The Hindu Business Line : ‘US airlines will have to raise fares’

Recently in Cincinnati, Ohio Airlines are increasingly looking to have not only more fuel-efficient but also more environment-friendly engines. The President and Chief Executive Officer, GE Aviation, Mr Scott Donnelly, who quit the company to join Textron as Executive Vice-President and Chief Operating Officer days after this interaction with select media persons from across the globe, including Business Line, outlined the prospects and what the future holds.

Excerpts from the interaction:

Post 9/11 there was a slowdown in the aviation industry. There are fears that the industry is going into recession again, is this affecting your predictions?

You had different dynamics for the post-9/11 period. What happened then was that there was a radical fall in passenger demand, so no one was flying. Airlines took capacity out of the system in order to adjust to that though we were not that impacted. We (GE) saw some revenues drop and did not sell so many engines.

Today, I think you have a very different dynamics with primarily a US phenomenon of some airlines taking some capacity out. If you look at those taking capacity out, what they are doing in many cases is taking in a string of new aircraft and taking out some of their older aircraft, some of which will be our aircraft. But most of these aircraft will go to other places around the world as the global growth in passenger demand is still there.

US airlines will have to dramatically raise fares to make the economics work even if they have high load factors of 70-80 per cent. I think they will have to raise prices significantly and they are expecting that this will reduce passenger demand. So the right way for them is to make sure that they scale their aircraft capacity down.

I think it is a much healthier dynamic to recognise what price is needed to be able to survive as a business at these fuel costs. The way to do this is not by lowering prices to maintain load factors but to take capacity out to maintain high load factors.

So the slowdown is in no way affecting your investment in the research and development of engines or the number of engines that are being produced?

Not at all, as the fuel burn efficiency of the new aircraft and engines coming off the line is so far superior to the older pieces.

Our business has been growing rapidly. If you look over the past couple of years, the industry itself has been growing rapidly with big airplane manufacturers around the world including Boeing, Airbus, Embraer, Bombardier and new entrants in China, Russia and Japan. The business of servicing the engines is bigger than selling new engines from a revenue and margin perspective. Most of these assets go out there and they are there for at least 20, 30 and sometimes even for 40 or more years. The service continues with our customers for the time-frame. The backlog of service contracts with airlines is now growing to over $50 billion.

Right now, there is a real premium on having a modern fleet of aircraft. With fuel costs being where they are, it makes more sense for airlines to not only re-fleet older aircraft models but also have modern fleets. In Latin America, West Asia, China and India, just the net growth in passenger traffic needs more aircraft to meet the demand. During the fourth quarter of 2006 versus fourth quarter of 2007, the revenue passenger miles or the demand on the airlines grew by 7.4 per cent while the available seat miles, which are the number of aircraft available to meet that demand, grew by 6.2 per cent. The way to think about this is the increase in load factors, which basically means that there are not too many empty planes around the world any more.

Is the growth coming from any particular region?

If you look at the backlog, world demand is pretty balanced. It is probably 20 some per cent from the US, 10 per cent in Latin America and 30 per cent in Asia and Eastern Europe.

The interesting thing about the cycle of demand is that it is not about a region. People talk about China and India and these are strong markets for sure. But if you look around the world at both developed and developing markets, it is a pretty balanced business.

The reason for this is that in the developed market, there are very established airlines that have big fleets and they are looking for new aircraft; they need to re-fleet because they need more efficient aircraft and many will retire some of the older aircraft.

You go to Latin America, India and China and there is huge growth in the middle classes and people with disposable incomes who can afford to get on to an aircraft and fly.