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Opinion: Overcapacity Is A Viable Threat To Today’s Market

Opinion: Overcapacity Is A Viable Threat To Today’s Market

One would be hard-pressed to find an industry segment that sells twice as many products as it produces, yet Boeing and Airbus are doing just that. The archrivals have enjoyed unprecedented success in the commercial transport market in the past several years and have repeatedly increased their production rates to a combined 100 single-aisle twinjets. 

Airbus has now decided to boost production to 50 A320s per month, up from 42; the manufacturer is scheduled to soon begin delivering aircraft assembled in Alabama in addition to aircraft coming off assembly lines in Hamburg and Toulouse as well as Tanjin, China. 

The European manufacturer holds firm orders for 6,386 narrrowbody twinjets. The huge backlog includes 1,456 contracts signed in 2014; 456 aircraft were delivered. The contrast between intake and outgo is jarring. The manufacturer may be selling more aircraft than it can deliver, putting its customer airlines on track for huge fleet problems somewhere down the line. Or perhaps the analysts’ long-term capacity-need assessments were far too rosy.

At the current production rate, delivering the A320s already in the backlog would take at least 150 months, an absurd situation. In the interim, some customers could simply disappear—mergers or bankruptcies are virtually guaranteed in some markets—and the airline industry could suffer from record-breaking overcapacity.

Obviously, Airbus (and Boeing) do not acknowledge this possibility publicly; however, it is certainly being discussed behind closed doors. On several occasions in the last 10 years, top executives, including Giovanni Bisignani, then-chairman/CEO of the powerful International Air Transport Association (IATA), have urged that production rates be cut to avoid white tails. 

Manufacturers rejected such pessimistic views, averring that a sudden turnaround is highly improbable. Moreover, they state, in case of mass cancellations, the backlog would nevertheless be strong enough to maintain the current production pace.  

In other words, at this point both key airline manufacturers are opting to restrict some production dates despite robust demand. The rivals share certain traits: They monitor their backlogs well and protect the identities of their customers, of which more than a few could be facing bankruptcy within the next few years. 

Engine manufacturers face a similar dilemma. Snecma’s record backlog comprises 13,000 CFM56s and Leaps, while its average production rate is 1,560 per year. This is impressive but certainly not enough to maintain realistic delivery rates. The ultimate goal, which it downplays, is to refrain from overcapacity.

Adopting the broader view, difficulties are systemic, and run deep and wide. The prime contractors are the focal point for industry analysts who detail the market’s moves daily. However, they seem to be underestimating the impact on the supply chain. Myriad small companies are involved, many of which are under-capitalized because banks are reluctant to support their growth. Either the banks have sized up the problem realistically or are being too prudent.   

While Airbus and Boeing make headlines when they secure orders for hundreds of aircraft, their partners and suppliers are barely mentioned. This could be the analysts’ biggest blunder. Global industry giants—IATA, the International Civil Aviation Organization, the Association of European Airlines and Aerospace ID Technologies Program—along with regional trade groups, all see air traffic growing at about 5% per year in the next 20 years, barring a global catastrophe. 

The best aviation economists can’t be all wrong. Year after year, noted experts in Toulouse and Seattle, supported by their colleagues in Geneva and Montreal, project airline growth at a robust 5% or more.

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Union Budget 2015: Aviation industry seeks sops for survival

Union Budget 2015: Aviation industry seeks sops for survival

According to the report, the Indian civil aviation industry is on a high growth trajectory, albeit with minor hiccups.   

“The industry has ushered in a new wave of expansion driven by low cost carriers (LCC), modern airports, 

foreign direct investments (FDI) in domestic airlines, cutting-edge information technology (IT) interventions and a growing emphasis 

on no-frills airports (NFA) and regional connectivity,” the report said adding that the industry is amongst top 10 in the world with 

a size of around USD 16 billion. However, the aviation industry is facing its own set of challenges.  

Present Challenges/scenario: Notwithstanding the extraordinary traffic growth over the past decade, with addition of new airlines like Vistara 

and Air Asia in the Indian skies last year, the situation is still grim for the sector. Most of them are staring at huge losses. 

National carrier Air India is sitting on a pile of massive debt, amounting around Rs 44,000 crore as of FY14. Kingfisher Airlines has been grounded over payment default,

 while SpiceJet is hoping for a turnaround post a change in management control.

After posting seven quarters of consecutive losses, Jet Airways has finally managed to report an operating profit of Rs 3 crores in its third quarter ended December on 

the back of falling fuel costs and increased revenues. Moreover, the country has fewer airports and even lacks on aviation safety infrastructure.  

Industry expectation: The last Budget announced schemes for development of new airports in Tier I and Tier II cities. However, the industry 

has been seeking more sops.    Union Minister of Civil Aviation, Ashok Gajapathi Raju, in a pre-Budget meet with the representatives and stakeholders 

of the industry, on February 3, held discussions on the problems plaguing the sector.   Issues pertaining to updation of standards for security 

equipment, establishment of a “green” channel for MRO equipment and allocation of appropriate funds for air navigation facilities were discussed 

among other subjects.  

The industry made several suggestions for the promotion of MRO sector, including removal of service tax, reducing VAT on MRO activities,

 10-year tax holiday, abolition of central excise duty on MRO component etc.   If these measures are taken, it was represented, 

 there would be creation of one lakh jobs with more than a billion dollar revenues to the country on account of MRO activities.

 The stakeholders also requested to treat ATF as a “declared goods” so that VAT on ATF could be reduced to 4 percent. 

 This would make airlines more viable as ATF constitutes more than 45 percent of the cost.   

 The airlines representatives have also sought infrastructure status to enable access to funds with lower rate of interest through 

 external commercial borrowings. The industry stakeholders also made suggestions with regard to dedicated air cargo stations and general 

 aviation as a necessary force-multiplier.

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