The European Commission is in the first stages of an investigation into the OEM aero engine aftermarket control. The Financial Times reports that European Commissioners have sent CFMi and Rolls-Royce a number of questions to be answered. For five years now Airline Economics has been warning that engine OEM aftermarket dominance/control will bring with it regulatory attention. From issue one of Airline Economics all the way through to present day we have written on the matter in depth, especially with regard to CFM and Rolls Royce aftermarket control. Airline Economics has also contacted European regulators to draw their attention to engine OEM aftermarket control on a number of occasions over the past five years, leading to interviews and quotes from the same. The European Commission has always maintained to Airline Economics in interviews that it will watch the matter closely and will wait to see evidence of price escalation above “what can be considered fair inflation” at a time when it can also be demonstrated that the OEM(s) have risen above 75% market control on a product.
Of course the truth of the matter is that no third-party maintenance provider or airline can give the European Commission or anyone else anything by way of information unless it is forced out of them because terms of contract with the OEMs prevent disclosure. The OEMs will no doubt wish to try and keep this investigation between them and the Commission, preventing matters from getting as far as going to third-party maintenance providers and/or customers. Therefore it is likely that this whole process, if handled correctly by the OEMs, will lead to a loosening of data provisions and a loosening of the grip on the aftermarket with it. If the engine OEMs fight this investigation, we will likely see the US and Japanese regulators taking notice, exacerbating the situation significantly.
Now it could be argued those that purchased engine products over the past five years did so knowing full well that they were getting heavy discounts off the purchase price (or even free of charge if our sources are correct) in return for a long-term management contract with the relevant OEM, which in the process allowed the customer to predict maintenance costs over the long term – a win-win situation. It can be further argued that all Rolls-Royce customers knew exactly what they were doing when they purchased the products and Rolls Royce has been clear from the word go that they control the parts that go into their products. As such I would argue that Rolls-Royce has been drawn into this mess because it is at the vanguard of the OEM aftermarket control model and not due to a developing concern.
The real problem here, and the real target for the European Commission, is CFMi. The CFMi retrospective attack on clients of 2012 was a total disgrace. By implementing TRUengine, CFMi at a stroke forced clients to maintain and provide retrospective detailed records of their engines to prove that they had only had CFMi-approved parts installed at any time in their life. This process totally disregarded the fact that when airlines go bust ensuring the retrieval of maintenance records was nigh on impossible and not an absolute requirement in the recent past. As such, many engines were at a stroke devalued by CFMi. The engine lessors, CFMi’s staunchest supporters and best clients, saw their portfolios devalued overnight by huge numbers. It was beyond doubt a piece of serious mismanagement by CFMi. To counter this, CFMi decided to launch PML “to assist in the transferability of assets” and in the process help the engine leasing market. Everyone with a modicum of knowledge of the aero engine sector knew full well that PML would delay a European Commission probe but it would only avoid one if CFMi kept a lid on escalation and keep everyone happy. Alas escalation at this point is time is very high at +5% per year and rising across the board with all OEMs, not just CFMi according to most appraisers and many clients.
The OEMs will lobby very hard to limit the danger of this preliminary investigation and they might yet be successful, but it is the case that their business models revolve around the fact that all OEMs have total aftermarket control over their products and this in turn means monopolistic control over prices as a direct result. This means in short that engine OEMs have a monopoly over aircraft types. The aero engine sector failed to follow the path of car manufactures, which left enough loopholes for outright owners of their products to be safe from the gaze of the regulators when it came to aftermarket control. But aero engine manufacturers do not at this time care if you lease or own a product; they want total control and as such limit the supply of data. That erasure of choice for the customer was always going to garner regulator attention; the only surprise is that it has taken this long. If one OEM were to relax there rules on aftermarket control tomorrow, their share price would tank but in the long term aircraft with their engines on wing would increase in value exponentially as they would be free to trade. Rolls-Royce has over the past few years, since the A340 Investor Day in London, genuinely tried to help the market and open-up the aftermarket to trade their assets but they are in a position where without aftermarket control the company simply would not run in the black, especially during this huge delivery cycle, so RR is in a bind.
Conversely, the only way to keep residual values on engines high is to ensure that there are no alternative engines. This is the reason why the 737Max remains a single-engine option aircraft and the reason why so many larger aircraft are single-engine manufacturer options. This is why the market is predictable and relatively safe to navigate with regard to investment in aircraft assets. But there is another way. OEMs such as Rolls-Royce, which genuinely wish to rethink how their aftermarket control destroys aircraft values in the secondary market, should start taking decisive action.
I argue that engine OEMs should relax control over an asset when it reaches a certain age as standard, maybe 15 years of age. I would also suggest that engine OEMs should also have the flexibility and determination to relax control over specific products when it is determined such a policy is causing an aircraft type to fail in the secondary market. If this were a standard procedure for engine OEMs then those aircraft with their products on wing would see residual value curves improve over night and aircraft investment would become an even hotter ticket. In the long term this is a highly logical argument for sustained market success across the board. It might also assist with those regulators. But, as previously mentioned, this is a job for RR to take the lead on and it is unable at this time to create revenue stream problems for itself. So where does it leave us? Cue CFMi – will it assist the market?
People need to learn from the Rolls-Royce model of aftermarket control and what effect it had on the A340. As things stand every aircraft will be worth very little for teardown (save for scrap and recycling or to increase the overall value of a portfolio) in 20 years. The matter is seriously compounded when considering the 787 in the long term. This aircraft will cost a fortune to break-up and dispose of because its raw materials are not easily recycled (although there are many R&D dollars being spent on developing markets for this material) and indeed currently suffer from strict regulations on disposal. So without any teardown values in the engines of a 787, owners and investors are left with an asset that is a cost to dispose of and with engines and parts that are untradeable on the open market.
It would be unfair not to mention Pratt & Whitney (P&W) in all of this. P&W has been following the course of CFMi and RR for some time now. Customers report that it too is looking to control the entire life of their asset by offering favourable purchase prices with aftermarket agreements.
Going forward the future could lie in the past where customers have a clear choice: Pay for the engine and be free or don’t pay and face lifetime controls but with predictable costs in the long term and far less up-front costs. That is what we know the European Commission wants to see and that is perhaps the future. But this will create a mess as it will mean that some aircraft are worth a great deal more in later life than others and those that are purchased up front with no ties will be far more financeable than those that are not. We will continue to follow the story as it develops.Date: October 13, 2015