avolon - proposed market-entry strategy
TRANSCRIPT
A report on the industry dynamics of the aircraft leasing sector; with a proposed entry strategy to the Chinese
market forAvolon - an Irish-based aircraft leasing firm.
ByJohn Byrne
Robert SmythYueqin Huang
Group 5
Date Submitted: 21/04/15
Table of Contents
1. Executive Summary
2. Company Background
3. Key Personell
4. Current Financial Position
5. Avolon’s Business Model Canvas
4.1 Customer Segments
4.2 Value Proposition
4.3 Key Activities
4.4 Key Resources
4.5 Key Partners
4.6 Customer Relations
4.7 Channels of Distribution
4.8 Cost Structure
4.9 Revenue Stream
6. Market Analysis
7. Diamond of National Advantage – China
6.1 Firm Strategy, Structure & Rivalry
6.2 Demand Conditions
6.3 Related & Supporting Industries
6.4 Factor Conditions
8. Five Forces Analysis
7.1 Degree of Rivalry
7.2 Buyer Bargaining Power
7.3 Supplier Bargaining Power
7.4 Threat of New Entrants
7.5 Threat of Substitutes
9. Market Entry Strategy
10. Implementation of Strategy
11. Pivotal Questions for Management
12. Conclusion & Recommendations
13. References
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14. Bibliography
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Executive Summary
At present, nine of the world’s top ten aircraft leasing firms are headquartered in
Dublin. Of the 8,000 leased commercial aircraft currently in service 4,000 are
managed from Dublin.
Avolon, one of the largest leasing firms in the world, operates a fleet of 251 aircraft
and is currently valued at €1.2 billion euro.
This report is an insight into the Avolon operation. We have rigorously analysed the
company’s business model and future plans in order to develop a winning market
entry strategy into the Chinese market. Our decision to focus our sights on China is a
result of a global analysis of industry growth and more importantly the shifting
industry demand.
The development of this strategy required us to perform an in-depth analysis of the
current industry parameters in China and the position of the Chinese economy itself.
From this analysis we have selected what we believe to be the best performing airline
in the industry, China Southern, to target for an asset-acquisition based mode of entry.
Further to our market strategy development we have also devised a set of
recommendations to the Avolon board of directors. These recommendations are a
result of our thoughts and opinions that we derived from our meeting with Avolon
senior executives. These recommendations are based on the topic of future
development and planning and it is our hope that the company will find these
recommendations relevant and useful.
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Company Background
Avolon is a leading global aircraft leasing firm, focused on acquiring, managing and
selling commercial aircraft. Avolon's stated objective is to invest exclusively in
modern fuel‐efficient aircraft that demonstrate the strongest long‐term value retention
characteristics.
The company was established in 2010 by Domhnall Slattery (CEO) and his two
partners Andy Cronin (CFO) and John Higgins (CCO). They were the core team from
RBS Aviation Capital – the aircraft-leasing department of RBS, who actually acquired
Domhnall Slattery’s previous aviation business International Aviation Management
(IAM) in 2001.
They were joined by several other high level managers from RBS such as Dick
Forsberg, now head of Strategy, Pat Hannigan, Tom Ashe and Ed Riley.
This is an experienced and respected team of industry experts and have a proven track
record through a number of industry cycles. They state themselves that their growth
and global platform is “underpinned by a clear set of corporate values, which are the
basis for how (they) run (their) business”.
In five years they have amassed a fleet totalling 251 aircraft of 13 different models.
They are operational in 51 airlines globally in 29 different countries and have 64 staff
spread across 5 offices, including Stamford, CT, USA; Singapore; China; Dubai and
with headquarters in Dublin. Avolon boast a portfolio of 30 lenders including Wells
Fargo, Citibank, Deutsche Bank and UBS. They were publicly listed on the New York
Stock Exchange in 2014 under the ticker symbol AVOL and at the time it was the
largest ever listing of an Irish founded company on the NYSE.
In November 2013, Avolon announced it had commissioned a documentary on the
history of Irish Aviation titled: "Pioneers and Aviators, A Century of Irish Aviation.
The documentary tells the story of the remarkable, pioneering individuals whose
vision, passion, successes and failures helped forge Ireland’s unique aviation
landscape.
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Key Personnel
On Wednesday 11th of March our group held a meeting with three of Avolon’s senior
managers (pictured above). The meeting lasted three hours and the following topics
were discussed.
Company history, founding members and initial growth.
Growing popularity of aircraft leasing and the strategic decisions required.
Current market characteristics and strategic responses to demand shift.
New market entry and financeability requirements (Debt/Equity Funding).
Regional distribution and focus on the Asia-Pacific region, in particular China.
Analysis of airlines and considerations involved in targeting lessees.
Analysis of Business Model canvas.
Discussion of pivotal management questions.
Future planning and development
Cross-cultural challenges and strategies.
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Current Financial PositionFigure: 1
Breakdown of RevenuesFigure: 2
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Business Model Canvas
A business model consists of four key interlocking elements (value proposition, profit
formula, key processes, key resources) that, taken together, create and deliver value
(Christenesen & Kagermann, 2008) and the most important to get right is the value
proposition.
Avolon’s business model is not unique in absolute terms, but they are extremely good
at what they do and provide a tangible representation of their value proposition
through expert delivery of service. The key to Avolon’s success is not only their value
proposition; it is the overall implementation of their strategy through a clearly
structured commercial infrastructure. This business model has been detailed below
using the framework of the business model canvas (Osterwalder, 2008).
Customer Segments
Put Simply, Avolon have three primary customer segments:
- Incumbent Airlines
- Capital lenders i.e. banks
- Other lessors
Incumbent Airlines:
Avolon’s primary customer segment is airlines looking for sale and leaseback
agreements for their assets. They target established air carriers with strong
backgrounds and stable reputations. They do not limit themselves specifically to one
region, nation or airline, however as minimising risk is a key factor in their overall
business strategy, it is vital for them to choose only airlines that are most strongly
positioned within their given markets. In the event that they enter into agreements
with smaller subsidiary airlines, it is important to Avolon’s overall strategy that these
airlines are underwritten by stable parent companies.
Banks & Capital Lenders:
As a separate customer segment, Avolon target capital lending companies that want to
enter into the aircraft-leasing market but do not necessarily have the infrastructure to
do so – namely the industry expertise and network connections.
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Other Lessors:
Another aspect of Avolon’s overall strategy is having high asset liquidity rate and
consistently maintaining this turnover rate. In other words, to ensure that Avolon
adhere to their own value proposition (having the best aircraft at the leading edge of
technology) they must ensure that they are always purchasing the newest aircraft. To
finance this they sell ageing leases as well as ageing assets to other lessors with
different value propositions.
Value Propositions
Avolon have a focused-differentiation strategy (according to Bowman’s Strategy
Clock, 1996) and target a clearly defined niche.
Airlines:
Avolon allow carriers to purchase aircraft for their fleet in a way that’s financially
viable for the airline, saving them the cost and risk associated with major purchases
from aircraft manufacturers.
1. Innovation
Avolon are only focused on the newest state-of-the-art aircraft. They position
themselves at the leading edge of technology.They are solely investors and are
not wedded to one type of aircraft, however the aircraft needs to have critical
mass in the marketplace. As the lead times are so long, it offers stability to
Avolon on the one hand, but also means that for new manufacturers it could
take up to a decade to bring in new aircraft – which is hundreds of billions in
cost.
2. Ubiquity
Despite dealing in the newest aircraft, Avolon only enter into leasing deals and
trade the most widely used aircraft. This ensures they adhere to their policy of
maintaining a high liquidity rate of assets – if a given aircraft in their fleet is
not widely used by many carriers (i.e. if it doesn’t have critical mass) in the
industry then Avolon will find it more difficult to trade the asset in the future.
If an asset has a wide operator base then it is much less likely to challenge the
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value of the asset. For example the Airbus A320 has a myriad of carriers, it is
an easy aircraft for which to acquire parts and there is huge, industry-wide
demand for the aircraft – all facilitating easy liquidation if necessary.
3. Quality
Avolon have sacrificed innumerable growth opportunities to hone in on and
uphold their high standards regarding the quality of their assets. This is a key
factor of their general value proposition and is basically what separates them
from the pack as they are not diluting their brand image.
In essence, they will only invest in, and ultimately offer their customers, the newest,
technology but proven to the industry.
Capital Lenders:
Avolon offer a well-established, proven platform for lenders looking to establish
instruments (leasing agreements) with other airlines but don’t necessarily have the
infrastructural means (industry expertise, client network/industry connections and
know-how etc.)
This creates value for the financiers insofar as they can establish an aircraft leasing
section of their business and have the confidence to outsource the activities to Avolon,
who are renowned experts in the field, without the absolute cost, risk or liability of
entering into a totally new industry.
Avolon perform all the necessary activities, and the lenders have the peace of mind
knowing their only duty is to provide the required capital.
Other Lessors:
Avolon extend value to other lessors, who have different value propositions to that of
Avolon (i.e. lessors looking to purchase older and thereby cheaper aircraft – which is
not what Avolon is interested in, so in effect these other lessors are not direct
competitors) by offering them competitive financing deals when selling on their
ageing lease agreements.
***
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Avolon has several key success factors (Daniel, 1961 McKinsey & Co.) in terms of
activities, resources and partners that are necessary to the successful realization of
its business model and effective implementation of its strategy.
Key Activities
Raising capital:
Avolon’s profitablity is primarily derived from its success in raising capital at
cheaper rates than its competitors. This means it is able to raise both debt and
equity capital for the purchase of assets at rates that are competitve in comparison
to its competitors. They are chiefly focused on the financing element of the
business than on the mechanical or technical aspect.
Trading Assets:
Avolon has the number 1 youngest fleet out of the top ten lessors worldwide.
Purchasing aircraft cheaper than competing lessors and the ultimate sale of the
assets at a profit further down the line is not only important to supplementing
revenue from leasing activity, but also for achieving their strategic goals of
ensuring high asset liquidity rates (turnover of assets) and maintaining their value
proposition of having the youngest fleet available to lessees. It should be noted that
Avolon perpetuate a 20% asset turnover rate and on average make a profit of
$3.5million per aircraft traded.
Securing Instruments:
Another key activity in which Avolon regularly out-performs their competitors is
the ability to secure deals with both lessees and capital lenders that their
competitors cannot. These deals could be in terms of leasing aircraft to particular
carriers that may be somewhat captious in nature or even in procuring competitive
rates from financiers that regard Avolon as a highly credible debtor, and would not
be as prone to lending to Avolon’s rivals.
Managing Debt:
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Avolon are one of the top 10 aircraft lessors in the market and this is evident from
the platform they both use and make available to lenders looking to enter the
aircraft leasing market. They are adept at optimising returns in this industry
through their vast expertise, network of clients, contacts and financiers and diverse
portfolio of clients mean that debt-finance providers know their capital investments
are safe.
Key Resources:
Personnel
One of Avolon’s most vital resources is its almost unrivalled industry expertise. Of its
core team, 10 of those left RBS’ aircraft leasing division in 2010 to establish the
company. Between them they have almost 160 years of industry expertise
Assets
Avolon, as referenced above, have the no. 1 youngest fleet out of the top 10 lessors
worldwide. This is another crucial element to their business model and value
proposition. According to Dick Forsberg, Avolon’s head of strategy, there are
approximately 20,000 commercial jets currently in operation worldwide, with about
8,000 less than 7 years old. Avolon operate entirely within this bracket.
In respect of the global fleet of aircraft, (or any fleet for that matter) the oldest aircraft
will be jettisoned first, as they are the least up to date, both technologically and in
terms of efficiency – this is logical. This means that there would have to be a massive
reduction in demand and accelerated obsolescence of aircraft resulting in a 75%
reduction in the global fleet before Avolon were to truly take a hit. Having said that,
in the highly unlikely event that this were to happen, the assets would still be useable.
The only major affect would be a drop in monetary value; so in reality, the airlines
would take the first hit.
Location
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There are two elements for which Avolon use location as a resource:
Domestic:
The aircraft leasing industry was started in Ireland by Irish man Tony
Ryan in the early eighties. The establishment of cross-border leasing
agreements, withholding tax treaties and other such arrangements (along
with a relatively low and stable corporation tax) gave Ireland first-mover
advantage in the industry. Aircraft leases were being put into operation
when very few other people in the world knew what aircraft leasing
entailed. This structure takes decades to replicate and as such Ireland has
since become the global hub for aircraft leasing firms with 55% of all
lessors being based in Ireland (according to the IATA). This provides
Avolon with easy access to any necessary expertise, infrastructure and
support that they might not otherwise have within the company.
International:
In terms of location on an international basis, Avolon also have offices in
China, Dubai, USA, Singapore. This permits them to offer support to all its
customers, regardless of where in the world they are located.
Financial
At inception Avolon was able to obtain start-up funding from 3 core equity-financing
firms of $1.5billion in order to begin operations. These were CVC Capital, Cinven
and Oakhill Capital Partners. Through sustaining profitability, growth and good
stakeholder relations Avolon have been able to retain a committed equity capital base
from its financiers.
Brand Reputation
Avolon’s brand reputation is an intangible representation of the aforementioned key
success factors and value propositions. Its differentiated strategy, which offers
premium service, as opposed to low-cost lease providers, ensures that they maintain
good customer relations across all segments – as well as through all elements of the
value chain (Porter, 1985).
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Growth of Airline Industry
The overall future growth forecast for the airline industry can almost be considered a
resource to the firm. The industry is expected to grow, not only in terms of passenger
numbers and overall freight, but also as the demand curve for the operation of aircraft
continues to swing heavily from purchasing to leasing, Avolon can expect a continued
growth in business.
Key Partners:
In addition to key activities and resources, Avolon has a pool of key partners that are
a quintessential part of the business.
Capital Lenders
With a portfolio of over 30 lenders, these capital lending firms are necessary for
Avolon to obtain both debt and equity finance for its own operations as well as
entering into strategic operations alliances with certain banks and lending associations
that don’t have the required platform to operate independently in the leasing market.
One major example of this type of agreement is the joint venture alliance that Avolon
have with major US bank Wells Fargo (WF). WF provide the necessary capital and
Avolon manage the debt by way of leasing activity.
Air Carriers
Avolon has clients spread all across the globe. Their highest distribution of assets is in
Europe, USA and the Asia Pacific, but they also have clients in Africa, South
America and Australasia. Some of their most notable clients include Virgin (Atlantic
and Australia), Air Berlin, Etihad, Air Asia, American Airlines and DHL to name but
a few.
Manufacturers
Airbus and Boeing operate an effective duopoly on the airline manufacturing industry,
thus contributing to over 90% of Avolon’s deliveries.
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Private Equity Firms
As previously mentioned, CVC, Cinven and Oakhill are Avolon’s core providers of
private equity. They are also listed on the New York Stock Exchange and this is
another source of equity capital.
Many of Avolon’s key resources, activities and partnerships are largely intangible and
developed through years of high performance within the industry. This ensures that
they stand the test of inimitability and durability. Given the strategic position in which
Avolon put themselves, the business model also stands the test of competitive
superiority, allowing their entire supply chain to create value for all stakeholders
(appropriability). In addition, given the conditions of the aircraft leasing market,
Avolon easily withstand the test of substitutability as well. (Collis & Montgomery,
2008).
Customer Relations:
Based on their position in the market and their overall brand reputation it is evident
that Avolon keep excellent customer relations, both with the airlines they service and
the banks for whom they provide a leasing platform.
Airlines
Airlines are offered full autonomy in terms of managing the asset. This means
that they are in full control of all aspects of operating, maintaining and
servicing the asset.
Customers are well integrated into the other aspects of Avolon’s business
model. If Avolon can obtain a competitive rate from a lender, this is in turn
passed on to the customer, although at a profit for Avolon. The manufacturer
then delivers the aircraft to the customer on behalf of Avolon, they do not
physically touch the aircraft.
Aircraft are personalised for the specific airlines. For example a Virgin
Atlantic aircraft will have the layout of a typical Virgin aircraft (number of
seats etc), it will be decorated like a Virgin aircraft, have the look and feel of a
Virgin aircraft. Even the pilots won’t know it is leased.
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Avolon have a diverse customer base, spread across the globe. With such
widespread operations in so many countries, on nearly all continents, it means
that there is support available to clients no matter where in the world they are
located.
Lenders
Avolon already have established relationships in the finance community, as so
many of the founding team came from the aircraft leasing division at RBS.
Their vast expertise translates to success in the market which means customers
are consistently satisfied.
Through borrowing for themselves (for their own activites) and through
effective and efficient debt management facilitating stable returns – i.e. doing
the grunt work so lenders don’t have to – Avolon have built up a stable
reputation in the lending community. This means lenders can have peace of
mind knowing they can take a step back and reap the rewards of their
investment without having to get embroiled in the focal activities.
Channels of Distribution:
In terms of delivery of aircraft, the manufacturers (usually Airbus and Boeing)
distribute the aircraft based on the orders made, so Avolon generally don’t physically
handle the aircraft.
Cost Structure:
Avolon have an extremely high fixed cost base, primarily focused on two elements:
1. Human Capital
Avolon provide competitive remuneration to their staff who have vast industry
knowledge. With nearly 160 years of combined industry experience, very few
competitors can rival this.
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2. Asset Acquisition
Aircraft, as expected, are expensive! Hence the acquisition of assets by Avolon
is a major expense for the company.
Variable Costs
Costs are value driven: The two primary influencers on variable costs to Avolon are
conditions in the capital markets and conditions in the airline industry.
Profit is derived from the difference between the rate that the firm borrow
money to finance the delivery of aircraft and the rate at which the firm leases
the aircraft to a given airline. Therefore the cost of debt-financing rates is very
important.
Costs are also influenced by industry conditions in the airline sector eg.
emissions regulations on new aircraft (or new engines); fuel prices which are
constantly fluctuating; passenger demand in a given region etc.
Scale is also a factor in determining costs i.e. the number of aircraft being delivered in
a given contract. Hypothetically, if Avolon purchase 100 aircraft, it will cost them
significantly less per aircraft delivered than if they were to only purchase 10.
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Revenue Streams:
As has been detailed above, it is clear to see from where Avolon’s revenue is derived:
Leasing Agreeements
Sale of Assets
Debt-Management Service Fees
Sale of Ageing Leases
Leasing agreements are Avolon’s core source of revenue. Customers are
willing to pay premium prices as they are getting the best, newest and most
widely used aircraft.
This core activity is heavily supplemented by the trading activity and turnover of
assets (i.e. the purchase and subsequent sale of aircraft – purchasing from the
manufacturer and sale of asset to a 3rd party within a few years).
In addition to this service fees are charged to capital lenders, which are another source
of income.
Each of these aspects are key to the prosperity and profitability of the company,
however leasing agreements are the primary source.
For a detailed breakdown of revenues see Fig. 2, page 5.
.
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Current Market ShiftFigure: 3
Boeing announces production forecast for next 15-20 years with an estimated value of
$4.8 trillion. Source: Capital Aviation.
Figure: 4
Airbus figures for same period. Combined together these two manufacturing giants
will produce an average of 269 aircraft per month for the next 17 years.
Source: Capital Aviation
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Current Market Shift
As we can see from this graphic the Asia Pacific region and China in particular will
be experiencing huge levels of growth in terms of air traffic over the next 15-20 years.
This growth combined with the increased production and more frequent availability of
newer fuel efficient aircraft is a clear justification of our strategic market entry into
the Chinese market and in particular China Southern Airlines. The next section will
outline our entry strategy and detail the factors that must be considered in any
strategic market entry.
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As we have focused our strategic plan on the Chinese market we have prepared a
Diamond of National Advantage, a framework introduced by Michael Porter, to
showcase how well suited China and the Chinese economy is to the aircraft leasing
industry.
Firm Strategy, Structure & Rivalry
China is home to a number of large, well run airlines. These include China Southern,
Air China, Cathay Pacific and China Eastern. Combined together these airlines
operate fleets that consist of approximately 1,280 aircraft. In 2014 alone these four
carriers served 299 million passengers. What makes these big carriers attractive is the
fact that they operate fleets that include a wide variety of aircraft, in terms of
manufacturers and size. This fits well with Avolon’s desire to maintain a wide spread
portfolio and to avoid focusing on acquiring a certain aircraft model or size.
Regarding cultural fit Chinese companies operate with a high level of long-term
orientation. Geert Hofstede's cultural dimensions study scored China at 87 meaning
that it is a very pragmatic culture. In societies with a pragmatic orientation, people
believe that truth depends very much on situation, context and time. They show an
ability to adapt traditions easily to changed conditions, a strong propensity to save and
invest, thriftiness, and perseverance in achieving results (Hofstede Center). All of
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these attributes are crucial in maintaining a professional work ethic and match well
with the fast paced, professional environment that is aviation financing & leasing.
Demand Conditions
With regard to demand in China, a report issued by KPMG Hong Kong states China
will require a further 5,000 aircraft over the next two decades with a large amount of
these being acquired through lease agreements. More importantly, Asia is driving
growth and shifting aviation’s center of gravity eastward. In 2010 about 33% of
passengers traveled on routes to, from or within Asia-Pacific. For North America and
Europe the equivalent number was 31%. By 2015 IATA’s passenger forecast
anticipates that Asia-Pacific will represent 37%, while traffic associated with Europe
and North America will fall to 29% (IATA 2012).
On average a Chinese person flies 0.2 times per year compared with 1.8 times in the
United States (IATA 2012). According to Tony Tyler, CEO of IATA, within the next
decade China is expected to reach the per capita income level of $15,000 at which
annual air travel becomes a possibility. This growth could generate an extra billion
potential travellers annually.
Related & Supporting Industries
Beijing is home to one of the worlds largest maintenance firms, Ameco. Founded in
1989 they currently employ 3,750 employees and play a crucial role in the Chinese
airline industry. Ameco also operates 6 smaller facilities dotted around China in
locations such as Shanghai and Guangzhou. The presence of a reputable maintenance
industry is a crucial factor that airline leasing companies must consider as they need
to ensure their assets are as protected and supported as possible.
Factor Conditions
In the Chinese economy there is a wide availability of capital and sources of finance
for leasing firms seeking to do business. Generally most leasing firms are in
partnership with financial institutions and banks in their home countries however it is
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extremely beneficial to have domestic banks and institutions willing to provide
debt/equity financing.
The once heavily regulated airline industry has undergone radical changes. The
CAAC, Chinese Aviation Authority introduced in 2004 a set of new regulations that
heavily supported international private investment into the Chinese airline industry.
CAAC’s new regulations encourage private investment in key aviation infrastructure,
including domestic airlines, airports, and cargo facilities, as well as in services such as
fuel supply and storage, maintenance and repair, operations, catering, and distribution
systems (Worldwatch.org, 2005)
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This industry analysis will cover both the competitive forces at work in the Chinese
airline industry and the competitive forces affecting aircraft leasing in the industry.
We have covered both aspects, as we believe that significant changes to the Chinese
airline industry have great bearing on the leasing industry.
In the case of the Airline industry the buyers are taken as leisure & business
passengers. With regard to the leasing industry the buyers are the airlines seeking to
secure lease agreements on new aircraft. Fuel suppliers, aircraft manufacturers and
employees are taken as the suppliers to the airline industry. Suppliers to the leasing
industry are Banks and other Financial Institutions looking to provide both debt and
equity funding. The players are airlines and aircraft leasing companies.
Degree of Rivalry - The competitive environment is made up of several large airlines
such as Air China, China Eastern and China Southern and smaller low cost carriers
including Spring Airlines and China United Airlines. In general rivalry in the industry
is strong due to the size of the competitors and difficulties in exiting the industry.
Regarding the competitiveness between lessors there currently are 14 out of the top 15
companies who have assets with Chinese airlines. The competitive nature of both
industries is assessed as strong.
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Buyer Bargaining Power - With specific regard to the leasing industry the buyers are
the leasing companies customers, banks and airlines. The bargaining power of these
buyers is quite high as there are many lessors operating within the industry. As Porter
(2008) states buyers are powerful if they have negotiating leverage relative to industry
participants. This negotiating leverage is particularly strong for airlines. This leverage
that airlines possess comes as these large carriers are the only airlines who can
financially support long term leases and so leasing companies are attracted to them.
Looking at the industry from an airlines point of view the buyers in this are the
passenger customers. Price sensitivity is high due to the growth of online price
sensitivity sites. Airlines can defend against this sensitivity by differentiating their
service in ways such as focusing on additional features including more legroom and
inflight services. Switching costs for buyers are low which further strengthens their
position. To combat this airlines have introduced loyalty schemes. An example of a
popular loyalty scheme in the industry is the China Airlines Dynasty Flyer Program,
which sees return customers rewarded for their loyalty through air miles and other
value added services.
Supplier Power - As mentioned Boeing and Airbus are traditionally the two main
suppliers of aircraft. Although they are run separately they effectively operate a
duopoly over airlines especially with regards to larger aircraft such as Boeing’s 747
and Airbus’s A380. Similarly to other industries around the world the Asian airline
industry is also supplied by smaller manufacturers. These include Bombardier and
Embraer. These aircraft manufacturers are suppliers to both the Airline industry and
the leasing industry and so play an important role in the competitive environment.
Considering there are only a miniscule amount of suppliers, their bargaining power
over airlines and aircraft lessors is extremely high.
Focusing solely on the Airlines companies, they employ a significant amount of staff.
For example Air China currently employ over 25,000 people. The bargaining power
of large groups of employees increases as they wield the threat of industrial
action/strikes. A threat which, if came to fruition, would have detrimental effects on
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the day to day service provision of airlines. Currently the Chinese Aviation Worker’s
Union has 360,000 active members (actfu.org, 2012). Fuel is a crucial input to the
airline industry and so fuel providers have a strong bargaining power over firms
operating in the industry.
According to Market Line the International Air Transport Association (IATA)
estimates fuel costs to have represented 31% of the total operating costs in 2013, up
$4bn over 2012 for the global airline industry (MarketLine 2013). However strong the
supplier’s powers are they are restricted by the unlikeliness of integrating forward into
the airline business, mainly due to excessive capital requirements and lack of
knowledge expertise. To combat the strength of the supplier power airlines in the
industry are forming strategic alliances or joining pre-existing alliances. Examples of
this include Air China and Shenzhen Airlines, two prominent Chinese carriers,
becoming members of the worldwide Star Alliance.
Threat of New Entrants
Entry barriers to the airline industry are especially high. If an entirely new airline was
to enter the market the start up capital requirements would be astronomical. However
there is always a consistent threat of existing airlines entering the market by launching
new services in the region. Distribution is not particularly easy, as new players need
to establish an online
booking system, and relationships with travel agents and other sales intermediaries. It
is also vital to obtain airport ‘slots’ for take-off and landing (MarketLine 2013).
The threat of new entrants into the leasing industry in China is assessed as moderate -
strong. This is due to the huge start-up capital requirements and the necessity of
human expertise. The threat, however, is driven up due to the possibility of
international lessors focusing their interests to the Chinese market. This is expected
given the huge forecasted growth of air traffic in the region and demand for aircraft.
John M. Timpany, Senior Tax Partner KPMG, stated in an interview with the Wall
Street Journal that ‘China will require 5,000 aircraft in the next two decades’.
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Other barriers to entry which could affect new entrants include industry regulation.
The Civil Aviation Administration of China takes responsibility for safety, security,
airworthiness, and related issues (MarketLine, 2013). A unique regulatory issue for
the airline industry is the prohibition of Cabotage. A MarketLine Advantage report
into the industry defines Cabotage as being the provision of domestic transport
services in a country by companies based in a different country. Airline Cabotage is
generally forbidden, unless explicitly permitted by an agreement between two or more
countries.
Threat of Substitutes
The threat of substitutes in both industries is relatively low. The main substitutes of
air travel are sea, rail and other land transport methods. Domestic flights which
account for over 90% of air passenger volumes in China (MarketLine 2013), can be
substituted with other methods such as land and sea travel. However considering
China covers such a large geographic area, air travel makes it easier to travel longer
distances in smaller amounts of time even factoring in waiting times.
Regarding the threat of substitutes to aircraft leasing, we would assess this threat as
low. The only alternative to leasing is for an airline to fully purchase an aircraft. This
strategy has become less popular due to the huge up-front costs and liability of such a
large purchase. Essentially, as Dick Forsberg (Head of Strategy, Avolon) put it,
‘airlines would rather not have large amount of aircraft on their books, it’s an
unnecessary move and very unattractive when compared with small payments over a
longer term’.
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New Market Entry Strategy
For any new market Avolon typically adopt an equity mode of entry, namely through
acquisition of assets (Pan & Tse, 2000).
The acquisition model adopted by Avolon is that of a hybrid, incorporating a
combination of both debt and equity financing; the former making up 75% of the
acquisition and the latter 25%. Financiability is central to both the business model and
overall strategy. As Avolon only have a limited pool of equity, they NEVER finance
solely through equity; it is always a 75:25 split. Again this is a strategic fit to their
policy of minimizing risk for optimal return. Whether the opportunity is market
driven or counterparty driven, the fundamental element is always financiability.
As is detailed in the business model canvas, Avolon also employ other equity modes
of market entry such as joint ventures, as seen in the example above with Wells
Fargo.
Contrary to what one might think, Avolon do not target specific regions, nations or
airlines as primary drivers for new market entry. They are driven by asset
classification and liquidity – i.e. aircraft – and a carefully crafted concentration-
distribution strategy.
The fact that they operate on a global scale is very important to their business as it
ensures they can maintain diversity – and ultimately spread their risk – across the
portfolio of assets. The airlines actually consider themselves as operators, rather than
owners, of aircraft in that they also want minimal residual risk. This is why they enter
into agreements with lessors in the first place.
Avolon follow where the industry demand goes, while at the same time ensuring they
do not oversaturate a particular region, nation or airline, as their whole strategy is
based on optimum returns on financing agreements at a minimal level of risk. In other
words they can’t lease to all the airlines in one region or country as it too risky and
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diversity across its pool of clients is vital. As the common idiom says “don’t put all
your eggs in the one basket!”
An example of this was Avolon’s recent investment in the Indonesian market. For a
single market, there was, in relative terms, heavy investment made, so Avolon are not
considering investing further resources in that country for the short to medium term as
it would not be a good strategic fit (Collis & Montgomery, 1995).
Before looking at any specific market opportunity for Avolon, there are several
generic factors to be considered:
1. Asset:
The best definition of a new market for Avolon is a “new asset type” For this reason
the asset is the most important factor for Avolon. Does the asset fit with Avolon’s
value proposition - providing the best, most diffuse aircraft for the best airlines.
They are always looking at how to transition from one set of aircraft models to a new
set. For example, with the launch of the Airbus A320neo’s (New Engine Option) in
2010, Avolon decided that that was where the future of narrow-bodied aircraft lay and
they embarked upon a strategy of transition from the previous generation of aircraft to
the newer generation over the following years.
2. Airline:
Another important aspect to consider is the carrier itself. Does the airline make sense
to Avolon’s concentration-distribution strategy? Is it a credible airline (with a good
credit history)? Is it a startup or an incumbent? Is it a parent or subsidiary company?
If it is a subsidiary, does it have a credible underwriter as a parent company? Avolon
will always take a deep dive into the performance of the airline, its credit rating, how
the airline is managed, its position in the market (i.e. is it a price maker or a price
taker) etc. before making a decision on whether or not to enter into an agreement with
the airline.
3. Structure:
The structure of the instrument also plays an important role. Some questions that need
to be answered are: Will the investment deliver the appropriate level of returns for the
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level of risk involved? What are the criteria regarding security deposits? What are the
repossession risks? (For example, given today’s conditions, flying domestically in
Russia there would be difficulties in repossession.) How good is the national
infrastructure? Is there a risk of material adverse change to either the region, nation or
airline? (For example in India, Kingfisher had leased aircraft from several different
lessors. They subsequently went bust and aircraft were grounded. As property rights
were not fully developed, lessors couldn’t access the aircraft as their claims on the
assets were not supported through the courts – yet they still had to obligations to
financiers to pay their debts.)
4. Time:
Given that it takes months, if not years, to complete the process of agreeing lease
terms to final delivery of the asset, time is another important consideration for new
market entry. When looking at entering a particular market an agreement is reached
with the lessor, the financier and the carrier based on one set of parameters.
At the time of delivery, which is usually 12 months down the line, these criteria could
be different depending on market or industry conditions. For example, if Avolon
agree to enter into a less traveled or less populated market it may be difficult to break
out later on (i.e. to sell on the instrument) and so they may have to take the hit. The
risk of adverse change must be low – i.e. the risk of the country going into recession,
the airline going bust, or even more extremes that can occur in developing economies
such as war, must all be low in relative terms for Avolon to consider entering the
market. However this can be difficult to ensure as no one can predict the future.
This might sound a complicated process, and in reality it is, however the fundamental
economics to note of any market entry is the financiability of credit:
The rate at which Avolon can borrow the money to finance delivery
The rate at which Avolon lease the asset to the lessee
And the difference between the two figures is ultimately the profit.
Opportunity
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The new market entry opportunity we have chosen for Avolon is as follows:
Target: China Southern Airlines
5 new aircraft, 1 per annum
Over the course of 5 years
Supplement this activity with the sale of lease agreements with Spring Airlines
Reasoning
Taking a deeper look at both China Southern Airlines and Spring Airlines will
give an indication as to why to target China Southern and jettison the
instruments with Spring Airlines.
China Southern Airlines:
China Southern is one of China’s “Big Three” airlines – along with Air
China and China Eastern, both of which are already part of Avolon’s
client portfolio. This would further spread their risk across the Chinese
market in the event that something happens to either one (or both) of the
other two “Big Three” airlines.
China Southern is the 6th largest airline in the world in terms of
passengers carried and kilometers flown per passenger.
It possesses the largest fleet in China and the 5th largest worldwide.
China Southern also boasts the most developed network of routes of any
Chinese carrier, offering diversity as well as an avenue for an expansion
of contract in the future, for different aircraft models.
There is a good strategic fit for Avolon with China Southern as they
have a history of acquiring the best, newest aircraft and releasing older
models. For example China Southern are the only airline in the world to
operate both the Airbus A380 and the Boeing 787-8 in its fleet. These
are the newest “Dreamliner” aircraft and considered to be the height of
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technological advancement and offer the best customer experience
within the industry.
Airbus have announced an industry-wide strategy to replace all current
models of the A330 with the A330neo starting in 2016.
China Southern have 32 A330’s, their latest version being the A330-300,
which are approaching 25 years of age. This is the industry average age
of retirement of the aircraft – and China Southern, in keeping with their
own value proposition, are set to replace all of these A330’s with the
newer A330neo.
Spring:
Spring Airlines have, in relative terms, a very new and young fleet, with
the average age of their aircraft being 3.5 years old.
Spring are quite a young company having started in 2004. They
currently have 51 aircraft. This, coupled with the average age of their
aircraft, suggest that they will not be expanding or upgrading their fleet
in the short to medium term future.
This does however make for an attractive lease to purchase from the
point of view of other lessors (those with different value propositions to
that of Avolon).
Selling this lease would be in keeping with Avolon’s strategy of
conducting asset-trading activity to supplement its core leasing revenue.
They average $3.5million profit per aircraft traded, along with
maintaining a 20% turnover rate of ageing assets.
Spring also operate a primarily domestic flight network. They have a
few international routes with Japan, Korea and most recently Singapore,
however China Southern boast a much more broad and diverse network
of routes (and therefore a more broad and diverse range of aircraft
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models).
In addition, for such a young airline, Spring have had numerous
political, legal and public relations issues in the last number of years.
Two of the more recent high profile incidents were: They were
threatened with government sanctions over pricing strategies and in
terms of PR they refused to allow 3 passengers who have HIV onboard
cancelling their tickets – they lost the subsequent legal battle.
These issues imply a risk of material adverse change in the future – i.e.
they could be hit with governmental sanctions or they could face future
court proceedings and ultimately could go bust.
In summation, when comparing the two airlines, Spring pose, in relative
terms, a much higher risk than China Southern. This is contrary to
Avolon’s strategy of optimal returns at minimal risk and so for this reason
Avolon should consider this strategy for growth in the Chinese market.
Implementation
This implementation plan should provide an appropriate platform to execute the new
market entry strategy.
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1. When
All airlines, not only China Southern, regularly issue requests for proposal
(RFP’s) for leasing agreements in order to get the best financing rates.
Following an RFP, Avolon can begin to draft leasing agreements with China
Southern from next year (2016) with a view to begin delivery of the assets in
the subsequent 12 months (2017).
As lead times are so long and both Boeing and Airbus are heavily booked with
orders for delivery for the medium to long-term, Avolon would look to deliver
1 aircraft per annum for the subsequent 5 years (2017 – 2022).
This is a fairly standard agreement in which Avolon engage. It would be
unusual for them to offer more than 10 aircraft to any one airline at a time.
This is in keeping with their distribution strategy.
In 2022, once the delivery of aircraft to China Southern has been completed,
Avolon can issue an RFP to sell the Spring Airlines lease. There would still be
a number of years to run on the lease, and as it is 5 years down the line (from
today) the average age of the fleet will be approximately 8 years. This ensures
that it is attractive for other lessors looking for older aircraft while at the same
time perpetuates Avolon’s strategy of selling on ageing instruments and
retaining the youngest fleet.
2. How
To ensure that they can optimize profits for themselves as well as passing on a
competitive rate of financing to China Southern, Avolon can utilize the
network of financiers and lenders, with whom they have established relations.
This will constitute 75% of the capital necessary to finance delivery.
For the other 25% required they can use their committed equity capital
provided by their private equity partners.
Having already agreed instruments with several Chinese partners, Avolon
have established a regional office in Shanghai. This is a prime location for
Avolon as, in geographical terms, Shanghai is situated in the middle of the 3
34
core Chinese commercial hubs: Beijing (further north), Shanghai (relatively
central) and Guangzhou (in the south).
In addition to this, the other two airlines of the “Big Three” Chinese airlines
that Avolon serve are located in each of these hubs; Air China are situated in
Beijing; China Eastern Airlines in Shanghai and China Southern Airlines in
Guangzhou.
This facilitates a customer support network for China Southern without
Avolon having to sacrifice support to its other major Chinese clients.
In 2022, after the final delivery of aircraft to China Southern, Avolon can issue
an RFP for the Spring Airlines lease. They can use their vast industry expertise
and relations with the debt-financing community to negotiate a competitive
deal to ensure they get a maximum return.
3. Scale
Once a successful and sustainable relationship has been developed with China
Southern, there is room for Avolon to expand this contract.
The size and classification of China Southern’s fleet allow for the expansion
on leasing agreements in relation to different aircraft models.
For example, Boeing are currently in the process of an industry-wide removal
from operation of their 737 fleet to be replaced with the 737MAX, starting
with first deliveries in 2018.
China Southern has over 150 737’s in operation with the 737-300 and 737-700
series to be replaced in the medium term future.
This is an example of just one asset model. Given that China Southern have a broad
and diverse range of models in their fleet and their value proposition ensures they
remain at the leading edge of technology (similar to Avolon) it can be said with
reasonable certainty that China Southern will be looking to upgrade several models of
their aircraft in the future - short, medium and long term – suggesting scalability and
room for growth with Avolon.
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Pivotal Questions for Management
Having read and analysed the reading ‘The Power of asking Pivotal questions’ by
Schoemaker & Krupp (2015), we put two of these questions to members of Avolon’s
top management with whom we met in Avolon’s Dublin headquarters. We will briefly
look at each question and give a brief overview of the discussion that took place.
Q: How well do you understand the implications of broad market trends and less
visible undercurrents for your business and for upcoming strategic choices?
Dick Forsberg, Head of Strategy, explained to us that a large part of their business
depended on successfully following and taking advantage of market demand. In
recent years the demand has shifted eastward to the Asia-Pacific region and Avolon
have carefully altered their fleet distribution respectively.
Mr. Forsberg also touched on the importance of not over saturating the company’s
interests in any one market. He explained that while a heavy emphasis was placed on
China they still were focused on the United States as the average age of fleets were
increasing and this meant that in the near future newer aircraft will be required there
too.
Q: How thoroughly have you analyzed major externalities and future scenarios
that could significantly impact your business decisions?
A major step in the creation of a lease agreement is economic planning. Andy Cronin,
Chief Financial Officer, explained to us the rigorous process that occurs prior to
signing a lease agreement. He discussed the issue of country risk and how a country's
current economic state factors into their strategic planning. To help us understand he
gave examples of future scenarios that would have a huge effect on business.
Hypothetically lets assume Avolon had committed to a lease of three aircraft to a
Greek Airline five years ago.
There is an extremely high chance the current economic climate in a country like
Greece would pose a huge threat on the Greek Airline to make payments on time,
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particularly if the airline in question was a legacy carrier or semi-state body. Similarly
when signing deals with Sub-Saharan African based airlines, the question of country
risk also comes into play. Future scenarios such as conflict & economic recession are
far more likely in these areas and so present a higher chance of impacting Avolon’s
business decisions.
Conclusions & RecommendationsHaving provided an in-depth analysis of Avolon and prepared what we feel to be a
concise market entry plan we will now provide three recommendations. These
recommendations are focused on improvements for Avolon’s current business model
and the improvement of future global operations.
1. We recommend that Avolon open further offices in either Europe or the USA to
facilitate better customer service to their customers in those areas. Currently
Avolon is placing a big focus on the east with offices in Dubai, China and
Singapore. We understand that these offices are crucial, however we do not believe
it is wise to appear to be neglecting the rest of the client portfolio.
2. We recommend that Avolon look at potentially hiring one or two Chinese aviation
experts in their Shanghai office, as to improve their presence in the region. We feel
that this is a smart strategic move and will drastically improve the company’s
further expansion in terms of cross-cultural and linguistic challenges. An
appreciation for culture is of major importance in China. A further development of
this idea would be to focus on hiring Irish business and Chinese graduates to be
deployed in the Shanghai office. The industry is growing at a substantial rate and it
would be invaluable experience for the company’s future leaders to be directly
present in the market.
3. Finally we recommend that Avolon deploy multiple lenses to connect dots from
diverse sources and stakeholders (Schoemaker, Krupp 2015). As with any growing
business it’s extremely important that Avolon seek second opinions on their
primary industry observations by engaging with the views of their customers and
strategic partners.
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References
Reinventing Your Business Model; Mark W. Johnson, Clayton M. Christensen
and Henning Kagermann; Harvard Business Review, Dec. 2008.
Daniel, D. Ronald, "Management Information Crisis," Harvard Business
Review, Sept.-Oct., 1961.
Alexander Osterwalder (2004). The Business Model Ontology - A Proposition
In A Design Science Approach. PhD Thesis University of Lausanne.
Business Model Generation, A. Osterwalder, Yves Pigneur, Alan Smith, and
470 practitioners from 45 countries, self published, 2010.
Introduction to Aircraft Leasing (2014). Capital Aviation [Youtube]. Date
Accessed 28th March 2015.
Hofstede Centre. The Hofstede Centre: Strategy, Culture, Change. Available
at: http://geert-hofstede.com/china.html Accessed: 26th March 2015.
Chiu, Joanne (2014). Asian Companies Flock Into Aircraft Leasing. Wall
Street Journal Online. Available at: http://www.wsj.com/articles/asian-
companies-flock-into-aircraft-leasing-1415827382 Accessed: 23rd March
2015
MarketLine (2014). Industry Profile: Airlines in China. Available at:
http://advantage.marketline.com/Browse?nav=842+4294855287&q=aircraft
%20leasing. Date Accessed: 21st March 2015.
IATA (2012). Press Release: Use Aviation Strategically, 13th February 2012.
Available at: http://www.iata.org/pressroom/pr/pages/2012-02-13-01.aspx
Date Accessed: 29th March 2015.
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Worldwatch Institute (2005). China Opens up Aviation Market. Available at:
http://www.worldwatch.org/china-opens-aviation-market-bringing-potential-
environmental-challenges. Date Accessed: 30th March 2015
Morrison Forester (2004). China Moves to increase private and international
participants in Airports & Aviation. Available at:
http://www.mofo.com/resources/publications/2004/06/china-moves-to-
increase-private-and-international Date Accessed: 1st April 2015.
Bowman, C. and Faulkner, D. (1997), “Competitive and Corporate Strategy”,
Irwin, London.
Competing On Resources, Collis & Montgomery, HBR 2008.
Collis, D. J., and C. A. Montgomery (1995). "Competing on Resources:
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Porter, Michael E. (1985). Competitive Advantage: Creating and Sustaining
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Questions", MIT Sloan Management Review, vol. 56, no. 2, pp. 39-47
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Bibliography
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BMGT 30290 Applied International Business Project GROUP PROJECT SUBMISSION – COVER PAGE
Spring 2015
Group number ___________ Word count ___________ (main body only, excluding table of contents, graphics, appendices, references)
Project title
___________________________________________________________________________
___________________________________________________________________________
___________________________
We confirm that:1. We are the original authors of this project report.2. This report does not contain any material taken from unacknowledged sources and
all material has been adequately referenced.3. This report has been prepared for assessment in this module and has not been
presented as course work in any other module.
Group Member Student Number Student Signature
We confirm our submission includes the following (please tick the boxes):
□ Standard cover page with honesty declaration and submission checklist.
□ All sources and references in Harvard style using endnotes.
□ Evidence (data) and logic supporting our insights and recommendations.
□ Copy of our presentation slides in an appendix.
□ A soft copy submitted via Blackboard Assignment Folder
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