A part of the solution

Non-OEM parts account for around 2% of the global spares market, and less than that in the Middle East. However, as Dave Armstrong explains, cost-conscious airlines both around the world and within the region are beginning to pay attention to the benefits of alternative suppliers.

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By  Dave Armstrong Published  March 27, 2005

|~||~||~|Just from looking at the numbers, one could dismiss the increasing attention being paid to the independent aircraft parts industry as much ado about nothing. After all, the still relatively unknown sector accounted for just 2% of sales in the global spare parts market in 2003. So why has the sector suddenly become such a hot topic? As with so many issues in the current environment, the driving factor for the sector’s popularity is price. The independent parts maker sector (called PMA, for parts manufacturing approval) participates in the manufacture of replacement parts for aircraft engines, components and airframes, selling them to airlines and maintenance outfits, and doing so in competition with the firms that have manufactured the equipment and its original parts. According to Robb Baumann, executive vice president with the sector’s largest player, Florida-based HEICO Industries, a part manufactured in a PMA factory typically sells for about 70% of the price charged by the original equipment manufacturers (OEMs). This, the industry is learning, represents savings that can no longer be dismissed without consideration. Although the sector has begun to make news in recent years, it has been around for decades. Baumann explains that HEICO Aerospace, which, with annual revenues of US $153 million, commands more than 50% of the independent market and which offers a catalogue of almost 4000 different parts, burst onto the PMA scene in a meaningful manner in 1985. Then, their combustion chamber for the Pratt & Whitney JT8d jet engine — which boasted the largest installed base of any commercial powerplant at the time — became the market leading part after a fatal crash was initially blamed on the OEM part. It is no surprise that the sector’s newly received attention is in no small part owed to the current financial shape of the airline industry. If in prior years inertia and traditional business practices favoured buying parts from the OEMs, these days any potential avenue for cost savings is winning serious examination. A case to illustrate the change of attitude toward the PMA firms is found in the Middle East. “In order for us to do business with an airline, it has to want to save money,” says HEICO’s Baumann. “That has not always been the case with the Middle Eastern carriers, and as a result there has historically been less motivation there in looking past the OEMs for replacement parts.” However, he notes that as carriers from the region have begun to focus more on cost recovery and even profit generation, their perception towards PMA parts providers has changed. “There has been much more interest in the last few years and it is growing,” Baumann observes, adding that HEICO now sells parts directly to Saudi Arabian Airlines and to several other carriers through its agreements with independent maintenance and overhaul enterprises. Still, for all their inherent price advantages, PMA firms remain minor players on the maintenance stage. According to a comprehensive study conducted by leading US consultancy AeroStrategy, the total sales recorded by PMA providers in 2003 (the latest year for which there is data) was of the order of approximately $250 million. An impressive enough figure, to be sure, except that AeroStrategy’s report — which has become the resource of record in the replacement parts industry — estimates that the total annual market for parts is approximately $13 billion. With the potential for savings so apparent, the question asked by outsiders more logically would not be why so much is being made of the independent parts sector, but rather why it has the not captured more of the market. The biggest reason behind it still being a small player is remaining skepticism within the airline community as to the wisdom of using independently made parts, a line of thought done no harm by the OEMs. Questions surrounding the PMA sector historically have centred on safety, and for years the independent manufacturers have had to battle persistent, false, rumours that their parts were shoddily made and unsafe, nothing more than the counterfeit parts investigators often found in post-crash engine inspections. Happily for the independents, that reputation no longer holds amongst those in the know. This victory has been helped in no small part by the transaction in which Lufthansa Technik took a 20% stake in HEICO. With the maintenance arm of the German flag carrier enjoying a solid reputation for technical expertise, HEICO and the sector as a whole have benefitted considerably from this halo effect. Subsequently, the Florida company inked a joint venture agreement with American Airlines, as well as strategic partnerships with Air Canada and United, Delta and Japan Airlines, further discrediting the ‘unsafe’ tag. But that, contends Baumann, has not kept the OEMs from trying to win the PR war. “They continue to spread FUD — fear, uncertainty and doubt,” he says. Although the airworthiness issue has mostly been put out to pasture, doubts have been raised about the effects of introducing new parts into a mechanism as complicated as a jet engine.||**|||~||~||~|Executives at several powerplant manufacturers have expressed concern that parts emanating from outside the manufacturer’s workshop can increase the complexity (and thus cost) of repairing the engines. They also say that parts should be manufactured with an intimate understanding of the system in which they will be operating as a whole. This caveat naturally handicaps the PMA firms, none of which make all the parts on a given engine. The result of not having all the components work in perfect concert, the OEMs argue, will be reduced operating life and increased repair time of the engines, both of which would wipe out any costs saved by purchasing the less expensive parts. This analysis is compelling, but one industry insider has noted that its credibility is eroded somewhat by the fact that the manufacturers who hold MRO contracts with mixed-fleet airlines routinely purchase PMA parts to use on engines built by their competitors. Still, that fact has not ended the questions of quality that continue to hinder PMA acceptance. Christopher Whiteside, managing director of the UK-based firm AJ Walter Aviation, a maintenance and overhaul provider with annual revenues approaching $100 million, has firsthand experience with this phenomenon. Of AJW’s client base, which includes over 50 major flag carriers, including British Airways and Singapore Airlines, Whiteside says that only those carriers hailing from the developing world typically express any interest in moving away from the OEM-provided parts, a decision he puts strictly down to cost savings. “We don’t have a problem with the PMA parts. In fact, I think they are often superior — they are certainly newer and more refined,” he explains. “But we are not the customer, and the technical directors of airlines usually specify that they want the ‘real thing’.” “The independent players,” he adds, “have always been the victims of scaremongering, and they continue to battle questions of credibility, quality and possible safety.” From afar, these tactics seem only questionably fair, but, even more than that, unnecessary. By HEICO’s own analysis, the independent firms have captured about $100 million (or 3%) of the $4.2 billion global engine replacement parts market, with the rest lodged safely with the OEMs. On the surface, this hardly seems like the type of market penetration to cause sleepless nights for the incumbent firms. So, why should the manufacturing community worry itself with such minor players, as the PMA firms? The likely answer to this question is found in two factors that make the increased acceptance and use of PMA parts more worrisome for the OEMs than is indicated by their relatively meager loss of market share. First of all, the volume of PMA parts is widely forecast to grow. Secondly, and more immediately, is the effect new competition has had on OEM pricing power. A 2002 survey of the PMA parts sector jointly conducted by the global consulting firm AT Kearney and the University of Stuttgart forecasted that PMA parts will enjoy annual market share gains of about 10%, with their share of the total engine replacement part market exceeding 20% by 2015. AeroStrategy agrees, saying that a growing acceptance of their wares, plus growth in the MRO market as a whole, will result in PMA sales doubling to $500 million by 2008. More immediately, the advent of competition in the market for several critical replacement parts — markets that until recently had been natural monopolies — has meant that the OEMs no longer enjoy the ability to basically set prices where they like. This development is of critical importance to the powerplant manufacturers in particular, because the prevailing market practice has been to sell the engines themselves at prices hovering around the break-even point and then generate big margins on the aftermarket service contracts, of which the sale of spares represents 60% of the bill. That the margins are large is somewhat attested to by the fact that the PMA firms can profitably sell their parts for 30% less than the OEMs, even though it costs them significantly more to make the individual parts. A lot of the profit for the OEMs apparently accrues from a pricing strategy in which the rates creep inexorably higher, a strategy now greatly endangered. AeroStrategy estimates that the OEM catalogues have traditionally posted annual price increases of 5-6%. With the market marked by unprecedented competitiveness, the consultancy estimates that price increases on the parts for which there are multiple manufacturers will now more likely be on the order of 1% a year. The cost of this competition is steep, with each 1% drop in annual price increase resulting in a loss to the OEMs of $1.7 billion over five years. With this kind of revenue at stake, it is little wonder that the incumbent firms should fight to maintain the traditional state of play. HEICO’s Baumann certainly understands the OEM’s incentive, saying that their lack of effective competition in the parts market has been key to their profitability. Citing the pharmaceutical industry, in which generic manufacturers have seized over half the market, he says that it is not difficult to grasp why the original manufacturers will try to maintain a status quo in which they command 98% of their replacement parts market. Even if what HEICO labels ‘FUD’ tactics will be less prevalent in the future, the OEMs can be counted upon to employ a host of techniques to curtail the interlopers’ market share. For example, AeroStrategy predicts that the manufacturers will in future attempt to lock airlines into more long term overhaul contracts and otherwise expand their market share in the MRO arena so as to win a degree of exclusivity for their parts. The consultancy also forecasts that the OEMs will put forth efforts to aggressively enforce intellectual property rights and increase the number of parts in a family of engines, both measures being aimed at making it harder and more expensive for the independent competition to gain access to the playing field in the first place. It remains to be seen if these new potential barriers to entry will succeed in keeping the PMA firms from further increasing their sales. What seems more certain is that the battle for the replacement parts market will move from being a side issue to heated topic in the airline industry. ||**||

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