved into a major competitor that would eventually surpass Boeing in market share. Figure  1.1 chronicles the mergers of commercial aircraft manufacturers in the U.S. over the last century—we have omitted the military aircraft manufacturer’s mergers for the sake of clarity.

1909

Wright Aircraft Company

1912

1916 Wright-Martin Company

Glen L. Martin

1930

1961 Martin Marietta Company

American Marietta Corporation Lockheed Aircraft Company

1926

1995 Lockheed Martin

Boeing Company

1916 1938

McDonnell Aircraft Corporation

1921

1997 1967

McDonnell Douglas

Boeing Company

Douglas Co. (Formerly David Douglas Co. 1920)

Figure 1.1  U.S. commercial aircraft manufacturer mergers. (Source: Compiled by the authors from Boeing and Lockheed Martin data)

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1  The Globalization and Evolution of the Aviation Industry

1.3.1 Boeing Aircraft Company Boeing has been a dominant player in the commercial aircraft market for the greater part of the last century. The recent loss of market share to Airbus does not diminish the fact that Boeing is an extremely strong company and a leader in commercial aviation. While this section will focus on commercial aircraft history, it is important to note that Boeing’s start, and much of its success, came from the sale of military aircraft. In 1916, William Boeing (the founder and namesake of Boeing) built his first seaplane, which he sold to the New Zealand government. The following year, Boeing sold 50 seaplanes to the U.S. Navy and continues to receive crucial military and defense contracts from the U.S. government, including a $32 billion contract to build a new generation of refueling tankers for the Air Force.12 The Boeing Co. has also received a $2.4 billion contract to develop the next 19 P-8 Poseidon aircraft for the U.S. Navy. The financial success of military aircraft projects allowed the company to endeavor into high-risk commercial aircraft projects that may not have been profitable. Having the financial ability to undertake these high-risk commercial aircraft projects is one of the reasons Boeing is at the forefront of aircraft development. Boeing began to learn the aircraft manufacturing trade by first building and modifying existing designs from other manufacturers. In 1918 Boeing was contracted to build the Curtiss-designed HS-2L, a military patrol plane. Later, in 1919, Boeing modified the de Havilland DH-4 (“Heritage of Innovation,” 2009). These modifications allowed Boeing to take apart and rebuild the aircraft in order to relocate the fuel tank. As most engineers know, being able to take apart and reassemble a manufactured product such as an airplane allows one to see how the item is constructed and how it works, providing insights into how to make the item. The process of designing something through the deconstruction and reconstruction of a similar item is called reverse engineering. The use of reverse engineering helped Boeing to develop its own planes, including its first commercial aircraft, the B-1 mail plane, which was launched in 1919, the start of a 90-year history of building commercial airplanes.13 Boeing’s real start in the commercial aviation business came through the U.S. mail network. The U.S. Postal Service awarded Boeing a contract to transport mail by air between San Francisco and Chicago in 1927. Boeing founded the airline Boeing Air Transport to fly this route and used its own mail plane that Boeing had developed, the Model 40A. The Model 40A was unique in that it had a nose made from steel, combined with a wood and fabric fuselage (“Heritage of Innovation,” 2009). Boeing built 25 of these mail planes for Boeing Air Transport’s fleet. The Model 40A could hold two passengers, also making it the first real passenger aircraft. Boeing continued to design passenger aircraft throughout the late 1920s and early 1930s, progressively building aircraft that could hold more and more passengers as well as mail. The 1932 Model 247 presented the best combination of speed  Congressional Research Service. Air Force KC-46A Pegasus Tanker Aircraft Program Updated April 21, 2020. 13  United States Centennial of Flight Commission, The Early Years of Boeing. 12

1.3  North America

9

and capacity, carrying ten passengers and 400 pounds of mail at speeds of up to 200 miles per hour. Together with the Douglas DC-2, the Model 247 heralded the modern era of air transportation (“Comprehensive index of historical products,” 2009). The 1930s were a slow time for Boeing, especially on the commercial aviation front, due to the Great Depression. During this time, Boeing mainly focused on military aircraft such as the B-17. Boeing could never have known how big the B-17 Bomber project would be. The B-17, nicknamed “The Flying Fortress”, would prove crucial in World War II for Allied forces in defeating the Germans and the Japanese (“Heritage of Innovation,” 2009). Despite the tough economy and the B-17 being the only major success for Boeing at the time, Boeing was laying the groundwork for future successes. In 1936 Boeing bought the 28 acres, which constitute the modern-day Boeing Field in Seattle (“Heritage of Innovation,” 2009). In addition to buying the site, Boeing invested $250,000 to build a facility to manufacture airplanes onsite. As the 1930s wore on, Boeing decided to develop two new commercial aircraft despite the ailing economy. They developed the Model 307 Stratoliner and Model 314 Clipper, and the gamble of developing new aircraft during tough economic times paid off. Both models were acquired by Pan American Airways and were wildly popular. The Pan Am Clipper became an icon of modern air transportation, opening up the Americas, Europe, and Africa to the world. However, all was not successful on the Model 307 project; the prototype crashed during a test flight, killing all ten people on board (“Heritage of Innovation,” 2009). The crash of the 307, along with another crash of a B-29 during test flights, led to the creation of better pre-flight testing protocols for new aircraft, including the design of wind tunnels for performance testing. World War II brought a renewed focus on military aircraft for Boeing, as the defense business was very lucrative at the time. It was not until 1952 that a major development in the commercial aviation industry would come from Boeing. At that time, Boeing began to build a prototype of the 707, named the Model 367-80, or Dash 80 for short. The Dash 80 would become Boeing’s first commercial jetliner and one of the first jetliners in the world with military and government applications as well. The Dash 80, currently on display at the Smithsonian, was the basis for the KC-135 military fuel tanker and the first Air Force One (“Heritage of Innovation,” 2009). Used for mid-­air refueling of other aircraft, Boeing would produce 820 of the KC-135 tankers by the time production ended in 1965. On the commercial side, the Dash 80 prototype would undergo a few years of testing before the first 707-120 was produced and delivered to Pan Am in 1958.14 Before the introduction of the 707, Douglas and Lockheed aircraft were preferred planes by U.S. airlines. That all changed after the 707 became the first U.S. manufactured jetliner; Boeing would become the premier aircraft manufacturer for U.S. airlines and airlines around the world. In all, 916 Boeing 707s were delivered to customers from 1958 to 1982 (Eden, 2008). The 707’s development and success spurred the development of a line of narrow-body aircraft from the 1950s all the way through the 1980s.

14

 The aircraft made its maiden flight on December 20, 1957.

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1  The Globalization and Evolution of the Aviation Industry

1.3.1.1 The Boeing 727 (1962–1984) In addition to variants of the 707 itself, the fuselage cross-section of the 707 was used as the basis for the designs of the 727, 737, and 757. The first of these aircraft produced was the 727 in 1962. There are two types of 727. The first one is called the 727-100. Airlines began to use it in February 1964. Airlines began to use the next type, the 727-200, in December 1967. Boeing 727 Orders and Deliveries 350 300 250 200 150 100 0

1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984

50

Orders

Deliveries

The 727 would be the only commercial tri-engine jet that Boeing would ever design and produce, as well as the only T-tail jet.15 The three-engine design allowed for a compromise between airlines that wanted the efficiency of a twin-engine and airlines that wanted the performance of a four-engine aircraft. This mix of efficiency and performance led the 727 to be a popular aircraft for medium-haul routes.16 The 727 became a mainstay of U.S. airlines like American, Delta, and United until the turn of the century and was the first commercial airplane to break the 1000-sales mark. The success of the 727 led Boeing to develop a stretch version of the airplane that would seat around 180 passengers during the 1970s. Production of the 727 extended from the early 1960s to August 1984, and a total of aircraft 1831 were delivered to customers.

1.3.1.2 The Boeing 737 Originally envisioned in 1964 and designed to compete with Douglas’s 100 passenger twin-jet, the DC9, the 737 was the first Boeing jetliner to feature a two-man cockpit crew instead of a three-man crew.17 The 737 family include: • The Original (737-100 and 200) • The Classic (the 737-300, 400 and 500)  After McDonnell Douglas and Boeing merged in 1997, the 100-seater McDonnell Douglas T-tail MD-95, was renamed the Boeing 717. 16  The 727 was the first airplane to have a triple-slotted flap system for superior takeoff and landing performance. 17  Flight International, Reed Business Information, April 22, 2009. 15

1.3  North America

11

• The Next Generation (the 737-600, 700, 800 and 900) • The 737 MAX Series Since the introduction of the 737-100, Boeing has continued to develop new ­versions of the jet and today makes the 737Max. The Boeing 737 Classic is the name given to the -300/-400/-500 series of the Boeing 737 after the introduction of the -600/700/800/900 series. The 737NG series offers four differently sized aircraft to meet the varying capacity needs of airlines while keeping a maximum amount of commonality. Why is the 737 so successful for Boeing? In large part, the success of the 737 has been due to its popularity with low-cost carriers (LCCs), such as Southwest Airlines, Ryanair, WestJet, and Virgin Blue. Southwest currently operates 737 Boeing 737 jets representing nearly 10.2% of all 737s produced (as of January 31, 2021). Ironically, the challenge for Boeing with the success of the 737 program is what to do for a replacement. As fuel prices and economic conditions continue to remain volatile, airlines want the next generation of narrow-body aircraft to have even greater gains in fuel efficiency and reductions in maintenance costs. Boeing and Airbus were under pressure from low-cost airlines to develop their narrow-body replacement for the current 737 and A320 plans. The new composite twin-aisle 737 replacement could give an airline a boost in its daily utilization and has many advantages once you get above 200 seats.18 This newly redesigned aircraft series became the 737MAX family of aircraft. • The 737-300, 126 passengers in two classes, and a range of 2060 NM • The 737-400, 188 passengers in two classes, and had a range of 2375 NM • The 737-500, 110 passengers in two classes, and have a range 2100 NM • The 737-600 holds 108 passengers and can reach 3235 NM. The 737 MAX program was formally launched on August 30, 2011, in response to the introduction of the A320neo program by Airbus.19 The design was based on the older generation 737NG family of narrow-body aircraft with more enhanced CFM LEAP-1B engines that would produce lower fuel burn. There are four variants Max7-10 plans a capacity of 138 to over 200 seats for the MAX 10 would replace the older generation of narrow-body aircraft. The first delivery of the MAX 8 variant was to Malindo Air on May 22, 2017. Originally in 2006, Boeing was considering a new design narrow-body, but given Airbus’s announcement of the A320neo family in December 2010 and the orders that were placed, Boeing decided to go for a quicker and cheaper launch of a reengined 737 instead. The 737Max, with more fuel-efficient engines, improved avionics, a longer range, lower operating cost, and enough in common with previous models, made it extremely desirable to airlines around the world. The fortune ended soon. In October 2018 and March 2019, 2 MAX8 aircraft flown by Lion Air and Ethiopia Airlines crashed, which resulted in the worldwide grounding of the aircraft family. Currently, the world is waiting for the various  Centre for Asia Pacific Aviation, March 18, 2011.  http://boeing.mediaroom.com/2011-08-30-Boeing-Launches-737-New-Engine-Family-withCommitments-for-496-Airplanes-from-Five-Airlines 18

19

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aviation regulatory authorities to identify the resolve the problems and return the aircraft back to service. U.S. carriers, including United Airlines, Southwest and American Airlines, who operate the variant have removed the aircraft from their schedules out until as far as July 2020.20 The Boeing Company in November got clearance for the plane to return to the skies after convincing the Federal Aviation Administration that changes in design, software and crew training would eliminate the flaws that caused fatal crashes in 2018 and 2019. The Boeing 737 Max returned to U.S. skies on December 29, 2020, more than 20 months after the FAA grounded the aircraft. FAA give the green light to resume passenger flights in November of 2020.21 Brazilian airline GOL became the world’s first carrier to fly the recertified B737MAX planes.22

1.3.1.3 The Boeing 747 While the 747 is the largest of Boeing’s wide-bodies, Boeing also has three other twin-engine wide-body aircraft that are in production today. In 1965, Boeing amassed a design team to work on the new aircraft, which was given the Boeing 747 designation. Boeing’s 747 was the largest commercial aircraft built at that time and would usher in a new category of airliners, the “Jumbo Jet”. Two years later, the 490-passenger jumbo jet rolled out of the new plant in Everett and eventually placed into service with Pan Am in 1970.23 US airplane manufacturer Boeing will stop production of its 747 jumbo jets in 2022, retiring the iconic passenger aircraft after over 50 years of service midst a coronavirus crisis in the air transport industry. The first Boeing variant was the 747-100 and was designed to carry 366 passengers in a three-class configuration. Boeing developed the 747SP in the mid1970s as a longer range, shortened 747, trading off passenger seating for extra range. The 747SP is 48 feet 4 inches shorter than the 747-100.24 The Boeing 747-400 introduced a major change for airlines and the industry as a whole by reducing the cockpit crew from three to two. In February 1989, the 747 400 entered service with Northwest Airlines on the Minneapolis to Phoenix route. In 2005, Boeing produced the last 747-400s. The final 747 400 is delivered to China Airlines. On November 14, 2005, Boeing announced it was launching the 747-8. Sensing the need to compete with the Airbus A380, Boeing was forced to modernize the 747. The 747-8 was designed to be quieter, more economical, and more environmentally friendly. The new model had 16% more payload capacity than its predecessor, allowing it to carry seven more standard air cargo containers, with a maximum payload capacity of 154 tons of cargo. Originally launched as a freighter with orders from Cargolux, the

20  Forbes. When Will the Boeing 737 Max Return to Service—Production Now Officially Halted, February 16, 2020. 21  USA Today, December 29, 2020. 22  Reuters, Business News, December 9, 2020. 23  Aviation Week and Space Technology, September 4, 2006. 24  The idea came from a joint request between Pan American World Airways and Iran Air who were looking for a high capacity airliner with enough range to cover North America and Asia.

1.3  North America

13

747-8 meets the demand for both high-capacity passenger and cargo aircraft. As of March of 2021, a total of aircraft 1560 were delivered to the customers.

1.3.1.4 The Boeing 757 In part due to the oil crisis of the 1970s, Boeing eventually decided to scrap the idea of a stretched version of the 727 and went for a conventional two-engine replacement. This aircraft would be called the 757 and provided airlines with a narrowbody aircraft that was used on short, medium, and long haul routes while still offering the superior performance airlines had come to expect from the 727. Boeing launched the aircraft in 1982 and made a fortune for the company. The 757 operated on such diverse missions as a short field, noise-restricted airports (Orange County, California) and transatlantic flying. Due to its versatility and performance, about 622 Boeing 757 aircraft in service as of October 2020, despite the fact that 757 service dates back to 1983. The success of Boeing’s 757 pales in comparison to the leader in the commercial aircraft market, the 737. Even though the 757 was originally designed for short-to-medium routes, but it was successful as an efficient transcontinental, intercontinental and transatlantic airliner. The cargo version of the 757-200 was launched in 1985, and deliveries began in 1987 to UPS. 1.3.1.5 The Boeing 767 Boeing developed the 767 alongside the 757 and largely functioned as a replacement for the 707. Like the 707, the 767 was a medium to long-range wide-body airliner with slightly more capacity. A military version of the 767, the KC-767 tanker, was also developed to replace the KC-135. The development of the 767 benefitted from significant economies of scope from being developed alongside the 757 during the 1970s. A single flight deck design was used on both aircraft, and this created economies in terms of development costs for Boeing and allowed the FAA to issue a single-type rating for both airplanes. This offered significant economies25 in terms of training and standardization to airlines wanting to incorporate both aircraft into their fleet (“Heritage of Innovation,” 2009). The 767s came in three different fuselage lengths as well as short and long-range versions. The aircraft maker launched the program on July 14, 1978, when United Airlines ordered 30, 767-200s. Then American Airlines and Delta Airlines placed their own orders for the aircraft. Boeing delivered the first Boeing 767-200 to United Airlines on August 19, 1982. The original 767-200 entered service on September 8, 1982, with United Airlines, and the 767-300 entered service with Japan Airlines on October 20, 1986. As of early January 2021, Boeing has received 1281 orders from 74 customers, with 1206 delivered, while the remaining orders are for cargo or tanker variants.

 Economies of scope is an economic concept that the unit cost to produce a product will decline as the variety of products increases.

25

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Variant 3-class seats 2-class seats 1-class Length Range

767767767767767-200 200ER 300 300ER/F 400ER 243 174 210 296 214 261 409 245 290 201 159
180
3,900 6,590 3,900 5,980 5,625

1.3.1.6 The Boeing 777 Subsequently, Boeing developed the 777, or “Triple-Seven”, which would provide airlines with a twin-engine wide-body aircraft closing the gap between the 747 and 767. In 1992, Boeing founded Boeing Integrated Systems Laboratory to help test the design of the 777. The Integrated Systems Lab enabled Boeing to integrate new systems before ever installing them in a production airplane (“Heritage of Innovation,” 2009). With the help of the Systems Lab, Boeing was able to produce and deliver the first 777 to launch customer United Airlines in May 1995. The 777 was the first aircraft to receive Extended Range Twin-Engine Operations (ETOPS) approval before the aircraft ever entered into service due to extensive flight-testing by Boeing before delivery and advancements in engine technology.26 The introduction of more powerful engines has made the giant twinjets possible as they were rolling back the ETOPS restrictions. ETOPS allows twin-engine aircraft to fly over water for extended periods of time based on their ability to operate safely on one engine should one of the engines fail in-flight (Gunston, 1988). The 777 is a popular aircraft due to its excellent tradeoff between high capacity and operating efficiency. While United Airlines was the launch customer and currently operates a fleet of 116 Boeing 777s, Emirates has the largest fleet in operation with 154 Boeing 777 variants (“Fleet and order status,” 2019). There have been a total of 1649 Boeing 777s delivered as of November of 2020. The 777X was launched in November 2013 with two variants: the 777-8 and the 777-9. The 777-8 provides seating for 384 passengers, while the 777-9 has seating for 426 passengers. The 777-9 first flew on January 25, 2020, with deliveries expected to commence in 2022. 1.3.1.7 The Boeing 787 … we do remain very confident in the long-term outlook and certainly, with the health of the 787 as you’ve seen between the versatility and just the demonstrated market-leading economics that airplane brings to the marketplace. The long-term potentials post-pandemic are very robust. Chief Financial Officer Greg Smith, December 4, 2020

 ETOPS is the term introduced by the International Civil Aviation Organization (ICAO) which describes the operation of twin engine aircraft on a route that contains a point further than one-hour flying time from a diversion airport.

26

1.3  North America

15

The most recent Boeing aircraft to enter development and production is the 787, the Boeing Dreamliner.27 The Dreamliner features new technology such as increased use of composite materials and presents significant improvements in fuel economy and automation. Boeing’s first 787 test jet took its maiden flight in December 2009, after more than 3 years of delays.28 However, since 2003 there have been production delays that have pushed back flight testing and entry into service. The first deliveries of 787s were delayed until the second half of 2011, a delay of more than 3 years from the original schedule.29 Airlines with orders for the 787 were concerned about the delays and demanded compensation per their order contracts. This is a repetition of the delays suffered during the production of the 777 when the process was facing significant design and labor challenges. In order to maintain the 777’s production schedule, Boeing had to spend an additional $3 billion over projected costs. The investment paid off in the case of the 777; however, given current economic conditions, a decline in air travel, airline revenues, and airline spending power that define the current aviation market, it might be difficult to justify or get access to such financing in the case of the 787. Boeing produces three unique versions of the Dreamliner (787-8, 787-9 and 787-10) that optimizes for different passenger loads and distances. • B787-8 can carry 248 passengers in three classes to a range of 7305 nautical miles • B787-9 can carry 296 passengers in two classes to a range of 6350 nautical miles • B787-10 can carry 336 passengers in two classes to a range of 6345 nautical miles The smallest and base variant, 787-8, was designed to replace the Boeing 767-200ER and 767-300ER models and competes against the Airbus A330neo. The longest variant, 787-10, was designed to replace the Boeing 777-200ER and compete against the A350-1000 models. The -8 variant first delivered in 2009, followed by the -9 to Air New Zealand in July 2014 and -9, the longest version, to Singapore Airlines delivered in March 2018. There are two engine options on the aircraft with both the Rolls-Royce Trent 1000 and GE GEnx-1B engines. Boeing planned to move the production of 787s to Carlson, SC facility. In December 2020, it was announced that the move would be completed by March 2021, and the production rate will be reduced to 5 per month as the undelivered fleet is accumulating.30 It would not be wise to talk about the history of Boeing’s commercial division without mentioning the merger and integration of McDonnell Douglas. In 1997, Boeing merged with McDonnell Douglas, taking over the production of McDonnell Douglas’s commercial aircraft. Boeing acquired McDonnell Douglas for $13.3 billion, which created the world’s largest aerospace company. 31 Boeing committed to  Washington Business, January/February 2004.  U.S. Department of Energy, Office of Energy Efficiency and Renewable Energy Jan. 11, 2010. 29  Boeing Company Chief Executive Office, Jim McNerney, Feb. 10, 2011. 30  Wolfsteller, P.  Boeing to hasten 787 production in South Carolina. FlightGlobal. December 23, 2020. 31  The Sun, Baltimore, MD: Dec. 16, 1996. 27 28

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finishing all outstanding orders before phasing out all of the McDonnell Douglas aircraft except the MD-95, which Boeing transformed into the 717. The 717 captured the 100-seat market that opened up after the collapse of Fokker that dominated the market with its Fokker 100 (Norris & Wagner, 1998). In addition, Airbus was rumored to be developing its A318 at the time to compete in the same 100-seat segment. The 717 program lasted from 1998 until 2006 when Boeing made the final delivery to the original launch customer of the aircraft, AirTran Airways. Boeing decided to end production of the 717 due to slow sales and the fact that Boeing’s own 737-600 competed in nearly the same market. Despite discontinuing all commercial aircraft of McDonnell Douglas, Boeing continues to build off McDonnell Douglas’s strong background of military aircraft, including the F-15 and F-18 Hornet (“Heritage of Innovation,” 2009). In recent years, Boeing has continued to perform well financially despite the instability of the airline industry. From 2005 to 2019, Boeing increased sales of its products from $44 billion to $76 billion. In 2019, Boeing generated about 76.6 billion U.S. dollars in revenue. The revenue is significantly less than $101 billion in 2018. Currently, Boeing is ranked as the secondlargest aerospace company in the world behind Airbus. Following the two plane crashes in less than 6 months, the number of orders for Boeing’s 737 fell from 837 units in 2018 to 69 units in 2019, resulting in a net loss of 636 million U.S. dollars. Figures 1.2 and 1.3 show Boeing’s in and out of production aircraft from the mid1950s (Tables 1.1 and 1.2).

Boeing 707

Boeing 707

Boeing 717

Boeing 717

Boeing 727

Boeing 727

Boeing 737-100/-200

Boeing 737-100/-200

Boeing 737-300/-400/-500

Boeing 737-300/-400/-500

Boeing 747-100/-200/-300

Boeing 747-100/-200/-300

Boeing 747-400/-400D

Boeing 747-400/-400D

Boeing 757

Boeing 757 1950

1960

1970

1980

1990

2000

2010

Figure 1.2  Boeing out-of-production aircraft. (Source: Compiled by the authors from Boeing aircraft data)

1.3  North America

17

Boeing 737-600/-700/800/-900/-900ER

Boeing 737-600/-700/-800/-900/-900ER

Boeing 737 MAX

Boeing 747-8

Boeing 747-8

Boeing 767

Boeing 767

Boeing 777

Boeing 777

Boeing 787

Boeing 787

1980

1985

1990

1995

2000

2005

2010

2015

2020

Figure 1.3  Boeing in-production aircraft. (Source: Compiled by the authors from Boeing aircraft data (as of April 2021)) Table 1.1  Boeing out-of-production aircraft Aircraft model Boeing 707/720 Boeing 717 Boeing 727 Boeing 737-100/200/300/400/500 Boeing 747-100/200/300/400 Boeing 757

Launch customer Pan Am Air Tran Eastern Airlines Lufthansa Pan Am Eastern Airlines

Produced 1010 155 1831 3132 1418 1049

Source: Compiled by the authors from Boeing commercial orders & deliveries *As of April 2021 Table 1.2  Boeing in-production aircraft Aircraft model Boeing 737-600/-700/-800/-900/-900ER Boeing 737 MAX 8/9 Boeing 747-8 Boeing 747-8F Boeing 767-200/-300/-400/-F Boeing 777-200/-300/-F Boeing 787-8/-9/-10

Launch customer Southwest Airlines Southwest Airlines Lufthansa Cargolux United Airlines United Airlines All Nippon Airways

Delivered 6921 453 47 95 1209 1657 992

Source: Compiled by the authors from Boeing commercial orders & deliveries *As of April 2021

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1.3.2 McDonnell Douglas (1967–1997) McDonnell Douglas came into existence in 1967, with the merger of McDonnell Aircraft and Douglas Company in 1967.32 Like Boeing, much of the Douglas Co.’s early entry into aircraft manufacturing was on the military aircraft side of the market. The Douglas Co. was incorporated in 1921 in California with the first flight of its DT-1 Bomber later that year (“Heritage of Innovation,” 2009). Douglas built other military planes, including the DT-2 and C-1, before developing its first commercial plane, a mail transport, in 1925. A Douglas mail plane, the M-2, would fly Western Air Express’s first two passengers on the mail route between McDonnell Douglas for a fare of $90 (“Heritage of Innovation,” 2009), which would be equivalent to $1107.27 in today’s dollars (CPI index, Bureau of Labor Statistics). To demonstrate the effect of competition in the airline industry today, passengers can fly on this same route many years later for $167 (United.com, 2021). When the company merged with Boeing, well over 40,000 aircraft had been built in various plants and, some of which are still flying. In 1928, the Douglas Co. reorganized as the Douglas Aircraft Co. and moved in 1929 into a new manufacturing plant in Santa Monica, California. By 1932, Douglas would fully enter into the air transport industry by agreeing to a contract with Trans World Airlines (TWA) to build Douglas’s first airliner, the DC-1. The DC-1 would become a prototype for the larger DC-2 aircraft, which held 14 passengers and up to 3600 lbs. of cargo. The production of the DC-2 would begin 64 years of aircraft production for the Douglas Co. Out of the DC-2 design came a new and larger airliner, the popular DC-3. Accommodating anywhere from 14-28 passengers, 455 DC-3s were sold to several airlines in the U.S., including American and United, and more than 16,079 globally.33 However, the real popularity of the DC-3 was apparent on the military front, with the DC-3’s conversion into the C-47. This aircraft was extensively utilized during World War II, and over 10,000 of these transports were produced. Douglas’s work on commercial aircraft that could also be used as military aircraft would continue to pay dividends even after World War II. Douglas developed the DC-6 for commercial transport and would later develop military versions of the aircraft, which would be named the C-118A Liftmaster (“DC-6/C-118 Liftmaster Transport,” 2009). The original passenger version of the DC-6 could carry 52 passengers and was one of the first commercial aircraft to feature a pressurized cabin; later versions would feature a stretched fuselage with seating for up to 102 passengers. The first two DC-6s were delivered to American and United Airlines at a dual ceremony in 1947; in total, over 700 DC-6s were produced over the aircraft’s 12-year production run from 1946 to 1958 (“DC-6/C-118 Liftmaster Transport,” 2009). Pan Am inaugurated its first trans-Atlantic tourist-class flights in 1952 by flying a DC-6B. The Douglas DC-6 was one of the first airplanes to fly a regularly scheduled around-the-world route.34

 Los Angeles Times, Los Angeles, CA.: Oct 9, 2004.  Gradidge, J. The Douglas DC-1/DC-2/DC-3: The First Seventy Years Volumes One and Two. Tunbridge Wells, Kent, UK: Air-Britain (Historians) Ltd., 2006. 34  U.S. Centennial of Flight Commission, 2010. 32 33

1.3  North America

19

Douglas would continue to work on military cargo transports during the late 1940s and 1950s, developing the C-124 and C-133 transport planes. In 1953, Douglas developed the last of its propeller-driven passenger aircraft, the DC-7. Despite being a propeller aircraft, the DC-7 delivered quite amazing speed and range for its time. The DC-7 could carry up to 110 passengers and had a range of over 5000 miles at speeds of up to 400 mph (DC-7 Commercial Transport, 2009). At this time, however, the jet age was just beginning, and Douglas entered the jet age with the production of the DC-8 in 1958. Produced about a year after the Boeing 707, the DC-8 was built to compete with its main rival and offered similar size and speed. Douglas continually offered new improvements to the DC-8 from the original Series 10 all the way up to the Series 60. The Series 60 would offer increased range and a stretched fuselage capable of seating up to 260 passengers (DC-8 Commercial Transport, 2009). An interesting note on the DC-8 is that United Airlines was, just as for the DC-6, one of the launch customers for the aircraft. United Airlines used to be part of the Boeing Co. before the government broke the company up, so in some sense, the strength of the Douglas airplanes at that time is reflected by the fact that United chose Douglas over Boeing aircraft. Back in the 1960s, global airlines could choose mainline products from Convair, Douglas, deHavilland, Vickers, Dassault, Lockheed, Sud-Aviation, and Boeing, all of which had jet airliners on the market.35 The next major event for the commercial transport industry was the introduction of the DC-9 in 1965 by Douglas Aircraft Company. The DC-9 essentially was the catalyst for the 100+ passenger twin-jet single-aisle jetliners that include the 737 family, A320 family, and MD-80/90/95. The DC-9, and its successor MD-80, would prove to be a very reliable aircraft, with many still in service over 40 years later. Delta Airlines still has a sizeable fleet of 53 DC-9s in service today.36 The early success of the DC-8 and DC-9 in the 1950s and 1960s would allow Douglas to become an attractive target for a merger. In 1967 Douglas Co. merged with aerospace and defense manufacturer McDonnell to form the McDonnell Douglas Corp. (“Heritage of Innovation,” 2009). The combined company would continue to be a force in both the commercial aviation and defense aircraft sectors. The C-9A Nightingale was a perfect example of the tradition of using aircraft designs for both commercial and military purposes. The C-9A was a version of the DC-9, which the military used as a transport for sick and wounded soldiers during the Vietnam War (“Heritage of Innovation,” 2009). McDonnell Douglas would continue this tradition with the DC-10. The Boeing Company announced yesterday that it planned to acquire the McDonnell Douglas Corporation in a $13.3 billion deal, the 10th-largest merger in American history and the largest ever in the aerospace industry. The acquisition would make Boeing the only manufacturer of commercial jets in the United States while catapulting it ahead of the Lockheed Martin Corporation as the world’s largest aerospace company. The New York Times, December. 16, 1996 35 36

 Forbes. Nov 26, 2018.  Delta Airlines Inc., 2010.

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The DC-10 became McDonnell Douglas’s first attempt to enter into the “Jumbo Jet” segment of commercial aircraft. Entering into service in 1971 with United and American Airlines, the DC-10’s entry was not without problems. As with any large object with hundreds of movable parts that need to work in order for the object to function properly, mechanical failures were a part of the DC-10’s early years. In 1972 a cargo door blew off of an American Airlines DC-10 after takeoff from Detroit. Luckily, there were no fatalities in the incident; however, modifications to the design of the cargo door were needed. Other incidents with the DC-10 would not prove so fortunate. In two separate instances, engines—or parts thereof—were ripped from the wings of DC-10s; a National Airlines DC-10 successfully made an emergency landing in Albuquerque in 1973, while an American Airlines DC-10 crashed in Chicago in 1979, killing 273 people. These events led to the grounding of the aircraft by the FAA. While the ultimate cause of the crash was determined to be faulty procedures by airline maintenance personnel, the crash demonstrated the DC-10’s vulnerability to hydraulic failure. Hydraulic lines on the DC-10 are placed close to the engines; these hydraulic lines control the flight surfaces of the wing (slats, flaps, and ailerons). In these incidents, the separation of the engines from the wing destroyed hydraulic lines and caused the aircraft to involuntarily retract the left slats. McDonnell Douglas had to make design changes to the slats system to prevent this type of accident from occurring in the future, and the aircraft was ultimately allowed back into service by the FAA. Despite its early failures, the DC-10 was still selected by the Air Force as an advanced aerial tanker and cargo transport aircraft (“Heritage of Innovation,” 2009). The U.S. Air Force would eventually purchase 60 of these aircraft for its fleet, and both the DC-10 and KC-10 would continue to be produced up until the last aircraft was delivered in 1990. In 1982, McDonnell Douglas decided that all new aircraft models would have the designation MD instead of the previous designator DC. The first model to carry this designator was the MD-80, previously known during its development and early deliveries as the DC-9 Series 80. The MD-80 featured a much longer fuselage than its predecessor but retained many of the same features, such as the 2 × 3 (or 3 × 2) seating. The 2-by-3 seating was preferred by many passengers to the 3-by-3 seating of its competitors, the 737 and A320, because there was only one middle seat per row. The popularity of the MD-80 with passengers led to its popularity with airlines; nearly 1200 MD-80s were delivered during the aircraft’s 19-year production run (“MD-80 and MD-90 Commercial Transports,” 2009). In 1995, McDonnell Douglas modernized the MD-80 with a new version dubbed the MD-90 and MD-95. The MD-90 series would feature an all-new modernized cockpit, which included electronic flight instruments and LED lights that showed crucial systems data on the aircraft’s engines (“MD-80 and MD-90 Commercial Transports,” 2009). The MD-90 was designed to capture the same market as the MD-80, seating between 140 and 150 passengers. The MD-95, which later became the Boeing 717, was designed to replace the DC-9-30 series, which held approximately 100-115 passengers (“MD-80 and MD-90 Commercial Transports,” 2009). After Boeing’s acquisition of McDonnell Douglas in 1997, production of the MD-80 and MD-90 slowed down and eventually ceased after all outstanding customer orders were fulfilled.

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21

McDonnell Douglas produced one other commercial aircraft during the 1990s before being acquired by Boeing. The MD-11 went into production in 1990 in three different versions: passenger, combi, and freighter as a replacement for the DC-10.37 The first MD-11 was delivered to Finnair on December 7, 1990. The MD-11 had a longer fuselage for extra capacity and included new features, such as winglets, that would help to increase range and reduce fuel consumption (“MD-11 Commercial Transport,” 2009). The winglets were a compromise between airlines and McDonnell Douglas between the inefficiencies of the current wing of the DC-10 and the cost to McDonnell Douglas to design an entirely new wing (Badrocke & Guston, 1999). The aircraft is a wide-body airliner, with two engines mounted on under-wing pylons and a third engine at the base of the vertical stabilizer.38 While the aircraft was never very popular with airlines (only 200 were sold during its 10-year production run), the aircraft was popular with some cargo operators as a freighter. FedEx, UPS, and Lufthansa Cargo are the largest current operators of MD-11s (“MD-11 Commercial Transport,” 2009). McDonnell Douglas initially estimated that it would sell more than 300 aircraft, but only a total of 200 planes were sold. The last MD-11 ever built in 2001 marked the end of McDonnell Douglas commercial aircraft production.39 Despite shutting down McDonnell Douglas’s commercial division, Boeing continued to produce many of McDonnell Douglas’s military aircraft, including F/A-18 Hornet and Super Hornet and C-17 transport planes (“Heritage of Innovation,” 2009) (Figure 1.4 and Table 1.3).

1.3.3 Lockheed Corporation The Lockheed Aircraft Corporation, now the Lockheed Martin Corporation, began with two brothers who wanted to fly in 1912. In a sense, the story of Allan and Malcolm Loughead (the last name later changed to Lockheed) parallels the story of the Wright Brothers and William Boeing. Enamored with flying, the Lockheed brothers began their foray into aviation by building a two-seat flying boat and selling rides during the Panama-Pacific International Exposition in the 1910s (“Civil aircraft today: The world’s most successful commercial aircraft: 1903–2003,” 2004). Ultimately unsuccessful in the late 1910s and early 1920s to get customers for their single-seat bi-plane, the brothers went their separate ways and closed down what was then Lockheed Aircraft in 1921.40 Eventually, Allan Lockheed would team up with famous aviation businessman Jack Northrop to form the Lockheed Aircraft Corporation and return to building aircraft with the introduction of the Lockheed Vega. Despite the fame of the Vega—it was used by aviators like Amelia Earhart on her two record-breaking flights across the Atlantic in 1932 and Wiley Post for his high-altitude record-breaker in 1934 at 50,000 feet—the Vega’s notoriety was not  Airways online, September/October 1997.  Steffen, A., McDonnell Douglas MD-11: A Long Beach Swansong. Midland, January 2002. 39  Boeing Announces Phase-Out of MD-11 Jetliner Program, Seattle, June 3, 1998. 40  World War II-Lockheed Burbank Aircraft Plant Camouflage. Amazing Posts. August 16, 2008. 37 38

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DC-2

DC-2

DC-3

DC-3

DC-6

DC-6

DC-8

DC-8

DC-9

DC-9

DC-10

DC-10

MD 11

MD 11

MD 80

MD 80

MD 90 1925

MD 90 1935

1945

1955

1965

1975

1985

1995

2005

Figure 1.4  McDonnell Douglas commercial aircraft. (Source: Compiled by the authors from Boeing & McDonnell Douglas aircraft data)

Table 1.3  McDonnell Douglas commercial aircraft data Aircraft model DC-2 DC-3 DC-6 DC-8 DC-9 DC-10 MD 11 MD 80 MD 90

Launch customer TWA US Army US Army Delta/ United Airlines Delta American Airlines Finnair Swiss Air Delta

Produced 156 16,079 704 556 976 386 200 1191 116

Source: Compiled by the authors from Boeing & McDonell Douglas commercial orders & deliveries *As of April 2021

enough to keep the company afloat; Lockheed Aircraft went into bankruptcy a couple of years later. The company was sold to investor Robert Gross, but Allan Lockheed would keep an informal relationship with the company for many years (“Civil aircraft today: The world’s most successful commercial aircraft: 1903–2003,” 2004). After the company was purchased by Gross, Lockheed began the development of the 10-passenger Electra. The Model 10 Electra featured a unique twin-­fin and

1.3  North America

23

rudder design that was the result of wind tunnel testing of the prototype.41 Lockheed produced two different versions of the aircraft. The one was a single-tail four-engine turboprop-powered by Allison. The military had a version of that airplane they called the P3 Orion, which was used as a submarine hunter. There were 148 Electra built between 1934 and 1941, including five different military versions of the aircraft. The Electra is most famous for being the aircraft that Amelia Earhart attempted to pilot around the world before presumably crashing in the Pacific Ocean. The company’s next foray into commercial aircraft came at the request of the famous aviator and TWA majority owner, Howard Hughes. Hughes wanted an airplane with superior speed and range for transcontinental flights comparable to the Boeing 307 Stratoliner the airline was flying at the time.42 Lockheed kept the project secret until World War II when the military version of the plane, the C-69, was pressed into service (“Civil aircraft today: The world’s most successful commercial aircraft: 1903–2003,” 2004). After World War II, the passenger version of the plane, the Constellation, entered passenger service with TWA in 1945. The Constellation and an eventual longer-range version, the Super Constellation, were incredibly advanced for their time—they reached top speeds of 340 miles per hour and, thanks to a pressurized cabin, an altitude ceiling of 35,000 feet (“Civil aircraft today: The world’s most successful commercial aircraft: 1903–2003,” 2004).

1.3.3.1 A Perfect Storm for Lockheed Trouble struck Lockheed’s TriStar just after the first of the 300-passenger jets rolled off the Palmdale, Calif, assembly line. Production temporarily stopped in February 1971, when Britain’s Rolls-Royce, the prime engine supplier, went bankrupt. The British government took over Rolls-Royce’s aero-engine division, but demanded proof that Lockheed was financially sound before providing the equipment. Lockheed was indeed in trouble, but Congress approved a controversial $250 million loan guarantee for the company. The first TriStar was delivered to Eastern Air Lines in April 1972, about six months later than scheduled. The delays and uncertainties caused by the Rolls-Royce bankruptcy gave Boeing and McDonnell Douglas an additional competitive lead in the wide-bodied market. Lockheed was never able to make up that disadvantage, even though airlines found the TriStar plane reliable and efficient. The largest TriStar customer was Delta Air Lines, which operates 35 of the 220 now in service, and is buying three of the remaining 24 on firm order. —John Greenwald, Jerry Hannifin, Joseph Kane “Catch a Falling TriStar”, Dec. 1981

Lockheed would stay out of the commercial jet revolution for a while. Lockheed had no plans to build a commercial jet aircraft until American Airlines approached aircraft manufacturers, including Lockheed, with the request that a high-capacity, medium-range jet be built (“Civil aircraft today: The world’s most successful commercial aircraft: 1903–2003,” 2004). It was evident from the very beginning that Douglas and Lockheed would be in competition with each other as they were both developing essentially the same aircraft.43 Like the DC-10, the Lockheed L-1011  Electra. Pima Air & Space Museum. Retrieved April 1, 2021.  The Boeing Model 307 Stratoliner was the world’s first high-altitude commercial transport and the four-engine airliner in scheduled domestic service. 43  Beyond the Horizons: The Lockheed Story. St. Martin’s Press: New York, 1998. 41 42

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would be a tri-jet capable of carrying up to around 300 passengers. Also, like the DC-10, the L-1011 ran into engine troubles—Rolls Royce developed an entirely new engine for the L-1011, and the newly designed engine suffered from reliability problems during testing. Receiving federal loan guarantees from their respective governments, Lockheed and Rolls-Royce44 finally continued work on the L-1011, and a suitable engine, the RB211-22B, was developed.45 However, by this point, it was too late; American Airlines had already chosen the DC-10 due to its earlier date of service entry (“Civil aircraft today: The world’s most successful commercial aircraft: 1903–2003,” 2004). Although the L-1011 received early orders from Eastern and Delta Air Lines, the DC-10 proved to be more popular with airlines than the L-1011. Even with all of its problems, the DC-10’s popularity came down to range and timing (Sedaei, 2006). Douglas had a long-­range version of the DC-10 (the DC-10-30) almost immediately after introducing the basic model. Lockheed waited until 1978, 8 years after the L-1011 went into service, before developing a longrange version that could compete directly with the DC-10-30.46 In some sense, the L-1011’s production came as a perfect storm for Lockheed. The project ran into problems from the outset because of a redesign, as the L-1011 was conceived as a twin-engine design and later had to be revised into a threeengine model (Eden, 2008). Further, the project ran into cost overruns associated with the Galaxy C-5 government contract. The development of the C-5 was undergoing teething problems like critical wing weakness and production slippage. Additionally, the bankruptcy and nationalization of Rolls-Royce in 1971 led to further production delays, and by the time the L-1011 was eventually delivered, most of the 144 orders that were to drive the program into profitability had been lost to the DC-10. Once the choice of aircraft has been made, the switching cost for most airlines in terms of fleet planning is too high, and the L-1011 found itself at a distinct disadvantage. Further, the original L-1011 had a substandard performance in hot and high elevation environments and had a significantly truncated range compared to the DC-10. By the time Lockheed had designed a long-range version of the L-1011, the L-1011-500, the DC-10 was already well established among airlines that were reluctant to switch. Add to this the softening of the economy in the 1970s, and Lockheed found itself in dire straits. The L-1011 program eventually collapsed.47 Lockheed needed to sell 500 planes to break even, but in 1981, Lockheed announced production would end with only 250 aircraft delivered by 1984.48 The collapse of the L-1011 program led to Lockheed’s exit from the commercial aircraft manufacturing business, at which point Lockheed decided to focus exclusively on military aircraft, an area in which it had a comparative advantage. Lockheed continued to refine and progress in the development of the C-5, which is  Rolls-Royce went bankrupt while developing the engines for Lockheed’s L1011; Lockheed officials persuaded the British government to take over Rolls-Royce and continue the engine production. 45  The Washington Post, Washington, D.C.: Jul 7, 1987. 46  An unusual aircraft, it had a center landing gear in addition to the tricycle gear. 47  Sumter Daily Item. 8 December 1981. 48  Saddened Lockheed workers still view L-1011 with pride. Los Angeles Times. December 8, 1981. 44

1.4  Western Europe Aircraft Companies: Evolution and Constellation

25

one of the cornerstones of the U.S. Military to this day. Through a series of strategic acquisitions and internal development, Lockheed created an impressive product portfolio, including the legendary F-16, more than 4300 of which have been produced and used by governments throughout the world, the F-35 Lightning II, the F-22 Raptor, and the C-130 Hercules. The majority of Lockheed Martin’s business is with U.S. federal government agencies. In addition, the company provides military and rotary-wing aircraft to all five branches of the U.S. armed forces along with military services and commercial operators in other countries. We would be remiss in this discussion of Lockheed to ignore one of the greatest aviation accomplishments of the twentieth century. The SR-71 Blackbird was not only a revolutionary new technology for the U.S. Air Force, but it shattered every existing speed record known to aviation. The SR-71 first flew in 1964 and was the first aircraft that was able to sustain speeds above Mach 3 (SR-71 Blackbird). In addition, the Blackbird flew at altitudes of over 85,000 feet, unheard of at the time it entered service with the Air Force. From its first operations in 1966, the SR-71 proved to be a valuable tool in reconnaissance until its retirement nearly 25 years later. Today, civilians can enjoy the SR-71 on display at the Udvar-Hazy Center near Washington Dulles International Airport. The Lockheed Martin Corporation is one of the leading defense companies in the United States today. With many contracts with the U.S. and other governments, Lockheed Martin should be able to withstand any fluctuations in the aviation industry and the economy in general (unless defense spending is drastically cut). In fact, Lockheed Martin performed exceptionally well in 2010. Lockheed Martin’s annual revenue for 2019 was $65.398 billion, an 9.3% increase from 2019, and with a market cap as of March 30, 2021, is $102.16B (Figure 1.5 and Table 1.4).

1.4

 estern Europe Aircraft Companies: Evolution W and Constellation

Airbus and Boeing are in continuous competition to be the world’s leading commercial aircraft manufacturers. In 2003, Airbus became the market share leader delivering 52% of all commercial airplanes that year. Airbus’s recent success in surpassing Boeing shows just how far the company has come in its 40-year history. It should be noted that Airbus had the luxury of learning from the mistakes and products of a well-established Boeing company. Airbus’s dramatic history and competitive edge are attributable to the introduction of advanced materials and technology in its aircraft, including automating the flight engineer role common to Boeing aircraft at the time. Like in North America, the aircraft manufacturing industry in Europe has been characterized by several small manufacturers that have consolidated or gone out of business in the past 60 years. Airbus S.A.S. has emerged as the single largest aircraft manufacturer in Europe, while other companies (e.g., Fokker) had their commercial aircraft business go bankrupt or turned their focus to military contracts. Figure 1.6 shows Airbus and Boeing deliveries since 1980. Both companies delivered 723 jets during 2020, down a staggering 42% from 2019. Airbus received

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Model 10 Electra

Model 10 Electra

Model 14 Super Electra Martin M-130

Model 14 Super Electra

Martin M-130

L-049 Constellation

L-049 Constellation L-188 Electra

L-188 Electra

L-1011 TriStar 1930

L-1011 TriStar 1940

1950

1960

1970

1980

1990

Figure 1.5  Lockheed commercial aircraft. (Source: Compiled by the authors from Lockheed aircraft data (updated 2021)) Table 1.4  Lockheed commercial aircraft Aircraft model Model 10 Electra Model 14 Super Electra Martin M-130 L-049 Constellation L-188 Electra L-1011 TriStar

Launch customer Pan Am Northwest Airlines Pan Am Pan Am American Airlines Eastern Airlines

Produced 149 354 3 74 170 250

Source: Compiled by the authors from Lockheed aircraft data *As of April 2021

383 of those in 2020, with 115 jets cancellation with only 268 net new orders in 2020, 65% fewer than received 1 year earlier. Boeing customers canceled more than 650 planes last year (that is 2020).

1.4.1 Airbus Industries Airbus is a relatively new company.49 In 1967 ministers from the French, British, and German governments came together to develop a joint aviation technology company that would bring together the aviation expertise of each country. The British and French had previously worked together on the Concorde program, a  Airbus Industrie started as a consortium supported by the British, French, German and Spanish governments.

49

1.4  Western Europe Aircraft Companies: Evolution and Constellation 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 1,750

1,250

750

250

Boeing gross orders

250

750

27

1,250

1,750

Airbus gross orders

Figure 1.6  Airbus and Boeing market shares. (Source: Compiled by the authors from Airbus and Boeing delivery data (as of January 2021))

supersonic passenger jet. The three founding nations, and later the Dutch and the Spanish, each would be assigned different components of the proposed twin-engine passenger jet to manufacture. By having each country be responsible for different parts of the aircraft, the idea was that each country could focus on its respective engineering and manufacturing comparative advantages and collaboratively develop the “best” possible airplane. In a slight variance to traditional M&A and internal development strategy, Airbus, in October 2017 has entered into a partnership with Bombardier on the CSeries with a 50.01% stake, with Bombardier retaining 31% and Investment Québec 19%.50 In mid-2018, Bombardier of Canada transferred its promising new CSeries jet airliner program to Airbus. The aircraft has since been rebranded as the A220-300 and A220-600. Following the sale of its Q400 turboprop aircraft to Viking Air and of its CRJ regional jets to Mitsubishi Heavy Industries, the deal forces Bombardier’s exit from commercial jet aviation.51

1.4.1.1 Airbus 300 However, the project was not without setbacks. The first problem that the proposed wide-bodied twin-engine passenger jet ran into was the lack of a suitable engine. Airbus believed it had an agreement with Rolls-Royce to develop an engine, the RB207, for the plane now known as the Airbus A300. As time passed, however,  www.bombardier.com/en/media/newsList/details.binc-20171016-airbus-and-bombardierannounce-c-series-partnershi.bombardiercom.html 51  Forbes. Airbus Buys Bombardier Out Of Commercial Aviation for $591 Million. February, 13, 2020. 50

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Rolls-­Royce found itself stretched for resources and focused all its effort on the RB211 for the U.S. market, eventually signing an exclusivity deal with Lockheed for the RB211’s use on the L-1011. Airbus had to find a replacement engine. Airbus decided to buy the engine “off the shelf” and, in the process, made the development costs of the A300 more manageable. Additionally, Airbus had to modify the size of the aircraft after demand forecasts for air travel in Europe were tapered. Consequently, Airbus reduced the capacity of the aircraft from the original design of 300 passengers down to 250 passengers. Finally, in 1969, Airbus had an aircraft design and engine partner to officially launch the aircraft. The aircraft was named the A300B, used the GE CF6-50A engine, seated 250 passengers, and had a range of 1200 nautical miles. One of the A300-600 and A310’s notable innovations had been the introduction of electrical signaling on secondary flight controls, replacing the maze of cables and pulleys customarily used.52 In place of the pilots’ control column would be a simple sidestick control. The side-stick is used in many modern military fighter aircraft, such as the F-16 Fighting Falcon, F-22 Raptor, and also on civil aircraft, such as the Sukhoi Superjet 100, and all Airbus aircraft. “Another advantage of Airbus commonality is a pilot’s ability to be current on more than one Airbus fly-by-wire aircraft type at a time. This is known as Mixed Fleet Flying, and enables a properly rated pilot to switch from A330 wide-body operations to single-aisle flights at the controls of the A320 Family. Allowing operations by a common pool of pilots, Mixed Fleet Flying opens new crew scheduling possibilities and provides a mix of flying opportunities that are highly appreciated by pilots.” Source: Airbus Company Report Despite gathering information and input from potential customers prior to the launch of the aircraft, Airbus was still without an order for the A300B in 1970. The company seemed doomed to fail. Without an order, Airbus had to go back to the drawing board and modify the aircraft. Air France worked with Airbus to develop an airplane that would meet Air France’s specifications. The plane would be stretched to seat 270 passengers and was ordered by Air France in September of 1970. Later in 1970, Airbus S.A.S. would officially be recognized as a consortium with equal controlling shares by French and German companies. Two years later, in October 1972, Airbus made their first flight of the new version of the aircraft, which was called the A300B2. The aircraft would later go into service with Air France in May 1974. Airbus would later add the A300B4 to the A300 family line; the—B4 added additional range at the urging of airlines due to the relatively short range of the original model. Despite making these modifications, the A300 was on the verge of failure largely because of economic factors in conjunction with a nascent company 52

 Fly-by-wire (1980–1987). Airbus, 2021.

1.4  Western Europe Aircraft Companies: Evolution and Constellation

29

that was just beginning to emerge with a viable product portfolio. Over a period of 18 months during the 1970s oil crisis, the A300 failed to receive a single order. If Airbus was to survive as a commercial airplane manufacturer, something drastic had to happen. That drastic occurrence was an unusual lease agreement that Airbus offered to Eastern Airlines, a major U.S. carrier. Airbus allowed Eastern to lease four A300s over a 6-month period at no charge; if Eastern did not like the aircraft at the end of 6 months, they could return the aircraft to Airbus. This highly innovative program essentially gambled the company on a 6-month trial period with one potentially major customer, but it paid off. Eastern Airlines was so impressed by the performance of the aircraft that at the end of the trial period in 1978, they ordered 23 of the longer-range A300B4s. The enthusiastic response from Eastern Airlines to the A300 paved the way for Airbus to eventually grow from a company struggling to stay in business to a company that would eventually pass Boeing as the commercial aircraft market share leader much further down the road. Despite the struggles to sell just one model of aircraft, Airbus executives knew that Airbus’s success would hinge on offering an entire family with modifications according to customer needs. By having various models and sizes of aircraft, Airbus could transfer technology between models and take advantage of the reduced learning curve associated with developing multiple products based on existing technology and processes. Airbus took the lessons learned from the A300 to develop a derivative model, the A310. The A310 was a shortened, longer-range version of the A300 and incorporated all of the high-performance features of the A300 while adding new technology such as a composite tail fin, which reduced the weight of the aircraft by nearly 250 pounds and enhanced performance. Due to the impressive performance of the A300B4 model, the A300 and A310 became the first family of twin-engine aircraft to become ETOPS (Extended-Range Twin Operations)-certified.53

1.4.1.2 Airbus 320 Technological advances would continue to be at the forefront of Airbus’s rise to the top of the commercial aviation market. The first Airbus entered into the narrowbody market was equipped with the “fly-by-wire” (FBW) technology.54 The main feature of Airbus’s FBW system is that a computer controls the flight control services by responding to pilot inputs on a side stick and replaces the traditional control column. The side-stick technology debuted on commercial aircraft when the A320 rolled out in 1987 to the excitement of many in the aviation community. Since then, the A320 family of aircraft, which includes the A318 through A321, has grown to over 3100 aircraft worldwide and is widely regarded as one of the most popular families of aircraft ever produced. The A320 Family is comfortably seating from  U.S.  Department of Transportation Federal Aviation Administration, Advisory Circular, AC:120-42B, June 13, 2008. 54  Dominique Brière, Christian Favre, Pascal Traverse, Electrical Flight Controls, From Airbus A320/330/340 to Future Military Transport Aircraft: A Family of Fault-Tolerant Systems, chapter 12 du Avionics Handbook, Cary Spitzer ed., CRC Press 2001, ISBN 0-8493-8348-X. 53

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120 to 244 passengers. The aircraft allows airlines to match the right aircraft size to demand, covering the entire market, from low to high density markets. In the narrow body segment, only the A320 Family does offer containerized cargo, increasing the airlines’ profitability. As the A320 was making its first flight, Airbus was working on new wide-body aircraft. To capture the expanding demand for air travel and replace older aircraft, Airbus created the twin-engine A330 and four-engine A340. These two wide-bodies would feature a newly designed wing that would be thicker than previous wings and have a greater aspect ratio, allowing for reduced drag and increased aerodynamic efficiency (Gunston, 1988). Another major feature of the A330 and A340 was the degree of cross-commonality among the two wide-bodies and the A320. Crosscommonality allowed pilots who were type-rated in one of the three Airbus models to earn the type rating for the other models with very little additional training. This cross-commonality allowed greater flexibility for airlines in scheduling airplanes and pilots.55 Airbus delivered 9572 A320 aircraft to more than 330 airlines around the world, with 9053 aircraft in service as of October 2020.

1.4.1.3 Airbus 340 and Airbus 350 The A340 is a long-range, wide-body commercial passenger jet airliner that was developed and manufactured by the Airbus Company. In the mid-1970s, Airbus conceived several derivatives of the A300, its first airliner, and developed the A340 four-engine in parallel with the A330 twinjet. There are four variants in Airbus’ A340 Family: the A340-200, A340-300, A340-500 and A340-600 (Airbus, Airbus 340, 2021). The first flight of the A340 was on 21 October 1991 and on February 2, 1993, and the first A340-200 was delivered to Lufthansa.56 On March 15 of the same year, it entered into service. The A340-600 is the largest-capacity member of the A340 Family. With a seating capacity between 320 and 370 passengers in a typical three-class layout or 475 in high-density seating capacity. A330-200 can carry 246 passengers in two classes to a range of 7250 nautical miles. • A340-500 can carry 293 passengers in three classes to a range of 9000 nautical miles Lufthansa became the launch customer for the Airbus A340 200, on 02 February 1993. The aircraft entered service on 15 March 1993. There were 4 variants of the A340 (A340-200, A340-300, A340-500 and A340-600), with the main difference being fuselage length. • A330-300 can carry 300 passengers in two classes to a range of 6350 nautical miles • A340-200 can carry 303 passengers in two classes to a range of 7600 nautical miles  The Airbus-Boeing subsidy row, the Economist. March 23, 2005.  Norris, Guy; Wagner, Mark (2001). Airbus A340 and A330. St. Paul, Minnesota: MBI Publishing. ISBN 0-7603-0889-6.

55 56

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• A340-300, 335 passengers in two classes to 7150 nautical miles • A340-600, 380 passengers in three classes to a range of 7550 nautical miles • A380-800, 544-passengers in three classes to a range of 9444 nautical miles The fuselage of the A330 and A340 is based on a stretched A300 fuselage. The dawn of the fuel price hikes in 2008 ensured that the A340 was doomed to fail. On 10 November 2011, Airbus announced that it is ceasing production of this aircraft because it could no longer compete against the twin-engine Boeing 777. Airbus delivered 377 A340 to the customers. The A350 was designed to succeed the A340 and to compete with the Boeing 787 and 777. The aircraft was the first Airbus aircraft with both fuselage and wing structures made primarily of carbon fiber reinforced polymer. In December 2006, the Airbus board of directors approved the industrial launch of the A350-800, -900, and -1000 variants. Airbus continued to work on developing new aircraft, including the A350 XWB or extra wide-body, a new wide-body designed to compete with Boeing’s 787. The aircraft was designed to replace the A340 family of aircraft in the segmentation with its commitment to developing new technology; Airbus will continue to be a very strong player in the commercial aircraft manufacturing industry for years to come. The A350-900 variant aircraft was launched on January 15, 2010, to Qatar Airways, and subsequently, the more stretched A350-1000 variant of the aircraft was launched on February 24, 2018, also with Qatar Airways. Airbus is now focusing on new developments to the narrow-body segment with re-engineering the A320 family to create the A320neo, which offers up to a 15% fuel savings with respect to comparable aircraft. The aircraft is an update of Airbus’s wildly popular narrow-body aircraft line designed to increase fuel efficiency, range or capacity and decrease noise and other environmental concerns. This was formally launched on December 1, 2010, with two enhanced engine options Pratt & Whitney PW1000G and CFM LEAP-1A. There are three variants based on the A319, A320 and A321 models. Expansion of the family came with the development of longerrange variants of the A321neo, which are called the A321LR and the A321XLR variants. The A321LR concept was launched in October 2014 and formally delivered to launch customer Arkia of Israel on November 13, 2018. Extending the range even further to almost 5000 nm, the A321XLR concept was launched at the Paris Airshow in June 2019, with first deliveries expected in 2023. In addition to redesigning the narrow-body, Airbus is also producing a redesigned wide-body in the A330neo, which was launched in 2014. This launch was following the demand by existing A330ceo owners wanting a more efficient aircraft faced with competition from the Boeing 787-8. This is re-engine wide-body based on the existing -200 and -300 variants would mean that -800 and -900 neo variants would be more fuel-efficient than their predecessors. The first -800 aircraft was delivered to TAP Air Portugal in November 2018, with the -900 expected to be delivered in 2020.

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1.4.1.4 Airbus A380 The 1990s brought additional derivatives of the A320 and A340 families, expanding the Airbus family from anywhere from 100 seats to 380 seats. Consequently, the number 380 would inspire the next Airbus project, the A380 “super-jumbo” aircraft. In 1996 Airbus would begin plans to develop its own very large airliner, then designated as A3XX (Now the A380), a double-decker passenger aircraft that holds approximately 600 people, to compete in the long haul highly trafficked intercontinental routes.57 It would compete in a class above the Boeing 747. Airbus would have to overcome many challenges and obstacles in the design and performance of such a large aircraft. One of those design challenges was to develop an aircraft that would be acceptable to airports around the world. The aircraft would weigh over 380 tons, and Airbus had to develop a landing gear configuration that would support that weight without crushing the runway underneath (Aris, 2004). Another issue in the design of the A380 was the method of evacuation of the aircraft in the event of an emergency. Airbus had to develop an escape mechanism that would allow passengers to safely exit from the A380’s 27-foot high second deck (Aris, 2004). After 4 years in the design and planning stages working through many issues, the A380 was officially launched in December 2000. The break-even for the A380 was initially supposed to be at 270 units, but due to technical problems, delays and the falling exchange rate of the US dollar, it had increased to 420 units.58 The challenge to Airbus after the launch of the A380 was to convince airlines to buy the aircraft. Airbus needed to communicate that despite the increase in weight over the 747, the A380’s Cost per Available Seat Mile (CASM) would be lower due to the aircraft’s greater capacity (Aris, 2004). In addition to selling the aircraft’s cost advantages, Airbus also used the capacity of the A380 to offer other unique selling points. The large interior of the A380 was marketed as a space that could install anything from sleeping quarters to saunas in the airplane, making the travel experience more like a cruise ship than an airliner (Aris, 2004). Airbus’s marketing team was successful in convincing Maurice Flanagan, one of the founders of Emirates Airlines, in purchasing the aircraft. “We decided fairly quickly that the A380 was the aircraft that we wanted. Not because we wanted to put gymnasia or saunas in there. It’s not there for that: it’s there for people.” (Aris, 2004). The year 2000 saw not only the launch of the A380 but also a new owner for Airbus. Airbus was now controlled by EADS (European Aeronautic Defense and Space Company), and the name of the company was subsequently changed to Airbus S.A.S. (Societé par Actions Simplifieé).59 EADS was formed in July 2000 as a merger between the French company Aérospatiale-Matra, the German company DASA (DaimlerChrysler Aerospace AG), who had also merged with CASA (Construcciones Aeronáuticas SA) of Spain. The idea behind EADS was to set up a company that would rival Boeing in both the defense and commercial aircraft industries as the premier aerospace manufacturer (Aris, 2004). By achieving the greatest  “Airbus will reveal plan for super-jumbo.”The Independent. June 4, 1994.  Global Investor Forum, Andreas Sperl, Airbus Chief Financial Officer October 19 & 20, 2006. 59  BAE was still a 20% shareholder at this time and sold its stake in Airbus to EADS for good in Oct. 2006. 57 58

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market share of any commercial airplane manufacturer, EADS can certainly lay claim to being the premier manufacturer on the commercial side. However, it remains to be seen whether EADS will become the premier company on the defense side of the aerospace industry.60 In 2004, Airbus reorganized its manufacturing process to coincide with the production of the A380. Airbus set up “centers of excellence” near its manufacturing sites to help improve product quality and production efficiency. In the same year, Airbus opened the A380 final assembly line in Toulouse; this assembly line would quickly roll out the first A380 for its unveiling to the aviation community and the general public. On January 18, 2005, the A380 was displayed at the Toulouse factory for national leaders from Spain, Germany, France, and Great Britain, as well as over 5000 guests and reporters. The first aircraft delivered was handed over to Singapore Airlines and entered into service on the 25th of October, 2007, with an inaugural flight between Singapore and Sydney.61 The A380 has since taken to the skies and serves airlines such as Singapore and Emirates.62 After 240 deliveries to fourteen operators, with the majority of the deliveries and orders going to Emirate airlines, Airbus announced on Feb 14, 2019, that the A380 would be shut down. Before this, there were discussions with Emirates on an expanded version for the A380 new engine options, but this was not elected to go ahead. Some concerns were the market potential as well as the complications from other new aircraft that were launched, such as the A320neo family and A350 family. The last A380 was produced for Emirate Airlines and made its first test flight on March 17, 2021.63 Today, Boeing and Airbus have monopoly power in the global market for commercial jets comprising narrow-body aircraft, wide-body aircraft and jumbo jets. In the period between 2010 and 2019, Boeing received 10,081, and Airbus received 11,911 orders. In 2019, Airbus gained the advantage of the grounding on the Boeing 737 MAX and had an 82% of the market share in sales out of the 18% of sales from Boeing (Figure 1.7 and Table 1.5).

1.4.2 Fokker (1912–1996) The company operated under several different names, starting out in 1912  in Germany, moving to the Netherlands. Fokker’s beginnings started in Amsterdam in 1919 when Anthony H.G.  Fokker established the Netherlands Aircraft Factory Fokker (“The Fokker Heritage 1911–2009,” 2009). That year, the Fokker F.2, an airplane capable of carrying four passengers, was constructed and cruised at 100 miles per hour. The F.2 was the predecessor to the F.7 Trimotor that was extremely popular with both airlines and prominent aviators such as Charles Lindbergh. KLM Airlines used the Trimotor for the longest aircraft route at that time between the  Hoover’s Company Information, 2010.  Wallace, James, Airbus all in on need for jumbo – but Boeing still doubtful. Seattle PI., October 24, 2007 62  Nineteen A380s have been delivered to airlines as of As of December 2019. 63  O’Hare, M. (March 18, 2021) The final Airbus A380 superjumbo makes its first flight, CNN. 60 61

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A300

A300

A310

A310

A318

A318

A319

A319

A320

A320

A320 NEO

A320 NEO

A321

A321

A321 NEO

A321 NEO

A330

A330

A340

A340

A350

A350

A380 1970

A380 1980

1990

2000

2010

2020

Figure 1.7  Airbus commercial aircraft. (Source: Compiled by the authors from Airbus production data (as of April 2021)) Table 1.5  Airbus commercial aircraft Aircraft model A220-100 A220-300 A300 A310 A318 ceo A319 ceo A319 neo A320 ceo A320 neo A321 ceo A321 neo A330-200 A330-200F A330-300 A330-900 A340 200/300 A340 500/600 A350-900 A350-1000 A380

Launch customer Swiss Global Air Lines airBaltic Air France Swissair Frontier Airlines Swissair Spirit Air Inter Lufthansa Lufthansa Virgin America Air Inter ILFC Air Inter TAP Air Lufthansa Emirate Qatar Airways Qatar Airways Singapore Airlines

Produced* 47 96 239 69 67 1434 1 4403 748 1724 224 613 38 753 29 138 112 280 32 237

Source: Compiled by the authors from Airbus commercial orders & deliveries *As of April 2021

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Netherlands and the East Indies (“The Fokker Heritage 1911–2009,” 2009). By 1934, Fokker had begun to concentrate on military aircraft production, including the T.9 bomber, the first Fokker plane built entirely out of metal. Anthony Fokker later died in 1939, but his company lived on for many years after his death. During World War II, the Fokker aircraft factory in Amsterdam was destroyed, and production came to a halt. Finally, in 1951, the Fokker Company was back on its feet through the construction of a new factory next to Schiphol Airport in Amsterdam (“The Fokker Heritage 1911–2009,” 2009). During the 1950s, Fokker concentrated on a return to the commercial airliner market, and in 1958, Fokker developed the F27 Friendship turboprop. The F27 became the world’s best-selling turboprop, with 768 produced and sold to airlines throughout the world (“The Fokker Heritage 1911–2009,” 2009). The F28 was very spacious compared to contemporary aircraft of the same size and considered one of the first regional jets. With seating for 60–70 passengers, the F28 was ideal for routes where turboprops were too small and 100-seat jets were too large. In the 1980s, Fokker decided to modernize their commercial aircraft fleet and offered replacements for the F27 and F28 with the Fokker 50 turboprop and the Fokker 100 jet, respectively. The Fokker 100, as a larger jet than the F28, tried to tap into the 100-seat market that the DC-9 and 737 were so successful at capturing. Some prominent airlines bought the Fokker 100, including American and US Air and Piedmont.64 Piedmont operated the F28-1000 and -4000 (configured to 65 and 85 seats respectively), and US Air operated the F100. It was not until the 1990s that Fokker made a true 70-seat replacement for the F28 (the Fokker 70). However, the market domination of major players like Boeing and Airbus, coupled with the airline crisis of the 1990s, quickly sent the Fokker 70 into an unrecoverable spiral. Eventually, the commercial aircraft division of Fokker Aviation went bankrupt in 1996, and the company was divided into five parts: Fokker Elmo, Fokker Aerostructures, Fokker Services, Fokker Special Products, and Fokker Defense Marketing (“The Fokker Heritage 1911–2009,” 2009). After the bankruptcy of the former aircraft manufacturer Fokker in 1996, Stork B.V. acquired the Fokker companies specialized in the building of aircraft components and aircraft maintenance services, which were named Stork Aerospace. These five divisions were bought out by Stork Aerospace Group, and all of these divisions exist today except for the Fokker Defense Marketing division. Presently, the Fokker Services division assists current Fokker commercial aircraft operators in the day-to-day operations of their fleet and with remarketing and selling used Fokker 50 and Fokker 100 aircraft (“The Fokker Heritage 1911–2009,” 2009) (Figure 1.8 and Table 1.6).

1.5

Russia and Eastern European Countries

Before World War I, the development of aviation in the Russian Empire was mostly driven by military needs. More than 307 different aircraft models had been designed by the end of the war, but only one of them could have been characterized as a 64

 Piedmont Airlines (1948–1989) was absorbed by USAir in 1989.

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F7 Trimotor

F7 Trimotor

F27 Friendship

F27 Friendship

F28

F28

Fokker 50

Fokker 50

Fokker 70

Fokker 70

Fokker 100

1925

Fokker 100

1935

1945

1955

1965

1975

1985

1995

Figure 1.8  Fokker commercial aircraft production. (Source: Compiled by the authors from Fokker aircraft production data)

Table 1.6  Fokker commercial aircraft Aircraft model F7 Trimotor F27 Friendship F28 Fokker 50 Fokker 70 Fokker 100

Launch customer Sabena Aer Lingus Braathens DLT Ford Motor Company Swissair

Produced 230 768 241 213 47 283

Source: Compiled by the authors from Fokker aircraft data *As of April 2021

passenger aircraft. The world’s first four-engine bomber created by Igor Sikorsky performed the first charter flight with passengers on board in July 1914. A month later, Russia went to war, and then it faced the communist coup and civil war. Consequently, regular air services were not resumed until 1921 when three converted Sikorsky “Ilya Muromets” began flying between Moscow and Nizhniy Novgorod. However, the first experiments were not successful, and after only 43 flights, the first airline in Russia ceased all operations. During 2010, 7 aircraft were delivered, including 2 TU-204s, 1 TU-214 and 4 AN-148s.65

65

 Joint Stock Company United Aircraft Corporation 2010 Annual Report.

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1.5.1 The Early Years The first sustainable air service was established by the Soviet-German airline Deruluft in 1921. From then and until the middle of the 1930s, there were several independent airlines in the U.S.S.R.  German Junkers F13, Dornier Merkurs, and Junkers Ju-52/3m were the main types of aircraft in the early years of commercial air services both for domestic and international routes. Gradually, the Soviet models replaced foreign types. The most common aircraft at the time were Tupolev ANT-9 (PS-9), Kalinin K-5, Stal 2/3 and KhAI-1, which had four to nine seats. Slightly fewer than 600 of these aircraft had been produced prior to World War II. Only one larger capacity airplane was utilized by Aeroflot on transport routes in the late 1930s—Tupolev PS-124, which had 64 passenger seats. Besides the mass production aircraft, some experimental or converted military bombers were flying passengers and cargo. In 1932, the Soviet Government made a decision to centralize all of the independent airlines and establish a single national carrier under the name of Aeroflot. In order to ensure its operations, a license to manufacture the Douglas DC-3 was purchased in the United States in 1935. Under the local designations of the PS-84 in 1939 and the military variant, Lisunov Li-2, in 1942, this model was in production until 1952. The total number of these aircraft produced in the U.S.S.R. was 4853; most of them were transferred to the Soviet Air Force in order to run supply lines during World War II. After the unification of all air carriers under Aeroflot’s flag, the Soviet airline industry acquired the shape that is retained for the next 60 years. The sole national carrier was responsible for all possible types of air operations, from crop-dusting to intercontinental passenger service. In addition, the Ministry of Civil Aviation that controlled Aeroflot was also responsible for such things as aircraft repairs, pilot and engineer training, and construction and operation of airports. The production side of the industry was not very centralized. There were quite a few different design bureaus that were engaged in multiple projects–from creating a light biplane to designing heavy bombers or transport aircraft. However, this formally competitive environment did not imply real competition. The customer (the government) had always been the same, and the number of new orders was not based on market perception of the aircraft. The design bureau’s success depended on the art of delicate maneuvering among different group interests in the Soviet government decision-making machine. The situation was even worse for civil aviation projects because military assignments had absolute priority for the Soviet government and, thus, for the design bureaus. Moreover, until the 1960s, every aircraft designed in the Soviet Union had to be tested by the Soviet Air Force before entering service in civil aviation. At that time, the easiest route to serial production was presenting newly designed aircraft as military models and converting them into civilian versions afterward. However, if the Soviet Air Force generals were concerned that the development of a new civil aircraft might jeopardize work on any military aircraft, the order could have been handed over to a competing firm.

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1.5.2 Russian Aircraft Manufacturers To illustrate the common features of the Soviet system, let us use an example of one of the most successful Soviet aircraft, the Antonov An-2. When the An-2 was developed, nobody was interested in this project. The Soviet Air Force believed that there was no need for a slow piston-driven biplane in the upcoming jet era. Aeroflot proclaimed that this aircraft was too small for Aeroflot’s main lines and too large for Aeroflot’s feeder routes. Yakovlev Design Bureau, which employed Oleg Antonov at the time, also did not demonstrate an enthusiasm regarding the aircraft because of its old-fashioned style. In order to push the An-2 into the air, Antonov had to turn for support to the communist party leaders to obtain permission to build an experimental aircraft. However, serial production of the An-2 was in question because every assembly line in the Soviet Union was overloaded with the manufacturing of military aircraft. Again, Antonov had to use his contacts with the top members of the communist party. This time, Nikita Khrushchev, who in a few years would succeed Stalin, helped him. If Khrushchev had not done this, the most long-lived and most-produced Soviet-era aircraft would have never seen the light of the day. However, this design seized its fortune, and in 60 years of production in the U.S.S.R., Poland, and China, more than 18,000 copies of An-2 were produced before the production ended in 1991 (Exhibit 1.3).66 As in the rest of the world, the early postwar decade in the Soviet Union saw the production of the first jet engines in the aviation industry. At the same time, the last piston-driven aircraft entered commercial service in the 1950s. Two Ilyushin67 piston twins were the last main-line piston aircraft in serial production. The aircraft made its maiden flight on August 15, 1945, and about 660 Ilyushin Il-12s were produced in 3 years of production from 1945 to 1948.68 The Ilyushin Il-14, which

Exhibit 1.3  Antonov, An-2 1

 Gordon,Yefim & Komissarov, Dmitry. “Antonov An-2”. Midland. Hinkley. 2004.  The company was founded by Sergey Vladimirovich Ilyushin in the Soviet Union and its operations began on January 13, 1933. 68  Ilyushin Aviation Complex. Dates of Maiden Flights. 66 67

1.5  Russia and Eastern European Countries

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first took off in 1950, was much more successful and was used for mainline operations up until the middle of the 1960s. After that, this 30-seat aircraft was used in polar and Far East operations until the 1980s. The Il-14 was manufactured not only in the Soviet Union but also in East Germany, former Czechoslovakia, and China and the total number produced reached 3500 units. The transfer of Il-14 production to other communist countries was one of the most effective ways to support Soviet-friendly regimes. For East Germany, the production of the Il-14 was an important sign of recovery of lapsed industrial greatness. For East German authorities, it was an excellent piece of propaganda. While capitalists in West Germany were able to make only primitive three-wheeled BMWs, socialists in the east were already producing aircraft. Similarly, Il-14 was the plane of influence in Czechoslovakia—a country that had lost in the war one of the most high-tech economies of that time. Subsequently, the trick with technology transfer would be used more than once—different eastern European allies were producing military and regional aircraft and flying into space onboard Soviet spacecraft. In the 1970s, this was a priceless accomplishment. After phasing out the last generation of piston-driven commercial aircraft, the Soviet Union joined a race with the leader in civil aviation at the time—the United Kingdom. The U.K. was the only country in the world that already had commercial jet aircraft. Using British engines and the work of German engineers, the Soviets designed their own engine that was powerful enough to propel large aircraft. A bomber, the Tupolev Tu-16 that first took off in 1952, was transformed over 2 years into the Tupolev Tu-104, the first passenger jet in the U.S.S.R. and the second passenger jet in the world. Soviet propaganda called it the world’s first passenger jet aircraft in sustainable operations—due to a series of crashes, the British Comet 1 was grounded for several years. The production life of the Tu-104 was very brief. In less than 5 years, about 200 aircraft were produced in several variants that ranged from 60 to 100 seats. The first Soviet experience with commercial jet aircraft was very controversial. Even though the aircraft remained in the fleet of Aeroflot until the end of the 1970s, the Tu-104 had a terrible safety record, low reliability, and high operating costs. Over a third of the Tu-104s produced were lost in accidents, and the only foreign carrier that dared to use this airplane was Czech airline CSA. This somewhat contentious experience with Tu-104 operations led to a delay in the development of new commercial jets. Turboprops were the predominant aircraft type during the 1950s in the Soviet Union. First, as it turned out, one of the most successful attempts to create a turboprop was the design of the Ilyushin Il-18. This four-­engine airplane originally was intended to be used on medium-haul routes but shortly became the backbone of the entire Aeroflot network. The later versions of the Il-18 had ranges of up to 4000 miles and capacities of up to 120 people. The Il-18 was phased out of mainline operations in the late 1970s, and since then, many Il-18s have been converted to freighters. Some of them still fly in Africa and the Far East. Another four-engine turboprop was created at the same time. The Antonov An-10 was similar to the Il-18 in size but had a completely different design and proposed area of operations. It was designed for short-haul routes with the idea of combining

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in one body the strength of a cargo aircraft and the luxury of a first-class rail car. However, neither plush seats nor ceiling fans helped to keep this aircraft in the fleet of Aeroflot. After a series of crashes caused by structural weakness, the An-10 was retired. A different approach to the design of regional turboprops was demonstrated by Antonov a couple of years later. In 1959, the 50-seat An-24 made its maiden flight. The An-24 quickly became a workhorse of regional airlines of Aeroflot and former Soviet Union allies. More than 1300 copies of the An-24 were produced, and a cargo version, the An-26/32, would add 1100 more units to this number. In China, a significantly modernized version of this aircraft, the MA60, is still in production. Another Antonov aircraft, although less successful compared to the An-24, was the An-14, a piston-driven 14-seater for local routes. The An-14 was in far less demand than the An-24. Conceived as a replacement for the An-2, the An-14 was unable to compete with its cheaper and simpler predecessor. The An-14 with piston engines was in production until 1972. More modern versions of the An-14 with turboprop engines are still in production as the An-38 in Russia and as the M-28 “Skytruck” in Poland. After more than 40 years of production, only about 500 airframes have been released. Another passenger turboprop that was designed by Tupolev became the most famous Russian turboprop ever. The 220-seat Tu-114 was equipped with four powerful turboprop engines and was the first Soviet intercontinental airliner. Such an aircraft could appear only in a country that had no competition in its air transport industry but had a lot of strategic bombers. The Tu-114 was the Tu-95 “Bear” strategic bomber with a larger fuselage. Although only 33 of them were ever built, the Tu-114 was utilized until the mid- 1970s on both domestic and international routes of Aeroflot and was especially useful for flights from Moscow to Havana. Models created in the 1950s defined the face of commercial aviation in the U.S.S.R. and, in many ways, the entire Eastern bloc for more than a decade and a half. In the West, propeller-driven commercial aircraft were phased out quickly and retained only on regional routes. In the U.S.S.R., however, turboprops played a crucial role almost until the mid-1970s. Despite the fact that the development of jet aircraft was driven by the latest achievements in science and technology, Soviet engineering was very conservative. Soviet designers were aware of their limited technological capabilities and typically preferred to follow the rule of “if it works, don’t fix it.” Tupolev’s Tu-124, the first Soviet airplane created in the 1960s, was a classic representative of this philosophy. Envisioned as an aircraft for low-density routes, the Tu-124 was a scaled-down version of the Tu-104. Similar to its prototype, the new Soviet aircraft did not have any outstanding features but had inherited all of the problems of the former bomber. Engine installation in the wing made engine maintenance and replacements expensive and almost impossible. The lack of air conditioning and small cabin made the plane uncomfortable for passengers. However, there were no other regional jets for Aeroflot, and the national carrier had to accept the Tu-124. By 1965, 165 units of the Tu-124 were produced and sold to Aeroflot, East German Interflug, CSA, and the

1.5  Russia and Eastern European Countries

41

Iraqi Air Force.69 Despite its very limited commercial success, the Tu-124 was able to make a mark on the history of jet aviation. In August 1963, due to problems with the fuel system, an Aeroflot Tu-124 plane performed an emergency landing in the Neva River in the heart of St. Petersburg. All passengers safely escaped through the only rescue hatch on the roof of the aircraft While the Tu-124 ceased operations in 1980, all other Soviet commercial aircraft designed in the 1960s are still in the fleets of airlines of former U.S.S.R. allied countries. All this time, disputes have raged about how original the Soviet-designed airplanes were and to what extent the credit for every Soviet airliner design belongs to the ubiquitous KGB spies. Was the Il-12/Il-14 just a copy of the Convair 240? What about the similarity of the Il-18 and the Britannia? If the VC-10 and the BAC-111 were designed differently, how would the Il-62 and the Tu-134 have looked? If Dutch designers had built the Fokker F-27 as a low-wing airplane, would the An-24 still have a high-wing airframe? If the Boeing 727 had four engines rather than three, how many engines would the Tu-154 have had? Furthermore, the main question, of course, should the Soviet supersonic passenger aircraft have been called the Tu-144, or should it have been called the Concordski? There are no simple answers to these questions. The Soviets admitted that their first strategic bomber, the Tupolev Tu-4, was a full copy of Boeing’s B-29 (with the exception of the engines). However, the KGB played no role in obtaining information about the Superfortress. Several B-29s were delivered to the former U.S.S.R. (the Union of Soviet Socialist Republics) by American pilots, who were forced to land in Soviet territory after their raids on Germany and Japan during World War II.

1.5.3 The 1960s It seems that industrial espionage was an integral part of Soviet intelligence. It is difficult to assess now to what extent Soviet aircraft designs were copied and to what extent they were original. However, the general rule for Soviet engineers was that the airplane design that had an equivalent in the western world would have a preference over other designs. There were two reasons for that. First, it would save time and resources in designing an aircraft, and second, the Soviet industry would receive the benefits of market-based competitive selection procedures without spending money to develop competitiveness at home and without questioning the ideological foundations of the communist regime. Soviet commercial aircraft designed in the 1960s illustrate the statement above. The Ilyushin ll-62, which first took off in 1963, apparently resembled the British VC-10. Designed to replace the monstrous passenger bomber Tu-114, the 200-seat aircraft would satisfy the needs of the U.S.S.R. and its allies in long-haul transport for almost a quarter of a century. In more than 30 years of production, 292 units of the Il-62 were produced. That was the second Soviet aircraft that could be seen in capitalist livery. Japan’s JAL and 69

 Duffy and Kandalov 1996, p. 224.

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Aeroflot jointly operated the Paris-Moscow-Tokyo route using the Tu-114. In the 1970s, with the introduction of the Il-62, transcontinental routes became very popular. Aeroflot received Sixth Freedom rights for flights between Japan and London (with British Airways), Copenhagen (with SAS), Rome (with Alitalia), and Frankfurt (with Lufthansa). In addition, the Il-62 was used by Air India for flights between Delhi and London.

1.5.3.1 Modernization of the Failed TU-124 The design of a new short-haul commercial jet, which became known as the Tu-134, was originally an attempt to modernize the failed Tu-124. However, shortly after the beginning of the Tu-134 project, it was decided to create a clean-slate design. The Tu-134 was born at about the same time as a similar breed of western aircraft. The BAC 111 took off 1 month after the first flight of the Tu-134, while the DC-9 and the Fokker F.28 first flew 2 and 4 years later, respectively. The 70-90 seat Tu-134 aircraft was a success, with more than 1000 units ultimately built. Most of these aircraft are still flying in the former Soviet Union. Another Tupolev model—the medium-haul Tu-154—was also popular among eastern European air carriers. This airplane became the core of the fleets of all airlines in the Soviet bloc for more than 30  years. In the mid-1980s, the Tu-154 received new, more efficient engines that helped it continue in production until 2006, with about 1000 airplanes produced overall (Exhibit 1.4). Building on the wave of success of the Tu-134 and Tu-154, Tupolev’s design bureau attempted to create a supersonic passenger plane. The Tu-144 was a little ahead of its only rival, the French-British Concorde—the Tu-144 took off in December 1968, just 2  months earlier than the Concorde. Also, the Tu-144 first started commercial operations flying cargo from Moscow to Alma Ata in December 1975. The only area in which the Tu-144 did not succeed was efficiency. Obviously, there was no need to transport mail over a distance of 2500 miles with supersonic speed. These flights were promotional efforts to rehabilitate the aircraft’s reputation after a crash at the Paris Air Show in the summer of 1973. A few months of passenger service were enough to disappoint Aeroflot with the lack of economic efficiency and technical characteristics of the Tu-144. The aircraft’s fuel consumption was too

Exhibit 1.4 TU-154

1.5  Russia and Eastern European Countries

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high even by generous Soviet standards, and the airplane’s reliability was low. Eventually, all 20 Tu-144 that was built went to rest. Some of them went to museum displays, others were used to train pilots for the Soviet space shuttle “Buran” program, and one aircraft was used as a test for NASA’s SST-2 program. The only aircraft of the 1960s that was entirely free from suspicions of copying Western designs was the Yakovlev, Yak-40. This 32-seater became the world’s first commercial jet aircraft for short-haul routes. It seems that the Soviet Union, as early as the mid-1960s developed a regional jet concept that later led to the success of Brazil’s Embraer and Canada’s Bombardier. However, the conservatism and lack of similar aircraft in the West played a negative role in this case. Throughout its life, the Yak-40 was produced virtually with no modifications—with 28 or 32 seats, fuelguzzling engines, and Soviet avionics sets. Only a few airplanes out of more than 1000 manufactured were exported to Italy and Germany. Virtually all Yak-40s remained in the U.S.S.R. and its allies. Two more aircraft that performed their maiden flights in the 1960s were turboprops for feeder lines. The Czech-built Let L-410 was commissioned by Aeroflot and was the main airplane for its feeder routes for many years. More than 1100 units of the L-410 were produced. Slightly bigger than the 19-seat L-410, the An-28/38 was a vast modernization of the obsolete An-14. While still in limited production in Russia and Poland (as the M-28 “Skytruck”), this airplane has not been successful. In the first 5  years after World War II, passenger traffic in the Soviet Union increased four-fold. In 1940, the last year before the U.S.S.R. entered the war, 400,000 passengers were transported by air. In 1950, this number was 1,600,000. Over the next 10 years, passenger traffic grew by a factor of 10—in 1960, Aeroflot transported more than 16 million people. By 1970, passenger traffic on domestic and international routes grew to 68 million. At that time, the U.S.S.R. was the second-ranked country in the world in terms of commercial air traffic. Only in the U.S. did airlines carry more commercial air traffic—about 170 million people.

1.5.4 The 1970s The results of the 1970s were much more modest. In 1980, only 90 million passengers were transported in the U.S.S.R. The exponential growth of previous decades was followed by only 30% cumulative growth over the next 10 years. The Soviet aviation industry witnessed a lack of enthusiasm and lost its momentum. In terms of the development of new commercial aircraft, the 1970s were one of the worst decades in the history of the U.S.S.R, whereas the most successful decade for the Soviet aircraft industry was the 1960s. Eight brand new designs took off during the 1960s, and most of them are still in operation. The 1950s were also good for the Soviet aviation industry, with seven new aircraft from this time period making it into mass production. However, from 1970 to 1980, only two new commercial aircraft were designed in the Soviet Union—a short-haul regional jet known as the Yakovlev Yak 42 and the short-to-medium haul wide-body known as the Ilyushin Il-86. Thus, the 1970s were a lost decade for the Soviet aviation industry.

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1.5.5 The 1980s The Yak-42, a regional jet with 120 seats, had to fill a niche between the TU-134 (80 seats) and the Tu-154 (160 seats). The Yak-42 had three turbofan engines and was designed to operate on short routes—up to 1500 miles. Even though the Yak-42 was economically efficient by Soviet standards, the aircraft’s narrow specialization led to limited success. With the capacity and comfort of a mainline jet, the Yak-42 could fly from short runways and had a built-in ladder. Its minimum wing sweep angle resulted in excellent takeoff and landing characteristics but significantly reduced the cruise speed. Because of its range, the Yak-42 could operate only in the European part of the Soviet Union, where the passenger demand could not justify the usage of the larger Tu-154. Nevertheless, in the eastern part of the county, with its great distances between cities, the Yak-42 was not suitable due to its short-range and low speed. The Yak-42 was the second failed attempt to create a commercial airplane for a very narrow market niche. The An-10, built in the 1960s, tried to combine the comfort of a mainline plane with the ability to take off and land on unpaved airstrips. As a result, only a small number of these two aircraft types were ultimately produced—188 of the Yak-42 and 108 of the An-10. The Illyushin Il-86 made its first flight in 1976. This 350-seat wide-body commercial jet was also designed for a very narrow niche, which was determined by the rather unusual geography of the Soviet Union. The vast majority of the country’s population lived within 2000 miles from Moscow. Therefore, the main passenger traffic in the Soviet Union was condensed in the European part of the country and flowed primarily from north to south and vice versa. Latitudinal traffic flow from west to east was relatively light and could be handled with the smaller and longerranged Il-62.70 Accordingly, Aeroflot needed a large-capacity, medium-range airplane to satisfy passenger demand in the European part of the U.S.S.R. The viability of this concept was confirmed by the designs of the European Airbus A300, which had a slightly smaller capacity and about the same range, and the U.S.-built Lockheed L-1011 and McDonnell Douglas DC-10 that had a similar capacity and slightly greater range. Evidence of how badly Aeroflot needed such an airplane could be found in the fact that the Soviet government did not use industrial espionage to expedite the development of this type of aircraft but decided to officially acquire a production license instead. In the early 1970s, the Vietnam War was over, and the U.S.S.R. and the United States were considering a number of joint projects, including the space program “Apollo-Soyuz” and the transfer of technology to produce a wide-body commercial jet. In the middle of 1973, top-ranked Soviet officials arrived in the United States to buy several wide-body aircraft for Aeroflot and to purchase a license to produce these aircraft at an assembly line in the city of Ulyanovsk. The Soviet delegation visited all three American commercial aircraft manufacturers at  For example, the SIP-PKC route (Simferopol – Petropavlovsk-Kamchatskiy), with a distance of about 5000 nm, was the world’s longest domestic flight and the longest transcontinental route ever.

70

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that time—Boeing, McDonnell Douglas, and Lockheed Martin. The Soviet officials divided themselves into two groups. The industrial part of the delegation supported the L-1011 as a base model for a new Soviet aircraft, but Aeroflot managers backed the Boeing 747. After 2 years of discussions, the project was taken off the table, and instead of buying a ready-to-fly production model, the Soviets decided to design their own wide-body aircraft. Over the following 5  years, they built the Ilyushin Il-86 with the exact same number of seats as the L-1011.

1.5.6 The 1990s–Present Introduced into commercial operation in 1980, the Il-86 generally delivered what was expected. Only 112 of these aircraft were ever built. The only other country that utilized the Il-86 was China, where, as in the U.S.S.R., there were several mediumand short-haul high-density routes linking the country’s major industrial and political centers. Other Soviet allies had no interest in the Il-86. For eastern European countries, the aircraft was too large for domestic service but had an insufficient range for intercontinental flights. The Soviet commercial aircraft industry came back to life only in the middle of the 1980s. The existing fleet of commercial aircraft had to be replaced with more efficient and modern machines. The three oldest models—the regional turboprop Antonov An-24, the medium-range Tu-154, and the long-haul Il-62—were the first candidates for replacement. Since the planned Soviet economy could not afford to spread money thin and organize design competitions, the decision was made to use the same engine for both the Tu-154 and the Il-62. In the early 1980s, nobody expected the economic and political crisis the country would go through in the next few years. All the new aircraft were designed to be larger than their predecessors to accommodate the continuous growth of demand in air transportation. Between 1980 and 1990, passenger traffic in the Soviet Union increased by almost one-and-a-half times and reached 140 million enplanements. Therefore, the Il-114 that was intended to replace the An-24 was designed with a 25% increase in size, reaching a capacity of 60 passengers. The Tu-204 was also designed with a 25% larger capacity of 200-220 passengers than the model it was intended to replace, the Tu-154. The Il-96, which was intended to replace the Il-62, had a 300-seat capacity, more than 50% greater than that of the Il-62. It was unclear what aircraft would fill the gaps among these three airplane sizes. Being close in size to the Boeing 777-200 and Airbus 340-200, the Il-96 had four newly-designed PS-90 engines. While the engine was a substantial achievement of Soviet technology, it remained inefficient and unreliable by Western standards. However, the real problem of the Il-96 was not in its engine but in a dramatic change in the economic environment by the time the airplane was ready for mass production. In the early 1990s, the Soviet Union ceased to exist, and all of the 15 newlyformed states fell into a deep economic crisis that led to a sharp decline in passenger traffic. In 1990, a year before the Soviet Union’s collapse, the number of passengers carried by Aeroflot in Russia reached its historic high of 91 million people,

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compared to 1999 when fewer than 22 million people flew on domestic and international routes.71 In the new environment, large airplanes were no longer needed. The Ilyushin design bureau’s attempts to market the Il-96 with Pratt & Whitney engines and Rockwell-Collins avionics were also unsuccessful. The commercial success of this aircraft in the Soviet Union had been negatively affected by the traditional inflexibility of the system. In an economy with no competition among manufacturers, the process of negotiation between buyers and sellers was distorted beyond recognition. In rare cases, a buyer could get what he wanted. More often, though, manufacturers were pushing customers to buy what they could develop. Under pressure from the Russian government, the flag carrier Aeroflot agreed to buy 12 Il-96s. However, only six planes were delivered, and the remaining six were rejected by Aeroflot even though they were modified into freighters. As of 2008, only 22 of these aircraft have been built. Some of them are used as VIP transports for Russian, Venezuelan, and Cuban leaders, while others are utilized for charters. It has been asserted that the core expertise required for Soviet aircraft manufacturing was political connections and influence and not effective design and/or manufacturing capabilities. Labor and fuel were cheap, so the efficiency was not terribly valuable. Consequently, it was not the most effective or efficient product that made it to the market. It is probably not a problem until those products and industries had to compete with those in the rest of the world. Designed similarly to the Boeing 757, the Tu-204 was not as successful as Tu-154. However, the Tupolev design bureau was better prepared than the Ilyushin firm to work in the new environment, and the Tu-204 had more sales. A few different derivatives were developed—the Tu-204-200, with increased maximum take-off weight and range of up to 4000 miles; the Tu-204C, for cargo; and the Tu-204-300, aimed at a very specific niche of long-haul low-­demand routes. The Tu-204-300 has a capacity of 160 seats and a range of 6000 miles. Another variant of the Tu-204 is still in development. The Tu-204SM will be a direct replacement of the outdated Tu-154 and will have a lighter structural design, reduced maximum takeoff weight, and smaller passenger capacity. It is anticipated that this aircraft will become an intermediate model between the original Tu-204 and a new generation of narrow-body aircraft, the MS-21. According to Tupolev, the Tu-204SM should enter the market in 2012 before Boeing and Airbus release their replacements for the 737 and the A320. The last commercial airplane made in the U.S.S.R. was the Ilyushin Il-114 regional turboprop. Traditionally for Soviet aircraft development, the confirmation of the chosen design was based on Western influences. British BAe ATRs had similar features—low wing design and a maximum capacity of 60 passengers. Similar to the ATR, the Il-114 was not a commercial success. Despite the manufacturer’s attempts to improve the turboprop by installing Western engines and avionics, only a few aircraft were delivered to customers in Russia and Uzbekistan. It seems that for domestic markets, the aircraft was too large and expensive, while internationally, the Il-114 could not compete with large families of regional turboprops from ATR and Bombardier.  Before the Soviet Union’s collapse Russian traffic represented about 75% of all traffic in Soviet Union.

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Number of passengers boarded by domesc airlines in Russia (in millions) 10. 8. 6. 4. 2. 0.

Despite the failure of the Il-114, manufacturers from CIS countries continued their attempts at commercial success in the niche encompassing the market just under Boeing’s and Airbus’s production lines. CIS manufacturers assumed that the huge market of regional air transportation in ex-Soviet countries would recover and that a simple and rugged replacement for the old An-24 would be needed. As it stands now, this assumption has not been validated yet. Beginning in 2000, the demand for air travel in the former U.S.S.R. started to grow. However, the demand structure had undergone radical changes. For more than a decade of economic crisis, the national airport network had deteriorated, with small regional airports been affected the most. There were 1300 airports in Soviet Russia. By 2000, this number had decreased to 300, and only about 100 of them were actually in operational condition. In addition, the passengerflow directions had changed dramatically. In the U.S.S.R., the vast majority of passengers flew on domestic routes. In 2008, the proportion of domestic and international flights was about fifty-fifty, with 90% of all connecting passengers flying through Moscow’s three airports. These factors have led to the stagnation of the key markets for new small turboprops. From 2000 to 2008, the total annual passenger traffic in Russia more than doubled, from 23 million to 51.4 million, while the regional traffic remained almost unchanged, staying around 1 million passengers per year (in the Soviet Union, this figure was 10 million passengers per year).72 The first post-Soviet plane was the Ukrainian-built An-140 turboprop. With its 50- seat capacity and simple design, this model targeted regional routes in former Soviet countries. Even though the An-140 is currently being produced in Ukraine, Russia, and Iran, it has not achieved any significant commercial success yet.

1.5.6.1 United Aircraft Corporation (UAC) We are forming in Moscow a unified management organization and a unified center of design competencies for all UAC companies. Systemic reforms should improve the structure of the company and solve the issues of its financial stability, increase the competitiveness of 72

 http://www.gks.ru

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United Aircraft Corporation is a Russian civilian and aerospace corporation and was created on 20 February 2006 by merging shares from Ilyushin, Irkut, Mikoyan, Sukhoi, Tupolev, and Yakovlev. A new joint-stock company named UAC in order to optimize production and minimize losses. In April 2015, the Company changed its full name to Public Joint-Stock Company. (PJSC UAC).73 Of the 8 years (2012–2019), only 2012 saw UAC sell less than one hundred aircraft. The highest number was sold in 2014 at 156, while in 2017, 133 aircraft were sold. More attempts to avoid direct competition with Boeing and Airbus have resulted in the development of two regional jets in former Soviet counties—the Ukrainianbuilt An-148 and Russian-built Sukhoi SuperJet (SSJ) 100 and later the MC-21. These three aircraft, however, have a number of important differences in market positioning and design. The An-148 is positioned to capture regional markets in the former U.S.S.R. and Iran. This 70-seat aircraft was designed with minimal use of Western equipment. On the other hand, the key market for the SSJ 100 is outside the former Soviet Union, and it is designed to compete against the Embraer E-Jets and the Bombardier CRJ programs.74 The MC-21 family of aircraft by Irkut, a subsidiary of United Aircraft Corporation, is aimed at the mainstream narrow-body aircraft market rivaling the Airbus A320neo and the Boeing 737MAX.  The -300 variant has a 130-170 passenger capacity with a shorter variant MC-21-200 along with a longer -400 variant are scheduled as well. Engines will be Pratt & Whitney PW1000G and eventually add the locally sourced Aviadvigatel PD-14 and other systems suppliers are a mix of Russian and western companies. It made its successful maiden flight on May 28, 2017. Originally, it was planned for entry into service in the second half of 2019 with Russian certification but the plan was pushed back to 2021 due to US sanctions, as announced in February 2019.75 Aeroflot is the launch customer and will lease 50 aircraft from Aviakapital.76 Most of the initial airline customer base is Russian, along with some from the former Soviet republics. UAC was founded by the russian government in 2006 to consolidate and combine russian aircraft manufacturing companies and is a majority state-owned Russian aerospace conglomerate based in Moscow. On 25 October 2018, a deal was approved by Russian President for the UAC to be acquired from the Federal Agency for State Property Management by Russian state owned conglomerate Rostec.

 United Aircraft Corporation, History. https://www.uacrussia.ru/en/corporation/history/  Flight International. Export Driven: The Sukhoi Superjet, Retrieved, January 17, 2010. 75  https://aviationweek.com/commercial-aviation/us-sanctions-trigger-one-year-mc21-schedule-delay 76  https://www.flightglobal.com/news/articles/aeroflot-outlines-performance-expectationsfor-mc-21-449175/ 73 74

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According to Sukhoi, another division of United Aircraft Corporation, out of a planned production of 800 units, only about 200 aircraft are intended for the Russian market. At the beginning of its development in early 2000, the SSJ 100 was envisioned as a line of aircraft with capacities from 60 to 100 passengers. However, the Sukhoi design bureau soon admitted that in the high fuel price environment, there was no economically justifiable way to create a family of aircraft with such a wide range of capacities—the base model with 80 seats, the shortened version with 60 seats, and the stretched derivative with 100 seats. Therefore, Sukhoi’s plans to create a 60-seater were dropped. The 100-seat derivative has become the basic model, and the 130-seat version is under consideration. The first flight of the Sukhoi Superjet 100 took place in May 2008.77 At the 2009 Paris Air Show, Hungarian national carrier Malev Airlines signed a statement of intent to purchase 30 Superjet 100. In another transaction, the Mexican low-cost carrier Interjet signed a firm order to purchase 15 Superjet 100 regional jet plus five options, which it opens that markets the Russian-built aircraft to Western customers. They eventually took 22 aircraft but announced its intent to sell all of the aircraft as they had issues with the OEM and could not come to terms in negotiations, as in January 2020, only 3 of them are in service. As of February 2021, there were 205 aircraft produced with 171 deliveries as of 2019.78 This capacity range satisfies Aeroflot, which is the launch customer of the SSJ 100.79 Aeroflot urgently needs to replace its outdated fleet of regional Tu-134 aircraft with a plane that has a smaller capacity than that of the Tu-154. To be able to compete internationally, Sukhoi invited some Western companies to participate in the SSJ 100 project. Italian Alenia Aeronautica has become a 51% shareholder in the SSJ and is in charge of marketing, sales, customization, and delivery of the SSJ 100 in Europe, the Americas, Oceania, Africa, and Japan. This Italian firm will also be in charge of worldwide after-sale support. Boeing is involved as a consultant, and some component manufacturers (Snecma) are risk-sharing partners. The first SSJ 100 was delivered to launch customer, Armenian airline Armavia, on April 12, 2011, with Aeroflot taking delivery shortly thereafter as the second operator of the type in June of 2011. With the events of reliability and service issues of the aircraft along with international wariness from US sanctions, there have been headwinds for Sukhoi on selling the Superjet outside of its Russian market.80 Time will tell (Figure 1.9 and Table 1.7).

1.6

Asia-Pacific

Japan had manufactured a successful commercial jetliner during the 1950s through the Nihon Aircraft Manufacturing Corporation, a consortium of several Japanese heavy industry companies. Japan had manufactured numerous aircraft during World  Aerospace-technology, Retrieved January 14, 2010.  Airline News Europe, April 18, 2011 http://superjet100.info/registry-english 79  Flight Global, May 5, 2008. 80  https://www.themoscowtimes.com/2019/05/06/russias-plane-making-ambition-exceedsits-competence-a65502 77 78

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AN-24

AN-24

AN-140

AN-140 AN-148

AN-148 Il-114

Il-114

Il-96

Il-96 Il-62

Il-62 TU-104

TU-104

TU-124

TU-124 TU-134

TU-134

TU-144

TU-144

TU-154

TU-154

TU-204

TU-204

SSJ 100

SSJ 100 1950

1960

1970

1980

1990

2000

2010

2020

Figure 1.9  Antonov, Tupolev, Ilyushin and Sukhoi commercial aircraft production. (Source: Compiled by the authors from available aircraft production data as of April 2021)) Table 1.7  Russia and Eastern European Bloc commercial aircraft Aircraft model AN-24 AN-140 AN-148 Il-114 Il-96 Il-62 TU-104 TU-124 TU-134 TU-144 TU-154 TU-204 SSJ 100

Launch customer Aeroflot Aeroflot Aerosvit Airlines Uzbekistan Airways Aeroflot Aeroflot Aeroflot Aeroflot Aeroflot Aeroflot Aeroflot Aeroflot Aeroflot

Produced* 1367 35 42 20 30 292 201 164 852 16 1026 83 150

Source: Compiled by the authors from Antonov, Tupolev, Sukhoi and Ilyushin aircraft data *As of April 2021

War II but could not engage in aircraft manufacturing post-war following the terms of its surrender. However, during the 1950s, these restrictions were gradually lifted to allow Japan to manufacture the civilian turboprop YS-11. This was designed as a replacement for the DC-3. However, further expansion was unfeasible due to the

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extensive capital requirements associated with developing or purchasing jet aircraft engines, and the company was dissolved in 1983. The key player in the Asia-Pacific region is China. The playing field may change dramatically in the near future as China enters the market for the manufacturing of commercial airliners. China’s aeronautics industry was established in the 1950s and is trying to become another viable commercial aircraft manufacturer in the world. In 2008, China announced that it had formed the China Commercial Aircraft Corp. of China (COMAC) with an initial investment of $2.7 billion. China initially planned to build a 150-seat aircraft by 2020 to compete with Boeing and Airbus. Since the aircraft manufacturing industry is strategically important for national security and the balance of payments, most governments support firms either by direct support or indirect subsidization through defense contracts. Commercial aircraft manufacturing in Asia is still at an embryonic stage of development. Since the region is comprised mostly of developing economies, it had hitherto lacked the technology and the capital to undertake aircraft manufacturing. Most Chinese aircraft manufacturing has been driven by the military. Established during the Korean war in 1951, the aviation industry in China has been through twelve reforms, and the last reform in 1999 resulted in splitting China Aviation Industry Corporation (AVIC) into two arms, AVIC I and AVIC II. AVIC I specializes in large military aircraft, while AVIC II focuses on smaller civilian airliners, transports and helicopters. The companies that constitute AVIC II are Harbin Manufacturing Corporation, Hongdu Aviation Industry Corporation, Shaanxi Aircraft Company, Changhe Aircraft Industries Corporation, and Shijiazhuang Aircraft Manufacturing Company. Harbin manufacturing previously was the only civilian aircraft producer in the consortium. The main offering of Harbin is the Y-1181 and Y-12, which entered production in 1975 in response to the Chinese government’s requisition for a light utility aircraft. The Y-11 was a twin-engine turboprop airliner with short take-off and landing (STOL) characteristics, which was superseded by the Y-12. Airlines in China, South Pacific and Japan still operate the Y-12. In 2003, Embraer entered into a partnership with Harbin Manufacturing to produce the ERJ 145 in China for the Chinese market. The other companies produce supersonic military aircraft, transports, helicopters and avionics testbeds. China’s Xian Aircraft Industrial Corporation under AVIC launched the MA-60 turboprop aircraft and received China Aviation Administration of China (CAAC) type certificate approval in June 2000 with the first delivery to Sichuan Airlines in August of that year. The aircraft design was based on the Russian An-24 aircraft. Operators are predominately in China and other China-friendly jurisdictions in Africa and Southeast Asia as the aircraft has not been certified by the FAA or EASA. On October 28, 2008, AVIC-I and AVIC-II re-merged back together to form the newly named Aviation Industry Corporation of China (AVIC).82 This led to synergies, which eliminated overlapping programs and resources.

81 82

 Twin-engined STOL utility transport aircraft.  China Daily, AVIC I & II closer to merger, 18 June 18, 2008).

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1.6.1 Commercial Aircraft Corp. of China (COMAC) The Commercial Aircraft Corp. of China is the production of large domestic passenger jets by using world-class manufacturing techniques in the production of the homegrown C919 airplane. China has built an assembly line for its homegrown C919 jetliners in Shanghai for narrow-body commercial airliners with 168-190 seats.83 The C919 made its maiden flight in May 2017 and to begin deliveries by 2021 to China Eastern Airlines.84 The aircraft is expected to compete against the Boeing 737 MAX and Airbus A320neo family. The aircraft uses a wide array of international suppliers, including the Honeywell APU and CFM LEAP-1C engines. There will be a domestic alternative engine option AVIC Commercial Aircraft Engine Co was also tasked with developing an indigenous engine, CJ-1000A, from AVIC Commercial Aircraft Engine Co. that was announced in 2012. The aircraft has not been certified by FAA as of April 2021, but it is in the process of certification. So far, there are 208 firm orders with 20 options. Most of these companies that have placed orders are Chinese airlines and leasing companies with five orders by GECAS. The C919, can seat up to 168 passengers, is meant to compete in the market for single-aisle jets dominated by Boeing 737 and Airbus A320. In addition to the C919, the COMAC produces the ARJ-21 regional jet. There are two variants, -700 and -900. The original concept was initiated with the 10th FiveYear Plan and began in 2003.85 The first flight was on November 28, 2008. The Type Certificate was received from CAAC on December 30, 2014. It is currently still undergoing FAA certification for the global market, even though it has obtained EASA certification. In November 2015, the first ARJ21-700 aircraft was delivered to Chengdu Airlines. There are currently a few Chinese operators, with the most by Chengdu Airlines with 23 aircraft. There is a stretch version -900 being developed as well with a capacity of 95 to 105 seats. On October 26, 2019, the ARJ21 started the first international service between the northeastern Chinese city of Harbin to Vladivostok in Russia’s Far East.86 There is also a new wide-body CR929 in development starting June 2011 with a target of 250-320 seats. The 50-50 partnership with Russia’s United Aircraft Corporation (UAC) on this wide-body was signed in May 2017 to establish the China-Russia Commercial Aircraft International Corporation Limited (CRAIC). The three variants include a shortened and stretched versions are planned. Enginewise, it is planned to have western OEM engines with more Chinese and Russian  Dimensions of the C919 are very similar to the Airbus A320, to allow for a common pallet to be transferred. 84  Reuters, August 6, 2019. 85  http://english.people.com.cn/200211/04/eng20021104_106234.shtml 86  Free Press Journal28 January 2020. 83

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domestic alternatives coming online later. The expected first flight is 2025, with the first delivery in 2027.87 The development of a commercial aircraft manufacturing center in China is a logical progression of the forecasted traffic increase and rapid economic growth of the region. The International Air Transport Association (IATA) had predicted that China would surpass the U.S. as the world’s largest aviation market in the mid2020s.88 Even amid the global economic downturn, the growth of Chinese air traffic has continued unabated (Reuters, January 13, 2010). In fact, CAPA reported in April 2020 that China displaced the U.S. already despite the COVID-19 complications.89 In the long term, China has a relatively low passenger-to-population ratio (0.13 per thousand population) compared to developing economies in Asia (“ICAO Traffic Data,” 2010). Coupled with a robust population growth projection, the demand for airline transportation and consequently, for aircraft in China is likely to be extremely high. Therefore, the Chinese government has an active interest in developing a local manufacturing solution to aircraft manufacturing.

1.7

Regional Jet Market

In the discussion about Boeing, McDonnell Douglas, and Lockheed Martin, we were largely paying attention to the history of wide-body or narrow-body airliners with a seating capacity of 120 or more passengers. There is a vital secondary market for commercial aircraft, and that pertains to regional jets. Regional Jets (RJs) are roughly classified as aircraft that seat between 37 and 122 people and have a shortto medium-haul range (“Schedule Tapes for June 2009,” 2009). The market for Regional Jets is similarly dominated by two players: Embraer from Brazil and Bombardier from Canada. The rest of the aircraft manufacturers ultimately grew to have an exclusively military focus, such as Lockheed Martin, and Northrop or were eventually absorbed into the major players. One can split this segment to the jets below 70 seats and those between 70 and 120 seats. These are used mainly by commuter, feeder, or air-taxi operations to serve markets that are too thin to justify the costs of operating a full-sized jet. Primarily, these commuter operations are part of a major airline, either via codesharing, shared branding, or regional partnerships. United Express, which is a network of commuter airlines operating as feeders for United Airlines, and Delta Connection for Delta Air Lines are good examples of commuter airline operations. They serve to fill in the network structure of a mainline hub-and-spoke model by linking low-traffic origins and destinations to the primary hub-and-spoke network. Generally, these airlines have a mixed fleet of turboprops and regional jets. Another type of commuter airline aims to provide specialized, point-to-point service to  https://www.flightglobal.com/interview-cr929-boss-details-progress-timeline/131526.article  IATA Press Release, IATA Forecast Predicts 8.2 billion Air Travelers in 2037. October 24, 2018. 89  https://centreforaviation.com/analysis/reports/china-becomes-the-largest-aviation-marketin-the-world-521779 87 88

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select, thin markets. Cape Air and Colgan Air are good examples of this latter type of commuter airline. The economic crisis and increase in fuel cost make small regional jets unaffordable for airlines because of the high cost per available passenger seat mile. The two major players in the regional jet manufacturing industry for a long time were the Brazilian Embraer and the Canadian Bombardier. With the exit of Bombardier from the commercial jet industry by passing CRJ to Mitsubishi and Cseries to Airbus, the regional jet market now has different players.

1.7.1 Empresa Brasileira De Aeronáutica, S. A. (EMBRAER) Embraer was established by the Brazilian government in 1969. Embraer had a mixed capital structure and was controlled by the government. Embraer is the world’s third-­largest commercial planemaker and the world’s largest producer of regional jets.90 The first aircraft produced by Embraer was the twin-engine turboprop, the IPD-6504, otherwise known as the Bandeirante (“Tradition & Background,” 2009). The Bandeirante was intended to be a light-transport aircraft for military and civilian use by the Brazilian Aeronautics Ministry, and the aircraft’s popularity soared because of the plane’s combination of efficiency, speed, and capacity. The Bandeirante underwent 11 incarnations, with Embraer embarking on variants and improvements almost immediately after the first Bandeirante was delivered. In addition to the basic 12-seat transport (EMB 110), there was the aerial photography version, the initial airline version with 15 seats (EMB 110C), the 18-seat enlargement (EMB 110P), the convertible passenger/freight model (EMB110P1), and several other models which were the result of customization or improvements (Airliners. net). As of 2011, 83 Bandeirantes remain in service, in use primarily by North, Central, and South American commuter airlines and air taxi services (KaminshiMorrow & Fafard, 2011). The Bandeirante ceased production in 1990. The next major commercial aircraft produced by Embraer was the EMB 120, the Brasilia, developed in 1980, with its maiden flight in 1983 (“Tradition & Background,” 2009). The Brasilia could seat 30 passengers, and it was developed expressly for the regional jet market. It was a twin-engine, T-tail turboprop and found a burgeoning market in the regional airlines of the United States, which were just beginning to come to the fore (Eden, 2008). Like the Bandeirante, the Brasilia went through several variants, each offering better takeoff and landing performance, extended ranges, aerofoil improvements, and passenger/freighter modifications. Besides finding a solid market among regional airlines, the Brasilia was the prototype upon which the Embraer ERJs would be developed. Many of the components of the famous ERJ 145/135 were initially used in the EMB 120, and the EMB 120 formed the perfect “bridge” aircraft for Embraer to enter the jet playing field in 1989. The biggest operator of the Brasilia in the U.S. was commuter airline Skywest, which had a fleet of 43 aircraft as of July 2011 (Kaminshi-Morrow & Fafard, 2011). 90

 Reuters, Jul 29, 2011.

1.7  Regional Jet Market

55

After more than 28  years, on May 5, 2015, SkyWest Airlines operated its last Embraer Brasilia revenue flight from Santa Maria to Los Angeles. In 1986, in partnership with Argentina, Embraer embarked on the CBA 123 Vector, a 19-seater developed in conjunction with Argentina’s Fabrica Militar de Aviones (FMA). The CBA 123 Vector incorporated cutting-edge technologies, such as the pusher propeller with the 1300 shp TPF 351-20 engine developed by the Garrett Engine Division of the Allied Signal Aerospace Company. The CBA 123 Vector was also the first turboprop to incorporate Full Authority Digital Engine Control FADEC to yield increased power plant efficiencies (Reuland & Inc., 1991). The aircraft was designed for cruising at a maximum altitude of FL41, with a speed of 360 ktas. However, production costs and rising fuel prices in the early 1990s lead Embraer to price this aircraft at $6 million, in a market that was dominated by the Beech 1900 and the Fairchild-Swearingen Metroliner, each priced at around $2 million. In light of the fuel crisis and the wake of the Gulf War, there was no way regional commuter airlines could justify paying such a premium for a 19-seat aircraft, and the project met with poor demand. The early 1990s also saw Embraer take on a huge amount of debt, both to finance the CBA 123 Vector and the upcoming regional jet project. In 1989, Embraer issued $85 million in convertible debt and hoped to raise $100 million more through the conversion of commercial bank-held foreign debt (from previous aircraft sales) into non-voting equity. The Brazilian government blocked this particular plan at the last minute and refused to release funds from the already-authorized debt conversion. This, coupled with rising development costs and weak demand, drove Embraer into a deep financial crisis. In October 1990, Embraer laid off 32% of its workforce and posted a loss of $265 million. Further aircraft development slowed to a trickle, and after the prolonged upheaval, Embraer was eventually privatized in 1994 (Frishtak, 1992). Embraer began the ERJ 145 project in 1989, 9  years after the launch of the Brasilia, and this was a much larger project than any project the 20-year old company had undertaken to date. Total development costs were projected at $300 million, primarily because of the requirement of a swept-wing and engine redesigns (Eden, 2008). After the 1990s crisis, the ERJ 145 project took a back seat to internal reorganization at Embraer for a period of time. The prototype of the 50-seat ERJ 145 was assembled in October 1994, and the aircraft began regular revenue flights with Continental Express in 1997. This was quite a success, and over the course of the next several years, several variants were developed with increased range and capacity. The ERJ 145 found a very receptive market with U.S. and European commuter airlines, such as Continental Express and Switzerland’s Crossair. A smaller version of the ERJ 145, the ERJ 135, was developed close on the heels of the ERJ 145 and found similar success in a reviving commuter airline market.91 Subsequently, Embraer decided to take a different tack and develop the EMBRAER 170 (78-86 passengers), the 175 (98-106 passengers), the 190 (98-106 passengers),  ERJ 135 has 37 passengers, ERJ 140, 44 passengers, and ERJ 145, 50 passenger configuration capacities.

91

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1  The Globalization and Evolution of the Aviation Industry

and the 195 (118 passengers). The E-190/195 family is a larger stretch of the E-170/175 family fitted with a new, larger wing, larger horizontal stabilizer and a new engine. This placed Embraer jets in direct competition with the narrow-bodied aircraft of Boeing and Airbus, the industrial giants. Embraer’s major rival, Bombardier, was expanding in the same direction before exiting the jet aviation market in 2019-2020. The outcome of such competition is still uncertain, but Embraer is primarily looking to capture the fleet-modernization market. Both Embraer and Bombardier-made jets were replacement candidates for older 100-seat aircraft, such as Fokker 70/100s, DC-9s, and MD-80s, and early Boeing 737s, thousands of which were in service. The EMB 190 and 195 at 100+ seats are being operated by JetBlue, Aeroméxico Connect, Tianjin Airlines, Azul Brazilian airline, and a variety of other airlines globally. Of course, one of the main reasons for the 50 seat (and below) jets was due to scope provisions in pilot contracts. Otherwise, the economics did not necessarily fully justify the aircraft’s existence. Embraer also entered into a joint venture with Harbin Aircraft manufacturing in China to produce the ERJ 145 for the Chinese market. During this joint venture, more than forty ERJ 145 and five Legacy 650 were assembled in China from parts produced. The last delivery out of the joint venture, Harbin Embraer Aircraft Industry (HEAI), was in March 2016, and it was set to phase out.92 Embraer’s E175-E2 and Mitsubishi’s M90 are too heavy to comply with the Scope Clause limits imposed by pilot labor agreements. Given the competition, Bombardier was developing larger than named C-series aircraft; Embraer also began developing larger regional aircraft. In 2013 at the Paris Airshow, Embraer launched the successor to the E-Jets family called E-Jets E2 family of aircraft. There were designed with more enhanced engines to be fuel-efficient with three variants based on the E-Jets variants and thus named E175-E2, E190-E2, and E195-E2 models. The aircraft uses the Pratt & Whitney PW1000G engines and the E190-E2 variant delivered in April 2018 to Wideroe, a Norwegian airline. For the E175-E2 variant, the first flight took place on December 12, 201993 with 2021 entry into service despite not having many orders or a launch customer yet.94 For the E195-E2 variant, the first flight was in March 2017, and the first delivery was to Azul, a local Brazilian airline, in September 2019. The E195-E2 is expected to compete with Airbus 220-300 (formerly Bombardier CS300); however, in 2018, JetBlue announced its plan to replace its aging E190 fleet of 60 aircraft with A220-300s. The first delivery was on December 31, 2020.95 As of the end of September 2020, Embraer has reported 22 (151) firm orders and 63 (47) options for E190-E2 (E-195-E2). In addition, 14 E190-E2 and 8 E195-E2 have been delivered.96  Trautvetter, C. Embraer to Close Legacy 650 Assembly Facility in China. AINonline.com, June 6, 2016. 93  https://www.flightglobal.com/programmes/embraers-first-e175-e2-takes-to-the-skies-in-saojose-dos-campos/135768.article 94  https://www.flightglobal.com/news/articles/embraer-sticks-to-schedule-on-e175e2-and-promises-s-460864/ 95  Boon, T. JetBlue’s First Airbus A220-300 Delivered. Simple Flying. January 1, 2021. 96  Embraer Earning Results 3rd Quarter 2020. 92

1.7  Regional Jet Market

57

In 2018, Boeing and Embraer announced a plan for a joint venture where Boeing would own 80% of the Embraer commercial aviation division.97 Some viewed this plan as a reaction to the acquisition of Bombardier by Airbus a year earlier. This plan, however, was eventually canceled by Boeing in April 2020 due to the aftermath of 737 Max issues and financial complications caused by the COVID-19 pandemic (Figure 1.10 and Table 1.8).98

[CATEGORY NAME] (354)

EMB 120

CBA 123

CBA 123

ERJ 135/ ERJ 140/ ERJ 145

ERJ 135/ ERJ 140/ ERJ 145

EMBRAER E170/ E175

EMBRAER E170/ E175

EMBRAER E190/ E195

EMBRAER E190/ E195

EMBRAER E190/ E195 E2

EMBRAER E190/ E195 E2

1980

1985

1990

1995

2000

2005

2010

2015

2020

Figure 1.10  Embraer commercial aircraft production. (Source: Compiled by the authors from Embraer aircraft data (as of April 2021))

Table 1.8  Embraer commercial aircraft production Aircraft model EMB 120 (Brasilia) CBA 123 ERJ 135/ ERJ 140/ ERJ 145 EMBRAER E170/ E175 EMBRAER E190/ E195 EMBRAER E190-E2/ E195-E2

Launch customer SkyWest, Swiftair – ExpressJet Airlines LOT Polish Airlines JetBlue Wideroe, Azul Brazilian Airlines

Produced 352 2 prototypes 890 857 737 29

Source: Compiled by the authors from Embraer aircraft data (2021)

 Boeing and Embraer to Establish Strategic Aerospace Partnership to Accelerate Global Aerospace Growth. Boeing.com 98  Kaminski-Morrow, D.  Boeing walks away from Embraer tie-up. FlightGlobal.com. April 25, 2020. 97

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1.7.2 Bombardier Aerospace With more than 3,000 aircraft delivered since its entry-into-service in 1963, the iconic Learjet aircraft has had a remarkable and lasting impact on business aviation. However, given the increasingly challenging market dynamics, we have made this difficult decision to end Learjet production, President and CEO Éric Martel, February 2021

One of the few aircraft manufacturers that did not start out with an airplane, Bombardier was established by Joseph Armand Bombardier in 1942 as a result of his commercial success in building a snowmobile that could handle the inhospitable winters of rural Quebec (Bombardier, 2009). Bombardier’s company, originally known as L’Auto-Neige Bombardier Limitée “Bombardier”, manufactured these snowmobiles and launched the iconic Ski-Doo in 1959. After the death of its founder in 1964, Bombardier went on to acquire mass transit technologies and win the contract to build the Montreal subway system. In 1986, Bombardier expanded into Europe by acquiring a stake in the Belgian manufacturer BN Constructions Ferroviaires et Métalliques S.A.  That same year, Bombardier expanded into the aerospace industry by acquiring Canadair, a leading aircraft manufacturer and known for producing the popular Challenger wide-body business jets (“About us,” 2009). Bombardier made most popular aircraft currently include its Dash 8, CRJ100/200/440, and CRJ700/900/1000 lines of regional airliners. Most of Bombardier’s growth and diversification since its inception was derived from mergers and acquisitions. Bombardier’s strategy differs markedly from other North American aircraft manufacturers in that Bombardier had very little engineering or original design-oriented growth. Rather, Bombardier specialized in acquiring strategic business interests from other manufacturers and incorporating them into innovative business models or continuing previously started initiatives. In 1986 Bombardier purchased Canadair, which had been the developer of the Challenger Business Jet and the twin-engine T-tail design that would become the basis for the Bombardier CRJ.99 With funding by Bombardier, the 50-seat regional jet rolled out in 1991. The 50-seat Canadair Regional Jet (CRJ), known as the CRJ100 program, beat Embraer to market because the Brazilian company was embroiled in a financial crisis that would not be resolved until the mid-1990s. In the meantime, the Bombardier CRJ dominated the skies, enjoying the firstmover advantage in a market that was previously deemed impractical for anything except turboprops (Eden, 2008). However, due to design innovations in turbofan engines, jets were slowly becoming economical, especially in aircraft with a 40–50 passenger capacity. Due to a strong consumer preference for jets over propellers, once a regional airline had successfully introduced jets in its service, the others would have to follow its lead (Eden, 2008). Once jets had been introduced into the regional jet market, therefore, subsequent market growth was all but inevitable. To help with the certification and construction of the CRJ, Bombardier bought Short Brothers, an Irish firm that became the chief provider of sub-assemblies for the

99

 Bombardier Launches C Series Jet, New York Times, July 13, 2008.

1.7  Regional Jet Market

59

CRJ.  Lufthansa was the launch customer, and the first CRJ100 was delivered to them in 1992. Comair, a U.S. commuter airline, was the U.S. launch customer. The CRJ proved to be highly popular, and several additional versions (with extended range and fuselage elongation) were produced. When the Embraer ERJ 145 finally came into the market in the mid-1990s, it found itself in competition with the Bombardier CRJ, which was dominating the 50-seat market. Embraer, however, addressed itself to the 70-110 seat market, which was precisely in between the smallest offering of Airbus and Boeing and the market served by Bombardier (ICMR, 2007). By concentrating on this underserved segment, Embraer was able to compete viably with Bombardier, especially since the economics of the regional airline market favored a gradual increase in capacity due to economies of scale (Eden, 2008). In 1999, Bombardier developed a stretched version of the CRJ100, the CRJ700, which could seat 70 passengers. This achieved a level of commercial success comparable to that of the CRJ 100, and both went on to become mainstays of regional airlines like United Express, Delta Connection, and Lufthansa CityLine (“Airliners.net,”). Following its strategy of acquisition-led growth, Bombardier acquired Learjet in 1990 and used Learjet’s assets to launch the innovative Flexjet program in 1995. Following the example of NetJets (1986), Bombardier entered the field of fractional jet ownership through a mixture of owned Learjet business aircraft and subcontracted assets. Fundamentally, this differed from the charter business in that customers purchased a fraction of the aircraft and were not charged for repositioning legs. This program was extremely popular and has been the basis for competitors like Raytheon Travel Air in 1997, now Flight Options. Currently, the Flexjet program offers Learjet 40 XR, Learjet 45 XR, Learjet 60 XR, and Challenger aircraft. In 1999, Flexjet started European operations, and in 2000, they acquired Skyjet, a pioneer in online charter reservations and scheduling. In 2001, Flexjet entered the Asia market. Additionally, in 1992, Bombardier acquired the de Havilland Aircraft Company, then a subsidiary of Boeing, specializing in bush and STOL aircraft.100 In the 1980s, de Havilland had begun to develop a 36-seat, twin-engine turboprop airplane, the Dash 8, to fill the market gap between its popular bush Twin Otter (20 seats) and the Dash 7 (50 seats). The Dash 8 had two initial versions, the Dash 8-100 and -200 (offering better performance and cruising speed over the -100), both of which met with success among regional airlines like the Austrian-based Tyrolean and the Dutch-based Schreiner. A stretched version, the -300, was later conceived, and the resulting increase in passenger capacity (and the corresponding fall in CASM) made the Dash 8 even more attractive. The -400 series was introduced shortly thereafter in 1987. Under Bombardier’s leadership, the production of all four versions of the Dash 8 was reinstated, with significant improvements, including a noise and vibrations suppression system (NVS), which resulted in significant decreases in noise production. While the Dash 8 series’ success has been undermined to an 100

 Reed Business Information UK Jun 16-Jun 22, 2009.

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1  The Globalization and Evolution of the Aviation Industry

extent by the new wave of regional jets from Embraer and Bombardier’s own product line, the Dash 8 series continues to find a niche market among operators who fly relatively short-haul routes and require the excellent economies offered by this aircraft family (Eden, 2008). Once again, Bombardier’s growth strategy was to acquire de Havilland at a strategically crucial point in Bombardier’s development cycle, reinvent and re-market the purchased product, and expand its own product portfolio in the process. Bombardier strived to remain competitive in the regional jet market. Bombardier introduced the CRJ1000 NextGen, which features flight deck improvements and increased use of composite materials to compete in the market for large regional jets on December 15, 2010, with inaugural delivery to Air France affiliate, BritAir. Furthermore, Bombardier has been aggressively expanding into the business jet sector. For example, in 2002, Bombardier launched the Global Business 5000, a super-­ large business jet, and followed it up a few years later with the Global Express XRS, which offers improvements in speed and cabin size for transatlantic travel (“Bombardier Aerospace,” 2009). However, struggling with heavy losses, Bombardier in 2017 announced its partnership with Airbus on the C-Series. Having relinquished majority control of 50.01% to Airbus, Bombardier only retained 31%. In June 2019, the Q-series was sold to De Havilland Aircraft of Canada Limited (formerly Longview Aircraft Company of Canada Limited) for approximately $300 million.101 Also, in June 2019, Bombardier announced its intention to exit commercial aviation with the sale of the CRJ line to Mitsubishi Heavy Industries Ltd. for $550 million. Mitsubishi, with its ambitions of the MRJ, subsequently renamed SpaceJet aircraft, are making a big effort to enter the commercial aviation sector. The deal was concluded in June 2020.102 In the heat of the COVID-19 pandemic, Bombardier sold its remaining aerostructure division to Spirit AeroSystems.103 As a closing to its endeavor in commercial aircraft manufacturing, Bombardier exit the industry by selling its remaining interest in A220 to Airbus in February 2020.104 Currently, Bombardier retains its business jet production that consists of Learjet 70/75, Challenger 300/600, Global Express and Global 7500. On February 11, 2020, Bombardier announced that it would cease production of the Learjet at the end of 2021, after 60 years (Figure 1.11 and Table 1.9).

101  https://www.bombardier.com/en/media/newsList/details.binc-20190603-bombardier-concludes-sale-of-the-q-series-aircraft.bombardiercom.html 102  https://www.bombardier.com/en/media/newsList/details.binc-20200601-bombardier-concludes-sale-of-the-crj-series-region.bombardiercom.html? 103  Canning, M. Bombardier becomes Spirit AeroSystems as the deal is done on milestone day for Belfast aerospace firm. Belfast Telegraph. October 30, 2020. 104  Bombardier exits the commercial plane business, sells remaining A220 stake to Airbus. CBS News (February 13, 2020).

1.7  Regional Jet Market

61

CRJ 100

CRJ 100

CRJ 200

CRJ 200

CRJ 700

CRJ 700

CRJ 900

CRJ 900

CRJ 1000

CRJ 1000 Q100

Q100

Q200

Q200

Q300

Q300

Q400

Q400

A220-100 (CS100)

A220-100 (CS100)

A220-300 (CS300)

A220-300 (CS300) 1980

1985

1990

1995

2000

2005

2010

2015

2020

Figure 1.11  Bombardier commercial aircraft production. (Source: Compiled by the authors from Bombardier aircraft production data (as of April 2021)) Table 1.9  Bombardier commercial aircraft Aircraft model CRJ 100 CRJ 200 CRJ 700 CRJ 900 CRJ 1000 Q100 Q200 Q300 Q400 A220-100/CS100 A220-300/CS300

Launch customer Lufthansa Northwest BritAir/ Air France Mesa Airlines Air Nostrum/BritAir NorOntair BPX Colombia Time Air All Nippon Airways Swiss Global Air Lines airBaltic

Produced 226 709 346 436 63 299 105 267 587 50 102

Source: Compiled by the authors from Bombardier aircraft production data (March 2019) and Airbus orders and deliveries (April 2021)

1.7.3 Mitsubishi Aircraft Corporation The Mitsubishi SpaceJet family represents our plan to redefine the business of regional air travel… This is a commercial segment where we see great opportunity. As we prepare for entry-into-service for the SpaceJet M90, we are also announcing the SpaceJet M100—the result of our research and development during the past few years and the answer to the regional market’s current and future needs. H. Mizutani, President, Mitsubishi Aircraft Corporation, June 25, 2019.

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1  The Globalization and Evolution of the Aviation Industry

Mitsubishi Aircraft is a joint venture of MHI and Toyota Motor, with numerous contractors such as JAMCO, Rockwell Collins and Spirit AeroSystems to design various parts of the jet. The other major partners include Pratt & Whitney who is to supply geared turbofan engines, Parker Aerospace, to supply the aircraft’s hydraulic system and Hamilton Sundstrand, providing electrical power.105 The originally named Mitsubishi Regional Jet (MRJ), or the current Mitsubishi SpaceJet106, is the first entrance of a Japanese manufacturer into the regional jet market. MRJ is a family of 70 to 90 seat next generation regional jets.107 The first mock-up was introduced at the Paris Air Show in 2007, and the product was launched in 2008. Japan’s All-Nippon Airways placed an order for 15 MRJs with an option for ten more in 2008 (Aerospace Technology, retrieved January 2009). Similarly, SkyWest, Japan Airlines and Rockton AB placed orders for expected 2021 entry to service. Variant Single class Mixed class Cargo Cabin Length Wingspan Tail height MTOW OEW Fuel Capacity Mitsubishi Aircra

M90 M100 88Y @ 31" pitch 84Y @ 31" pitch 81 (9J@36" + 72Y@30") 76 (12J+12W+52Y) 644 ³ 481 ³ 6  8 in Height × 9  1 in Width 117  5 in 113.2  95  10 in 91.3  34  2 in 33.9  94,358 lb 92,594 lb 57,320 lb 3,200 US gal / 21,344 lbs

Upon rebranding the MRJ series to SpaceJet, the original MRJ 90 was renamed as M90. The M90 is a 90-seat aircraft with two Pratt & Whitney PW1200G engines. Later, a variation of M90 was developed as M100, which was a revision of MRJ70. The smaller M100 is planned for 76 seats in consideration of the US scope clause (even though some complication with compliance was noted108). Once the jet is developed, it will be a direct competitor to the Embraer regional jets and CRJ regional jets (that was acquired from Bombardier by Mitsubishi). The MRJ series was expected to have a strong presence in the Asian and Pacific markets. Trans States Airlines is the first international customer with an order of 500 firms and 50 options for MRJ 90s, and All Nippon Airways (ANA)109 is the first customer, with an order for 15 MRJ 90s and an option for ten more.110 The MRJ was scheduled to make its first flight in 2011 but was subsequently delayed due to  Mitsubishi Aircraft News No. 2, January 13, 2010.  Mitsubishi rebranded the MRJ program as the SpaceJet in June 2019. 107  Mitsubishi Aircraft News No.1, 2, January 13, 2010. 108  Evolving the MRJ into the SpaceJet. Leeham News. June 13, 2019. 109  ANA Selects Mitsubishi Regional Jet, Company News. 110  First Foreign Order for Mitsubishi Jet, 100 Planes to America. 105 106

1.8 Summary

63

technical issues and flew in November 2015, with initial deliveries originally scheduled for 2013 and now scheduled for 2020.111 The certification is not yet complete and due to the COVID-19 pandemic, it was reported that Mitsubishi Aviation has cut the development budget and put a temporary hold on the operation while still pursuing the certification. A scope clause is simply the scope of the bargaining agreement between a company and its represented employees. In the airline industry, the scope clause is part of a contract between a major airline and its pilot unions that limit the number and size of aircraft that may be flown by the airline’s regional airline affiliate. A clause restricts regional carrier flying to 76 seats and 86,000 lbs MTOW, while also restricting the number of regional jets that can be flown by each carrier. The original baseline model under development was the MRJ 90, as there was the expectation that there would be a loosening of the strict scope clause for aircraft serving US regional routes beyond the current 76 seat capacity maximum. This did not come to light, and as part of the renaming of the aircraft to SpaceJet, the aircraft was redesigned to be smaller with 70 seats instead of 90 seats to be within the scope clause limits. In addition, it was announced that the US production facility for the aircraft was also being considered. There is still progress on the 90 seat model, but it is pushed back from the now baseline 70 seat model. On October 30, 2020, MHI announced that it would halt the SpaceJet project, citing the plunge in air travel caused by the COVID-19 pandemic.112

1.8

Summary

The global commercial aircraft manufacturing industry is still dominated by two major manufacturers; Boeing and Airbus. In the 1960s, the US commercial aircraft manufacturers had over 90% market share. Today, Airbus has more than 50% market share. The industry is characterized by massive capital requirements and massive research and development costs in the tens of billions of dollars. Therefore, the industry is characterized by a tendency towards natural monopolies, with smaller manufacturers consolidating into larger entities in an effort to gain greater economies of scale, scope and density. It may also be argued that most large commercial aircraft manufacturing is cross-subsidized by regional governments, either through  Mitsubishi Aircraft News No.3, September 4, 2008. https://asia.nikkei.com/Business/Companies/Mitsubishi-to-turn-MRJ-into-cheapersmaller-Space-Jet 112  The Japan Times, Pride before a fall: Why Mitsubishi Aircraft’s SpaceJet project is grounded, November 13, 2020. 111

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1  The Globalization and Evolution of the Aviation Industry

direct subsidies or investments or through defense contracts that are executed by the same company. Typically, aircraft manufacturing is not as exposed to the volatilities in consumer demand as airlines or airports are. Aircraft manufacturers have highly inelastic supply schedules since an expansion in production involves extensive capital and human resource investment. Generally, manufacturers maintain a backlog of orders that grows shorter if demand is slack and lengthens if demand is high. Therefore, production and sales are maintained at a relatively constant level. The two main commercial aircraft manufacturers at present are Boeing and Airbus for airliners with greater than 90 seats, especially given Airbus’s tie up on Bombardier’s C-Series renamed A220 aircraft and forsaken Boeing’s partnership with Embraer. The main manufacturers for the regional jet market are more fragmented with Embraer and Mitsubishi with the SpaceJet aircraft along with the acquisition of the CRJ aircraft line from Bombardier. Now players include also include de Havilland Aircraft of Canada after its acquisition of the Q series from Bombardier and COMAC with its ARJ21 aircraft. Recent developments include the emergence of China into regional and large commercial aircraft manufacturing. In addition, Russian commercial aircraft continues to develop with the SuperJet and MC-21 aircraft lines. Its partnership with COMAC on the CR929 wide-body aircraft will also continue to show its strengths. However, given such highly inflexible cost and supply structures, long-term development models and the existence of a stable duopoly in aircraft manufacturing, neither the development of large regional jets nor the entrance of China is likely to alter the dynamics of the industry profoundly for some time. Aircraft manufacturing will always remain a technological and capital-intensive undertaking, and the high switching costs associated with aircraft purchases can imply that most airlines face a monopoly supplier.

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Fleet and order status. (2019). The Emirates Group fact files webpage, 2018, from http://www. theemiratesgroup.com/english/media-­kit/fact-­files.aspx Gunston, B. (1988). Airbus. Osceola, WI: Osprey. ICAO Traffic Data. (2010). Retrieved January 13, 2010, from International Civil Aviation Organization http://icaodata.com/ Ingells, D. J. (1968). Tin Goose: The fabulous Ford Tri-Motor. Fallbrook, CA: Aero Publishers. Kaminshi-Morrow, D., & Fafard, A. (2011). World airliner census. Flightglobal, 27. Retrieved from http://www.flightglobal.com/features/census-­2011/ Kay, A. L., & Couper, P. (2004). Junkers aircraft and engines, 1913-1945. London: Putnam Aeronautical Books. Larkins, W. T. (2004). The Ford Tri-Motor, 1926–1992. West Chester, PA: Schiffer Publishing. Model 10 Electra. (2009). The Lockheed Martin Corporation History webpage. Retrieved January 22, 2009, from http://www.lockheedmartin.com/aboutus/history/Model10Electra.html Norris, G., & Wagner, M. (1998). Boeing. Osceola, WI: Motorbooks Intl Publishing. Sandler, T., & Hartley, K. (2007). Handbook of defense economics: Defense in a globalized world, 2. North Holland. Schedule Tapes for June 2009. (2009). Available from Official Airline Guide (OAG) BACKOffice Schedules Retrieved 2009, from Official Airline Guide (OAG). Sedaei, S. (2006). Commercial Aircraft Industry. Lux Esto Law Review, 2(1), 7. SR-71 Blackbird. (2009). The Lockheed Martin history webpage. Retrieved January, 2009, from http://www.lockheedmartin.com/aboutus/history/SR71Blackbird.html Stork Technical Services annual report 2007. (2007). Retrieved from http://www.stork.nl/d/STCf/ StorkJV2007ENG.pdf The Boeing Commercial Company, Heritage of Innovation, 2009. The Boeing Commercial Company. Orders and delivers, 2021. The Fokker Heritage 1911–2009. (2009). Fokker History webpage. Retrieved January, 2009, from http://www.fokker.com/frp-­History Tradition & Background. (2009). About Embraer, 2009.

2

Aircraft Variants and Manufacturing Specifications

Choosing the right aircraft is crucial for management in ensuring reliable on-time services hence a stream of revenue and profit. Airlines should develop a comprehensive range of models that allows them to assess the financial and operational impact of flying different aircraft types. Several attributes of an aircraft, including the aircraft size, commonalities, cost, revenue, along with operational specifications such as range, payload, fuel efficiency, and the potential for generating ancillary revenue, must be considered. Furthermore, exogenous factors such as the spread of communicable diseases, economic and population growth, air transport liberalization, privatization, passenger bills-of-rights, regulations and deregulations, legal restrictions and labor restrictions are critical to the aircraft selection and valuation process. Many manufacturing specification and performance factors determine how well an aircraft retains its value, as well as how effective the prospect for remarketing is. In 2013, Frontier Airlines retired the last A318 at the young age © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 B. Vasigh, F. Azadian, Aircraft Valuation in Volatile Market Conditions, Management for Professionals, https://doi.org/10.1007/978-3-030-82450-1_2

67

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of 10. Requiring the same amount of crew on board as the A319, weighing just 3000 pounds less and having only 85% the seating capacity of the A319, the A318 just could not find its place in the market. Over its 10-year production (2003–2013), Airbus built only 81 A318. This chapter provides the financial and physical specifications of the different commercial jetliners that are currently in service. For each major manufacturer, we will discuss both commercially produced narrow-body and wide-body aircraft. Airlines must utilize aircraft-specific data, as well as other information, to determine the type of aircraft they are going to acquire. This chapter will present the basic general, physical, and operating metrics for a wide variety of airline models in order to provide a roadmap for valuation. We have organized this chapter as follows: Boeing’s Commercial Aircraft • Boeing Existing Fleet –– General Characteristics of the Existing Fleet • Boeing out-of-production airplanes Fleet –– General Characteristics of the Retired fleet Airbus’ Commercial Aircraft • General Characteristics of the Fleet McDonnell Douglas’s Commercial Aircraft • General and Physical Characteristics of the Fleet Lockheed • Commercial Aircraft Characteristics COMAC’s Commercial Aircraft • General and Physical Characteristics of the Fleet Regional Jets • Embraer • De Havilland Aircraft of Canada General Characteristics of the Fleet • Mitsubishi Heavy Industries At the end of the chapter is a summary of this chapter’s highlights and a selected bibliography for further study.

2.1

Introduction

The aircraft selection process is very complex for an airline, and selecting the right aircraft is a key determinant of failure or success for an airline. Financial managers must convalesce a comprehensive range of methodologies that allows for a thorough investigation of the financial metrics of different aircraft. For fleet planning purposes, financial planners should utilize a detailed model incorporating the aircraft price, operating cost estimates, the position of the hub-airport, along aircraft operational specifications such as speed and potential revenue. These financial considerations are the heart of the airlines’ fleet section process. Fuel and labor costs are, by a significant margin, the highest

2.1 Introduction

69

single cost of operating an aircraft. Nonetheless, macroeconomic factors such as economic, population growth, and future demand are critical to aircraft selection and aircraft pricing. Other factors that consistently rank high among potential investors consist of: • • • • • •

Aircraft’s order-book Financing environment Market penetration, Production life cycle Secondary market prospects Surplus/shortages

Choosing an appropriately sized aircraft is a critical and complicated process for every airline. Unlike full-service carriers, low-cost carriers, such as Southwest, Ryanair, and easyJet, typically only use one plane type. Ryanair, for example, operates only the narrow-body Boeing 737 aircraft on over 850 routes across Europe and North Africa.1 Commonly used aircraft for low-cost carriers like easyJet include members of the Airbus A320 and Boeing 737 families, which reduce training, spare parts inventory, and servicing costs. With the development of the Airbus A320neo and Boeing 737MAX family of aircraft, we have observed that airlines upgrade to the latest generation of technology with better operating metrics. Narrow-body aircraft are also more suitable for short-haul markets and enable faster enplanement and deplanement than wide-body aircraft. The fuel crisis and the global financial crisis of 2007–2008 prompted a dramatic drop in load factors beginning in the middle of 2008. In response, airlines took aircraft out of service and imbedded plans to order replacements for existing planes. Since this period, the industry has seen a bull run as many aircraft have been produced, and many airlines have been created to absorb this supply to satisfy the growing demand. Consolidation, lower fuel prices and economic growth have resulted in record profits for the industry. The airline industry is known for boom and bust cycles that give profits during the boom and destroy the portfolios during economic crashes. The coronavirus pandemic of 2020 has resulted in a severe decline in air travel. United Airlines cut capacity by about 50% for April and May of 2020. Many other airlines experience a drop in demand because of the coronavirus outbreak.2 Delta Air Lines cut its flight capacity by 40% due to a coronavirus-­ related decline. Singapore is cutting capital spending by S$2.2 billion in 2020–21, S$1.7 billion in 2021–22 and by a more limited amount in the following 3 years.3 Since the beginning of 2020, new aircraft deliveries are down nearly 40% on original plans. Seeking to reduce costs and preserve liquidity during the pandemic, airlines have requested more cancellations and deferrals into 2021. These reductions in

 http://www.ryanair.com/site/about/invest/docs/2010/q1_2010_doc.pdf  The Vege. Delta is cutting more flights now than it did after 9/11, May 13, 2020. 3  Reuters, February 9, 2021.

1

2

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2  Aircraft Variants and Manufacturing Specifications

demand were the most significant cutback in operations in the airline’s history, surpassing the financial crisis of 2008 and the aftermath of 9/11.4

2.2

Boeing’s Commercial Aircraft

This is a crucial time for Boeing … We have work to do to uphold our values and to build on our strengths. I see greatness in this company, but I also see opportunities to do better, much better. David Calhoun, Boeing CEO, Jan. 14, 2020

Since its entry entered into the large jet market in 1954, Boeing has produced both narrow and wide-body jets, each with several variants and specifications. Boeing is the world’s largest manufacturer of commercial aircraft. Three main groups of products and services cover Boeing’s business model: • Commercial airplanes • Military aircraft • Missiles, and space and communications Boeing manufactures seven distinct commercial aircraft families; the narrow-­ body Boeing 727 (discontinued in 1984), 737, 757 aircraft (discontinued in 2004), the wide-body Boeing 767, 777and 787 aircraft and a limited number of the largely discontinued 747 s.

2.2.1 Boeing Existing Fleet Currently, Boeing produces 737 MAX variants, 747-8 variants,5 767-300F, 777-200LR, 777-300ER, 777-200LRF, and 787 variants. The newest of these aircraft, the 737 MAX, is a twin-engine jet airliner, the first aircraft delivered to Indonesian-owned Malindo Air in May 2017. There are currently more than 10,000 Boeing commercial jetliners in service around the world, as either passenger airliners or freighters.6 Boeing commercial aircraft range from 128 seats (in the Boeing 737-700 NG models in mixed configuration) to 605 seats (Boeing 747-8, high-­ density configuration). The new MAX seats between 172 and 230 passengers, reducing fuel costs and CO2 emission by 14% over the newest Next-Generation 737, and 20% better than the first Next-Generation 737 s. It is targeted at the single-­ aisle market, and the MAX 8 variant will be 8% more fuel-efficient than its direct competitor, the A320neo.7 The Boeing Commercial Airplanes provides varieties of

 ICF, Projecting the market future of commercial narrow-body aircraft, August 13, 2020.  Boeing has announced it will end production of its 747 airliner in 2022. 6  Boeing Company, Boeing in Brief, February 12, 2022. 7  Boeing Commercial Airplanes, Singapore Airlines defers $3 billion of spending on Airbus, Boeing planes,2020. 4 5

2.2  Boeing’s Commercial Aircraft

71

models and versions to meet the demand of airlines. Currently, only the following models are in production. • • • • • • •

Boeing 737 MAX Boeing 747-8 variants Boeing 767-300F Boeing 777-200LR Boeing 777-300ER Boeing 777-200LRF Boeing 787 variants are in production

Boeing delivered 157 planes in 2020 as its 737 Max crisis intensified by the Coronavirus pandemic. Commercial aircraft deliveries in 2020 reflect the significant impacts of the COVID pandemic on the airline and airport operations that included a shutdown of the commercial aircraft production for several weeks. Aircraft 737 Max 7 737 Max 8 737 Max 9 737 Max 10 777 200 777 200ER 777 200LR 777 300 777 300ER 787-8 787-9 787-10 747-8i

Specification Twin engines, single aisle Twin engines, single aisle Twin engines, single aisle Twin engines, single aisle Twin engines, twin aisle Twin engines, twin aisle Twin engines, twin aisle Twin engines, twin aisle Twin engines, twin aisle Twin engines, twin aisle Twin engines, twin aisle Twin engines, twin aisle Four engines, twin aisle

Seats 138–153 162–178 178–193 188–204 301–400 3-class 301–400 3-class 301–400 3-class 365–451 3-class 365–451 3-class 242 2-class 280 2-class 330 2-class 410 3-class

Range (nmi) 3850 3550 3550 3330 4240 7065 8555 6006 7370 7355 7635 6430 7730

2.2.1.1 General Characteristics of the In-Production Fleet It wasn't until the jet engine came into being and that engine was coupled with special airplane designs — such as the swept wing — that airplanes finally achieved a high enough work capability, efficiency and comfort level to allow air transportation to really take off. -Joseph F. Sutter, Boeing Commercial Airplanes

The development cycle of commercial aircraft typically begins with creating a base aircraft model from which variants with unique range, seating, power plant, capacity and other characteristics are developed. Boeing has produced six narrow-­ body (not including the MD 80/90 models) and four wide-body aircraft base models since its entry into commercial jet aircraft manufacturing. These base models are divided into variants with varying operational, physical and technical specifications. For example, the Boeing 737 base model has several variants including the 737-100,

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-200, -300, -400 and -500 (Classic) and 737-600, -700, -800, -900 (NG) and 737 MAX7, MAX8, MAX9, MAX10. While the Boeing 737NG runoff its building program, the new technology production Boeing 737MAX continues to build on its predecessor base model’s strengths as the most popular (and only) Boeing narrow-body aircraft design currently in production.8 On December 18, 2019, Boeing delivered the last Boeing 737 NG aircraft, ending a production run that started in late 1997. On the wide-body market, the newest 747 variants, the 747-8 Intercontinental is to be 30% quieter, 16% more fuel-efficient, and have 13% lower seat-mile costs with nearly the same cost per trip than the out of production Boeing. The aircraft used to be Boeing’s top-selling wide-body with record deliveries of 1555.9 The Boeing 777 family stands as the bestselling wide-body aircraft in the history of aviation, with 1656 deliveries as of February 2021. The Boeing 777X is the latest series of the long-range, wide-body, twin-engine Boeing 777 family. More fuel-­ efficient engines and aircraft composition have extended the range of the super twin aircraft. Table  2.1 outlines the general characteristics of Boeing’s in-production commercial aircraft from the earliest 737NG to the 787, which had its maiden flight in December of 2009. Boeing aircraft, by offering a significant variety of capacity types, cater to the needs of a wide range of commercial aircraft operators. The smallest in production member of the Boeing family, the 737-600, can carry between 108 to 149 passengers and the largest 737 MAX, the 737 MAX 10, can carry up to 230 passengers in a two-class layout, compared to the highest density capacity available in the Boeing family of a 605-seat 747-8. Table 2.2 outlines the main physical characteristics of the Boeing commercial aircraft currently in production. In-production Boeing aircraft operate with Pratt & Whitney, General Electric, CFM and Rolls-Royce variants for the various aircraft types. Similar to the commonality benefits of operating the same aircraft model, a common engine type across aircraft models and variants provides maintenance, time and savings benefits to airlines utilizing more than one aircraft model. Other Boeing aircraft and variants purposefully and competitively fill in the gap between the highest capacity available and the lowest. For example, the Boeing 787-8 has a 359 high-density seat capacity, halfway between that offered by the 737MAX and the 747-8. The newest member of the 747 family (747-8) fits the seat market between the 555-seat Airbus A380 and 365-seat Boeing 777-300ER.  oeing 737 MAX B Boeing’s latest aircraft re-design, the Boeing MAX family, builds upon the existing best-selling 737NG family and replaces them with more fuel-efficient CFM International LEAP-1B engines. The Boeing MAX 7, MAX 8 and MAX 9 are centered on the 737-700, 737-800 and 737-900, respectively. According to Boeing

 As of April 2021, orders for the Boeing 737 MAX were 5409 with 453 deliveries.  Boeing Orders and Deliveries 2020.

8 9

2.2  Boeing’s Commercial Aircraft

73

Table 2.1  General characteristics of Boeing in-production aircraft Model Type 737 Narrow-­ Body

Variant -700 -800

-900/-900ER -MAX (-8/-9) 747

Wide-­ Body

-8 -8F

767

Wide-­ Body

-300ER/-300F

777

Wide-­ Body

-200/-200ER/200LR -300/-300ER

-F 787

Wide-­ Body

-8 -9

-10

First flight 9-Feb-­ 97 31-Jul-­ 97

Major operators Southwest/ Westjet Southwest/ Ryanair/ American 3-Aug-­ United/ 00 Delta/Alaska 29-Jan-­ Southwest/ 16 Lion Air 20-­ Lufthansa Mar-­11 8-Feb-­ Cargolux 10 30-Jan-­ Delta/ 86 United/UPS/ FedEx 12-­ United/ Jun-­04 American/ British 16-­ Emirates/ Oct-­97 Cathay Pacific 14-Jul-­ FedEx 08 15-­ ANA/Qatar Dec-­09 Airways 17-­ ANA/Air Sep-­13 Canada/ United 31-­ Singapore/ Mar-­17 Etihad

Total ordered 1408

Total delivered 1128

In-service 730

5441

4989

3580

629

557

390

5370

435

71

57

47

21

142

95

93

890

772

436

665

570

153

951

884

647

265

202

200

661

375

241

1009

556

448

212

61

60

Source: Compiled from Boeing & Centre for Aviation & Cirium fleet data (as of March 2021)

MAX gives a 7% greater fuel reduction than the A320neo. Boeing delivered its first Max in 2017, 2 years after Airbus’s A320neo.10 The 737 MAX incorporates a new aerodynamic design that helps increase fuel capacity and efficiency, both of which increase range.11 The 737 MAX is fitted with split winglets, also called split-scimitar winglets. Winglets are added to the end of a plane’s wings to reduce drag and ultimately enable more fuel-efficient flight. Boeing claims this design delivers the maximum contribution to fuel efficiency.12 In

 Boeing (2011, August 30) Press Release: Boeing Introduces 737 MAX with launch of new aircraft family. 11  CFM International is a joint venture between GE Aviation and Safran Aircraft Engines (formerly known as Snecma), of France. 12  Simple Flying. Why Does The Boeing 737 MAX Have Split Winglets? January 15, 2021. 10

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2  Aircraft Variants and Manufacturing Specifications

Table 2.2  Physical characteristics of Boeing in-production aircraft Capacity: mixed

Capacity: high densitya

Power plant manufacturerb

# of engines 2

Variant

Wingspan

Length

-700/-800/-900 (NG)

117′ 5″

110′ 4″-138′ 2″

126

220

CFM

-MAX (-8/-9)

117′ 10″

116′ 8″-143′8″

138

230

CFM

747

-8/-8F

224′ 7″

250′ 2″

515

605

GE

4

767

-300/-300ER/300F -200/-200ER/200LR

156′ 1″

180′ 3″

261

290

GE, PW, RR

2

199′ 11″-212′ 7″

209′ 1″

305

440

GE, PW, RR

2

-300/-300ER

199′ 11″-212′ 7″

242′ 4″

365

550

GE, PW, RR

-F

212′ 7″

209′ 1″

-

-

GE

186′ 1″

242

381

GE, RR

420

GE, RR

440

GE, RR

Model 737

777

787

-8

197′ 3″

-9

197′ 3″

206′ 1″

290

-10

197′ 3″

224′ 1″

330

2

Source: Boeing aircraft production data a FAA exit limit b CFM, GE, PW, RR stand for CFM International, General Electric, Pratt & Whitney and Rolls Royce respectively

November 2020, the FAA finally recertified the Boeing 737 MAX for commercial service after two fatal crashes and following a 20-month grounding. Table 2.3 lists some of the major operational characteristics of Boeing aircraft. Since the time of the 737, the industry (and therefore the manufacturer’s) focus has been on producing more fuel-efficient aircraft rather than continuous increases in cruising speed or range. The Boeing 747 represented the first real speed/range increase over the out-of-production 707, albeit in a completely different market, the wide-body jetliner market. Boeing 767 The Boeing 767 is a wide-body, twin-aisle airliner, and the prototype first flew on September 26, 1981, and the original 767-200 entered service on September 8, 1982 with United Airlines. Boeing has produced the aircraft in three different fuselage lengths. These introduced in progressively larger model as the 767-200, 767-300, and 767-400ER.13 The 767-400ER entered service with Continental Airlines in 2000. A key issue in early Boeing 767 operations was proving the aircraft’s reliability for overseas operations. The 767 can be equipped with special features to enable it to fly extended range operations in 13

 Boeing Commercial Airplanes, Airport Planning. September 2005.

47,890 33,340 33,384 33,384

44,700–46,623

0.84

0.84 0.85 0.85 0.85

31,000–47,890

16,700–24,140

0.84

0.80

63,034 59,734

6638

0.79

0.86 0.85

Fuel capacity (U.S. Gallons) 6,875–7837

Cruising speed (Mach) 0.78–0.79

4970 8450 8800 7400

3225– 6850 5900– 9900 9000

Range (nm)a 3950– 3500 3100– 3800 8000 4120

43,000 43,000 43,000 43,000

43,000

43,000

43,000

43,000 43,000

41,000

Max. altitude (Ft) 41000

5828 5405 6013 4951

7773

6618

4907

N/A 5718

236–352

Total flying cost per block hour ($)b 2796

Source: Compiled by Boeing aircraft production data & Airline Monitor (as of 2020) 1 Range varies on variant & engine type 2 737-800, 767-300ER, 777-300ER were used as benchmarks for operating costs per BH & average stage length c No operating data available

787

-F -8 -9 -10c

-300/-300ER/300F -200/-200ER/200LR -300/-300ER

767

777

-8c -8F

747

Model Variant 737 -700/-800/-900/900ER (NG) -MAX (-8/-9)c

Max. Takeoff weight (Lbs) 154,174– 187,181 181,200– 194,700 987,000 975,000– 987,000 345,000– 412,000 506,000– 766,000 580,000– 775,000 766,800 502,500 560,000 560,000

Table 2.3  Operating characteristics of Boeing in-production aircraft

1074 1344 1369 410

1554

1567

859

N/A 774

583–545

Total maintenance cost per block hour ($)b 760

8369 8279 8726 5576

10,792

9405

6661

5832– 4963 N/A 9377

Total cost per block hour ($)b 4088

2981 3882 5648 3393

5454

4138

3453

N/A 3189

1067–1043

Average flight stage length (nm)b 1079

2.2  Boeing’s Commercial Aircraft 75

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remote areas. Prior to the 767, the FAA restricted twin-engine aircraft to overwater flights of 90  minutes or less distance from diversion airports. The 767 was the main competitor of the Airbus A310. The first 767 accommodated seven-abreast seating in the economy class (2-3-2) compared to the eightabreast interior of the A310. The aircraft was designed based on fly-by-wire controls, glass cockpit, flexible interior, and 10% better seat-mile costs than the A330 and MD-11. The 767-400 ER flight deck instrument panel has 82% fewer parts than other 767 s driving production time down from 180 hours to just 20. The aircraft was the first Boeing aircraft to be stretched twice; the 767-400ER is 21 feet longer than the 767-300, which is 21 feet longer than the original 767-200. Size-wise, the 767 fits the gap between the 737NG and 777 aircraft, being 4 feet wider than single-aisle jetliners, allowing five, six, seven or eight abreast seating. In a typical three-class seating of 181 to 245 passengers, there are five-abreast first-­class seats, six-abreast business class and seven-abreast economy class.14 The only current 767  in production is the freighter version, 767-300F. Although the Boeing 767 appears to have the lowest operating and flying cost per block hour, it is considerably limited in range compared to the 777. Extended Twinjets Operations (ETOPS) describes the operation of twin-­ engine aircraft over a route that contains a point further than sixty minutes’ flying time from a diversion airport at the approved one-engine inoperative cruise speed. In 1985, TWA received special allowance to fly their twin-engine 767 transatlantic from Boston to Paris. This was the first ETOPS 120 minutes certification rating given. ETOPS-240, meaning a certification that allows twin-engine jets to operate four hours away from the nearest diversion airport.

Boeing 747 The Boeing 747, is a wide-body commercial airliner and cargo transport aircraft, was developed in the mid-1960s, following a failure to obtain a US military contract for a large jet transport, and the contract that eventually went to Lockheed’s C-5 Galaxy. However, the research and development that was conducted as part of the military transport aircraft were reapplied towards a high capacity, the four-engine civilian jetliner that was capable of servicing hightraffic routes both domestically and internationally. The 747-100’s first flew in the early morning hours of January 22, 1970, from New York to London operated by Pan Am, inaugurating a new era for air travel. This aircraft altered the economics of long-haul commercial air transportation. Boeing delivered 250 of the 747-100 s, the last in 1986. Subsequent variants included the Boeing 747-200 with a stretched upper deck, the immensely popular extended range Boeing 747-400, and 747SP, which is a shortened version of the 747 with a longer 14

 Boeing 767 Family Technical and Production Facts.

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range. The 747 represented a significant improvement in range, speeds and fuel efficiency, being two and a half times the size of the Boeing 707 and achieving longer ranges with greater fuel efficiency than its predecessor. It presented a viable long-range, high-capacity commercial airline to service trans-­Atlantic and intercontinental American routes. Derived from the earlier versions of the Boeing 747, the 747-400 incorporated numerous technological and structural changes to produce a more efficient airframe. After 747 established as the market standard for wide-body, long-range aircraft, Boeing recognized the need for a medium-haul wide-body. Continuous improvements in the 747 program, with the 747-8, delivered even more efficiency as well as greater speeds and ranges – a capacity of over 60,000 gallons resulting in a range up to 8000 nm.15 The 747-8 also has seat-mile costs that are 13% lower than for the 747-400, with 2% lower trip costs. The 747-8 Intercontinental is also more than 10% lighter per seat than the Airbus A380 and consumes 11% less fuel per passenger. Boeing announced its decision to complete production of the 747-8 in 2022. Now airlines are retiring their 747 s left and right, they are often converting them into cargo planes. With demand for air travel rising the Boeing 747 offered airlines greater seating capacity, increased range, and extra room and comforts such as onboard lounges and bars. The Boeing 747 entered service with Pan Am on January 22, 1970 it has been a game changing aircraft in so many ways. A total of 1,562 Boeing 747 aircraft are delivered as of December 2020. Boeing 777 Boeing designed 777 in the early 1990s as the most technologically advanced aircraft in Boeing’s portfolio. United Airlines was the launch customer for the 777-200, and the aircraft made its first commercial flight, a transatlantic from London Heathrow to Washington Dulles on June 7, 1995. The most common and successful variant is the 777-300ER with 833 aircraft ordered and 820 delivered (As of March 1, 2021).16 The first 777-300 was delivered to Cathay Pacific Airways in June 1998. New features in the 777 include a large-scale use of composites, fly-by-wire technology and a five-screen integrated glass flight deck. New design variants had been developed, such as the 777-200LR, which has a range of 16,417 km. The 777 is an extremely popular aircraft, which fills the wide-body space between the Boeing 767 and the 747. It could fly 350 passengers in first, business and economy over 8000 miles easily. Since the introduction of this aircraft, 1656 aircraft were delivered and 2020 orders have been placed as of February 2021.17 The most popular variant is the 777-300ER with 838 delivered and 14 orders unfulfilled as of February

 Nm is the abbreviation for “nautical mile”, and by international agreement, it is set at exactly 1852 meters. 16  Boeing, Orders and Deliveries, March 2021. 17  Boeing, Orders and Deliveries, February 2021. 15

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2  Aircraft Variants and Manufacturing Specifications

2021.18 Since its entry into service in June 1995, Boeing has expanded the 777 family to five passenger models and a freighter version. The current variants that are in production are the 777-200LR and the 777-300ER and the freighter version, 777-200LRF. A long-range aircraft seats from 301 to 368 passengers, with a range from 7370 to 8555 nm, and produced in two fuselage lengths. The 777-200 variants are 209, compared to the 242 foot 777-300 variants. The 777 is the world’s largest twinjet and it is powered by two PW4090 turbofans, Trent 892 GE90-92Bs, or PW-4098 s. The Boeing 777 was designed as the most advanced Boeing aircraft of its time, outperforming the Classic versions of the 747 in terms of efficiency and range, although smaller in capacity. The new Boeing 777X will be the world’s largest and most efficient twin-engine jet; the airliner will offer 10% lower fuel consumption and emissions and 10% lower operating costs than the competition.19 The Boeing 777X has made test flights in 2020, and it is due to enter service in 2022. There will be two versions of the 777X, the 777-8, and the larger 777-9, with a third option for an ultralong-range model not currently planned. The 777-8 seats 350-375 passengers with an incredible range capability of 8700 nautical miles and the 777-9 seats 400-425 passengers with a range of 7600 nautical miles. According to Boeing, with a spacious cabin, new custom design the 777X could deliver flight comfort and efficiency.  oeing 787 Dreamliner B Boeing’s 787 represents a new technological and manufacturing frontier in aircraft manufacturing. The maiden flight took place on December 15, 2009. The 787 Dreamliner is becoming the fastest-selling twin-aisle jet in history with 29 orders in 2020 or about 1504 since the program launched.20 The Boeing 787 features an all-­ composite construction with a 210–300 passenger seating capacity. It is also the first aircraft to be rebuilt primarily by outsourcing and assembling – the parts were outsourced to independent contractors and later assembled at Everett, Washington. This resulted in leaner manufacturing techniques and lower costs. One of the main benefits offered by the 787 to airliners is in fuel efficiency – the materials, structure, design and power-plant improvements will serve to make it about 20% more efficient than the 767, according to Boeing’s estimates. In April 2004, All Nippon Airways (ANA) became the launch customer for the 787 Dreamliner by ordering 50 aircraft with an option for 50 more. By February 2020, 957 Boeing 787 s had been ordered by 67 airlines. Boeing had originally planned for a first flight by the end of August 2007 and beginning service in May 2008. The project encountered many delays and was more than 3 years behind schedule. The FAA on August 26, 2011 approved certification of Boeing’s 787-8 and ANA took delivery of the first unit later that year. In 2014, Air New Zealand took delivery of the -9 variant and 2018 saw the certification by the FAA and delivery of the first -9 variant. The Boeing 787 program continues the trend of producing fuel-efficient aircraft amid a global

 Boeing, Orders and Deliveries, 2021.  Boeing Company Internal Report, April, 2020. 20  Boeing Company Report. January 8, 2019. 18 19

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79

aircraft market that tends to favor efficiency over speed. The 787-8 with its 8000 to 8500 nautical mile range has the ability to replace aging, less efficient aircraft on long haul routes such as Los Angeles – Bangkok by carrying 210 to 250 passengers at a cruising speed of 0.85 Mach with 20% greater fuel efficiency and emission levels compared to current available aircraft. Variant Milestones Maiden Flight Launch delivery Launch Airline Boeing 787 Price list Fuselage length Wing Span Wing area Seating

Boeing 787 8

Boeing 787 9

Boeing 787 10

12/15/2009 9/25/2011 All Nippon Airways $224.6 million 186 Ft 197 feet, 3 inches 4058 square feet 242 (2 class)

9/17/2013 7/10/2014 Air New Zealand $264.6 million 206 Ft

3/31/2017 3/26/2018 Singapore Airlines $306.1 million 224 Ft

280 (2 class)

330 (2 class)

The next 787 model to be developed, dubbed the 787-10 is expected to seat up to 336 passengers in a two-class seat configuration.21

2.2.2 Boeing Out-Of-Production Fleet Lack of sufficient demand or outdated technology would force the manufacturer to end an aircraft production. Some of Boeing’s most successful and pioneering commercial aircraft products, including the highly successful Boeing 737 NG family, are currently out of production. As of January 2021, 6920 Boeing 737NG aircraft have been ordered and delivered. Another recently retired commercial aircraft models are the 767 families of aircraft other than the freighter variant. Boeing’s decision to retire the various narrow-body aircraft models has historically been based on customer needs and market conditions. In January 2021, Atlas air announced four orders for Boeing 747-8 freighters.22 The 747-8 freighters are the largest and the most advanced cargo aircraft Boeing has ever produced. This order, however, marks the end of the production of Boeing 747 as the company announced the caseation of production in 2022.23

2.2.2.1 General Characteristics of the Out-of-Production Fleet Of the five Boeing narrow-body base models ever developed, four are currently out-­ of-­production (the exception being the Boeing 737 base model from which the Boeing 737 Max aircraft was developed). It can also be noted from Table 2.4 that the entire out-of-production aircraft families sold at least 1000 individual units, except for the Boeing 717. The Boeing 717 was originally part of the McDonnell  Boeing 787 Technical Information 2020.  Atlas Air Press release, January 12, 2021. 23  Boeing Company Press Release, July 29, 2020. 21 22

Narrow-Body

Wide-Body

Narrow-Body

Wide-Body

737

747

757

767

19-Feb-82 2-Aug-98 26-Sep-81 9-Oct-99

-300 -200/-200ER/-200F -400ER

29-Apr-88

-400/-400F

-200/-200M/-200PF

9-Feb-97 9-Feb-69

First Flight 20-Dec-57 2-Sep-98 9-Feb-63 27-Jul-67 9-Apr-67

-100/-100C -200/-200F -100/-200/-200C/-300/400/-500 -600 (NG) -100/-200/-300

Variant

Major operators PanAm Delta/Hawaiian United Delta Lufthansa/United/Southwest/ Malaysia Airlines/Continental SAS/WestJet PanAm/British Airways/ Lufthansa British Airways/Lufthansa/ Qantas/KLM FedEx/Delta/UPS/United/ American United/Delta El Al Delta/United

Source: Compiled from Boeing & Centre for Aviation & Cirium fleet data (as of Mar 2021)

Type Narrow-Body Narrow-Body Narrow-Body

Model 707 717 727

Table 2.4  General characteristics of Boeing out-of-production aircraft

55 249 38

994

665

69 753

3132

Total ordered 1010 155 1831

55 249 38

994

665

69 753

3132

Total delivered 1010 155 1831

36 56 15

137

146

10 11

In-service N/A 77 0 36 293

80 2  Aircraft Variants and Manufacturing Specifications

2.2  Boeing’s Commercial Aircraft

81

Douglas family and designated as the MD-95, prior to the 1997 merger. However, despite weak Boeing 717 sales, all 155 aircraft produced remain in service worldwide. Table 2.4 shows the general characteristics of Boeing’s out-of-production aircraft from the 707 to the 767. The physical characteristics of Boeing’s out-of-production aircraft are outlined in Table 2.5. Further evidence of Boeing (and the industry’s) move toward creating more efficient aircraft with lower operating costs.

Table 2.5  Physical characteristics of Boeing out-of-production aircraft Capacity: mixed 141

Capacity: high densitya 189

Power plant manufacturerb PW, RR

# of engines 4

Model Variant 707

Wingspan

Length

145′ 9″

152′ 11″

717

93′ 4″

124′

106

134

RR

2

-100/-100C

108′

133′ 2″

106

131

PW

3

-200/-200F

108′

153′ 2″

134

189

-300/-400/500 (Classic)

94′ 9″- 102′ 5″

101′ 9″119′ 7″

108–146

149–189

CFM

2

-600 (NG)

117′ 5″

102′ 6″

108

149

-100/-200/300

195′ 8″

231′ 10″

331

550

GE, PW, RR

4

-400/-400F

211′ 5″

231′ 10″

416

660

GE, PW, RR

-200

124′ 10″

155′ 3″

186

239

PW, RR

2

-300

124′ 10″

178′ 7″

243

279

-200/-200ER/200F

156′ 1″

159′ 2″

216

255

GE, PW, RR

2

-400ER

170′ 4″

201′ 4″

243

409

GE, PW

727

737

747

757

767

Source: Boeing aircraft production data FAA exit limit b CFM, GE, PW, RR stand for CFM International, General Electric, Pratt & Whitney and Rolls Royce respectively a

82

2  Aircraft Variants and Manufacturing Specifications

 oeing 707, 717 and 727 B The oldest Boeing commercial jetliner, the B707was the first narrow-body jet produced in 1953. The aircraft has a range of 3735–5000 nm with a fuel capacity of 23,000 gallons. B707, was the fastest aircraft, as well as the longest-range aircraft in the narrow-body market until the advent of the 737’s, and even then, it was only outperformed in efficiency. It was not until the 737NG entered production, that the 707 was outperformed entirely. The first commercial Boeing 707 carried 189 passengers with four engines. The 727-200, in comparison, had the same capacity but reduced the number of engines to three. When further compared to the later 757 models, which supported a 100 more passengers with two engines, it can be inferred that Boeing aircraft and engines have become more efficient and powerful. The 727 was designed to compete against the similar de Havilland Trident, and replace propeller-driven aircraft on short and medium-haul routes. Boeing developed two versions of the 727, the original −100 and a stretched version, the −200. In addition to being popular with passenger airlines, the 727 also became popular with cargo airlines as a freighter, used by such carriers as FedEx and UPS. The 727 was a tremendous success for Boeing. The 727 was the world’s best-selling jetliner, until it was surpassed by 737 sales, when it went out of production in 1984 with 1832 units delivered (Eden, 2006). The first point of interest in Table 2.6 is that no current out-of-production Boeing aircraft had achieved any significant increase in speed since the Boeing 707. In comparison, the Boeing 757 family achieves a range of 3395–3900  nm with a capacity of 11,466-11,489 gallons. Therefore, while the aircraft do not appear to have gotten much faster in absolute terms, they did become massively more efficient. The Boeing 717 was originally a McDonnell Douglas designed aircraft, and competed in the 100-seat market. The Boeing 717 was designed to replace older DC-9 s, and competed against the Fokker 100, Airbus A319 and smaller versions of Boeing’s own 737. Boeing 737 Boeing’s 737 almost never happened, as Boeing contemplated pulling the twin-­ engine jetliner before production began, when Eastern decided to order the DC-9 instead (Eden, 2006). Boeing, however, decided to move forward with the project and developed the 737 to compete in the 100-seat short-haul passenger aircraft market; the early versions of the 737 (−100, −200) began to take flight in 1967.The 737 went on to become the bestselling commercial aircraft in history with over 7000 orders. The 737NG replaced the Classic series of 737, which included the 737-300, −400 and − 500, with longer range and improved performance. Over 5000 orders were placed for the Next Generation (NG) of the 737 since its introduction in 1997 (Boeing Company, 2009j). The 737 NGs represent the first real leap in fuel efficiency, since they achieved nearly two-thirds of the range of the 707 with a quarter as much fuel capacity. After the Pratt & Whitney JT8D-powered −100 and − 200 series, later 737  s were powered by two CFM International engines. The twin-­ engine narrow-body design combined with innovations in propulsion and aircraft

-300 -200/-200ER/200F -400ER

-200

0.80 0.80

0.80

450,000

0.80

0.85

24,140

11,490 12,140–24,140

11,276

53,765–60,585

48,780–50,360

6875

0.79

0.85

5331–6295

8060–10,585

0.86

0.79

7680

3673–4403

0.86

0.77

Fuel capacity (U.S. Gallons) 17,330–23,855

3400 3950– 6590 5625

4620– 6560 2825– 7585 3915

1500– 2500 2060– 2375 3235

Range (nm)a 2900– 5000 1430– 2060 3110

43,000

42,000 43,000

42,000

45,000

45,000

41,000

37,000

36,100

36,100

37,000

Max. altitude (Ft) 41,000

a

Source: Compiled by Boeing aircraft production data & Airline Monitor (as of October 2020) Range varies on variant & engine type b No operating data available

767

757

-100/-200/-300

747

-400/400F

-300/-400/-500 (Classic) -600 (NG)b

-200/-200Fb

-100/-100Cb

737

727

717

Model Variant 707b

Cruising speed (Mach) 0.79

Max. Takeoff weight (Lbs) 257,340– 335,000 110,000– 121,000 160,000– 169,000 184,800– 209,500 115,500– 150,000 124,000– 144,500 630,000– 696,000 800,000– 910,000 220,000– 255000 270,000 395,000

Table 2.6  Operating characteristics of Boeing out-of-production aircraft

5143

3,743 3645

3470

7,190

N/A

N/A

2796

N/A

2583

Total flying cost per block hour ($) N/A

809

1002 2059

822

1643

N/A

N/A

759

N/A

659

Total maintenance cost per block hour ($) N/A

6730

5403 6591

4927

10,774

N/A

N/A

4088

N/A

3870

Total cost per block hour ($) N/A

3712

1634 1063

1645

5531

N/A

N/A

992

N/A

439

Average flight stage length (nm) N/A

2.2  Boeing’s Commercial Aircraft 83

84

2  Aircraft Variants and Manufacturing Specifications

design gave the 737’s their unique advantages in the low cost market. The advent of the 737 also marked the beginning of viable low cost carriers such as Southwest Airlines.  oeing 757 and 767 B During the last 23  years of production time, Boeing produced 1050 B757. The Boeing 757 has been in the skies for nearly 40 years. The 757-200 carried up to 228 passengers and had a range of approximately 3900 nautical miles. Boeing produced the twin jet engine 757 from 1981 to 2004. The 757 was the replacement for the 727, which had received enormous popularity and was still the mainstay of many airline fleets around the globe. Delta is the world’s biggest operator of the 757. There were 625 Boeing 757 aircraft in service as of December 2020, comprising 572 757-200 s and 53 757-300 s. Boeing developed the 757 alongside the 767 during the late 1970s and early 1980s. After originally designing another stretch version of the 727 design, Boeing decided on a twin-engine, instead of a tri-engine, aircraft in order to improve fuel efficiency. The fuselage remained the same width as the 727 and 737, and featured cockpit commonality with the 767 (Eden, 2006). This cockpit commonality allowed pilots to fly both the 757 and 767 under one-type certificate; a large advantage for airlines in achieving labor cost savings. 747SP. The 757-200ER, produced from 1982 to 2005, it is a two men cockpit and can transport up to 200 passengers. The aircraft has a maximum operating altitude of 42,000', a normal cruise speed of 459 nautical miles, and a 6,026 nautical mile range. The aircraft has a total baggage capacity of 1,650 cubic feet. Airbus was targeting that particular market with their A300, and in response, Boeing developed the twin-engine 767 wide-body. The Extended Range (ER) versions of the 767 would provide greater range than the A310, an advantage that many airlines appreciated. The larger 767 aircraft were replaced by the new generation of technology from the 787 family of aircraft. Northwest Airlines was the first US airlines to place the 747-400 in commercial service on February 9, 1989.

2.3

Airbus Commercial Aircraft

In addition to Boeing, Airbus is another leading commercial aircraft manufacturer. Airbus, a European aircraft-manufacturing consortium created in 1970 to fill a market to serve short, medium, and long range markets. The members of the consortium include the German, -French-Spanish-owned European Aeronautic Defense and Space Company (EADS), with an 80% interest, and Britain’s BAE Systems, with 20%.24 Current Airbus production line includes:

24

 https://www.britannica.com/topic/Airbus-Industrie, Retrieved, January 15, 2020.

2.3  Airbus Commercial Aircraft A220 A319 A320 A330 A350

85 Twin engines, single aisle Twin engines, single aisle Twin engines, single aisle Twin engines, twin aisle Twin engines, twin aisle

108–130 seats 124–156 seats 150–186 seats 246–300 seats 270–350 seats

Airbus’s commercial jetliners in production include theA220, A320ceo family, A320neo family, A330, A330neo, A350 XWB and A380. Airbus’s aircraft span about the same range of size and capabilities as Boeing’s jetliners making the competition for an airline’s business very intense between the two manufacturers. In the late 1990s, Airbus finally overtook Boeing in market share, and the two companies have competed evenly since that time. Figure 2.1 outlines the market share in terms of orders from Boeing and Airbus during the period 1990–2019 while Figure 2.2 exhibits the market share in terms of deliveries. The companies tend to move in lockstep with each other, generally trading places in terms of market share every few years. This competition is expected to continue as Boeing and Airbus generate similar products for the future. Airbus’ A320neo family improves upon the best-selling A320ceo family of aircraft and provides two new jet engine choices – CFM International’s LEAP-1A and the PW1100G Pure Power from Pratt & Whitney. This new generation of engines generate a 15% reduction in fuel consumption, while adding 500 nm of range; this, in turn, equates to 16% less fuel burn per seat compared to Boeing’s winglet-equipped 737-800.

Airbus delivered 566 aircraft meanwhile Boeing delivered only 157 aircraft in 2020. The two manufacturers form a duopoly in the market for large jet airliners. With only 157 deliveries, Boeing experienced its worst year in more than a decade. Boeing's gross orders came to only 184 aircraft in 2020. Boeing's net orders excluding conversions and cancellations down to a negative 87 units

2.3.1 General Characteristics of the Fleet Airbus now produces only three narrow-body families of aircraft, the strong-selling A320ceo, A320neo, and the new CS100 then A220-100. Airbus acquired 50.01% of the CS 100 program from Bombardier in July 2018, and the aircraft was rebranded as the A220. Airbus increased its share to 75% as Bombardier exited the program in February 2020. A320 usually seats 140 to 170 passengers and has a maximum capacity of up to 180 travelers. The rest of Airbus’s families of aircraft have been strictly widebodied aircraft. The first Airbus wide-body model, the A300, was later developed into the A310, and A340 are the only Airbus aircraft models out of production. Airbus has planned to stop the production of A380 in 2021. Over 600 A300s, A310s and A340s were still in service as of February 2010 (Airbus S.A.S., 2021). The next wide-body family Airbus developed was the A330, A330neo and A380, with over 1000 of those three models in service. Airbus’s newest model is the A350 XWB. Table 2.7 outlines some general characteristics of the Airbus range of commercial aircraft.

86

2  Aircraft Variants and Manufacturing Specifications 1600 1400

Number of Orders

1200 1000 800 600 400 200 0 1990

1995

2000

2005

Boeing Orders

2010

2015

2020

Airbus Orders

Figure 2.1  Market share in terms of orders between Boeing and Airbus (Net in year of cancel). (Source: Compiled from Boeing & Airbus deliveries (as of January 2021))

1000 900

Number of Deliveries

800 700 600 500 400 300 200 100 0 1990

1995

2000 Boeing Deliveries

2005

2010

2015

2020

Airbus Deliveries

Figure 2.2  Market share in terms of deliveries between Boeing and Airbus. (Source: Compiled from Boeing & Airbus deliveries (as of January 2021))

Wide-Body

Narrow-Body

Wide-Body

Wide-Body

Wide-Body

Double Deck-Wide-Body

A310

A320

A330

A340

A350

A380

-700/-800–800F/-900

-800/-900/-1000

-200/-300/-500/-600

In Production

-800/-900

In Production

In Production

In Production

In Production In Production

Production phase Out of Production Out of Production In Production

-318/-319/-319CJ/320/-321 -319neo/-320neo/321neo -200/-200F/-300

Variant -B2/-B4/-600/-600F/600ST -200/-200F/-300

Source: Compiled from Airbus (as of January 2021)

Type Wide-Body

21 A300

Table 2.7  General characteristics of Airbus aircraft First flight 28-Oct-­ 72 3-Apr-­ 82 22-Feb-­ 87 25-Sep-­ 14 2-Nov-­ 92 19-Oct-­ 17 25-Oct-­ 91 14-Jun-­ 13 27-Apr-­ 05 Lufthansa/Iberia/Virgin Atlantic/South African Qatar Airways/Cathay Pacific/ Singapore Airlines Emirates/Singapore/Qantas

Delta/Turkish Airlines/Saudia/ Air China AirAsia X/Iran Air/Delta

Major operators UPS/FedEx/Air France/ American Lufthansa/Singapore Airlnes/ FedEx/Mahan Air American/EasyJet/United/Air France IndiGo/AirAsia/Frontier

251

913

377

331

1479

7451

8127

255

Total ordered 561

246

408

377

58

1454

1629

8080

255

Total delivered 561

243

407

229

58

1381

1629

7549

61

In-service 238

2.3  Airbus Commercial Aircraft 87

88

2  Aircraft Variants and Manufacturing Specifications

Table 2.8  Physical characteristics of Airbus aircraft

Model Variant A300 -B2/-B4

A310 A32X

-600/600F -200/300 -318 -319/319CJ 319neo

A330

A340

A350

A380

Capacity: high densitya 345

Power plant manufacturerb GE, PW

147′ 1″

175′ 9″

Capacity: mixed 269

147′ 1″

177′ 5″

274

345

GE, PW

144′

153′ 1″

220

275

GE, PW

2

111′ 11″

103′ 2″

107

132

CFM, PW

2

117′ 5″

111′

124

156

CFM, IAE

117′ 5″

111′

140

160

CFM, PW

180

CFM, IAE

Wingspan

Length

-320

117′ 5″

123′ 3″

150

-320neo

117′ 5″

123′ 3″

165

189

CFM, PW

-321

117′ 5″

146′

185

236

CFM, IAE

-321neo

117′ 5″

146′

206

240

CFM, PW

406

GE, PW, RR

-200/200F -300

197′ 10″

193′ 0″

247

197′ 10″

208′ 11″

277

440

GE, PW, RR

-800

210′ 10″

193′ 0″

257

406

RR

-900

210′ 10″

208′ 11″

287

440

RR

-200

197′

194′ 10″

261

420

CFM

-300

197′

209′

277

440

CFM

-500

208′ 11″

222′ 5″

293

375

RR

475

RR

-600

208′ 11″

247′

326

-800

212′ 5″

198′ 7″

276

440

RR

-900

212′ 5″

219′ 5″

325

400

RR

-1000

212′ 5″

242′ 7″

366

440

RR

238′ 7″

544

853

(GE&PW), RR

-800/800F

261′ 8″

# of engines 2

2

4

2

4

Source: Airbus aircraft production data FAA Exit Limit b CFM, GE, IAE, PW, RR stand for CFM International, General Electric, International Aero Engines, Pratt & Whitney and Rolls Royce respectively a

Table 2.8 shows a comparison of the major physical characteristics of Airbus commercial aircraft. The out-of-production aircraft, like the A300 and A310, used solely General Electric and Pratt & Whitney engines with A340 utilized CFM International for early variants and solely Rolls Royce engines for later variants.

2.3  Airbus Commercial Aircraft

89

Others such as the A320ceo and A320neo utilize primarily CFM International and IAE engines.

2.3.1.1 The Airbus A220 and A320 The smallest aircraft in the product lineup is the A220 with two variants. The A220-100 variant seats 116 (135 passengers at high-density configuration), and the A220-300 seats 141 (160 passengers at high-density configuration). These aircraft’s sole engine option is the Pratt & Whitney PW1500G. Other than the smaller A220 family, the Airbus A320ceo and A320neo families are significantly shorter, in terms of both length and wingspan, to the other Airbus aircraft models currently available, accentuating the variety offered by Airbus. The shortest member of the family, the A318ceo, which is out of production, is approximately 90 feet shorter in both length and wingspan than the next available family of aircraft, the A330ceo family. The cornerstone of the A320ceo family (the A320ceo) accommodates 150 passengers in a typical two-class arrangement, and up to 186 with high-density seating. The stretched-fuselage A321ceo version seats 185 passengers in the two-class layout and up to 236 for a high-density cabin. The A320neo family (the A320neo) are all slightly higher in capacity than the ceo family, which accommodates 165 passengers in a typical two-class arrangement, and up to 195 with high-density seating. The stretchedfuselage A321neo version seats 206 passengers in the two-class layout, and up to 240 for a high-density cabin. The A320neo entered into service in January 2016 with Lufthansa, and was followed by the A319neo by 2019. Finally, the A321neo entered service with Virgin America (which later merged into Alaska Airlines) in May 2017.25 As of January 2021, a total of 7451 A320neo family aircraft had been ordered by more than 115 airlines, making it the fastest-selling commercial aircraft ever.26 The majority of the orders are in the A320 and A321neo variants. There are very few orders for the A319neo variant competing directly with the A220-300. 2.3.1.2 The Airbus A330 The A330 base models and their variants cover a significant portion of the commercial aircraft market. The A330-300 carries 300 passengers on routes of up to 6000 nautical miles, while the shorter A330-200 accommodates 250 passengers on routes of up to 7230 nautical miles.27 True to Airbus’s commitment to commonality in aircraft design, the A330-200 and A330-300 are nearly identical, except for length and the A330-300’s activated center tank and extended fin and rudder.28 The updated engine option, the A330-800 and the -900 variants, uses the Rolls-Royce Trent 7000-72. The new A330neo capacity is similar to the -200 and -300 variants. The A340 comes in four versions with four fuselage lengths; this range of lengths makes the seating capacity of this family of aircraft vary between 240 to 349 passengers in two-class cabin

 Airbus (2020) A320neo Aircraft Information.  Airbus. Orders and deliveries, February, 2021. 27  Aircraft Monitor. Basic of Aircraft Market Analysis, March, 2012. 28  Airbus A330 Technical Specifications . 25 26

-600/600Fa -200/200Fa -300a

-318a

A310

A32X

-321neo

-321

-320neo

-320

-319/319CJ 319neoa

Variant -B2/-B4a

Model A300

275,577– 313,056 330,695– 361560 123,459– 149,914 136,686– 166,449 141,096– 166,449 145,505– 171,961 154,324– 174,165 171,961– 205,030 176,370– 206,132

Max takeoff weight (Lbs) 302,032– 363,760 308,650– 378,530

0.78

0.78

0.78

6261–7842

6261–7842

6303–7835

6303–7835

6303

0.78

0.78

6303

0.78

6303

16,132

0.80

0.78

16,132

Fuel capacity (US Gallons) 11,623– 16,380 16,380– 20,184

0.80

0.78

Cruising speed (Mach) 0.78

Table 2.9  Operating characteristics of Airbus aircraft

4000

3200

3500

3300

3750

3750

3100

5150

3500

4050

Range (nm) 2900

39,000– 41,000 39,000– 41,000 39,000– 41,000 39,000– 41,000 39,000– 41,000 39,000– 41,000 39,000– 41,000

41,000

41,000

40,000

Max Altitude (Ft) 40,000

2867

3137

2481

2760

N/A

2392

N/A

N/A

N/A

N/A

Total flying cost per block hour ($) N/A

885

775

329

779

N/A

737

N/A

N/A

N/A

N/A

Total maintenance cost per block hour ($) N/A

4792

4593

3733

4156

N/A

3636

N/A

N/A

N/A

N/A

Total cost per block hour ($) N/A

2105

1271

1045

1012

N/A

765

N/A

N/A

N/A

N/A

Average flight stage length – miles (nm) N/A

90 2  Aircraft Variants and Manufacturing Specifications

-800/800F

-1000a

-900

-800a

-600

-500

-300

-200

-900

-800

-200/200F -300

423,287– 533,519 405,650– 533,519 507,063– 533,519 507,063– 533,520 558,872– 606,271 558,872– 609,578 811,301– 837,586 804,687– 837,586 462,971– 617,295 462,971– 617,295 679,024– 685,638 1,058,219– 1,267,658 85,472

41,212

0.85

0.85

36,456

56,550– 58,966 52,343– 55,196 36,456

37,153

37,153

0.85

0.85

0.82

0.82

0.82

0.82

0.86

36,744

25,765– 36,744 36,744

0.82

0.86

36,744

0.82

8200

7950

8100

8245

7800

9000

7300

6700

6550

7500

6350

7,250

43,000

41,000

43,000

43,000

41,000

41,000

41,000

41,000

41,500

41,500

41,500

41,500

N/A

N/A

6125

N/A

N/A

N/A

N/A

5797

3137

Source: Compiled by Airbus aircraft production data & Airline Monitor (as of October 2020) a No operating data available

A380a

A350

A340a

A330

N/A

N/A

577

N/A

N/A

N/A

N/A

895

244

N/A

N/A

7491

N/A

N/A

N/A

N/A

7615

1400

N/A

N/A

6136

N/A

N/A

N/A

N/A

4084

3443

2.3  Airbus Commercial Aircraft 91

92

2  Aircraft Variants and Manufacturing Specifications

configurations and a range of 9000 nautical miles.29 The A330-300 is a member of the A330 family of twin-engine, medium to long-rage wide body aircraft. Both variants are twin-aisle passenger aircraft available with three engine choices: the General Electric CF6-80E1; Pratt & Whitney PW4000-100; and Rolls-­Royce Trent 700. The Airbus families of aircraft provide a significant variety in terms of capacity. The narrow-body A220-100, with its high capacity of 116 caters to one end of the airline spectrum while the wide-body A380 seats 840 in high capacity. However, the typical layout for the A380 is a three-class configuration that seats 525 passengers for an 8300 nm range. Other available aircraft fill in gaps between the wide-body and narrow-body market. One of the biggest operating hindrances to early Airbus aircraft was the limited range available. The early model A300s had a range of between 1850 and 3400 nautical miles. The A330 improved upon the range for Airbus’s wide bodies, reaching a range of up to 6750 nautical miles. The four-engine A340 improved range even further by increasing range up to 8500 nautical miles. The A340 has also allowed Airbus to gain faster cruising speeds as well, up to 632 miles per hour (Mach 0.83) compared to the 534 miles per hour (Mach 0.70) offered by the A330.30 Subsequent development of the A380 and the A350 XWB expanded the range further. The out-of-production A300 was the first aircraft produced by Airbus. The A300 is a twin-engine wide-body aircraft that seat between 250 and 336 passengers and first flew in April 1974 (Airliners.net, 2010). While as successful as Airbus’s first product, the A310 was hampered by a limited range, especially compared to the competitive Boeing 767-ER. Airbus’s answer to the 767 was the introduction of the A330, a twin-engine wide-body with a similar range and capacity. With over 1809 orders as of January 2021, the A330 remains a very popular regional and intercontinental aircraft for airlines today. The updated A330neo family, −800 and − 900 variants, is a redesign of the existing −200 and − 300 aircraft with enhanced generation of engines. So far, it has over 331 orders, 58 deliveries as of January 2021. There is overlap with the A330neo and the smaller A350 variants. The Airbus A318 was the smallest aircraft in the Airbus production line, with a seating capacity between 107 to 132 passengers, and a maximum range of 3100 nm. A318 is useful for serving a high yield-low density long-haul market. The aircraft entered service in 2003, and because of the lack of demand, the production ended in 2013. A318 could not compete on price and operating costs with other regional jets such as the ERJ-195. The A220 regional, narrow-body family includes the A220-100 and A220-300. The A220 family was acquired from Bombardier, and it was previously known as the C-Series. Given the low seat count, it covers the same capacity as the A318ceo and A319ceo aircraft. Given the similarities in the A319neo has not received as much interest with the preference for the A220-300. The A220 was introduced with its first flight in 1987. These aircraft also compete directly with Boeing’s 737-700 and 737 Max 7 series by offering similar seating capacities and

29 30

 Airbus A340 Technical Specifications.  Airbus Commercial Aircraft Specifications 2020.

2.3  Airbus Commercial Aircraft

93

range. There have been 658 orders for the A220 family since its inception, with 111 of the planes having been delivered.31 The A320ceo narrow-body family includes the A318ceo, A319ceo, A320ceo and A321ceo. The A320ceo family is one of three narrow-body aircraft families in the Airbus lineup. The A320ceo was the first of these aircraft; introduced with its first flight in 1987. The A320ceo was followed by the production of the stretched version, the A321ceo, and then the two shortened versions, the A319ceo and A318ceo. These aircraft compete directly with Boeing’s 737NG series by offering similar seating capacities, range and generation of engine technologies. There have been 4752 deliveries for the A320ceo since its inception, with 4360 in fleet as of January 2021. With 4770 orders, it is clear that the A320ceo family is prevalent among the world’s airlines today but now will be replaced with the updated A320neo aircraft family.32 Indeed, the A320ceo family may become only the second commercial jetliner to reach the 7000-order mark, a mark previously set by the rival 737. The A320neo narrow-body family includes the A319neo, A320neo and A321neo. The A320neo was the first of these aircraft; introduced with its first flight in 2016. The A320neo was followed by the production of the stretched version, the A321neo in 2017 with the shortened version, the A319neo waiting for the initial delivery and entry into service. These aircraft compete directly with Boeing’s 737 MAX series by offering similar seating capacities, range and generation of engine technologies. There are 3907 orders for A320neo, with 1157 of the planes having been delivered (Airbus, 2021). With 7373 aircraft on order as of January 2021, it is clear that the A320neo and A321neo are very popular among the world’s airlines today.33 The A340 first flew in 1991 and gave airlines another viable option to replace older DC-10s and L1011s. The four-engine wide-body offers seating for anywhere from 260 to 400 passengers (Airliners.net, 2010). The A340 has competed with the Boeing 777 since the 777 entered the market in the mid-1990s. The Boeing 777 has been a much greater success than the A340 was for Airbus as the four-engine design of the A340 is less efficient with higher fuel prices than a twin-engine wide-body. Still, with 377 ordered as of January 2021, the A340 family is more of a success as a DC-10 replacement than McDonnell Douglas’s own DC-10 replacement, the MD-11. The aircraft was discounted from production in 2011 as the increase in fuel prices caused operators to prefer more efficient two-engine aircraft options. As the world’s largest airliner, the Airbus A380 offers distinct product differentiation. The double-decker wide-body A380 with its two new-generation engine options (Engine Alliance GP7200 and Rolls-Royce Trent 900), combined with its advanced wing and landing gear design, is significantly quieter than its direct competitor, the Boeing 747-834; however, its operating costs are approximately 22% higher

 Airbus Orders and Deliveries 2020.  Airbus Order and Delivery Summary as of January 31, 2021. 33  Airbus Order and Delivery Summary as of January 31, 2021. 34  Airbus A380 Efficiency and Reliability as of December 31, 2019. 31 32

94

2  Aircraft Variants and Manufacturing Specifications

(FlightGlobal, 2006).35 As of January 2021, Airbus had 251 firm orders for the A380, with 246 aircraft having already been delivered and in operation around the world.36

2.4

Mcdonnell Douglas’s Commercial Aircraft

In 1932, Douglas Aircraft Company began its Douglas Commercial (landmark DC) series with the DC-1 prototype. The DC-3, the world’s first successful commercial airliner, was long a workhouse on the airline industry after its introduction in 1935 (Exhibit 2.1). McDonnell Douglas was formed in 1967 due to the merger of the McDonnell Aircraft Corporation (founded in 1939) and the Douglas Aircraft Company (established in 1921). McDonnell Douglas and Boeing were the top two commercial aircraft manufacturers for many years before the rise of Airbus. McDonnell Douglas products competed directly for orders with many of Boeing’s products - the DC-8 against the 707, the DC-9, and later the MD-80, against the 737, the DC-10 against the 747, and the MD-11 against the 777. The popularity of McDonnell Douglas’s products eventually faded and the company merged with Boeing in 1997. Boeing continued to deliver McDonnell Douglas airplanes until the last 717 s (formerly known as the MD-95) were delivered in May 2006 to AirTran Airways and Midwest Airlines.

Exhibit 2.1 DC-3

While no longer in production, McDonnell Douglas aircraft are still flown around the world by a variety of operators. Largely known for their reliability, McDonnell Douglas airplanes, such as the DC-9, up to 40 or more years old, are still found in the fleets of some smaller airlines, including Aeronaves TSM and USA Jet Airlines.  FlightGlobal article retrieved January, 2020 from https://www.flightglobal.com/boeings-747-8-­ vs-a380-a-titanic-tussle/65936.article 36  Airbus Orders, Deliveries, Operators – Worldwide February 2021. 35

2.4  Mcdonnell Douglas’s Commercial Aircraft

95

2.4.1 General Characteristics of the Fleet Table 2.10 illustrates the general characteristics of McDonnell Douglas’s aircraft (all are currently out of production). The McDonnell Douglas aircraft family includes the narrow-body DC-8, DC-9, MD-80 and MD-90 and the wide-body DC-10 and MD-11. All of McDonnell Douglas’s aircraft were developed from three basic base models  - the DC-8, DC-9 and DC-10. The DC-8 had many variants within the DC-8 family, while the DC-9 and DC-10 were the basis for the MD-80/ MD-90 and MD-11, respectively. The MD-80 was McDonnell Douglas’s most successful product by the time production ended with 1191 aircraft deliveries. Another acclaimed commercial aircraft success for McDonnell Douglas is the DC-9 with 976 units ordered and delivered. Most of the McDonnell Douglas aircraft came with Pratt & Whitney jet engines as the sole engine choice. This close relationship between McDonnell Douglas and Pratt & Whitney spanned from the DC-8 to the MD-80. The MD-90 was the only passenger jet aircraft built by McDonnell Douglas not to have Pratt & Whitney engines as an option. The Douglas DC-8 was a narrow-body aircraft. The six-abreast, low-wing airliner was a four-engine jet aircraft; the initial variants were 151 feet long. An interesting note from Table 2.11 is that the early DC-8 versions had approximately the same 170-seat capacity and 150′ length as the MD-80 and MD-90, McDonnell Douglas’s smallest models at the time that the company merged with Boeing. The physical difference between the models was in the length where the DC-8 had a nearly 40′ wider wingspan than the MD-80 and MD-90 in order to accommodate two extra engines. One of the interesting statistics from Table 2.12 is that total cost per block hour is actually lower for the DC-9 than the MD-80. The low operating costs may explain why Northwest Airlines (now Delta) kept so many of their aging DC-9 s (some as old as 40 years old). The MD-90 also has lower operating costs than the DC-9 or MD-80 on similar stage lengths due to lower maintenance costs. Table 2.12 shows the operating characteristics for McDonnell Douglas aircraft. McDonnell Douglas aircraft only came in three basic families - the DC-8, DC-9 and DC-10. The three later models, the MD-11 and MD-80/90, were derivatives of the DC-10 and DC-9, respectively. This strategy of continuously modifying existing designs rather than introducing new designs generated mixed success for McDonnell Douglas. The MD-11 was not as successful as its predecessor, the DC-10. Only 200 MD-11 s were ever ordered, significantly less than the MD-11’s competitors: The Boeing 777 and A330/340. The older three-engine design of the MD-11 could not compete with the efficiencies of newer twin-engine designs of the 777 and A330. The DC-9 can be described as somewhat of a predecessor to the regional jet phenomenon. Early DC-9 versions held between 80 and 90 passengers and were used for many of the same short-haul routes that regional jets fly today. DC-9 s were popular with airlines and passengers due to their 5-abreast (2 by 3) seating compared to the 6-abreast seating of other narrow-bodied aircraft. The MD-80 was even more popular than the DC-9, with nearly 1200 airplanes ordered. The reliability of the DC-9 and the fuel efficiency of the MD-80 compared to the Boeing 737 Classics helped to contribute to the MD-80’s popularity.

Wide-Body

DC-­ 10

-87 -30/-30ER/-30T

-81/-82/-83/-88

-10/-15/-30/-30CF/-30ER/-30AF/40/-MD-10 KC-10A/KDC-10 MD-11/-F/-C/-CF/-ER

-40/-50

-10/-15/-20/-30/-30CF/-30F/C-9

-60/-70

Variant 10/-20/-30/-40/-50/-50CF/-50AF

Out of Production

Out of Production Out of Production

Out of Production

Out of Production

Production phase Out of Production

10-Jan-­ 90 18-Oct-­ 79 4-Dec-86 22-Feb-­ 93

First flight 30-May-­ 58 14-Mar-­ 66 25-Feb-­ 65 28-Nov-­ 67 29-Aug-­ 70

Source: Compiled from Boeing & Centre for Aviation & Cirium (as of March 2021)

MD-­ Narrow-­ 90 Body

MD-­ Wide-Body 11 MD-­ Narrow-­ 80 Body

Narrow-­ Body

DC-­ 9

Model Type DC-­ Narrow-­ 8 Body

Table 2.10  General characteristics of McDonnell Douglas aircraft

Delta/Saudia/JAL

FedEx/Lufthansa Cargo Delta/American/ Allegiant

Fedex

Delta/Northwest

Major Operators United/UPS/Delta

75 116

75 116

1116

60 200

60 200 1116

386

167

809

262

Total delivered 294

386

167

809

262

Total ordered 294

3 N/A

59

N/A 104

42

0

32

1

In-service 0

96 2  Aircraft Variants and Manufacturing Specifications

2.5  Lockheed Corporation

97

Table 2.11  Physical characteristics of McDonnell Douglas aircraft

Model Variant DC-8 10/-20/-30/-40/-50/50CF/-50AF -60/-70

DC-9

-10/-15/-20

-30/-30CF/30F/C-9 -40

DC-­ 10

MD-­ 11 MD-­ 80 MD-­ 90

Capacity: high densitya

Power plant manufacturerb

Wingspan

Length

capacity: mixed

142′ 5″

150′ 6″

132

189

PW, RR

142′ 5″-148′ 5″

157′ 5″-187′ 5″

180–220

259

CFM, PW

89′ 5″-93′ 5″

104′ 5″

80

109

PW

2

93′ 5″

119′ 4″

105

127

93′ 5″

125′ 7″

110

128 139 3

# of engines 4

-50

93′ 5″

133′ 7″

125

-10/-15/-30/-30CF/30ER/-30AF

155′ 5″-165′ 5″

182′ 1″

255–270

399

GE

-40

165′ 5″

182′ 1″

255

399

PW

MD-11/-F/-C/CF/-ER

169′ 6″

200′ 11″-202′ 2″

298

410

GE, PW

3

-81/-82/-83/-88

107′ 10″

147′ 10″

143

172

PW

2

139 172

IAE

2

-87

107′ 10″

130′ 5″

117

-30/-30ER/-30T

107′ 10″

152′ 7″

153

Source: Boeing aircraft production data a FAA exit limit b CFM, GE, IAE, PW, RR stand for CFM International, General Electric, International Aero Engines, Pratt & Whitney and Rolls Royce respectively

2.5

Lockheed Corporation

Lockheed was founded in 1926, and later merged with Martin Marietta in 1995 to form today’s Lockheed Martin. Lockheed only produced one commercial jetliner, the L-1011. In the late 1960s, passenger traffic in North America was growing at an astronomical rate in order to cope. Lockheed had launched the Tri-Star L-1011, a plane designed largely for Eastern Airlines. The L-1011 was first delivered to British Airways in 1979 and the following year to Pan Am American Airways. The TriStar’s design featured a twin-aisle interior with a maximum of 400 passengers and a three-­ engine layout. The aircraft was one of the first to be equipped with an auto land capability, and an automated descent control system. Competing against the DC-10, A300, and 747  in the wide-body market, the L-1011 never could secure enough orders to make the production of the aircraft profitable. While sales of the other three wide-body aircraft of the time were very good, Lockheed could only sell 250 of the airplane, but needed to sell 500 airliners to break even before production ended in 1983. Finally, Lockheed decided to depart the civil market completely, as TriStar

Variant

0.82

0.82 0.84 0.84 0.84 0.82 0.82 0.82 0.82 0.82 0.80 0.80 0.80 0.80 0.76

325,000–355,000 90,700–98,000 108,000–114,000 121,000 430,000–440,000 555,000 602,500 602,500 630,500 140,000 149,500 160,000 140,000–149,500 156,000–168,000

23,393–24,275 3679–3693 3679 3679 21,700–26,647 36,652 38,615 38,615 41,615 5846 5846 6981 5845–6980 5840–6405

17,550–23,393 2300–5300 1300–1500 1200–1500 1300 3300–3785 4000–6505 6840 3950 7240 1800 2050 2554 2400–2900 2045–2250

3760–5855 35,000 37,000 37,000 37,000 42,000 42,000 43,000 43,000 43,000 35,000 35,000 35,000 35,000 37,000

35,000

Cruising Fuel capacity (US Max altitude speed (Mach) Gallons) Range (nm) (Ft)

315,000–325,000

Max takeoff weight (Lbs)

Source: Compiled by Boeing aircraft production data & Airline Monitor (as of October 2020) a No operating data available

10/-20/-30/-40/ -50/-50CF/-50AF -60/-70 DC-­9a -10/-15/-20 -30/-40 -50 DC-10a -10/-15 -30/-40 MD-11a -11 -11F -11ER MD-80 -81 -82/-88 -83 -87 MD-90 -30/-30ER/-30T

Model DC-­8a

Table 2.12  Operating characteristics of McDonnell Douglas aircraft

N/A

N/A N/A N/A N/A 516

485

N/A N/A N/A N/A 3089

3037

N/A

4184

N/A N/A N/A 4207

N/A

N/A

N/A

Total maintenance cost per block Total cost per hour ($) block hour ($)

N/A

N/A

Total flying cost per block hour ($)

700

N/A N/A N/A 470

N/A

N/A

Average flight stage length – miles (nm) N/A

98 2  Aircraft Variants and Manufacturing Specifications

2.6  The Commercial Aircraft Corporation of China (COMAC)

99

almost pushed them into another bankruptcy. The L-1011 featured advanced technology, and Lockheed boasted that it was quieter than a 747 or DC-10. The L-1011 fleet had a remarkable in-service rate that reached 98.1% reliability (Eden, 2006). The major flaw of the L-1011 was its range; early versions of the L-1011 lacked the range sufficient for long-haul operations that the rival, DC-10, was being used on. The shortened L-1011  −  500 finally corrected the range deficiencies; however, by the time the airplane was built the market for such aircraft had already been filled.

2.6

The Commercial Aircraft Corporation of China (COMAC)

COMAC is a state owned commercial aircraft manufacturing company in China established on 11 May 2008. COMAC aircraft family includes the regional jet, ARJ21, narrow-body C919 and the wide-body CR929. COMAC has access to a huge and growing market in China. The International Air Transport Association (IATA) had predicted that China would surpass the U.S. as the world’s largest aviation market in the mid-2020s37 In fact, CAPA reported in April 2020 that China displaced the U.S. already despite the COVID-19 complications.38 The Company produces large jet civil aircraft, passenger aircraft, and other equipment. At this time, it has built two jets - the ARJ21 and the C919 - and is working with Russia on a third. The COMAC C919 is a twinjet narrow-body airliner developed by the company. The dimensions of the C919 are quite similar to those of the Airbus A320; its fuselage is 13.0 feet wide and 13.67 feet high with a 139.02 square feet cross-section. The development of CR919 started in June 2011. The CR919 made its maiden flight in May 2017, and its first commercial deliveries are expected for 2021 to China Eastern Airlines.39 As of January 2021, COMAC has received 1008 orders (305 firm orders) from mostly Chinese companies.

Number of passengers on airlines worldwide in 2019 (bilion)

UAE CAN BRA DEU TUR RUS JPN UK IND IRL CHN USA 0

200

400

600

800

1,000

 IATA Press Release, IATA Forecast Predicts 8.2 billion Air Travelers in 2037. October 24, 2018.  https://centreforaviation.com/analysis/reports/china-becomes-the-largest-aviation-marketin-the-world-521779 39  China’s COMAC says first delivery of C919 jet planned for 2021. Reuters, February 5, 2018. 37

38

100

2  Aircraft Variants and Manufacturing Specifications

Table 2.13  Lockheed commercial aircraft characteristics First flight

Wingspan Model Variant L-­1011 -1/-100/- 16-­Nov-­ 155′ 4″ 200 70 -500 16-­Oct-­ 164′ 4″ 78

Max. takeoff Length weight

Max. Cruising Range altitude # of Passenger speed (nm) (ft) engines capacity 3110– 42,000 3 256 to 400 177′ 8″ 430,000– 0.78 466,000 4918 6100 43,000 3 246 to 330 164′ 2″ 510,000 0.78

Source: Lockheed aircraft production data Table 2.14  COMAC Aircraft general characteristics Model C919 ARJ21

First flight 5-May-17 28-Nov-08

CR929

Expected 2025

Major operators N/A Chengdu Airlines, Genghis Khan Airlines N/A

Total ordered 1008 208

Total delivered N/A 46

In-service N/A 41

N/A

N/A

N/A

Source: COMAC commercial aircraft & CIRIUM data (2021)

2.6.1 General and Physical Characteristics of the Fleet There are three main baseline models of the respective type and variants based on those models. There are currently 46 ARJ-21 delivered with 41 in service and 1008 orders of C919 aircraft.40 ARJ-21 is a small aircraft that looks similar to the MD-80. The first prototype rolled out on 21 December 2007, and made its maiden flight on November 28, 2008. ARJ21 is a 78-105 seat regional jet, is another aircraft manufactured by COMAC. The maiden flight of the ARJ21 took place on 28 November 2008. In November 2015, the first ARJ21-700 aircraft was delivered to Chengdu Airlines. Four major variants of the ARJ21 currently exist or have been proposed: the ARJ21-700, ARJ21-900, ARJ21F, and ARJ21B. The ARJ21F is a freighter version intended to haul up to 23,000 lb. of cargo. COMAC is advancing plans to develop and test the COMAC Business Jet (CBJ) version of its ARJ21 to market mainly to local Chinese parties. The CRAIC CR929 (formerly Comac C929), a planned long-range 250-to-320-seat wide-body twinjet airliner, is a joint project between China and the Russian United Aircraft Corporation (UAC) to build a wide-body plane capable of competing with the Boeing 787. The first delivery is projected for 2028–29. Table  2.14 illustrates the general characteristics of COMAC’s aircraft (one in production and the other in development). The ARJ uses the General Electric CF34-10A engine, while the C919 uses the CFM LEAP-1C while the C919 engine selection is currently ongoing. AVIC Commercial Aircraft Engine Co is developing an indigenous engine option for the

40

 COMAC Products and Services (Dec. 2019).

2.7  Regional Jets

101

Table 2.15 COMAC′s Commercial Aircraft Physical Characteristics

ARJ21

Variant -Mixed, All ECO, -High Density -700,-900,-F, -B

CR929

-600, -500, -700

Model C919

127.8″

Capacity: Mixed 158–168

Power plant manufacturera CMF

# of engines 2

89.5″

109.8″

78–105

GE

2

209.5″

209.2″

258–440

RR, GE

2

Wingspan

Length

117.4″

Source: COMAC commercial data a CFM, GE, IAE, PW, RR stand for CFM International, General Electric, International Aero Engines, Pratt & Whitney and Rolls Royce respectively

two aircraft, CJ-1000A for the C919and a version for the CR929. Table 2.15 illustrates the physical characteristics of COMAC’s Aircraft. All three aircraft in production uses a wide array of international suppliers, including the Honeywell APU and CFM LEAP-1C engines along with domestic supplies. The ARJ21 is a competitor to Embraer’s ERJ and now Mitsubishi’s CRJ products in the regional jet space. The C919 is expected to compete against the Boeing 737 MAX and Airbus A320neo family with similar passenger capacity and aircraft dimensions. The CR929 is expected to compete against Airbus’s A330ceo, A330neo and the smaller Airbus A350 and Boeing 787 variants.

2.7

Regional Jets

Regional Jets have become more popular among a large group of airlines as they experience the benefits of connecting low-density markets to major hub airports. Like the wide-body and narrow-body commercial aircraft market that is currently dominated by Airbus and Boeing, the regional market is also dominated by few leading manufacturers. The leaders in the regional jet were Embraer and Bombardier. Among these, Embraer is still intact after the failed sale of the firm to Boeing, even more now with the exit of Bombardier from commercial aviation. However, Bombardier sold its Q-series line to De Havilland Aircraft of Canada and passed the CRJ series to Mitsubishi. Mitsubishi has previously entered the regional jet market by developing the SpaceJet, at the same time the emergence of COMAC’s ARJ21 and Suhkoi’s SuperJet.

2.7.1 Embraer Embraer (Empresa Brasileira de Aeronautica SA) is one of the world’s main aircraft manufacturers, headquartered in São José dos Campos in Brazil. Embraer prides itself on being a leader in the industry with innovative regional and commercial jet product lines. With nearly complete (up to 95%) commonality among the ERJ 135, 140 and 145 families of aircraft, Embraer has generated success by utilizing one base model of aircraft and stretching and shortening the fuselage accordingly to

102

2  Aircraft Variants and Manufacturing Specifications

create tremendous versatility for airlines seeking to tailor capacity to market size (Embraer, 2021). Despite the COVID-19 pandemic, the company delivered 130 aircraft in 2020.41 The E2 family of aircraft is relatively more advanced in design while retaining many of the commonalities to the previous generation of E Jets.42 In July 2018, Boeing, in response to Airbus’s partnership with Bombardier regarding the then named C-Series aircraft, entered into a memorandum of understanding (MOU) for a partnership 80/20 with Embraer for its commercial aviation interests valued at $4.75  billion. This plan, however, was eventually canceled by Boeing in April 2020 due to the aftermath of 737 Max issues and financial complications caused by the COVID-19 pandemic.43 Table 2.16 outlines the general characteristics of Embraer’s fleet of regional jets. Since it was founded in 1969, Brazilian manufacturer, Embraer, has delivered more than 8000 aircraft; it is the main exporter of high value-added goods in Brazil.44Embraer’s most successful regional jet in terms of orders and deliveries, by a wide margin, is the ERJ 145. With 22 years of operations, with over 120 operators, the ERJ 145 remains a strong selling point for Embraer and the entire family of ERJ aircraft by offering the versatility necessary for building a successful regional

Table 2.16  General characteristics of Embraer aircraft Model EMB 120 ERJ 135 ERJ 140 ERJ 145 E170 E175 E175-E2

First flight 27-Jul-83

Major operators SkyWest, Swiftair

4-Jul-98 27-Jun-00 11-Aug-95 19-Feb-02 14-Jun-03

Expressjet, American Eagle

E190

In Development 12-Mar-04

E190-E2 E195 E195-E2

24-May-16 7-Dec-04 29-Mar-17

Republic, US Airways Skywest, Republic, American Skywest JetBlue, Hainan, Air Canada Air Costa Azul, Lufthansa Azul

Total ordered 352

Total delivered 352

in-service 82

108 74 708 191 798

108 74 708 191 666

42 18 240 121 603

100

0

0

568

565

316

22 172 153

15 172 14

14 122 11

Source: Compiled from Embraer & Centre for Aviation & Cirium fleet data Note: Orders and Deliveries are as of December 2020; In-service data is as March 2021

 Embraer Press Release, February 12, 2021.  https://aviationweek.com/crossover-narrowbody-jets/embraer-s-e2-advances-e-jet-withoutsacrificing-commonality 43  Kaminski-Morrow, D.  Boeing walks away from Embraer tie-up. FlightGlobal.com. April 25, 2020. 44  Embraer official website 2020. 41

42

2.7  Regional Jets

103

Table 2.17  Physical characteristics of Embraer aircraft Model EMB 120 ERJ 135

Wingspan

Length 65′ 7″

Capacity 30

Power plant manufacturera Pratt & Whitney

# of engines 2

64′ 11″ 65′ 9″

86′ 5″

37

Rolls Royce

2

ERJ 140

65′ 9″

93′ 5″

44

Rolls Royce

2

Rolls Royce

2

ERJ 145

65′ 9″

98′ 0″

50

E170

85′ 4″

98′ 1″

70–78

General Electric

2

E175

85′ 4″

103′ 11″

80–86

General Electric

2

E175-E2

101′ 8″

106′ 3″

80–88

Pratt & Whitney

2

General Electric

2

E190

94′ 3″

118′ 11″

94–106

E190-E2

110′ 7″

118′ 9″

97–106

Pratt & Whitney

2

E195

94′ 3″

126′ 10″

106–118

General Electric

2

136′ 2″

120–132

Pratt & Whitney

2

E195-E2

115′ 2′′

Source: Embraer production aircraft data

network. The ERJ family of aircraft as a whole is one of the most successful in aircraft history, with over 1200 deliveries of aircraft based on the ERJ 145 platform as of 2017.45 This family of aircraft shares 98% parts, systems and training commonality. With the same fuselage, wing and tail structure, same engine hardware, crew type rating and common equipment, the ERJ family of aircraft offer tremendous benefits to airlines seeking to capitalize on reduced operating costs.46 Embraer’s 170, 175, 190 and 195 aircraft models with seating capacities ranging from 70 to 130 are commonly referred to as E-Jets. Within these four models, the E-175 has had the most success, establishing itself as a market leader, with 634 aircraft delivered as of 2020 and currently in use as a narrow-body medium-range jet. There is 95% systems commonality between the E-170 and E-175, as well as between the E-190 and E-195; an 89% commonality exists between the two families.47 In 2013 at the Paris Airshow, Embraer launched the successor to the E-Jets family called E-Jets E2 family of aircraft. There were designed with more enhanced engines to be fuel-efficient with three variants based on the E-Jets variants and thus named E175-E2, E190-E2, and E195-E2 models. With more advanced design, the family retains many of the commonalities to the previous generation of E Jets.48 Embraer has been very successful in the transition between its older ERJ family models to the new E-Jets E2 family, avoiding the risk of cannibalizing the demand for older models. Several U.S. regional airlines have placed orders for the new  Embraer receives customers to celebrate 20 years of the ERJ 145 jet operations. Embraer New (Nov. 2017). 46  Embraer ERJ 145 Technical Information. 47  Embraer E-Jets Specifications. 48  https://aviationweek.com/crossover-narrowbody-jets/embraer-s-e2-advances-e-jetwithout-sacrificing-commonality 45

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E-Jets E2 family aircraft in an effort to renew their older E-175 fleets. The first flight of E175-E2 took place on December 12, 201949 with 2021 entry into service despite not having many orders or a launch customer yet.50 For the E195-E2 variant, the first flight was in March 2017, and the first delivery was to Azul, a local Brazilian airline, in September 2019. The E195-E2 is expected to compete with Airbus 220-300 (formerly Bombardier CS300); however, in 2018, JetBlue announced its plan to replace its aging E190 fleet of 60 aircraft with A220-300  s. The first delivery was on December 31, 2020.51 As of the end of September 2020, Embraer has reported 22 (151) firm orders and 63 (47) options for E190-E2 (E-195-E2). In addition, 14 E190-E2 and 8 E195-E2 have been delivered.52 As outlined in Table 2.16, the ERJ family of aircraft offers a variety of lengths and seat capacities on a base model. The ERJ 140, for example, is essentially a shortened version of the ERJ 145, offering six fewer seats and 96% commonality. The largest member of the family, the ERJ 145, is 12 feet longer than the smallest ERJ 135 and seats 13 more passengers while maintaining the same wingspan and engine type. The ERJ family strictly employs Rolls Royce engines while the E-Jets utilize General Electric power plants. Similarly, the Embraer 195 is a stretched version of the Embraer 190, which is, in turn, a stretched version of the Embraer 175 and 170. Accordingly, the Embraer 195 is roughly 28 feet longer than the Embraer 170 and at high capacity can accommodate 40 more passengers. The E2 family of aircraft offers a variety of lengths and seat capacities on a base model. The E175-E2, for example, is essentially a shortened version of the E190-E2 offering 16 fewer seats and high commonality. The largest member of the family, the E195-E2, is 30 feet longer than the smallest E175-E2 and seats 40 more passengers while increasing the wingspan 13 feet and bigger Pratt & Whitney engines. The E2 family employs strictly Pratt & Whitney engines while the E-Jets utilize General Electric power plants. Table 2.18 shows the operating characteristics displayed by Embraer’s aircraft. It is interesting to note that within the E2, E-Jet and ERJ families, cruising speeds, fuel capacity and range are nearly identical for all models of the family, with the ERJ 145 being an exception. The ERJ135 and ERJ140 have identical cruising speeds, fuel capacities and ranges that differ by 50 nm; the exception to this is the highly successful ERJ145, which carries 300 more gallons of fuel and translates that into 200–1000 extra nautical miles of range. The complete Embraer family of aircraft offers a high degree of commonality, which allows airlines to cut down on training and operation costs, thereby increasing their flexibility and strengthening their profitability. This philosophy of

 https://www.flightglobal.com/programmes/embraers-first-e175-e2-takes-to-the-skies-in-saojose-­dos-campos/135768.article 50  https://www.flightglobal.com/news/articles/embraer-sticks-to-schedule-on-e175-e2and-promises-s-460864/ 51  Boon, T. JetBlue’s First Airbus A220–300 Delivered. Simple Flying. January 1, 2021. 52  Embraer Earning Results third Quarter 2020. 49

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Table 2.18  Operating characteristics of Embraer aircraft

Max. Takeoff weight Model (Lbs) EMB 25,353– 120a 26,433 ERJ 41,888– 135a 44,092 ERJ 44,312– 140 46,517 ERJ 44,070– 145 53,131 E170 79,344– 82,012 E175 82,673– 89,000 E175-­ 98,767 E2a E190 105,359– 114,199 E190-­ 123,900 E2a E195a 107,564– 115,280 E195-­ 135,584 E2a

Max. Cruising speed Fuel capacity Range altitude (Mach) (U.S. Gallons) (nm) (Ft) 343mph 875 945 30,000

Total flying cost per block hour ($) N/A

Total maintenance cost per block hour ($) N/A

Total cost per block hour ($) N/A

Average flight stage length (nm) N/A

0.78

1300– 1750 1250– 1650 1550– 2000 2150

37,000

N/A

N/A

N/A

N/A

37,000

1,238 419

2090

366

37,000

1237

419

2090

395

0.75

1360– 1690 1360– 1690 1360– 1950 3071

41,000

1436

591

2385

596

0.75

3071

2200

41,000

1370

414

2187

633

0.82

2265

2060

41,000

N/A

N/A

N/A

N/A

0.78

4234

2450

41,000

2415

823

3786

519

0.82

3519

2880

41,000

N/A

N/A

N/A

N/A

0.78

4234

2300

41,000

N/A

N/A

N/A

N/A

0.82

3519

2600

41,000

N/A

N/A

N/A

N/A

0.78 0.78

Source: Compiled from Embraer aircraft production data & Airline Monitor (as of October 2020) a No operating data available

commonality began with the EMB 120 and the subsequent ERJ family, including both the E-jets and E2 jets. The EMB-120, with its 30-seat capacity, achieved a speed of roughly 500 km/ hr. and enjoyed relative success until the 1980s. In response to the demand of the global market of the 1980s, Embraer soon developed a jetliner, the ERJ 145, which would seat 20 more passengers than the twin-turboprop EMB 120. The EMB 145, in its design, kept the EMB 120’s three abreast (2 + 1) seating configuration but replaced the turboprops with Rolls Royce engines and a more than doubled- range of 1500 to 2300 nm. The EMB 140 was the next aircraft developed by Embraer and was based on the EMB 145, with 96% parts commonality and the same crew type rating. The only difference between the models is the shortened fuselage with fewer seats and a slightly increased range of the EMB 140 compared to the EMB 145 to accommodate the needs of the regional jet market. Optimized for the 70 to 120 seat-capacity segment is the E-Jet aircraft. The E-Jets family of aircraft is composed of two base model aircraft (the E-170

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and E-175) and their stretched versions, the E-190 and 195. The E-170 and E-175 have 95% commonality as do the E-190 and E-195. Between the two families exists 89% commonality with identical fuselages, cross-­sections and avionics (Embraer, 2021). The new-generation E2-Jet aircraft are optimized for the 80 to 120 seat-capacity segment. The E2-Jets family of aircraft is composed of a base model aircraft (the E175-E2) and its stretched versions, the E190-E2 and E195-E2. The E-170 and E-175 have 95% commonality as do the E-190 and E-195. Between the two families exists 89% commonality with identical fuselages, cross sections and avionics (Embraer, 2021).

2.7.2 De Havilland Aircraft of Canada The De Havilland Canada (DHC) was created in 1928 by the British De Havilland Aircraft Company. In the 1980s, DHC was privatized by the Canadian government and in 1986 was sold to Boeing. DHC, later on, was acquired by Montreal-based Bombardier Aerospace in 1992. In 2006, Viking Air of Victoria, British Columbia, purchased the type certificates for all the original out-of-production de Havilland designs. In 2018, Longview Aviation Capital (the holding company of Viking Air) acquired the Q-series from Bombardier and the DHC trademark. Of course, Bombardier has ended the Q-100, −200, and − 300 in 2008; consequently, the only Q-series in production was Q-400. The De Havilland Aircraft of Canada was formed in 2019 to take over the production responsibility of the Q-400, now known simply as Dash 8-400. The renaming of Q-400 as Dash 8-400, in fact, revived the original name of the model. In the late 90s, Bombardier added the Active Noise and Vibration System to all new products. The system was designed to reduce cabin noise and vibration levels to a comparable level to jetliners. To emphasize this point, Bombardier renames the product after 1996 with new active noise control as Q-Series turboprops. In 2020, De Havilland Canada delivered just 20 new aircraft to customers. De Havilland Aircraft of Canada is planning to stop production of the Dash 8-400 turboprop, once it completes the assembly of the remaining airplanes in its backlog by the middle of this year.53 The DHCs (formerly Q-series) remain the workhorse of many fleets. With over 600 aircraft still in service worldwide operating in a variety of capacities, the Q-series remains one of the great successes despite production having been ended on the Q100, 200 and 300 versions of the series. Parent company to the Canadian aircraft manufacturer Viking Air Limited, LAC, has acquired the entire Q-series program, assuming the responsibility for the worldwide product support business of the aircraft still in operation; this transaction made LAC the largest commercial

53

 Flight Global, February 17, 2021.

2.7  Regional Jets

107

Table 2.19  De Havilland Aircraft of Canada Aircraft general characteristics Model First flight Q-100 20-Jun-­83

Q-200

19-Apr-­95

Q-300

15-­May-­87

Q-400

31-Jan-­98

Major operators USAir Express, Northwest, Horizon Air USAir Express, Horizon Air, Wideroe Air New Zealand, Air Nostrum, Flybe, Horizon Air, QANTAS,

Total ordered 299a

Total delivered 299a

Total in World Air Traffic Fleet N/A

105a

105a

21

267a

267a

37

645a

587a

346

Source: Compiled from Bombardier & Centre for Aviation & Cirium fleet data (as of March 2021) Data is as of March 2019

a

Table 2.20  De Havilland Aircraft of Canada Aircraft Physical Characteristics Model Q-100

Wingspan

Length

Capacity 37

85′

73′

Q-200

85′

73′

37

Pratt & Whitney

2

Pratt & Whitney

2

Pratt & Whitney

2

Q-300

90′

84′ 3″

50

Q-400

93′ 3″

107′ 9″

82

Power plant manufacturer Pratt & Whitney

# of engines 2

Source: De Havilland Aircraft of Canada Aircraft Physical Characteristics

turboprop aircraft manufacturer in North America.54 Table 2.19 shows some of the general characteristics of the Q-series. Table 2.20 outlines some of the physical characteristics of the aircraft De Havilland Aircraft of Canada manufactures and differences between various aircraft in the series. The airframe of the original Q-100 with its 37–39 seat-capacity was the same airframe used on the Q-200. The difference between the models lies in the power plant used, in that, although both were Pratt & Whitney models, the Q-200 offered more powerful engines that improved performance. De Havilland Aircraft of Canada offers aircraft with a variety of operating characteristics. These characteristics are outlined in Table 2.21 for the Q-series of aircraft. Table  2.21 shows that for consecutive models of aircraft a complementary incremental increase in cruising speed occurred, from 500 km/h for the Q-100 up. With the exception of the Q-200, which had a shorter range than its predecessor, the aircraft have progressively become more fuel-efficient. The Q-series aircraft are currently in service in a multitude of roles, operating in three sizes, the 37-seat Q100/200, the 50-seat Q300 and the 70-seat Q400. The original Q100 did so well in developing regional airline routes that its operators soon required an aircraft with more power and more seats. The answer was the Q300, which was eleven feet longer than the Q100/200 and had the capacity to seat 54

 Aerospace Manufacturing and Design (Nov. 2018).

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2  Aircraft Variants and Manufacturing Specifications

Table 2.21  De Havilland Aircraft of Canada Aircraft Operational Characteristics Model Q-­100 Q-­200 Q-­300 Q-­400

Max. Takeoff Weight (Lbs) 36,300 36,300 43,000 61,700–64,500

Cruising speed (Mach) 333mph 333mph 330mph 402mph

Fuel capacity (U.S. Gallons) 835 835 835 1724

Range (nm) 1125 1125 924 699–1114

Max. Altitude (Ft) 25,000 25,000 25,000 25,000

Source: Compiled by the authors from De Havilland Aircraft of Canada Aircraft

56 passengers, although most versions are configured to hold 50 seats (Bombardier, 2021). The Q200 is a more powerful version of the Q100 airframe with a larger payload and more powerful Pratt & Whitney PW123 engines also used on the Q300. The Q400 is a stretched and improved 70–78 seat turboprop that entered service in 2000. Its cruise speed is 140 km/h higher than its predecessors are. By having an increase in cruise speed, the Q400’s 667  km/h cruise speed now approaches jet speeds and presents an advantage to short-haul airlines who can usually replace a regional jet with a Q400 without having to change their gate-to-gate schedules.

2.7.3 Mitsubishi Heavy Industries (MHI) The Mitsubishi SpaceJet is a regional jet developed by Mitsubishi Aircraft Corporation (MAC), a Mitsubishi Heavy Industries (MHI) subsidiary. After several years of delayed development, finally the maiden flight of the MRJ90 took place on 11 November 2015. In June 2019, Mitsubishi rebranded the Mitsubishi Regional Jet (MRJ,) program as the SpaceJet. The program is expanded by the acquisition of the Canadair Regional Jet (CRJ) family from Bombardier announced in June 2019 for $550 million, which was completed in June 2020. The transaction was completed despite recently significant changes to the Mitsubishi Aircraft SpaceJet program. The CRJ family remains one of the world’s most successful regional jet programs, with approximately 1500 aircraft still in service around the world.55 All Nippon Airways (ANA) was the first customer, with an order for 15 MRJ 90s. The CRJ 900 has been Bombardier’s most successful aircraft in terms of sales in recent years, and it remains as the primary competitor to Embraer ERJ 145 in the U.S. regional jet market.56 On the other hand, Mitsubishi’s newest MRJ program is scheduled to start deliveries in 2020 as a 90 seat variant called SpaceJet M90 and also a 76 seat variant called M100 which is targeted specifically for the US market to fall within the US scope clause for the seat limit of aircraft that fly on regional routes. The M100 is scheduled for delivery in 2023. The 100 seat variant is still being developed MRJ 100, while the smaller 70 seats is scheduled for delivery in 2024. Table 2.22 shows some of the general characteristics of Mitsubishi’s fleet. The CRJ 700 and CRJ 900 have the same engine type, which allows for greater commonality and maintenance costs. The largest member of the family, the CRJ 55 56

 Aerospace Manufacturing and Design (November, 2018).  Bombardier Commercial Aircraft 2019.

2.7  Regional Jets

109

Table 2.22  Mitsubishi Aircraft characteristics Model CRJ 100

First flight 10-May-­91

CRJ 200

1-Dec-­95

CRJ 700

27-May-­99

CRJ 900

21-Feb-­01

CRJ 1000

28-Jul-­09

CS100 CS300

16-Sep-­13 27-Feb-­15

Major operators COMAIR, Lufthansa CityLine, BRIT AIR Delta Connection, SkyWest, Independence Air American Eagle, SkyWest Delta Connection, Mesa Air Nostrum, Garuda Indonesia Delta Swiss, airBaltic, Air Canada

Total ordered 227

Total delivered 226

In-service 25

782

782

353

333

317

79

322

284

50

70

40

33

90 539

49 99

40 78

Source: Compiled from Bombardier & Centre for Aviation & Cirium fleet data (as of March 2021) Table 2.23  Mitsubishi Aircraft Physical Characteristics Model CRJ 100

Wingspan

Length 87′ 10″

Capacity 50

Power plant manufacturer General Electric

# of engines 2

69′ 7″

CRJ 200

69′ 7″

87′ 10″

50

General Electric

2

CRJ 700

76′ 3″

106′ 8″

66–78

General Electric

2

CRJ 900

81′ 6″

119′ 4″

76–90

General Electric

2

CRJ 1000 CS100

85′ 11″

128′ 5″

97–104

General Electric

2

115′ 1″

114′ 9″

108–133

Pratt & Whitney

2

CS300

115′ 1″

127′ 0″

130–160

Pratt & Whitney

2

Source: Compiled by the authors from Mitsubishi Aircraft

900, seats a maximum of 90 passengers and is approximately 20 feet longer than the original CRJ 100 and 200 which sat 39 and 50 passengers, respectively. The MRJ all uses the Pratt & Whitney PW1200G, which allows for greater commonality and lower maintenance costs. The largest member of the family under development is the 100 seater. The baseline model is the M90 with 90 seat capacity, and the M100 has a 76 seat capacity. The smallest variant was the M70, which has a 70 seat capacity. The M70 later was redesigned as M100. The M100 is 3 feet 7 inches longer than the M70 and 4 feet 3 inches shorter than the M90.57 Mitsubishi offers aircraft with a variety of operating characteristics. These characteristics are outlined in Table 2.24 for the CRJ-series and MRJ series of aircraft. Table  2.24 shows that for consecutive models of aircraft a complementary  https://www.flightglobal.com/news/articles/mitsubishi-rebrands-mrj-as-spacejetand-plans-new-76-458878/ 57

51,000–53,000

72,750 82,500 91,800 134,000 149,000

Model CRJ 100

CRJ 200

CRJ 700 CRJ 900 CRJ 1000a CS100a CS300a

0.78 0.78 0.78 0.78 0.78

0.74

Cruising speed (Mach) 0.74

2903 2903 2903 4665 4665

2135

Fuel capacity (U.S. Gallons) 2135

Range (nm) 1305– 1650 1229– 1585 1378 1553 1622 3100 3300 41,000 41,000 41,000 41,000 41,000

41,000

Max. altitude (Ft) 41,000

1365 1374 N/A N/A 1003

Total flying cost per block hour ($) 1132

Source: Compiled by Bombardier aircraft production data & Airline Monitor (as of October 2020)

Max. takeoff weight (Lbs) 51,000–53,000

Table 2.24  Mitsubishi Aircraft operational characteristics

$455 $325 N/A N/A $1747

Total maintenance cost per block hour ($) $523

$2249 $2172 N/A N/A $3100

Total cost per block hour ($) $1963

461 485 N/A 3100 3100

Average flight stage length (nm) 369

110 2  Aircraft Variants and Manufacturing Specifications

2.8 Summary

111

incremental increase in cruising speed occurred, up to 850 km/h for the CRJ 900. The aircraft have progressively become more fuel-efficient. In the CRJ family for example, the CRJ 700 and CRJ 900 have the same fuel capacity and engines, but the CRJ 900 has an increased range of 2956 which is 300 nautical miles further than the CRJ 700. The MRJ aircraft family has the same fuel capacity and engines, but the M90 has an increased range of 2040 which is 130 nautical miles further than the smaller seating capacity M100. The CRJ 200 was designed to provide superior performance and operating efficiencies in the regional airline industry. When compared to its nearest competition, it flies faster and further, while burning less fuel and having lower operating costs. The Bombardier CRJ 200 was designed to carry 50 passengers in a 4-abreast configuration and boasts an outstanding maximum speed of 860 km/h. The CRJ 700 was developed as an evolution of the CRJ 200, keeping the cockpit commonality while incorporating new structures and systems. With an increased passenger seat-capacity of 70–78 passengers and an increased maximum cruising speed of 875 km/h, the CRJ 700 improves upon the performance of the CRJ 200 and ranges up to 150 nm. An all-new wing was also designed that incorporates full span leading edge slats, which allow excellent airfield performance with only a small increase in wingspan from the CRJ 200. Designed to hold 86–90 passengers in the same 4-abreast configuration as other members of the CRJ family, the CRJ 900 further improves upon the features and design of the CRJ 700. The newly designed MRJ product is compared favorably with the older technology CRJ family of aircraft. The aircraft will not only establish a new standard for regional travel in terms of comfort and customer experiences, offering the most spacious cabins, widest economy seats, and latest in-cabin technologies in the regional travel market, but also in terms of cost savings and operational efficiency. This aircraft engine and aerodynamic design are the key factors to its advantages. The Pratt & Whitney PW1200G engine PurePower Geared TurbofanTM technology, with 60% fewer turbine blades than conventional turbofan engines, will reduce maintenance costs, and the larger wing extensions, will reduce fuel consumption by 20%. The new engines and improved aerodynamics combined will reduce noise exposure by 40% compared to similar aircraft.58

2.8

Summary

This chapter reviews the different types of aircraft that the manufacturers have produced and their product characteristics. We have begun to piece together some of the physical and operating specifications that aircraft operators often have to take into consideration when determining which available aircraft to purchase from the various manufacturers. Airlines’ decision to add an aircraft is based on the expected present value of the aircraft revenue and the cost of flying that aircraft.

58

 Mitsubishi SpaceJet Family Specifications 2020.

112

2  Aircraft Variants and Manufacturing Specifications

From an aircraft design perspective, it is important to look at the capacity, fuel efficiency and range. For example, to meet the market challenges a feeder airliner may fly up to 100 passengers on short-haul aircraft. The ERJ-195’s maximum passenger capacity is slightly less than that of the 737-600; however, it seems to be slightly faster. The E195 has less range capability than the −600, but it is much lighter and therefore more fuel-efficient. With the introduction of longer-range regional aircraft, these aircraft increasingly found their niche feeding the newer and longer-range markets. Sukhoi Superjet 100 is a new regional aircraft designed to compete with its Embraer and former Bombardier’s CRJ family of aircraft. For the selection process, the specifications for a particular aircraft must be compared to a competing aircraft from a different manufacturer. Comparing specifications allows for a more accurate determination of aircraft most suited for the operations. These specifications also provide the roadmap to aircraft valuation.

Bibliography Airbus S. A. S. (2021). Aircraft families. Retrieved February 5, 2021 from http://www.airbus.com/ en/aircraftfamilies/ Airliners.net. (2010). Aircraft data: Airbus A300B2/B4. Boeing Company. (2002, June 14). The secret behind high profits at low-fare airlines: A majority fly the Boeing 737 exclusively. Bombardier (2021) Bombardier Q200 Factsheet. Retrieved on April 2021 from https://www2. bombardier.com/Used_Aircraft/pdf/Q200_EN.pdf. Eden, P.  E. (2006). Civil aircraft today: The world’s most successful commercial aircraft. Summertime Publishing Ltd.. Embraer (2021) Commercial Aviation. Retrieved on April 2021 from https://www.embraercommercialaviation.com. FlightGlobal. (2006). Boeing’s 747-8 vs A380: A titanic tussle.

3

Aircraft Financial and Operational Efficiencies

According to the latest Boeing and Airbus projections, the number of aircraft in the skies will more than double by 2040. In the future, aircraft are expected to be more fuel-efficient, faster, and maybe powered with electric propulsion. The flight from Sydney to London in 1947 took an incredible amount of 4 days, which included two overnight stays on land and four stops for refueling. A flight operated by the Australian airline Qantas has enjoyed the record-breaking trip from London to Sydney nonstop, spending 19 h and 19 min. In addition, the average aircraft size has increased steadily over the past 30 years, with an associated rise in the numbers of seats and aircraft range. Currently, the importance of aircraft fuel efficiency has increased with concerns of climate change and the rise of jet fuel prices. Airlines demand more fuel-efficient aircraft engines. In this chapter, we outline several single-­factor ratios that can be used to benchmark aircraft financial and operational © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 B. Vasigh, F. Azadian, Aircraft Valuation in Volatile Market Conditions, Management for Professionals, https://doi.org/10.1007/978-3-030-82450-1_3

113

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3  Aircraft Financial and Operational Efficiencies

performance for both narrow and wide-body aircraft. We have chosen several narrow-­body, wide-body and regional aircraft. We demonstrate how these efficiency ratios can be used to compare and benchmark commercial aircraft and lay the foundation for using these metrics as determinants of aircraft value in subsequent chapters. The remainder of the chapter is organized as follows: Airline Fleet Composition Single Factor Ratios • Aircraft Technical Performance Ratios –– Average Seats per Aircraft –– Cargo Capacity –– Range –– MTOW • Operating Ratios –– Fuel Efficiency –– Aircraft Utilization –– Average Stage Length –– Breakeven Load Factor • Financial and Operational Performance –– Total Operating Costs –– Crew Cost –– Depreciation and Leases –– Fuel Cost –– Maintenance costs –– Soft Costs Comparative Analysis of Efficiency • Narrow-body: Boeing vs. A320 Family • Wide-body: Boeing 777-200 vs. Airbus A330-300 • Regional jets: CRJ 100/200 vs. ERJ 145 At the end of the chapter is a summary for this chapter review and a selected bibliography for further study.

3.1

Airline Fleet Composition

The Wright Brothers created the single greatest cultural force since the invention of writing. The airplane became the first World Wide Web, bringing people, languages, ideas, and values together. Bill Gates, CEO, Microsoft Corporation Fleet composition refers to decisions concerning the number and the types of aircraft in operations. Selecting, evaluating, financing and managing the optimum fleet, matching capacity to demand are crucial to airlines’ success.

3.1  Airline Fleet Composition

115

The fleet composition is one of the most important decisions that an airline has to make. Fleet composition refers to decisions concerning the quantity and the types of aircraft that will support an airline’s business plan. The selection of a proper aircraft type has a significant impact in terms of the overall operational effectiveness, as well as costs and financial viability. We have identified two different business models within the fleet selection process; legacy airlines and low-cost airlines. Interestingly, the difference between legacy airlines and low-cost carriers is tapering (Azadian & Vasigh, 2019). Unlike full-service carriers, low-cost carriers typically only operate one type of aircraft. For instance, since its inception, Southwest Airlines exclusively operates single-aisle, narrow-body Boeing 737 aircraft.1 By operating a single fleet of aircraft, an airline is able to keep the cost of inventory of spare parts down and reduce training costs with standardized crew training and maintenance routines. Several factors, including passenger demand, range, and seat capacity, come into consideration when an airline decides to diversify its fleet. Nonetheless, having different types of aircraft allows airlines to manage capacity better and keep revenue high. On the other hand, by operating a single fleet of aircraft, airlines are able to streamline maintenance and repairs, as well as keep pilot training costs low. Like many other assets, aircraft values depend on two factors: technical efficiency and operational efficiency. Operational efficiency is the airline’s ability to provide services to its passengers in the most cost-effective manner while ensuring the high quality of its services. A technically efficient airline should produce the maximum output while using the minimum quantity of inputs. In this context, we can consider factors such as gross takeoff weight, convertibility (passenger to cargo), fuel burn, maintenance expenses per block hour, aircraft wear-and-tear, and cruising and landing distance. Aircraft efficiency can be measured by a single factor or multifactor measures. Single-factor measures are based on a single input and output, including fuel burn per block hour, crew costs per block hour, load factor and average seats per aircraft. Single-factor ratios can be broken down into three types: technical, operational and financial. Some technical metrics are aircraft characteristics that are considered fixed in the short term. Examples include average seats per airplane, cargo capacity, airspeed and range. These characteristics influence an aircraft operator when purchasing the aircraft, but once determined, they are exogenous to airline operations. Operational characteristics impact aircraft value and are determined by the aircraft operators. Many factors further influence operational characteristics, out of which aircraft utilization is probably the most important. Other factors include scheduled stage length and fuel efficiency. Some operating procedures can affect fuel efficiency, but basic aircraft fuel efficiency characteristics are much more a determinant of overall efficiency than the airline’s patterns of use of the aircraft itself. The financial

1  In 2012, after acquisition of AirTran Airways, the largest Boeing 717 operator at that time, Southwest decided not to integrate the fleet and reach an agreement with Delta to lease the fleet of Boeing 717 (Southwest News release, July 9, 2012).

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characteristics of an aircraft include crew costs, maintenance, depreciation and other operating costs. Economic efficiency occurs when the firm produces a given level of output at the least cost. Technological efficiency happens when a firm produces a given level of output by using the least amount of inputs. Operational efficiency is the ability of a business firm to produce a product or services in the most costeffective manner, while still ensuring the highest quality of the products. In the 1960s, the three U.S. commercial aircraft manufacturers  – Boeing, Lockheed, and McDonnell Douglas – had over 90% market share. Until 1980, the U.S. commercial aircraft industry enjoyed a monopolistic position in the world market, despite the European-based Airbus Industrie having come to exist in 1970. Surprisingly, today Airbus has over 50% market share. The entry of Airbus was one of the major factors leading to the demise of McDonnell Douglas. McDonnell Douglas had two families of aircraft, the DC-9, targeting the short-haul market with a low seating capacity, and the DC-10, a medium to long-haul aircraft with a medium seating capacity.2 For airlines, operational cost is a crucial measure of aircraft performance. The Boeing 787-9 was the most fuel-efficient aircraft, on 2016 transpacific flights at 39 passenger kilometers per liter of fuel, or 60% better than the A380. The 787 Dreamliner was the first airliner with a mostly composite airframe. In 2013, Boeing grounded the fleet of 787 Dreamliner due to issues in onboard lithium-ion batteries. Boeing claimed that the 737 MAX 8 uses 8% less fuel per seat than the A320neo. Sadly, in March 2019, its entire global fleet of 737 MAX aircraft was grounded after two fatal aircraft crashes.3 Consequently, Airbus’ market share spiked to almost 62.5% in 2019 due to a significant reduction in Boeing deliveries. As of February 2021, Boeing has 3966 unfilled orders for Boeing 737MAX. Table 3.1 presents a general summary of aircraft types in the world. We can see that Boeing dominates the market, constituting over 50% of the global commercial aircraft fleet. In contrast, Airbus Industrie has a market position that has been growing steadily over the past decade. The A320 family has become a short and mediumhaul workhorse for airlines around the world; it is reasonable to surmise that the Boeing 737 and Airbus A320 family of aircraft will dominate the U.S. markets in the near future. Another interesting detail is that there was a 4.4% fleet reduction in 2008, primarily due to the economic recession. To counteract some of the severe losses experienced by North American carriers, massive fleet reductions were initiated. This fleet reduction continued well into 2010; the current annual growth rate as of 2020 is 0.9%.4

 These aircraft were extended and updated with the MD-80 and MD-90 as derivatives of the DC-9 and the MD-11 as a derivative of the DC-10. 3  FFA has cleared the MAX to return to service once necessary design modifications have been made on November 18, 2020. 4  FAA Aerospace Forecast Fiscal Years 2020–2040. 2

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Table 3.1  United States Fleeta World fleet data – Boeing aircraft Actual year end fleet 2015 2016 2017 717-200 155 155 155 737-700 1229 1221 1216 737-800 3940 4366 4771 737-900/ER 419 471 508 737-7 MAX – – – 737-8 MAX – – 74 737-9 MAX – – – 747-400 521 497 444 747-8 101 110 124 757-200/300 905 863 786 767-200/400 894 877 851 777-200/300 1339 1425 1484 787-8/-9/-10 363 500 636 Total Boeing 9866 10,485 11,049 World fleet data - Airbus aircraft Actual year end fleet 2015 2016 2017 A319 1430 1424 1431 A320 3868 4090 4242 A320 NEO – 68 229 A321 1194 1406 1583 A321 NEO – – 20 A330-­ 1230 1287 1344 200/300/800/900 A350-900/1000 15 64 142 A380 179 207 222 Total Airbus 7916 8546 9213 World fleet data – Regional aircraft Actual year end fleet 2015 2016 2017 Bombardier 1594 1584 1553 Embraer 2032 2117 2198 ARJ21-7/900 1 2 4 SSJ-75/95 75 103 126 Total other 3702 3806 3881

2018 155 1203 5051 542 – 309 20 439 130 758 853 1511 781 11,752

2019 155 1206 5096 564 – 356 29 420 137 725 866 1556 939 12,049

Projected year end fleet 2020E 2025 2030 155 108 54 1209 1157 837 5133 5111 4555 564 564 504 10 110 250 562 3162 6272 39 209 389 398 297 264 147 182 182 686 493 360 862 831 803 1581 1560 1378 1079 1854 2894 12,425 15,638 18,742

2035 30 557 3755 404 390 9412 544 192 182 242 754 1145 4134 21,741

2040 17 387 2285 264 560 13,232 814 93 182 121 627 785 5784 25,151

2018 1412 4324 513 1671 122 1386

2019 1416 4336 894 1709 290 1439

Projected year end fleet 2020E 2025 2030 1423 1356 1047 4315 4076 3631 1340 3480 5850 1745 1692 1538 480 1750 3570 1508 1813 2086

2035 528 2931 8070 1351 5700 2187

2040 186 1589 10,840 992 8610 2299

235 233 9896

347 471 241 250 10,672 11,532

2018 1565 2266 24 151 4006

2019 1581 2337 54 181 4153

1,031 1871 250 250 15,448 19,843

Projected year end fleet 2020E 2025 2030 1585 1501 965 2451 3106 3392 84 234 384 211 371 601 4331 5212 5342

2941 4571 243 155 23,951 29,242

2035 490 3636 534 831 5491

2040 292 4325 724 1079 6420

Source: Compiled by the authors from Airline Monitor (as of February 2020) a Data for annual world fleet of jet aircraft (Deliveries minus retiremenets)

3.2

Single Factor Ratios

Financially, 2020 will go down as the worst year in the history of aviation. On average, every day of this year will add $230  million to industry losses. In total that’s a loss of $84.3 billion. It means that – based on an estimate of 2.2 billion passengers this year – airlines will lose $37.54 per passenger. That’s why government financial relief was and remains crucial as airlines burn through cash. Alexandre de Juniac, IATA’s Director-General

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Aircraft manufacturers are in a continuous search for processes and safety improvements that will eventually lead them to achieve a superior level of performance in their industry. Benchmarking helps the aviation industry to identify opportunities and challenges to effectively obtain breakthrough levels of performance. Ratios are a mathematical relationship between one variable over another variable. Single-factor productivity refers to the measurement of productivity that is a ratio of output and one input factor. Suppose you have 100 aircraft and 2500 pilots, then the ratio of pilots to aircraft is 25:1. Single-factor ratios can be beneficial for comparing and benchmarking aircraft efficiency across aircraft types. However, they are limited to the consideration of one or two operational aspects at a given time and are unsuitable for comprehensive aircraft efficiency comparisons. For example, an aircraft with superior fuel efficiency and maintenance costs per block hour may be unsuitable for short-haul markets if the depreciation per block hour is too high and hurts profitability. Multifactor productivity comparisons attempt to address this shortcoming by integrating several input and output measures into a single productivity measure. This section is essentially concerned with the calculation of relationships between outputs and inputs to provide necessary information to management about the operations and financial performance of an aircraft. There are three aspects of operational indicators that we can evaluate according to: • Fuel efficiency or average fuel burn (per block hour): For example, an older generation of 737 will burn 750 gallons (5000 pounds) an hour typically, while the MD-88 uses about 1200 gallons an hour. The current generation burns about 5000 pounds (750 gallons) an hour. • Average aircraft utilization (in block hours): It is calculated by dividing aircraft block hours by the number of aircraft days assigned to service on air carrier routes. Higher aircraft utilization results in lower average fixed costs, as the total fixed costs spread across more air trips and passengers and results in a lower cost per available seat mile. According to Boeing, for an average trip distance of 500 nautical miles, a 10-min reduction in turn-time will increase aircraft utilization by 8%. The 737 MAX is designed to be 14 percent more fuel efficient than the current generation of 737  s. A320 could deliver 15–20% operating cost reduction over the present generation, since the new engines will burn 16% less fuel. Made from lightweight composite materials, the new wingtip extensions provide up to four percent overall fuel burn savings. • Average stage length (ASL): ASL is calculated by dividing total aircraft miles flown by the number of total aircraft departures performed. For Southwest Airlines in 2019, the ASL was 748 miles, with an average duration of approximately 1.7 h. • Breakeven load factor

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The levels and historical trends of these ratios can be used to make inferences about an aircraft’s operational performance and its attractiveness as an investment. There are four different financial indicators: • • • •

Crew cost per block hour Depreciation per block hour Fuel cost per block hour Maintenance cost per block hour

3.2.1 Aircraft Technical Performance Ratios Technical factors are aircraft characteristics that influence the costs and profitability of an airline. While the airline can determine technical efficiency factors before acquiring the aircraft, once the acquisition is complete, the airline has relatively little control over these factors. We will examine the following technical ratios: average seats per aircraft, cargo capacity, fuel capacity, range, and maximum takeoff weight (MTOW). To better elaborate the technical performance ratios, we explore the concept through a case study. In the commercial aircraft market, there is vigorous competition between Boeing and Airbus. The Airbus cockpit commonality brings cost savings to the operators in terms of training costs, spare parts, and maintenance costs. Both manufacturers have two main aircraft types: narrow-body and wide-body aircraft, within which sub-categories differentiated by seat capacity, aircraft range, and configuration exist. Competing with the Airbus A320 family, the Boeing 737 family has relatively similar characteristics. Tables 3.2 and 3.3 show the technical specifications of Boeing’s narrow and wide-body aircraft and those of comparable Airbus models. Tables 3.4 and 3.5 show the competing wide-body aircraft from the two manufactures. The Boeing 777 family has become the best-selling wide-body aircraft in the world, and it is operated by many carriers in the long-haul markets. In 1996, Boeing launched a more powerful version of the 777, with an even greater range, called the 777-200ER for extended range. Tables 3.2, 3.3, 3.4, and 3.5 show the technical specifications of Boeing’s narrow and wide-body aircraft and those of comparable Airbus models. At the end of March 2020, Boeing 777 orders and deliveries reached 2009 and 1633, respectively, making it the best-selling wide-body aircraft. Competing with the Boeing 777 family is the Airbus 330 family, which has comparable characteristics. The Boeing 777 is the first Boeing commercial transport, which employs a Fly-By-Wire flight control system.

3.2.1.1 Average Seats per Aircraft The key measurements of aircraft capacity are seat density and aircraft utilization. When making decisions on aircraft acquisition and fleet planning, airlines consider

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Table 3.2  Boeing Narrow-Body aircraft technical specifications Seats (2-class configuration) Cargo Volume (Cubic ft) MTOW (Lb) Fuel Capacity (US GAL) Range (nm)

737-700 126

737-800 162

737-900ERa 178

737 MAX 162

757-200 186

966 154,500 6875 3010

1555 174,200 6875 2935

1826 187,700 7837 2950

1543 181,200 6820 3515

1790 220,000 11,276 3915

Source: Compiled by the authors from Boeing airplane characteristics a B737-900ER with winglets & auxiliary fuel tanks Table 3.3  Airbus Narrow-Body aircraft technical specifications Seats (2-class configuration) Cargo Volume (Cubic ft) MTOW (Lb) Fuel Capacity (US GAL) Range (nm)

A319 124

A320 150

A320 NEO 165

A321 185

A321 NEO 206

978 166,000 6300 3750

1322 172,000 6300 3300

1322 174,200 7060 3500

1828 206,000 6350 3200

1828 213,800 8700 4000

Source: Compiled by the authors from Airbus airplane characteristics Table 3.4  Boeing Wide-Body aircraft technical specifications

Seats (2 or 3 class configurationa) Cargo Volume (Cubic ft) MTOW (Lb) Fuel Capacity (US GAL) Range (nm)

747-­ 400 400

747-­ 800 515

767-­ 400ER 243

777-­ 300ER 370

787-­ 800 242

787-­ 900 290

6371 875,000 57,285 7285

6345 987,000 63,034 7730

4905 450,000 24,140 5625

7552 775,000 47,890 7370

4826 502,500 33,340 7355

6090 560,000 33,384 7635

Source: Compiled by the authors from Boeing airplane characteristics a 787 typical 2 class configuration is assumed Table 3.5  Airbus Wide-Body aircraft technical specifications

Seats (2 or 3 class configurationa) Cargo Volume (Cubic ft) MTOW (Lb) Fuel Capacity (US GAL) Range (nm)

A330-­ 200 247

A330-­ 300 300

A340-­ 600 326

A350-­ 900 325

A350-­ 1000 369

A380-­ 800 555

4673

5591

7121

6088

7138

6187

533,500 36,750

533,500 36,750

840,000 54,000

617,295 36,500

685,640 41,210

1268,000 85,400

7250

6750

7800

8100

7950

8200

Source: Compiled by the authors from Airbus airplane characteristics a A330, A350 typical 2 class configuration is assumed

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Table 3.6  Short-haul economy class Airline Air Canada Air China Air France AirAsia Alaska Airlines American Airlines ANA Azul British Airways China Eastern Delta Frontier Iberia Japan Airlines KLM Korean Air LATAM Qantas Southwest Spirit United Vietnam Airlines WestJet

Airbus A220-300 (CS3) Airbus A319 (319) Airbus A321 (321) Airbus A320neo (320) Airbus A320 Airbus A320 (320) Airbus A320 (320) Airbus A320neo (320) Airbus A320 (320) Domestic Airbus A320 (320) Airbus A320 (32M) Airbus A320 (320) Airbus A320 (320) Boeing 737-800 (738) Domestic Boeing 737-900 (739) Boeing 737 MAX 8 Airbus A320-200 (320) QantasLink – Airbus A320 (320) Boeing 737 MAX 8 (7M8) Airbus A320neo (320) Airbus A320 (320) Airbus A321-200 (321) Boeing 737 MAX 8

Seat pitch 30–32 30 32 29 37–38 31–32 31–32 30–34 31–34 31 34 28–29 28 31 30 32–38 33 28–30 32–33 28–34 30 32 31–34

Seat width 19 17.7 18 18 17 16.5–18 17 17 17.5 17.7 18 18 17 17.3 17 17.8 18 18 17.8 17.75 17.7 18 17

Source: Seat Guru, January 2021

the seating capacity and its compatibility with operations. Seat pitch is the distance from any point on one seat to the exact same point on the seat in front or behind. Seat pitch may vary greatly among airlines, even among different aircraft types for the same airline. For the past several years, airlines have been reducing legroom for passengers on aircraft. Table 3.6 presents seating density for several airlines. One or two extra inches of seat pitch can make a significant difference in passengers’ comfort and productivity. An airline business model prescribes the optimal number of seats on their fleet. Narrow-body aircraft have lower seat capacity and fewer aisles than wide-body aircraft, making them inherently ideal for smaller markers and short-haul segments. For a given seat capacity, the airline then decides on the aircraft seat configuration. Seat configuration is one of the characteristics of an aircraft that could be limited to the original decision. Generally, there are three cabin seat configurations: • One class configuration, where all the seats are economy seats, has become the mainstay of low-cost carriers (LCCs) such as Ryanair, Air Asia, JetBlue, easyJet, WizzAir, and Southwest Airlines. Interestingly, Etihad Airways introduced its

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first “all economy” class aircraft to its fleet in October of 2010, becoming the only non-LCC in the Middle East operating such a configuration. However, more full-service carriers have opted for “all economy” class aircraft or an option where the configuration can be modified depending on how many first-class or business seats are sold, if any. In 2017, British Airways introduced the “Club Europe” business class. Club Europe business class allows the airline to offer business-class service in short-haul routes by simply blocking off the middle seats on a regular economy class seat row,5 and moving a curtain down the cabin to block off the rest of the cabin from that row. In the case that no business class seats are purchased, no middle seats are blocked off, and the cabin remains an all economy-class cabin, this allows airlines to increase the efficiency of revenue management and maximize sales. • Two class configurations are used by many domestic network carriers and some LCCs. US Airways’ first-class flatbed seats in their Airbus A330-300s had a seat pitch of 94 inches. Several Asian airlines, including Air India, Jet Airways, Kingfisher Airlines, Mahan Air, Oman Air, Royal Jordanian, and Saudi Arabian Airlines, have offered economy services as well as business and first-class services. AirAsia X was the first LCC to offer flatbed seats on its long-haul routes, which combines the comfort of premium travel with the affordability of no-frills flying.6 • Three-class configurations are in low use by North American carriers, but it remains a popular choice for international hub-to-hub routes in Europe and Asia. For example, in Air France’s fleet of 225 planes, there are 43 Boeing 777-300s, which have a total seating capacity of 472 passengers in 3 class layouts (14-­business class, 28 premium economy and 430 economy seats).7 A seat’s pitch refers to the distance between one point on an aircraft passenger seat to the same point on the seat in front of it. The seat pitch is measured in inches and the higher the number, the more legroom and space a passenger will have between his seat and the one in front of the passenger. The seat pitch of low-cost airlines is usually about 28 inches, compared to a traditional conventional economy class pitch with 32 inches. Lower seat pitch can mean more rows of seats and higher productivity, resulting in much lowers CASM. For Tables 3.2 and 3.3, all seat capacities are estimates based on a two-class (business and economy) configuration. It is important to emphasize that seat capacity is one of the significant indicators of the revenue capabilities of a particular aircraft. The Boeing 737 MAX 7, in a two-class configuration, holds 138 passengers 5  During COVID-19 pandemic in 2020, many airlines who continue their operations followed the same policy but to create social distance in compliance with health recommendation. 6  Osman-Rani, AirAsia X CEO, Air Transport Aviation Society, 15th Annual Conference, Sydney, Australia, July 2, 20 11. 7  Air France Aircraft Fleet Figures, as of Summer 2020.

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Table 3.7  Typical cabin configurations and seat capacity Category Regional Regional Regional Regional Narrow-Body Narrow-Body Narrow-Body Narrow-Body Narrow-Body Narrow-Body Narrow-Body Narrow-Body Wide-Body Wide-Body Wide-Body Wide-Body Wide-Body Wide-Body Wide-Body

Aircraft type CRJ700 CRJ900 ERJ 145 E190 737-700 737-800 737-900ER 737 MAX 8 737 MAX 9 A319neo A320neo A321neo 747-8 777-200LR 777-300ER 777-8 787-8 787-9 A330-300

Seats (2-class)a 66 81 – 96 126 162 178 178 193 150 180 220 – 313 396 242 248 290 –

Seats (3-class)a – – – – – – – – – – – – 410 305 368 – – 349 290

Maximum seats 78 90 50 114 149 189 220 210 220 160 194 244 – 440 550 381 381 406 440

Source: Compiled from the authors of Boeing, Airbus, and Embraer aircraft specifications (January 2020) a Values assume a standard 31″ pitch seating

per aircraft while its competitor, the Airbus A319neo, holds slightly less, i.e., 120 passengers per aircraft.8 Table 3.7 shows typical seating configurations and capacities for selected aircraft currently in production. As the number of seats per aircraft is increased, the cost per seat is expected to fall. However, as the number of seats increases, the level of cabin comfort decreases and subsequently, the possibility of revenue erosion increases.9 Additionally, more seats in an aircraft could potentially lower the price premium that an airline can charge. In many cases, the decline in cost per seat may be offset by decreased yields per seat. Furthermore, certain seat configurations may require higher power-plant requirements to counteract increased airplane weight, which increases seat costs in the process. Given its operating cost profile and product placement, an airline chooses an optimal seat configuration. Once this is determined, it remains invariant under normal operations.

3.2.1.2 Cargo Capacity Cargo capacity is another important factor of productivity, not only to the freighters but also to the passenger airlines, which not only have to be able to carry passenger baggage but also utilize excess cargo space to increase aircraft revenue. Overall,  Seat capacity is taken from Airbus and Boeing’s aircraft technical specifications and dimensions data. 9  The biggest single cost advantage enjoyed by the LCC is seating density. 8

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world air cargo traffic will more than double over the next 20 years, expanding from 264 billion RTKs in 2019 to 578 billion RTKs in 2039.10 Although around 90% of international trade is carried by maritime, air cargo transports over $6 trillion worth of goods annually and accounts for about 35% of trade by value.11 From this amount, all cargo transports half of the world’s air cargo rest goes in the bellies of passenger aircraft along with luggage.12 The loss of passenger traffic in the middle of COVID-19 has forced many airlines to operate passenger planes as cargo-only flights as passenger traffic decreases. Several airlines have resorted to putting aircraft in long-term storage as they ran out of space at their hub. Top major boneyard airports combined store more than 1100 aircraft as of today. There are also more cargo-friendly wide-body aircraft. Boeing 787-9s and A350s are coming onto the market at the expense of inefficient and a lower cargo capacity, such as the A380. Some of the largest cargo aircraft include: • Antonov An-225 Mriya is the world’s largest operational cargo plane. It has a range between 2160 nm and 8315 nmi., with 551,155 lbs. payload capacity. • Lockheed C-5 Galaxy. A fully loaded aircraft has 2984 nmi. range, and a maximum payload capacity is 260,145 lbs. • Antonov An-124 Condor. A fully loaded aircraft has 2430  nmi. range, and a maximum payload capacity is 330,693 lbs. • Boeing 747 Dream lifter. A fully loaded aircraft has 4200 nmi. range, and a maximum payload capacity is 250,000 lbs. • Boeing C-17 Globemaster. A fully loaded aircraft has 5200 nmi. range, and a maximum payload capacity is 170,900 lbs. • Antonov An-22 Antei. A fully loaded aircraft has 2694 nmi. range, and a maximum payload capacity is 176,000 lbs. • Airbus A400M Atlas. A fully loaded aircraft has 1782 nmi. range, and a maximum payload capacity is 81,571 lbs. • Airbus A300-600ST Beluga. A fully loaded aircraft has 1950 nmi range, and a maximum payload capacity is 78,600 lbs. • Aero Spacelines Super Guppy. It has a maximum range of 1700  nmi., and a maximum payload capacity is 54,500 lbs. • Lockheed Martin C-130J Super Hercules. A fully loaded aircraft has 1800 nmi. range, and a maximum payload capacity is 42,000 lbs. • Boeing 787-8. A fully loaded aircraft has 19,440 nmi. range, and a maximum payload capacity is 40,860 lbs. The aircraft identified in Tables 3.2 and 3.3 have two cargo spaces forward and aft in the belly of the aircraft. After filling the cargo spaces with passenger baggage, the remaining available space is used by carriers for commercial cargo. Most  Boeing Commercial Airplanes, World Air Cargo Forecast 2020–2039.  Forbes. Medicine, phones and strawberries: As passengers drop 90%, desperate airlines convert to cargo to stay afloat, March 26, 2020. 12  Ibid. 10 11

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wide-­bodies and the A320 family allow containerized cargo pallets called Unit Load Devices (ULD’s). These devices allow a much more efficient turnaround time for an aircraft, increasing its cargo-carrying capacity and, therefore, its value. Air carriers place importance on cargo capacity as an important technical metric. Tables 3.4 and 3.5 show the cargo volumes available for Boeing and Airbus’s narrow and wide-­ body aircraft products. The 777-300ER offers the most cubic feet of cargo at 7552 cubic ft.

3.2.1.3 Range Capability The range of an aircraft model is a tradeoff between the maximum take-off weight (MTOW) and airspeed. The technology available today has made ultra-long-haul flights more prevalent and efficient. The aircraft range has increased from the time of B707s with 5000 nautical miles of range to 9000 nautical miles today on aircraft such as the A340 and the B777ER. Longer-range flights will need to take account of additional fuel and passenger amenities such as crew sleeping facilities. In 2018, Singapore Airlines operated the world’s longest flight, linking Singapore and Newark in 19 h. With the expansion of international trade and the progress of trade liberalization, the aircraft with the longest range is preferred since this gives the airlines flexibility in fleet assignments. An aircraft with a 4000-mile range can be used in short, medium or long haul markets; whereas, an aircraft with a 2000-mile range is restricted to short-haul markets. However, a longer range implies higher total operating costs since these aircraft require larger engines, burn more fuel, and have cost profiles that are efficient only if the range capability is fully utilized. Range often determines an aircraft’s deployment within the airline network. The narrow-body, short-range aircraft are suited for short-haul markets and are preferred by LCC and domestic network carriers. Wide-body aircraft are efficient for long-­ haul markets and are widely used by legacy carriers on international routes and long-haul domestic routes. • The Airbus 350-900URL is the world’s longest-range aircraft with a range of 9700 nmi. • The Boeing 777-200LR is the world’s 2nd longest-range airliner, allowing for a maximum distance of 9420 nmi. • The Boeing 787-9 Dreamliner, with a range of 8000 nmi to 8500 nmi, stands 3rd among the 10 longest-range airliners in the world. • The Airbus A380, known as the world’s biggest passenger aircraft for its passenger capacity of 853 passengers, with a range of up to 8477 nmi. is 4th • The Boeing 787-8 Dreamliner, with a range of 7620 nmi. to 8500 nmi., is the 5th among the 10 longest-range airliners in the world. • The Boeing 747-8 InterContinental’s (747-8I) range of 8000 nmi. makes it the 6th longest-range airliner in the world. • The Airbus A350-1000, with a designed range of 8000  nmi. ranks as the 7th longest-range passenger aircraft in the world. • Airbus A340-600 is the 8th longest-range passenger aircraft in the world.

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• Boeing 777-300ER (Extended Range) is one of the top longest-range aircraft, flying up to 7825 nmi. • The Boeing 737 700 Max, with a range of 3850 nmi. (which is the longest range of the MAX airplane family). The Airbus A220–300 enjoys the range of 3678 nmi.13 • The A320 is one of the most popular aircraft with a range of about 3300 nmi.

3.2.1.4 Maximum Takeoff Weight (MTOW) This is the maximum amount of weight that the aircraft can carry and become safely airborne on a standard length runway. MTOW is highly regulated by national aviation authorities and explicitly stated by aircraft manufacturers. Regulatory agencies, including the Federal Aviation Administration (FAA), and Joint Aviation Authorities (JAA), specify rigorous structural and performance requirements, including various engine-out performance capabilities, structural integrity requirements in turbulent air, and crosswind restrictions; all of which use MTOW as a key input. The MTOW restricts operations for certain aircraft, specifically in terms of the number of passengers and cargo that airlines can carry safely. The following are MTOW capabilities for some widely used aircraft. • • • • • • • • • •

Antonov An-225 with a maximum takeoff weight of 575,000 Kg. The A380’s with a maximum takeoff weight of 575,000 Kg. The Boeing 747-8F with a maximum takeoff weight of 447,700 Kg. The Boeing 777-300ER with a maximum takeoff weight of 351,800 Kg. The Airbus A350-900 with a maximum takeoff weight of 270,000 Kg. The Airbus A321-100 with a maximum takeoff weight of 830,000 Kg. Boeing 737-700 with a maximum takeoff weight of 700,000 Kg. Boeing 717-200BGW with a maximum takeoff weight of 500,000 Kg. Bombardier CRJ200 with a maximum takeoff weight of 230,000 Kg. Embraer Phenom 100 with a maximum takeoff weight of 48,000 Kg.

This becomes an especially important consideration for freighters. The following factors will influence the MTOW:14 • Airfield altitude. At higher altitudes, the density of air decreases and the thrust generation capability of an aircraft’s engine decreases; as altitude increases, MTOW is further restricted. • Air temperature. As air temperature increases, air expands and becomes less dense. This impacts the amount of lift that can be generated by aircraft’s wings negatively; hence, as altitude increases, MTOW is further restricted. • Condition of the runway. If the runway’s surface is not perfectly hard and smooth, the aircraft’s ground rolls during takeoff increases.  The Airbus has a range of almost 2000 more kilometers than the Boeing 737. This means hundreds of more routes and way more versatility when it comes to route planning. 14  FAA Pilot’s Handbook of Aeronautical Knowledge – Aircraft Performance. 13

3.3  Operating Ratios

127

• Length of the runway. If the runway’s length does not meet the minim requirements specified in the aircraft’s manual, the aircraft will not have sufficient runway length to take off at MTOW. • Obstacles and terrain beyond the end of the runway. The environmental conditions must be above the aircraft’s limits in order for the aircraft to be able to clear any obstacles and takeoff safely • Runway wind factors. A headwind can help an aircraft achieve lift-off at lower airspeed, while a tailwind will force an aircraft to increase airspeed for lift-off. • Wind strength. Higher wind speeds will require an aircraft to lift-off at higher airspeed in order to generate more thrust; MTOW can only be achieved up to a certain limit of wind speed.

3.3

Operating Ratios

Operational efficiencies are those that an airline can influence by changing some aspect of its operations. These are variable in the short run and consist of metrics such as aircraft utilization, fuel efficiency, and average stage length; although, the latter is an indirect function of aircraft range. In a sense, operating ratios present a mixed indication of efficiency since they are influenced by the airline’s operating characteristics. However, they are an important determinant of aircraft value, and they are rooted in technical and financial aircraft characteristics. We present three ratios – fuel efficiency, aircraft utilization, and aircraft stage length.

3.3.1 Fuel Efficiency People are talking about the third revolution in aviation. The first was the invention of heavier-than-air flight. The second was transatlantic flight. The third will be electric. ZeroAvia, August 30, 2020

The fuel efficiency of an aircraft is a measure of how much fuel an aircraft burns to provide certain services. For example, we can measure fuel efficiency as the number of gallons of fuel per block hour or per passenger. Fuel efficiency is an important part of air carrier operation, and fuel consumption is determined by the average speed, aircraft weight, environmental factors, and other technical design characteristics, such as blended winglets design. The objective of any Wing Tip Drag Reduction Device is to increase the efficiency of an aircraft by reducing induced drag resulting from lift-induced wing tip vortices. An increase of weight on the aircraft will increase the lift and thrust required for operation, increasing the drag and fuel flow; thus, increasing the fuel burn.15 The poor fuel efficiency of older four-engine aircraft such as the 747-400, the A340 family and the Airbus  BAE System. 100 Ways to Reduce Fuel Burn. https://www.regional-services.com/wp-content/ uploads/2016/01/100-Ways-to-Reduce-Fuel-Burn.pdf

15

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superjumbo A380 contributed to the decision to discontinue their production prematurely due to the strong competition from more fuel efficient aircraft such as Boeing’s 777 and Airbus A350.

Additional Fuel Flow  5%Additional Weight  Hours Flown

From a fuel consumption perspective, a full thrust takeoff and a full thrust climb profile offer the most fuel economy for an unrestricted climb. However, from an airline’s cost perspective, this must be balanced with engine degradation and time between overhauls, as well as guidance from the engine manufacturer. Boeing. Aero Magazine. Fuel Conservation Strategies: takeoff and climb. For example, 100 lbs. of additional weight would result in around 5 lbs. of additional fuel flow per flight hour. The pressure to reduce aircraft weight has forced manufacturer to develop new materials that can outperform conventional airplane construction materials at lower weight. United Airlines was able to save 643,000 liters of fuel and $300,000 a year by printing its in-flight magazine on lighter paper, which saves 28 grams per copy. However, airlines can also control fuel consumption by: • • • • • • • • • • • •

Considering the use of lighter catering trolleys, carpets, and seats Detaching unnecessary safety equipment and tools Improving aircraft turnaround time Operating one engine during taxing Optimize the amount of potable water in the aircraft Removing redundant galleys, in-flight magazines, blankets, pillows or in-flight entertainment Removing unnecessary aircraft modifications Request to take-off and land on the most convenient runways Start engines as late as possible Stay as high as possible for as long as possible Switching to ground power as soon as possible after landing Use ground power start when available

Usually, fuel is the top expense since it accounts for approximately 50% of operating costs for most airlines. Reducing and optimizing fuel consumption can be essential to the financial survival of the airline. We can measure the fuel efficiency of any aircraft by dividing the gallons consumed per block hour, by the average number of seats or average stage length. Hence, the cabin layout and the seating density are important factors in determining average fuel costs. A high-density, one-class seat configuration used by LCCs will have a lower average fuel consumption than a legacy carrier with a three-class configuration. Another factor is the average stage

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129

Table 3.8  Impact of takeoff flaps selection on fuel burn

Airplane model 717-200

737-800 Winglets

777-200 Extended Range 747-400 747-400 Freighter

Takeoff flap setting 5 13 18 5 10 15 5 10 20 10 20 10 20

Takeoff gross weight Pound (Kilograms) 113,000 (51,256) 160,000 (72,575) 555,000 (249,476) 725,000 (328,855) 790,000 (358,338)

Fuel used Pound (Kilograms) 933 (423) 950 (431) 965 (438) 1274 (578) 1291 (586) 1297 (588) 3605 (1635) 3677 (1668) 3730 (1692) 5633 (2555) 5772 (2618) 6389 (2898) 6539 (2966)

Fuel differential Pounds (Kilograms) – 17 (8) 32 (15) – 17 (8) 23 (10) – 72 (33) 125 (57) – 139 (63) – 150 (68)

Source: Boeing. Fuel Conservation Strategies: takeoff and climb (2020)

length of the aircraft. Recalling that an aircraft has maximum fuel burn during takeoff and the climb to cruising altitude, as well as during the descent and landing, an aircraft with a high stage length would increase its efficiency since it has shorter landing and takeoff cycles. Aircraft with longer ranges are likely to have higher stage lengths, and thus, likely to be more fuel-efficient. Table  3.8 indicates that higher flap selection tends to increase fuel consumption and thus, decrease efficiency. Table 3.9 shows fuel efficiency for different aircraft types, with newer models with more fuel-efficient engines reflecting the most positive figures. Figures 3.1, 3.2, and 3.3 depict the fuel efficiency of various regional jets, narrow-body and wide-body, in terms of gallons of fuel burned per seat mile. Table 3.9 also shows fuel efficiency by displaying the fuel consumption per block hour across the regional, narrow-body and wide-body market. As the number of aircraft seats and the average stage length increase, the average fuel consumption (CASM fuel) decreases. Additionally, aircraft fuel efficiency has increased with newer models; this is, attributed to aircraft manufacturer’s incorporation of aerodynamic and power plant efficiency with new technological innovations. According to Boeing, the 747 burns approximately 4 gallons of fuel every second;16 hence, it burns 3600 gallons of fuel per hour, while a Boeing 787-9 burns approximately 2511 gallons of fuel per hour. Aircraft with four engines are less fuel-efficient than those with two engines, twinjets due to inherent design factors, such as a higher wing weight.

 The lack of fuel efficiency contributed to obsolescence of Boeing 747. British Airways who was the largest operator of the B747 family announce its decision to retire remaining B747-400 immediately (CNBC July 17, 2020).

16

777-­ 200ER 2236 7.83 0.00189 0.00146 0.00179

767-­ 767-­400 300ER 1586 1742 7.43 7.21

0.00215 0.00194

723 5.12 0.00444 0.00367 0.00364

688 6.16

777-­ 787-8 300ER 2601 1579 7.94 6.96

737-8 MAX 673 3.87

0.01403 0.00749

471 6.23

737-­800 737-­ 900ER 800 843 4.79 4.71

626 6.27

717-­200 737-­700

410 8.19 0.02074 0.01052 0.00983

477 6.26

1081 6.04

757-­200

1927 6.61

1760 6.63

0.00117 0.00162

A330-­300

787-9

0.00275 0.00367

737-9 MAX 735 4.10

0.01208

626 6.27

CRJ 900 ERJ 145 ERJ 170 ERJ 175 ERJ 190

0.01490 0.01291

CRJ 700 467 6.87

Source: Compiled by the authors from Airline Monitor (as of October 2020)

CRJ-­ 1/200 GF per BHR 340 GF per BHR 6.80 per seat GF per BHR 0.01843 per seat per mile Narrow-­ MD-80 Body GF per BHR 961 GF per BHR 6.54 per seat GF per BHR 0.01391 per seat per mile 747-­400 Wide-­ Body GF per BHR 1999 GF per BHR 6.55 per seat GF per BHR 0.00107 per seat per mile

Regional Jet

Table 3.9  Fuel efficiency by aircraft type in the United States

819 5.11

A320

929 5.00

A321

A320 NEO 689 3.72

A321 NEO 794 4.17

0.00561 0.00505 0.00393 0.00356 0.00201

710 5.28

A319

130 3  Aircraft Financial and Operational Efficiencies

3.3  Operating Ratios

131

0.040

Fuel Burn per Seat per Mile

0.035 0.030 0.025 0.020 0.015 0.010 0.005 0.000

CRJ100/200

CRJ200

CRJ700

CRJ900

EMB 145

EMB 190 Xian MA700

Aircraft Type

Figure 3.1  Fuel efficiency (Regional jets). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

0.025

Fuel Burn per Seat per Mile

0.020

0.015

0.010

0.005

0.000

Aircraft Type

Figure 3.2  Fuel efficiency (Narrow-body). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

132

3  Aircraft Financial and Operational Efficiencies 0.018

Fuel Burn per Seat per Mile

0.016 0.014 0.012 0.010 0.008 0.006 0.004 0.002 0.000

Aircraft Type

Figure 3.3  Fuel efficiency (Wide-body). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

3.3.2 Aircraft Utilization Aircraft is the most expensive asset for airlines, and high utilization efficiency is important in order to obtain an acceptable return on investments. Aircraft utilization is the number of hours an aircraft is operated on a given day. Aircraft Utilization is the most significant measure of aircraft productivity. Optimizing aircraft utilization requires efficient aircraft turn-around time at the gates and efficient maintenance systems. Flying longer routes can help an airline to maximize the rate of return on investment. Airlines have a better chance of making a profit with higher aircraft utilization since the fixed costs are spread out over a greater number of revenue hours. To make an airplane ready for another flight, it must remain at the gate to let passengers exit the aircraft, have cargo and baggage unloaded, have the airplane serviced, cargo and baggage loaded, and board passengers for the next trip.17 Efficient fleet utilization is one of the key factors for an airline’s efficiency, productivity and profitability. While this is clearly, a function of airline operations, the costs associated with high aircraft utilization can often become a factor in determining the optimal utilization rate for the airline. Aircraft utilization is a measure of productivity. To get an average number of block hours per day, we divide the total number of block hours flown per year by the service days per year. 17

 Boeing, Aero Quarterly. Economic impact of airplane turn-times, 2019.

3.3  Operating Ratios

133

Aircraft utilization is determined by each carrier, as well as the costs and times associated with maintenance and other events. Aircraft utilization is an indicator of operational efficiency. Southwest uses its aircraft on many short flights per day, which leads to higher aircraft utilization. This creates a quick turnaround time, with little idle time on the ground. Reducing airplane turn times means more efficient airplane utilization, particularly for airlines that emphasize point-to-point routes. Figures 3.4, 3.5, and 3.6 depict aircraft utilization by average stage length (ASL). If you were taking a flight from Narita, Japan (NRT) to Shanghai Pudong International Airport (PVG) with two stops along the way, then that flight would have three stage lengths. Note that, on average, higher stage length implies higher aircraft utilization because the longer the stage length, the longer the flight time for a given aircraft. However, a significant anomaly exists in the utilization pattern of the Boeing 737-700 (Figure 3.5). This aircraft has a significantly higher utilization time compared to a short stage length due to the “Southwest Effect”.18 Generally, the low-cost airline business model is based on short stage length flights with low turnaround time and efficient scheduling, and that is why the Boeing 737–700 exhibits an above normal utilization, given the relatively short stage length. Southwest’s average flight length (757 miles) is less than that of United (1200 miles), Delta (870 miles), and American (1020  miles).19 This implies that with more than 10  h of utilization, Southwest aircraft get more cycles each day. In the case of the Boeing 767-300, we see a below-average utilization given stage length, while the Boeing 767-400 has above-average utilization. Delta currently operates the majority of 767-300 and -400s in the United States,20 and this effect may be partly attributable to the designated routes being served by these aircraft. Some international routes, which involve an overnight stop at a foreign destination, may present lower aircraft utilization (due to the idle time experienced by the aircraft at the airport) compared with routes that do not require an overnight.

3.3.3 Average Stage Length The economically optimal aircraft size is a function of market demand, competitive nature of the industry, and aircraft stage length (Wei & Hansen, 2003). Average Stage Length (ASL) is determined by the airline’s flight schedule. Generally, the longer the stage length, the greater the number of available seat miles, and the lower the total operating cost per seat mile. Stage length is the number of miles an aircraft travels between a takeoff and landing. The average is a ratio between the total distance traveled and the number of takeoffs (or landings). Hence, the aircraft range is

 The Southwest Effect is generally referred to the downward pressure on fares when Southwest enters a market. 19  SEC 10-K Fillings 2019. 20  As of February 2021, Delta operates 34 Boeing 767-300ER and 21 Boeing 767-400ER. 18

134

3  Aircraft Financial and Operational Efficiencies 10.50

Utilization -Block Hours per Day

10.00 CRJ900

9.50

EMB 190

9.00 8.50 8.00

CRJ700 CRJ100/200

7.50 7.00 6.50 350

EMB 145 370

390

410

430

450

470

490

510

530

550

Average Stage Length (nm)

Figure 3.4  Aircraft utilization by stage length (Regional jets). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

12.50 737-900ER

Utilization -Block Hours per Day

A320 NEO 11.50

A321 737-700737-800

10.50 A319 9.50

8.50

7.50

6.50 400

757-200

A320 737-8 MAX

737-9 MAX

717-200

A321 NEO

MD-80

600

800

1,000 1,200 1,400 1,600 Average Stage Length (nm)

1,800

2,000

2,200

Figure 3.5  Aircraft utilization by stage length (Narrow-body). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

3.3  Operating Ratios

135

16 787-9 747-400

Utilization -Block Hours per Day

15

A330-300

14

777-300ER

787-8 13 777-200ER 12 767-400 767-300ER

11

10 3,000

3,500

4,000

4,500 5,000 5,500 Average Stage Length (nm)

6,000

6,500

Figure 3.6  Aircraft utilization by stage length (Wide-body). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

a significant determinant of the ASL.  An airline can provide more capacity by increasing service frequency, increasing aircraft size, or increasing the stage length. Figures 3.7, 3.8, and 3.9 present fuel efficiency and its correlation with the average stage length. Fuel efficiency is measured in terms of gallons consumed per block hour per seat per mile. The graph illustrates data for regional jets, narrow-­body, and widebody aircraft. The regional jet aircraft category has the least fuel efficiency due to the ratio of the number of seats to stage length. The average seat capacity of a regional jet is between 50 and 100 seats, and the stage length is approximately 500 nmi. Regional jets are an important element of a hub and spoke network and are typically operated as feeders, which is why they have a relatively lower ASL. The average stage length (ASL) of each flight any is the sum of departures divided by the amount of nautical miles flown. ASL is the average length of the flight, and generally longer average stage lengths associated with lower yields and lower unit costs. The 737-800 and A320 have very similar operating characteristics when it comes to ASL.  Both aircraft burn about the same amount of fuel per block hour. The narrow-­body aircraft depicted in Figure 3.8 have a better fuel efficiency profile than regional aircraft but lag behind wide-body aircraft on an ASM basis. This is because, on average, wide-body aircraft have a much higher ASM per block hour. Even with

136

3  Aircraft Financial and Operational Efficiencies 0.033 EMB 145

Fuel Burn per Seat per Mile

0.031

0.029

0.027

CRJ100/200

0.025

CRJ700

0.023

EMB 190 CRJ900

0.021

0.019 350

370

390

410

430 450 470 Average Stage Length (nm)

490

510

530

Figure 3.7  Fuel efficiency by stage length (Regional jets). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

Fuel Consumption of Boeing Aircraft Boeing 757-200 – 3320 kg/h Boeing 757-300 – 3900 kg/h Boeing 767-200ER – 4500 kg/h Boeing 767-300 – 4800 kg/h Boeing 767-300ER – 4940 kg/h Boeing 767-400ER – 5200 kg/h Boeing 787-8 – 4900 kg/h Boeing 787-9 – 5600 kg/h Boeing 777-200 – 6080 kg/h Boeing 777-200ER – 6630 kg/h Boeing 777-200LR – 6800 kg/h Boeing 777-300ER – 7500 kg/h Boeing 747-8 – 9600 kg/h LCCs such as Southwest operating narrow-bodies, their ASM is likely to be lower than that of a legacy carrier operating wide-bodies over long trans-Atlantic and trans-Pacific routes. An interesting development in the B737 has been the increase in the average stage length in recent years. This increase in stage length may be due to the introduction of the 737-800ER and the 737-900ER for Extended-Range Twin-engine

3.3  Operating Ratios

137

0.023

Fuel Burn per Seat per Mile

0.021

MD-80 717-200

0.019 0.017 0.015

A319

737-700

A321

0.013

A320 737-800 737-900ER

0.011

A321 NEO

737-8MAX A320 NEO

0.009 0.007 400

757-200

600

800

737-9MAX

1,000 1,200 1,400 1,600 Average Stage Length (nm)

1,800

2,000

2,200

Figure 3.8  Fuel efficiency by stage length (Narrow-body). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

0.017 0.016

767-300ER

777-200ER

777-300ER

Fuel Burn per Seat per Mile

0.016 767-400 0.015 0.015 787-8 0.014 A330-300 0.014 787-9

0.013

747-400 0.013 0.012 3,000

3,500

4,000

4,500

5,000

5,500

6,000

6,500

Average Stage Length (nm)

Figure 3.9  Fuel efficiency by stage length (Wide-body). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

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3  Aircraft Financial and Operational Efficiencies

Operational Performance Standards (ETOPS).21 ETOPS operations require certification from the FAA and the inclusion of additional safety equipment, such as life rafts and/or vests, aboard the aircraft. Both Alaska Airlines and Southwest Airlines use the 737-800 for flights from the U.S. west coast to Hawaii; although, Southwest has expressed its intention to operate these flights with the 737 MAX 8 in the future (Goldstein, 2019). Finally, wide-body aircraft retain the most fuel-efficient position, with higher seating capacity and longer stage lengths. For example, the Boeing 747-800 consumes about 3600 gallons of fuel per block hour22 and carries an average of 410 seats with an average stage length of 3800 nmi. Figures 3.10, 3.11, and 3.12 show the fuel efficiency of the aircraft against airspeed per block hour. First, it is important to note that since a block hour starts at chocks-off time and ends with chocks-on, taxiing time influences this calculation. The average speed shown in Figure 3.4 is lower than the cruising speed of the aircraft and is a clear illustration of the economies of greater airspeed trading off with the increased fuel consumption associated with high airspeeds. The aircraft spends a great deal of its flight time below cruise speed for reasons other than fuel consideration. Takeoff and climb to cruise altitude are done at less than the cruise, and all flights below 10,000 feet are restricted to 250 kts of airspeed. Additionally, ATC frequently slows aircraft for spacing or sequencing, particularly in congested airspace, such as the east coast. High airspeeds lead to greater ASMs, which lowers the cost of fuel consumed per ASM. However, high airspeeds often consume more fuel, which could cause a decrease in fuel efficiency. The 737-800 and -900s present a good tradeoff in this case  – they have the lowest fuel burn for a given airspeed. Generally, Boeing aircraft outperform Airbus in terms of fuel efficiency, and the company claims the 747-8I to be over 10% lighter per seat and to have 11% less fuel consumption per passenger, with a trip-cost reduction of 21% and a seat-mile cost reduction of more than 6% compared to the A380.

3.3.4 Breakeven Load Factor Airlines regularly seek to reduce their costs in order to lower the Breakeven Load Factor (BFL). If an airline has lower costs and hence a lower BLF, the airline has a more competitive position and can enjoy the flexibility to compete based on prices. The Breakeven load factor is measured by airlines as the average percent of seats that must be filled on a given flight in order for the passenger revenue to break even with the airline’s operating expenses.23 We can calculate the break-even load factor by dividing cost per available seat mile (CASM) by revenue per RPM.

 U.S. Department of Transportation, Federal Aviation Administration, Advisory Circular, AC No: 120-42B. 22  Approximately 1 gallon of fuel every second. 23  Bureau of Transportation Statistics. https://www.bts.gov/archive/publications/special_reports_ and_issue_briefs/issue_briefs/number_08/entire 21

3.3  Operating Ratios

139

33.000 EMB 145

Fuel (gallons) per ASM

31.000

29.000 CRJ100/200

27.000

25.000

CRJ700 EMB 190

23.000 CRJ900

21.000

19.000250

255

260

265 270 275 280 285 Average Airspeed (miles per block hour)

290

295

Figure 3.10  Fuel consumption per ASM vs. airspeed (Regional jets). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

23.000 717-200

Fuel (gallons) per ASM

21.000

MD-80

19.000 17.000 A319

15.000

757-200 737-700 737-800

13.000

A320 A321

737-900ER A320 NEO

11.000 9.000 270

290

737 MAX 8

737 MAX 9

A321 NEO 310 330 350 370 390 410 Average Airspeed (miles per block hour)

430

Figure 3.11  Fuel consumption per ASM vs. airspeed (Narrow-body). (Source: Compiled by the authors from Airline Monitor (as of 2019))

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3  Aircraft Financial and Operational Efficiencies

16.5 16.0

777-200ER

767-300ER

777-300ER

Fuel (gallons) per ASM

15.5 15.0 767-400

14.5

787-8

14.0

A330-300

13.5 13.0

787-9 747-400

12.5 12.0 465

470

475

480 485 490 495 500 Average Airspeed (miles per block hour)

505

510

515

Figure 3.12  Fuel consumption per ASM vs. airspeed (Wide-body). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

Where:

BLF =

CASM Revenue / RPM

• CASM = Cost per available seat mile • ASM = mile flown × seats available • RPM = mil flown × seats sold For example, if the unit cost is $0.125 (CASM) and unit revenue is $0.20 (Revenue/RPM), consequently the BLF is:



BLF 

$0.125  100  62.5% $0.20

Hence, as operating expenses increase, the breakeven load factor increases. Conversely, as airline ticket prices increase, the breakeven load factor decreases. A positive difference between the load factor and break-even load factor contributes to excess passenger revenue over and above its operating costs. The sale of one or two tickets determines if an airline makes a loss or a profit on that flight, given that airlines typically operate very close to their breakeven load factor. Breakeven load factors remain relatively low as the ticket prices increase or the average cost is reduced. However, in the aftermath of COVID-19, airlines had to reduce prices, and in turn, the BLF increased to 78.1% in 2020, comparing to 65.7% in 2019.24 24

 Economic Performance of the Airline Industry, November 2020, IATA.

3.4  Financial and Operational Performance

141

Breakeven Load Factor (BLF) is the average percent of seats that must be filled a given flight for the airline’s passenger revenue to equate with the airline’s operating expenses. A high load factor indicates that an airline has full planes with most seats occupied by passengers to cover the cost. The break-­ even load factor is calculated by dividing cost per available seat mile (or CASM) with yield per passenger mile.

3.4

Financial and Operational Performance

In this section, we compare and measure the performance of different narrow-body aircraft models and makes to illustrate the financial metrics and variability that exists between them. An important aspect of analyzing any aircraft is the cost to operate the aircraft. Operating costs can vary significantly from one aircraft type to another, and from one airline to another; hence, analyzing existing cost per available seat mile may be more of a function of which airline is operating the aircraft rather than inherent characteristics of the aircraft itself. However, fuel prices are relatively the same across most airlines so analyzing the fuel cost for competing aircraft should tell us which aircraft is more fuel-efficient. In addition, we consider other factors such as seats per aircraft, stage length, and aircraft utilization. Comparisons are made on aircraft that compete in the same market segment. Furthermore, the comparison will be broken down further into an operating and a financial comparison. Financial performance evaluation has become increasingly important to airline managers due to recent global financial problems. Aircraft financial and operational performance allows managers to plan for capital investment as efficiently as possible. Productivity measurements are used as comparisons and guidelines in strategic planning, in the internal analysis of operational efficiency, and in analyzing the competitive position of an aircraft in the market.

3.4.1 A  ircraft Financial Performance Through Financial Ratios Analysis Financial ratios are used to measure an aircraft’s overall financial characteristics over the entire ownership time. In addition, an operator use them to compare similar type aircraft across the same market segment to compare manufactures or aircraft type. Financial ratios are used to analyze aircraft efficiency. Financial ratios are an important tool for airline managers to measure the progress for achieving targeted goals. If an airline buys an aircraft from Boeing, then the airline can compare the

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3  Aircraft Financial and Operational Efficiencies

financial performance of other aircraft produced by Airbus or other manufacturers. For example, the 787 is considered the most advanced and efficient aircraft in its class, carrying 200 to 300 passengers while providing airlines with savings in fuel and operating costs.25 For the airlines in the United States, the FAA requires them to report aircraft operating costs with significant detail, providing an in-depth analysis of aircraft operating costs (FAA’s Form-41). Some of the major cost components and financial metrics, which an airline would like to analyze prior to aircraft procurement are reviewed next. To put aircraft costs in perspective, this section first introduces different components of aircraft costs and then presents disaggregation of total airline costs.

3.4.1.1 Crew Costs One of the largest categories for direct operating costs is the flight crew cost. Crew cost is comprised of the costs attributed to pilots, flight attendants, test pilots, reserve pilots, trainee pilots and instructors for that aircraft type. One of the most critical developments in aircraft technology is using a two-person flight deck on newer aircraft. This feature, coupled with advanced glass displays,26 has made the third member of the crew (i.e., the flight engineer) redundant and provides cost advantages. As an exception, the An-225 requires a six-cockpit crew to operate the enormous aircraft (two pilots and four engineers). Crew costs do not include maintenance or flight dispatch personnel; these expenses are allocated to the maintenance and administrative expenses categories. Cockpit commonality makes it easier for pilots to move across a full family of aircraft, while saving time and money in training. In addition, one of the larger savings comes from eliminating the need for a completely separate group of reserve crews. A two-person cockpit crew has reduced crew costs. The aircraft’s common pilot type rating has ensured greater crew scheduling flexibility and efficiency for carriers that operate multiple aircraft types. Airbus’s commonality of flight deck may be a reason why some operators prefer to operate Airbus aircraft. Identical cockpits and operating procedures were applied to each of the A320 Family aircraft (the A318, A319, A320 and A321), allowing pilots to fly all these aircraft with a single type rating. Commercial airlines are particularly pleased with the use of fly-by-wire (FBW) technologies and the common cockpit systems in use throughout the Airbus aircraft. FBW is a system that replaces the conventional manual flight controls of an aircraft with an electronic interface. Boeing adopted some FBW airliners (777, 787) and some that are not (707, 737, 747, 757, and 767). On the 737, the pilot’s yoke and pedals are mechanically connected to the plane’s aerodynamic control surfaces. These include ailerons, elevators and rudder. In an aircraft like the A320, the 25 26

 Simple Fly, October 1, 2019.  The third crewmember was made redundant prior to the introduction of advanced glass displays

3.4  Financial and Operational Performance

143

movements of the side-stick are interpreted by the computers driving the control surfaces. A full analysis of crew costs and the relevant methodologies for calculating them is contained in Chapter 6 of this text.

3.4.1.2 Depreciation and Leases Two of the most important financial estimates that airline management teams must make are the aircraft depreciation rate and aircraft residual value assumptions. Airlines periodically review whether the residual value attributed to their aircraft has been appropriately estimated. The tax system will generally stipulate the useful life of an aircraft and depreciation rate, rather than leaving it to the imagination of management for tax purposes. Depreciation and leases represent the capital cost of aircraft ownership. A large part of an airline’s cost structure is aircraft depreciation. That amount will ultimately depend on the useful life of the aircraft. Lease payments also represent significant expenditures, which can affect an airline’s free cash flow. Depreciation is a reduction in the value of an aircraft due in particular to wear and tear. Generally, aircraft assets are depreciated over 15 to 25 years with residual values of between 0 to 20 percent. Freighter aircraft over 20–27  years to residual value of between 10% to 20% of cost and over 10 years to nil residual value for freighters converted from passenger aircraft. Airlines financing is quite complicated, especially for airlines with high financial and operational leverage. The increase in demand, combined with lower fuel costs and cost of capital, has led to profit in recent years. But the industry is expected to lose $118.5 billion in 2020 for a net profit margin of −36.2%.27 It is important to note that while other industries generally have a significant advantage to ownership over leasing due to the tax shield offered by depreciation, the airline industry has typically experienced an extremely low corporate tax rate due to accumulated Net Operating Losses (NOLs). These losses can be carried forward indefinitely after they are incurred. Since the Tax Cuts and Jobs Act (TCJA) of 2017 reduced corporate taxes, the airline industry has had an effective tax rate of around 2.3% on average. In contrast, the corporate tax rate for similar-sized corporations is 11.3%.28 Additionally, the TCJA, section 13302, eliminated the option for most taxpayers to carry back a net operating loss. Depreciation policy varies from one airline to another. Airlines prefer to depreciate aircraft using different salvage values and depreciation lives because of their respective financial policies regarding the appropriate depreciation expense. For example, in 2014, Lufthansa decided to change its aircraft depreciation policy from 27 28

 Economic Performance of the Airline Industry, November 2020, IATA  Institute of Taxation and Economic Policy, 2020.

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3  Aircraft Financial and Operational Efficiencies

12 years (15% residual value) to 20 years (5% residual value) after a review from auditors that advised that the useful life of an aircraft was more than 12 years.29

3.4.1.3 Maintenance Costs We define the maintenance expenses as the costs of materials and labor that constitute routine and non-routine aircraft repair. Typical metrics include cost per block hour, cost per departure, and cost per aircraft. Globally, airlines spent $81.9 billion on MRO, representing around 9% of total operating costs in 2019. We measure maintenance cost, not maintenance expense since maintenance costs contain accrued costs for periodic aircraft checks that will be expensed as the check is conducted. In general, there are two categories of aircraft maintenance costs. First, direct maintenance cost, which is the cost of materials, equipment and workers directly related to maintenance as a whole. Second, indirect maintenance cost, which is the cost related more to the organization of an airline than to the design of the aircraft. We have divided maintenance cost into the following general classes: • Labor –– Labor cost is usually one of the larger components of airframe maintenance cost and is comprised of inspection checks, removal, installation, and operational checks • Materials and parts –– This includes all materials, both consumable and non-consumable, component usage and other material used in the aircraft maintenance process In 2019, the industry’s total maintenance cost was $81.9 billion, and it is expected to grow to $116 billion by 2029.30 The direct maintenance cost per flight hour varied according to the aircraft category, from an average of $1670 per flight hour for narrow bodies to $3378 per block hour for wide body aircraft equipped with three or more engines, and $2829 per flight hour for wide body aircraft equipped with two engines.31

3.4.1.4 Soft Costs Soft cost metrics capture an airline management’s opportunity of selecting the right aircraft at the right time to support business objectives. Soft costs are defined as a catch-all category. Soft costs capture aircraft insurance, navigation costs, and other miscellaneous operating costs.



 Fuel  Maintenance  Crew  Soft Costs  Total Operating Costs   .   Depreciation and Leases 

 CAPA. News. 2014.  Oliver Wyman Global Fleet & MRO Market Forecast Commentary, 2019–2029. 31  FAA Economic Values and Aircraft Operating Costs. 29 30

3.4  Financial and Operational Performance

145

Table 3.10  Narrow-Body aircraft analysis in the United States 737-­ 737-­ 737 A319 A320 700 800 MAX8 $913 $1035 $1125 $1124 $1242

Crew cost/ block hour Depreciation $529 and leases/ block hour Maintenance $575 costs/block hour Soft cost/block $44 hour Fuel cost/ $1442 block hour $3504 Total operating costs

737 MAX9 $1650

757-­200 320NEO $1268 $864

321NEO $1171

$618 $388

$532

$2613

$565

$635

$924

$1040

$779 $883

$760

$583

$546

$822

$328

$885

$73

$59

$68

$114

$33

$77

$119

$1653 $1442 $1613 $1326

$2088

$2170

$1540

$1577

$4156 $3919 $4088 $5832

$4964

$4928

$3734

$4792

$82

Source: Compiled by the authors from Airline Monitor (as of October 2020) 7000 6000 5000 4000 3000 2000 1000 0

A319

A320

Crew Cost/Block Hour Soft Cost/Block Hour

737-700

737-800 737 MAX8 737 MAX9 757-200

Depreciation and Leases/Block Hour Fuel Cost/Block Hour

320NEO

321NEO

Maintenance Costs/Block Hour

Figure 3.13  Aircraft operating cost breakdown for narrow-body aircraft. (Source: Compiled by the authors from Airline Monitor (as of October 2020))

To demonstrate the applicability of the financial metrics defined above, we present a comparison between narrow-body aircraft from Boeing and Airbus in Table 3.10 and Figure 3.13, which also presents the variability that exists between aircraft products. Figure 3.13 presents a five-way comparison of aircraft operating costs across different narrow-body aircraft; the smaller the cost envelope, the more operationally efficient the aircraft. In other words, we prefer to utilize the aircraft with the

146

3  Aircraft Financial and Operational Efficiencies

smallest cost envelope. The small cost envelope, however, often comes at a higher price of aircraft. It shall be noted that the values presented in this figure and corresponding table earlier represent the operational outcome of the aircraft types during 2019. Boeing’s first delivery of 737MAX8 and 9 was in 2017 and 2018. Moreover, 737MAX were globally grounded for a long time due to two subsequent accidents in 2018 and 2019. Accordingly, the sample data for calculating the operating cost of 737MAX is very limited (15 aircraft) and thus a poor estimation of the actual costs. Overall, MAX models are expected to provide a low operating cost. The disadvantages of the 757-200 are immediately apparent when compared to the 737-700 or 737-800, and even against various Airbus aircraft models. Considering all cost factors, the 757-200 has the largest cost envelope of these narrow-body aircraft. The 757-200 underperforms in every category except soft costs. As pointed out earlier, the tradeoff for the lower soft costs of owning the 757-200 is the higher cost of operation. In contrast, the Boeing 737-700 presents a competitive cost profile. It is the most fuel-efficient aircraft among the narrow-bodies presented above, as well as the most inexpensive for depreciation and lease. It is interesting to note that while Boeing aircraft appear to be more expensive to crew than Airbus aircraft, they are less expensive to insure (lower soft costs). This may be a function of Airbus’s higher degree of automation – crew training might be lower. Still, insurance costs and other soft costs are higher due to the greater degree of automation technology. In terms of total costs, the Boeing 737-700 offers strong competition to Airbus A320neo. The Airbus A320 and A319 present similar operating profiles. The A319 is a shortened version of the A320. From the figure, we can observe that, as expected, A320neo is more fuel-efficient compare to A320ceo, which is equipped with older engine technology. The A320neo has five more rows of seats than the A319neo; an A319neo with a two-class configuration (120–150 passengers) has a range up to 3700 nm.32 As noted previously, they are less expensive in terms of crewing but more expensive in terms of soft costs. They also present a higher maintenance cost profile, indicating that their equipment is more expensive to upkeep. This also could be a function of greater automation and the necessity for more extensive and expensive checks to ensure its normal operation. Airbus’s A320 and A319 are also less fuel-efficient than the Boeing 737-700 since they have a higher fuel cost per block hour. Building on our previous discussion on fuel efficiency in the section on operating ratios, we will analyze the topic in greater depth next. Interestingly, fuel is the highest operating cost among all aircraft types disregarding the manufacturer. Fuel costs account for nearly 40% of the operating costs of an aircraft in 2019.33 Table 3.11 presents a more detailed fuel efficiency analysis for each of the selected narrow-­ body aircraft. Airbus 320neo and Boeing 737-700 seem to have a very close total operating cost, even though A320neo shows a slight advantage in the sample. In an  Airbus A319neo Specifications, 2020.  This ratio fluctuate based on the price of jet fuel. Airbus estimates that the share of fuel cost increase to 50% when fuel cost goes above $100 per barrel.

32 33

A320 2.75 $1653 1,578,629 115,853 73.39 160.2 375 1,928,255

A319 2.99 $1442 873,564 59,324

67.91 134.3 359 1,231,126

68.91 141.2 353 2,168,197

737-700 2.89 $1442 1568,198 108,068

Source: Compiled by the authors from Airline Monitor (as of October 2020)

Fuel cost per ASM (cents) Fuel cost per block hour Gallons of fuel (000) Total ASMs (millions of miles) Fuel efficiency (ASM/g) Average number of seats Average airspeed Block hours

Table 3.11  Fuel efficiency analysis in the United States

80.02 166.8 384 3,059,711

737-800 2.52 $1613 2,447,500 195,859 97.80 174 380 41,496

737MAX8 2.00 $1326 27,989 2737 100.05 179 411 9035

737MAX9 2.84 $2088 6638 664

69.13 178.9 418 725,947

757-200 2.90 $2170 784,870 54,260

100.67 185.1 375 233,660

320NEO 2.22 $1540 161,021 16,211

103.63 190.4 430 94,492

321NEO 1.93 $1577 74,784 7750

3.4  Financial and Operational Performance 147

148

3  Aircraft Financial and Operational Efficiencies

industry with wafer-thin profit margins per route, this cost difference represents significant savings to the major operating cost driver. We can attribute this advantage to the inherent technical efficiency of the aircraft and to the significant economies of scale of the fleet.

3.5

Comparative Analysis of Efficiency

Currently the narrow body market is dominated by Boeing 737 and the Airbus A320 Family aircraft. Wide body aircraft are made by a number of different aircraft manufacturers provided again by Boeing and Airbus. In the following section, we compare the financial and operational performance of two different types of aircraft (narrow-body and wide-body).

3.5.1 Narrow-Body: Boeing 737NG vs. Airbus A320 The 737 series has been the best-selling jet airliner in the history of the airline industry34 even though it competes closely with Airbus 320 family.35 As of February 2021, Airbus has cumulative order of 15,578 orders for A320 family aircraft, of which 9178 are in active service. Boeing, on the other hand, has reported 16,714 orders for 737 family with 10,487 recorded deliveries. The Boeing 737-700, 737-800 and 737-900 compete directly with the Airbus A319, A320 and A321 in the narrow-­ body, short to medium-haul commercial aircraft market. These two families of aircraft are widely popular with low-cost carriers. Southwest, Virgin Australia and Ryanair use the 737NG while JetBlue, Virgin America and Air Asia use the A320 family. On the other hand, easyJet started with the Boeing 737 family but phased the fleet out and replaced them with Airbus; so, as of 2020, it only operates Airbus 320 family. Legacy carriers such as United, Delta, and American Airlines operate both 737NG and A320 families. In fact, American Airlines is the largest operator of the A320 family in the world. Other users of the A320 family are Frontier and Spirit Airlines; both exclusively use the A320 family as of 2021. In order to complete the comparative analysis of the 737NG versus the A320 family, we have selected two competing models from each manufacturer, the Boeing 737-700 and the Airbus A319. We will compare the block hour costs of these models for legacy carriers and LCCs individually, then further analyze each aircraft’s costs and the associated benefits and savings they offer. To set the proper framework for analysis, we compare the two products from the operational standpoint of legacy carriers, as presented in Figure 3.14. In terms of  Kingsley-Jones, Max. 6000 and Counting for Boeing’s Popular Little Twinjet. Flight International, Reed Business Information, April 22, 2009. 35  Slotnick, David (Nov 18, 2019) Boeing’s 737 officially lost the title of world’s most popular airplane, BusinessInsider.com 34

3.5  Comparative Analysis of Efficiency

149

Load Factor, %

82

85

Utilization (revenue hours/BH), %

84

82

125

Seats per aircraft 369

Speed, miles per BH Fuel, gallons per BH Average flight stage (miles)

130 354 701

730

848

917 A319

737-700

Figure 3.14  Operational characteristic comparison (Legacy Carriers  – AA, DL, UA, AS). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

operational characteristics, we see numerous similarities between 737-700 and A319 operations and a few significant differences. Both aircraft, with similar seat numbers and utilization per day, have different stage lengths. Legacy carriers that use the 737-700 use it on a stage length that is about 70 miles longer, compared to the A319. Similarly, they tend to fly at a higher speed that is accompanied by higher fuel consumption of the 737-700 planes. When examining these aircraft from an operational and financial standpoint, it is important to realize that some costs are dependent on the airline, and some costs are relatively invariant to airline operations. Fuel burn, for instance, is invariant, although it is indirectly affected by stage length and flight procedures. However, other costs, including crew costs, depreciation, leases, and soft costs, are all highly dependent on an individual airline’s operating characteristics. Figure 3.15 highlights the advantages that the Airbus 319 offers to legacy carriers in comparison to its competitor, Boeing 737-700. The 737-700 presents higher costs on all the measured metrics except for rent and other costs. One of the most significant cost differences is in the maintenance costs of each aircraft. The maintenance cost for 737-700 is over 69% more. In terms of the most significant cost factor to airlines, fuel, the A319 also has the upper hand for legacy carriers by costing approximately $34 less per block hour. This number quickly translates into real savings when the considerable fleet sizes and numbers of hours legacy carriers fly are taken into account. The effect that airlines’ operational characteristics have must be taken into account when interpreting this data. During 2019, the fuel cost per block hour for the 737-700 was $1473, while the same figure was slightly lower for A319 ($1406).

150

3  Aircraft Financial and Operational Efficiencies $130

Aircraft Rent Depreciation

$355

Total Maintenance Costs

$333 $614

$1,040 $35 $36

Other Costs Fuel Cost

$178

$1,473

$1,406

$1,134

Flight Crew Cost

$939 $3,506

Total $4,166 A319

737-700

Figure 3.15  Block hour cost comparison (Legacy Carriers  – AA, DL, UA, AS). (Source: Compiled by the authors from Airline Monitor (as of October 2020)) 737-700

A319

CASM 8 6 4 2 0

CASM excluding fuel

Fuel cost per ASM

Figure 3.16  CASM (in cents) for narrow-body aircraft (Legacy Carriers – AA, DL, UA, AS). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

Figure 3.16 shows that CASM is significantly less for legacy carriers who operate the A319. The A319 has a CASM of 7.63 cents, while the 737-700 costs 9.01 cents per seat-mile. There is no significant difference between the two models when it comes to fuel cost per ASM. However, with lower crew and maintenance costs and after factoring out fuel costs, it still holds that the A319 has about 27% cost advantage over the 737-700. In Figure 3.17, we see the opposite trend of operating characteristics by LCCs. Here, the 737-700 is flown on shorter stage lengths, and the average is 281 miles

3.5  Comparative Analysis of Efficiency

151 83

Load Factor, % Utilization (revenue hours/BH), %

83

Seats per aircraft

143

Fuel, gallons per BH Average flight stage (miles)

85 150 378

351

Speed, miles per BH

85

741

723 665

946 A319

737-700

Figure 3.17  Operational characteristic comparison (LCCs  – SY, WN, G4, F9, NK). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

less than the A319. The chief LCC operator of 737-700 is Southwest Airlines. Compare to the other LCCs, Southwest has a shorter stage length, which impacted the result presented here. Load factors are slightly less on the 737-700, which on average has 7 fewer seats than the A319 when utilized by LCCs. By increasing daily utilization, airlines certainly enjoy the lower CASM produced by these aircraft. Serving smaller, uncongested airports and focusing on point-to-point flights enables airlines to maximize the number of daily block hours and, thus, aircraft utilization. We should be careful as this also may have an adverse effect on profitability if the managers deploy these aircraft on routes to sparsely populated local airports with a very competitive yield. Adding ASMs into current markets (lowering yields as a result) or deploying incremental ASMs into markets where the yields are already low or where there is insufficient, traffic to support the increased capacity reduces profits for airlines. We can also observe in Figure 3.17 that A319 flies faster, at 378 miles per block hour over an average stage length of 946 miles compared to the 737-700 flying at 351 miles per block hour over a 723 mile average stage length. In return, the fuel consumption of A319 is 18 gallons more per block hour at 741 gallons compared to the 737-700. The operating characteristics are shown in Figure 3.17 translate into the cost-­ comparisons shown in Figure 3.18. An interesting effect of Southwest Airlines can be observed as an anomaly. The Boeing 737-700 costs are significantly more when it comes to crew costs; specifically, $309 more than the A319 per block hour. This can be attributed to Southwest’s higher crew compensation when compared to the other LCCs (and, as we will see later on, legacy carriers as well). LCC crew compensation amounts are therefore dominated by the relatively high-paid crew of

152

3  Aircraft Financial and Operational Efficiencies Aircraft Rent

$102 $275

Depreciation

$87

Other Costs

$75 $1,582

$1,438

Fuel Cost

$1,124

Flight Crew Cost Total

$369 $427

$865

Total Maintenance Costs

$228

$3,892

$815 $3,496

A319

737-700

Figure 3.18  Block hour cost comparison (LCCs – SY, WN, G4, F9, NK). (Source: Compiled by the authors from Airline Monitor (as of October 2020)) 737-700

8

A319

CASM

6 4 2 0

CASM excluding fuel

Fuel cost per ASM

Figure 3.19  Cost per available seat-mile (LCC – SY, WN, G4, F9, NK). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

Southwest Airlines. Furthermore, the higher rent and depreciation are attributable to the higher market price of A319. However, the significantly higher maintenance cost of 737-700 is a concerning factor. Nevertheless, it should be considered that some maintenance events are based on the number of operations, and shorter stage lengths result in additional maintenance cost per block hour (Figure 3.19). With a longer average stage length, we expect CASM to be lower for the A319 if the fuel efficiency of each aircraft were equal. We could observe that based on the operational data from 2019, A319 had a CASM of 6.17 cents per seat-mile

3.5  Comparative Analysis of Efficiency

153

comparing to 7.75 cents per seat-mile for Boeing 737-700. The fuel cost per ASM for these models are almost equal at 2.8 cents per seat-mile (A319 is about 2% cheaper). Comparing the CASM excluding fuel cost allows us to better see the impact of higher crew cost and shorter stage length in increasing the CASM for Boeing 737-700. The CASM excluding fuel cost for Boeing 737-700 was 4.88 for 2019, which was about 45% higher than A319 at 3.38 cents per seat-mile. The lower fuel price for the 737-700 is due in part to the successful operational performance of Southwest Airlines, which operates a fleet of over 300 737-700s (Southwest Airlines, 2008). However, 2018 data shows that when comparing the 737-8 MAX and the A319, both CASM and fuel costs have become more comparable; and before its grounding, the 737-8 MAX actually had a slightly higher cost for fuel ($2.37 compared to $2.16), but still maintained a lower average CASM (7.82 cents compared to 8.20 cents). Figure 3.20 compares the operating cost of Boeing 737-700 for legacy and LCC. As expected, on most fronts, the costs experienced by LCCs are lower than those of legacy carriers on a block-hour basis. These cost advantages enable LCCs to compete on the basis of price in a highly commoditized market, giving them a significant competitive advantage. Southwest’s successful fuel costs are $1721 compared to $2242 for legacy carriers. Another way of interpreting the cost comparisons shown in Figure 3.20 is to identify the cost structure in terms of percentages for the Legacy carriers and LCCs. This is represented in Figure 3.21 as a breakdown of the Boeing 737-700 cost structure. We see similar cost structures but notable differences. For both legacy airlines and LCCs, the highest cost was fuel, which accounted for 35% and 37% of costs, respectively. However, LCCs had a higher percentage of flight crew costs partially due to the relatively highly compensated Southwest Airlines flight crews. Other cost factors contribute less to the cost structure of the LCCs comparing to the legacy airlines (Figure 3.22). The LCCs have a clear advantage on CASM with 7.75 cents per seat-mile against 9.01 cents for legacy carriers. Fuel costs per ASM of legacy airlines are aver 11% higher at 3.18 cents per seat-mile. Even after removing the effects of fuel costs, the CASM experienced by LCCs is about a cent cheaper. Figure 3.23 compares the block hour costs of the legacy and LCC carriers who operate the A319. Overall, legacy carriers pay slightly more per block hour when using the A319 compared to LCC carriers. However, legacy carriers paid, on average, $176 less on fuel per block hour, $36 less on depreciation costs, and $50 less on aircraft rent. The cost advantage of legacy seems to be canceled due to the higher cost of flight crew and maintenance, resulting in a very close total cost per block hours for legacy carriers and LCCs at around $3500. Looking at the normalized costs (in terms of their respective percentages), we see similarities as well as differences between the cost structure of legacy carriers and LCCs. The majority of the costs for both types of operators were for fuel, as expected. Similarly, the cost of flight crew contributes significantly to the total cost. However, a larger percentage of legacy carrier costs are attributable to flight crew costs, at 27%. Higher cost percentages are also present for depreciation cost and rent in the LCC cost structure. Many network airlines such as Delta, United, and American Airlines (and US Airways) filed for bankruptcy in the past. Chapter 11

154

3  Aircraft Financial and Operational Efficiencies $130

Aircraft Rent

$355

Depreciation

$275 $865

$1,040

Total Maintenance Costs

$35 $87

Other Costs $1,473

Fuel Cost

$1,438 $1,124

$1,134

Flight Crew Cost Total

$102

$4,166

$3,892 LCC

Legacy

Figure 3.20  Boeing 737-700 block hour cost comparison (Legacy vs. LCC – AS, DL & UA vs. WN & SY). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

LCC

37%

Legacy

35%

29%

27%

22%

25%

Fuel Cost

Flight Crew Cost

Total Maintenance Costs

Depreciation

Aircraft Rent

Other Costs

7% 3% 2%

9% 3%1%

Figure 3.21  Boeing 737-700 cost structure (Legacy vs. LCC – AS, DL & UA vs. WN & SY). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

protection allowed these airlines to pursue cuts in wages and make changes to pension and health benefits for workers and retirees (Figure 3.24). CASM numbers for the Airbus A319 show a similar pattern to that of the Boeing 737-700, despite a smaller cost differential between legacy airlines and LCCs (Figure 3.25). The CASM for legacy carriers was 7.63 cents compared to 6.17 cents for LCCs. Even after removing the effects of fuel, the CASM was still 1.19 cents lower for LCCs. The new generation A320neo with more fuel-efficient engines has allowed low-cost carriers like Spirit to lower their CASM to a level that is more

10

CASM

8 6 4 2

Legacy

0

LCC Fuel cost per ASM

CASM excluding fuel

Figure 3.22  Boeing 737-700 CASM (in cents) comparison (Legacy vs. LCC – AS, DL & UA vs. WN & SY). (Source: Compiled by the authors from Airline Monitor (as of October 2020)) Aircraft Rent

$178

Depreciation

$228 $369

$333

Total Maintenance Costs

$614

Other Costs

$427 $36

Fuel Cost

$75 $1,582

$1,406

Flight Crew Cost

$939

Total

$815

$3,506

$3,496 LCC

Legacy

Figure 3.23  Airbus A319 block hour cost comparison (Legacy vs. LCC – AA, DL, UA & AS vs. F9, G4 & NK). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

LCC

45%

Legacy

40%

23%

27%

Fuel Cost

Flight Crew Cost

Total Maintenance Costs

Depreciation

Aircraft Rent

Other Costs

12%

18%

11%

10%

7%

2%

5% 1%

Figure 3.24  Airbus A319 cost structure (Legacy vs. LCC – AA, DL, UA & AS vs. F9, G4 & NK). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

156

3  Aircraft Financial and Operational Efficiencies CASM 8 6 4 2

Legacy

0

LCC

CASM excluding fuel

Fuel cost per ASM

Figure 3.25  Airbus A319 CASM comparison (Legacy vs. LCC – AA, DL, UA & AS vs. F9, G4 & NK). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

aligned with its business model. When looking at 2019 financial data for all U.S. airlines and comparing ULCCs against full-service carriers, we find CASM figures of 12.98 cents (United Airlines) and 13.30 cents (Delta Air Lines), compared to figures of 7.96 cents (Spirit Airlines) and 7.83 cents (Frontier Airlines).36

Model Airbus A319neo Airbus A319neo Airbus A320neo Airbus A321neo Boeing 737-300 Boeing 737-600 Boeing 737-700 Boeing 737 MAX 7 Boeing 737 MAX 7 Boeing 737-800 Boeing 737 MAX 8 Boeing 737-900ER Boeing 737 MAX 9 Boeing 757-200 Boeing 757-300 Bombardier CRJ100 Bombardier CRJ200 Bombardier CRJ700 Bombardier CRJ900 Bombardier CRJ1000 Airbus A220 100 Airbus A220 300 Airbus A220-100 Airbus A220-300

36

 Form 41 (2019) BTS, US DOT.

Seats 144 124 154 192 126 110 126 128 144 162 166 180 180 200 243 50 50 70 88 100 115 140 125 160

Fuel efficiency per seat L/100 km 2.92 2.82 2.25 2.19 3.46 3.59 3.19 2.77 2.93 2.77 2.28 2.66 2.28 2.91 2.66 4.68 4.49 4.36 3.94 3.33 3.07 2.75 2.57 2.23

3.5  Comparative Analysis of Efficiency

157

3.5.2 Wide-Body: Boeing 777-200ER vs. A330-300 The 777-200 and A330-300 compete in the long-haul commercial aircraft market. Both aircraft have two engines and are heavily used by airlines on high-demand transatlantic routes. Notable 777-200 operators include United Airlines (launch customer), American Airlines and British Airways; notable A330-300 operators include Turkish Airline, Cathay Pacific, Saudia, and Delta Airlines (Figure 3.26). The A330-300 burned less fuel per block hour than the 777-200ER;37 lower fuel burn provides a huge advantage to airlines that operate the A330 when fuel prices are high. The A330-300 also holds, on average, 5 more passengers than the 777-200 (291 seats vs. 286 seats); however, this may be more a function of airline seating layouts rather than the actual potential seating capacity of the two aircraft, as Boeing lists a higher seating capacity for the 777-200 (Thomas et al., 2008). Both aircraft have a high aircraft utilization rate of over 12 h per day which is due to the fact that they are operated on longer stage lengths than narrow-body aircraft (Figure 3.27). The A330, based on most measures, is more economical to operate than the 777-200, specifically on fuel, maintenance, flight crew and depreciation costs. Maintenance costs for 777-200 are about a 75% higher than A330; the A330’s average total maintenance costs were $895 compared to $1568 for the 777-200. The lower fuel costs for the A330 can be traced in part to the lower fuel burn per hour when compared to the 777. The A330’s fuel cost per block hour is $3861, while the 777 costs $620 more per block hour. Due to the lower fuel burn, the A330 has a much lower CASM than the 777 (5.45 cents compared to 6.70 cents). In addition, the A330 also holds a significant Load Factor, %

83

85

Utilization (revenue hours/BH), %

94

93

286

Seats per aircraft

492

Speed, miles per BH

480

2,236

Fuel, gallons per BH Average flight stage (miles)

291

4,138 A330-300

1,927 4,084

777-200ER

Figure 3.26  Operational characteristics of wide-body aircraft. (Source: Compiled by the authors from Airline Monitor (as of October 2020))

37

 Our sample includes 10 777-200LR, 19 777-200, and 102 777-200ER.

158

3  Aircraft Financial and Operational Efficiencies $283

Aircraft Rent

$937

Depreciation Total Maintenance Costs

$1,568

$675 $895

$80 $26

Other Costs Fuel Cost

$3,861

$4,481

Flight Crew Cost Total

$249

$1,909

$2,058 $9,406

$7,615 A330-300

777-200ER

Figure 3.27  Block hour cost comparison of wide-body aircraft. (Source: Compiled by the authors from Airline Monitor (as of October 2020))

advantage in non-fuel cost per ASM (2.69 cents compared to 3.51 cents). This indicates that the A330 is less expensive to operate when it comes to other costs and maintenance. We can further compare the A330 and 777 by looking at the individual operators of the two aircraft types. Using the Airline Monitor database to analyze U.S. operators of the two aircraft types, we can achieve a better idea of the economics of the two aircraft. Delta and United had the lowest CASMs of U.S. 777 operators in 2019, with 5.53 and 6.21 cents, respectively. This may go back to the aircraft utilization statistic; an aircraft that is being utilized more is spreading its costs out over a larger number of available seat-miles (Figure 3.28). One interesting fact to note is how few A330-300s are in service with U.S. airlines. Despite having been in service for 15 years around the world, there are few operators of the aircraft type in the U.S., namely, Delta Airlines and Hawaiian Airlines. American Airlines used to operate the A330-200/300 inherited from the US Airways merger, but they phased it out due to the COVID-19 market downturn. Delta operates 31 A330-300s and 11 A330-200s. Hawaiian started operations of A330s as a result of its re-fleeting project to replace its Boeing 767-300ERs; currently, Hawaiian operates 24. Another interesting fact is the relationship between the aircraft’s average speed and fuel burn. Northwest Airlines (merged with Delta airlines in 2008) steadily decreased the average speed of the A330 over the first 5 years of its operation with the airline (2003–2007), in order to achieve a lower fuel burn. Many airlines are implementing similar procedures to reduce the speed of aircraft while in flight in order to conserve fuel.38 Boeing uses a cost index in the flight computer to compute  According to Airbus, the reduction from max cruise to long range cruise is 7%, which is the widest possible range.

38

3.5  Comparative Analysis of Efficiency

159

CASM 8 6 4 2

A330-300

0

CASM excluding fuel

777-200ER Fuel cost per ASM

Figure 3.28  CASM comparison (777-200 vs. A330-300). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

the best cruise speed for each flight given flight conditions, fuel, and block hour costs. The 777, on the other hand, has been very popular with U.S. carriers since its introduction into service with United Airlines in 1995 as the launch customer (Eden, 2006). U.S. operators include American, Delta, and United; with United having 74 777-200/200ERs the most of all U.S. carriers. The advantage of wide-body aircraft over narrow-body aircraft is in the CASM figures. The wide-body aircraft like the A330 and 777 aircraft make up for a higher fuel burn by flying more people over longer distances, reducing their costs per available seat mile (CASM).

3.5.3 Regional Jets: CRJ 900 vs. EMB 175 To complete the regional jet analysis, we have selected two competing models popular with regional carriers. Bombardier and Embraer used to compete for head to head for the regional jet market, offering tremendously similar aircraft with similar capacities, ranges and other operating and financial specifications. Bombardier CRJ family was started in 1991 by CRJ 100/200 with a 50-seat capacity. The later variant of the series is CRJ 700 (66 to 78 seats), CRJ 900 (81 to 90 seats) and CRJ 1000 (over 100 seats). The production of CRJ 100/200 ceased in 2006. After selling the larger CSeries to Airbus (now A220) and the Q series turboprop to Viking Air, Bombardier sold the CRJ series to Mitsubishi Heavy Industries in 2019. The production of the remaining CRJ series ended in December 2020 after delivering the 1945th aircraft. Throughout its life, the CRJ series has competed directly with Embraer E-family. Embraer E-family consists of E170 (72 to 78 seats), E175 (78 to 88 seats), E195/195 (over 100 seats). EMB 175, with 666 deliveries at the end of 2020, is the most popular aircraft in the E-family. More recently, Embraer developed the E2 family that, with better engines and higher fuel-efficiency, is expected to be intense competition for Bombardier CSeries. The prominent operators of the newer CRJ series are Skywest Airlines, PSA Airlines, Endeavor Air, and Mesa Airlines, among which

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Skywest and Messa also operate Embraer 175 as well. Prominent Embraer E-family operators include Republic Airline, Envoy Air, ExpressJet, and Horizon Air. In this section, we study two competing regional jet models of EMB 175 and CRJ 900. From the operational characteristics presented in Figure  3.29, we see that the CRJ 900 and EMB 175 families have nearly identical operating characteristics, with the primary differences being traceable to their average speed and stage length. Both aircraft families offer similar fuel burn. EMB 175s are, on average, flown on longer flight segments and utilized 8.11 block hours per day compared to 9.8 for CRJ900s. Overall, covering longer stage length with higher speed and slightly better fuel cost indicate an efficiency advantage of EMB 175. Further analyzing these two regional jet offerings, we see a much smaller range of differences in operating cost compare to similar measures for the narrow-body and wide-body airplanes we studied earlier. After incorporating all the block hour costs, there is less than 1% difference in block hour costs of operating EMB 175 and CRJ 900 in 2019. The most outstanding difference between the models was higher rent costs for CRJ 90039 and higher maintenance costs for EMB 175. The EMB 175 costs $326 per block hour for maintenance compared to $414 for the CRJ 900. The flight crew costs for both families are comparable, despite the EMB 175 costing $8 more per block hour, on average. Comparing the CRJ 900 and EMB 175 on cost per seat-miles indicate a slight advantage for Embraer. The CASM for CRJ 900 is 9.91, which is about 7 cents Load Factor, %

80

80

Utilization (revenue hours/BH), %

74

77

Seats per aircraft

76

76

288

Speed, miles per BH Fuel, gallons per BH

477

Average flight stage (miles)

485 EMB 175

312 471 633 CRJ 900

Figure 3.29  Operational characteristic regional jet cost comparison. (Source: Compiled by the authors from Airline Monitor (as of October 2020))

39

 Driven by the higher sales prices of Embraer vs Bombardier.

3.5  Comparative Analysis of Efficiency

161

Aircraft Rent Depreciation

$124

$126 $414

$326

Total Maintenance Costs Other Costs

$18

$19

$954

Fuel Cost Flight Crew Cost Total

$278

$349

$942 $401

$409 $2,187

$2,173 EMB 175

CRJ 900

Figure 3.30  Regional jet block hour cost comparison. (Source: Compiled by the authors from Airline Monitor (as of October 2020))

CASM 10 8 6 4 2

EMB 175

0

CASM excluding fuel

CRJ 900 Fuel cost per ASM

Figure 3.31  CASM comparison (ERJ 175 vs. CRJ 900). (Source: Compiled by the authors from Airline Monitor (as of October 2020))

higher than EMB 175, as presented in Figure 3.30. It is likely that the advantage is due to the lower fuel costs of the EMB 175. The Fuel cost per seat-mile of CRJ 900 is about 9% higher than EMB 175 (about 4 cents per ASM). Even after excluding the effects of fuel costs, the CRJ 900 still shows a higher CASM of 5.56 cents compared to 5.27 cents for the EMB 175 (Figure 3.31).

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3  Aircraft Financial and Operational Efficiencies

Summary

This chapter provided a coherent description of the main concepts and tools used to analyze aircraft efficiency and performance. Productivity is the single most important factor that determines profitability and financial viability in the long run. Many low-cost airlines have enjoyed an excellent productivity and efficiency such as aircraft turnaround time, aircraft block hours knowing the fact that the plane is not making any money while it is on the ground. The selection of a proper aircraft has a great impact in terms of the overall operational effectiveness, as well as its costs and profitability. In this chapter, we have presented aircraft efficiency from different perspectives: technical and operating efficiencies. Technical efficiency is derived directly from an aircraft’s physical characteristics over which the airline has relatively little control. This includes average airspeed, fuel burn, and available seats. Operating characteristics are those that an airline can influence during the course of normal operations. The most prominent among these are aircraft utilization and average stage length. Financial characteristics are the financial implications to an airline of an aircraft’s technical and operational characteristics, often expressed as fuel cost per block hour and fuel cost per available seat mile. Maintenance and depreciation characteristics are determined for each aircraft model and expressed in the form of maintenance and depreciation costs per block hours. To illustrate these characteristics and efficiencies, competing for narrow-body, wide-body and regional jet aircraft models from the major manufacturers were selected and analyzed using the various operating, financial and technical metrics.

Bibliography Alaska Airlines. (2008, August 28). Alaska Airlines completes transition to all-Boeing fleet. Retrieved February 5, 2009 from http://www.alaskasworld.com/Newsroom/ASNews/ ASstories/AS_20080828_140339.asp Alaska Airlines. (2009). Route map. Retrieved February 11, 2009 from http://www.alaskaair.com/ as/alaska/images/asqxroutemap.pdf American Airlines. (2008a). AMR Corporation reports second quarter 2008 loss of $284 million excluding special items, as record fuel prices drove $838 million in higher costs compared to a year ago. Retrieved February 6, 2009 from http://www.americanairlines.jp/content/jp/aboutUs_en/pr20080724.jhtml American Airlines. (2008b). 2008 3rd quarter SEC filing. Retrieved February 6, 2009 from http:// phx.corporate-­ir.net/phoenix.zhtml?c=117098&p=irol-­IRHome Azadian, F., & Vasigh, B. (2019). The blurring lines between full-service network carriers and low-cost carriers: A financial perspective on business model convergence. Transport Policy, 75, 19–26. CH Aviation. (2009). Fleet lists. Retrieved February 11, 2009 from http://www.ch-­aviation.ch/ aircraft.php Delta Air Lines. (2009, January 27). Delta Air Lines reports 2008 financial results. Eden, P.  E. (2006). Civil aircraft today: The world’s most successful commercial aircraft. Summertime Publishing Ltd.

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Goldstein, M. (2019). Can HawaiianAirlines Survive Southwest’s entry into the Hawaii market? Forbes. Retrieved April 21, 2020 from https://www.forbes.com/sites/michaelgoldstein/2019/02/08/ can-­hawaiian-­airlines-­survive-­southwests-­entry-­into-­the-­hawaii-­market/#6df73b57529f Thomas, G., Norris, G., Creedy, S., & Smith, C. F. (2008). Plane truth: Clearing the air on aviation’s environmental impact. Aerospace Technical Publications International. US Airways. (2009). US Airways chronology. Retrieved February 11, 2009 from http://www.usairways.com/awa/content/aboutus/pressroom/history/chronology.aspx Wei, W., & Hansen, M. (2003). Cost economics of aircraft size. Journal of Transport Economics and Policy (JTEP), 37(2), 279–296.

4

The Foundation and Economics of Aircraft Valuation

Aircraft valuation and the projection of its future price is an intricate process. The following three chapters provide a comprehensive review of the fundamental concepts of aircraft valuation, various approaches for valuation and present a methodology that estimates commercial aircraft value. The “value” of an aircraft certainly depends on internal factors directly related to the aircraft’s specifications and conditions. Some examples of these are the aircraft’s age, size, capacity, fuel efficiency, and maintenance status. In addition, the aircraft value depends on external factors such as the economic cycle, the spread of communicable disease fuel cost, and environmental regulations. The external factors are crucial because they indicate where in the aviation industry cycle the aircraft is, and this, in turn, has the most significant impact on aircraft value. The dramatic drop in the number of airline passengers due to the COVID-19 pandemic is threatening the viability of many airlines and even the rest of the aviation industry. As a result, the values of many aircraft such as the A380, the B747-400, and the B777 have collapsed, and others such as the A330 and © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 B. Vasigh, F. Azadian, Aircraft Valuation in Volatile Market Conditions, Management for Professionals, https://doi.org/10.1007/978-3-030-82450-1_4

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B777-300ER are struggling. Narrow body aircraft values fell by around 15–30%, and wide body aircraft values by between 20% and 45% during the pandemic. Boeing reduces forecast for new aircraft demand, expects coronavirus pandemic to hurt sales for more than a decade. Consequently, the theoretical value of a commercial aircraft highly depends on the economic environment and the assumptions underlying the specification of the valuation model. By examining the relationship between an aircraft’s physical and operational characteristics, the key parameters in an aircraft pricing model will be developed. This chapter will cover the following topics: Introduction Definition of Value and Price of an Asset • Base value • Current market value • Future value and securitized value • Parts, salvage and scrap value • Forced sale, liquidation and distress value Depreciation and Obsolescence • Economic useful life • Economic obsolescence • Functional obsolescence Approaches to Valuation • Cost approach for valuation • Revenue approach • Applicability of valuation approach Economics of Aircraft Valuation • Time value of money and estimation of discount rate • The weighted average cost of capital • Methods of investment assessment At the end of the chapter is a summary of this chapter’s highlights and a selected bibliography for further study.

4.1

Introduction

Valuation is the process of assigning a value usually expressed as a monetary number or a range of numbers to an asset. Asset valuation can be applied to tangible assets such as real estate, properties, machinery equipment, stocks, and bonds. Market values are dynamic in nature because they depend on a host of factors, from economic conditions, physical operating conditions to the variability of supply and demand. For instance, in their press release in January 2018, Airbus value the Airbus A380 as $445.6 million. However, in February 2019, Airbus announced the cessation of production of the A380 by 2021. Consequently, a valuation analysis published by Cirium estimates that the actual market value of an A380 now ranges

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between $77 million for a 2005-build “half-life” aircraft and $276 million for a new 2019-build aircraft in “full-life” condition. A ‘slot’ is simply the permission of the airport operator for an airline to land a plane and then take off during a certain time window. The right gives not just the permission to land the aircraft, but also to use all necessary airport services and infrastructure. When Monarch (UK airline) went to bankruptcy in 2017, their slots at Gatwick Airport were one of their most valuable assets. Valuation also applies to intangible assets such as goodwill, brands, intellectual properties, and patents. The International Accounting Standards Board standard 38 defines an intangible asset as: “an identifiable non-monetary asset without physical substance.” An intangible asset can be traded and thus need to be evaluated. Landing slot privileges are an example of intangible assets that are traded by airlines. A landing slot, or take-off slot, is a right granted by an airport operator, which allows the slot holder to schedule a landing or departure during a specific time period. The London Heathrow Airport (LHR) is one of the most heavily slot restricted airports in the world. Oman Air set a record by paying Air France-KLM $75 million for a pair of take-off and landing slots in early 2016.1 More recently, Air New Zealand (NZ) sold its slot pair at $27  million, as it has planned to end flights to LHR in October 2020.2 The slot pair sold by NZ is for landing at 10:45 am and departure at 3:20 pm, while the slot pair obtained by Oman Air includes a prime morning arrival. The examples mentioned above from the airline industry may have already demonstrated how the value of an asset is affected by various factors and how complicated it could be to estimate it accurately. Nevertheless, correct valuation is crucial to the success of any business entity in the aviation industry. In the commercial sector of the aviation industry, particularly for the non-­ governmental segment, aircraft are the most valuable assets of a company, whether it be a leasing company or an airline. Figure 4.1 presents the share of invested capital of various sectors of the global aviation industry. As can be seen in this figure, over 90% of the invested capital belongs to airlines, airports and leasing companies. Aside from the airports that are often (partially) owned by public entities, airlines and lessors’ main asset is their aircraft. Accordingly, our primary focus in this chapter will be on aircraft valuation. Indeed, the fundamental concepts and methodology presented here are applicable and easily transferable to the valuation of other tangible assets. Before we investigate the details of the aircraft valuation process, we shall review some of the fundamental concepts of valuation. First, we should develop a clear

1  Point Guys. Why London Heathrow Has Some of the Most Expensive Airport Slots on Earth, May 15, 2019. 2   Horton, W. (2020, March) Air New Zealand Sells London Heathrow Airport Slot for $27 Million, Forbes.

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Airlines

Lessors 6%

Airports Lessors ANSPs

Airlines 48% Airports 36%

Manufacturers Freight Forwarders Ground Handlers MRO CRS Travel agents Catering

Figure 4.1  Global share of invested capital of different sectors of the aviation industry. (Source: IATA 2013)

understanding of the definition of value. Next, we need to review some of the approaches we use to assess the financial value of an investment.

4.2

Definition of Value and Price of an Asset

The value of an asset is defined by the Uniform Standards of Professional Appraisal Practice (USPAP) as “The monetary relationship between properties and those who buy, sell, or use those properties, expressed as an opinion of the worth of a property at a given time.” As implied by this definition, the value of the same asset is probably different for different interested parties and may vary based on the transaction’s time and conditions. It should also be noted that value and price, while they may be used interchangeably, are technically different. Price is the “amount asked, offered or paid for a property”.3 A price paid for an asset may be different from the asset’s value due to the interest and motivation of the buyer and seller of the property and their financial capabilities. For instance, after September 11, the air transportation industry was in a downturn. The orders for new planes were low, and the market prospect was not encouraging. Under such circumstances, Ryanair placed an order for 100 new Boeing 737-800 planes with Boeing in January 2002. The sizeable order was welcomed by the aircraft manufacturer struggling with the aftermath of 9/11. The transactional price of this contract has never been publicized, but it is understood that the prices paid for the planes were heavily discounted (lower than the value market assigned to the planes). The following quote is attributed to Michel  Uniform Standards of Professional Appraisal Practice (2020). Appraisal Foundation.

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4.2  Definition of Value and Price of an Asset

169

O’Leary, the CEO of Ryanair at the time regarding this deal: “I would call the discount wholly inadequate. Boeing would call it rapacious! I wouldn’t even tell my priest what discount I got off Boeing. Some things will forever remain a secret”.4 In the aviation industry, the actual price of properties (i.e., transactional price) is often not disclosed except in exceptional circumstances (e.g., public auctions) and considered propriety information. The aircraft and engine manufacturers often announce the prices of their products (i.e., list prices). However, it is generally understood that the actual price for the product will be determined after negotiation and maybe (notably) lower than the list price. Moreover, the transaction price may also be affected by the conditions of sale such as payment terms, place of delivery, customizations, additional services and many other factors. Our emphasis in this book will be on the value of an asset rather than its prices. Similar to price, the value of a property is also affected by the expected conditions and circumstances of the transaction. Thus, it is critical to clarify the conditions assumed in expressing a value associated with a property. Next, we review some of the common conditions and assumptions that serve as the basis of valuations.

4.2.1 Base Value The aircraft’s price tag does not seem to be an issue now, as first-generation Embraer E-Jets, Next-Generation 737s and A320ceos have reduced their value in a market that has been depressed since March 2020, when the coronavirus pandemic hit full-force around the world. If an operator is feeling lucky and wants to take a chance, there are also scores of white-tail 737 MAX aircraft that Boeing is willing to sell at significant discounts. Airline Geeks, March 2, 2021 Airline Geeks, March 2, 2021 The Base Value (BV) is an aircraft’s theoretical value in an open, unrestricted and stable market where the supply and demand are reasonably balanced. For valuation purposes, the sale of such aircraft is considered to be without duress and at arm’s-length with cash transaction between willing, able and knowledgeable buyers and sellers who act in their own best interests. This valuation assumes that the subject aircraft is in average physical condition for its age with its maintenance status at mid-time or mid-life or generally above average conditions. Moreover, it is assumed that the aircraft is to be employed at its highest and best use. As can be expected, the valuation grounded on these assumptions is a hypothetical value of an aircraft and may not match the reality of the asset or the market environment. The primary purpose of developing base value is to establish a baseline for a given aircraft that can serve as the starting point for applying adjustments to match the asset and market’s realistic conditions. The base value also may be  Rajan Datar (2003, June 4) Ryanair perfects budget flying. BBC.

4

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4  The Foundation and Economics of Aircraft Valuation

used to establish and trace trends of value for a given aircraft over time for financial assessment of its future value.

4.2.2 Current Market Value The market value that may also be referred to as Current Market Value (CMV) or Fair Market Value represents the most likely value of an aircraft if traded under the current market environment accounting for supply and demand balance. The asset in question is assumed to have adequate exposure to attract hypothetical buyers. It is assumed that the parties to the aircraft’s hypothetical trade are knowledgeable about the asset and negotiate in an open market without unusual duress for completing the transaction promptly. The market value is often established based on cash or cash equivalent transactions; however, it can be stated under different sales conditions as well. It is assumed that the asset is to be employed under its highest and best use. Similar to the base value, the aircraft’s physical condition and its maintenance status can be assumed average for establishing its market value. However, it is possible to abandon these assumptions and establish the market value based on the actual physical and maintenance conditions of the asset. The value driven from this approach is often referred to as Adjusted Value for clarity and distinction. Market value is the most commonly used condition for valuing an aircraft. Since it refers to the likely transactional value of an asset, it is critical to clarify all the assumptions that are used to reach a conclusion (e.g., assumption related to physical conditions, sales terms, maintenance status, and delivery location).

4.2.3 Future Value and Securitized Value The future value of an aircraft, which may also be referred to as residual value, is the hypothetical value of a given aircraft at a point in time in the future. The concept of future value is often employed in connection with the conclusion of an aircraft leasing, where we want to know the value of the asset after it is used by the lessor under certain assumptions about the usage and maintenance status. This view of residual value is different from a similar concept in accounting. Due to the nature of future value, it is often reasonable to convert the value to the equivalent present value for financial considerations by considering a discount rate. The process of this conversion will be discussed further in the next section. A related concept to future value is the securitized value. The securitize value is the value of an airplane that is under a lease. This valuation relied on the terms of the lease and the revenue stream it generates along with the residual (future) value of the plane at the end of the lease. Indeed, future revenue and residual value need to be adjusted and stated based on the current currency value. Interestingly, due to the aviation market’s volatility and the possibility of a long-term lease, the securitize value of an aircraft may be more than its market value.

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4.2.4 Parts, Salvage and Scrap Value Sometimes due to the state of the market, the motivation of the seller, condition of an asset or some other factors, it may be decided to value an aircraft not as a whole plane but only as parts (or some of the parts) to be sold separately either for re-use or as salvage. Generally, selling an aircraft as parts often results in a less overall gain; however, it is expected to be done in a shorter period with a larger pool of potential buyers. The decision to value an asset for parts often motivated by financial considerations that deems it uneconomical to restore the aircraft to an airworthy condition, for instance, due to the age of the asset or severe damages. Moreover, market conditions may also impose that decision on asset owners. In valuing an aircraft as its parts, one should consider the potential market for those parts. The number of aircraft that could use the parts and the consumption rate of parts play a critical role in establishing the parts’ estimated value. Customized parts enjoy a more limited pool of potential buyers but, in turn, may enjoy a less saturated market. In valuing parts, the critical factor is the ability to establish the airworthiness of the parts. Parts supported by verifiable records that could corroborate the airworthiness of the parts per civil authority’s maintenance standards are significantly more valuable. Parts that are not airworthy (either not serviceable to restore airworthiness or have unknown airworthiness status) but still considered to have potential aviation used are considered salvageable parts.5 In the valuation of an aircraft as salvage or for its parts, it is necessary to consider the cost of time and efforts to disassemble the aircraft and the potential cost of transportation, storage and repair of the components. Some parts require manufactured prescribed storage to maintain airworthiness. The cost of such procedures must be considered in calculating the net gain from the sales of the parts. Since many aviation components have time limitations, it is crucial to account for components that cannot be sold since they are close to the end of their life cycle. Thus it is critical to note the condition of the component in the valuation approach (e.g., as is, as removed, serviceable, overhaul, and new). An aircraft or aircraft parts that are not considered worthy or not eligible to be used for aviation purposes may be considered as scrap. For instance, an aircraft that suffered substantial damage or is destroyed may be considered only for its value of recyclable materials. The scrap value of an airplane may be zero due to the cost of removal and disposal. It shall be noted that scrap should not be used interchangeably with salvage value.

4.2.5 Forced Sale, Liquidation and Distress Value Sometimes an asset may need to be valued as if it is to be sold under abnormal conditions. Various conditions could be recognized as abnormal conditions that affect  Federal Aviation Administration (October 01, 2015). Production Under 14 CFR Part 21,Subparts F, G, K, and O. (Advisory Circular 21-43A). 5

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the value of an aircraft. Earlier, under market value, it was assumed that the seller is not under duress to sell the asset. However, suppose the owner is compelled to sell the asset within a limited period of time, or with a sense of immediacy, or under as-is/where-is condition. In that case, it is expected that the owner realizes less than the market value of the aircraft. In general, any factor that imposes significant limitations on the exposure time of an asset in the market results in a smaller pool of potential buyers and, in turn, lowers the expectation of high earnings for the hypothetical sale. The aviation industry is known to have both barrier-to-entry and barrier-to-exit. Forced liquidation and orderly liquidation imply that the owner is compelled to sell, although the latter scenario assumes that the owner has a reasonable time to offer the asset to the market and attract buyers. Nevertheless, liquidation reduces the value of an aircraft from its market value. Due to the sense of urgency in selling the asset, the valuation under liquidation is often conducted with the assumption of as-is condition. In other words, there may not be time for or the possibility of preparing the aircraft or sale. Under all the aforementioned scenarios, it is critical is establishing proper value estimation to assess the availability, correctness and completeness of records that allow for assessing the airworthiness of the aircraft, engines and parts. The absence or corruption of records, which could be a common observation under liquidation and distress sales, may significantly diminish the value of the assets. The perception that the aircraft owner is under pressure to sell, significantly reduces the bargaining power and gives the potential buyers a significant advantage that can translate into deeply discounted actual trading prices.

4.3

Depreciation and Obsolescence

While the value of an asset can be defined under various viewpoints, as discussed earlier, the value is also expected to change through time and due to endogenous or exogenous factors. The decrease in the value of assets is referred to as depreciation. Depreciation is often gradual deterioration or impairment (or obsolescence). It is vital to recognize and apply depreciation to the analysis to reach a proper estimate of value in valuing aircraft. Depreciation is a concept used in finance to measure the decline in the value of an asset over the useful life of an asset due obsolescence and wear and tear. Depreciation allows for future investment that is required to replace usedup assets. One of the most commonly known uses of depreciation is in accounting. Accounting depreciation is the process of gradually reducing the book value of an asset as it ages and is based on its level of activity. This practice is to ensure that the

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173

ledgers present a more realistic picture of a firm’s assets. Through this process, the original acquisition value of an asset is reduced gradually based on a selected method in a way that, at the end of a specific time period, the value of the asset gets to its salvage value (e.g., zero). As can be seen, two primary factors affect the depreciation process: (1) the time period of depreciation and (2) the depreciation method. The time period of depreciation is often selected based on the estimation of the useful life of a given asset. In accounting, various methods are applied for calculating the depreciation’s installments. Some of the more common practices are as follows: • Straight-line depreciation (SLD) –– The straight-line method of depreciation assumes a constant rate of depreciation; the SLD spreads the depreciation evenly across the useful life of an asset. • Double-declining balance depreciation (DDB) –– DDB method charges twice the rate of straight-line deprecation on the asset’s carrying value at the start of each accounting period. DDB depreciation is an accelerated depreciation practice. • Sum-of-the-year’s-digits depreciation (SYD) –– SYD is an accelerated depreciation method that can be used to depreciate the value of the asset over the useful life of the asset. • Units of production depreciation • Modified accelerated cost recovery system (MACRS) –– MACRS is a form of accelerated depreciation enacted by the US Congress in 1981 and 1986. Since depreciation is reflected as a cost item in the balance sheets, the process of accounting depreciation has tax implications and is heavily regulated. The legislators may consider various factors in regulating the acceptable practice for applying the depreciation that varies from one sovereignty to another and over time. A common practice is that the assets are categorized based on their type and usage. Next, a specific depreciation period and method are prescribed (or can be selected) for each asset category. For instance, in the US, the Internal Revenue Code allows for aircraft used for qualified business purposes (i.e., under FAR Part 916) to be depreciated under MACRS over a period of 5 years. Firms could also choose to use the Alternative Depreciation System (ADS), which is a variation of the straight-line depreciation method, with a 6-year recovery period. If the aircraft is utilized as commercial aircraft (i.e., under FAR 1357), the depreciation options are MARCS over 7 years and ADS over 12 years. Due to legislative influence (and often restrictions), the depreciated value of an asset for tax purposes could be legitimacy different from the depreciated value prepared for the firm’s internal purposes. Nevertheless, it shall be noted that accounting depreciation is governed by two principles of accounting: The Cost Principle and the Matching Principle. The cost  14 CFR Part 91 – General Operating and Flight Rules.  14 CFR Part 135 – Operating Requirements: Commuter and On Demand Operations and Rules Governing Persons on Board Such Aircraft. 6 7

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principle requires that the values should be based on the original cost of the asset (not the cost to replace the asset or the current market value of the asset). Consequently, for aircraft valuation purposes, as was defined in this chapter, we often could not rely on the depreciated value of an asset as presented in the ledgers. For aircraft valuation purposes, depreciation represents how much the value of an asset in its current situation and under the current market circumstances should be adjusted (reduced) based on a comparable new asset. This analysis is often carried out by considering the physical state of the asset and its level and intensity of activities. The physical inspection of the actual state of the asset is common in appraising an aircraft. However, we could also work based on specific assumptions and estimate the value of a hypothetical asset at a specific time based on some underlying assumptions about its deterioration level due to age and usage to establish a baseline or future value. The level of desperation often expresses as a point in reference to the life span of an asset; thus, the critical point here, similar to accounting depreciation, is to establish the life span of an asset that we will discuss next.

4.3.1 Economic Useful Life Tangible assets have a limited lifespan; in other words, it is expected that through time and due to wear and tear, the utility and performance of assets deteriorate and eventually fall below a level that justifies utilizing them, considering the operating cost of maintaining such assets in working condition. For instance, the fuselage is subject to pressurization and decompression during a normal flight cycle that causes stress and fatigue. Moreover, exposure to elements causes deterioration and corrosion. Accordingly, manufacturers prescribe a certain lifespan for an aircraft and its components and demand scheduled inspection and maintenance that are aimed to keep the aircraft in safe working conditions. These maintenance requirements are determined by flight hours, flight cycles and some are based on calendar time. For economic reasons and to improve operational efficiency, the maintenance tasks, as listed in the Maintenance Planning Document (MDP), are divided into groups that are performed at varying intervals. The detailed process of this packaging is governed by Maintenance Steering Group8 decision logic and is beyond the scope of this discussion. In practice, these maintenance tasks are grouped into packages that are often referred to by letter characters (A, B, C and D) representing the level of intensity. Typically, A-checks take place bi-weekly to monthly (every 200–300 flights). B-checks are performed approximately every 6–8  months and require about 160–180 labor hours. C-checks are often planned for 12–20 months. Moreover, D-checks, which are the heaviest maintenance tasks, take place every  The Maintenance Steering Group first formed in 1968 and compromised of various aviation bodies including aircraft manufacturers, the FAA, Air Transport Association, and aviation suppliers. The group developed MSG-1 that prescribed decision logic for developing scheduled maintenance program. In 1970, MSG-2, an updated version of MSG-1 was developed. The most recent development in MSG-3. The scheduled maintenance of all commercial airplane are developed based on MSG-3 decision logic. Moreover, the majority of the business jet manufacturers also adopted MSG-3.

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6–12 years and take up to 50,000 labor hours. The time range is due to the difference in the operations level of a given aircraft. For example, an aircraft that is utilized for short flights experiences more flight cycles than one used in long-haul flights; thus, flight cycle-based maintenances need to be performed more often. The more tedious checks (i.e., heavy C-checks and D-checks) demand extended grounding of the airplane and expensive maintenance tasks to be performed. For instance, the cost of a Boeing 747-400 D-check that takes place in about 72 months intervals is estimated at 4–4.5 $million. Accordingly, an owner needs to assess whether the cost of maintenance is justifiable against the utility that the aircraft provide or not. In that approach, the point in time that maintenance cost overcomes the utility that an asset provides marks the end of the asset’s economic useful life. Figure 4.2 presents a conceptual illustration of the economic useful life and the trend of an asset devaluation. The vertical axis in this graph represents the value (utility) of the asset, and the horizontal axis is time. As an asset age, its desirability deteriorated due to various factors such as wear and tear, stress, corrosion, exposure to elements. In turn, the reduction of desirability decreases the value of the asset. Even though in this graph, we represent the deterioration trend as a smooth trend, it shall be noted that in practice, this trend depends on the level of activity of an asset and its working environment. For instance, for an aircraft that operates in Sahara, the sand in the air caused the engine blades to deteriorate faster. The decreasing trend of the value of an asset illustrates the level of deprecation of the asset. Some depreciation is curable (recoverable). For instance, during maintenance events, components that are at the end of their lifespan or damaged are replaced with new ones, and some wear and tear may be fixed. Accordingly, we see a jump in the value of the asset upon competing maintenance. In practice, all maintenance events result in an increase of value but at a different level based on the intensity of the maintenance events. For simplicity, in this illustrative graph, we only presented major maintenance events (e.g., D-check). The original value of an asset depreciates through time, and while it may be (partially) restored through maintenance, it will eventually reach a point that the restoration of value does not justify the cost of maintenance. In our illustrative example, the airplane goes through a major maintenance event in the 12th and 24th year. Each of these D-checks is costly, although it results in an appreciation of value. However, it seems the third D-check is not justifiable as the restoration of value is negligible. Thus, one may conclude that the economic useful life of this asset is about 35  years. Of course, in practice, many factors could significantly impact the lifespan, as will be discussed in the next section. While a typical depreciation of an asset and its economic useful life follows the graph similar to the one presented in Figure 4.2, a few points need to be mentioned. In some cases, the lifespan of an asset is restricted by the manufacturer. However, these caps are often long enough not to be a significant obstacle.9 Moreover, the subscription to a Manufacturer’s Maintenance Program could impact the perceived 9  For instance, Cessna 172 Skyhawk has a fixed 30,000 h total time airframe (TTAF) limit of its airframe, beyond which the aircraft airworthiness cannot be certified. It should be noted that aver-

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15

Asset Value$

10

5

0

-5

0

10

20

30

40

50

60

Asset Age

Figure 4.2  Example of economic useful life concept

economic useful life of some component. This scenario is mostly applicable to major components of aircraft (i.e., engines). Under the manufacturer maintenance program, the manufacturer takes responsibility for the cost of all the shop visits and maintenance works (often, the costs of life-limited parts are excluded, but there are other programs to cover these parts). Considering the guarantee from the manufacturer, it is reasonable no to limit the economic useful life of the asset as it is to be renewed as needed. So the contract time span may then be considered instead. Finally, it shall be noted that the economic useful life is not equivalent to the designed life of an aircraft. An aircraft may be designed to be used safely for a long time with proper maintenance. However, at some point, it may not be economical anymore to operate it, and this threshold is often a financial decision rather than a technical decision.

4.3.2 Economic and Functional Obsolescence As discussed earlier, the depreciation of the value of an aircraft during its economic useful life is continuous and, in many cases, a gradual process (albeit with varying acceleration). However, an asset may also lose its value due to impairment or obsolescence. Two categories of obsolescence can be defined based on the underlying causes: • Economic Obsolescence • Functional Obsolescence age annual flight hours range between 100 and 300 (e.g., flight schools) hours. Thus, reaching the TTAF limits is not an immediate concern.

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Economic obsolescence is caused by external factors that may cause significant depreciation in the value of an asset. The economic obsolescence may be a result of the passage of new regulations, change of market conditions (e.g., a rise of fuel prices or labor cost), or lack of demand. For example, aviation noise pollution as public concern has always been the subject of various regulations in the past few decades. In the US, the FAA regulates the maximum noise level that an aircraft can emit.10 The requirements of the FAA’s standards are categorized into stage designation. Currently, four stages are established (stage 5 is forthcoming) that are comparable with ICAO’s standards. Stage 1 is the loudest, and stage 4 is the most restrictive requirement. The increasing noise restriction affects older turbojet engines that could be found on such jest as Gulfstream II/III, Hawker 400/600, and Learjet 24/25. Therefore the passage of the noise regulation force the aircraft owner to choose between the costs of compliance (installing a hushkit) or foregoing the asset. In a study performed by the FAA11 in 2011, an analysis was provided for the impact of stage 3 noise standards on existing aircraft. Table 4.1 presents the estimation for two models. As can be understood from the table, the cost of installing hushkit exceeds the highest estimated average value of the aircraft for Gulfstream II, and it is very close to the upper estimated for Gulfstream III. So an owner of such an asset will reach the conclusion that the cost of compliance with the new regulation exceeds the value of the asset; thus, it does not make economic sense to invest in installing a hushkit. Accordingly, the value of an asset will drop significantly (to scrap with maybe some salvageable parts) due to economic obsolescence. Another example of economic obsolescence is the supersonic passenger airliner Concorde. Concorde was built jointly by aircraft manufacturers in Great Britain and France and made its first test flight in 1969. Economic inefficiency was the major contributor to the Concorde’s downfall (high fuel consumption and the beginning of the era of high jet fuel prices). Table 4.1  Airplane retail value and cost of hushkit installation

Equipment Gulfstream II (G–1159/B/TT/ SP) Gulfstream III (G–1159A)

Number of aircraft (time of the study) 109

108

Average retail value Low 250,000

High 1,050,000

Average Average hushkit scrap value installation cost 8075 1,162,500

1,000,000

2,200,000

8075

1,162,500

Source: FAA 2013

 The US noise standards are defined in the Code of Federal Regulations (CFR) Title 14 Part 36 – Noise Standards: Aircraft Type and Airworthiness Certification (14 CFR Part 36). The FAA publishes certificated noise levels in the advisory circular, Noise Levels for U.S Certificated and Foreign Aircraft. 11  Federal Register. Vol. 78, No. 127. Tuesday, July 2, 2013. Rules and Regulations. 10

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Functional obsolescence, on the other hand, often cause by internal factors and limitation of an asset that deems it undesirable in the presence of newer and better technology and change in design. Perhaps, a proper example of functional obsolescence is the change in the technology of the Electronic Flight Instrument Systems (EFIS). The EFIS. The EFIS replaced the electromechanical system of displaying flight data. As recent as a couple of decades ago, the technology utilized in the EFIS was Cathode Ray Tube (CRT). Similar technology was in use for many consumer goods. However, the CRT technology was rapidly replaced with LCD and LED technology, so the manufacturers cease the production of CRT parts and equipment. In the EFIS, the CRT displays are used for altitude and heading, which represent an image that often remains unchanged. In time, the static image burn on display, and the equipment get damaged beyond economic repair. As a result, many aircraft that were built in the 1980s to mid-2000s are quickly facing a shortage of parts and use to the lack of production of replacement parts. The owners are forced to upgrade the entire system to the new generate of avionics technology. The upgrade is expensive, and for some older assets, it may not be economical to make such an investment. Accordingly, the value of the impacted asset could drop to salvageable parts or scrap.

4.4

Approaches to Valuation

As may be suggested by the previous section, various factors, both internal and external, could affect the value of an asset. Moreover, the value tends to vary over time. In essence, the true value of an asset is conceptually unattainable. Consequently, valuation often results in a statement of an opinion that, although it may have been reached by sophisticated analysis, still is subjective. It is not uncommon for different appraisers to reach different conclusions about the value of the same asset at the same point in time. Bearing that in mind, in this section, we provide an overview of common approaches that can be employed to obtain an estimation of value for an asset. We take a broader view of introducing these approaches and even discuss some of the methods that are less often used in aircraft valuation to provide a comparative view for the readers. Later in the book, we discuss the methods that are commonly used for aircraft valuation in more detail and with examples. In general, the value of an asset may be estimated based on three approaches: • Cost approach • Revenue approach • Market comparison

4.4.1 Cost Approach for Valuation One way to approach the value of an asset is to consider that the maximum amount that one would be willing to pay for an asset is the cost of substitute produce (identical replacement or very similar item) that offers the same utility. Accordingly, by

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establishing the cost of substituting or replacing an asset, we can construct a maximum value of an asset. By relying on the principle of best and highest use, we can argue that this estimate can be offered as the asset value. Let us consider an example. In certain geographical locations, the low temperature makes airplanes susceptible to icing; that is, accumulation and coating of plane surfaces with ice. Icing interferes with flight dynamics and is considered hazardous. Therefore, before departure, aircraft go through the de-icing process that removes the existing icing and also prevents the formation of ice (at least for a period of time). If we intend to value a used de-icing equipment, we can consider the cost of replacing the subject asset with identical (or similar) equipment, adjusted for the current physical condition of the subject asset. It should be noted that in some scenarios, the cost approach may demand estimating the reproduction cost of the subject asset if it is the only (or cheaper) option. Such analysis is more applicable to assets that may not be obtainable through purchase (e.g., custom-made or discontinued products). For instance, Full Flight Simulators are replicas of a specific type, make and model of aircraft that are used for training and assessment purposes. They provide an artificial environment that strives to be close to reality (depending on their level). It can be argued that the value of an existing simulator can be estimated by assessing the cost of a device to substitute the subject asset. Due to the limited market and customizations, perhaps reproduction costs could be the only option. However, the decision to consider the value of customization is a crucial choice. Sometimes, the cost of specialized customization may not be recoverable at the time of sale since the changes may not add value for potential buyers (or may even be a deterrent). For applying the cost approach accurately, one shall consider the price of a new or reproduction asset of the same (or very similar) type and specifications and then adjust the value based on the depreciation of the subject asset. The reduction of the value is due to the fact that as assets age and deteriorate, their desirability, functionality, and performance reduce. As discussed earlier, assets have an expected economical useful life. While it may be possible to extend an asset used beyond its useful economic life, it often results in higher expenditures to maintain its functionality and utility. The vital question in this method is to assess the level of depreciation. The depreciation could be estimated theoretically through some simplifying assumptions by considering the history of the asset. However, a more accurate assessment can be achieved by assessing the actual level of deterioration of the asset by inspecting its physical conditions. While under theoretical depreciation, we apply various forms of smooth trends for depreciation, in practice, assets deteriorate in a non-linear pattern and based on actual usage and the environmental conditions. Disregarding whether we use new or reproduction cost methods, it is essential for the accuracy of valuation to consider the additional expenditures such as logistical costs, setting and installation cost, legal and registration fees and so forth as they apply to acquire the asset.

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4.4.2 Revenue Approach Firms invest in an asset to generate a return. Thus, one way to consider the value of an asset is to consider the future gains from owning the asset. In aviation, this approach is well in line with the business model of commercial airlines. In essence, to establish the value of an asset in this method, one needs to estimate the future revenues and expenditures associated with ownership of an asset and their time of occurrences. Next, we need to convert these values to a present value by accounting for the time value of money. The outcome represents the estimated value of the asset based on the revenue approach. Indeed, the proper discounting of future gains and correct estimation of future revenues and costs are critical in the accuracy of this approach. Due to the significance of this method in commercial aircraft appraisal, we will discuss this approach in more detail in the next section.

4.4.3 Sales Comparison A natural way to value an asset is to consider how much buyers have paid for the same asset in a similar situation. In theory, such a value might be very close to the true value of an asset, and that is the essence of the sales comparison approach for valuation. Despite the promising prospect of this approach for aircraft valuation, there are hurdles and obstacles in applying the sales comparison. One of the primary challenges is that in the aviation industry, the transactional sales data are often proprietary and are not available to the public. While this issue is prominent for used aircraft, even the actual sale price of a new aircraft is unobtainable. It is well understood in practice that the list price of aircraft published by the manufacturers does not reflect the final sale price. Moreover, the price depends on other factors such as terms of the contracts, delivery, added support, customization and so forth. In the absence of transactional data, we have to rely on asking prices that are more representative of existing sellers’ expectations. The expectation that may or may not get responded to by buyers. Available aircraft for sale, particularly in general aviation, are listed online and offline and may even be offered in auctions. Often the length of time that an aircraft has been offered for sale is indicative of market interest at the subject asset with its asking price. In practice, one may adjust (reduce) the asking price to produce a more realistic picture of the offered aircraft value. The rate of adjustment may be subjective and be based on the knowledge of the market but often may vary between 5% and 15%. Another option in estimating sale price is to utilize the consolation of appraisal companies who publish estimation of the value of a wide range of aircraft (particularly business jets and general aviation aircraft). The estimations provided in these subscription-based services are often the result of a combined market study (including transactional sale data) and analytical modeling. Some of the prominent companies in this field are as follows.

4.4  Approaches to Valuation

• • • • • • • •

181

AVITAS mba Aviation, Morten Beyer & Agnew (REDBOOK) Cirium12 Aircraft Value Reference (VREF) Aircraft Blue Book Price Digest AMSTAT (Business aviation aircraft market research) JETNET iQ AircraftPost

These companies provide reference prices for many different aircraft types through inquiries and subscriptions, either online or as a periodic publication. They also often provide aircraft valuation services, among other services. Some even provide reference prices for turboprop aircraft, helicopters, and major aircraft components. For example, The Aircraft Block Hour Operating Costs and Operations Guide from AVITAS is designed to assist airline managers in formulating fleet and route analyses as well as monitoring specific maintenance productivity and performance analysis against industry standards. The guide offers direct operating costs for flying operations, maintenance reserves and maintenance burden. It also provides average aircraft utilization per day for various operational indices such as departures, ASMs and seat-mile operating costs. Under sales comparison, the critical factor is to compare an asset against other similar assets to establish a valuation basis. In practice, however, it is rather unlikely to find multiple assets of identical nature in the market for building the sales comparison. This complication may be remedied by adjusting the comparable asset to match the specifications of the subject asset. The adjustment is accomplished by demoting the value of superior assets and promoting the value of inferior comparable. In adjusting the comparable assets to the subject asset, one should strive to consider any differences that significantly influence the value of an aircraft. The most common factors to consider are as follows. • • • • • • •

Age of the aircraft and its current condition History of damage and accidents Engine time Airframe time Avionics and instruments Interior and exterior raring (e.g., seat condition or body paint) Customization, modification, added equipment

The extent of factors to be considered for adjustment varies from an aircraft to another, and not all factors affect the value at the same magnitude. Overall, considering the remaining economic useful life of the asset and its life-limited components have the most significant impact.

 In 2011, Ascend Worldwide was the provider of aircraft and engine data. Ascent was acquired by FlightGlobal, which was part of Cririum until mid-2019. After separation of FlightGlobal and Cirium, the market data service provide by Ascent is not offered by Cirium.

12

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To further clarify this approach, we present a numeric example. Let assume that we want to value a Cessna 172 Skyhawk SP.  This aircraft per manufacturer have an engine overhaul time of 2000 h. Let us assume that the average cost of engine overhaul installed is $25,500. Accordingly, we can estimate the value of each hour on the engine at $12.75 per hour. Now let us consider that our subject asset has engine time since major overhaul (SMOH) of 1000 h (i.e., the engine is at its midtime). Now, if for a comparable aircraft SMOH is 1200, then it implies that the engine on the comparable aircraft is 200 h more depreciated (i.e., inferior to subject asset). Thus, we adjust the price of the comparable by increasing it by $2550 (i.e., 200 multiply by $12.75).

4.4.4 Applicability of Valuation Approach The applicability of the approaches of valuation highly depends on the conditions that the appraisal is taking place, the purpose of valuation and the availability of data. It is hard to identify one and only one right approach for a given asset, but the appraiser shall strive to select the most appropriate one. In practice, however, it is common to see, for some scenarios, one approach is favored more than the others. For instance, private jets operate under FAA part 91 and are barred from commercial usage. Under this scenario, and motivated by a lack of revenue information, it is common to see appraisers utilize comparable assets for valuing such aircraft. On the other hand, the case of flight simulators could be different. The Full Flight Simulators (FFSs) are replicas of a specific type, make and model of an aircraft that cost between 10 and 20 million dollars. In civil aviation, airlines utilize them for their internal training. The FFSs have to be supported by trained staff and maintained according to specifications. Due to the specificity of the FFS, the market for them is limited, and they are not often traded regularly. Accordingly, using comparable sales and revenue approaches may be challenging, and appraisers may choose to use the cost approach for valuing a given FFS. Similarly, for valuing an airliner, the revenue approach may seem the most suitable of the three. In the end, the best approach should be selected case by case. An appraiser may choose to use more than one approach or may be asked to use a specific approach when required by regulations. The most responsible way is to carefully consider the appropriateness of each approach and then choose the one the results in the most accurate valuation.

4.5

Economics of Aircraft Valuation

An airlines’ decisions on which and what type of commercial aircraft to buy, when to buy, and how long to keep are long-term financial decisions that affect airline profitability. On the general aviation side, even though revenue generation may not be the primary purpose of buying an aircraft, many business jets and corporate aircraft are obtained to provide indirect savings by facilitating transportation. Due to the nature of corporate airplanes that are not for-hire, it is hard to estimate the gain. Thus, as discussed earlier, the revenue approach may not be the best option for

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valuing these types of aircraft. Thus, in this section, our focus is on commercial airplanes or general aviation planes that are used for-hire and generate revenues. For-hire airplanes, including charter planes, commercial passenger and cargo transportation, training planes, special service planes (e.g., air ambulance), are expected to generate a revenue stream during their lifespan. On the other hand, there is a cost associated with owning and operating the planes. The expenses consist of both fixed and variable costs that evolve dynamically based on the level of operation and external market factors (e.g., wages or fuel prices). Obtaining an aircraft can be viewed as any other long-term investment. Accordingly, its profitability can be analyzed to assess if it is a worthy investment. In other words, for aircraft valuation, we are interested in calculating the minimum value that justifies the investment (given the expected future revenues and costs). The acquired value will be the value of aircraft according to the revenue approach. Next, we focus on some common methods in assessing investments based on expected future cash flows (that is, the future differences between revenues and costs for each time period).

4.5.1 Time Value of Money and Estimation of Discount Rate The key concept in assessing an investment is the time value of money. For-profit firms are expected to generate returns using their capital. There is a minimum expectation on return for each firm based on the attributes of the firm and the other existing comparable investment options shareholders have. Clearly, any investment that commits a firm’s capital for a period of time should provide a corresponding return above the minimum expectations, or it would be a poor choice of investment. To evaluate an investment option accurately, we need to know: • the future cash flows • the length of the investment, and • the required rate of return on investment As far as aircraft valuation is concerned, the length of the investment (i.e., the ownership of the aircraft) is determined by the economic useful life of the asset. The economic useful life of the aircraft can be determined, as discussed earlier in this chapter. Given that the economic useful life of an aircraft is often more than a couple of decades, it is challenging to develop an accurate estimate of the future cash flows. In practice, the aviation industry has proven to be extremely volatile and cyclic. Thus, future revenues and costs could, at best, estimated roughly. It is critical to bear this in mind as the value developed based on these estimates is also probabilistic. We have no choice but to make a series of assumptions about the future trends of internal and external factors such as transportation demand, fuel cost, wages, and so forth to be able to estimate the future cash flows. Lastly, we need an estimate for the acceptable Internal Rate of Return (IRR), that is, the minimum return expected by shareholders over time. Different firms, based on their capabilities and exogenous factors, provide a different return on invested capital and the return also fluctuation over time. For the sake of comparison, the IRR is an

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average return over a period of time. Determining this value is a challenging task as, similar to the future cash flows, it is subject to the effect of indigenous and exogenous factors. The details of various methods for estimating the IRR is beyond the scope of this book. However, we discuss the Weighted Average Cost of Capital (WACC) that can be used as a (conservative) estimate of IRR for aircraft valuation purposes.

4.5.2 The Weighted Average Cost of Capital Businesses raise capital through various sources. They include raising money through equity financing, debt financing, retained earnings or government grants or subsidies. The Weighted Average Cost of Capital (WACC) is the averages of the costs of the different types of capital a company or project uses in proportion to its weights. The Weighted Average Cost of Capital (WACC) reflects a firm’s cost of capital in which each category of capital is proportionately weighted. Airlines’ overall cost of capital reflects the required rate of return on the airline’s investment as a whole. The cost of capital depends on the risk, and hence primarily on the use of the funds and the potential return on this investment. Commonly, the required rate of return is estimated as a function of the firm’s WACC and reflects the costs of debt, equity, and preferred stock. The WACC reflects both the current market rates of return as well as the risk specific to the company. WACC is calculated by multiplying the cost of each capital source by its relevant weight and then adding the products together to determine the value. The formula defining the weighted average cost of capital is as follows. WACC  wd kd 1  tax _ rate   we ke Where: wd = proportion (weight) of debt financing kd = cost of debt ke = cost of equity we = proportion (weight) of equity financing tax _ rate = corporate tax rate Applying the WACC method is effective in determining the necessary rate of return at which to discount the expected net cash flows (Lloyd & Davis, 2007). In the airline industry, often executives and the board of directors use a weighted average to judge whether a merger is acceptable or not. However, to obtain a valid net present value (and subsequently a correct theoretical asset value), the investment or asset discounted under the WACC method must have a risk similar to the average risk of the firm’s existing investments. This is probably truer for the airline industry than most others because the existing principal investment is the aircraft fleet. As of December 31, 2019, the WACCsof several major US airlines are presented in Table 4.2.

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Equity Risk Premium

Cost of Equity

Beta

Risk free rate WACC Tax sheild Cost of Debt (aer tax) Average Yield on Debt

Table 4.2  The WACC for Major US airlines (January 2021) Airlines Air Canada American Airlines Group Inc. ANA Holdings Cathay Pacific Airways China Eastern Airlines China Southern Airlines C Delta Air Lines, Inc. Deutsche Lufthansa AG International Consolidated Airlines Group, S.A. Southwest Airlines Co. Qantas Airways Ltd United Airlines Holdings, Inc. Wizz Air Holdings PLC

WACC 8.42% 4.60% 2.35% 5.35% 4.59% 5.15% 6.21% 5.26% 4.98% 7.47% 6.49% 5.50% 6.64%

Source: Collected by Authors (January 2021)

4.5.2.1 Net Present Value Net present value (NPV) of a project is the present value of net cash inflows. The present value of net cash flows is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.

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The concept of Net present value (NPV) plays a vital role in capital budgeting decisions. The NPV is used to calculate the present value of financial projects and, consequently, to compare them. Calculation of the NPV for aircraft valuations relies on estimates of numerous parameters, including all the potential sources of revenue and cost. There are many parameters uncertain and should be modeled stochastically. For example, operating costs, pilot shortage, economic growth, and outbreaks of infectious diseases should be presented in the model. n

NPV   t 1

Where

TRt  TCt

1  k 

t



RVn

1  k 

 TC0

n



TRt: Total revenue during time period t TCt: Total cost during time period t TC0: The initial cost RVn: Salvage value at the end of the time horizon n: Number of time periods k: Discount rate, or the required rate of return on the investment The net present value of any project can be positive, zero or negative. If NPV is positive, the benefits of the project are enough to cover its expenses; therefore, the project should be accepted. If NPV is negative, the benefits of the project are not enough to cover the costs. Therefore, we should reject the project. The NPV of zero implies indifference, and the decision-maker may choose to adopt the project or not based on other strategic and operational factors. Example 4.1  Consider that an airline purchases a pushback tow tug and Tractor at the cost of $160,000. The tow tractors provide safe, efficient and reliable aircraft push back and towing operations on the flight line or in the hangar and will save the airline $25,000 annually over 10 years. Assume there is no residual value at the end of the project, and the required rate of return is 8%. The NPV of the project is calculated as follows:

NPV  $160, 000 

$25, 000

1  0.08 

1



$25, 000

1  0.08 

2





NPV  $160, 000  $167, 752



NPV = $7, 752

$25, 000

1  0.08 

10



The positive NPV of $7752 means that the present value of the revenue exceed the present value costs at the 8% discount rate. Hence, this project should be accepted.

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187

4.5.2.2 Utilizing Multiple Discount Rate Implementing a proper discount rate is crucial in obtaining an accurate result. The discount rate needs to represent both the time value of money and the risk over time. Often in practice, firms develop a discount rate that is used across various projects for decision making. However, a given airline may be subject to different volatility for its cost and revenue, or even different components of its cost and revenue. Additionally, the variation in risk and volatility of different factors, such as cost and revenue, may support using multiple discount rates that provide an opportunity for accounting for the uncertainty by adjusting the discount rate. As a case in point, an airline’s cost is governed by its cost of capital, which may remain stable through time, given the sources of capital. On the other hand, the future revenue streams of an airline are affected by various internal and external factors that are more volatile. Under this approach, the NPV formula can be revised as follows to utilize different discount rates for cost and revenue. n

NPV  TC0  

t 1

TRt

1  k1 

t



TCt

1  k2 

t



RVn

1  kn 

n



In this formula, k1 is the discount rate for revenue and k2 is the discount rate for cost items. Indeed, establishing the proper discount rate for different components is challenging and demands a more sophisticated analytical assessment, for which it may not be easy to obtain reliable data. The success of the multiple discount rates relies on the correct selection of the discount rates, as misusing the rates may diminish any advantages that multiple rates may offer. The discount rate is a subjective concept that is often challenging to assess. Indeed, it is even more challenging to estimate multiple rates correctly. Moreover, the choice of using different discount rates may introduce managerial biases as the selection of the discount rates may be polluted by the optimism or pessimism of the manager about individual projects (Martin & Titman, 2008). Despite the potential benefits of added sophistication, in practice, financial institutions, particularly airlines, prefer straight forward methods such as single discounted cash flow to more advanced techniques. For example, the survey conducted by Bancel and Mittoo (2014) shows that 87% use WACC and “while the financial theory suggests that a discount rate appropriate for the riskiness of different cash flow streams should be used, most (61%) ignore this advice and use a single discount rate for all expected cash flows”. Various surveys demonstrated that practitioners prefer less sophisticated approaches that are easy to apply and easy to explain (Graham & Harvey, 2001; Bancel & Mittoo, 2014; Pinto et al., 2019).

4.5.3 Methods of Investment Assessment In this section, we review some of the prominent methods of assessing investments. The primary criteria for selecting these methods was their applicability in aircraft valuation (even if they are a less popular choice).

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4.5.3.1 Discounted Cash Flow The Discounted Cash Flow (DCF) is one of the oldest and most commonly used models for valuation. Its simplicity of logic and input parameters has made this approach one of the first tool analyses utilized for assessing a project, investment or asset valuation. The essence of this method is based on considering the NPV of all the future cash flows (i.e., gains and expenditures). n

VDCF  

CFt



RVn

t  0 1  kt  1  kn  Where CFt: Cash flow during time period t RVn: Salvage value at the end of the time horizon n: Number of time periods kt: Discount rate, or the required rate of return on the investment at time period t t

n

Discounted Cash Flow is a technique of estimating what an asset is worth today by using discounted projected cash flows.

Discount Rtae

Projected Cash Flows

Terminal Value

Period of me

Often in practice, one may use the same discount rate for all the time periods. To account for the risk and volatility of the industry, we could adjust the discount rate by increasing it. This approach, however, has the disadvantage of funneling all the volatilities and risk through this parameter. The other option to adjust the future cash flows individually based on assessed risk. This method is, however, more

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laborious and has the hazard of allowing users biases to more readily introduce to the model and affect the final outcome. Example 4.2  The uncertainty and volatility of maintenance cost are often undesirable for corporate jet operators that would prefer a simpler expenditure budgeting. The maintenance reserve contract allows the operator to pay a fixed (often based on operation level) fee. In return, the contractor will cover all the maintenance costs when they occur through the contract period. Since maintenance fees may come in big installments (e.g., major maintenance events), this contract allows the operator to absorb the cost in a smoother and more consistent way. For illustration purposes, let us simplify this scenario and consider a 60-month contract with the following payment and cost schedule: • The operator pays a fixed fee of $12,000 every month • The regular maintenance cost is $5000 per month • Every 12  months, there is a major maintenance event that cost an additional $50,000 Assume a firm is interested in buying this contract from the original maintenance provider. We need to assess the value of this maintenance contract. Following the DCF notation, from the perspective of the maintenance service provider, we have the following.

= TRt $= 12, 000 t 1, , 60



$55, 000 t  12, 24, 36, 48, 60 TCt   otherwise  $5, 000 Accordingly, the CFt can be calculated as follows.

$43, 000 t  12, 24, 36, 48, 60 CFt   otherwise  $7, 000 The contract has no residual value at its completion; thus, RVn is zero. Assume that the buyer firm has the required rate of return of 7.5%. The buyer is concern about the risk of a potential increase in labor costs in the future. After careful consideration, the management decided to account for the risk of an increase in labor cost by adjusting the discount rate by .5% and increase it to 8%. Therefore, VDCF 

$7, 000

1  .08 

1



$7, 000

1  .08 

2

 

$43, 000

1  .08 

VDCF = $54, 027

12

 

$43, 000

1  .08 

60



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The given contract has a value of about $54,000, so it could be an advisable investment if the buyer could acquire the contract cheaper than this value. We may note that over the life of the contract, the total earning from the operator is $720,000, and the total maintenance expenditures are $550,000. The difference between these two values (i.e., $170,000) is not a realistic measure of the worth of the contract, as it does not account for the time value of money.

4.5.3.2 Internal Rate of Return The IRR is used to evaluate viability or profitability of investment projects, and it is the discount rate that makes the net present value of all cash flows equal to zero. As a general rule, if the IRR is higher than, or equal to the opportunity cost, a company can accept the project or investment. One way to avoid dealing with the challenge of selecting a discount rate is to revise the evaluation model, so the decision-maker is not forced to set the rate upfront. The Internal Rate of Return (IRR) achieves this by considering the valuation problem from a different perspective. In this approach, we utilize the NPV model but strive to find the discount rate that brings the NPV to zero. Identifying this rate has the immediate advantage that we would know any higher discount rate deem the investment unadvisable. Any lower discount rate, on the other hand, makes the asset more valuable. In the IRR model, we often find the discount rate numerically and then we can compare this against the cost of capital of the firm to judge the valuation. For the purpose of valuation, this approach is applicable if there is an estimate of value on hand, and we are seeking to assess if obtaining the subject asset is advisable. Mathematically, the IRR model tries to solve the following equation for r, the break-even discount rate. In this equation, V0 is the estimated value or asking price of the asset. n

V0   t 1



CFt

1  r 

t



RVn

1  r 

n

0



Example 4.3  Following the previous example, assume the subject maintenance contract is offered at the price of $51,000. We would like to assess this deal using the IRR. To obtain the discount rate that makes the investment break even, we have to solve the following equation for r, where r is the discount rate. $51, 000 

$7, 000

1  r 

1



$7, 000

1  r 

2

 

$43, 000

1  r 

12



$7, 000

1  r 

13

 

$43, 000

1  r 

60

0



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191

By solving the above equation, we obtain a discount rate of 8.72%. In other words, this deal is advisable if the expected internal rate of return for the buyer firm is 8.72 or less. Calculating the IRR can be tedious if one has to consider multiple cash flow periods. In this case, by using financial calculators (e.g., through Microsoft Excel), we can calculate the IRR. To illustrate this, we briefly present the instruction for using the IRR function in Excel.  tep-by-Step Instructions for Using Excel to Calculate the IRR S 1. Enter the initial cash flow (e.g., initial investment) into any spreadsheet cell. For our example, the initial investment is $51,000, so we enter −51,000 in cell B6 from as shown in Figure 4.3. 2. Enter subsequent cash flow values for each period in chronological order into cells directly adjacent to the initial cash flow. In our example, we enter CFt for t from 1 to 60 into cell B7 to B66. 3. Instruct Excel to calculate the IRR by entering the function IRR in a given cell and selecting the cash flow range as the function input. For our example, we typed “=IRR(B6:B66)” in cell B3. The IRR function requires at least a positive and a negative number in the data range. If the function fails to produce the result (often shown as error #NUM!), one needs to check for the requirement. Additionally, the calculation can be facilitated by providing Excel with a guess of the final result. For example, we could have entered the function as “=IRR(B6:B66,.05)” which uses the guess of 5% for the IRR value. A close enough guess could speed up the calculations.

4.5.3.3 Payback Period The payback period is the length of time an investment reaches a break-even point. In other words, the payback period refers to the amount of time it takes to recover the cost of an investment. The payback period disregards the time value of money. In addition, the payback method does not consider the cash flows received after the end of the payback period. Similarly, the Payback period (PBK) method as an alternative approach tries to reexamine the advisability of an investment based on the length of time that it takes for the investment to break even. The PBK method to establish the break-even period is to count the future payments against the original investment to find the break-even point. This method is rather simplistic as it does not consider the time value of money. Consequently, the PBK is more appropriate for evaluating short-­ term decisions or as a rule of thumb for the initial assessment of the viability of an investment option. Indeed, if the payback period of an asset gets close to or exceeds its estimated useful economic life, it is not an advisable option. We could represent the PBK model as follows.

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Figure 4.3  Using Microsoft Excel for calculating the IRR

4.5  Economics of Aircraft Valuation

193

TPBK =

V0

CF In this equation, V0 is the estimated value or asking price of the subject asset, CF estimated net annual cash flows. The ratio of V0 to CF provides TPBK, which is the number of years required to recover the initial investment in the subject asset.



Example 4.4  Assume that the buyer decided to evaluate the deal in the previous example through the PBK method. To calculate the payback period, we could consider the annual cost of the contract that is 12 monthly payment of $5000 and one payment of $50,000 that makes a total of $110,000. The annual revenue from this contract is 12 installments of $12,000 for a total of $144,000 annual revenue. Therefore, the annual net earnings of the contract is $34,000.



= TPBK

$51, 000 = 1.5 years $34, 000

Under the PBK approach, it takes one and half year to recover the $51,000 price of obtaining the contract through the collection of the $34,000 annual net gains. Since the annual gains are positive and the length of the contract (i.e., 60 months) is longer than 18 months, the deal advisable. Example 4.5  Assume an airport is planning to purchase several snow removal trucks for $11 million. The trucks is expected to save the airport $1.25 million per year. The payback period of this project is:



T= PBK

11 = 8.8 years 1.25

4.5.3.4 Adjusted Present Value To be exact, the APV takes the net present value, plus the present value of debt financing costs, which include interest tax shields, costs of debt issuance, costs of financial distress, financial subsidies, etc. As described earlier, the DCF model converts the future cash flows to their present values by discounting them with the given discount rate. It, however, understood that the components of future revenues and costs might be subject to different risks. In contrast to the DCF, which in essence, ignores these differences, the Adjusted Present Value (APV)13 tries to address these variations in risks. Accordingly, the  We presented a modified APV here that is more appropriate for valuation purposes. The traditional APV is concerned with the cost of equity as the discount rate and includes tax shields as provided by deductible interests. For discussion on traditional APV see Myers (1974), Myers et al. (1976), and Copeland and Weston (1982).

13

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Figure 4.4  Using Microsoft Excel for calculating the APV

APV discounts the cash flows of different risk classes at rates representing the risk class of each cash flow. Example 4.6  Assume that in the maintenance contract discussed in the previous examples, the firm believes that the major maintenance expenditures are more prone to variation and carry a higher risk. Suppose the firm uses a discount rate of 7%. The discount rate could be adjusted by 2% to account for the risk.



 $7, 000 $7, 000 $7, 000  $50, 000 $50, 000  VAPV         1 2 60 12 60  1  .07  1  .07  1  .07   1  .05 1  .05 VAPV  $98,274   $59, 462  $38, 812

Example 4.7  DirectJet is planning to acquire a used CRJ aircraft for $9.8 million dollars, and has decided to finance this transaction by borrowing $1,000,000 to consummate this transaction. DirectJet is evaluating this transaction through the APV method (Figure 4.4).

4.5.3.5 Real Options Value Analysis (ROV) The DCF is a deterministic model, and while the APV allows for accounting for the variation of risk in different items, it still relies on the inflexibility of decisions. In

4.6 Summary

195

other words, under the DFC and APV user is a passive operator that commits to an asset for its entire economic useful time despite potential changes in the market. The Real Options Analysis (ROV) initially came from investment and stock market literature. Black and Scholes (1973) and Merton (1973) developed the quantitative methodology of pricing financial options. The ROV recognizes that an operator may react to future circumstances and revise its decision. The ROV concept can be used in valuation as well. Real options mitigate the inherent uncertainty in the business operations with managerial creativity. The company adopts appropriate strategies from the available options presented to them as time progresses and conditions change. For instance, an operator may change the level of utilizing an asset in response to the change of future demand. On the other hand, an aircraft could be grounded or sold if the future prospect of demand is not promising enough. Utilizing the ROV requires the proper setup of the options structure. Possible options must be identified, and the policy for selecting them on each given circumstance shall be established. Next, given the probability of each possible circumstance, we could establish the expected outcome of applying the options and calculate the present value of each scenario. Analyzing the distribution of the present values of the probabilistic scenarios provide the ROV value for the subject asset. In contrast to the simplicity of DCF and other methods discussed earlier, proper application of the ROV demands a more complex calculation. It relies on correctly identifying the possible future events and their likelihood. Indeed, with correct and accurate input, the ROA is expected to outperform other methods by establishing a more realistic value for the subject asset. However, in practice, estimating the required parameter for the ROV method is very challenging. Inappropriate and arbitrary selection of parameters’ value introduces user bios to the models that may negatively affect the results and mislead decision-makers. Perhaps, for this very same reason, the application of the ROV for valuation in the industry has been very limited, and most of its utilization has been limited to academic studies.

4.6

Summary

The goal of this chapter was to lay the foundation for valuation and appraisal. Whether we are valuing a physical asset or intangible assets, there are three general approaches to determining value: cost approach, revenue approach, and market comparison approach. The value of an aircraft depends on internal factors directly related to the aircraft’s specifications and conditions, such as the aircraft’s age, size, capacity, fuel efficiency, and maintenance status. In addition, the aircraft value depends on external factors such as the economic cycle, the spread of communicable disease fuel cost, and environmental regulations. The values of narrow-bodied aircraft dropped by between 15% and 30%, and wide-bodied dropped by between 20% and 45% as a result of the COVID-19. In this chapter, we discuss the primary concepts and definitions that are used in valuation. We provided a description of the three main valuation approaches and discussed how they could be applied to the valuation of different assets. Next, we reviewed the economic foundation of valuation and presented a summary of the prominent methods in valuation.

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In the next chapter, we will demonstrate the valuation process for commercial aircraft using a case study for Airbus and Boeing models.

Bibliography Bancel, F., & Mittoo, R. (2014). The gap between the theory and practice of corporate valuation: Survey of European experts. Journal of Applied Corporate Finance, 26(4), 106–117. Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economy, 81, 637–659. Copeland, T. E., & Weston, J. F. (1982). A note on the evaluation of cancellable operating leases. Financial Management, 11, 60–67. Graham, R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2–3), 187–243. IATA. (2013). Profitability and the air transport value chain. IATA Economics Briefing No. 10. Lloyd, J. & Davis, L. (2007). Building long-term value. Journal of Accountancy, 204, 5, 56–61. Martin, J., & Titman, S. (2008). Single vs. multiple discount rates: How to limit “influence costs” in the capital allocation process. Journal of Applied Corporate Finance, 20(2), 79–83. Merton, C. (1973). Theory of rational option pricing. The Bell Journal of Economics and Management Science, 4(1), 141–183. Myers, C. (1974). Interactions of corporate financing and investment decisions-implications for capital budgeting. The Journal of Finance, 29(1), 1–25. Myers, S., Dill, A., & Bautista, A. (1976). Valuation of financial lease contracts. Journal of Finance, 31, 799–819. Pinto, J. E., Robinson, T. R., & Stowe, J. D. (2019). Equity valuation: A survey of professional practice. Review of Financial Economics, 37(2), 219–233.

5

A Step-By-Step Methodology for Commercial Aircraft Valuation: Case Study of Boeing and Airbus

In the previous chapter, we reviewed the foundation of asset valuation and discussed some of the most common methodologies for estimating the value of an asset. In this chapter, we focus on commercial aircraft valuation. The valuation of commercial aircraft is slightly different from other categories of aircraft. Commercial aircraft are primarily owned and operated by for-hire airlines to transport passengers and cargo. Generating revenue and, in turn, profitability is a significant, if not the main, reason for operating a given aircraft. This scenario is in contrast to corporate aviation. Even though some financial justification can be provided for acquiring and operating business jets, it is often challenging to accurately assess the exact amount of revenue generated by flying business jets. In other words, explicit revenue generation is not the primary justification of corporate jets. By and large, a similar observation applies to the majority of general aviation that are mainly focus on leisure and personal use. Even in the case of general aviation fleet used for training, it is often challenging to estimate a regular stream of revenue over a plane’s lifespan since that market is governed by factors that are different from commercial transportation. Therefore, in this chapter, we narrow the discussion to commercial © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 B. Vasigh, F. Azadian, Aircraft Valuation in Volatile Market Conditions, Management for Professionals, https://doi.org/10.1007/978-3-030-82450-1_5

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operations of aircraft that makes the most considerable portion of the operators in the aviation industry. The asset valuation for general aviation will be discussed in detail in a dedicated chapter later. This chapter will cover the following topics: Intricacy and Resourcefulness Aircraft and Data Selection • Boeing Aircraft • Airbus Aircraft Sources of Revenue • Passenger Revenue • Cargo Revenue • Ancillary Revenue Aircraft Total Cost Structure • Direct Operating Costs (DOC) • Indirect Operating Costs (IOC) • Non-Operating Cost (NOC) Aircraft Valuation Methodology • Discounted Cash Flow Model Theoretical Aircraft Value vs. List Price The Trend of Aircraft Values • Aircraft Value Volatilities • Fuel Price Sensitivity • Passenger Yield Sensitivity • Other factors Sensitivity Elasticity At the end of the chapter is a summary for this chapter review and selected bibliography for further study.

5.1

Introduction

It is considered important to develop a methodology for estimating an aircraft’s value as well as its efficient utilization to ensure an acceptable rate of return on the investment. However, estimating an aircraft’s value is a complex process. Aircraft manufacturers incur significant development and assembly costs to offer safe and reliable airplanes. The total cost for the development and manufacturing of Boeing 787-9 Dreamliner, along with the deferred production cost and unamortized tooling, has been more than $32 billion,1 and the total development cost for the Airbus 350 was around $15 billion.2 Factors determining an aircraft’s value not only include the 1  Gates, D. Boeing celebrates 787 delivery as program’s costs top $32 billion. The Seattle Times, September 25, 2011. 2  Hepher, T. Airbus wins European approval for its new A350 jet. Reuters, September 30, 2014.

5.2  Intricacy and Resourcefulness

199

physical characteristics of the aircraft such as size, age, engine type and cycle, seating capacity, fuel efficiency, and physical condition, but also include such items as maintenance status and maintenance documentation, operating expenses, and revenue. The price of jet fuel has a significant influence on the operating costs, consequently on aircraft value. Exogenous factors such as demand and its elasticity, inflation rates and interest rates, safety issues and regulation, and, finally, environmental regulations will influence prices. After more than 300 people died when two 737 Max aircraft crashed in Indonesia and Ethiopia, the entire fleet of 737 Max remains grounded. Boeing said it would suspend production of its 737 MAX jetliner for the time, in an escalation of the crisis facing the giant plane maker that will ripple through the global aerospace industry. Boeing would continue to lose over $1 billion a month even after stopping production; consequently, Boeing suspends the production of its 737 MAX jetliner On December 19, 2019.3 United Airlines received the first MAX planes after regulators grounded the jet in March 2019 following two crashes. The FAA lifted its MAX flight ban on November 18, 2020 after it approved safety fixes. In this chapter, we review the process of assessing aircraft value based on influential factors. In the approach presented in this chapter, we use future gains and expenses to assess aircraft value as an investment with a limited lifespan. The presented methodology is closely associated with the revenue approach presented in the earlier chapter. To better illustrate the approach, we use numerical examples throughout this chapter and the next one. We utilized two aircraft models from the two prominent commercial aircraft manufacturers in the world: Airbus and Boeing. The selection of these models is merely for illustration, and the presented approach can be used for any commercial aircraft.

5.2

Intricacy and Resourcefulness

During this analysis, it became evident that many internal characteristics of the aircraft contributed to the value disparities between Airbus and Boeing. Although there are numerous factors involved, the seating capacity, class configuration, containerized cargo space, cargo capacity, fuel consumption and capital cost rates all drive cash flows. For example, having containerized cargo space could automate cargo handling, an otherwise labor and time-intensive work process. The consequential reduction in on-ground time and labor cost would then contribute to a lower operating cost. Consequently, it is observed that the narrow-bodies have a lower cargo yield than wide-bodies because they have less available cargo space while may incurring extra costs since cargo often has to be loaded manually. Many factors such as the availability of a particular model, quality of refurbishments and upgrades, fuel crisis, terrorism,4 financial crisis, and predatory practices  Wall Street Journal, Marc 2, 2020.  In the period immediately after 2001, values of the 737-300 fell to record lows, with some even being scrapped. Aircraft Value News, April 20, 2008. 3 4

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can significantly alter the demand for aircraft and, therefore, aircraft value.5 For instance, there is an increase in demand for old wide-body aircraft when there is a capacity shortage or significant diminution in fuel costs. On the other hand, the technological progress that reduces the operating costs of new aircraft, or environmental regulations that restrict older aircraft, or higher fuel prices, would have a dampening effect on the values of old wide-body aircraft.6 In addition, the value of an aircraft depends on its operating costs, thus older aircraft are retired when the break-even load-factor is too high to generate enough revenue to justify operating costs. These operating costs are mainly determined by fuel efficiency, range, seat capacity, maintenance expenditures, and airport fees. In general, higher operating costs result in lower aircraft value. In particular, airlines pay higher prices for new aircraft if the aircraft lowers the operating costs by allowing for more fuel-efficient operations. An airline’s evaluation is based on this trade-off between one-time capital investment and lifetime operating expenses, including depreciation and fuel costs. As an aircraft ages, the increase in scheduled and un schedule maintenance means an increase in maintenance down time and consequently the number of days the aircraft is in for repair. At some point, If the total of cost holding the aircraft outweigh the cost of acquisition for the new aircraft, it is the time to replace the old aircraft. Recent decades, however, have seen a marked lowering of operating costs through several factors that have contributed to an increase in energy efficiency; among these are aerodynamic improvements and enhancements in engine thrust. The wear and tear of an aircraft is appraised on the basis of flight hours and on the number of cycles. This can vary significantly from one operator to another since the same type of aircraft can be operated on different routes with different distances and a varying number of landings per hour. Macro-economic factors are also extremely important because they indicate the aviation industry cycle, which can have the greatest impact on aircraft values. All of these factors make aircraft valuation complex and dynamic. The question of valuing commercial aircraft, while it bears significant importance in practice, has not been explored in depth by researchers in academia. We use a modified Discounted Cash Flow (DCF) model. This approach is based on the financial theory that the value of an investment can be estimated from the future cash flows that the investment is expected to generate. However, a number of other research papers and articles have attempted to approach aircraft valuation under different methodologies. We briefly review the most relevant literature in this section.

5  Aloha Airlines filed for Chapter 11 bankruptcy protection on March 12, 2008. The airline said, it was unable to generate sufficient revenue due to what it called “predatory pricing” by Mesa Air Group Inc.’s go! airline. 6  Values of older wide-bodied aircraft continue to face weakness as the effects of higher maintenance and operating costs take precedence over lack of newer products. (Aircraft Value News, 2008).

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One of the valuation methods that has been studied in the literature is the real options analysis. Under this approach, it is assumed that companies react to changes and take actions to steer a project toward profitability. Thus, the actual value of a project shall be estimated by accounting for the managerial inputs and reactions to potential future scenarios. Stonier (2001) discussed option values for commercial aircraft and utilized the binomial-tree pricing model to obtain a set of potential NPVs under Monte Carlo simulations. Vasigh et al. (2021) propose the adoption of a Weighted Average Cost of Capital (WACC) and Net Present Value (NPV) technique. The model is adjusted to offer the potential for flexibility beyond its classic interpretation. The proposed Adjusted Present Value (APV) concept provides insight into lease versus purchase decisions as well as an equity NPV that demonstrates the overall returns from an aircraft from the shareholders’ perspective. They argued that the APV approach is advantageous since it measures the cost of flexibility. Sala et al. (2008) applied real options analysis in studying the impact of environmental regulation like carbon emission on the value of an aircraft. Hu and Zhang (2015) utilized real options analysis with two options: the shutdown-­ restart option and the aircraft delivery deferral option. They claimed that results obtained by this approach are closer to actual values than the static NPV method. Hu et al. (2019) further utilize real options analysis to justify the underlying reasons behind the different approaches to using regional jets in three different countries (US, Brazil, and China) and demonstrated how regional options affect the value of an aircraft. More Recently, Chen (2020) proposes a theoretical value evaluation model for commercial aircraft from the perspective of Chinese airlines using real options analysis. On the other hand, Ackert (2012) takes a rather qualitative and empirical view of how aircraft values can fluctuate. Specifically, he identifies several aircraft value retention factors that are either market or performance-driven. For example, he argued that the orders for a particular aircraft type, surpluses, or shortages in its segment, and the general financing environment could all affect an airplane’s residual value. Similarly, aircraft specifications, aircraft economics, and overall aircraft family characteristics also play a crucial role in appraising an aircraft. This study was an expansion of the earlier work in which Ackert (2011) examined the relationship between an aircraft’s value and its maintenance status. Ackert developed Future Base Value (FBV) forecast cycles to predict the value that the asset should achieve with reference to the normal depreciation of the underlying asset. Bruno et al. (2015) introduced a hybrid novel model for aircraft evaluation rather than valuation, based on the investigation of airlines’ needs. In an effort to overcome the weaknesses of the previous NPV-APV, Monte Carlo simulation, and real option analysis models, they propose a model that combines two main approaches to address evaluation problems: the Analytic Hierarchy Process (AHP) and the Fuzzy Set Theory (FST). The model includes four criteria (economic performance, technical performance, aircraft interior quality, and environmental impact) and eight sub-criteria (aircraft price, operative cost, cruise speed, autonomy, seat comfort, cabin luggage compartment size, noise, and environmental pollution). This hybrid approach may be used as an evaluation system and as a strategic tool. Bruno et al. (2015) argued that airlines and manufacturers could use the model, both ex-­ ante and ex-post, to identify their requirements.

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The diversity of the methods proposed for aircraft valuation is due to the complexity of the process. Some approaches, such as Ackert (2012) and Bruno et al. (2015), may rely on data that are not publically available to the interested parties. On the other hand, the real options analysis method seems to be mostly utilized in academic studies. Gibson and Morell (2005) present the result of their survey of the airline industry regarding valuation methods used and preferred in practice. Their study suggests that airlines indicated a strong preference for Net Present Value and a weaker preference for accounting-based ARR.  Concerning the advanced techniques, the airlines’ responses showed a very weak preference for both Real Options Analysis and Adjusted Present Value, even less than the general business community. The Common criticisms levied against ROA is that it is difficult to explain, rather theoretical than practical, and obtaining the required data is challenging. Similar observations have been reported by other surveys (Graham & Harvey, 2001; Bancel & Mittoo, 2014; Pinto et al., 2019). Our objective is to offer a method that can utilize public information and provide a quick assessment of the value of a given aircraft at a time. Sophisticated analytical methods, when applied correctly, may offer a more accurate valuation of assets. However, the survey of the practitioners in the aviation industry consistently showed that sophisticated methods tend to be avoided in favor of simpler methods. In this chapter, we present an approach based on a modified discount cash flow model, which distinguishes our study from some of the existing literature that employed complex analysis to achieve a similar goal. Using four popular aircraft models as our case study, we demonstrate that a relatively straightforward approach can be employed to estimate the value of aircraft using only publicly available data. In addition, to identify the key factors affecting the value of an aircraft, we conducted a Monte Carlo based simulation for sensitivity analysis in the next chapter.

5.3

Aircraft and Data Selection

The proposed model presents a comprehensive aircraft valuation technique and provides a multidimensional model for aircraft appraisal and valuation. It presents a methodology that will more accurately measure return on investment, improve the efficiency of managing operating costs, and more effectively determine yield analysis. As such, it should provide the basis for an improved negotiating position for the purchase or lease of new or used aircraft. Additionally, it also provides quantitative evidence to determine when an aircraft should be retired and replaced. In the following model, two popular narrow-body and wide-body aircraft produced by Boeing and Airbus were selected, and a modified Discounted Cash Flow (DCF) model was applied. The theory assumes that the value of an investment can be estimated from the cash flows that are expected to be generated in the future (Vasigh & Erfani, 2004). This discounted cash flow model provides a reasonable estimate of aircraft value. However, since many factors are considered in the DCF model, small variations in these factors can significantly affect the theoretical value of any aircraft.

5.3  Aircraft and Data Selection

203

The relevant expense and revenue data for the four aircraft were collected for the time period starting from 2009 to 2019. The information was obtained for two different aircraft from competing manufacturers, Boeing and Airbus. From these manufacturers, two narrow-body and wide-body aircraft were selected. Data sets were obtained for Airbus 320-200, Boeing 737-700, Airbus 330, and Boeing 767-400. Both Boeing and Airbus produce to order and collect deposits upon receiving the orders for the full payment to be paid upon delivery.

5.3.1 Boeing Aircraft Boeing received the first order for a B-737-100 (737 program) in 1965. In 1991, Boeing started the 737 Next Generation (NG)7 program on which the current versions of the 737s -600/-700/-800/-900 series are based. As of December 30, 2019, a total of 6914 Boeing 737NG aircraft have been delivered. The top airlines actively operating 737-800-900 aircraft are Ryanair (268), American Airlines (249), Southwest Airlines (207), China Southern Airlines (163), Xiamen Airlines (136), and Malta Air (120). The Boeing 737-700 model was launched in 1993, and the 737-700ER on January 31, 2006.8 As of September 30, 2020, a total of 7110 737NG aircraft had been ordered, of which 7064 had been delivered, with remaining orders for the -700W, -800, and -800A variants. In September of 2014, Boeing launched its 737 MAX 200 with an order for 100 of the aircraft from Ryanair in a deal valued at $11 billion at list prices. As of December 2019, the Boeing 737 MAX had received 5258 firm orders and delivered 387 aircraft. The wide-body 767 family from Boeing is in service with 100 airlines worldwide. According to Air Transport Intelligence, the current (2020) total of aircraft-in-­service is 482. Boeing’s 767 family includes four models: the 767-200, 767-200ER, 767-300, 767-300ER, 767-300F and 767-400ER. In 1989, the FAA approved the 767 as the first jetliner for 180-minute extended operations (ETOPS). According to Boeing, 767s burn significantly less fuel and produce lower emissions per pound of fuel used than any comparably sized jetliner, including the A330-200. The three top operators of the 767-400ER are Delta with 21 (including 13 inactive) and American Airlines with 16 aircraft (inactive). The model selected is the 767-400ER, which was launched in 2000.

5.3.2 Airbus Aircraft Airbus started its A320 program in 1984 with the A320-100. A newer version, the A320-200, was introduced in 1988.9 Based on the information retrieved from Air Transport Intelligence, 257 airlines operate a fleet of 4303 (including 1394 inactive)

 Next generation program includes, 737-600, 737-700, 737-800 and 737-900 airplane models.  Boeing Company, News Release, Seattle, Jan. 31, 2006. 9  The A-320 family comprises four aircraft that share the same cockpit, have the same cabin cross-­ section and fly with the same operating procedures. 7 8

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Airbus A320-200 models. The three top airlines operating A320s are China Eastern Airlines (178), China Southern Airlines (106), and JetBlue Airways (100). To compare the wide-body Boeing 767-400 with a model from Airbus, the A330-200 was selected. This model is the only wide-body from Airbus that is operated by a US airline. The A330-200 was launched in 1993. According to Air Transport Intelligence’s website,10 80 airlines currently (2020) operate a total fleet of 554 Airbus A330-200 models (including 343 inactive). The three top global operators of the A330-200 are Air China (30), China Eastern Airlines (25) and China Southern Airlines (14). Tables 5.1 and 5.2 summarizes some characteristics of all of the aircraft models selected. The current operators of each aircraft model are given for the United States only because only financial data of US carriers was obtainable through Back Aviation Solution’s Form 41 database.

5.4

Sources of Revenue

The amount of money an airline earns through the sale of tickets, ancillary services, and other sources. Revenue is the amount the airline makes; revenue should not be mistaken with profit, which is revenue less expenses. Airlines receive a part of their revenue from passengers directly, and the remaining ancillary revenue. Ancillary revenue comes from baggage fees, frequent-flier miles to credit card companies, and other a la carte services and on-­ board retail. Understanding and proper definition of revenue is key to being able to promote the profitability of an airline. Revenue (sales or turnover) is the income that an airline receives from its normal business activities, usually from ticket sales, cargo delivery and ancillary revenue from the passengers. Airlines are constantly in search of new revenue sources. Travelers have gotten used to paying for food onboard. But it’s going to be harder to adjust to fees for services that used to be free. Globally, commercial airlines made a combined revenue of around 838 billion U.S. dollars in 2019. They were expected to generate 872 838 billion U.S. dollars for 2020 before the COVID-19 pandemic. The current estimate by IATA for 2020 is around 419 billion U.S. dollars. In 2020, due to the coronavirus outbreak, commercial airlines were estimated to have net profit losses of 118.5 billion U.S. dollars. For aircraft valuation purposes, revenues (cash inflows) generated by passengers and cargo/freight transport have to be estimated. These estimates can be complex and require several assumptions. Total revenue is calculated by adding the revenue generated from passengers and cargo. Passenger revenue is derived from multiplying passenger yield with revenue passenger miles (RPM). Similarly, cargo revenue is calculated by multiplying cargo yield with revenue ton-miles (RTM). Several 10

 As of November, 2011.

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Table 5.1  Narrow-body aircraft type specifications and US Operations (2020) Launch Normal seating Range, miles Speed (Mach) Fleet in service (World/US) Fleet inactive (World/US) US Operators

A320-200 1988 164

737-700 1993 126

2167 0.78

5179 0.79

2909/377

730/468

1394/162

302/104

JetBlue Spirit Allegiant United American Airlines Delta

In-service 100 64 55 49 40

Inactive 30 0 10 52 8

35

28

Alaska Frontier

20 14

29 5

Southwest United Alaska Kaiserair ConocoPhillips Alaska Inc US Marshals Service Delta Sun Country

In-service 426 30 9 1 1

Inactive 72 19 2 0 0

1

0

0 0

10 1

Source: Compiled by the authors from Aircraft Manufacturers and CAPA (as of October 2020) Note: The uncharacteristically high number of inactive aircraft is due to the COVID-19 pandemic at the time of collecting this data Table 5.2  Wide-body aircraft type specifications and US operations (2020) Launch Normal seating Range, miles Speed (Mach) Fleet in service (World/US) Fleet inactive (World/US) US Operators

A330-200 cert. 1998 293 7674 0.82 211/16

767-400 2000 243 4315 0.8 8-Sep

343/35

29/29

Hawaiian Delta American Airlines

In-service 13 2 0

Inactive 11 9 15

Delta United

In-service 8 0

Inactive 13 16

Source: Compiled by the authors from Aircraft Manufacturers and CAPA (as of October 2020) Note: The uncharacteristically high number of inactive aircraft is due to the COVID-19 pandemic at the time of collecting this data

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assumptions are made to match each aircraft type with the more appropriate yield. It is observed that the narrow-bodies have a lower cargo yield than wide-bodies because they have less available cargo space while may incurring extra costs since cargo often has to be loaded manually. Given the above-mentioned factors, the total revenue (cash inflows) becomes the sum of revenue generated from passengers, cargo and any additional ancillary revenue. The majority of the operators of commercial aircraft are combination carriers. So even though they carry (underbelly) cargo, the primary source of revenue, by comparison, is passenger revenue. Consequently, in the valuation of aircraft for such a purpose, we may focus on passenger revenue and combined cargo and ancillary revenue as the other source of revenue. Indeed, if we are intended to value a freighter aircraft, the primary source of revue will be cargo, and that would be the revenue we shall focus on in the analysis. Where

TRit  TRitPax  TRitCargo  TRitAR

TRit: Total revenue of individual aircraft i at time period t TRitPax : Total passenger revenue of individual aircraft i at time period t TRitCargo : Total Cargo revenue of individual aircraft i at time period t TRitAr : Total ancillary revenue of individual aircraft i at time period t For our analysis, we need to disaggregate the revenue by contributing factors to allow for a better projection of future revenues. In essence, the revenue depends on the operations level, load factor, and yield. The operations level is measured as Available Seat Miles (ASM) for passengers and Available Ton Miles (ATM) for cargo.11 The load factor indicates the portion of the capacity that has been utilized for generating revenue. For the passenger, the Revenue Passenger Miles (RPM) measures the quantity of Seat Miles that has been used by revenue passengers. Therefore, the load factor for the passenger is the ratio of RPM to ASM. A similar calculation can be conducted for cargo. Yield is the measure of revenue per RPM and is often expressed as cents per RPM.  Figure  5.1 illustrates the relationship between various measures for the passenger. With minor adjustment, the relationship can be expressed for cargo. Another measure that is closely related to the performance of an aircraft is the number of Block Hours. For a given aircraft (where the number of seats and cargo capacity remains constant), the block hour and ASM (or ATM) are directly correlated based on the average speed of the aircraft.

ASM  Number of Seats  Miles Flown

 The corresponding measures in metric system are Available Seat Kilometers (ASK) and Available Tonne Kilometers (ATK).

11

5.4  Sources of Revenue

207

Block hours =

Miles Flown Speed

ASM  Number of Seats  Speed  Block Hours    Block Hours

Accordingly, for our analysis, we could exploit this relationship and present measures based on block hours.12 Since aircraft configuration (number of seats) and operational policies (speed) may change, the constant ρ can be estimated for each individual aircraft and each period.

5.4.1 Passenger Revenue The organization just updated its analysis showing an airline passenger revenue drop of 314 billion USD in 2020. This is a 55% decline compared to 2019. Last month, IATA was expecting the loss to be up to $252 billion. And previously it was pegged at $113 billion USD. This shows the extent of the hit the crisis has had on the air industry. Simple Flying, April 14, 2020

Passenger revenue includes income from the transportation of passengers by air from the origin to the destination. Generally, the largest percentage of a passenger airline’s revenue is created through passenger revenue, which amounts to about 90% of the total carrier’s revenues. Legacy carriers traditionally have multiple class cabin configurations, typically set as premium and economy class. The premium class cabins subsequently create higher margins of passenger revenue but offer the carrier fewer seating volumes due to the typically larger seat pitch. Many Low-Cost Carriers (LCCs) have a one-class cabin configuration and charge for amenities above the minimum provided. These extra amenity charges are part of ancillary Miles Flown

Passenger

Fare ($)

RPM

Revenue

Yield

Seats

ASM

LF

Figure 5.1  Relationship between airline performance measures for passenger transportation  This relationship is not true in general. Even for a given aircraft, the speed and perhaps seat configuration may vary over time. Therefore, this conversion is a rough estimate of block hour based on ASM for a given aircraft.

12

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revenue that will be discussed in this section. In 2020, due to the coronavirus pandemic, ancillary revenue was estimated to drop to only $58.2 billion, a 47% decrease compared to 2019. The total passenger revenue could be estimated as follows. TRitPax  YielditPax  RPMit



TRitPax  YielditPax  TRitPax 

ASMit LFit

YielditPax it  it LFit

Where for aircraft i in time period t TRitPax : Total passenger revenue YielditPax : Revenue per Revenue Passenger Miles (RPM) LFit: Load factor βit: Block hours ρit: Conversion constant for block hours to ASM To illustrate the calculation of total passenger revenue, we present a numerical example next. Example 5.1  The typical total passenger revenue of Boeing 737-700 can be calculated as follows. The average yield of selected major US carriers in 2018 was 14.07 cents per RPM. In this time period, the average load factor was 82.7%. To estimate the conversion rate between ASM and block hours, we can consider that in 2018 the average number of seats per B737-700 aircraft was 141.2, and the speed per block hour was 355 miles per block hour. Therefore,

  141.2  355  50126 A typical Boeing 737-700 is expected to perform 3789 block hours annually. Therefore, we could estimate the total passenger revenue as follows. TR Pax 

$0.1407  50126 Yield Pax  3, 789  $32, 313, 000 .827 LF 

5.4.2 Cargo Revenue Although capacity operated by freighters has risen, thanks to higher daily utilization, belly space in passenger aircraft has fallen due to depressed levels of passenger flights. The overall reduction in freight capacity, plus much more robust demand for air cargo versus

5.4  Sources of Revenue

209

air passengers, has pushed up cargo yield and load factor. This has the potential to offset lower volumes and drive cargo revenue to positive growth in 2020. CAPA, October 6, 2020

Similar to passenger revenue, revenue generated from cargo transportation is an important revenue stream for airlines. Many passenger-oriented wide-body aircraft can accommodate substantial amounts of cargo in addition to the passenger luggage. The amount of cargo revenue generated depends on the type of aircraft, its “belly space”, destination, Maximum Takeoff Weight (MTOW) and other factors. Separated from fully-fledged cargo airlines, passenger airlines tend to have a cargo department that handles commercial cargo accounts. The demand for air cargo transportation has been growing with the demand from logistic delivery optimization widely used in the commercial sector. The fee charged for checked passenger baggage is, however, not considered as cargo revenue but rather as ancillary revenue. The total cargo revenue could be estimated as follows.

TRitCargo  YielditCargo  ATMit TRitCargo  YielditCargo 

TRitCargo 

FTMit LFit

YielditCargo  it  it LFit

Where for aircraft i in time period t TRitCargo : Total cargo revenue YielditCargo : Revenue per Freight Ton Miles (FTM) LFit: Load factor βit: Block hours σit: Conversion constant for block hours to ATM

5.4.3 Ancillary Revenue Global airline ancillary revenue is due to exceed $100 billion in 2019. It’s a river of gold that has come from nowhere in the space of a generation. In the last ten years, airline ancillary revenue has increased fivefold. It is having a significant impact on how airlines operate and market themselves. Simple Flying, November 22, 2019 Airline passengers represent a huge potential source of revenue from ticket revenue to ancillary revenue. Ancillary revenue is revenue from non-ticket sources, such as baggage fees, extra legroom, seat selection, priority boarding, and on-board food and services. Airline ancillary revenue was estimated to be $100 billion worldwide in 2019.

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Currently, the airline industry is experiencing an ancillary revenue revolution to help lead the march towards more profitable airline operations. Many airlines in Europe, North America, and in other parts of the world are using this additional source of revenue to enhance ticket revenues. Ancillary revenues mark up a big part of total revenue for low-cost airlines. In fact, ancillary revenues are the foundation of the new airline business model, and therefore very critical to the future of airline operations.13 Ticket prices around the world have fallen sharply since the onset of the recession, further increasing the importance of ancillary revenue items for the airline industry. Furthermore, innovations in technology have enabled handheld Point-of-Sale devices to make direct transactions in the cabin, facilitating ancillary revenue sales and improving management reporting. The sources of ancillary revenue can be divided into many segments: • Pre-Flight Items such as the sale of improved seat selection increased checked baggage allowances, pre-boarding preferences, charges for overhead bin space, etc. • Buy on Board food, beverages, in-flight entertainment, pillows, etc. • Buy on Board duty-free sales such as alcohol, tobacco, jewelry, etc. • Commissions from the sale of: (a) Hotel accommodations, (b) Car rentals, and (c) Travel insurance at airline websites • Virtual Merchandise (theater tickets, credit cards and even theme park entry) As we said earlier, ancillary revenue includes the extra fees being charged for baggage, food, improved seating, and priority boarding. Airline ancillary revenue is projected to reach $110  billion worldwide in 2019, compared to $92.9  billion in 2018. Many airlines in the United States and around the world turned to the ancillary revenue generated by charging passengers for different services to improve their financial positions. In 2018, American Airlines generated over $1.221 million in revenue from passenger baggage fees, followed by United Airlines with $889 million. In the past few years, ancillary revenue has become an important component of low-cost airlines’ income. American Airlines took the top slot at $7.2  billion, followed by United Airlines at $5.8  billion and Delta at $5.5  billion.14 Breaking down ancillary revenue per passenger reveals Spirit at the top of the table at $50.94, followed by Allegiant at $50.01 and Frontier at $47.62. The top five airlines with the highest ancillary revenue as a share of total revenue in 2018 are Viva Aero Bus (47.6%), Spirit Airlines (44.9%), Frontier Airlines (42.8%), Allegiant (41.2%) and Wizz Air (41.1%).15 A similar concept exists on the cargo side. Additional revenue can be generated by selling additional services such as GPS tracking, extended storage, priority processing and so forth. However, as discussed earlier, in the same  Looking back at the Recession’s Impact and Looking Forward: The changing face of the airline industry and ancillary revenues in 2010, An industry briefing. Raphael Bejar, Airsaving. 14  CarTrawler, September 19, 2019. 15  Source. Statista; CarTrawler. 2020. 13

5.5  Aircraft Total Cost Structure

211

way, that passenger revenue surpasses cargo revenue for combination carriers, the ancillary revenue from passenger overshadow the ancillary cargo revenue. Hence, the ancillary revenue can be modeled by estimating it based on ASM as follows. TRitAR  Where for aircraft i in time period t

ARit it  it LFit

TRitAR : Total ancillary revenue ARit: Ancillary revenue per Revenue Passenger Miles (RPM)

5.5

Aircraft Total Cost Structure

In addition to cash inflows, cash outflows must also be estimated. These include operating expenses as well as non-cash expenses (e.g., frequent flyer miles, amortization, and depreciation). Generally, there are three main kinds of costs related to the operation of an aircraft. These include the airborne operating costs, the ground costs, and the variable costs. A cost is the amount of financial, physical, or natural resources required to produce a given good or service. The cost of operating a commercial aircraft can be broken down into two main categories: Direct operating costs and indirect-operating costs. The challenging economic environment and high fixed cost bases force airlines to minimize costs by optimizing their operations. Direct operating expenses for an aircraft include the cost of fuel, flight crew expenses, maintenance costs, and indirect costs such as flight equipment capital costs, as well as expenses for marketing, sales, and general administration. There are numerous characteristics that can be used to classify airline cost structure (drivers). In the following analysis, we will discuss the different cost components of a commercial aircraft and compute the ownership and operating costs. Generally, the cost structure of an airline refers to the collection of operating costs and non-operating costs. Non-operating costs can be divided into true variable costs and step variable costs. The operating cost categories include pilot crew, cabin crew, fuel, landing fees, en route air traffic control charges, airframe maintenance, maintenance, the ownership costs of the aircraft, and airport charges. • Direct Operating Costs: –– Airport landing fees and standing charges. These charges are levied by airport authorities for the airport facilities). –– Crew salaries are usually treated as indirect operating costs

212

•

•

5  A Step-By-Step Methodology for Commercial Aircraft Valuation: Case Study…

–– Flight operations (total) –– Flight crew –– Fuel and oil, the fuel costs for a given flight are based on the price of fuel and the fuel consumption, stage length and the efficiency of the aircraft involved. –– Enroute and navigation fees (these costs are charged by governments to cover the cost of navigation facilities.) –– Inflight catering, the costs of the food and beverage that are served at a given flight. –– Maintenance cost (Maintenance costs are unavoidable in the airline industry to meet safety requirements). –– Traffic-Related Direct Operating Costs –– Passenger related costs. These include mishandled baggage costs, interrupted and canceled flight expenses, and denied boarding. Indirect Operating Costs: –– Aircraft Standing Charges –– Flight Crew Pay –– Cabin Crew Pay –– Maintenance Pay –– Handling Costs –– Overheads –– Sales Costs Administration: (a) General Management (b) Real Estate Costs, etc.

Aircraft operating costs are important factors in the evaluation of an aircraft and the operating expenses during the aircraft life cycle. Tables 5.3 and 5.4 provide unit metrics comparison between wide and narrow-body aircraft. In 2018, the average cost of aircraft block time for U.S. passenger airlines was $74.20 per minute, 9% more than in 2017. Fuel costs rose 27% to $27.01 per minute. Similarly, crew costs rose 3% to $23.35 per minute.16 Small aircraft such as Bombardier Dash 8-300 (50 seater) costs around $1564 per block hour, and the 72 seat ATR 72 costs around $2250 per block hour. The average airborne operating cost of a Boeing 747-400 is between $24,000 and $27,000 per hour, around $39 to $44 per mile, using approximately $15,400 in fuel per hour. For Airbus A380, the cost per block hour is between $26,000 and $29,000 by burning roughly $17,500 of fuel.17 It should be noted that airport costs may be out of an airline’s control, and costs are rising at major international hubs. To estimate costs for aircraft valuation, the following are applied: total operating costs, direct operating costs, variable direct operating costs, indirect operating costs, and non-operating costs.

16 17

 Airlines for America. U.S. Passenger Carrier Delay Costs, May 8, 2019.  Forbes, How Much Does It Cost Per Hour To Fly A 747? May 5, 2017.

5.5  Aircraft Total Cost Structure

213

Table 5.3  Operational factors for narrow-body aircraft Factor Fuel cost ($ per Gallon) Gallons of fuel per BH Flight crew cost per BH Direct maintenance – airframe per BH Direct maintenance – engine per BH Other costs per BH BH Passenger yield (cents per RPM) Other yield (cents per RPM)

Airbus 320-200 % 2020 0.6 2.75 0.18 819 2 1034 2 424.87

2047 2.64 847.01 1760.27 724.51

Boeing 737-700 % 2020 0.6 2.89 0.05 141.2 2 1124.94 3 437.13

2047 2.5 737.03 1822.40 855.6

1.5 1.5 0.05 1.2 1.2

360.93 146.53 3791 19.65 4.02

3.75 2 0.5 1.2 1.2

834.6 141.82 4379 19.65 4.02

193.04 72.57 4156 13.91 2.75

287.7 81.78 3919 13.91 2.89

Note: BH Block Hour; all dollar values are inflation-adjusted to 2020 equivalent. The percentage represents the compound annual increase (or decrease) of a factor from the 2020’s baseline Table 5.4  Operational factors for wide-body aircraft Factor Fuel cost ($ per Gallon) Gallons of fuel per BH Flight crew cost per BH Direct maintenance – airframe per BH Direct maintenance – engine per BH Other costs per BH BH Passenger yield (cents per RPM) Other yield (cents per RPM)

Airbus 320-200 % 2020 0.6 2.75 0.18 819 2 1034.52 2 424.87

2047 2.64 847.01 1760.27 724.51

Boeing 737-700 % 2020 0.6 2.89 0.05 723 2 1124.94 3 437.13

2047 2.5 737.03 1822.40 855.6

1.5 1.5 0.05 1.2 1.2

360.93 146.53 3791 19.65 4.02

3.75 2 0.5 1.2 1.2

834.6 141.82 4379 19.65 4.02

193.04 72.57 4156 13.91 2.75

716.62 81.78 3919 13.91 2.89

Note: BH Block Hour; all dollar values are inflation-adjusted to 2020 equivalent. The percentage represents the compound annual increase (or decrease) of a factor from the 2020’s baseline

5.5.1 Direct Operating Costs Direct Operating Costs (DOC) are those costs that can be easily and conveniently traced to a unit of product. DOC can be expressed in terms of dollar per hour, cents per mile, cents per seat-mile, or, for cargo aircraft, cent per ton-mile. For example, the fuel cost is one of the key operating costs for airlines that is heavily impacted by the fuel price and fuel consumption rate of an aircraft. The increase in fuel efficiency mainly attributes to the progress in aircraft engine and aerodynamic technologies. As a result of these technological developments and new managerial skills to enjoy higher load factors, airlines have been able to achieve higher aircraft fuel economy efficiency. Aircraft operating costs include: • Crew cost • Fuel cost

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• Maintenance cost • Ownership cost The same aircraft can exhibit different fuel efficiency characteristics (consumption) under different operating conditions. For instance, operating a narrow-body aircraft for short flights (typical of the point-to-point business model of LCCs) will increase fuel burn in comparison to operating the same aircraft for longer flights. Direct operating costs (DOC) comprises all applicable expenditures related to aircraft flying operations including pilot wages and salaries, fuel cost, maintenance expenses, and aircraft ownership. The DOC consists of two types of costs: Fixed and Variable. An aircraft’s fixed direct operating costs are those costs of operation that occur whether or not flights are operated. These costs include aircraft leases, terminal leases, and crew salaries. Variable direct operating costs are those costs that are incurred based on the level of activity (number of flights) an airline operates. Fuel, landing fees, passenger services, and maintenance are all considered variable operating costs since they vary depending on the number of flights taken over the course of a year. Some flight crew costs, such as overnight accommodations, could also be deemed variable operating costs. On the other hand, some cost categories may include both fixed and variable operating costs. For instance, the maintenance cost elements may be categorized into fixed and variable components, given that sufficient data is available. These components include: • • • • • • • • • • •

Labor Maintenance and repairs Avionics Basic structure including fuselage tail and wing Engine Power plant Materials Fixed direct operating costs: Aircraft standing charges Annual flight and cabin crew costs Engineering overheads

Given the nature of the variable DOC, they can be expressed as cost per block hour or cost per ASM (as we discussed earlier, these two measures for a given aircraft are correlated). For instance, we could estimate the average cost of fuel per block hours (or per ASM by conversion). Then, if we denote that estimate as θˆfuel , the multiplication of θˆfuel and block hours (i.e., βit) will provide the cost of fuel for the given aircraft over a given time period.

5.5  Aircraft Total Cost Structure

215

Accordingly, we can express the total direct operating costs as a summation of all the direct operating costs as follows.



TCitDOC  TCitfDOC   it ˆij  TCitfDOC  jJ

ASMit it

ˆ

ij

jJ



TCitfDOC  ˆij  it



Where for aircraft i in time period t TCitDOC : Total direct operating cost TCitfDOC : Total fixed direct operating cost J: Set of cost factors affecting cost per block hours (e.g., fuel, maintenance, etc.) θˆij : The estimated cost per block hour of factor j γˆi : The estimated cost per block hour of fixed cost factors βit: Block hours ρit: Conversion constant for block hours to ASM Example 5.2  In this example, we calculate the total direct operating cost of a given Airbus 320-200. First, we need to estimate the cost per block hours of cost factors. Often the exact cost for the subject aircraft is not obtainable. Consequently, we could use the average of the cost factors for a sample of the identical aircraft type and model. Cost information for a sample 510 Airbus 320-200 of US carrier is collected. The average of the cost per block hours of the sample is calculated as presented in Table 5.5. Now, consider a given Airbus 320-200 that is expected to have 3500 block hours annually. In this scenario, the subject aircraft is expected to operate less than the average (that is, 3737 block hours annually). We calculate the estimated total direct operating expenses based on the cost factors presented in Table 5.5.

TC fDOC  767.70  3500  $2, 686, 950



TC DOC  2, 686, 950  3500   991.23  1,787.28  407.98  234.37  95.15



TC DOC  $14, 992, 985  $14, 993, 000

Table 5.5  Estimation of the direct operating cost factors for Airbus 320-200 in 2020 Cost factors Flight crew cost Fuel cost Direct maintenance – airframe Direct maintenance – engine Other flying costs Fixed direct operating cost Total operating cost per block hour

Cost per block hour $991.23 $1782.28 $407.98 $237.37 $95.15 $768 $4281

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5.5.2 Indirect Operating Costs Indirect operating costs (IOC) are those expenses necessary to keep the airline in operation, and cannot be directly associated with the actual flight of the aircraft. The Indirect Operating Costs (IOC) cannot be directly associated with the actual flight of the aircraft and are sometimes more difficult to identify. Indirect operating costs are those costs not directly related to the core function of the airline, such as some labor training costs, selling expenses and administration costs. These costs are necessary for an airline to operate; however, indirect costs cannot be directly linked to a specific flight since the expenses provide support to all operations. Of course, given that IOC does not directly impact an airline’s operation, they represent the first area of concentration for a manager aiming to reduce total operating costs. Some examples of IOC are as follows. • • • • • • • • • •

Baggage and cargo handling General and administrative costs Passenger service costs: Staff Variable flight Indirect cabin crew Insurance expenses Reservations and sales Station and ground expenses Ticketing, sales and promotion related costs

Since the IOC is not directly connected to a specific flight, it is challenging to estimate their impact on a given aircraft. However, since they are associated with operations, one approach to assess the share of a given aircraft in the overall IOC is to divide the total IOC of an airline based on individual aircraft activity level (i.e., ASM or block hour). In other words, for the purpose of our analysis, we should still be able to estimate the IOC per block hours (or ASM). Therefore, we can estimate the total indirect operating cost as follows. TCitIOC  ˆ it  it  ˆ it

ˆ it 

IOCt  vV vt



ASMit it



5.5  Aircraft Total Cost Structure

217

Where for time period t TCitIOC : Total indirect operating cost of aircraft i µˆ it : estimated indirect operation cost per ASM of aircraft i V: the set of all the aircraft used for estimating µˆ it ; indexed by v IOCt: the combined indirect operating cost of all the aircraft in set V βit: Block hours of aircraft i ρit: Conversion constant for block hours to ASM Example 5.3  In 2018, Delta Airlines performed 263,365 million ASM. The total indirect operating expenses were 22,892 million $USD. Accordingly, we could estimate the indirect operating expenses per ASM as 8.69 cents. Multiplying this estimate by the expected ASM (or corresponding block hours) provides the estimate of total indirect operating costs for a given aircraft.

5.5.3 Non-operating Cost Airlines also incur costs that are not related to operations. Non-Operating Costs (NOC) are expenses arising from activities not associated with the rendering of air transport services. The most common reason for mergers and acquisitions between airlines is the savings in non-operating costs it creates. Usually, this category of cost is related to the financial structuring of the company. These are the strategic financial instruments used by an air carrier. Interest expense is the most common non-­ operating cost in the airline industry, and this is a result of the sizeable debt loads airlines carry. While the debt is necessary to fund the operations, interest expense is considered a non-operating cost because the cost is not directly related to an airline’s operations. Other non-operating costs for an airline include any loss on the sale of aircraft and other assets and expenses in non-aviation activities. Airlines may receive income from investments or from non-core activities, such as hotel management, car rental and other non-aviation operations. Some examples of the NOC are as follows. • • • •

Net loss or gain on asset disposal Interest expenses Foreign exchanges charges Administrative costs

Assessing the amount of NOC that incur due to a given aircraft is very challenging. Since these costs are often associated with the financial structure of the company, we could assess the NOC as a percentage of total operating costs (that is, the total of DOC and IOC).





TCitNOC  ˆ t TCitDOC  TCitIOC

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Where for aircraft i in time period t TCitNOC : Total non-operating costs TCitDOC : Total direct operating costs TCitIOC : Total indirect operating costs ωˆ t : The estimated ratio of the NOC to the total operating costs Example 5.4  Following our previous example, in 2018, the total non-operating expenses of Delta Airlines was $113 million. In the same year, the total operating expenses (summation of direct and indirect operating expenses) was $39,174 million. Therefore, we could estimate the ratio of NOC to total operating costs as follows.

ˆ t 

113  .28% 39,174

Multiplying ωˆ t by the total operating cost that is estimated for the subject aircraft provides the estimate for total non-operating cost for the subject aircraft. In summary, the total cost could be expressed as the summation of its component: DOC, IOC and NOC as follows.

TCit  TCitDOC  TCitIOC  TCitNOC

Example 5.5  We can conclude our cost example by calculating the total cost for our subject Airbus 320-200 with estimated 3500 annual block hours. We have already calculated the total direct operating costs at $14,992,985. On average, the number of seats per aircraft for A320-200 and its speed in 2018 was 158.9 seats and 378  miles per block hour, respectively. Thus, ρ is 6006. Consequently, 3500 block hours roughly translate to 210  million ASM.  We estimated that the indirect operating expenses is about 8.69 cents per ASM.  So the estimated total indirect cost for the subject aircraft is about $18,249,000. We have estimated ωˆ as .28%. Thus, the total non-operating expenses will be $95,737. Overall, we could calculate the estimated total cost for the subject aircraft as follows.

5.6

TC  14, 992, 985  18, 249, 000  95, 737  33, 338, 000

 Model of Aircraft Valuation Decisions Based on Net A Present Value Calculations

In this section, we develop our theoretical aircraft valuation model. To stay in business, every big or small airline needs to earn a profit. Financial theory indicates that the value of an investment is estimated from the future cash flow that such an

5.6  A Model of Aircraft Valuation Decisions Based on Net Present Value Calculations

219

investment is expected to generate, and a commonly used approach is the discounted cash flow (DCF) model. The generic model requires a present value calculation of projected future cash flows (e.g., operating as well as non-operating incomes and expenditures). In order to apply the DCF model, future cash flows have to be projected first. Both revenue and costs of an aircraft are influenced by various factors that change over time. Table 5.6 presents a list of some of these factors. The following main factors were defined: passenger and cargo revenues, direct expenses (e.g., personnel, fuel), maintenance, depreciation and amortization, general administrative costs and other transport-related expenses. Some of the figures had to be calculated as they were either not directly available (total gallons consumed), not segregated by aircraft type (e.g., servicing, sales and general expenses) or were dependent on other figures (e.g., total block hours). Passenger and cargo demand, or fuel and crew costs, for example, all fluctuated over the past decade, impacting the net income of airlines. The influential factors are often affected by different forces and may change independently of each other. Accordingly, it is more appropriate to forecast them separately and then assess the future revenue and cost based on the predicted values of the factors. Therefore, in our aircraft valuation model, we develop cost and revenue as a function of influential factors so as to be able to predict future value more accurately. Discounted cash flow analysis (DCF) is widely used by management professionals in investment finance, real estate development and corporate financial management. The DCF model is based on the theory that the current price of a physical or financial asset represents all the information about the future income generated by the asset discounted at a proper rate. In this section, we apply the discounted cash flow model to estimate the value of aircraft under different physical and market conditions. The following can be used to discount future cash flows in order to compute the present value of an investment. The sum of all the future cash inflows and outflows is the Net Present Value (NPV). These computations can assist in the valuation of the aircraft according to the perceived future cash inflows and outflows. n

NPVi   t 0



TRit  TCit

1  k 

t



RVn

1  k 

n



Table 5.6  Model factors and their respective calculations Factor Gallons consumed Fuel cost Passenger revenue Cargo revenue Servicing, sales, and general expense

Calculation Gallons per block Hour multiplied by total block hours Gallons consumed multiplied by fuel cost ($/gallon) RPM multiplied by overall passenger yield RTM multiplied by overall cargo yield Allocated based on ASM

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Where for aircraft i NPVi: Net present value TRit: Total revenue at time period t TCit: Total cost at time period t RVn: Residual value at the end of the time horizon n: Number of time periods k: Discount rate, or the required rate of return on the investment Example 5.6  Let us consider the valuation of an Airbus 320-200. We are interested in the full-life valuation18 of a typical aircraft with an average level of operation and cost comparing to the rest of the fleet in the US. Following the procedures discussed in this chapter and using the data presented in Tables 5.3 and 5.4, we could calculate the total revenue and cost for each year. We assume the economic useful life of the plane is 30  years with no residual value. Useful economic life and residual values of present aircraft fleets are increasingly being impacted by new aircraft technologies. Advances such as the introduction of new materials that increase fuel efficiency make it difficult to predict the future useful life of the aircraft. Accordingly, we could calculate the net present value for IRR of 9% as follows. NPVi 

34.39  26.26

1  .09 

1



34.82  26.99

1  .09 

2

 

49.31  39.65

1  .09 

30



The NPV is calculated as $88.97 million for a full-life new Airbus 320-200 in 2018 currency. To put this into perspective, the appraisal estimates for the subject aircraft, as provided by Airline Monitor, provide the value range of $85.46–89.0 million. Interestingly, the list price for the subject aircraft is reported as $101 million. The difference between the list price and the appraisal price is not surprising and is expected in practice. We discuss this difference in the next section.

5.6.1 Theoretical Aircraft Value vs. List Price Aircraft prices occupy a wide scale based on various configurations and available options, including performance capability, interiors, avionics and fuel capacity. Airbus and Boeing often sell planes at a discount to list price, and the final aircraft purchase price often is the result of negotiations, which are highly weighted on global economics, the buyer’s position and other environmental and financial factors. In 2005, Ryanair enjoyed a huge discount from Boeing for its big order for  Often appraisals are presented for half-life which means all the parts and components are in mid-­ life condition or better.

18

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221

737-800s. Each aircraft was alleged to be priced at $29m, with a retroactive pricing benefit to its previous order.19 American Airlines signed letters of intent to purchase a total of 260 A320neo with 365 options and purchase rights for additional aircraft between 2013 and 2022. Airbus had never won a narrow-body order from American Airlines, just a small order for the A300 wide-body.20 In 2017, Airbus received its gargantuan $49.5  billion order to supply 430 aircraft to U.S. private equity fund Indigo Partners, to deliver 274 A320neos and 156 A321neos.21 Table 5.7 present a comparison between the list price and aircraft value calculated based on the methodology discussed in this chapter. We also provided an independent appraisal estimate on the aircraft values provided by the Airline Monitor. As discussed earlier, the ideal benchmark for obtaining the value of an aircraft is its transactional prices, as the closest estimator of the fair market value. In the aviation industry, however, transactional prices are proprietary and highly confidential. As can be observed in Table 5.7, all the aircraft types have lower calculated values than the published list prices. The Airbus 320-200ceo’s calculated value is 13% lower than the list price of $101 million. The Airbus 330-200 and Boeing 737-700 show about 37% and 18% difference, respectively, while Boeing 777-200 displays the lowest difference between list price and calculated value. These differences can be explained by the fact that manufacturers generally price their products higher than the actual value of the aircraft to realize profits. Indeed, every deal between a manufacturer and a carrier depends on several factors, such as the number of aircraft ordered, the existing seller-buyer relationship, and market conditions, among others. A common understanding is that in practice, the actual purchase price after a negotiation is (much) lower than the list price. On the other hand, comparing the calculated value with independent appraisals from Airlie Monitor reveal a relative agreement. Our calculated values seem to have a much lower gap with these estimates, comparing to the list prices. Moreover, we observe that in contrast to list Table 5.7  Aircraft value and price list comparison Aircraft type Calculated value ($ million) Published list price ($ million) % Difference between Calculated and list price Appraisal value ($ million) % Difference between Calculated and appraisal value

A320-200 88.97 101 12.67

B737-700 71.51 85.8 18.17

A330-200 164.62 240.1 37.3

B777-200 283.52 314.6 10.39

86.7 2.58

71.6 0.13

164.2 0.26

284 0.17

Note: The list prices are presented based on the 2019 currency (Source: Airline Monitor). The Calculated Value is based on the valuation obtained, applying the methodology discussed in this chapter by the authors.  Commercial Aviation Report, February 15, 2006.  National Public Radio (NPR), National News, July 20, 2011. 21  CNBC.  Airbus confirms $50  billion jet order, one of the biggest aviation deals in history, December 29, 2017. 19 20

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prices, when we use appraisal values as the benchmark, our calculated value overestimates the aircraft value slightly. From Table 5.7, it can be seen that the wide-body A330’s value is approximately twice the narrow-body A320’s value. Tables 5.1 and 5.2 show the technical characteristics of these aircraft and illustrate the A330’s capability of carrying 120 more passengers in a standard configuration, roughly twice as much as the A320. As a narrow-body aircraft, of course, the A320 is a more popular aircraft with carriers worldwide with over 2900 aircraft in service or inactive (more than seven times the number of A330s that are in service worldwide).

5.6.2 The Trend of Aircraft Values The method outlined above is essentially a benchmarking procedure that provides an estimated value (under the assumptions of the model) for the aircraft. This valuation is based on the assumed future revenues and costs characteristics. That is, if the assumptions are reasonably accurate, the discussed valuation approach provides a base value for the aircraft for sale or a theoretical economic value of the asset for business decision-making. Having such a value can materially aid in managerial, financial decisions that involve the sale or purchase of capital assets in a timely manner. Moreover, this valuation is determined based on the revenue and cost factors. Thus, it can also aid in managerial, financial decisions by identifying those inputs that have the largest impact on the value of the asset. That is, we can determine the impact that various factors have on aircraft value. For example, an increase in fuel cost or gallons of fuel consumed leads to an increase in the total costs and a subsequent decrease in aircraft value. This effect partially explains the shift that airline manufacturers have undertaken to produce more fuel-efficient aircraft in order to increase the value of the aircraft and its attractiveness to operators. Similar trends in aircraft design can also be explained by this approach. The minimization of the cockpit crew through technological advances increases the value of the aircraft. Early entrants in the commercial aircraft world required as many as four crew members just to fly the aircraft. Currently, the standard has become two-person cockpit crews, even for the largest aircraft on the market. We can see that any decrease in in-flight crew costs decreases the total cost sector of the equation, thus increasing the value of a particular aircraft. Commercial aircraft have a useful economic life, as discussed in the previous chapter (often about 30 years). The value of an aircraft gradually decreases during its lifespan. The rate of decrease depends on many factors, including external factors such as transportation demand and fuel cost (i.e., economic or functional obsolescence). For a given aircraft, the level of operation and the maintenance status impact the value trend. The value fluctuates around major maintenance events as maintenance by nature cure depreciation of value and restores it to some extent. Indeed, in valuation, the cost of those maintenance events needs to be considered. Consequently, the actual value trend of a given aircraft is a fluctuating trend that is predominantly decreasing and may at times observe significant drops (i.e., functional obsolescence) or small raise (i.e., post major maintenance events). Figure 5.2

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223

Figure 5.2  A typical value trend and the corresponding theoretical value trend

illustrates a comparison between a typical actual value of a given aircraft and its corresponding theoretical value over the age of the aircraft. As discussed in the previous chapter, determining the actual level of depreciation demand a careful examination of the aircraft operation and maintenance status and may require physical inspection. For the sake of simplicity, we focus on a theoretical trend that represents the main characteristics of the value critical to the discussion in this chapter while recognizing that the actual value of a given aircraft may deviate from the theoretical value. The discounted cash flow model discussed in this chapter assists us in establishing the value trend through the life of an aircraft. Consider that we want to find the value of an aircraft at time period τ, where τ is a time period within the lifespan of the aircraft (i.e., 0  ≤  τ  ≤  n). The NPV of the aircraft at time τ is calculated as follows. n

NPVi     Where for aircraft i

t 

TRit  TCit

1  k 

t



RVn

1  k 

n



NPVi(τ): Net present value at time τ; 0 ≤ τ ≤ n TRit: Total revenue at time period t TCit: Total cost at time period t RVn: Residual value at the end of the time horizon n: Number of time periods k: Discount rate, or the required rate of return on the investment Example 5.7  Consider an Airbus 320-200 that we used in the previous example for valuation. Let say we are interested not only in calculating the current value of the

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subject aircraft but its value after 5, 10, 15 and 20 years. We have already calculated the full value of the new aircraft at $88.97 million. To calculate the subject aircraft’s value after 5 years, we could follow the above-mentioned formula. NPV  5  

36.14  27.75

1  .09 

5



36.14  27.75

1  .09  NPV  5   62.32 6

 

36.14  27.75

1  .09 

30



Similarly, we could calculate the NPV(10), NPV(15),and NPV(20). Figure 5.3 presents the calculated values. In this figure, we also presented the corresponding appraisal estimates from independent third-party sources (Airline Monitor). As can be observed from the figure, the values obtained from the model are comparable with industry appraisals, although the gap is expanding as the time horizon expand. We could utilize the approach illustrated in the previous example to calculate the value for the subject aircraft of our case study in this chapter. Figure 5.4 presents the integrated value trend of our subject aircraft. The value trends presented in Figure 5.4 demonstrate the decreasing characteristic that was expected. These trends are calculated based on the assumptions for revenue and cost factors, as presented in Tables 5.3 and 5.4. In the next section, we examine the impact of some of these assumptions on the value of aircraft.

Figure 5.3  Comparison between aircraft value estimation at time intervals from model and independent appraisers

5.7  Aircraft Value Volatilities

225

Figure 5.4  Aircraft value trend based on aircraft age in 2021 currency

5.7

Aircraft Value Volatilities

The discounted cash flow formula that we presented combines various revenue and cost factors to determine the estimated value of an aircraft. Consequently, another way we could view the model is to calculate the sensitivity of the value of the aircraft to changes in inputs. As mentioned earlier, this model provides financial justification for the aircraft price changes due to variation in costs or revenues. In this section, we explore the capabilities of the methodology and how sensitive an aircraft’s theoretical value is to changes in these volatile factors. The factors analyzed include fuel price, passenger yield, block hours, maintenance expense and cost of capital. Indeed, the model can be easily applied to changes in other factors. Example 5.8  For an Airbus 320-200, we could calculate the changes in value based on 1% change in passenger revenue, fuel price, engine maintenance cost per block hour, performed block hour, and the applied discount rate. The original estimated value is $88.97 million. Table 5.8 presents the result of this sensitivity analysis. In this table, all aircraft values are presented in a million dollars. The changes applied to the year-to-year growth rate of the factors; except for the discount rate. The original discount rate was 9%. The aircraft values in the table are based on applying a discount rate of 8 (i.e., −1%) and 10 (i.e., +1%) percent. As evident from the table, changes in the passenger yield have the largest impact on the present value of the aircraft. This is clearly a result of the compounding value of increased revenue over the relatively long lifespan of an aircraft as a capital asset. On the other hand, a 1% increase in fuel cost has a bigger impact than the same 1% increase in maintenance costs and so forth.

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Table 5.8  Aircraft value under 1% increase or decrease of the selected factors Factor Discount rate Fuel cost per gallon Engine maintenance per BH Pax yield (cents/ RPM) Block hour

Aircraft value with –1% change in the factor growth $97.82 $101.45

Original factor value 9% $2.22

Aircraft value with +1% change in the factor growth $81.37 $74.55

$90.78

$234.37

$86.87

$60.65

13.91

$121.72

$81.49

3373

$97.61

Note: The aircraft value are presented as million-dollar

Figure 5.5  Sensitivity analysis of Airbus 320-200 value based on the different year-to-year growth rate of factors

Figure 5.5 illustrates the sensitivity analysis for the value of Airbus 320-200 over an extended range of variation for influential factors.

5.7.1 Fuel Price Sensitivity A good understanding of cruise flight can not only help crews operate efficiently and save their companies money, but can also help them deal with low fuel situations. As an additional benefit, the less fuel consumed, the more environmentally friendly the flight Boeing.com/commercial/aeromagazine, 2019

Fuel is the number one expense for the majority of airlines and can account for up to 50% of an airline’s operating costs, and often the most considerable expense

5.7  Aircraft Value Volatilities

227

after salaries. The airline industry is working hard on fuel conservation measures as a critical way to reduce fuel costs. Aircraft and engine manufacturers are also working on the development of new engines and lighter weight jetliners that will help to conserve fuel consumption. The factors that affect fuel consumption are speed selection, altitude selection, and center of gravity. As a result of higher fuel prices, airlines have incorporated a number of practices to reduce fuel burn during ground operations. Such strategies include: • Minimizing the use of the auxiliary power unit while planes are parked at airport gates, • Controlling speed on the taxiway system, • Reducing surface congestion and delays by holding aircraft at the gate, • Reducing the weight of their aircraft,22 • The use of winglets: installations on the Boeing 737 and 757, • Delta Airlines replaced its 50-seat regional jets with larger, 100-passenger versions because the larger jets get better fuel cost per passenger. • Allegiant Air has replaced its entire legacy fleet of MD-80s with an all-Airbus fleet of more fuel-efficient A320s and A319s in 2019. Rising fuel prices force airlines to reduce the number of flights to conserve fuel. Hence, higher fuel prices trigger airlines to reduce frequency and up-gauging to larger, or more fuel-efficient aircraft (Ferguson et al., 2009). The volatility of fuel prices threatens airline profitability and their aircraft ownership demand. Airlines stored 1167 aircraft in 2008. The total number of aircraft grounded is about 2300, or 11% of the global air transport fleet of 20,293.23 Many airlines such as U.S. Airways, Delta, and American were forced to lay off employees and come up with a new source of revenue as the price of fuel skyrocketed. Operating expenses will also increase when market fuel prices increase.24 In addition, if the aircraft is operated for longer hours per day, fuel consumption will increase, resulting in higher total fuel costs (but not per block hour). The changes in fuel cost are also dependent on the fuel efficiency of the aircraft. A continuous improvement in fuel efficiency reduces the gallons consumed per block hour. Rising fuel costs has forced airlines to reduce aircraft fuel burn by coming up with innovative ideas to reduce fuel consumption. For example, many airlines now have single-engine taxi procedures to minimize fuel burn. From the A320-200 theoretical value changes, we could see the significant impact that fuel prices have on an aircraft’s value. That is why airlines switching to more technologically advanced aircraft with higher fuel efficiencies has become a trend in the commercial aviation industry. A 2% increase in fuel price from $2.22  In 2011, United Airlines purchased 11,000 iPads to replace pilots’ bulky paper manuals in the hopes of saving 326,000 gallons of fuel annually. 23  Air Transport World, February 25, 2009. 24  July 11, 2008, the price of crude oil reached $147.27 per barrel on the New York Mercantile Exchange, setting another record. 22

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results in over a $30  million drop in the theoretical aircraft value of the Airbus A320-200. Figure 5.5 shows how highly dependent the A320-200’s value is to the rise and fall of fuel prices, which remain one of the most volatile factors impacting commercial aircraft values. The sensitivity to fuel prices is part of the reason for the re-engineering efforts of several Airbus products, including the A320. The A320neo is expected to increase fuel efficiency and help reduce the impact that changing fuel prices have on the way airline operators perceive an aircraft’s value; increasing the aircraft’s value to its operators effectively increases the price that future and current buyers and investors are willing to pay for the aircraft.

5.7.2 Passenger Yield Sensitivity As expected, passenger yield has the opposite effect on the theoretical value of aircraft than exhibited by fuel prices and maintenance costs. The passenger yield is the average fare paid per mile, per passenger.25 More ticket sales (thus increasing the load factor), or higher ticket prices, increase revenues. Non-ticket revenues from such activities such as baggage fees, reservation change fees, frequent flyer award program mileage sales and other ancillary and transportation fees have improved in the past few years as well. Airlines enjoy revenue and incur costs over the lifespan of the aircraft. The corresponding increases in the aircraft’s price and value associated with changes in the passenger yield makes it the most influential factor on the value of an aircraft.

5.7.3 Other Factors Sensitivity JetBlue founder David Needleman commented on the value difference after the company’s decision to place 80 orders for the Airbus A320 instead of the Boeing 737. According to JetBlue, the A320 had better fuel consumption, superior cabin technology and wider cabins. Also, it is less narrow at the end of the aircraft. These02 non-financial characteristics can convert into higher passenger satisfaction levels and a preference over the Boeing 737. Furthermore, highly computerized A320 operations save administrative time and labor costs.

5.7.4 Elasticity In economics, elasticity is the measurement of the percentage change of one variable in response to a change in another factor.

  Yield or average fare is calculated by dividing passenger revenue by revenue passenger miles (RPMs).

25

5.8 Summary

229

Table 5.9  Aircraft value arc elasticity for +/–1% changes in input factors Discount rate Pax yield Fuel cost per gallon Block hours Engine maintenance

A320-200 –0.83 0.40 –0.09 0.00 –0.03

B737-700 –0.80 0.35 –0.06 0.04 –0.12

A330-200 –0.81 0.49 –0.13 0.00 –0.06

B777-200 –0.85 0.39 –0.10 0.05 –0.03

Another way of looking at these changes is to use the well-known concept of elasticity. Elasticity measures the percent change in one factor relative to the percent change in another; consequently, it is a measure that is free of units. Point elasticity measures a relative change at a particular point, whereas arc elasticity measures the change over some larger amounts and is calculated as the average relative change. A cross elasticity of demand measures the change in demand for one product when the price of another one changes. With a positive cross-price elasticity, any price change by Boeing prompts a reaction by Airbus. Specifically, Boeing can expect its rival to follow suit with a price increase but not to raise prices by the same percentage. In other words, Boeing should expect to lose some market share to Airbus. The corresponding theoretical aircraft values at each level are computed for a +/− 1% increase/decrease in the input factor, and the arc elasticity of each factor for every aircraft model is calculated. The results are presented in Table 5.9. From this result, we see that the discount rate has the highest impact on the present value of subject planes, although the impact is relatively similar across the different models. Next, the growth rate of passenger yield has the most impact and the impact, as expected, is more significant for the wide-body aircraft as they have more seats. The change in block hours has a relatively small elasticity. Interestingly, the elasticity of Boeing 737-700 to change in the growth rate of engine maintenance cost is larger than other models. As we see, all of the elasticities have the correct signs. Generally speaking, the price of commercial aircraft will decrease when the discount rate, fuel cost or maintenance expense increases, and the value of the aircraft will increase when the price of the above factors decreases. On the other hand, a positive relationship between passenger yield and aircraft value, which is reflected in positive elasticities for all four different aircraft types. A 10% increase in the discount rate will cause a decrease of 8.3% in the price of the Airbus A320. If the yield increases by 10%, the price of 737-700 will increase by 3.50%. A 10% increase in the block hour will cause a slight increase of 0.50% in the value of B-777-200.

5.8

Summary

In finance, asset valuation is the process of determining the intrinsic value of a given asset, such as aircraft, aircraft engines, buildings, airport slots, equipment, brands, and goodwill. Monitoring how the aircraft value changes with technology, the

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business cycle can indicate if the investment required to maintain the proper fleet is being provided. In addition to aircraft specific performance attributes, the outside influence of macroeconomic forces, such as the business cycle, and the industry profitability, must be considered. Their direct and indirect operating costs are affected by sector length; utilization of aircraft, fleet size and labor costs. In this dynamic air transportation market, it is difficult to put a number on the value of special aircraft. All different exogenous, as well as indigenous factors, should be examined to obtain an accurate value for a given type of aircraft. Value is almost derived from the market forces; supply and demand. This chapter has utilized a modified DCF model to forecast the net cash flows generated by an aircraft over time and takes into consideration factors such as revenue per passenger mile, revenue per ton-mile of cargo, available seat miles, block hours, fuel consumed, flight personnel labor rate, maintenance and material costs, expected economic life, indirect costs, and capital cost per aircraft day in order to accurately forecast net cash flows. These net cash flows are then discounted at an appropriate cost of capital to estimate the theoretical value of an aircraft. This value provided a benchmarking procedure that was an acceptable first approximation to the value of the aircraft. The model provides a comprehensive review of aircraft valuation. It presents a methodology that will more accurately measure return on investment, improve the efficiency of managing operating costs, and more effectively determine yield analysis. Since the air transport industry is in a dynamic environment, it is quite likely that one or more of the base assumptions may change, and this in turn, will change the theoretical value of an aircraft. The impact of the COVID-19 pandemic is a sobering reminder of the vulnerability of the aviation industry to global economic turbulences.

Bibliography Ackert, S. (2011, April 15). The relationship between an aircraft’s value and its maintenance status. Aircraft Monitor. http://www.aircraftmonitor.com/ Ackert, S. (2012, March 2012). Basics of aircraft market analysis. Aircraft Monitor. http://www. aircraftmonitor.com/ Bancel, F., & Mittoo, U. R. (2014). The gap between the theory and practice of corporate valuation: Survey of European experts. Journal of Applied Corporate Finance, 26(4), 106–117. Bruno, G., Esposito, E., & Genovese, A. (2015). A model for aircraft evaluation to support strategic decisions. Expert Systems with Applications, 42(13), 5580–5590. Chen, C. (2020). Commercial aircraft value evaluation and sensitivity analysis from the perspective of Chinese airlines. In AIAA Scitech 2020 Forum (p. 0750). Ferguson, J., et al. (2009). Effects of fuel prices and slot controls on air transportation performance at New  York Airport. Eighth USA and Europe air traffic management research and development seminar. Gibson, W., & Morrell, P. (2005). Airline finance and aircraft financial evaluation: evidence from the field. In Conference conducted at the 2005 ATRS World Conference, 2005. Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2–3), 187–243.

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Hu, Q., & Zhang, A. (2015). Real option analysis of aircraft acquisition: A case study. Journal of Air Transport Management, 46, 19–29. Hu, Q., Zhang, A., & Zhang, Y. (2019). Why are regional jets less used in emerging economies? A real options valuation approach and policy implications. Transport Policy, 79, 125–136. Pinto, J. E., Robinson, T. R., & Stowe, J. D. (2019). Equity valuation: A survey of professional practice. Review of Financial Economics, 37(2), 219–233. Sala, A. S., Espuny, J. T. & Costa, C. M. (2008). A real option- based model to properly value aircraft purchase rights: impact of the coming EU legislation on Aircraft CO2 emission levels. In II International Conference on Industrial Engineering and Industrial Management, September 5, 2008, pp. 575–584. Stonier, J. (2001). Airline fleet planning, financing, and hedging decisions under conditions of uncertainty. In G. F. Butler & M. R. Keller (Eds.), Handbook of airline strategy (pp. 419–434). McGraw-Hill. Vasigh, B., & Erfani, G.  R. (2004). Aircraft value, global economy and volatility. Airlines Magazine, 28. Vasigh, B., Azadian, F., & Moghaddam, K. (2021). Methodologies and techniques for determining the value of an aircraft. Transportation Research Record, 2675(1), 332–341.

6

The Principles of Long Term Financing and Effective Cost Management

Aircraft and jet engine manufacturing are incredibly capital intensive and technologically driven industries; consequently, effective cost management is the key to profitability and growth. Effective capital budgeting and proper cost restructuring have become more and more important for airlines. In our current market environment, airline costs and revenues are dramatically impacted by the consequences of Coronavirus. In response to the collapse in air traveling caused by COVID-19, easyJet Airlines is cogitating to cancel an order for 107 Airbus aircraft, worth an estimated €5 billion.1 Hence, airlines should be able to manage costs, keep expenses low to increase profits. In earlier days, larger aircraft were designed and built with Captain, the First officer and Flight engineer’s position. In the early 60s, there was a rule requiring more than two crew on any aircraft grossing over 80,000 lb. In fact, the first A300 had a 3-person crew. Many four-engine airplanes such as DC-6, DC-7,

1  Forbes. As EasyJet Grounds Fleet, Founder Threatens Board to Cancel Airbus Order. Mar 30, 2020. The airline later reached an agreement to defer aircraft deliveries.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 B. Vasigh, F. Azadian, Aircraft Valuation in Volatile Market Conditions, Management for Professionals, https://doi.org/10.1007/978-3-030-82450-1_6

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6  The Principles of Long Term Financing and Effective Cost Management

Constellation, Boeing 307, Boeing 377 and early three- and four-engine jets, Boeing 707, 727, early B747, DC-8, DC-10, L-1011, required flight engineers. The introduction of a two-person cockpit eliminated the need for an on-board flight engineer, and it also pioneered fly-by-wire control, improving handling and safety. Airlines can acquire aircraft through traditional equity or debt financing in the form of capital leases, sales and leaseback or operating leases. This chapter first describes what is usually meant by the various methods of financing fixed assets and then will explore core elements of airline capital structure and finance before assessing the main aspects of an aircraft’s crew costs as they relate to an airline’s operation. Financing Capital Spending • Equity Financing –– Common Equity –– Preferred Stock –– Dividends –– Retained Earnings • Debt Financing –– Bonds Bankruptcy and Financial Distress Strategic Labor Cost Management • Financial Crew Cost Analysis –– Ratios • Operational Crew Cost Analysis –– Pay –– Productivity –– Benefits and Fringe Costs –– Total Aircraft Crew Cost Per Block Hour Rules of Thumb At the end of the chapter is a summary review and a selected bibliography for further study.

6.1

Financing Capital Spending and Sources of Capital

The aircraft manufacturing industry needs massive capital investments in factories for research and development and retooling. As an example, Airbus Supervisory Board approved a $13 billion investment to develop the A380, the biggest super jumbo jet that would seat from 550–1000 passengers. Airbus received some $3.2 billion in repayable government loans to build the A380. That support was authorized by the 1992 trade agreement between the European Union and the United States. The agreement allows companies to receive government subsidies to finance up to one-third of a new plane’s developmental costs.2 In 2019, the efforts of the  Site Selection Magazine. August 2, 2004.

2

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Airbus Division of research and development (R&D) reached over €2.4 billion. During the same time, Boeing studied various replacement options for the 737 NG, including a clean-sheet design but finally invested in 737Max. This aircraft has promised to cut fuel and maintenance bills.3 The new model is based on earlier 737 designs, re-engined with more efficient CFM International LEAP-1B engines. Boeing and Airbus are exposed to massive financial and operational risks; hence, Airbus and Boeing receive indirect subsidies from their respective governments (Table 6.1). Other problems that aircraft manufacturers may face with are the glitches during the manufacturing process. The manufacturers may have difficulty keeping up with the deadlines and thus this may lead to penalty fees for late deliveries of aircrafts. Assessing an aircraft’s value for an operator requires determining the potential cash flows the aircraft may generate over the life of the asset (including the residual value), as well as the impact of financing decisions on the company’s financial statements. An accurate estimation of the potential cash flows is essential for an airline to operate and grow from a sound investment. Hence, it is necessary to understand each element of the cash costs. An aircraft is expected to remain in service for as much as 30 years or longer. By understanding the costs of different resources (both physical and human capital), one can understand why airlines use different capital structures and business strategies. Determining the aircraft’s generated cash flow over a long period brings a certain amount of risk that projected targets would not be met. Breaking down the cost into different components allows the analyst to assess the risks of changes to each component and how sensitive overall cash costs and the cash flows would be to those changes. This chapter focuses on practical tools for the financial manager in determining an aircraft’s proper cost breakdown. It includes the definitions of the different types of costs, a review of capital structure alternatives, the concepts of labor costs, financial leverage and productivity. The air transport industry is an extremely capital and talent intensive business. External sources of capital are a vital determinant of an airline’s ability to acquire new aircraft, establish or expand a network and remain profitable. Automobile manufacturers, the housing industry and heavy equipment companies, in addition to the aircraft industry, are sensitive to the business cycles of related companies. Airlines, much like other transportation industries, repeatedly suffer when the economy is in a recession and benefit when the economy moves to recovery. In order to introduce a new commercial airliner, the aircraft manufacturers require billions of dollars of capital in order to develop and manufacture the aircraft. This capital comes from a

3  The aftermath of 737Max accidents, Lion Air Flight 610 on October 29, 2018 and Ethiopian Airlines Flight 302 on March 10, 2019, demonstrate the risk an aircraft manufacturer is exposed to.

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Table 6.1  Airline and airport development costs Project Aircraft manufacturers:  Boeing 737 MAX  Boeing 787  Airbus A220-300 (previously CS300)  Airbus A320neo Airport industry:  ORD 2nd Phase NE Cargo Development Project  JFK New Terminal Connected to Terminal 5  JFK Terminal 1,2, & 3 Replacement  Istanbul New Airport  New Beijing Daxing International Airport Jet engine:  The GE9X jet engine

Year

Costs (billions)

2017 2007 2016 2010

3 32 5.4a 1.5

2017

0.22

2020 2020 2015 2015

3 7 12 11.3

2017

4.3

Sources: CAPA Center for Aviation, Boeing, & Airbus a Total C-Series program costs by end of 2015 under Bombardier was $5.4 billion including a $3.2 billion write-off (Reuters, February 12, 2015)

variety of sources, potentially including subsidies and launch aid. These capital resources have been argued as unfairly advantageous to respective manufacturers. Boeing asserts that European governments provide billions of dollars to Airbus each time it develops a new airplane.4 Airbus argues that Boeing receives government assistance through military contracts, which Boeing then used for commercial aircraft.5 Airbus and Boeing have both sued each other through the World Trade Organization over subsidies to Boeing and launch aid to Airbus from their respective governments. The aircraft industry requires massive capital investment. Boeing invested over $5 billion to develop the 777X in order to compete with the A350–900. Beijing Daxing International Airport (PKK) opened its new international airport in September 2019. PKK is the largest single-terminal airport in the world, with a cost of $ 63 billion, and it took Chines 4  years to build it. Similarly, Delta Air Lines invested $1.2 billion on expanding a 1.5-million-square-foot Terminal 4 at John F. Kennedy International, which replaced the more than 50-year-old Terminal 3 for international passengers.6 Terminal 4 opened in May 2013 and a $175 million second-­phase extension of 11 new gates opened in January 2015.7 The airline has also invested more than $160 million to expand and update Terminals C and D at LaGuardia.

 The Seattle Times Company, October 18, 2010.  Airport Journal, July 2005. 6  Delta Airlines Press Release, July 19, 2011. 7  Delta Airlines Press Release, Delta Air Lines, The Port Authority of New York and New Jersey, and JFK International Air Terminal unveil newest expansion at JFK Airport’s Terminal 4. 4 5

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237

6.1.1 Capital Structure Capital structure refers to the mix of sources from where the long-term funds required in a business may be raised. The capital structure of a company thereby presents how the company finances its overall long term investment through some combination of long-term debt, preferred stock, and common equity. Long-term assets should be financed with long-term sources of financing, which may be internal as well as external. In the air transport industry, some sources of capital are internal to the business itself. These funds are generated from earnings not distributed to the shareholders (i.e., retained earnings). Also, companies can raise the needed funds by issuing new equity or through the selling of corporate bonds as well as commercial loans. The three of the more common types of business investments include common equity, retained earnings, and debt financing. Commom Equity

Sources of Long Term Financing

Preferred Equity

Debt Financing

6.1.2 Common Equity In financial theory, external financing is used to describe funds that firms obtain from outside of the firm. External equity financing takes the form of common stock and preferred stock. Common stock (common equity) represents the ownership rights in a corporation, and each share provides an equal portion of ownership of a company. Common equity can be calculated by subtracting the total liabilities of a business firm from total assets. Shareholders’ Equity = Total Assets – Total Liabilities



For example, if a company has $165,000 in total assets and $120,000 in liabilities, the shareholders’ equity is $40,000, which also represents the net worth of the business. We can also measure the value of Common Equity by multiplying outstanding common stock by the face value of the stock to get the desired figure. In the case of Boeing company, having 520,500,000 shares with a stock price of $160/ per share, its common equity will be about $84 billion. Japan’s LCC, Spring Airlines Japan, has increased its capital from ¥6000 million to ¥6900 million by issuing common equity.8 Potential investors would only consider investing in a company if  CAPA - Centre for Aviation and OAG, January 28, 2015.

8

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there were a solid business plan, an extremely experienced management team, and a company serving the right market. Former United Airlines CFO, Andrew Levy, is launching a new budget airline (AVELO AIRLINES9) by raising $125 million in a private equity fund and plans to start service before the end of the year.10 Generally, aircraft leasing companies raise capital as the market improves from private equity investors. A common stock is a representation of partial ownership in a company. Common shareholders have the right to vote, share in the company’s profitability and benefit from its stock price appreciation.

6.1.3 Preferred Stock Preferred stock is usually a hybrid of a bond and a common stock. Like a bond, the preferred stock generally has a dividend paid out before dividends to common stockholders. A dividend is a part of the profits of the company that is distributed to the shareholders. Companies are not required to pay any dividends at all, but they may choose to give portions of their earnings back to shareholders as an incentive to keep investing in their companies. Similar to bonds, preferred shareholders usually do not have voting rights. Preferred stocks come with different financial characteristics, and every company may use its discretion in setting its own rules about preferred stocks. Nevertheless, they are generally characterized by fixed dividend payments; preferred stock dividends tend to be considerably higher than dividends paid on common shares. Plus, preferred stockholders have a higher claim on assets and earnings of the company. Many investors turn to preferred stocks as a tool to set regular income via a preferred dividend. However, just as in the case of common stock shares, dividends on preferred shares also could be terminated. A dividend is a part of profits of the company which is distributed to the shareholders. On March 20, 2020, Boeing Co chief executive announced that the company will forego all dividend payments until the end of 2020. Boeing’s last dividend payment date was on 2020-03-06, when Boeing shareholders received a dividend payment of $2.06 per share. Shareholder ’s equity  or total equity   Common equity  Preference shares

This financing source has no end date nor maturity date. Stockholders expect a share of the profits, either in the form of dividends or retained earnings. In addition, the stockholders have the right to vote in a company’s general meeting for a board  Simpleflying, January 6, 2021.  Flight Global, February 14, 2020.

9

10

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239

of directors as well as corporate policy. Equity in a company is a residual claim on a company’s value existing after paying its debts, so common stockholders are at the bottom of the totem pole in the event of a bankruptcy. Should a company go bankrupt, common stockholders are only paid after creditors. Frequently, preferred stockholders receive their share of any remaining assets first (Miller & Rock, 1985). From the stockholder’s point of view, purchasing common stock in a company is, therefore, riskier than debt or preferred shares but usually outperforms both in the long run. Hence, common stocks enjoy the following rights and privileges: • Dividend rights: The right to receive dividend payments from earnings • Voting rights: The right to vote to elect directors and to approve fundamental transactions such as mergers, sale of assets, amendments to articles, dissolutions • Asset rights: The right to receive a proportionate distribution of assets on corporate liquidation • Preemptive Rights: If a company plans to issue new shares, current stockholders may have the right to purchase the new stocks before they are issued to the public. When a company issues stock, it eliminates the drawbacks of the contractual claim on earnings and assets associated with debt financing. For example, on November 10, 2020, American Airlines announced a proposed underwritten public offering of 38,500,000 shares of its common stock. The Company intends to grant the underwriter of the offering a 30-day option to purchase, in whole or in part, up to 5,775,000 additional shares of Common Stock.11

6.1.4 Common Stock Valuation In February 2020, Airbus increased its shares in the A220 program and reaching a total ownership of 75% of the company, while the Canadian Government kept the 25% of the shares.12

The value of a company is measured by its stock price, and common stocks represent shares of ownership in a corporation. The real-time stock price can be accessed from numerous financial sources. Supply and demand play a significant role in the rise and fall of stock prices. Hence, stock prices can fluctuate wildly from 1 day to the next. Financiers buy stocks in anticipation the stock will appreciate and enjoy dividends. Common stockholders typically receive quarterly dividends and voting rights in major corporate decisions. A dividend is defined as a payment made by a corporation to its shareholders from the existing profit. It is typically paid in cash and given to shareholders quarterly, although some companies pay dividends 11 12

 Source: American Airlines, November 10, 2020.  Flightglobal, Airbus takes 75% of A220 program as Bombardier exits.

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irregularly. A majority of investors focus on cash dividends, and generally, when dividends go up, the stock becomes more attractive to investors. To calculate dividends per share, one should divide the total dividends by the number of shares outstanding. The dividend payout amount is shown on the balance sheet by the number of outstanding shares. The company might not have earnings with which to pay dividends. The board might not declare dividends but instead reinvest earnings in the company. Investors buy common stock for essentially two reasons: Capital gain and stock dividend.

6.1.5 Methodologies of Valuing a Company’s Stock Price The market value of an airline is the same as market capitalization and is calculated by multiplying the total shares outstanding by the current price per share. An important feature associated with common stock is par value. Par value is an arbitrary value assigned to stock before it is issued and represents a shareholder’s liability ceiling. The next indicator of the value of common stock is book value, which is the value of common shareholders’ equity divided by the number of shares outstanding. Book Value 

Common Stockholders Equity Number of Shares Outstanding

There are several methods for determining the stock price. The proper mythology depends on the type and size of a company. The dividend discount model, or DDM, is a method used to value stocks that uses the theory that a stock is worth the sum of all of its future dividends under constant dividends. This can also be estimated using the Constant Growth Dividend (GGM) model.

6.1.5.1 Dividend Discount Model to Value Stock One of the common methods for valuing a stock is the Dividend Discount Model (DDM). The DDM is a quantitative technique used for calculating the price of a ‘‘company’s stock based on the theory that its current price equates to the present value of a stock’s future dividends. Suppose an investor wishes to value the common stock of DirectJet Airlines. The airline is expected to continue paying indefinitely $1.25 dividend per share (denoted by D). We want to introduce a model to estimate the worth of this common stock. If the investor determines the required rate of return (denoted by k) on this stock to be 2.5%, its value (denoted by PDDM) is as follows.

PDDM = = PDDM

D k

$1.25 = $50 0.025

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241

6.1.5.2 The Gordon Growth Model The DDM assumes a constant dividend. An alteration to the DDM is known as the Gordon Growth Model (GGM), which assumes a stable dividend growth rate and is named after American economist Myron J. Gordon. This model assumes a stable growth in dividends year after year. If the last year’s dividend was $ 1.25 per share and dividends are expected to grow at an annual rate (denoted by g) of 2% a year, then the value of the DirectJet’ s common stock is as follows. PGGM 

PGGM 

D kg

$1.25  $250 0.025  0.02

The value of DirectJet’ s common stock increased sharply from $50 under the no-growth assumption to $250 per share with assumed growth rates of 2% per year. Hence, a stock’s value depends on its fundamentals, such as its dividend and dividend growth. The cost of preferred stock is similar to common stock with constant dividends. Preferred stockholders receive a fixed dividend from the company, with the dividend payments acting as being paid in perpetuity. To determine the cost of the preferred stock (i.e., kps), the dividend amount (i.e., Dps) is divided by the price of the preferred stock (i.e., Pps). k ps =

D ps Pps

Conversely, if we wanted to calculate the value of the preferred stock, we would merely solve the equation for the price of the preferred stock. Pps =

D ps k ps

For example, suppose that ConnectJet paid a dividend of $5.00 per share on preferred stock currently selling for $40.00. Since we know the annual preferred dividend payments and the preferred stock price, we can calculate the preferred stockholders’ required rate of return on the preferred stock as follows.



= k ps

$5 = 12.5% $40

In the event of any liquidation, the holders of the Preferred Stocks shall be entitled to receive preference to the Common Stock for the original purchase price and unpaid dividends.

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6.1.5.3 Dividends If we stop expanding for a year or two, ‘‘we’ll see a big cash build-up and that should be distributed to shareholders in the event the companycan’t get the price it wants for new aircraft. Michael O’Leary, Ryanair13

Stock dividends are income received by shareholders from the proceeds of a company. Airlines paying dividends are relatively rare in the last several years because of the cyclical nature of the industry. For the airline industry, 2020 was one of the toughest financial periods in their history, any many airlines and scrapped paying dividends. The most recent dividend was announced by Hawaiian Airlines paying 12 cents a share to the investors.14 Investors receive a return on their investment through two means; a stock’s dividend and its capital gains (increase in stock price). However, common stock dividends may not usually remain constant. Dividends paid are recorded on a ‘‘company’s cash flow statement as a financing activity. The dividend (yields) and capital gains returns are added together to determine the total return on common stock (KE). As was mentioned earlier, common stockholders are eligible to receive dividends from the ‘‘company’s net profit if the company chooses to distribute dividends. Shareholders can receive those profits as payouts (i.e., dividends or repurchases), or the profits can be reinvested into the company for the shareholders’ benefit. Management must decide if the reinvested profits can return at least the cost of capital. Assume you have purchased a stock for $100 a share and received a $2.50 dividend at the end of the year. Hence, the dividend yield is as follows. K= E

D1 $2.50 = = 2.5% P0 $100

Now suppose, at the end of the first year, the stock is trading at $125 per share. When one sells, they realize $25 of capital appreciation or a capital gain. Hence, the total return is as follows. KE 

D1 P1  P0 $2.50 $125  $100     27.5% P0 P0 $100 $100

The investor receives a 2.5% dividend yield and a 25% capital gains yield, which add together to give the investor a return of 27.5%. Appealing return is required to gain investors because investors require compensation for the fact that they are foregoing consumption (time value of money) and for the risk involved in investing in the company. Companies must achieve enough profit (return on equity) to pay dividends and/or increase the value of the company. If not, investors will not invest in the company. On November 20, 2019, the Boeing Company had a dividend yield of 4.83% compared to the Aerospace Defense industry’s yield of 1.47%. In 2019, Delta Air Lines had one of the highest dividend yields at 2.5%. American Airlines, 13 14

 Independent, October 03 2009.  FlightGlobal, Oct 2017.

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243

Southwest Airlines, and Alaska Air Group had dividend yields of 1.1%, 1.2%, and 1.9%, respectively. The company’s dividend payout ratio of 24.4% is the second-­ highest among its peers. A dividend is a distribution of a portion of profit by a corporation to its shareholders. The dividend per share divided by the share price is called the dividend yield. A company can share a portion of its profits with two different types of dividends: cash dividends or stock dividends

6.1.5.4 Cost of Equity

Due to a high proportion of fixed-cost driven infrastructure, the cost of capital of an airport or an air navigation services provider can significantly impact the level of charges. It must be agreed with the airlines and set using fair judgment and transparency. Fair judgment, transparency, consideration of the specific market situation and recent relevant precedent in other regulated industries with independent oversight are key in overcoming the inherent challenges involved in airports and airlines agreeing to the amount for cost of capital. The International Air Transport Association (IATA), Cost of Capital, July 2019

Investors are not going to invest in an airline, or any other company, without expecting a minimum return on their investment. The return on investment that shareholders require from a company represents a company’s cost of common stock. The cost of common stock (KE) varies for each company. Investors will require different rates of return for each company they invest in, depending on the associated risks. Because the airline industry is considered a risky investment due to volatility and cyclicality, investors will likely require a greater rate of return on capital paid into Continental Airlines as compared to a company in a less risky industry such as United Health Care.

6.1.5.5 Retained Earnings There are two ways in which equity capital can be invested into a business, through the sale of stocks (common or preferred) or through the company’s retained earnings. A company can distribute net income to its shareholders through the payment of dividends, or they can keep part or all of their net income and invest back into the company as retained earnings. Hence, the retained earnings (RE) is the amount of net income left over for the company after it has paid out dividends to its shareholders. If a company decides to reinvest net income within the company, as has been the case with many airlines such as JetBlue, which have historically paid no dividends, the investors must still be compensated for the opportunity cost of foregoing a dividend. Remember that the rate of return for the investor is equal to the dividend yield plus the capital gains yield. If a company is not paying dividends, the capital gains yield must equal the investors’ required rate of return. Therefore, the cost of retained earnings is equal to the required rate of return. Airbus’s quarterly retained earnings declined from $3593 Million (Sep. 2019) to $2490 Million (Dec. 2019).

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K RE = K



The formula for cost of retained earnings is based on the value for the cost of equity found using the dividend discount model we discussed earlier. k

D1 g P0

For example, assume that a fictitious airline, DirectJet, decides that growth opportunities in the industry exist due to the capacity reductions by other U.S. airlines. As a result, the airline wants to hold most of its profits as retained earnings. The Board of Directors at the airline decides that next year’s dividend (next dividend paid) will be only $0.10 per share. DirectJet expects to grow at a rate of 6%, and its stock was trading at $14.77. kRE 



$.10  .06  6.68% $14.77

The cost to DirectJet for using retained earnings to finance expansion is 6.68%. A company can either distribute net income to its shareholders through the payment of dividends or they can keep part or all of their net income and invest back into the company as retained earnings. Hence, the retained earnings (RE) is the amount of net income left over for the company after it has paid out dividends to its shareholders.

Net Profit

-Dividend Paid

Retained Earnings

6.1.6 Debt Financing In addition to equity financing, companies may also use debt as part of their capital structure. The debt-to-equity ratio would probably be higher for the airlines because most airlines borrow heavily for their aircraft acquisition or capital leasing. Debt financing can be either short term or long term. Short term debt financing usually applies to money needed for the day-to-day operations of the business, such as inventories or other operating expenses. Some other examples of short term debt financing include bank loans and business lines of credit. Long-term debt financing usually applies to fixed assets like aircraft, airport terminals, buildings, land, and machinery.

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Table 6.2  Debt to Asset Ratio main US Airlines in Q3-2020 Airline American Alaska Delta United Southwest Hawaiian Spirit

Current assets (000) $2,08,45,698 $1,12,43,503 2,50,11,045 1,64,75,714 1,61,33,242 11,50,168 24,99,110

Fixed assets (000) $5,04,72,610 $93,42,749 $5,41,44,449 $4,47,13,708 $1,94,71,674 $28,87,053 $60,58,184

Total asset (000) 7,13,18,308 $2,05,86,252 7,91,55,494 6,11,89,422 3,56,04,916 40,37,221 85,57,294

Total liabilities (000) $6,43,28,917 $1,23,64,368 $7,56,85,372 $5,42,17,915 2,58,36,409 28,01,152 61,53,191

Debt-to-­ asset ratio 90% 60% 96% 89% 73% 69% 72%

Sources: Diio & Form 41, April 2021

The debt-to-asset (D/A) ratio is an important financial tool in assessing the health of an airline. American Airlines has the highest D/A ratio among the U.S. Major Airlines (Table 6.2). Airlines with heavy debt in relation to ownership equity are in greater danger of insolvency as compare to equity financing. But, the most powerful incentive for the use of debt in the capital structure is the tax-deductibility of interest expenses—the motivation to borrow money increases with an airline’s taxable income. On the negative side, the threat of financial distress and corporate bankruptcy are likely to increase as the level of debt an airline has in its portfolio increases. One of the key ratios used to interpret the level of debt and determine a company’s financing methods is the debt/ equity ratio. This ratio indicates the relative proportion of debt used to finance a company’s assets. A low debt-to-equity ratio indicates lower risk because shareholders have a claim on a larger portion of the company’s assets. A higher debt-to-equity ratio usually means that a company has been either aggressive in financing growth with debt or funding losses with debt, and both often may result in insolvency. Many airlines with heavy debt in their portfolios have never recovered from Chapter 11 bankruptcy, including Eastern Airlines, which had amassed $3.2 billion in debt and assets worth only $620 million when it ran out of cash in 1991. Eastern Airlines lost about 1.3 billion in only 22 months.15 In this unstable situation, there were a lot of disagreements between the former CEO Lorenzo and the unions, which further led to Lorenzo being forced to quit his job in Eastern Airlines (Weiss & Wruck, 1998). In 2005, Delta Air Lines filed for bankruptcy protection, after 19.months the airline emerged from bankruptcy, following a $3 billion restructuring during which the carrier thwarted a hostile takeover, cut costs and jobs, and eliminated some unprofitable routes.16 Pan American Airways and Trans World Airlines also did not emerge from Chapter 11 bankruptcy. Pan American filed for liquidation, and TWA was acquired by American Airlines. The D/A ratio is a calculation used to assess how much debt is being used to run a business compared to the asset of the business. If an airline has a total debt to total assets ratio of 81%, this shows that 81% of its assets are financed by creditors, with owners (shareholders) financing the remaining 19% with equity.

15 16

 Russell (2017).  Reuters, Delta exits bankruptcy after 19-month restructuring, April 30, 2007.

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6.1.6.1 Bonds The International Finance Corporation (IFC), the private sector arm of the World Bank Group, today signed an agreement to provide a US$180mn long-term financing package to Empresa Brasileira de Aeron‘utica (Embraer). The financing consists of a US$35mn loan for IFC’s own account and a syndicated loan of US$145mn. IFC’s financing will partially fund the end-stage launch program for the new Embraer 170/190 family of aircraft. Global Trade Review, June 22, 2005

Corporate fixed income debt instruments are known as bonds. The person that buys a bond from a company is the bond, or debt, holder. An indenture is a written agreement between the company and its bondholders that discloses all of the rights and privileges of bondholders as well as the terms of the bond. Bonds are essentially long term loan agreements between a borrower and an investor; the terms of a bond obligate the borrower (issuer) to repay the amount of principal by maturity. Most bonds also require that the borrower pay the investor a specific amount of interest (Table 6.3). In exchange for capital, the company agrees to pay the bondholder periodic interest payments, called coupon payments, until the bond has matured. A bond is a legally binding agreement between a lender and a borrower. Most corporations issue bonds in denominations of $1000 (face value) with maturity between 10 to 30 years. The maturity date is the date by which the par value must be repaid, and the payments are called coupon payments because when bonds were first issued, the bondholders would have to turn in a coupon they received with the bond in order to collect their interest payment. Nowadays, companies have much more modern systems of distributing interest payments; however, the name coupon payment remains the standard terminology. The cost of debt (coupon rate) depends on the market interest rate, the airline’s credit profile and the company’s tax rate and condition. The amount of the coupon payment is based on two items, the face value of the bond and the coupon rate. An important risk associated with bonds is default risk. If the issuer defaults, Table 6.3  Features of common stocks and preferred stocks Common stock Each share provides equal ownership Entitled to dividends (if the company pays them)

Preferred stock Hybrid of a bond and common stock Stockholders are granted high claim on assets and earnings

Riskier than debt or preferred shares Last to receive a share of assets in case of bankruptcy Grants owners voting rights

Generally, fixed dividend payments Dividends tend to be higher than dividends paid on common shares No voting rights

Bonds Debt instrument Interest is paid to bondholders before dividends are paid to stockholders Periodic interest payments, called coupon payments First to receive interest and face value of the bond in case of liquidation No voting rights

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247

investors receive less than the promised return on the bond. The greater the default risk, the higher the bond’s coupon payments. Generally speaking, a company with a high level of debt compared to equity is thought to carry higher risk, and investors, therefore, demand a higher rate of return. The Modigliani-Miller theorem (1958) states that, in a perfect market (and ignoring the effect of taxes), a firm cannot create more value by using debt. Bonds are normally assigned quality ratings by major rating agencies, such as Moody’s Investors Service and Standard and Poor’s Corporation. In finance, a bond is a debt security, under which the issuer (borrower) is obliged to pay the lender interest and the principal at the maturity. Thus a bond is a form of loan or IOU. Bonds and stocks are both securities, but the major difference between the two is that stockholders have an equity stake in a company, whereas bondholders have a creditor stake in the company. Face Value of a Bond The face value of a bond is similar to the par value of a stock. Face value is the amount printed on the bond; bonds usually come with $100, $1000 or $10,000 face values. The face value of the bond will be returned to the bondholder when the bond matures. The maturity of a bond is the length of time remaining on the bond until the company must pay the face value to the bondholder. Bonds typically come with 10 to 30  year maturity periods. However, bonds can typically be bought or sold between the original investor and a third party at any time while the bond is still outstanding. The coupon rate is the annual interest rate at which the bondholder will receive coupon payments. For example, a bond with a face value of $1000 and a coupon rate of 8% entitles the bondholder to $80 interest per year as their coupon payment. In much the same way that stocks are not always traded at their issued price, par value for stocks technically has a different meaning; bonds do not have to be sold at face value. There are three different types of bonds based upon their market value: par value bonds, premium bonds and discount bonds. The actual price that a bond sells at is based on current market interest rates (k) for bonds of companies with similar risk. Bonds sell at a premium if the coupon rate (c) is higher than the market interest rate (k) (Table 6.4). Premium bonds have a built-in mechanism of capital loss. As the bond approaches maturity, the market value approaches face value; the market value of the premium bond decreases. Discount bonds, on the other hand, sell for below face value because the coupon interest rates are lower than the market interest rate for the perceived creditworthiness of the company at that time (Brealey & Myers, 2020). Discount bonds have a built-in mechanism of capital gains. As discount bonds approach Table 6.4  Types of bonds based on market value Discount bond Bond’s market value is less than face value (c < k)

Par value bond Bond sells at face value (c = k)

Premium bond Bond sells for (or market value is) greater than face value (c > k)

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6  The Principles of Long Term Financing and Effective Cost Management

Bond Price

Premium bonds c> k

Par value c =k Discount bonds c< k

Maturity

Time to Maturity

Figure 6.1  Bond value over time

maturity, their market value also approaches face value; the amount of the discount below face value shrinks (Figure 6.1). The value of a bond (Vbond) can be determined by using an annuity formula and adding the face value discounted by the market interest rate. n

C

t 1

1  k 

Vbond  

t



FV

1  k 

n



1  FV 1  Vbond  C   t n k  k 1  k   1  k 

Where: • • • • •

C = annual coupon payment k = required rate of return, or market interest rate t = each payment period starting at t = 1 FV = Face value of bond n = years to maturity

We should note that bond prices vary inversely with market interest rates. Since the coupon payments are fixed, the higher the interest rates, the lower the present value of the expected coupon payments and, thus, the lower the price of the bond (Clifford, 1979). Conversely, when the interest rate goes down, the price of bonds goes up. For example, consider a bond selling in 2009 for $1000 with an annual coupon payment of $90 and a 10 year maturity. Now, suppose immediately after the

6.1  Financing Capital Spending and Sources of Capital

249

bond was issued, the interest rate drops to 8%. As a result, the bond would appreciate as follows.



 1  1 1000  Vbond  90   10 10 . 08  .08 1  .08   1  .08 



Vbond  603.90  463.00



Vbond = 1, 066.90

The purpose of bond valuation is to find out what price should be paid for a bond given the coupon payments, current discount rate, and the remaining time to maturity. Hence, the value of a bond depends on the amount and timing of the coupon payments, and the creditors required rate of return, and the riskiness of these coupon payments. Conversely, bonds can also decrease in value. As a case in point, using the formula for the market value of a bond (Vbond), we will determine the market value of a bond with 5 years until maturity, a face value of $1000 and a coupon payment of $70. Assume the market interest rate is 8%. n

C

t 1

1  k 

Vbond   Vbond 

$70

1  .08 

1

 

t



$70

1  .08 

5

FV

1  k 



n



$1000

1  .08 

5

 $960.07



The bond is selling at a discount since it is selling for $960.07, and the face value of the bond is $1000. As interest rates change, so do bond prices; however, we know that the bond will sell at a discount as long as the market interest rate remains above the coupon interest rate. However, how much of a discount the bond sells for depends on the time remaining until the bond matures. Suppose we know the price of the bond but do not know the market interest rate. We can use the same formula to find the interest a bond will yield its buyer, also known as the yield to maturity. Because this calculation is difficult to do manually, most people use a financial calculator or a computer spreadsheet program to determine the yield to maturity. An example of yield to maturity is provided below. Example  Consider a given bond has 3 years remaining until its maturity date. The coupon payment is $80, the face value is $1000, and the bond is currently selling for $1079.95. n

C

t 1

1  k 

Vbond  

t



FV

1  k 

n



250

6  The Principles of Long Term Financing and Effective Cost Management 3

$80

t 1

1  k 

$1, 079.95  

t



$1000

1  k 

3



Solving this equation for k = 5.06 % .

6.1.6.2 Cost of Debt (Bonds) As mentioned before, the interest rate on a bond is the rate of return for the investor and the cost of capital to the borrower. However, unlike the required rate of return on stocks, the rate of return is not the cost of a bond for a company. The cost of carrying debt is actually lower than the interest rate a company pays on its bonds. This is because the interest a company pays is tax-deductible. Any interest a company pays reduces the amount of taxes the company must pay on its earnings. Because interest is tax-deductible, financing a business through borrowing is usually cheaper than using equity. The cost of debt, therefore, is the interest rate minus the tax savings that come from interest being tax-deductible. We should bear in mind, the interest rate on a bond, k, is a combination of the risk-free rate of interest, default risk premium, liquidity premium, and inflationary risk premium. It is important to note that interest payments, as well as depreciation allowances, are tax-deductible expenses. The benefits of debt financing vs. equity financing favor a higher debt ratio as the tax benefits of debt typically mean that debt has a lower cost than equity. However, higher levels of debt increase the risk of default and may also carry higher costs: • The first cost of higher debt derives from possible conflicts between a firm’s shareholders and creditors. • The second cost is the higher probability of financial distress (Pinteris, 2003). Take, for example, an airline that issues bonds with a coupon rate of 9% and has a marginal tax rate of 35%. What is their cost of debt? K dAT  i 1  t 

Where: K dAT = After-tax cost of debt i = coupon rate of the bond t = tax rate

In effect, the government pays part of the cost of debt because interest is deductible (Block & Hirt, 2021). Therefore, if the airline can borrow at an interest rate of 9%, and if it has a marginal federal tax rate of 33%, then its after-tax cost of debt is 6.03%.

6.2  Bankruptcy and Financial Distress

251

K dAT  .09 1  .33   6.03%



The tax benefit of debt makes acquiring capital through debt financing more attractive to companies. In addition, bondholders have rights to be paid before shareholders, making bonds less risky than stocks. Because of the lower risk of a bond, the required rate of return is also lower for a bondholder than with a shareholder. It should be noted that bond ratings from credit rating agencies help investors determine a company’s future potential risk of default. Bond ratings are extremely important because a company’s bond rating tells much about the cost of funds and the firm’s access to the debt markets. Bonds that have a high credit rating and low likelihood of default are known as investment-grade bonds. Bonds that have a higher likelihood of default are called speculative or non-investment grade. These non-­ investment grades, or “high yield”, bonds typically offer interest rates that are much higher than safer government and investment-grade issues. Bonds with a Standard & Poor’s (S&P) rating of BB+ and below or a Moody’s rating of Ba1 and below are called below-investment-grade bonds.

6.2

Bankruptcy and Financial Distress

Avianca Holdings AVTp.CN, Latin America’s second-largest airline, filed for bankruptcy on Sunday, after failing to meet a bond payment deadline, while its pleas for coronavirus aid from Colombia’s government have so far been unsuccessful. Reuters, May 10, 2020

Since the airline deregulation act of 1978 in the United States, the industry has experienced severe volatility in earnings, with airlines recording periods of substantial profits that are closely followed by periods of financial distress. Massive mergers and bankruptcies over the last 12  years have taken what had been ten major U.S. carriers down to four mammoth airlines, which dominate the market. Between 2009 and 2019, airline revenue globally increased at a compound annual growth rate of around 5.3%, reaching $838 billion in 2019. The industry is susceptible to market fluctuations and economic difficulties due to structural shocks. Several airlines have already collapsed due to the COVID-19 pandemic, including Flybe (UK), Trans States Airlines (US), Compass Airlines (US), Virgin Australia (Australia) and Avianca (Colombia). With more than 1000 commercial airlines operating internationally, the major challenge facing the industry is to gain passengers and return to profitability and avoid bankruptcy and liquidation. Bankruptcy is a legal process through which a business that cannot repay financial obligations to creditors may

252

6  The Principles of Long Term Financing and Effective Cost Management

seek relief from creditors. There are various types of bankruptcy, commonly referred to by their chapter within the U.S. Bankruptcy Code. All bankruptcy cases in the United States are litigated through federal courts. The U.S.  Bankruptcy Code include Chapters 7 and 11. Risk of collapse among airline groups worldwide 2020, byvv Altman's Z score

Grupo Aeromexico Gol Linhas Thai Airways AirAsia Indonesia Medview Airlines Azul Precision Air Pakistan Internaonal -7.

-5.

-3.

-1.

1.

6.2.1 Chapter 7: Straight or Liquidation Bankruptcy Business organizations file for Chapter 7 under the US bankruptcy law in which they liquidate their assets to repay their financial obligations. In a bankruptcy under Chapter 7 case, the court will take legal possession of the property and appoint a bankruptcy trustee for each case. The trustee sells off those assets and divides the proceeds among the creditors. Hence, Chapter 7 involves the closure of the debtor business and the sale of liquid assets to repay creditors. Numerous airlines have declared bankruptcy and have ceased operations or reorganized under bankruptcy protection. The early years of deregulation saw numerous filings amongst startup carriers and legacy carriers that lacked enough liquidity and a sound business plan. Pan American World Airways ceased operations on January 8, 1991, and most assets were purchased by Delta Air Lines.

6.2.2 Chapter 11: Reorganization Bankruptcy After 29 years in service, Miami Air International filed for Chapter 11, then proceeded to cease operations. The charter airline had a fleet of Boeing 737  s and

6.3  Strategic Cost Management

253

operated worldwide passenger flights for cruise operators and professional sports teams.17 Under Chapter 11 U.S. bankruptcy law, an airline attempts to restructure its debts to pay the financial obligations. A Chapter 11 bankruptcy begins with the filing of a petition with the bankruptcy court serving the area where the debtor has a residence. One of the main objectives of bankruptcy is to discharge certain debts to give an honest individual debtor a new start. A defunct company usually proposes a reorganization plan to keep its business alive and pay creditors over time. A petition may be a voluntary petition (filed by the debtor), or it may be an involuntary petition (filed by creditors). Once filed, creditors are temporarily forbidden to make any attempt to collect the debt. The airline has 4 months to come up with a reorganization plan, though that can be extended to 18 months. After that, creditors can propose reorganization plans. During the bankruptcy, the airline continues to operate the business, though the bankruptcy court must approve major financial decisions. Airlines can slash costs drastically during Chapter 11 reorganization, allowing them to renegotiate contracts and reduce debts and giving them an edge over other financially stronger competitors in the industry. Several major airlines have declared bankruptcy and have either ceased operations or reorganized under bankruptcy protection. US Airways and United Airlines filed for bankruptcy protection in 2002, and Delta and Northwest in 2005. Avianca Airlines, Virgin Australia, and LATAM Argentina all filed for bankruptcy in 2020.

6.3

Strategic Cost Management

Profits are up, the share price is up and our members have improved the airline’s bottom line by in-sourcing work from other carriers and finding new ways to boost productivity. The gains are there, it’s time to share. –James Little, TWU President

The cost rebalancing plan clearly describes specifically the methodology for monitoring and controlling airline costs during the project lifecycle.18 • • • • • • • • •

Fleet renewal Fuel conservation strategies Improving aircraft fuel saving performance Reducing the dead weight of an aircraft Correcting enroute flight plans and alternate airports Increasing direct ticket sales Increasing labor productivity One engine taxiing Optimizing aircraft fleet dispatch

 Forbes. You Won’t Believe How Many Airlines Haven’t Survived Coronavirus. How Does It Affect You? June 27, 2020. 18  A variety of contributions to this section have been made by Kelly Ison, an independent aviation consultant. 17

254

• • • • •

6  The Principles of Long Term Financing and Effective Cost Management

Optimizing flight speeds using the efficient cost index Payroll reduction Reducing aircraft drag Reducing aircraft weight19 Scheduling reasonable flight hours for flight crew

Labor accounted for 40.2% of the operating costs of the airline industry in 2019, although labor cost varies differently across the industry.20 For example, labor costs are 25.2% of all operating costs at AMR, but only 22.9% at Delta and 27% at United and Continental. Automations and downsizing are naturally the first strategies for airlines to reduce labor costs and increase labor productivity.21 In the post-­ deregulation period of the late 1970s, airlines were facing heavy price competition from startup airlines now open to competition. Competition from low-cost carriers, high fuel prices, and the ability of passengers to search for the cheapest fare has put considerable pressure on airlines to cut costs. To cut costs and stay profitable, airlines quickly became interested in minimizing the aircraft crew. The aircraft crew is a combination of the flight crew (Captain, First Officers, Flight Engineers, and Relief Pilots) and the cabin crew (Flight Attendants). Boeing’s first two-pilot commercial aircraft was the 737, and the manufacturer extended the two-crew flight deck to the 757 and 767 design as well. Boeing launched the 757 program in April 1979; FAA certification was awarded July 30, 1982, and United was the first airline to receive the aircraft in January 1983. The following section provides guidance on how to measure the cost of human resources in the airline industry. These costs are a significant cash cost of operating an aircraft; thus, improving productivity and efficiency significantly impact an airline’s profit. To determine the potential cash flows of an aircraft, it is necessary to analyze the total cost of crews. These costs have many components, which can vary substantially from airline to airline. Further complicating the cost analysis is the fact that different airlines staff aircraft differently and pay their crews according to different formulas. Even within the same airline, a variety of different pay formulas may be utilized.

6.3.1 Financial Crew Cost Analysis If the Wright brothers were alive today Wilbur would have to fire Orville to reduce costs. –Herb Kelleher, Southwest Airlines, USA Today, 8 June 1994

19  A380 went through an extensive weight-saving program that reduced aircraft weight by 1.8 tons after the introduction of light-weight metal alloys and more composites materials, and process simplification. 20  A4A Passenger Airline Cost Index (PACI), 2021. 21  C.B.S. World Press, May 19, 2011.

6.3  Strategic Cost Management

255

There are two major types of crew costs analysis that can be undertaken: Financial and Operational. The Financial analysis uses high-level information generally available from investor information, government filings, or third parties. The focus of the financial analysis is normally on the entire company as a unit and measures total output and cost ratios.

6.3.1.1 Ratios These ratios and measurements can be fine-tuned to suit the purpose of the analysis and are more useful for broad comparisons of companies. Some common ratios included in the analysis are: • • • •

Block hours per employee ASM (or ASK)per employee RPM (or RPK) per employee Total Revenue or Passenger Revenue per employee, etc.

These ratios provide a general picture; they do not account for differences in aircraft size, fleet makeup, stage length, or other variables that would allow an accurate forecast of a prospective aircraft’s specific crew cost.

6.3.2 Operational Crew Cost Analysis Conducting an Operational Crew Cost Analysis is more useful because it takes a departmental approach and deconstructs crew costs into its various components. The challenge of Operational Crew Cost Analysis for non-airline managers is that it relies on a company’s internal information. Although government and industry groups maintain filings for participating carriers, useful information is not always readily available to outsiders. Since there are many different methods for calculating crew pay, it is helpful to have a common denominator that allows an apples-to-­ apples comparison of crew costs across the industry. A generally accepted method to facilitate this comparison is to reduce those costs to an amount per aircraft block hour. A block hour is the elapsed time between an aircraft’s movement from the departure gate and the time it arrives at the destination gate. The following section does not provide a comprehensive list of individual airlines’ crew pay, work rule, and benefit structure. Instead, it outlines the steps for calculating each element of the Operational Crew Cost Analysis for the desired airline and/or aircraft to make meaningful comparisons. Aircraft block hours is the time from pushing back from the departure gate, to arriving at the destination gate. Crew cost per block hour is designed to assist airline managers in benchmarking specific aircraft costs and performance against industry standards.

256

6  The Principles of Long Term Financing and Effective Cost Management

6.3.2.1 Compensation and Pay Pay, typically stated as a rate per flying hour (or similar), is the simplest to quantify but arriving at a total pay rate for the aircraft is not always straightforward. As previously stated, airlines use varying methods to calculate crew pay. Most crew pay is somewhat variable, based on the amount that a crew flies per month (usually block hours). Rates usually are different for each crew member depending on the position (Captain, First Officer etc.). Calculating accurate pay rates requires summing the actual pay rate for each position, which can be found in the airline’s Collective Bargaining Agreement (CBA), Human Resources department, or other internal documents. To illustrate the calculations, the published rates for a Captain, First Officer and Cabin crew are given (Table 6.5). Modifications to the published pay rates can include items such as: • Pilot Seat Position: Captains, First Officers, Engineers, and Relief Pilots can all specify different pay rates. In some cases, Relief Pilots are simply extra Captains or First Officers and are paid their regular rate. It is important to determine the Flight Crew complement for the aircraft and the type of operation for its typical mission. For example, flights scheduled for extended flight times must contain several Relief Pilots, based on the scheduled block hours for the flight. • Aircraft Type: Many airlines pay different rates for different aircraft types. Although more typical for Flight Crew, Cabin Crew rates can also vary by aircraft type. Table 6.5  Published pay rates for flight and Cabin crew in 2019

Airline American Airlines Delta Air Lines United Airlines Alaska Airlines Southwest Airlines Hawaiian Airlines Spirit Airlines SkyWest Airlines Frontier Airlines

Employee statistics Cost of pilots and copilots (000) $32,59,845

Cost of Cabin crew (000) $2,45,471

Number of pilots and copilots 13,841

Number of Cabin crew 13,930

$31,63,875

$2,47,474

13,065

21,341

$29,37,513

$1,93,298

11,709

23,489

$5,98,714

$51,155

3048

23,489

$21,69,809

$1,38,630

9225

9891

$3,15,400

$51,000

859

1310

$1,80,000

$21,000

2381

1729

$1,91,500

$80,000

5239

1425

$1,01,687

$35,000

1522

2579

Sources: Diio & Form 41, April, 2021

6.3  Strategic Cost Management

257

• Crewmember Longevity: Pay rates frequently increase with the amount of time the crewmember has been employed with the airline. Each position’s longevity can vary with each flight, so it is customary to average the longevity of each position. • Cabin Crew Position: Cabin crewmembers can be paid differently for their positions on the flight. For example, the lead position, sometimes called “Purser,” or simply “Lead,” can carry an hourly override of some amount, which can vary with aircraft type or type of operation. • Special Qualifications: These can include any special rate adjustments for Flight or Cabin Crew. Some adjustments include language qualifications for international flights, or an hourly override for transoceanic, international, or even night operations. Once these differences are accounted for, the adjusted pay rate for each position is added to produce a Total Pay Rate. Utilizing the published rates given previously and any company adjustments, the Total Pay Rate calculation for an airline operating a Boeing 767 aircraft with one relief pilot can be made: Flight Crew    Captain (½ day rate and ½ night rate, 12 years longevity)    First Officer (½ day rate and ½ night rate, 6 years average longevity)    Relief Pilot (½ day rate and ½ night rate, 6 years average longevity)    International Override ($6 × 3 pilots)        Flight Crew Total Pay Rate Cabin Crew    Lead Flight Attendant ($6 lead override, 6 years average longevity)    Flight Attendant (6 years average longevity)    Flight Attendant (6 years average longevity)    Flight Attendant (6 years average longevity)    Flight Attendant (6 years average longevity)    Language Qualification ($6 × 2 Flight Attendants)    International Override ($5 × 5 Flight Attendants)        Cabin Crew Total Pay Rate

$144 $85 $85 $18 $332 $40 $34 $34 $34 $34 $12 $25 $213

6.3.2.2 Productivity Pay rate alone is not enough to accurately forecast the Crew Cost per Block Hour or to compare these costs to different airlines. It is necessary to account for any differences in efficiency caused by dissimilar route systems, fleet makeup, company structure, utilization, staffing levels, work rules, scheduling, and other issues. A key factor to the flight crew’s productivity is the productivity of the aircraft itself. Any time that the aircraft is not being flown represents lost productivity on the part of the crew. Maximizing the number of block hours that the aircraft is flying versus parked serves to maximize the productivity of the aircraft and the crew. For example, Southwest Airlines in 2019 had a daily utilization per aircraft of 10.51 block hours and an airborne time of 8.85 hours per aircraft.22 Any time the aircraft spends not in 22

 Massachusetts Institute of Technology Airline Data Project, 2020.

258

6  The Principles of Long Term Financing and Effective Cost Management

operation when the aircraft is parked at the gate for any or all of the following to occur is referred to as turnaround time: • Passenger boarding and deplaning • Cargo loading and unloading • Fueling • Galley servicing • Cabin cleaning • Potable water replenishment • Preflight checks Productivity measures output per unit of input, such as load factor, aircraft turnaround time, ASMs per Aircraft per Day, or aircraft utilization per day. The aircraft is often the costliest asset of an airline, making the maximization of its productivity (and its flight crew) a critical factor. One of the first steps to analyzing this productivity is to separate crew pay hours from crew or aircraft block hours. The Crew Pay Hour is an hour a crewmember is paid for, while a Crew Block Hour is an hour the crewmember actually operates the aircraft. Therefore, a crewmember generates both Pay and Block Hours for taxiing the aircraft out for departure, the flight time, and taxiing in at the destination. A flight may be scheduled for more time than it actually takes to complete the trip on a particular day. In that case, crews are often paid the greater of actual Aircraft Block Hours or scheduled Aircraft Block Hours. In addition to scheduling considerations, this allows pilots to save Aircraft Block Time when possible without reducing the hours they are paid. For example, changing to an altitude with more favorable winds could allow a flight from Charlotte, NC to London’s Heathrow Airport to be completed in 8 h instead of the scheduled 9 h. In this case, the flight generated nine Pay Hours for the crew but only eight Block Hours. A variety of other activities and decisions may create Pay Hours at a different rate than Block Hours. Some of these include: sick time, vacations, paid training time, penalty or “rig” time based on CBA rules, deadhead time, guarantee time to compensate reserve crewmembers for on-call time. In short, any hour paid to crewmembers without a corresponding Block Hour must be taken into account. As an example, following the pay rate calculation previously used, the flight would generate eight aircraft Block Hours and the following crew block hours and pay hours: Flight Crew Block Hours (8 × 3 Flight Crewmembers) Cabin Crewmember Block Hours (8 × 5 Cabin Crewmembers)         Total Crew Block Hours

24 40 64

Flight Crew Pay Hours (9 Pay Hours × 3 Flight Crewmembers) Cabin Crew Pay Hours (9 Pay Hours × 5 Cabin Crewmembers)         Total Crew Pay Hours

27 45 72

6.3  Strategic Cost Management

259

The ratio of Pay Hours to Block Hours (PTBH) for this flight is 72 to 64 or 1.13. This ratio is a generally accepted measure of crew productivity and will be the productivity multiplier in the Operational Crew Cost Analysis. Calculating the PTBH for this flight, however, is statistically too small of a sample to paint an accurate picture of the aircraft’s and airline’s characteristics. A year’s data is much better because it captures seasonal changes, but a few months of data can also be statistically significant if a full year’s data is not available. In addition to the statistical significance issue, this individual flight calculation does not account for the other factors that generate Pay Hours at a different rate than Block Hours. Often, calculating each flight and each factor (such as sick time, vacation, etc.) over a year is much too cumbersome to be useful. Therefore, it is much more practical to simply total the year’s Crew Pay Hours and Crew Block Hours for the target group, whether an airline, a specific aircraft type, or other subgroups as necessary, then divide Crew Pay Hours (CPH) by Crew Block Hours (CBH) to produce the (PTBH).



PTBH =

CPH CBH

Consider a hypothetical airline’s 767’s Crew Cost Analysis. According to information received from the hypothetical finance department for the most recent 12 months, Flight Crew Block Hours are 176,749, and Flight Crew Pay Hours are 250,984. Likewise, for the Cabin Crew, the finance department reports Block Hours of 294,582 and Pay Hours of 409,468. Thus, we can calculate the PTBH for flight crew (f) and cabin crew (k) as follows.



= PTBH f

250, 984 = 1.42 176, 749

= PTBH k

409, 468 = 1.39 294, 582

Consequently, we can calculate the crew cost using the ratio of Pay Hours to Block Hours (PTBH) as follows.



Crew Cost per BH  Pay Rate 

PTBH  Benefit & Fringe Costs BH

6.3.2.3 Benefits and Fringe Costs Benefit and Fringe Costs include such items as insurance, parking, transportation, company-paid retirement contributions, expenses, company-paid uniforms, or other items the company pays on behalf of the employee. Employer taxes based on payroll (employee’s contribution is included in payroll, as is the employee’s retirement plan contributions) both direct and indirect are also included. It is not unusual for this calculation to be roughly the same for each department since benefits, taxes, and retirement contribution percentages may not vary widely between employee groups. So it may not be necessary to separate data for Flight and Cabin Crews.

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6  The Principles of Long Term Financing and Effective Cost Management

Benefit Rollup =

Benefit and Fringe Payroll before Benefits and Fringe

The calculation takes total Benefit and Fringe Costs and divides that number total payroll costs before Benefits and Fringe Costs by to arrive at the percentage of Benefits and Fringe Costs to payroll cost. For the hypothetical airline, their payroll department reports for the latest 12  months employee payroll is $1,278,583,959, with Benefits and Fringe at $409,146,867. Benefit Rollup =

$409,146, 867 $1, 278, 583, 959

Benefit Rollup = 32%

This Crew Cost Analysis uses the Benefits and Fringe percentage as an inflator to “roll-up” the hourly cost. In fact, this percentage is referred to as the Benefits Rollup. In a hypothetical airline example, the Total Pay rate for Flight Crew is $332, and PTBH is 1.42 resulting in a cost per block hour of $471.44 before accounting for the Benefits and Fringe Costs. Mathematically, the Benefits Rollup calculation would add 32% of the result of the formula to that point to produce the total Crew Cost per Block Hour. Multiplying $471.44 by 1.32 is the same as calculating 32% of $471.44 and then adding it to $471.44, but eliminates the addition step. For ease of calculation, then, “+ Benefits and Fringe Costs” becomes “× (1 + Benefits Rollup).” The formula modification becomes:

Total Pay Rate  PTBH  1  Benefit Rollup   CrewCost / BH For the Flight Crew Cost per Block Hour



FCC  $332  1.42  1.32 FCC = $622.30 Repeating the calculation for the Cabin Crew:



KCC  $213  1.39  1.32 KCC = $390.81

Adding the Flight Crew Cost per Block Hour of $622.30 to the Cabin Crew Cost per Block Hour of $390.81 produces the Aircraft Crew Cost per Block Hour of $1013.11. For every 767 Aircraft Block Hour the hypothetical airline flies, it can expect to pay $1013.11 for Crews. Flight Crew Cost per Block Hour + Cabin Crew Cost per Block Hour Aircraft Crew Cost per Block Hour

$622.30 $390.81 $1013.11

6.5 Summary

261

The aircraft crew costs can then be added to other costs per block hour for various aircraft models and a table indicative of total costs per block hour can be generated. The block hour costs for each aircraft can also be contrasted to other performance and operational metrics it offers (including seat capacity, speed and range) to find the most suitable aircraft choice for the particular airline’s needs. For U.S. airlines, in 2019 the total operating costs averaged $3985 per block hour while variable costs averaged $3420 per block hour. Variable costs accounted for an average of 86% of total costs. Narrow-body aircraft with 160 seats and below accounted for nearly one half of activity, measured in block hours (Tables 6.6, 6.7 and 6.8).

6.4

Rules of Thumb

For U.S. carriers, some historical rules of thumb apply. These rules of thumb, by their nature, are not exact and do not apply to any specific airline, but provide a reasonableness test of the analysis. Indeed, these benchmarks are appropriate for normal conditions and are not applicable for special situations such as the COVID-19 pandemic. If the analysis results are significantly different from these, it is important to understand why because there may be either data or calculation issues. Crewmembers fly an average of approximately 1000 Pay Hours per year or 85 Pay Hours per month. The average Block Hours are 660 per year and 55 per month. Networks carriers average PTBH is 1.55 while low cost carriers’ average PTBH is 1.40, and regional airlines’ average is 1.30 (Table 6.9). Exploring the reasons for a company’s particular PTBH is beyond the scope of this book, but such an exploration would likely include, among others, factors such as: • Route Structure –– The mix of long- and short-haul, domestic, international, and transoceanic routes. • Company Structure –– Hub and spoke system or point-to-point, number and type of aircraft in the fleet, number and location of crew bases. • Work Rules –– These may or may not be contained in the CBA’s of the company’s employee groups. Work rules also include government regulations and company practices.

6.5

Summary

This chapter evaluated the various elements of cash costs that an aircraft operator may face as well as the potential impact of various capital structure decisions. Cost management is concerned with the process of finding the right inputs and carrying

Aircraft Type Wide-body more than 300 seats Wide-body 300 seats and below Narrow-body more than 160 seats Narrow-body 160 seats and below RJ more than 60 seats RJ 60 seats and below Turboprop more than 60 seats All Aircraft

$718

$737

$431 $479 $880 $727

$2054

$1741

$115 $92 $0 $1681

$444 $470 $360 $1012

$1034

$1152

$991 $1041 $1241 $3420

$3512

$3925

$7227

$1289

$4080

$1857

Total Variable $9097

Cost per Block Hour Fuel and Oil Maintenance Crew $5411 $1331 $2356

Table 6.6  Estimated operating and fixed costs per block hours

$131 $58 $439 $314

$306

$355

$685

$252 $227 $103 $239

$215

$217

$366

$1 $1 $0 $4

$5

$3

$4

$13 $7 $2 $7

$7

$7

$4

$397 $293 $544 $564

$533

$582

$10,508

Total Depreciation Rentals Insurance Other Fixed $845 $406 $4 $1 $1254

$1388 $1334 $1785 $3985

$4045

$4506

$8285

Total $10,351

35,65,900 13,26,851 1,16,701 2,05,79,720

92,67,585

39,91,243

20,91,230

Block Hours 2,20,210

262 6  The Principles of Long Term Financing and Effective Cost Management

6.5 Summary

263

Table 6.7  Total cost per block hour for narrow-body aircraft in year 2019 Flight Crew Cost Fuel Cost Other Costs Total Flying Cost Direct Maintenance – Airframe Direct Maintenance – Engines Total Direct Maintenance Maintenance Burden Total Maintenance Costs Depreciation Aircraft Rent Total Cost per Block Hour

B737-8 MAXa B737-9 MAXb A320-200 Nc A321-200 Nd $1,242.07 $0.00 $864.20 $1,170.94 $1,326.42 $2,088.43 $1,540.02 $1,576.95 $67.89 $1,764.14 $76.95 $119.34 _______ _______ _______ _______ $2,636.37 $3,852.57 $2,481.17 $2,867.23 $207.92 $134.45 $342.37 $240.70 _______ $583.07

$185.50 $24.13 $209.63 $335.92 _______ $545.55

$165.65 $26.02 $191.66 $136.87 _______ $328.53

$279.95 $224.07 $504.05 $380.50 _______ $884.55

$2,122.13 $490.77 _______ $5,832.35

$565.25 $0.22 _______ $4,963.59

$142.92 $780.87 _______ $3,733.49

$447.06 $592.94 _______ $4,791.78

Source: Adopted by the authors from Airline Monitor 2020 data Cost data for the B737-8 Max reflects total values for American Airlines and Southwest Airlines’ fleets b Cost data for the B737-9 Max reflects total values for United Airlines’ fleet c Cost data for the A320-200N reflects total values for Frontier Airlines’ fleet d Cost data for the A321-200N reflects total values for Hawaiian Airlines and Alaska Airlines’ fleets a

Table 6.8  Total cost per block hour for wide-body aircraft in year 2019 Flying Labor Cost Fuel Cost Other Costs Total Flying Cost Direct Maintenance – Airframe Direct Maintenance – Engines Total Direct Maintenance Maintenance Burden Total Maintenance Costs Depreciation Aircraft Rent Total Cost per Block Hour

B787-8a $2,146.39 $3,187.08 $71.95 _______ $5,405.43

B787-9b $2,404.69 $3,528.14 $81.02 _______ $6,013.86

B787-10c $1,524.98 $3,371.49 $54.97 _______ $4,951.44

A350-900d $2,111.17 $4,008.50 $5.56 _______ $6,125.23

$693.73 $495.79 $1,189.52 $154.61 _______ $1,344.14

$618.85 $295.25 $914.10 $454.97 _______ $1,369.07

$148.74 $28.57 $177.31 $232.31 _______ $409.63

$238.10 $182.99 $421.09 $155.78 _______ $576.87

$1,164.86 $364.70 _______ $8,279.12

$1,002.85 $340.89 _______ $8,726.66

$215.25 $0.14 _______ $5,576.46

$662.21 $126.87 _______ $7,491.18

Source: Adopted by the authors from Airline Monitor 2020 data a Cost data for the B787-8 reflects total values for American Airlines and United ‘Airlines’ fleets b Cost data for the B787-9 reflects total values for American Airlines and United ‘Airlines’ fleets c Cost data for the B787-10 reflects total values for United ‘Airlines’ fleet d Cost data for the A350-900 reflects total values for Delta Air ‘Line’s fleet

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6  The Principles of Long Term Financing and Effective Cost Management

Table 6.9  Approximate historical averages for US carriers Hours Crew member Pay Hours Crew member Block Hours Crew cost per block hour Network Carriers Low-Cost Carriers Regional Carriers

Per year 1000 660

Per month 85 55

1.55 1.4 1.3

out the task in the most efficient way. Using the described analytical framework of both debt and equity financing of long term fixed assets allows the manager to evaluate the best long term financing alternatives. Equity considerations may include the use of common or preferred stock, whether to pay dividends to shareholders, and whether to tap into retained earnings when the use of proceeds may justify it. The cost of equity for airlines will reflect the higher degree of earnings volatility and cyclicality as compared to other industries. Debt financing, in the form of loans or bonds, is likely an appropriate part of the airline’s capital structure. Bond value over time can be determined using the pricing formula described above, and investors will consider the market value of the bond and the Yield to Maturity, amongst other factors such as the underlying credit of the airline and the ratings assigned by the credit rating agencies. Strategic cost management of an aircraft operator’s labor costs involves both financial and operational considerations. Aircraft Crew consists of Flight Crew, pilots and flight engineers, and Cabin Crew, flight attendants, pursers, etc. There are two types of aircraft crew cost analysis. The appropriateness of each depends on the information needed from the analysis. Financial Crew Cost Analysis uses ratios to compare companies. Operational Crew Cost Analysis uses internal data to measure the components of crew cost. Converting airline and crew data into common formats is as much art as science. The watchword here is consistency. As long as conversions and computations are consistent for each airline, the data will present an accurate comparison. Rules of thumb provide reasonableness checks to highlight the possibility of data or calculation issues.

Bibliography Block, S., & Hirt, A. (2021). Foundations of managerial finance (16th ed.). McGraw-Hill. Brealey, R., & Myers, S. (2020). Principles of corporate finance (13th ed.). McGraw-Hill/Irwin. Miller, M., & Rock, K. (1985). Dividend policy under asymmetric information. Journal of Finance, 40(4), 1031–1051. Modigliani, F., & Miller, M. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48(3). Russell, E. (2017). Hawaiian to begin paying quarterly dividends. Flight Global. Weiss, K., & Wruck, K. (1998). Chapter 11’s Failure in the case of Eastern Airlines. Journal of Financial Economics, 48, 55–97.

7

Aircraft Secured Bond Transactions and Securitization

Air transport plays a pivotal role in connecting people and economies, particularly in emerging markets or where alternative options are not available. Roughly 4000 airplanes in today’s commercial fleet are at least 20 years old. Demand for commercial aircraft is driven by emerging markets in Asian Pacific, South America, China, Middle East and India, with airlines in developed markets such as Europe and the United States enjoying moderate growth. In China, the number of passengers should more than triple, and airline fleets will double in size by 2030. In fact, the International Air Transport Association (IATA) had predicted that China would surpass the U.S. as the World’s largest aviation market in the mid-2020s. These significant increases in demand mean airlines need to know how to acquire additional aircraft. The current downturn is expected to lead to the replacement of many older airplanes. Continued demand from emerging markets such as Asian Pacific and Latin America will keep demand for commercial aircraft strong, with global passenger traffic projected by Boeing to rise 4.0% annually for 2020–39, despite the © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 B. Vasigh, F. Azadian, Aircraft Valuation in Volatile Market Conditions, Management for Professionals, https://doi.org/10.1007/978-3-030-82450-1_7

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prospect of the COVID-19 pandemic. Similarly, Airbus predicted that the world airlines would need 47,680 jets by 2038. Traditionally airlines have acquired new aircraft through equity financing, debt financing, operating leases, or capital leases. This chapter will detail the two structures for aircraft lease securitization, including the Enhanced Equipment Trust Certificate (EETC) market that is widely utilized by airlines to finance their aircraft capital requirements and the pooled Aircraft Lease Portfolio Securitization structure. The rating process and the criteria for Aircraft Backed Securitization and Enhanced Equipment Trust Certificates will be discussed. The discussion will include conventional Equipment Trust Certificates (ETC), Pass-Through Certificates (PTC), and specific EETC features relating to loan-to-value, call features, appraised values, and cross-collateralization. This chapter covers the following topics. Aircraft Secured Bond Products • Asset-Backed Securities (ABS) • Pros of Asset-Backed Securities • Conventional Equipment Trust Certificates (ETCs) and Pass-Through Certificates (PTCs) • Bankruptcy protection issues • Aircraft Lease Securitization • Enhanced Equipment Trust Certificate (EETC) Credit Rating Agencies • Standard & Poor’s • Moody’s Investor Service • Fitch Ratings Altman Bankruptcy Index Aircraft Lease Securitization • Airline default or credit risk • Asset risk • Repossession risks • Quality of servicer • Stress tests At the end of the chapter is a summary for this chapter review and a selected bibliography for further study.

7.1

Aircraft Secured Bond Products

While airlines have traditionally owned their aircraft over the past several decades, many airlines have increasingly turned to aircraft leasing as a means of maintaining higher liquidity and lower cost (Vasigh & Rowe, 2020). Airlines secure aircraft through operating leases, capital leases or debt financing. Bonds are a type of debt security that is issued in the capital markets in a format that allows investors to freely trade the debt instrument without regard to authorization or consent by the

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issuer, as may be the case in private loan transactions. Bonds can be issued in a public registered format under the Securities Act of 1930 and its amendments, in a private format under a rule 144A exemption to registration with the Securities and Exchange Commission, or as a pure private (Regulation D) transaction United States Securities and Exchange Commission (2010). In order to attract the highest level of potential investors to a transaction and create price tension in the marketing of the bonds at issuance, issuers tend to issue bonds that are eligible for the Barclays Bond Index as well as bonds that are rated by the credit rating agencies. The index measures the performance of the U.S. investment-grade bond market. By ticking the box on these two items, the bonds will be eligible for investment by a larger group of institutional investors, particularly the fund managers or asset managers. Other institutional investors include insurance companies and banks. Secured bonds and securitization provide a dependable source of aircraft funding for the industry. Securitization is a method by which a company packages its illiquid assets as new security to diversify risk and increase liquidity. Simply put, it is the creation and issuance of debt securities, or bonds, whose payments of principal and interest are derived from cash flows generated by separate pools of assets. Securitization is used by organizations to create securities based on financial assets such as loans and credit cards. Securitization is also used by institutions to cover non-financial assets such as aircraft and buildings. In addition to aircraft, other assets that can be used to collateralize these securities include manufactured housing loans, equipment leases and loans, accounts receivables, and other assets. Financial institutions sell pools of loans to a Special-Purpose Vehicle (SPV), whose sole function is to buy such assets in order to securitize them. The SPV, which is usually a corporation, then sells them to a trust that repackages the loans as interest-­ bearing securities and actually issues them. The use of special purpose vehicle structures is very common in aviation finance. A Special Purpose Vehicle is a legal entity designed for a specific purpose. With the purpose of raising capital, a SPV can be used as a funding structure, by which all investors are pooled together into a single entity. In an aircraft financing, the SPV would acquire the aircraft from the manufacturer. To immediately realize the value of a cash-producing asset such as trade receivables and leases, the company puts these assets under the legal control of the investors through a special intermediary through the use of a mortgage lien or pledge of the shares of the SPV (the day-to-day control of the asset remains with the operator who continues to operate the asset as before). In other words, the regular stream of payments expected from a lease (in this case, the lease is the asset) can be utilized to support interest and principal payments on debt securities. By securitizing the lease, the originator (the aircraft owner) receives the payments stream as a single large payment rather than as individual payments spread out over the time of the lease. Assets with expected payment streams are known as asset-backed securities.

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In reality, the securitization of aircraft assets incorporates a package of several assets and their attached leases, and the analysis looks to the current and future lease streams during the useful economic life of the aircraft with a level of collateralization in the form of the equity risk retained by the issuer or sold to an equity investor. The profile of these assets is further improved by credit enhancements provided by the originator. Credit enhancements are structural features incorporated into the transaction that enhance the credit profile of the transaction. These may include an unfunded credit facility covering interest payments for a certain period of time, a loan-to-value ratio providing a buffer to the value of the asset or a residual value guarantee, among others. Aircraft securitizations are an extension of a spectrum of financing forms that range from a single aircraft lease or secured debt to a large multi-airline pool. The various financing vehicles available are dependent on whether the reliance is on either the airline’s creditworthiness or on the value of the aircraft: • Reliance on airline’s creditworthiness –– Equipment Trust Certificates (ETCs) and Pass-Through Certificates (PTCs) used for financing a single aircraft or multiple aircraft for a single airline –– Enhanced Equipment Trust Certificates (EETCs), which first look to the underlying credit of the airline and then up-tier the credit ratings of the securities based on the value and type of the underlying collateral • Reliance on aircraft value –– Multi-airline EETCs which allow for small portfolio securitizations –– Aircraft lease portfolio securitizations Before deregulation and, subsequently, bankruptcy reform in the U.S. in 1994, the traditional aircraft financing methods favored the credit side of the spectrum, primarily through loans and mortgages from the banking sector. As airline credit deteriorated, these traditional sources of financing that relied on corporate credit deteriorated as well. New structures evolved in the new market condition that moved across the spectrum to a higher reliance on asset value and structure to repay debt. Deregulation in the U.S. in 1978 led to an increase in the number of aircraft in the market, with the heightening of competition between airlines and the emergence of low-cost carriers as the main factors. One of the biggest gainers from deregulation was the aircraft manufacturing industry. Manufacturers increased their production rates as they expanded the customer base. The North American market grew to become the largest single aircraft user market in the 1980s. This created a sizable need for capital expenditures as airlines sought to grow and a substantial demand for capital to pay for the new aircraft. Moreover, the residual value of the aircraft deteriorated as more and more planes joined the national fleet. U.S. and Japanese banks began to slow the levels of their airline and aircraft lending in the 1980s. This, combined with the heavy manufacturer order books, drove U.S. airlines to tap into alternative sources of capital in the bond markets. Initially, Equipment Trust Certificates (ETCs) and Pass-Through Certificates (PTCs) were the primary forms of structured finance where airlines would seek to finance

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individual aircraft through the capital markets while still maintaining recourse to the airline/borrower in the event of default. These basic structures evolved into Enhanced Equipment Trust Certificates (EETCs) and Aircraft Asset-Backed Securities (ABS), which came from adding pools of aircraft, with more than one aircraft type, then issuing several tranches of debt with several risk profiles.1 Aircraft leasing and its growth have driven a large number of aircraft ABS transactions, as lessors seek financing for their fleets through these pooled aircraft securitizations.

7.1.1 Asset-Backed Securities In 2005, the United States Securities and Exchange Commission (SEC) created regulations that provided the final rules and definition of Asset-Backed Securities (ABS) as securities backed by a discrete pool of self-liquidating financial assets. In April 2010, the Commission proposed certain revisions to the existing rules applicable to ABS transactions. In October 2014, the SEC adopted final rules that implement the credit risk retention requirements mandated by Section 941. Asset-backed securitization is a financing instrument in which financial assets are pooled and converted into instruments that are offered and sold in the capital markets United States Securities and Exchange Commission (2005). However, the vast majority of aircraft ABS transactions were not executed as registered deals. Instead, these deals are usually sold to investors in a private format under a rule 144A exemption to registration with the Securities and Exchange Commission, or as a pure private transaction under Regulation D.  As an early example, in 1998, Canadian Regional Aircraft Finance Transaction (CRAFT) was launched partly as an aircraft securitization agency to provide lease and loan financing for customers buying Bombardier’s CRJ and Dash 8 aircraft.2 The modern securitization market originated in the 1970s, when the Government National Mortgage Association (Ginnie Mae), a wholly-owned U.S. federal government corporation, for the first time guaranteed a pool of mortgage loans.3 For several years, Mortgage-Backed Securities (MBS) were almost exclusively a product of Government-Sponsored Entities (GSEs) such as Freddie Mac, the Federal National Mortgage Association (Fannie Mae), and Ginnie Mae. Since the mid1980s, nonmortgage related securitizations have grown to include many other types of financial assets, such as credit card receivables, auto loans and student loans. The asset types that have been securitized have homogenous characteristics, including similar terms, structures and credit characteristics; these assets must represent a contractual obligation to make payments4  The Collaborative Market Data Network 2018.  Standard & Poor’s Presale Report, “CRAFT No. 1 Trust 1998 – A,” page 3. 3  Founded in 1968, the Ginnie Mae, Government National Mortgage Association, is a government-­ owned corporation of the United States Federal Government within the Department of Housing and Urban Development. Ginnie Mae guarantees the timely payment of principal and interest on mortgage-backed securities (MBSs) issued by approved lenders. 4  Guggenheim Summary Report: The ABC’s of Asset-Backed Securities Markets (Aug. 2017). 1 2

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Auto loans form the second largest sector and are categorized into prime, non-­ prime and sub-prime auto asset-backed securities. Prime auto asset-backed securities are collateralized by loans made to borrowers with strong credit histories. Non-prime auto asset-backed securities consist of loans made to lesser credit quality consumers. Sub-prime borrowers will typically have lower incomes, tainted credited histories, or both. Securities collateralized by credit card receivables were first launched in 1987 and form the third largest sector. Credit card holders may borrow funds on a revolving basis up to an assigned credit limit then pay principal and interest as desired, along with the required minimum monthly payments. Generally, MBSs are attractive and safe investments, which provide a stream of income coupled with a potential capital gain. Student loans are the fourth major sector of the asset-backed securities market and are of two types: Federal Family Education Loan Program (FFELP) and Private Student Loans. Federal Family Education Loan Program (FFELP) loans are the most common form. They are guaranteed by the U.S. Department of Education. A second and faster-growing portion of the student loan market consists of non-FFELP or private student loans.5

Asset-backed securitization (ABS) is a financing instrument in which financial asset are pooled and converted into instruments that may be offered and sold in the capital markets. These assets are typically residential mortgage loans, commercial mortgages, automobile loans, student loans, bank loans, accounts receivables, and credit card receivables.

 U.S. Department of Education, Office of Federal Student.

5

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271

7.1.1.1 Pros of Asset-Backed Securities There are Several Essential Benefits of Issuing ABSs • A significant advantage of asset-backed securities is that they enable the banks and financial institutions to remove risky assets from their balance sheet by having another institution assume the credit risk. In a case of insolvency or financial default, the holders of ABS securities would suffer capital loss rather than the originator. A business that has fixed assets on the balance sheet can leverage those assets to access additional working capital and secure additional funding for the business.6 • Loan originators are able to bring together a pool of financial assets that otherwise could not easily be traded in their existing form. By pooling together a large portfolio of these illiquid assets, they can be converted into instruments that may be offered and sold freely in the capital markets (Henzler, 2008).7 • Originators earn fees from originating the loans, as well as from servicing the assets throughout their life. • To the investor, these investments on these financial securities are backed by assets. The risk of a complete loss of capital is very low since the assets used to back the security can be sold to compensate for any capital losses due to defaults. • Investors gain a diversified investment in a pool of loans, which can be more appealing than a standard fixed-income investment or corporate bond. • For the original debtors (recipients of the auto loan, residential loan, or student loan), after their loans are sold or traded in the market, nothing changes except that the payments now go to the investors instead of the financing company.

7.1.1.2 Cons of Asset-Backed Securities There are several arguments against asset-backed securities. • Securitizations are expensive and often require large-scale structuring for all involved parties. A significant disadvantage for the investor lies in the fact the performance of an asset-backed security is solely dependent on the cash flows pertaining to the assets. For example, in the case of mortgage-backed securities, the value of the security is determined by the frequency and regularity of the payments by mortgage holders (Ivanov & Jiang, 2020).8 The majority of revolving asset-backed securities are subject to some degree of early amortization risk stemming from specific early amortization events or payout events that cause the security to be paid off prematurely.9

 U.S. Small Business Administration: Asset-Based Lending (Dec. 2017).  The Private Equity Securities Market: Alternative Routes to Liquidity: Securitizing Private Equity, Filip Henzler (2008). 8  Economy Watch 2010: Backed Securities Advantages and Disadvantages. 9  Fixed Income Sectors: Asset-Backed Securities: A primer on asset-backed securities, Dwight Asset management Company 2005. 6 7

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• The recent mortgage and financial crisis pointed out that analysis of risk within the asset-backed securities market had a critical flaw in that many investors were not fully aware of the risk in the underlying mortgages within the pools of securitized assets and over-relied on credit ratings assigned by rating agencies, which, in many cases, turned out to be wrong. Loan originators retained no residual risk for the loans they made (even though they have collected substantial fees on loan issuance and securitization), which doesn’t encourage the improvement of underwriting standards. The SEC has approved new rules, that upon taking effect in 2012, will require banks and other financial firms that issue asset-backed securities to review the quality of the underlying assets, including mortgages, credit card debt and student loans. The banks then must disclose their findings to investors and explain any discrepancies.10

7.1.2 Equipment Trust Certificates and Pass-Through Certificates The simplest forms of aircraft financings in the U.S. are secured debt and debt issued in leveraged leases to an airline. A growing percentage of the world fleet of commercial aircraft is leased by commercial aircraft leasing companies. Equipment Trust Certificates (ETCs) are a basic form of financing that depends entirely on the airline’s creditworthiness and involves the financing of a single aircraft at a time for that airline in a fashion similar to a typical mortgage. In this type of secured debt transaction, the airline and the owner of the aircraft issue equipment notes called Equipment Trust Certificates as agreements with a security trustee. This trust certificate is sold to investors in order to finance the purchase of an aircraft by a trust managed on the investors’ behalf. The trust then leases the aircraft to an airline, and the trustee routes payments through the trust to the investors. Upon maturity of the note, the airline receives the title for the aircraft.11 This is not considered a true lease since the aircraft is ultimately owned by the airline when the leasing period ends. Secured Loan Structure Purchase Price MANUFACTURER/ (Purchase Agreement) SELLER Aircraft

AIRLINE/ LEASING COMPANY

Loan Amount (Loan Agreement)

LENDER

Loan Payments

(Mortgage)

 Securities and Exchange Commission: Disclosure for Asset-backed Securities; Final Rule (17 CFR Parts 229, 232, 240 and 249) 11  Ernst & Young Global Aviation Finance (April 2017) 10

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For these kinds of transactions, it is required that the holders of the ETC have the first priority benefits when it concerns the interest of the aircraft and any related collateral. Depending on the agreed stipulations, the holders of the ETC may also have the benefits of Section 1110 in the event of the airline’s bankruptcy. The availability of the benefits of Section 1110, the status and effectiveness of the ownership and security interests in the aircraft are discussed and settled prior to entering into an ETC transaction.12 This represents an advantage that Enhanced Equipment Trust Certificates have over conventional ETCs (from the perspective of creditors); EETCs are automatically covered by Section 1110 protection, which stipulates that underlying aircraft will be available for seizure within 60 days following an uncured default. ETCs are a desirable way to finance aircraft because of the possibility of trading the equipment notes. It is also advantageous considering the protection available from airline bankruptcy for the trustees.

7.1.2.1 Pass-Through Certificates Pass-Through Certificate (PTC) offerings are an extension of the secured debt financings where different equipment notes issued for various aircraft within the airline are bundled into new securities.13 A PTC certificate is given to an investor against certain mortgage-backed securities that remain with the issuer and usually includes a single type of asset. A critical component when bundling the different equipment notes is to ensure that they have identical payment terms (Figure 7.1). For each aircraft, the airline issues equipment notes in various series with payment terms that correspond to those desired for the respective pass-through certificates.14 Each pass-through SPV purchases the corresponding equipment notes along with the proceeds from the sale of the same pass-through certificate. The purchasers of each series of pass-through certificates hold the entire beneficial interest in the pass-through trust.

• An equipment trust certificate (ETC) refers to a debt instrument that allows a company to take possession of and enjoy the use of an asset while paying for it over time. • Pass-through securities (PTS) are pool of fixed-income securities backed by a package of assets. The cash flows from the mortgage pool are passed-­ through to the investors on a pro-rata basis. Security holders receive payments from an intermediary that collects payments from a pool of assets.

 11 U.S.C. § 1110 – Aircraft Equipment and Vessels  The term “pass-through” means the issuing company has received money from the borrower and passed it to the investor 14  Structured Finance: Aircraft Securitization Criteria, Standard & Poor’s, 1999 12 13

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Borrowers Receive loans Make monthly paymentsv

Investment Bankers & Administrators Generate loans Receive monthly payments

PTC holders Invest funds Receive monthly paymants

Figure 7.1  Pass-through certificates

These certificates hold the same benefits as the single aircraft ETCs issued and are very similar except for the larger pool of aircraft. As in the ETCs methodology for secured financing, at the end of the leasing period, the airline owns the aircraft. Legal opinions on the validity and enforceability of the pass-through certificates must be obtained before entering into such a financing agreement. Typically, the pass-through certificates are sold in arms-length transactions to disinterested third-party investors. For each pass-through trust, these certificate holders constitute the owners of the trust. This ownership structure ordinarily does not raise the types of risks arising because of the owner participant’s role in a leveraged lease that would result in additional opinions and requests. For example, assume a banker sells $100,000,000 of pass-through certificates in $10,000 denominations. Monthly collections of interest and principal are remitted to certificate holders, except a portion of the annual principal that the administrator or banker keeps as a servicing fee.

7.2  Bankruptcy Protection Issues

7.2

275

Bankruptcy Protection Issues

The Air transport industry has had more than its fair share of financial uncertainty and bankruptcy risk over the years (Table 7.1). The industry has been at the center of the major financial crises from the financial markets collapse of New York City in the mid-­1970s, the Asian financial crisis of 1997–1998, the Enron financial meltdown of 2001, to the global financial crisis of 2007–08, and Coronavirus pandemic of 2020–21. More recently Germania, WOW Air France’s Aigle Azur and XL Airways, Adria in Slovenia and perhaps most dramatically, Thomas Cook in the UK seized operations. All of these cost investors globally hundreds of billions of dollars. When organizations or businesses are no longer able to repay all of their financial obligations, they may file for bankruptcy. Bankruptcy is a court proceeding Table 7.1  United States Airline Bankruptcy Filings, 2005–2020 US Airline Delta Comair MAXjet Aloha Airlines Gemini Air Cargo Sun Country Air Midwest Frontier Airlines ATA Airlines Skybus Primaris Airlines Mesa Gulfstream International Airlines Arrow Air American Airlines Global Aviation Holdings Ryan International Airlines Pinnacle Airlines Direct Air Comair Southern Air Seaport Airlines Dynamic International Airways PenAir Island Air Seaborne Airlines Onejet California Pacific Airlines Via Airlines Miami Air International

Year 2005 2005 2007 2008 2008 2008 2008 2008 2008 2008 2008 2010 2010 2010 2011 2012 2012 2012 2012 2012 2012 2016 2017 2017 2017 2018 2018 2019 2019 2020

Bankruptcy action Chapter 11 Chapter 11 Chapter 11 Chapter 7 Chapter 7 Chapter 11 Chapter 7 Chapter 11 Chapter 7 Chapter 7 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 7 Chapter 7 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 11 Chapter 7 Chapter 11 Chapter 11 Chapter 11

Source: Air Transport Association and Company Annual Reports 2020

Ceased operations – – 24-12-2007 31-03-2008 12-08-2008 – 30-06-2008 – 02-04-2008 05-04-2008 – – – – – – – – Apr-12 Sep-12 – – – – – – – Oct-20 Oct-19 May-20

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where an institution informs a judge that the institution cannot meet its financial obligations.

7.2.1 Chapter 11 Bankruptcy Reorganization If we went into the funeral business, people would stop dying. —Martin R. Shugrue, Vice chairman Pan Am

Under Chapter 11 of the United States Title 11 Code, an aviation company can file for bankruptcy protection to restructure/reorganize the company.15 Under Chapter 7 of the same Bankruptcy Code, the company ends operations, all non-exempt assets are liquidated, and the proceeds are distributed to the creditors.16 Chapter 11 bankruptcy proceedings allow the trustee (who may be the debtor) to operate the debtor’s business. A Chapter 11 filing means that the business intends to continue trading while the bankruptcy court supervises its debt and contractual obligations. Both creditors and owners must vote for the reorganization plan before the reorganization can be confirmed by court action and become effective. The court does have the power to cancel all or some of the company’s debts, including unsecured loans, vendor and customer contracts and real estate leases. Emerging from a Chapter 11 bankruptcy may take months or several years depending upon the size, complexity and terms of the bankruptcy. Chapter 11 gives the debtor a fresh start, subject to the debtor’s fulfillment of its obligations under its reorganization plan. Thus, Chapter 11 is often the choice of large businesses looking to restructure their debt; this particular chapter in the Bankruptcy Code places no limit on the amount of debt. The rate of successful Chapter 11 reorganizations is estimated at 10% or less. If the company is unable to recover from its debt, the ownership of the reorganized company will transfer to the company’s creditors. The most significant Chapter 11 filing by an aircraft corporation was in 2002 when the UAL Corp. filed with over $25 billion in assets; Delta followed in 2005 with $22 billion in assets.17 UAL Corporation and its subsidiaries emerged from bankruptcy protection 4 years after it filed in 2006, while Delta emerged from Chapter 11 protection 2 years after it filed in 2007.18 Chapter 11 is a chapter of Title 11, the United States Bankruptcy Code, means that the business intends to continue trading while the bankruptcy court supervises the company restructure its debt and contractual obligations. The court does have the power to cancel all or some of the company’s debts including unsecured loans, vendor and customer contracts and real estate leases.

 11 U.S.C. § 1121 - The Plan.  11 U.S.C. § 726 - Collection, Liquidation, and Distribution of the Estate. 17  New Generation Research Inc. – Bankruptcy Data. 18  Delta News Release April 30, 2007. 15 16

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The key component of Chapter 11 reorganization related to aircraft finance is Section 1110 of the Bankruptcy Code. Once a debtor files for bankruptcy, the Code’s automatic stay (as outlined in Section 362) prevents a secured creditor from repossessing its collateral as long as the collateral is “adequately protected.” However, following a default, Section 1110, generally limits the period in which airlines must decide whether to become current under the obligations owed to secured aircraft creditors or return the aircraft to the secured creditors for sixty days. There are several potential options for the airline under this Code section: • Under section 1110(a), the debtor may make an election to keep the automatic stay in place. However, in so doing, the company must pay the debtor the monetary remedies due (even if it is not affirming the underlying financing terms). • Section 1110(b) allows a debtor to agree, jointly with the creditor, to an extension beyond the sixty days under an “1110 Stipulation”. This would need to be negotiated and some monetary implications may result. • Section 1110(c) allows the creditor to repossess the aircraft and the debtor must immediately return it upon delivery of written demand notice. This means that a creditor in this U.S. construct may have a high degree of certainty over an event of default. The airline will either “affirm” or “reject” the individual aircraft within 60 days. A creditor will continue to receive money owed, or the aircraft itself will be promptly returned, easing repossession concerns. While there are definite benefits of this provision of the Code to creditors of airlines and other aircraft debtors, the airlines also benefit from this provision. Creditors have recognized through many applications of this provision that U.S. bankruptcy laws allow for prompt payment or return of the subject collateral to the creditor. As such, creditors have been able to offer U.S. aircraft debtors more favorable terms to reflect this reduced level of risk. The internationalization of this provision is also evidenced in many of the provisions of the UNIDROIT Convention on International Interests in Mobile Equipment (the Cape Town Convention).

7.2.2 Chapter 7 Liquidation Chapter 7 (sometimes referred to as straight bankruptcy) of the Title 11 of the United States Code governs the liquidation process that occurs when a company or individual files (or is forced by its creditors to file) for bankruptcy in a federal court. Chapter 7 is available to individuals, married couples, corporations and partnerships. However, debtors engaged in business would usually not prefer the option of liquidation and Chapter 11 might be a better option for persons associated with corporations and partnerships. Under Chapter 7, the business ceases all operations unless the operations are continued by a court-appointed trustee. The trustee is usually appointed almost immediately, with extended powers to examine the business’s financial affairs and generally sell all the assets and distribute the proceeds to the creditors. Fully secured creditors, such as collateralized bondholders or mortgage lenders, have a legally

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enforceable right to the collateral securing their loans or to the equivalent value, a right which cannot be voided by bankruptcy. For an individual filing Chapter 7, a discharge of all qualified debts usually occurs within 4 months.19 A corporation and partnership, however, do not receive a similar discharge of debts; instead, the entity is instead dissolved. The debts of the corporation or partnership theoretically continue to exist until all applicable statutory periods of limitations expire.20

7.3

Aircraft Lease Securitization

Aircraft lease securitization has become a very important source of capital for airlines as well as aircraft operating lessors. In the past few years, many aircraft leasing companies have engaged in portfolio securitizations as a means of accessing new sources of capital.21 Usually, aircraft lease securitization takes one of the following two structures: The aircraft lease receivable securitization, which is like any other securitization, is called an aircraft lease portfolio securitization. The second structure includes the utilization of Enhanced Equipment Trust Certificates (EETCs), which is a unique methodology employed mainly within the limits of the aviation industry. The EETCs are a result of the enhancement of the creditworthiness of the traditional Equipment Trust Certificates (ETCs). The main difference between the ETC structures and the portfolio securitizations is that the securitizations are not directly linked to the credit quality of a particular airline (Table 7.2). Debt securitization is the financial practice of combining different types of debt obligations such as; aircraft leases, residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations.

7.3.1 Aircraft Lease Portfolio Securitizations Aircraft lease portfolio securitizations depend on the value of the aircraft and the attached leases, which involve a large number of airlines and several aircraft. The airlines are typically located in different geographic regions of the world and provide the benefit of diversification of risk. The aircraft asset risk is vastly diversified in comparison to the other securitization methodologies discussed previously due to  11U.S.C. § 721 – Collection, Liquidation, and Distribution of the Estate.  11U.S.C. § 727(a)(1) – Discharge. 21  William C. Bowers, Aircraft Lease Securitization: ALPS to EETCs, 1998. 19 20

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Table 7.2  Characteristics of ETCs, PTCs and EETCs Size Liquidity Collateral age Aircraft diversification Rating enhancement (from senior unsecured)

ETCs Small ($25–$65 million) Low Average to old

PTCs Small to medium ($60–300 million) Medium to low Average to young

Maybe S&P and Moody’s Tranche A: 6–8 notches Tranche B: 2–6 notches Tranche C: 0–4 notches

Maybe S&P:

EETCs Large (up to $1 billion) Above average Less than average to very new Low to High S&P:

2 notches (HY)

2 notches (HY)

1 notch (HG)

1 notch (HG)

Moody’s:

Moody’s:

2 notches for all

2 notches for all

Source: Enhanced Equipment Trust Certificate (EETC) Primer, J.P.  Morgan U.S.  Corporate Research, January 2006

the combination of airlines and aircraft models. This diversification also has a varying degree of consequences. Within this form of securitization, the process itself may vary significantly depending on the portfolio size and the legal implications of having the airlines and aircraft operating in various geographic regions and under a variety of laws and structures. The type of financial asset being securitized can also vary, and structures may be expanded to include operating leases, tax-oriented finance leases, and loans. Aircraft lease portfolio securitization refers to the securitization of the receivables generated from the leases of the planes in the SPV. This is like any other kind of securitization and relies on a diversified portfolio of aircraft on operating leases to a number of airlines. These airlines could be in most countries (certain exclusions such as North Korea, Iran, etc. exist where there is a concern over the possibility of aircraft repossession in the event of default), and the rating of the debt securities issued are based on the existence of a worldwide aircraft leasing market and the estimated residual values of all the aircraft in the portfolio. The rating agencies and the ultimate investors in these types of securitization look to a variety of factors in assessing the risk and ultimate pricing of the transaction. As a general matter, the securitization of the portfolio is not simply an NPV analysis of the individual leases attached to the aircraft that contributed to the SPV underlying the transaction. Instead, the analysis goes to the aircraft itself and the future rental generation capacity of the asset. Similar to the analysis one would do in a REIT to the underlying cash generation capacity of the portfolio of real estate over their useful life, the aircraft lease portfolio securitization looks to the aircraft assets as the “moveable real estate” that will generate cash flows into the securitization waterfall where they will be applied against the various expenses and debt service costs of the transaction.

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Each of the aircraft which are contributed to the SPV will have a stream of cash flows that are currently contracted at the close of the transaction. At the closing of the deal, the SPV will have acquired each of the aircraft, and each individual lease attributable to each plane would need to be novated such that the SPV, as the new owner of the assets, would receive the payments from the airline lessees. There would be an assigned servicer to the special purpose company as well. This servicer is usually an established aircraft lessor who has the blessing of the rating agencies to act in that capacity. This servicer analysis is an integral part of the rating criteria and certain servicer with less experience may need to be supplemented by the addition of a contracted “back-up servicer” in the event of default. The servicer’s duties are to make sure the aircraft are leased, meet maintenance requirements, are re-­ leased upon lease expiration, etc. The cash flow generation of the planes depends on not only the type and quality of the aircraft, but the track record of the servicer in getting planes re-leased quickly and at attractive rates. The ratings agencies and investors will look at the servicer quality, the aircraft the SPV will own, and the initial lessee pool, amongst other factors. The general perception is that narrow-body aircraft in such securitizations are preferable to wide-body pools of planes. The reason for this is that there is a larger installed base to which the aircraft may be re-leased into and the fact that during most cyclical downturns, the first aircraft to be pulled out of service are the wide-body planes used on intercontinental routes by legacy carriers. Another point of note is that the younger the aircraft in the securitization pool, the better. The reason is that younger aircraft have a longer remaining useful life which translates into a longer period of time that the plane may be leased out to generate cash flows to service debt (which also means that the planes will have a higher residual value). In terms of lessees, investors and the agencies will know that better-credit lessees also usually are accompanied by lower cash flows from the contracted leases, reflecting the better credit quality of those airlines. As such, there is a tradeoff between having high-quality lessees and lower cash flows to service debt. The real key to lessee analysis is maximizing diversification in the airlines lessees, as well as geographic diversity. The logic is that the threat to having multiple airlines across geographies defaulting in the same time frame is diminished with greater numbers in these factors. Diversity in aircraft type can also be helpful, but that is also a function of the target pool. For example, diversifying a pool of narrow-body 737-700s and -800s by adding very old 747-200s is not helpful. Once the cash inflows are analyzed, sensitivities are modeled using Monte Carlo simulation. The modeling will assume a certain number of defaults will occur at once, and the cash flows will then be analyzed to see what cash will be available under various stress scenarios to meet the expenses of paying the servicer, meeting interest and principal payments, etc. The cost elements of the securitization are laid out in an explicit securitization “waterfall”, which outlines the priority of each payment. A sample securitization waterfall is provided in Table 7.3. The first international portfolio securitization was a transaction called Aircraft Lease Portfolio Securitization (ALPS 92-1). ALPS 92-1 was the first securitization of big-ticket items of leased property, i.e., aircraft with values from $15 million to

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Table 7.3  Indicative securitization “waterfall” priority of payments after collections Priority Payments 1 Required Maintenance Payments and Expenses 2 Interest on Class A Notes, Senior Hedge Payments, Senior Liquidity Facility Undrawn Fees 3 Senior Liquidity Facility Drawn Fees and Replenishments of Senior Liquidity Facility for Previous Draws 4 Monoline Insurance Premium (if applicable) 5 Class A Notes Minimum Principal Repayment 6 Maintenance Support Account Reimbursements 7 Interest on Class B Notes and Junior Liquidity Facility Undrawn Fees 8 Junior Liquidity Facility Drawn Fees and Replenishments of Junior Liquidity Facility for Previous Draws 9 Class B Notes Minimum Principal Repayment 10 Class E Holder Contribution Reimbursemenets/Cure Advances 11 Interest on the Class E Notes 12 Share Capital Margin Payments 13 Subordinate Hedge Payments 14 Discretionary Modification Payments 15 All Outstanding Class A Notes 16 All Outstanding Class B Notes 17 Additional Monoline Insurance Premium (if applicable) 18 All Outstanding Class E Notes Please note that, in the event of default, such a priority of payments may shift into a default priority of payments

$80 million.22 The ALPS 92-1 constituted a portfolio of 14 aircraft on lease to 14 lessees in 12 countries (not including the U.S.) and had an aggregate appraised value of U.S. $521 million. All lease securitizations prior to the ALPS 92-1 involved large portfolios of small-ticket items, and this was the first securitization of big-­ ticket items with values greater than the U.S. $15 million. The structure of the transaction, ALPS 92-1, was such that its debt was to be paid from aircraft sales 18 months prior to the maturity date. ALPS 92-1 was required to create a sinking fund by selling aircraft throughout this period. The primary credit risk in an aircraft securitization is a reduction in cash flows due to a combination of airline delinquency and a reduction in the value of the aircraft. In the case of ALPS 92-1, if it could not meet any of the required goals, the aircraft would be sold at levels sufficient to pay the senior debt. This financial structure forced aircraft sales within a limited period and required that sales proceeds be held in low-return investments. Each country in which a lessee was located was completely vetted, and each lease was carefully reviewed to ensure that it met certain legal standards. Similar standards were applied to the aircraft deliveries, adding to the time period between the initial funding and the transfer of the last aircraft.23 22 23

 Capital Markets. Aircraft Lease Securitization: ALPS to EETCs, 1998.  William C. Bowers, Aircraft Lease Securitization: ALPS to EETCs, 1998.

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ALPS 94-1 was the second ALPS transaction of a portfolio of aircraft on operating leases. It had the same legal structure as the ALPS 92-1 but differed otherwise. First, it was larger in size; this portfolio constituted leasing 27 aircraft to 22 lessees in 14 countries outside of the U.S. with a base value of U.S. $998 million. The aircraft in ALPS 94-1 had a lower average age, and the special purpose company was given more flexibility in selling aircraft to pay down the debt, although the aircraft were required to be sold once their lease term expired. If a lessee defaulted, then a new lease and aircraft would have to be substituted in the portfolio from a designated backup pool of aircraft. The financial structure of the ALPS 94-1 involved three multi-tranche classes of investment-grade senior debt. The debt was partially amortizing, with each class of debt having an expected repayment based on the assumption that the aircraft would be sold at the end of their leases and the sales proceeds would repay the debt. The expected maturity dates for the ALPS 94-1 were not as rigid as its predecessor. Also noteworthy is that a failure to repay principal on the said date was not to be considered as a default. A default was considered to have occurred only if all principal was not paid by the final maturity date. However, if any class of debt was not paid within 1 year after its expected maturity, the interest rate on that class would increase in order to motivate the ALPS 94-1 to sell the aircraft rather than leasing them. A default could also occur due to a failure to pay interest on the senior debt. In 1996, Lehman Brothers closed its refinancing of Guinness Peat Aviation (GPA)’s original aircraft securitization-ALPS 92-1. This deal was known as the ALPS 96-1. The passage of time has revealed several weaknesses in the ALPS 92-1 deal. One was the incapacity of the structure to deal with a fall in aircraft values, and another was the cost involved in moving the aircraft from GPA’s books to the ALPS portfolios. The refinancing was modeled on the ALPS 94 GPA securitization and involved the issue of $383531750144A (most aircraft lease portfolio securitizations rely on this safe harbor from the SEC registration requirements) pass-through certificates in four tranches. The 10-year notes had an average life of 6 years. Under the original ALPS 92-1 transaction, remarketing of the 14 aircraft in the ALPS portfolio was to begin 18 months prior to the maturity of the instruments. The portfolio included four 737-300s on lease to Malev, Istanbul Airways, British Midland and Asiana; a 737-500 on lease to China Southern Airlines, a 747-200 with Philippine Airlines; a 757-200 with Transwede; two 767-300ERs, one with Spanair and another on lease through Whirlpool Financial Corp; two MD-83’s- one with TWA and the other with British West Indian Airlines; an A300B4 with Air Jamaica; an A320-200 with Canadian Airlines and a Fokker 100 on lease to Portugalia. Nevertheless, the sharp fall in aircraft values since the deal was signed in 1992 meant that this remarketing exercise became inappropriate. In this growing environment, securitization provides a dependable source of aircraft funding for the industry. Securitization is the packaging of assets and/or cash flows backed by credit enhancement and liquidity support into a tradable form through the issuance of securities that are secured by the assets and serviced from the cash flows generated by the assets. For example, a company may obtain new capital through asset securitization through selling its account receivables.

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283

Securitization gives potential borrowers access to international capital markets, thus increasing the availability of funding. In most cases, securitization produces a lower cost of funds and enables a borrower to diversify away from traditional bank sources of financing into the capital markets.

7.3.1.1 Airline Default and Credit Risk In the cyclic world of commercial aviation, marked by a series of upturns and downturns closely linked to the world economy, the risk of airline default on leases and loans is an important consideration that lenders, investors and the airlines themselves have to take. Lenders who finance an aircraft purchase or invest in asset-­ backed securities face the risk that the airline will default on its loans, particularly during periods of high oil prices when airline-operating expenses on jet fuel increase significantly. If the airline defaults on a loan, the lender then has to go through the process of repossessing the aircraft and trying to sell it to another airline. This presents additional problems since airline bankruptcies tend to occur during times of economic downturns, which is exactly the time when the market for used aircraft is depressed. Taking into account these risks, the unregulated practice of credit swaps began. Credit swap refers to a credit default swap where a contract is created between parties to transfer the credit exposure of a fixed income product. Credit swaps are often used by financial institutions to protect against debt losses. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt Harrington (2011). This cost of protecting airlines from default increases and decreases over time; as oil and jet fuel prices attain new highs, the cost of this protection increases. 7.3.1.2 Asset Risk Asset risk involves the risk that market changes or poor investment performance of a financial asset will create. The asset risk typically involved with an airline is that of aircraft value. Operating leases do not keep the residual value risk with the airline. Aircraft lease securitizations will generally have annual reviews to update their base values; EETC securities, as described in Section 7.3.2, do not have annual reviews. EETCs are more exposed to market value risk where the stress on aircraft values will keep market values below base values for an extended period. 7.3.1.3 Repossession Risk When an airline defaults on its financial obligations to lenders, the lessor/lender has to decide if repossession of the aircraft should occur. Under the United States Uniform Commercial Code (2010), a lessor may repossess an aircraft under default without judicial process if it will not breach the peace. In many cases, allowing continued operations may be a preferred option to repossession. Even where an airline is not making lease rental or debt payments, it may be preferable for the lessor or lender to allow continued operations, at least for a fixed period of time, so that aircraft and engine records, manuals and technical logs can be recovered in an orderly manner; a collection of these records may not be feasible when an aircraft

284

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or engine is seized at short notice.24 A successful repossession requires that airframe, maintenance and engine records are recorded in their entirety while ferry flight, storage and aircraft remarketing post-repossession can all be carried out under a feasible schedule.

7.3.1.4 Quality of Servicer An essential element in aircraft lease securitization is the quality of the servicer of the portfolio, in monitoring the performance of the lessees and in re-leasing and selling the aircraft both at the normal expiry of leases and in the case of lease defaults (Bowers, 1998). The servicer of the portfolio may be employed in a range of capacities including, but not limited to, post-default management and workout, asset valuation, insurance, customer service, collateral perfection and management, collections and loss and litigation.

7.3.2 Enhanced Equipment Trust Certificates Enhanced Equipment Trust Certificates (EETCs) are a type of debt security issued by individual airlines to finance portions of their fleet of aircraft, and the debt is secured by a pool of aircraft or related collateral. As their credit ratings slid to sub-­ investment grade or high yield corporate ratings, they needed additional structural enhancements to increase the credit quality of the bonds, and the EETC was created. Contrary to corporate debt securities, a bankruptcy filing by the borrower does not equal a default for EETCs. Following the success of ALPS 92-1, American bankers began to consider how the principles of portfolio securitization might be applied to an individual airline. By the mid-1990s, the combination of the improved status of secured creditors in an airline’s reorganization filing with the bankruptcy court and the availability of tax equity created the pass-through trust or equipment trust certificate. The tax investor (typically a financial institution without sufficient assets to create a dent in their tax bill) needed a long-term lease to depreciate the aircraft. However, at the same time, U.S. banks were pulling out of the financing markets. The bond markets were ideal to source long-term funding at a fixed interest rate. While the financial fortunes of the airlines were worsening, their capital needs were increasing (Figures 7.2 and 7.3). The EETC structure is a type of financing that has less to do with the market and more to do with the need for capital.25 Under the EETC structure, the noteholder has two ultimate recovery sources should a default ever occur; the collateral backing the bond/notes and a claim on the airline itself.26 Consequently, EETCs are not non-­ recourse, unlike most aircraft pooled asset-backed securitizations. The addition of an unfunded bank line to cover the cost of repossessing the aircraft and remarketing it to obtain the proceeds to repay the creditors was the enhancement needed to gain  International Bureau of Aviation: Repossession. 2011.  Air finance Journal. Coggeshall: Nov 2007. 26  Joel Shpall, Up in the Air: Finding Value in Aircraft EETCs, March 2010. 24 25

7.3  Aircraft Lease Securitization

Mortgage Loan $

Manufacturer $

Finance Lease

Airline

285

Equipment Trust

Principal and interest pmts. $

EETC Investors

Loan Payments Leasing Trust

Lease Payments

Tax Equity Overflow Equity Investors

Figure 7.2  Structure of EETC Financing for Leased Aircraft. (Source: Adopted by the authors from Enhanced Equipment Trust Certificate (EETC) Primer, J.P. Morgan U.S. Corporate Research, January 2006) Figure 7.3  Structure of EETC Financing for Owned Aircraft. (Source: Adopted by the authors from Enhanced Equipment Trust Certificate (EETC) Primer, J.P. Morgan U.S. Corporate Research, January 2006)

EETC Investors

Principal and interest pmts.

$

Equipment Trust Loan Payments

Mortgage Loan $

Airline

$

Manufacturer

the additional credit quality in the transaction resulting in cost savings in the interest rate. Additional means of increasing the credit quality include: • Lower the advance rate or loan-to-value (“LTV”) below 100% of the appraised value: By lowering the LTV, more over-collateralization is created  - a buffer allowing for more certainty of recovery of principal in the unlikely event of the airline’s default and rejection of the mortgage or lease with the issuer.

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• Residual value guarantee: While not commonly used, certain insurance companies, banks or sometimes a manufacturer may provide investors with an insurance product enabling them to put the aircraft back to the insurance provider should it be worth less than the insurance amount and recover any shortfall under the outstanding principal. • Monoline insurance cover: The 2003 to 2007 period saw many issuers take advantage of a risk arbitrage product provided by the monoline insurance community. The monolines were in the business of providing investors with an unconditional guarantee to repay the investors. Their rating was Aaa/AAA by Moody’s and S&P. As the underlying transaction rating was either A2/A or Baa1/ BBB+, the spread differential for the issuer between the unguaranteed transaction and the Aaa/AAA guaranteed one was higher than the cost of the guarantee. Given the events of 2008 and the downgrades of the monoline insurance companies, this arbitrage no longer exists. • Cash liquidity reserve: To bridge shortfalls in cash flows under a lease or mortgage, a cash reserve may be incorporated to pay for all amounts due under the transaction. • Cross-subordination: EETCs are typically issues with several levels of debt or tranches. Each tranche is junior in a claim to the collateral to the more senior tranche(s). Under “normal” par recovery circumstances, aircraft can be liquidated to pay off the entire principal value of each equipment note, so Class A EETCs recover the full value of Series A Equipment Notes, etc. However, cross-­subordination unlocks value for A-Tranches by allowing them to recover Series B and C Equipment Note principal if aircraft recoveries are deficient. In the “Distressed Recovery” example shown here, the recovered balance of Series A notes is only $65MM, less than the Class A EETC balance of $90MM.  But by claiming the value of the subordinate tranches, the Series B and Series C Notes, Class A EETC holders recover par – at the expense of Class B and C EETC holders, who recover nothing from the aircraft value. • Cross-default: In the event of default under any existing indenture, the notes may cause a default under other indentures to which the cross-default provision applies. This is further described in Section 7.3.2.1. It should also be noted that such clauses may now also be accompanied by cross-collateralization.

7.3.2.1 Cross-Collateralization As EETCs continue to mature, new provisions have been built in overtime to assist with market placement and to address issues for investors and the airline seeking to lower its debt pricing. One such innovation was cross-collateralization. After JetBlue’s 2004 transaction and Continental’s 2007–1 EETC, often EETC transactions now provide for cross-collateralization of indentures such that, in the event of default, the defaulted equipment notes underlying an EETC may first cross-default other indentures (as noted above) and under a cross-collateralization provision will share in the proceeds from any dispositions under one or more of the various

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287

Table 7.4  EETC milestones Year 1994 1996 1997

1998 1999 2001 2004 2009 2020

Event NWAC issues first EETC CAL issues first EETC with both owned and leased aircraft NWAC issues first EETC utilizing prefunding FDX becomes first investment grade EETC issuer FDX issues first EETC backed by Cargo aircraft collateral Atlantic Coast Airlines issues first EETC backed by turboprop aircraft collateral CAL issues first EETC backed by regional jet collateral United issues first floating rate EETC CAL issues first EETC with bullet tranche Iberia becomes first non-U.S. based EETC issuer DAL widens pricing but successfully closes post 9/11 on a pre 9/11 syndicated EETC JBLU issues EETC under revised template where interest due on the junior notes are payable prior to principal on the senior notes CAL issues first EETC with full cross-default under the mortgages Hawaiian issues EETC’s to obrain financing secured by eight Airbus aircraft. United prices single tranche EETC. UA proposed $3 billion enhanced EETC transaction. Spirit EETCs downgraded.

indentures. EETCs can also be utilized for small portfolio securitization transactions called multi-airline EETCs (Table 7.4). Airlines that incur millions of dollars of new debt through EETCs lose some degree of financial flexibility. The risks associated with the loss of flexibility could reduce an airline’s credit rating for unsecured debt. In these financings, the airline credit is typically undiversified, but the aircraft portfolio may consist of one model of a plane or several, allowing some credit for diversifying asset risk. EETCs have become the predominant capital markets vehicle for U.S. airlines to finance aircraft, and they have generally withstood market ups and downs. In 2007 EETCs were strong with $4.2 billion in offerings from Continental, United, Southwest, Northwest, and Delta. However, in 2008, as the financial markets worsened, EETCs began disappearing. This lack of issuance lasted through mid-year 2009, at a point where it was thought that the structure would never come back or would take years to return after major structural modifications. In July 2009, Continental Airlines offered an EETC of $390 million, and American Airlines offered EETCs of $520 million to test the market. In October 2009, Continental and United offered EETCs of $644 million and $659 million, respectively. United and Delta Airlines pursued the following EETC offerings in November 2009, respectively: $810 million and $689 million. In 2009 airlines were pressured to offer more favorable economics than the 2007 EETCs to investors in order to spark a return of investors to the market. The coupons on the senior A tranche in the first two of the 2009 EETCs were 9% and 10.37%, while the A tranche in 2007 ranged between 6% and 7%. Nevertheless, the airlines were able to reduce the offered coupon on the A tranche in the later transactions in 2009 as the EETC market continued to improve. Furthermore, the EETCs had much shorter debt maturities than their predecessors in 2009. The tranche

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Cross-collateralization denotes that the collateral from one loan also secures other loans. In its easiest form, as a result one loan secured by several aircraft in a pool. When the borrower defaults, the lender has recourse to all the aircraft to secure repayment.

maturity in the 2007 EETCs ranged between 12 and 15 years, whereas in 2009, the EETCs ranged between 6 and 9 years. • The following are vital characteristics for financings that allow a higher rating: • Debt tranching, providing for various levels of over-collateralization. • Dedicated liquidity facilities, which usually pay interest only while an aircraft is being repossessed and sold. • Soft amortization scheduling, so that interest is paid on a fixed schedule, but the principal is legally not due until the final maturity date. • Reliance on a secure legal mechanism to assure access to the collateral on a timely and predictable basis.

7.3.3 Tranching Tranche is a French word meaning slice. Tranches are portions created from a pool of securities such as bonds or mortgages that are divided up by time to maturity, risk, or other characteristics in order to be marketable to different investors. EETC tranching before 2009 had different levels of strict subordination, but in early 2009 EETC arrangers said that investors preferred simplicity in EETC structures. This concern contributed to the simplification of the tranching of EETC certificates; Continental and American offered only a single tranche of EETC certificate in July 2009. However, as the EETC market continued to improve in the second part of 2009, Continental, United and Delta offered two tranches. The first EETCs generally included a strict subordination payment; waterfall payments of principal and interest on senior tranches were paid before any payments were made on junior

7.3  Aircraft Lease Securitization

289

tranches.27 The two 2009 July offerings each only had one tranche, while the later 2009 EETCs had multiple tranches preserving the modified 2004 waterfall. If the airline wanted to grant a liquidity facility for a subsequently issued tranche, it would have to supply security to the liquidity provider outside the EETC deal, such as a lien on additional aircraft or a letter of credit.

7.3.4 Liquidity Facility A liquidity facility covering interest on the applicable tranche for a number of interest periods is usually provided for the most senior tranche and may be provided for one or more junior tranches in order to obtain an enhanced rating for EETCs. During the course of 2008 and 2009, some of the financial institutions were either downgraded or left the air-finance markets, which previously appeared as liquidity providers for EETCs. From six EETC transactions that took place in 2009, three of the liquidity providers were affiliated with one of the underwriters of the transactions, and for the other three, the same foreign bank was engaged as the liquidity provider acting through a New York branch. Also, all of the EETCs in 2009 were configured as pre-funded agreements; the proceeds from the issuance of EETC certificates were placed in escrow to be used to purchase equipment notes in accordance to subjecting one or more aircraft to the EETC transaction in a future date. Due to this problem, the availability of depositories was constrained while the pool of liquidity providers in 2009 was reduced. EETCs add a dedicated source of liquidity support to pay interest and tranche the debt to increase the likelihood of repaying the principal on the securities that have been rated higher than the airline’s unenhanced ETC rating. The liquidity facility in the U.S. financings must cover 18 months of debt service, and the tranched debt can achieve ratings up to three full rating categories above the airline’s Section 1110 unenhanced ETC rating. One of the more attractive features to investors to market junior tranches introduced in 2007 EETCs was to provide holders of junior tranches of EETCs the right to buy out senior series of equipment notes issued under certain individual aircraft indentures. However, due to the EETC arrangers’ concerns about the simplification and making the senior tranche more attractive to investors, this buy-out right was eliminated in the 2009 EETCs. Nevertheless, junior tranches did retain the right to buy out in whole the tranches of the EETC to which they were junior in an airline bankruptcy.

7.3.5 Cross-Default Cross default and selective redemption were not provided among the aircraft indentures in the deal until 2007. In case of bankruptcy, the airline could pick and choose which of the aircraft in an EETC to keep and which aircraft to abandon. In order to hinder the airline’s aptitude in bankruptcy to abandon aircraft selectively, the 2007 27

 Air Finance Journal, May 2010.

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7  Aircraft Secured Bond Transactions and Securitization

structure included a limited cross-default among the indentures providing that in the event of default under any indenture existing at the final maturity date, the notes having the latest maturity date would cross-default all of the other indentures. For instance, a cross-default clause in a loan agreement may say that an individual automatically defaults on his mortgage if he defaults on his car loan. The limited cross-­ default to apply to all indentures at any time was broadened in the 2009 transactions, and the latest structure obliterated the right of airlines to do selective redemptions of equipment notes relating to individual aircraft that the airlines deem more desirable to pull from the collateral pool.

7.4

Credit Rating Agencies

Credit rating agencies play a crucial role in the financial system and play a crucial role in the airline world. The main concern of any creditor is whether a borrower is likely to meet its contractual agreement. Therefore, investors depend on credit rating agencies for independent evaluations. The credit rating agencies offer judgments and assess the creditworthiness of a corporation’s debt issues and serves as a financial indicator to investors as to the likelihood that a borrower will not default on the principal and interest on time and in full. These ratings are assigned by the credit rating agencies of which Moody’s Investor Service, Standard & Poor’s, and Fitch Ratings have the majority of the world market share.28 Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions. These agencies assign letter designations to their rating opinions; for example, AAA as a representation of quality ranging from Prime and High Grade at the top of the scale to Substantial Risks and In Default at the bottom of the scale.29 The global financial crisis of the late 2000s brought increased scrutiny to credit rating agencies’ evaluations of complex structured finance securities. The following major credit rating agencies are often the subject of criticism from countries whose public debt is downgraded, generally causing increased cost of borrowing due to the downgrade.

7.4.1 Standard & Poor’s Standard & Poor’s is a U.S.-based division of The McGraw-Hill Companies and began in 1860 as a book detailing the financial and operational state of U.S. railroad companies. McGraw-Hill acquired the company in 1966. Since its inception, it has grown to become a credit rating agency that issues both long and short-term credit ratings on more than $32 trillion in outstanding debt. Standard & Poor’s is also

 See, Partnoy (1999, 2002), Richardson and White (2009), and Sylla (2002).  Morgan Stanley Smith Barney, Bond Perspectives: An Educational Look at Bond Credit Ratings (2009).

28 29

7.4  Credit Rating Agencies

291

widely known for maintaining one of the most widely followed indices of large-cap American stocks: the S&P 500.30 Standard & Poor’s ratings range from AAA, AA, A, BBB, BB, etc., with pluses and minuses. An obligor rated ‘AAA’ has an extremely strong capacity to meet its financial commitments. An obligor rated ‘SD’ (selective default) or ‘D’ had failed to pay one or more of its financial obligations (rated or unrated) when it came due. For some borrowers, a credit watch is issued, which indicates whether it is likely to be upgraded, downgraded or uncertain.

7.4.2 Moody’s Investor Service Moody’s was founded in 1909 in a similar way to Standard & Poor’s; a book was published about railroad securities, using letter grades to assess their risk. Later, in 1914, Moody’s Investors Service was incorporated extended coverage to U.S. municipal bonds. By 1924, Moody’s ratings covered nearly 100% of the U.S. bond market. In the 1970s, Moody’s expanded into commercial debt and also began the practice, along with other rating agencies, of charging bond issuers for ratings as well as charging investors.31 A lawsuit filed by groups including Abu Dhabi Commercial Bank and King County, Washington, against Standard & Poor’s and Morgan Stanley along with Moody’s, alleged that these agencies inflated their ratings on purchased structured investment vehicles.32

7.4.3 Fitch Ratings Fitch Ratings is the last of the three Nationally Recognized Statistical Rating Organizations designated by the U.S.  Securities and Exchange Commission in 1975, along with Moody’s and Standard & Poor’s. The organization is dual-­ headquartered in London and New York, with 50 offices worldwide, and dedicated to credit opinions, research and data. Fitch Ratings’ long-term credit ratings are assigned on a similar alphabetic scale from ‘AAA’ to ‘D’. Fitch’s short-term ratings indicate the potential level of default within a 12-month period and range from the highest quality grade F1+ to grade D (in default), creditors.33 The leading credit rating agencies, including Fitch, were accused of misrepresenting the risks associated with mortgage-related securities, which included the collateralized debt obligation (CDO) market. A CDO is a type of structured asset-backed security (ABS). There were large losses in the CDO market that occurred despite being assigned top ratings by the credit rating agencies.  Standard & Poor’s, A History of Standard & Poor’s (2021).  Moody’s Corporation, Moody’s History: A Century of Market Leadership (2011). 32  CBS News, Moody’s to pay nearly $864 million to settle claims it inflated ratings, JANUARY 14, 2017. 33  Fitch Inc., Fitch Ratings: Overview (2011). 30 31

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7  Aircraft Secured Bond Transactions and Securitization

7.4.4 Altman Bankruptcy Index Although not used within the securitization context, Edward Altman, between 1946 and 1965, developed a z-score model that continues to be used to predict bankruptcy and other potential financial stress conditions (Grice and Ingram 2010). The model may be used to predict the probability that a firm will become insolvent. In its initial test, the Altman Z-score was found to be 72% accurate in predicting bankruptcy 2 years before the event. The lower a company’s Z-score, the higher its probability of bankruptcy. The Z-score developed by Altman is a combination of five common business ratios, weighted by coefficients. The formula’s approach has been used in a variety of industries and contexts; however, the z-score was originally designed for predicting the bankruptcy likelihood of publicly held manufacturing companies with assets of more than $1 million (Altman 1968). Altman was the first person to successfully use step-wise multiple discriminate analysis, by using five financial ratios, to develop a prediction model with a high degree of accuracy and his model takes the following form (Altman, 1984):

Z  1.2 A  1.4 B  3.3C  0.6 D  1.0 E A= B=

D=



Retained Earnings Total Assets

C=





Working Capital Total Assets

EBIT Total Assets

Market Value of Equity Book Value of Debrt E=

Sales Total Assets

The status of the company according to Altman’s z-score model for private industrial companies is as follows: • Healthy private company: z > 2.6 • Grey zone: 1.1