Bizjets: what comes after the fractional boom? July 2000

When the first business jets arrived in the early 1960s, they represented an elite form of transportation for governments, VIPs, large corporations, and pop stars. This generated a fairly profitable market for the manufacturers. However, annual sales stuck around the $2–3bn mark (in 2000 dollars) until 1996. But then, a funny thing happened: a mature market tripled. Deliveries in 1997 rose close to $6bn and close to $7bn in 1998. In 1999, manufacturers delivered 636 jets worth $9.2bn. If the new dedicated business jetliners are added (Airbus' A319CJ and Boeing’s 737 BBJ) the market was worth well over $10bn.

The key demand driver for business jets is corporate profits. Typically, business jet demand increases a few years after corporate profits improve, and the US has enjoyed an extended period of economic growth and high profitability. (The business jet market remains focused on North America: over 85% of the world’s private business jets are based there.)

Corporations have also changed their attitude towards business aviation. Thanks to regional airline service cutbacks, substantial increases in business fares in recent years and the near abolition of First Class, companies are looking to private aviation as a source of efficiency rather than simply a status symbol.

Demand has also been boosted by the use of new technologies to promote business aviation. In early 2000, one company, Transjet.com, became the first to sell fractional ownership shares online. This approach might be further extended, offering business jet seats, as needed, to passengers with no ownership stake.

New business jet models are expanding business jet capabilities at the high and low segments of the market, and creating attractive new middleweight models for companies that want the latest and best technology. Fractional ownership is bolstering these new models by providing large, up–front orders.

An unprecedented 15 new business jet models arrived during 1995–1999, largely as a result of the development of new engines, especially Williams International/ Rolls–Royce’s FJ44 and BMW/Rolls–Royce’s BR700. But there are no revolutionary new engines or other technologies on the horizon. While Pratt & Whitney Canada’s PW500 series has just entered service, and Honeywell’s AS900 will enter service in 2002, these engines are replacements for earlier business jet power–plants, not product line expansions.

Many of these 15 new business jet models have been accompanied by large up–front orders, often discounted bulk buys from non–end users (i.e., fractional ownership firms). This has driven the market up to its current peak.

Cyclical peak?

Intriguingly, most of these programmes were initiated before the market’s explosive rise. Either manufacturers believed that these new products would help stimulate the market, or they had some excellent market forecasters. Right now, the business jet manufacturing industries' biggest problems concern production and completion deliveries. Production lines have been pushed to their limits. The downside to all of the recent good news, of course, is that mature markets that triple in a few years never stay tripled. Already, we are seeing signs of a market softening. The fleet of available used planes is increasing, and prices paid for these planes are plateauing, if not shrinking.

There are good reasons to expect 2000 to be the high point of the market. Much of the catalyst for market growth has been fractional ownership companies, rushing to purchase large numbers of new models. This is in effect a first equipment cycle, which has "overstimulated" the market, and in a year or two, it will end.

Nevertheless, the fundamentals are in place for long–term market growth. This is a much broader clientele; despite the uncertainties surrounding fractional ownership providers, the evidence is that they really do grow the market. According to EJA, the leading fractional ownership company, 80% of their clients have never owned a jet. Also, the total number of flight departments continues to increase, even counting each fractional providers as only one department.

Retirements will also play a role. The first business jets arrived in the early 1960s, and most of the early models are still in service–half the Learstars built are still active. Some 25% of the world’s business jets are over 20 years old. Assuming a 25–30 year life span for business aircraft, there could be some major increases in new, or at least newer used, business jet demand after 2002–2005 to replace aircraft retiring from the market.

The market no longer caters exclusively to an elite, price–insensitive clientele. Increasingly, it is offering a commodity, complete with price competition (at both the user and manufacturer level). Margins will retreat somewhat from their recent healthy state. And, the question of industry profitability is greatly complicated again by the question of fractional ownership.

Fractional ownership firms will soon account for about 10% of the worldwide business jet fleet, and this may rise to 25%. Deliveries of new jets to fractionals are currently running at 15%.

Today, there is really only one true, independent large fractional ownership player–EJA. The other large concerns, Raytheon’s Travel Air and Bombardier’s FlexJet, are tied to manufacturers and only order planes from those manufacturers. They may be more about asset management and market share manipulation than expanding the fractional ownership market. EJA is also the only fractional emphasising international expansion.

Any kind of concentration of market power in buyers will increase their ability to negotiate lower prices, which would affect manufacturer profit margins. Also, if competition among fractional ownership firms grows, possibly with the emergence of discount fractional players, this will further increase pressure on manufacturer margins.

Another related problem may be the flexibility that fractional companies have when ordering aircraft. If a company buys one or two jets, the manufacturer will enforce the sales conditions and schedule, making deferrals difficult. But fractional companies, with their greater market power, will be able to demand deferrals (and possibly even cancellations) based on prevailing market conditions. So, sales to fractional firms may be somewhat less "firm" than sales to traditional users.

Fractional ownership will also have an impact on market cyclicality. Looking to the commercial jetliner industry for a parallel, there are two alternatives. If fractional companies behave like GPA did in the 1988–1990 market upturn, placing large block orders in anticipation of continued market growth, fractionals will exacerbate market cyclicality. However, if they behave a bit more rationally, like ILFC, they will place large block orders when the market is down and the buyer has the advantage over the manufacturer.

Lastly, because fractional ownership companies emphasise greater utilisation of aircraft, residual values may suffer. If a fractional firm uses a given plane twice as many hours per year as the current norm, values for the entire fleet may well decline from current levels.