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The top 10 risks the aviation industry is facing

The aviation industry has entered a golden age, supported by record order books and skyrocketing passenger traffic. In pursuit of these new opportunities, aviation is facing a series of challenges that must be addressed in order to sustain profitable growth. Derived from the world’s major Aerospace & Defense (A&D) companies, here are the top 10 risks for the aviation industry in 2019 and beyond.

Over the course of the next 20 years, the global commercial aircraft fleet is expected to double to approximately 45.000 aircraft, a growth particularly driven by increased air travel due to an expanding middle class in emerging economies.

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Meanwhile, new aircraft platforms and engines are emerging as a result of changing customer demand and the industry’s relentless pursuit of cost reduction; an entry-into-service period which has been characterised by a series of teething issues.

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Understanding the current risks in the aviation industry

As the supply chain struggles to keep up with demand due to the ramp-up in production, volatility in the geopolitical and economic environment is increasing, and a growing labour shortage is lurking in the background.

These risks will affect the very core of aviation companies and present new issues for the players within the aviation industry. Their strategic initiatives will be tested, their financial position could be threatened, their global operations will be pressured, and they will need to adapt to new compliance requirements in the different markets in which they operate.
 

According to Ernst & Young, a multinational professional services firm, understanding the aviation industry's biggest challenges and issues in 2019, and in the future, will enable companies to gain a competitive edge in the race for sustainable, profitable growth.

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The firm recently released a study named “Top 10 risks in aerospace and defense,” conducted by interviewing a series of major global aerospace and defense players; among them Airbus, Boeing and BAE Systems.

Below, we’ll take a deep dive into the findings of the report and present the 10 biggest challenges in the airline industry in 2019.

Risk 1: Volatility in the geopolitical and economic environment

Most airlines have a global footprint and are, thus, vulnerable to external factors, such as political tension and economic conjunctures. In the case of the commercial aviation sector, political stability and sustained economic growth are, according to Ernst & Young, major underlying factors driving long-term growth in air traffic.

Although the global economy has risen from the ashes of the financial crisis in 2007-2008, and the economic outlook is reasonable, uncertainty remains.

The US-China trade dispute is causing instability in markets around the world, and economies have started to show signs of a potential slow-down in —including China, the world’s largest economy that recently reduced its GDP growth target.

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In Europe, the financial markets have, likewise, experienced a series of disruptions lately, mainly due to concerns about certain Eurozone countries’ ability to reduce their budget deficits and pay off their sovereign debt obligations.

With regard to the geopolitical landscape, the aviation industry, too, is facing a series of challenges in the near future. Most notable is the uncertainty of Brexit and its impact on the aviation industry, which, at the time of writing, is anyone’s guess. With increasing talks of a "no-deal" Brexit, changes to geopolitical landscape could end up being one of the biggest threats in the aviation industry in 2019.

»An economic slowdown in any of the key markets for A&D players could potentially result in tightening in the credit markets; low liquidity; and extreme volatility in the credit, currency, commodity and equity markets,« writes Ernst & Young in the report, adding that a slowdown could cause airlines to review their order intake strategies and postpone or even cancel existing aircraft orders. If orders are cancelled, it will create a domino-effect across the industry, presenting multiple issues for the aviation industry as a whole. 

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Risk 2: Managing the supply chain

Aviation companies around the world are pointing to managing the supply chain as the second biggest threat in the aviation industry in 2019 and the years to come – and for good reason. A record number of new aircraft deliveries are set to keep the supply chain extremely busy during the next 8-10 years.

To meet the demand, the entire supply chain must ramp up their efforts and investments, ensuring timely deliveries while, at the same time, maintaining high quality and keeping costs somewhat controlled; a challenging task that could leave many suppliers financially vulnerable. 

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With such a vast network of suppliers, small mistakes and delays can cause a chain reaction and, as a result, budgets and schedules could spin out of control. There’s also a risk that companies will have disputes with suppliers or subcontractors related to work specifications, quality of supply or customers concerns, Ernst & Young notes.

»The A&D sector is experiencing a significant growth in demand. The growth in demand increases pressure on the production capacity for OEMs and their suppliers. In the case of critical parts and assemblies, the number of available suppliers is small. For such parts, the risk of production disruption due to supply failure is even greater,« says Bill Colbert, Partner, Advisory - US, Ernst & Young, in the report.

The study points to three additional challenges and types of risks in the aviation industry that could pose a threat to the efficiency of the supply chain.

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Niche parts and processes pose a greater risk to on-time delivery

For some parts, such as composite components and wing skins, MROs and airlines depend on a small number of suppliers, leaving them with few options in case of failures or disruptions.

This challenge can be somewhat mitigated by working closely with the supplier to understand the stability and detect potential disruptions before they develop into full-scale disasters.

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Further risks associated with low-cost countries

As the demand for air travel rises in emerging economies, OEMs, airlines and MROs are establishing new connections with local suppliers.

Though working with local suppliers has significant cost benefits, it, too, could expose this part of the aviation industry to critical issues, such as IP violations, delays and quality issues.

Investment to fund new programmes and technologies

Implementation of new programmes and technologies ties up significant capital. The cost to develop new initiatives, such as additive manufacturing, must be recouped on volume production, but the investment might initially leave companies more financially exposed, thus posing a risk to the entire aviation supply chain. 

Risk 3: Competition in domestic and international markets

Airbus and Boeing are the only players in the wide-body market, and they dominate the narrow-body-segment as well. In the medium-term, opportunities for new players in this market are unlikely, due to the duopoly of Boeing and Airbus.

In the supply chain, consolidation continues to increase due to OEMs seeking stronger suppliers with access to capital. The MRO industry and broader aftermarket are also undergoing changes.

New sensor technology, for instance, allows OEMs to control and predict the timing of maintenance much more accurately, reducing the MROs’ share of spend and thus leaving certain companies within the aviation industry at risk. In the case of the aftermarket, its traditional high-margin pricing is being affected by a surplus of certain parts as the retirement of older aircraft take off, potentially posing a critical threat to the financial viability of certain aviation aftermarket providers.

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Risk 4: Managing and retaining talent in the aviation industry

Due to the influx of new technologies and processes and the relentless focus on cost reduction, companies in the aviation industry will require, perhaps more than any other industries, a talented, engaged and increasingly specialised workforce in the future. The issue of work-force shortages in the aviation industry is very real indeed and it will be a challenge for the industry in the future as well. 

»Because of the highly specialised nature of the industry, companies must hire and retain the skilled and qualified personnel necessary to perform the business-critical processes,« notes Ernst & Young in the report.

aviation-risk-mro-labour-shortage

Ineffective succession planning, a lack of diversity and limited options for talent mobility are, according to the study, the major challenges for talent management in the aviation industry.

On top of these challenges, a labour shortage is looming and the industry is struggling to attract new kinds of talent, such as data scientists, that can help drive new innovations forward.

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Risk 5: Ability to perform in key contracts

The major OEMs in the industry are typically involved in multimillion-dollar contracts and have huge backlogs with tight deadlines. Failure to deliver on major programmes can lead to significant negative implications affecting the financial performance as well as brand value.

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For instance, Ernst & Young notes, one airline has refused the delivery of a series of Airbus A320 NEOs since December 2015 due to performance issues with the engines of the aircraft. The two parties are now negotiating to change the initial order for a different aircraft and another engine option.

The challenge for the entire aviation supply chain to deliver on time is more complex than ever before, as Boeing and Airbus both plan to ramp-up their production capacity to unprecedented levels in the years to come.

An open business culture, ambitious but realistic targets and a strong focus on project management is vital to mitigate this risk within the aviation industry, states Ernst & Young.

Risk 6: Compliance with a wide range of regulations and restrictions

The commercial aerospace industry has to comply with a long list of requirements for aircraft design, maintenance, pilot training activities and safety regulations. These regulations are critical for operators and passenger safety and hold the products and services of the OEMs and suppliers to the highest standard.

compliance-is-a-risk-in-aviation-industy
Aviation companies own a series of intellectual property portfolios, consisting of patents, unpatented know-how, data, software, trademarks and so forth. They enter into different types of confidentiality agreements with employees and suppliers, but these measures are not always enough to deter the misuse of IP and this could pose a threat to the aviation industry in the years to come.

Furthermore, Ernst & Young notes, IP laws vary from country to country. As a result, companies operating in a large number of foreign countries may be exposing themselves to IP infringement which could ultimately pose a series of issues for all sorts of aviation companies.

Risk 7: Incapacity to innovate

The demand from passengers is evolving constantly, pushing the aviation industry to adopt new work processes and technologies. Due to the conservative nature of the industry, it’s proving to be a hard race to win. The aviation companies that fall too far behind in great run of innovation will likely face a series of challenges in 2019 and beyond.

»Some of the technologies that A&D companies use in their manufacturing and other business processes are decades old. They need to upgrade these technologies on a regular basis as well as adopt new and advanced technologies to stay competitive,« states Ernst & Young in the report.

aviation-threat-7-lack-of-innovation

The good news is, a number of players in the supply chain - from OEMs to suppliers and aftermarket providers - are already pursuing digital advancements to optimise their own and their customers’ business processes, including Airbus with their data platform, Skywise, and Satair’s Integrated Material Services.

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»A company’s greatest opportunity to drive both top-line and bottom-line business results is through investments in R&D (research and development). In addition to being a reflection of a firm’s business strategy, the R&D portfolio is also one of the primary tools to manage risks through the diversification of investments,« says Bart Huthwaite, Partner, Performance Improvement Advisory Services - US, Ernst & Young.

Risk 8: Failure to realise the benefits of M&As and partnerships

Collaboration and partnerships in the supply chain is a hot topic in the aviation industry these days. According to the study from Ernst & Young, M&As (mergers and acquisitions) and partnerships can complement a company’s existing products, technologies, services and customer base. At the same time, failing to collaborate with other businesses could pose a real threat to some companies in the aviation industry. 

Although there are some clear benefits to partnerships, entering agreements with other businesses in the aviation industry isn’t without challenges and risk.

»While evaluating new M&A transactions, companies are required to make decisions regarding the value of business opportunities, technologies, other assets and cost of potential liabilities. Poor M&A decisions might result in an overvaluation of the acquired business, failure in achieving synergies, inability to retain talent, and financial challenges,« concludes Ernst & Young in their study.

The huge increase in demand for OE production has caused OEMs to actively pursue aftermarket opportunities, looking for distribution and service models.

As a result, tension is rising with MRO providers—particularly within the engine segment, where OEMs increasingly choose total life support models, using operational data to predict maintenance intervals and, thus, accelerate airline availability.

Risk 9: Exposure to cybersecurity events

The ninth biggest challenge in the aviation industry in 2019 is failure to have appropriate cybersecurity measures in place. As more airlines, OEMs and MROs pursue big data analytics and predictive maintenance, the risk of cyber breaches increases. And the problem with inappropriate cybersecurity can be very costly for the aviation industry. 

In fact, the total losses incurred by companies as a consequence of cyber crimes are estimated to be approximately US$400 billion per year, according to Ernst & Young.

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aviation-industry-disruptions-2019

In 2019 and beyond, it’s essential that the aviation industry have a significant focus on implementing a strong IT-infrastructure to defend their cyberspace from unwanted intruders.

»In the digital world that we live in today, the risks and consequences of cyber attacks get magnified by the complexities of our integrated value chain. With increased interconnection across the value chain, a cyber attack on one company can cascade across the network and affect other parts of the value chain as well, increasing risk for the entire aviation industry« says Bill Colbert, Partner, Advisory - US, Ernst & Young, in the report.

Risk 10: Foreign currency and commodity price fluctuations

Fluctuations in currency exchange rates is the tenth and final types of risks that in the aviation industry in 2019. Given that a large amount of aviation companies operate globally, a large portion of their revenue streams are earned in a variety of currencies, making them vulnerable to fluctuations in currency exchange rates. 

Furthermore, Ernst & Young notes, currency fluctuation also affects the receivables, payables and return on assets denominated in foreign currencies.

Financial performance is also affected by price fluctuations in key commodities or raw materials, such as aluminium, titanium and composites that have a significant effect on the manufacturing costs as well as the profitability of the entire supply chain.

»Fluctuation in commodity prices can lead to issues along the aviation supply chain. For instance, it might lead to late delivery and increased failure probability by smaller suppliers. Commodity price fluctuation risks are generally mitigated via structured contracts or financial hedges,« explains Harsh Suri, Senior Manager, Valuation and Business Modeling - US, Ernst & Young, in the report.

There you have it: 10 of the biggest risks, challenges and problems in the aviation industry in 2019 and the years to come.

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About this blog

This blog is driven by Satair Marketing & Communication with input from both internal and external contributors.