New Drivers Shaping Aviation Industry Cycles

Geographical Balance, Business Model Innovation Reduce Risk

The aviation industry is famously cyclical. In order to gauge the strength and length of particular cycles, financial analysts often track a multitude of factors, including airline profits, yields and load factors, and airplane values and lease rates.

Boeing analysis stretching back more than 50 years reveals that the best barometer of aviation industry performance is world gross domestic product (GDP). Historically, airline downturns coincide with worldwide economic slumps and airline operating margins grow as world GDP recovers.

Air transportation has become an integral part of the world economy and reflects the ups and downs of global GDP.

A healthy GDP is the primary driver of the current surge in commercial airplane demand, as it has been in previous upcycles. Yet several developments in the aviation business environment distinguish the current upcycle from those of the past.

The Market Is Diversifying Geographically

The phenomenal economic expansion of the Asia-Pacific region has unleashed demand for air transportation in a part of the world that has been underserved, based on its population and resources.

In 1970, India and China together accounted for only 5% of the world economy, on the basis of purchasing power parity, and all of Asia operated only 5% of the global commercial airplane fleet. By comparison, Europe and North America generated a 60% share of global GDP and operated 88% of the world’s commercial airplanes.

By 2000, the combined economies of India and China had grown to 17% of the global economy, on a par with the economic output of Europe. North America and Europe together still operated 71% of the world’s commercial fleet, but Asia’s share of the fleet had grown to 17%.

Projections for the year 2012 show China’s share of global economy pulling ahead of Europe’s to match the U.S. share at 18%. India and China together will generate more than a quarter of the world’s total economic output. Asia’s share of the world’s commercial airplane fleet will become equal to Europe’s share at 24%. Demand for airplanes will thus be shared more evenly between three major economic regions, rather than just two.

More Balanced Global Demand and Fleet Distribution Reduces Investment Risk

Traditionally, European and North American economies have been strongly linked, so an economic slowdown in one of these regions tended to ripple through the global aviation market, depressing demand worldwide.

Demand for commercial airplanes is becoming more diverse geographically, as Asia’s share of the aviation market begins to reflect the purchasing power of the region’s economy. The broadening global demand base dampens the effects of regional volatility.

As total demand for commercial airplanes continues to rise over the next 20 years, the expansion of Asia-Pacific’s economies—particularly those of China and India —will increasingly moderate the effects of fluctuations of the North American and European economies. Asia-Pacific’s share of the new airplane market rose to 19% of global demand in 2005. That is nearly even with Europe’s 24% share. By 2026, Asia-Pacific’s share will reach 29%, surpassing that of Europe. During the same period, North America’s share of the demand will decline from 43% to 35%.

Though Asia’s economies are stimulated by the market for Asian goods in North America and Europe, the region’s indigenous consumer markets are developing rapidly. Rising average income and a growing consumer economy will foster demand for air travel and transport within the region. Robust indigenous consumer markets will help sustain the region’s demand for air freighters and passenger airplanes, even in the event of slack exports to Europe or North America.

As China and India move up on the list of top 10 world economies, other economies will appear on the list for the first time. By 2040, China will lead the list and India will move up to third behind the United States. Brazil will pass up Germany, Britain, and France. Mexico and Russia will join the roster behind Japan. These rapid movers are currently under-served by commercial aviation, so growth will far outpace that in the more mature economies.

Distribution of demand among a wider base of relatively independent economies buffers global demand for airplanes against the effects of regional economic shocks or cycles.

Airline Business Models Are Evolving and Maturing

Liberalization has increased competition among airlines and spurred innovation in airline business models. A regulated market restricts innovation, allowing for a narrow range of business models. As a result, any economic or political disruption affects all airlines in a similar way. However, in liberalized markets, increased competition leads to a greater diversity of airline business models. Under a given set of market conditions, some business models will flourish, even as other models struggle.

This was highly evident in the recent economic downturn, when large network carriers experienced severe losses while low-cost carriers continued to thrive. Similarly, when the market for premium fares stumbles, the market for economy fares often picks up.

The increased opportunity afforded by liberalization, and the resulting growth in the diversity of airline business models, has kept the total number of airlines worldwide on an upward path for at least 20 years. Despite heavy media attention on airline bankruptcies and mergers, the number of airlines entering the market has consistently exceeded the number of companies leaving the business. Having risen steadily since 1986, the number of airlines in service around the world is at an all-time high today.

Innovative Business Models Create Airline Opportunities

As one of the most mobile of investment assets, commercial airplanes gain significant value as a result of the geographical diversity of the aviation market and the variety of airline business models. Largely in recognition of this mobility, aircraft value has come to equal the importance of airline credit in managing airplane investment risk.

The current upswing in airplane orders demonstrates how the market’s growing geographical and business model diversity counteracts demand cycles driven by U.S. and European network carriers. The record number of orders during the past two years was driven largely by low-cost carriers and requirements from emerging economies. This is reflected in the order backlog of both airplane manufacturers.

New airlines entering the market more than offset the number of airlines that leave the business through bankruptcy or consolidation. The number of airlines in the world is at an all-time high.