At the Paris Air Show, IndiGo announced an order worth $20 billion for aircraft engines. The order was placed with CFM International for 280 Airbus A320neo and A321neo aircraft. CFM is a 50:50 joint venture between General Electric from the US and Safran from France. The order was a significant coup given that 87 percent of the Indigo Airbus 320/21 fleet is currently powered by IAE and Pratt and Whitney. What led to such a move?
How airlines evaluate engine orders
Engine selection for any airline is a complex process because of the myriad inputs that have to be considered. From costs to commonality to potential changes in technology — all inputs are considered and weighted to arrive at a decision. Add to this the fact that engines are 25 percent the cost of any new aircraft and significantly affect the asset price — which is critical to success.
Technical specifications including the thrust requirements, maintenance packages and the availability of parts are layered including potential impact to existing fleet. Certain airlines like Delta and Air France further demand the right to maintain engines at their own facilities and offer services to other airlines as a part of the engine order.
After sourcing all of these inputs, a lifetime value for the engine is derived and consequent impacts on profitability and liquidity studied. At that point an engine choice is determined.
Indigo’s engine orders are inextricably linked to their fleet strategy
IndiGo’s fleet strategy has been one that combines pricing power by volumes coupled with a sale and leaseback financing mechanism. Together these help the airline keep its asset and engineering costs extremely competitive, while also delivering a sizeable profit stream.
The airline started with an order of 100 aircraft in 2005; followed by another 180 in 2011; and a whopping 250 with options for another 100, in 2014. Each successive order provided additional negotiation leverage – especially since Indigo was also delivering operationally.
For engines, the first 100 aircraft were powered by the IAEV2500s. Due to the volume of the order and also the OEMs desire to establish presence in India, it is widely held that Indigo got a very competitive deal. For the next batch of aircraft, Indigo again went to the market to source the best deal. At the time, Pratt and Whitney was offering an engine with a new architecture called the Geared TurboFan (GTF). The engine was the result of a $10-billion research and development programme by Pratt and Whitney and one of the first clean-sheet commercial engine designs. It promised to deliver 12-15 percent efficiency on fuel – which constitutes 35-40 percent of an airlines’ cost base. Add to that the fact that PW was very aggressive with pricing and Indigo choose Pratt and Whitney to power their next 150 aircraft.
In early 2019 with a fleet of 200-plus aircraft, Indigo once again went to the market for sourcing engines. CFM was ready and waiting.
It is not the cost of the engine, rather the lifetime value that matters
For any airline what matters is the asset cost over the life of the engine and more importantly over the period that it flies for the airline. Thus in Indigo’s case where the leases were initially six years and now are mostly eight years, the consideration for the asset is the value during this period. For the engine maker, profitability is contingent on the lifetime value exceeding the customer acquisition cost. In this case the cost would be the discounts offered to Indigo which will be made up via the significant presence in the market and the potential opportunity to power their future orders.
As airlines engage with engine manufacturers, negotiations centre on the savings delivered by the asset, the costs of maintaining the asset and the discount to the asset value. This includes maintenance considerations, parts considerations and the liquidity on the engine type.
Engines may fare better while being evaluated on a particular parameter but it is the total cost to the airline that matters. And it is here the CFM engaged successfully. By IndiGo’s own admission (See:
Interview with Ronojoy Dutta), if given a choice they would like to stay with one provider. But if given an overall better package, the airline has to consider the total package offered – of which costs is a key consideration. In other words, the life-time value. CFM offered a deal that was the most competitive in terms of LTV and came away with the sizeable order of over 600 engines including spares to power 280 aircraft.
Analysts are questioning the complexity such an order introduces. But closely examined Indigo is already flying a fairly complex fleet. On first glance it is a common manufacturer Airbus with majority of aircraft being A320s. But more closely examined it is already flying variants and sub-variants with three different engine choices.
Additionally, complexity does carry cost. But if the benefits of a change far exceed that cost the airline is likely to choose the supplier. This was the case with CFM.
As of now, CFM is on track to deliver on the “largest ever single engine order in history.” Indigo’s first CFM-LEAP-1A powered NEO will take to the skies in 2020.
Satyendra Pandey is the former head of strategy at a fast growing airline. Previously, he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling and turnarounds. Read his columns