January 2012 Letter

Dear Fellow Aircraft Industry Output Watchers,

We’ve updated Teal’s spreadsheets with fourth quarter numbers, and I have good news: 2011 was a good year for aircraft, and 2012 looks better still. Total industry output by value expanded 4.1% over 2010. Looking at rate plans and what’s in the military pipeline, output will expand by 9.3% in 2012. Since most aircraft are built in the developed world, and the developed world’s economy in 2011 was either sluggish (US) or terrifying (Europe), our industry remains an island of prosperity in a difficult environment. In fact, the industry sailed through the 2008-2011 with a 1.8% compound annual growth rate (CAGR). There were some weak segments, used jetliner values took a beating, and the aftermarket biz took a hit, but our industry grew through the worst recession since World War Two. That’s a victory.

Unfortunately, all the pain in our industry isn’t concentrated in inanimate flying objects and abstract market segments. There’s also Wichita, and the people who live there.

Arriving in Wichita, you see the sign, “Air Capital of the World.” Wichita is understandably proud of its status as one of the world’s five great aviation clusters (Dallas-Fort Worth, Montreal, Seattle, and Toulouse are the others). But in legacy, Wichita has a collection of great aero brands, rivaled only by Los Angeles before it largely got out of planemaking. They started with Beech, Cessna, Mooney, and Stearman (now Boeing, and soon to be a large abandoned building). They were joined by Learjet, and later Hawker. Wichita’s talent, heritage, and physical plant earn it the right to put up that sign.

But of all the aircraft industry segments, the bottom half (by value) of the business jet market has been hit worst, falling 60.4% by value in 2008-2011. All of Wichita’s business jet output is in this bottom half, and 90% of the world’s bottom half business jets are built in Wichita. The only other bottom half player is Embraer, which chose exactly the wrong moment to get into this market. How bad has Wichita been hit? Output at Wichita’s business jet primes fell a shocking 64.3% drop between 2008-2011 (a -29% CAGR). According to Wichita State University’s Center for Economic Development and Business Research, Wichita lost over 12,700 aviation manufacturing jobs over the last four years.

Recent events have been insult to injury. In December, Hawker Beechcraft’s AT-6, viewed as a slam-dunk for the Air Force’s Light Air Support (LAS) program, lost to Embraer’s Super Tucano (the contract has since been delayed for legal reasons, raising the question of whether Air Force procurement has been fixed since the KC-X and CSAR disasters). This was followed by another blow early this month when Boeing announced plans to close its Wichita facility in a few years. That’s another 2,160 lost aero jobs and the end of a factory with 82 years of history. It’s a magnificent facility where I once got to walk on top of a B-52. As one Wichita resident told me, “It was like Grandma died.”

(Sidebar: remember when Boeing and EADS kept upping their tanker jobs estimates and wound up with about 48,000? Those were fun days. Both guys fabricated numbers, but this is extremely ironic: Boeing won KC-X with Kansas political support, but in five years Airbus will employ more people in Wichita than Boeing does. Without being judgmental, let’s just say Boeing Community Affairs Manager is not a job title I’d want right now.)

What can the industry learn from Wichita’s woes? Lesson One: Diversify. Wichita’s heavy exposure to one half of one market rendered it extremely vulnerable. Through all the carnage in Wichita, Spirit AeroSystems stands out as a beacon of hope. Like any good first or second tier subcontractor, Spirit is hedged against risk, with exposure to multiple products and markets. Since independence from Boeing, Spirit management has done a superb job of diversifying a formerly all-Boeing work portfolio (while retaining a strong presence on Boeing’s best programs). Outsourcing would have been quite useful for Wichita as well; instead of sending work elsewhere and receiving work from elsewhere (as Spirit has done), Wichita became a vertically-integrated monolith. Unfortunately, all other large Wichita aero companies are bottom half business aircraft primes. Embraer, the only non-Wichita company going after the bottom half business jet market, is better diversified than any Wichita prime.

Lesson Two: Think globally. Those bottom half business jets sell largely to North American customers. The emerging markets may favor larger jets, but these markets are of huge importance for everyone (to their credit, Cessna and Hawker are now making a big push in China, and other emerging markets). Doing work for international customers is important too – Spirit has brought in work from Airbus, for example (although it isn’t done in Wichita). Finally, attracting foreign investment is key. The southern US states have learned this lesson well, with aerospace and with automobiles. One of the nicer properties in Old Town Wichita is occupied by that Airbus engineering facility, but it’s the only foreign transplant presence in the region.

Lesson Three: There are no easy lessons. One common criticism heard is that Wichita companies didn’t invest in the future. Cessna, for example, starved for cash by parent Textron, took a Derivatives R Us approach to new product development. Then, they cancelled Columbus, their first all-new jet in years, with plans to rely on just mixing and matching tubes, wings, and other people’s engines and avionics. This old wine in new bottles strategy, the criticism goes, was outmatched by Embraer, with its aggressive clean-sheet designs. There’s certainly a lot of truth to this criticism. But a few years ago, Cessna’s derivative new product development approach looked smart – an efficient way of leveraging investment money and a great price point management tool. Meanwhile, Embraer, viewed as the new aggressive company that’s doing everything right and attacking non-innovative Wichita companies, saw its business jet output fall 21.8% by value in 2011 from 2010. Monday morning quarterbacking is easy, but often wrong.

Also, by contrast with Cessna, Hawker Beechcraft did invest in all-new jets, such as the Premier One and Hawker 4000. These were very difficult and poorly executed programs, but they offered innovative new technologies. The market rewarded them with exactly nothing. The market didn’t care about new technologies. I’m a consultant. If I could think of useful advice to sell to Wichita’s jet primes I’d sell it. But I’ve got nothing. There was no shelter from this storm.

Wichita deserves better than to serve as a cautionary tale. That heritage shines through, both in the town and at the companies. There’s very good local press coverage of the industry, most notably by the Wichita Eagle’s Molly McMillan. There’s a fine Aero Club, which I have been privileged to address twice.

In October 2009 Aviation Week’s Joe Anselmo and Bill Garvey wrote an article called “Could Wichita Become The Next Detroit?” This was a smart, thoughtful piece, but I’d argue that Wichita won’t. Again, there’s a lot of talent, and this industry rewards talent. Barriers to entry remain high in aircraft production, and labor relations at the Wichita companies, while bad, were never as poisonous as in Detroit. Finally, just to keep some perspective: while 2011 was awful, it was a better year for Wichita’s business aircraft primes than any year prior to 1997. As the business jet market recovers Wichita will recover too.

Teal January aircraft updates this month include the Gripen, A340, S-92, AW101, ERJ 145, E-6, C-212, and MiG-29. Have a great 2012.

Yours, ‘Til Wichita Gets A Direct Air Route To Washington (or almost anywhere else),
Richard Aboulafia