Business Breakdowns
· Matt Reustle
[00:00:00] S0: It's a marvel in terms of what they've been able to do. Who's on the other side of the spectrum beyond Boeing and Airbus? What goes into those partnerships and those relationships that creates the ecosystem that now exists, where you do have certain parts of the value chain entirely relying on each other?
· Ramesh Narayanaswamy
[00:00:00] S1: When you look at jet engine makers, the primes, you only have three or four companies who can do this at scale. GE is one of them, along with Safran. Rolls-Royce is one of them, and Pratt & Whitney–MTU. Given the history of the industry, you can see that Rolls-Royce, for example, collapsed in the '70s and had to be nationalized trying to develop the RB211 engine, which was, ironically, a successful engine and the basis of their current Trent architecture. But they almost went bankrupt doing it. And similarly, if you think about state-owned companies, including China's COMAC, which is steeped in manufacturing muscle in China, it chose a GE or CFM engine to power their last aircraft. And while it's sort of developing its own engine, it just shows you the barriers to entry that even extremely scaled players and serious new entrants face when tackling this industry. Given these challenges in developing engines, it is not a surprise to see that most of the companies in the space enter into risk- and revenue-sharing agreements or joint ventures simply to mitigate the risk and to share the risk and revenue both when they are trying to develop new engines. For GE, the most prominent of that is in their narrow-body segment, where they have a joint venture with Safran. It's a 50/50 joint venture with Safran called CFM International, which we spoke about before. Through the CFM International program, you have a very strong presence that GE has in the Boeing platforms, which is sole, and the Airbus platforms, not to mention COMAC, which is also sole-source with GE.
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: For that joint venture, I just have to ask: what is Safran doing and what is GE doing? [00:00:00] S1: Historically, CFM International has been a 50/50 joint venture. GE historically has done more on the hot side of the engine, and Safran has done more on the cold side of the engine. But, effectively, everything is split 50/50 in the partnership. And it's a very longstanding partnership, almost 50 years old at this point. It is one of the best models of joint ventures and risk- and revenue-sharing agreements in the industry. [00:00:00] S0: Interesting. Yeah, to have that longstanding of a joint venture and to be taking something as complex as this and splitting it amongst two businesses. So I can only imagine.
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: Interesting. Yeah, to have that longstanding of a joint venture and to be taking something as complex as this and splitting it amongst two businesses. So I can only imagine. [00:00:00] S1: Technology also plays a role in terms of how these market shares evolve. It is not just the case that you only have a few players and, therefore, you tend to have consolidated market positions. When it comes to choosing an engine, you have two choices really that are being made. One is at the Airbus/Boeing level: they can decide if they want to go sole-source, which is a strategic decision as well as a technical decision, in terms of how much more efficient an engine is compared to the predecessor it is replacing. For example, Boeing 737 is on a sole-source with GE, but Airbus offers two engine options. And similarly, airlines can also choose engines based on their reliability—most critically, time on wing, which is a metric that airline operators care a lot about in terms of availability and reliability. Remember that these engines need to fly for 10 hours a day for years and years at a stretch before they can be brought in for servicing. So the total cost of ownership over 20–25 years, which is the life of an engine, is extremely important for airlines. So this combination of factors in the industry, so both the barriers to entry we spoke about and the choices that Airbus and Boeing have made in terms of sole source or dual source, has made the industry extremely consolidated and GE a dominant player in the industry.
· Matt Reustle
[00:00:00] S0: When I'm thinking about the revenue model itself, I'm sure there's this price that they're offering, but there's got to be some scaled pricing incentives. Can you talk a little bit more about the revenue model, which, again, because these new fleets and whatnot get scheduled out for such long periods of time, I would imagine there's visibility, but some of the more interesting details and nuance to it would be interesting to hear about?
· Ramesh Narayanaswamy
[00:00:00] S1: Before we get into the revenue model, it's important to think about who the buyer is. Within commercial aerospace, there are actually two distinct customer segments. The first customer segment is the aircraft airframers, so Airbus, Boeing, and COMAC. They make the aircraft itself; hence the engine is sold to them as an original equipment provider. But because Airbus and Boeing are so dominant in manufacturing, they can exert enormous negotiating leverage against engine makers and the entire supply chain. They have a huge influence in terms of engine choice and in terms of technology, whether or not they want to offer engine options, as we spoke about just before. So there's not that much profit on the OE sale for an engine maker because of this. You typically sell the OE engine at a loss or breakeven at best and make up for it in the aftermarket. Now, the second customer group that ties into the aftermarket is the airlines. Once an aircraft starts flying, it's owned and operated for 20 or 30 years by the likes of Delta or American or Emirates or Ryanair. That industry—the airlines—is a very fragmented industry. There are hundreds of airlines, so the engine makers are in a much better position in terms of negotiating leverage to make a profit, and they do. Because typically in the aftermarket, airlines have to bring the engines in for servicing at some point, and if they don't choose an OE spare part, they lose the warranty protection on the engine. Therefore, the engine makers tend to get spare parts revenues, which are very lucrative and very high margin. So this bifurcation of one buyer who is your engineering customer and another who is your usage-based customer also leads to significant barriers to entry for new entrants, and it informs the revenue model. When it comes to the revenue model, we have two different customer groups. The first is the OE. If you look at the LEAP engine, which is the current in-production next-generation engine for GE, the list price of a LEAP engine might be something like 20 to 22 million, so almost 20% of the list price of the aircraft itself. This is for delivery to Airbus or Boeing or COMAC. Typically on the OE side, you sell at a very deep discount—it can be up to 70 or 80%—until the program is mature or you're delivering spare engines. So you generally end up making losses on the OE side.