Since the initial wave of COVID-19 in the first quarter of 2020, the pandemic has caused entire countries to be shut down.
Rewinding back to the financial crisis of 2008-09 suggests that the economic repercussions can be compared to what is happening now, only much more severe. Due to a significant drop in economic activity in that period, there was a slowdown in the uptake of capital goods and industrial machinery. This was when original equipment manufacturers (OEMs) and other manufacturers realized the importance of aftermarket and service businesses. The revenue from aftermarket services stayed steady, and in fact, increased with time. Airlines, in particular, started utilizing their planes for longer periods, which meant greater maintenance, repair, and overhaul (MRO) activities and related revenues for OEMs.
This trend towards focusing on service revenues gradually morphed into a large-scale transformation of business models across multiple industries. Instead of selling an asset to customers, the new model was built around selling the outcome that the asset provided to the customer. Thus, ‘servitization’ was born in aerospace and industrial manufacturing. In this model, OEMs initially incurred a marginal loss while providing the asset itself. The customer was charged based on utilization and the OEMs monetized it by maximizing the asset utilization and optimizing the service costs.
Fast forward to the current COVID-19 scenario, manufacturers who adopted servitized business models are now facing the impact of the widespread suspension of economic activities. Although the model works well as long as the assumptions around asset utilization are valid, what happens when all economic activities come to a sudden standstill?
In the case of airlines, for example, a large portion of flights have been grounde since March 2020 causing significant reduction in asset utilization. This, in turn, means a far more devastating scenario for their suppliers, especially, for the ones following a servitized model. After all, a supplier’s revenue is based on the level of fleet activity, which has dramatically dropped. Let us take a closer look at servitization models adopted by the airline industry, particularly, in the aero-engines sector.
The ‘Power by the Hour’ model was initially adopted by manufacturers of aircraft engines, such as Rolls Royce (RR). RR introduced the concept over 50 years ago, offering a complete engine and accessory replacement service on a fixed-cost-per-flying-hour basis . This has now become widely prevalent in the industry and is offered by most engine OEMs. Long-term maintenance contracts are the primary source of profit, while the initial sale of the engine may incur loss. To get a sense of the scale, consider this - an engine MRO is a $43-billion business, of the total $91-billion market for all airline MRO services, according to data from global management consulting firm Oliver Wyman. A heavy-maintenance rebuild for a single engine is priced between $4-10 million and OEMs capture about 50% of the engine MRO business. This allows OEMs to capture recurring revenue based on the expertise, intellectual property, and talent developed during the design phase of the engine.
The impact of the grounded fleet on the servitized business models will be felt in many areas:
- Grounded airplanes do not accumulate engine hours, and hence, there would be no payments associated with the asset utilization.
- As planes are grounded, there is no need for maintenance and spares, which will impact associated revenue streams.
- Additionally, grounded airplanes represent a temporary, large source of spare engines and components which the operators will leverage to avoid any scheduled maintenance costs. So, instead of performing scheduled maintenance on the still-operating airplane engines, they can be swapped and replaced by engines from the grounded donors further diminishing the scope and expense of maintenance.
Responding to these challenges requires engine OEMs to demonstrate resiliency and adaptability in their businesses. Drawing experience from proven methodologies like TCS’ Business 4.0TM can help OEMs re-establish their stand in the economy, by embracing risks to deliver exponential value. Here are some ways to bring their operations back on track:
Align the pricing models to the new level of activities that are expected in the medium term. Switch to advanced analytical tools to assess and model the risk as well as dynamically address pricing.
Reduce operating capacity swiftly without permanently losing facilities and skilled technicians or causing suppliers to fail. Embrace a true ‘cloud’ operating model where fixed capacities are converted to variable ones through scalable infrastructure and organizations.
Implement solutions to improve traceability, engine and component appraisal, and predictive maintenance to mitigate the effects of the disruption.
In summary, a servitization business model in aerospace manufacturing is sensitive to the larger economic conditions and businesses need to analyze the implications of systemic disruptions on their working. They need to explore ways of making the underlying assets truly scalable and protect themselves from massive downturns. They need to build more sophisticated risk models in order to understand and mitigate risks. But above all, they need to embrace larger ecosystems so that together their business services can become more resilient and adaptable to the new normal.