The aviation industry has navigated significant challenges in the past, most recently 9/11 and the 2008 global financial crisis, after which passenger numbers flatlined for 2-3 years before continuing their upward trajectory. Following these crises many airlines and their supply chains merged and restructured in order to first survive and later thrive.
However, Covid-19 seems different. The initial impact has been enormous as the vast majority of international flights, and many domestic flights have been cancelled. The dramatic decline in passenger numbers has already resulted in 11 airlines going bust. While only time will tell, the initial signs are that the recovery from Covid-19 will not be as quick as before. Industry forecasts support this view, and ‘normality’ may not resume for a number of years. So there will probably be more failures.
Aviation analysts expect the greatest impact to be on long-haul routes, which are predominantly served by wide-body aircraft. In contrast, the short-haul market, served largely by narrow-body and regional aircraft, is forecast to recover at a faster rate. As lockdown’s start lifting across the globe, and debates continue about quarantine requirements between different countries, there is already evidence that neighbouring countries, such as Australia and New Zealand, will be amongst the first to open “air corridors” without the need for quarantine measures. Even then, consumer confidence may take time to pick up, with travellers potentially opting to holiday in their home country in the short term before braving international journeys that may be full of additional hurdles and challenges.
How has the industry reacted?
Airlines initially reacted by grounding fleets, converting certain passenger aircraft to carry freight, moving operations away from certain airports, cutting non-essential costs and pausing payments to various suppliers. Some airlines and suppliers turned to government employment support schemes to help further reduce operating costs.
Airlines also started reviewing their fleet make up, and began making decisions about whether or not to retire older aircraft, return leased aircraft early and/or to delay new aircraft orders to streamline costs and right size fleets for the recovery phase.
In the same way that many people have bonded in community with their neighbours during lockdown, suppliers and customers have been collaborating more closely. They recognise their mutual dependency and the benefits of working together, and are therefore more open to changes that previously could have taken years’ of negotiation and frustration.
In an industry where relationships are key, many such cost savings measures and much collaboration has been agreed on a goodwill basis, in the interests of speed, without formal agreements being put in place.
Contracts will now need to be adjusted to reflect the new normal
Many contracts in the airline industry, whether for leased aircraft, engine usage or maintenance are long term in nature. As more resolutions are reached and airlines recommence operation, it is vital that contractual terms are amended to reflect the new normal, and to formalise the previously agreed principles. Given the interlinked nature of the industry, for example where a change in an aircraft delivery date can have an impact on aircraft leases, engine maintenance contracts and the manufacture of engines, it is vital that all contracts reflect the revised terms, including amendments to financial provisions and other commercial terms.
Given the high-value and long-term nature of most aviation contracts, it is critical that agreements are amended sooner rather than later as part of a long-term recovery plan. This should ensure that actual or disputed contractual provisions do not create further issues or distractions during the upcoming recovery phase which will be challenging in itself to navigate.
Contracts provide the platform upon which commercial relationships are built, but key contracts may need to be more flexible going forwards. They will need to take account of the high level of cooperation currently being displayed by both customers and suppliers, and cater for any future events which may impact the industry. This will help maximise the chances of a strong sector recovery.
If you would like to discuss any of the points raised, do get in touch.
Supporting the contractual journey
Deloitte’s unique blend of commercial aviation specialists and aircraft/engine analysts, combined with knowledge in financial, operational and organizational restructuring can bring significant insight, knowledge and value to aviation clients in the current climate. Supported by a blend of knowledge proven processes and technology, Deloitte’s aviation contract team can provide a fast, scalable and effective solution to update and amend contractual terms to reflect the revised position and provide flexibility for the future.
Aimee is a Manager in the Extended Enterprise Risk Management Team and specializes in providing commercial contract related advisory services to aviation clients. Aimee has extensive experience of contract management having managed complex major airline contracts for 7 years in her former role at a jet engine manufacturer. Aimee utilizes this experience alongside cross-sector industry expertise, techniques and tools developed by the Risk Advisory service line she sits within to support clients across the globe with a variety of contract related services. The services delivered are tailored to the client’s needs and include examples such as utilizing Artificial Intelligence and contract analytics to understand large contractual landscapes, completing holistic contract reviews to advise on areas of risk and opportunity, and supporting clients with their recovery efforts in light of the current situation, among many more.
Mike leads Deloitte’s technical, legal and commercial aviation practice and provides technical, legal and commercial services to a range of aviation clients across the globe. Having worked for an aircraft engine manufacturer and leasing company for 8 years as a commercial business partner, Mike has considerable and in-depth experience advising on a range of complex aviation matters from both an OEM (supplier) and Airline/Lessor (purchaser) perspective. Mike is currently working on a number of active engagements for both airlines and leasing companies which involve reviewing the applicable client’s existing business plan and financial forecasts, and remodelling the plan in light of the current environment and conditions the aviation sector are facing. Part of these engagements involves mapping a variety of recovery models and assessing such models against business plans and projected revenue flows. In addition to assisting with the review and revision of the client’s business plan, Mike is also assisting such clients with how they re-shape their fleet to take into account adjusted business models and the current supply and demand in the market. Such work involves mapping existing contractual commitments against the revised business plan to drive the most cost effective strategy to reshaping the airlines current and future business.