The ingredients for a successful aircraft purchase decision include market timing, purchase price, financing, operational performance and economics. The proper mixture, however, is key.

By Geoffrey Thomas

Auckland, Toulouse & Seattle

Air Transport World, December 2005, p.30 Buy this issue

The world`s most famous transport, the DC-3, was launched on the back of a single telephone call between two friends, American Airlines President Cyrus R. Smith and Donald Douglas. And in contrast to today`s protocol, the contract was signed just before delivery.

There was no actual fleet planning, just a desire to widen the 14-passenger DC-2 to accommodate sleepers for a multistop, overnight US transcontinental service. Today, fleet planning is a science. The challenge is getting the right blend of the often divergent demands of purchase price, operational flexibility, economics, financing and marketing.

According to Boeing Commercial Airplanes VP-Marketing Kent Fisher, there have been some significant changes in the way carriers arrive at the right formula. ``Prior to 9/11, most airlines had robust balance sheets that could support the acquisition of aircraft, but airlines are now relying on leasing or third-party financing to acquire aircraft,`` he says. ``Many US airlines have now realized that they need more flexibility in their purchasing and are trading a higher price for that flexibility, while the price of fuel has altered the formula for new or used.``

With prices reaching $2 a gallonand above that in the USfuel is a significant factor. ``Fuel, combined with the maintenance burden, is now impacting on the new or used debate,`` notes Fisher. A new 737-700 costs $1.13 million less to maintain per year than a 10-year-old 737-300. Airbus has similar numbers for its A320 over the 737 Classic types. Contributing to the nail-in-the-coffin of older jets are moves in Europe to tax engine emissions, which will add a further financial burden to older types.

Airbus COO-Customers John Leahy also is bullish on airlines buying new aircraft, citing ``low interest rates and high fuel costs`` as driving more and more carriers to the manufacturer`s doorstep. He tells ATW that LCCs who traditionally had gone for used airplanes now have 480 new A320s in operation with a further 500 on backlog. Boeing has similar upbeat numbers.

One airline that was sold on the new-versus-old debate and buying at the right time was ATW`s 2005 Market Leadership Award winner AirAsia, which got off the ground with used equipment and eventually built a fleet of 20 737-300s, all acquired in the secondary market. According to CEO Tony Fernandes, ``We knew we had to go new eventually and we sensed that we were at the bottom of the buying cycle and it would only go up. We felt that Airbus was ready for one last big deal.``

The result was last year`s order for up to 100 A320s and Fernandes reckons that they will lower his ASK cost by 12% compared to his 737 Classics. ``Lease rates have gone back to pre-1997 rates for the 737-800 and A320,`` he notes. ``A newer 737-300 is costing $200,000 a month.`` The airline`s first A320 arrives this month. For AirAsia, which operates the world`s lowest-cost low-cost carrier with a single fleet type, the science of fleet planning was relatively clear cut: Two airplanes from which to choose, one decision to make.

Greenfield Approach

For ATW`s 2005 Phoenix Award winner, Air New Zealand, the science was more complicated. After the airline collapsed into government hands in September 2001, the new management took a ``greenfield`` approach to totally making it over and erasing more than 10 years of investment neglect. According to GM-Fleet Planning Mike Flanagan, ANZ was focused on four key elements: Size, simplification, flexibility of ownership and buying at the right time.

In September 2001, the carrier`s fleet essentially was made up of 737-300s, 747-400s and 767-300ERs. Only business and first class had individual inflight entertainment units and they were ``first generation`` and in need of a radical overhaul.

The first order of business was a new short-haul aircraft. ANZ wanted to offer greater frequency and open more direct services and its 737-300s, while fine for domestic operations, were wanting on the payload/range curve for westbound flights to Australia. Additionally, because the airline would be replacing 767s with narrowbodies, cabin comfort issues were in the forefront and Flanagan explains that the A320`s wider fuselage nudged out the 737NG series.

Far more complicated was a 767/747 replacement for long-haul routes. Size and range again were major factors. Flanagan says, ``The 767-300 simply could not compete on Asia routes against 777s and A330s/A340s. Its range was limited to markets such as Hong Kong and we could carry no cargo. The 747-400 was simply too big.``

ANZ was the first airline to receive a 787 (then the 7E7) proposal as part of a 777 offer, while Airbus pitched its A330 and A340 in a very closely fought battle. ANZ was in the box seat on pricing, with Boeing keen to get its 787 airborne. In the end, the airline ordered eight 777-200ERs and two 787s, recently raised to four, and importantly, 42 price rights for both types. It opted for flexibility in financing, leasing half the 777s from ILFC and buying the balance. Flanagan sees the Dreamliner and the newly launched A350 as representing significant breakthroughs for airlines: ``For the first time, we have a smaller aircraft that has better seat-mile costs than larger aircraft.`` ANZ viewed the 777 as providing greater flexibility than the Airbus offerings owing to its wider fuselage; ``It allows us to go 10 across in economy if that is the way the market goes, and at the same time gives our premium-class passengers extra room.`` In terms of financing the new fleets, ``flexibility is the major focus,`` he says. ``We aim for 45% of the fleet to be leased with leases staggered.``

Good Timing

One of the goals of the new management team was to buy at the right time to achieve the best pricing, important for a small carrier without the purchasing power of some of its competitors. ANZ`s order for A320s came not long after 9/11. The 787 order was the second placed, with the 777 order coming at a time when Boeing was seeking to arrest a slump in interest in its big twin as Airbus was scooping up orders for its A340-500/-600 from Virgin Atlantic and Emirates. Flanagan smiles broadly when he notes that ANZ ``is sitting on 42 attractive price rights for the Boeing jets, while the leasing rate for 767-300ERs has hardened from $250,000 to $500,000 a month and you can`t get a 777-200ER. The market for 10-year-old 747-400s is also tight. The deals we did in the last two years are not available today.``

While ANZ jumped into the 787 program early, as Qatar Airways has done with the A350 with an order for 60, airlines such as British Airways and Cathay Pacific favor a ``wait-and-see`` perspective. Former BA CEO Rod Eddington told this magazine in September that the carrier was taking a more conservative approach to buying aircraft. ``We are in no hurry to replace our 747s, and our 767s are good for another six years,`` he said. ``With the A380, we would like to see it in service before we commit, although that will not be my decision.``

On the other side of the world, Cathay Pacific with its superb engineering capability was for many years the master of buying and operating secondhand airplanes. Most of its Convair 880s, all of its 707s and most of its TriStars were purchased from other airlines. In the 1990s, that changed radically with Cathay going direct to the manufacturers for 747-400s, 777-200s/-300s and A330s/A340s. That experience has left it a little soured, with one executive conceding that it now does not want to ``launch anything.``

Carriers like Cathay, Singapore Airlines and ANZ have sophisticated fleet planning departments with a blend of young computer wizards and older hands who understand the dynamics of the industry. ``This is critical for success,`` says Scott Gustetter, MD of Sydney-based strategic fleet planning consultancy Aspirion. ``Some airlines are missing out on the best pricing on aircraft because their fleet planning departments sometimes lack the best skills or do not have a broad understanding of the industry.``

Washington-based consultant George Hamlin agrees, saying that some smaller carriers have little expertise in the area of fleet planning``With the exception of e-mail, they are still back in the 1960s.``

Gustetter, with partner Bill Meeke, has turned around a number of ``basket cases`` in the Australasia region, with his network and fleet planning software coming up with innovative solutions to leasing problems. Clearly, he says, in today`s market, financing and managing the risk are critical when it comes to starting a new airline or turning a fleet over at a legacy carrier. ``There is no question that more and more airlines are focused on new or near-new aircraft,`` he notes. He cites one he recently assisted that leased near-new 150-seaters at attractive rates by exploiting the seasonal differences between India and Europe. ``This enabled them to manage the risk and lower the cash flow requirement while testing the strength of the market.``

Over-optimization

Fisher says carriers have found that one of the greatest drains on profits can be a mixed fleet of aircraft fulfilling a host of different missions. Particularly since 9/11, they are ``focused on reducing fleet types wherever possible.`` US legacy airlines, which went to the extreme in trying to match aircraft exactly to missions in the pre-9/11 era, have embraced simplification. Delta, for example, aims to reduce its fleet to seven mainline types from 11 today and 14 in 2001. American and Continental are similarly engaged in fleet simplification programs.

In addition to adding costs, complexity can reduce fleet value. For many years, Ansett had the only three-crew 767s in the worlda concession to its flight engineersmaking leasing them out impossible. While such extremes are rare, many lessors are leery of financing widebodies owing to the wide array of buyer-furnished equipment that makes moving them to a new owner quite expensive. AerCap CEO Klaus Heinemann agrees that he is ``more hesitant on passenger widebody aircraft`` because of ``the substantial transition cost.``

Manufacturers are doing their part to simplify by reducing BFE wherever possible and particularly up front. Virtually everything forward of the cockpit door on the A380, A350 and 787 is standard.

The continuing growth of leasing is introducing a new dimension in fleet planning. Mike Bair, VP-787 Program, concedes that Boeing had never really thought much about financing of the aircraft, ``which was something the airlines arranged on delivery.`` Today, that view is much broader: ``We are now treating Citigroup, Credit Lyonnais and the Bank of Scotland as customers. They`ve influenced the design of the airplane and we have changed things . . . to suit their demands.``

In a bow to the importance of lessors, the 787 will offer a standard pylon attachment, making swapping one engine for another a realistic possibility as aircraft move between different operators. Until now, the performance, systems, shape of each engine type and critical attachment structure for a given model differed significantly, making changing engine types extremely expensive and sometimes impossible. Bair says bankers have told him that if Boeing achieves what it has set out to accomplish in terms of flexibility, the 787 will have ``a higher loan-to-value than any other airplane, and they see a significant reduction in the borrowing rate.``

Singapore Aircraft Leasing Enterprise MD and CEO Robert Martin is reserving judgment on engine swapping however. ``Theoretically it can be done, but the cost of having to buy new spare enginesand bear in mind there are never any discounts for new spare enginesto basically swap one I think will still be reasonably prohibitive. So yes, it`s there if you need to do it but I don`t think it will be done very much``.

While the 787 and A350 offer a new era in flexibility, airlines are taking the fullest advantage of extra performance on existing models to capture revenue wherever possible. An example is Continental, which has pulled 757s off low-fare domestic routes and is operating them from its Newark hub to more than a dozen secondary cities in Europehigher-yield markets that heretofore have not had direct service to the US. It is betting that passengers will trade a lower level of cabin comfort versus a widebody for getting there faster and more directly. Fisher sees more carriers using single-aisle aircraft for longer-range nonstop missions. When traffic softens, they are down-gauging rather than cutting frequency, he notes.

As they ponder seemingly endless fleet planning challenges, airline executives might look longingly at a 1956 Boeing marketing and operational proposal to Cathay Pacific for the purchase of the 707-120 Stratoliner. The 14-page presentation, with seven pages devoted to graphs, pictures and introduction, quoted a unit price of $4.416 million and a fuel price of 19 cents a gallon and promised a breakeven 38% load factor with 106 first-class passengers in a five-across layout. If only it were that simple today!