Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

{audio:0:00:20} Geert, to start, could you provide a short introduction to your background and role at Safran?

{audio:0:00:28} Since my education, I’ve been in aviation for 27 years now, of which 18 years were at Safran. During that time, I had several management positions from program management and sales to business development, so I have been in varied fields yet always related to the pure engine business on the MRO side.

{audio:0:00:58} When you first joined Safran, how were they approaching building out the CFM56 MRO network in the early 2000s?

{audio:0:01:12} At that time, they had already their own MRO facilities. If they are producing new engines, they need to have the MRO site next to it, to support the customers. At that point, the prime facility was in Paris but quickly they created some other facilities all over the world. In total today, Safran has five prime MRO sites in Mexico, Morocco, Belgium, Paris and China. Out of those five, two of them are joint ventures; Morocco with Royal Air Maroc and China with Air China. Only three are 100% owned by Safran.

{audio:0:02:09} How do you see the differences in the way they’re building out the LEAP MRO network versus those early CFM facilities?

{audio:0:02:18} There is a clear difference between the CFM approach and the LEAP approach. In the past, Safran did have a joint venture with GE to create a new engine CFM and it’s still the same way with LEAP; it’s a 50-50 joint venture. On the services and MRO side in the beginning, Safran was competing against GE for the MRO services side, so we had two different sales team competing with each other on sales on CFM56.

{audio:0:02:52} Around 2008, they came with the idea of creating CFM Services, which meant a joint approach instead of competing with each other. The CFM side still campaigned on Safran Services and the others on CFM Services. In the LEAP now, you only have CFM Services; you don’t have that competition with GE and Safran anymore.

{audio:0:03:16} Can third party and independents also compete for LEAP?

{audio:0:03:22} Yes, they can. Safran or CFM have been very open on this aspect in the sense that they are giving licenses to other MRO to start key LEAP business or the CFM business. It’s a little bit more restricted than on the CFM side, in order to keep out the independents that are doing PMA and things like that, but still they are providing licenses to big MROs like SRT, MTU,  LHT, GATES. All those shops are going into the LEAP business and it’s no problem.

{audio:0:04:01} We know that other engine OEMs sometimes refuse to give licenses to MROs and you are the single source and unique provider of that engine module. This is not the philosophy of CFM. For CFM, new engine sales have been so successful that Safran and GE quickly understood that they cannot only do the MRO side. They have to share it, otherwise they will never cope with the shop visit demand.

{audio:0:04:32} The competition also reduces the unit cost of repair or maintenance for the airline as well, which is good for the customer.

{audio:0:04:39} Yes. It’s healthy for the airline to have some competition somewhere. Some airlines like the OEM shop, some others don’t but it’s a choice of the airline to select his own MRO site.

{audio:0:04:59} You mentioned the LEAP CFM services contracts are more restrictive. How are they more restrictive than the old CFM56 terms and conditions?

{audio:0:05:10} If you’re looking at CFM56, still today you have 47 engine MROs doing the CFM56 from OEM airline shops. Everybody can start without any problem. On the LEAP side, you need to have a specific license otherwise you have no access to details, no access to all engine data. They would like to better control the market to make sure that everybody is working on an OEM level, to try to avoid PMA providers or DER getting introduced.

{audio:0:05:56} So it’s really to protect the IP of the engine?

{audio:0:06:01} Yes, exactly but you also have to understand that it’s not only the OEM asking this. Sometimes it is also the lessors because, as you know, most of the airline fleets are getting leased more and more and the lessors would like to keep their assets at a higher value. They don’t want to get it polluted with some PMAs because then their asset value is getting impacted. That’s why there’s already high pressure from the lessors to put it on an OEM level.

{audio:0:06:29} Do the PMA parts reduce the asset value even though they’ve been qualified?

{audio:0:06:38} It’s a good question. Some of them think it’s purely protective from the OEM side to get more margin. When CFM sells a new engine, most of those engines are getting sold with a loss and they need to get their revenue back during the lifetime of the engine. Material sales is the prime aspect to get back margin. If they are not able to get that money back through new engine materials and somebody else is selling a PMA material, then it could impact the business plan of the OEM.

{audio:0:07:16} On the other hand, if an airline sends an engine to a shop with an installed PMA part, then the OEM says we don’t know what the influence will be of those PMA parts into the engine and what the behavior of the engine will be with this new material, so all the aspects of guarantee will be gone. CFM will not recognize this engine anymore as a CFM engine.

{audio:0:07:46} Then again, PMAs are there for many, many years. Most of the time they are less critical parts, static parts. Why? Because it’s too high risk to create PMA  LLPs and PMA rotating parts, so that’s why that market is not particularly big and it remains slim. As I already mentioned, the lessors are putting pressure there to keep them at an OEM level; even more so because the fleet is becoming more and more leased. PMAs are never really a big danger for the OEM because it’s there, it’s limited and I think, for the LEAP side, it will be even more limited.

{audio:0:08:31} On the PMA DER side it’s a different aspect. Those repairs are FAA approved. That means that some lessors are getting more open to accept DER repairs. Then I’m talking more to older engine types like CFM56, not towards LEAP. It’s way too early for LEAP.

{audio:0:08:58} Potentially, the CFM strategy around LEAP could limit the growth of PMA in the industry?

{audio:0:09:05} As they are applying this license strategy, yes. The aspect of PMA, even DER, is very limited. It has already been limited and I don’t think it will be a big market in future.

{audio:0:09:16} Is there also a different approach to PMA in the US and Europe, with HEICO?

{audio:0:09:24} Correct, there is a difference.

{audio:0:09:27} On the US side, there is more respect for the rules of the FAA because they are in an FAA operation area. That means, as DERs are already FAA approved, they’re considered as fine but you also have to consider that the main lessors in the world are not based in the US. They are based more in Dublin and Europe so that’s why you have a bigger influence in this area and are more protective on that aspect of PMA and DER.

{audio:0:10:03} Can we walk through a typical sales process for MRO services? Let’s say an airline or a lessor buys an engine – and it’s different based on different incentives – but what is typically the process of selling the MRO services?

{audio:0:10:22} There is a slight difference between the CFM and the LEAP. In the past, the new engines were sold and as Safran and GE were competing, the service contracts were sold separately, not as a package deal. On the LEAP side these days, they always sell the new engines with the MRO as one package, or they try to.

{audio:0:10:47} It also depends on the fleet size and so on. A services contract will be attached to the new engine sales but that contract is mostly  a long-term contract for 10 to 12 years. These contracts are , most of the time, on  Power By the Hour (PBH) basis. You have different definitions of PBH contracts because every OEM use different definitions, but PBH contracts are generally  long-term contracts for big fleets and big fleets means bigger than 10 aircraft.

{audio:0:11:23} Take the CFM56, do they have to choose on day zero, whether they do shop visits with CFM or with an independent?

{audio:0:11:38} On the CFM side, they don’t produce them anymore, so that means that they are all old engines. By old engines, I mean they produced them one or two years ago but now it’s finished. That means they don’t sell the services with the new engine because they don’t sell them anymore. At the beginning, even when they sold the CFM engine, you had the option. Most of the time those negotiations for the sales contract were completely separate; it was a completely separate discussion.

{audio:0:12:06} Now with LEAP, it’s a joint discussion. That means that when you’re discussing the new engines with an airline, you’re in the same meeting room at the same time and you also discuss the MRO side.

{audio:0:12:17} Is it less likely that the airline is going to go with an independent or MTU or Lufthansa?

{audio:0:12:24} No, I don’t think so because they still have the option to sign the services  contract or not. They are still two different agreements. They are jointly prepared and presented but, in the end, the airline doesn’t have to sign the  services agreement. If he only goes for the new engine agreement, that’s also fine.

{audio:0:12:42} How do they choose who the MRO provider is? What are the variables the airline look at?

{audio:0:12:49} If you’re referring to LEAP, it’s a brand-new product. With a brand-new product, they have to be careful with configuration issues and design issues at the beginning of the development. Now LEAP is getting introduced there are some issues – there are always some issues with new engine introduction – so you make sure that you are well covered. If you’re covered by an OEM contract, you’re fine. In any case, every new engine is covered by a warranty by CFM for a certain time. After that period, if you’re covered by a CFM service contract then you’re fully covered by the OEM for 10 to 12 years, depending on how long you have the contract. It has better support for the full package.

{audio:0:13:39} That doesn’t mean that the MTUs or Lufthansa cannot do it. They can do it but it depends on what they can offer next to it. It’s not only the price. It’s not only the performance. It could also be other activities like aircraft maintenance, spare engine support or other services they can introduce as an added value against the OEM.

{audio:0:14:02} How much do those added services really matter to the airline?

{audio:0:14:06} I would say, for small airlines, sometimes it does matter because they have limited sources and they would like to have full support, from an engine change to spares support to aircraft maintenance, to all those side activities for which are not  possible with the OEM. The OEM is purely focused on engine MRO.

{audio:0:14:34} How are the warranties and guarantees different for LEAP versus CFM56 when it launched?

{audio:0:14:42} On the MRO side, there is no difference whatsoever. You have only one or two typical warranties on the MRO. Those are workmanship, which is the most frequently used and, sometimes, they also have the time  on wing (TOW) warranty. This is sometimes offered if it has been requested independently.

{audio:0:15:09} The same in terms of length and duration? They haven’t really extended those for LEAP?

{audio:0:15:14} On the MRO side, no. In terms of the way they have been calculating the maintenance costs, as LEAP is brand new, they have no experience of that. They just took a copy-paste of the CFM cost profile to simulate the LEAP costs, so it is quite similar.

{audio:0:15:35} How do all the independents really compete? What business do they typically win, the MTUs or Lufthansa MRO?

{audio:0:15:44} Again, it depends on the additional services, on the customer support, on the confidence, on the performance. I’m not saying that the others like MTU, Air Norway or Lufthansa are bad; no. They have a different way of doing customer support, a different way of performance on turnaround time, a different way of supporting other activities like spare engine support, like engine changes. If they want to do so, they can support them. Every shop has its own added values for a specific aspect.

{audio:0:16:22} What’s also important, especially on CFM56, is that there were so many shop visits that at a certain time there were not enough slots to induct the engines. That’s why sometimes airlines – especially the smaller ones – were forced to go somewhere else because their preferred choice was already filled up. They had to look elsewhere, for instance Lufthansa and MTU. That’s not really the case yet on LEAP but on the CFM56 there was a certain period where airlines were not forced but had the option to check out other MROs because of slot availability.

{audio:0:17:12} How do you think the MRO capacity today is on the CFM56 side, coming out of COVID?

{audio:0:17:22} COVID has had quite an impact. We know that a certain part of the older fleet is getting stored, it’s getting retired, phased out. Most of the airlines are keeping cash, keeping as much as possible, meaning that they try to extend the shop visits, try to postpone them or try to consume their own spares as much as possible. Maybe they will phase out an aircraft and use those engines to continue flying with another aircraft. It’s a puzzle at the moment for them to keep on flying and to keep the costs down.

{audio:0:17:55} There is indeed a huge impact on the number of shop visits, especially on the CFM56; I think the older types such as -3s, -5As, -5Cs are now getting quickly phased out. They are getting too old. We can see that with Lufthansa who are phasing out all the 5A fleet because they’re getting too old. Fuel price is also important; that has a huge impact on the requirement or the phase out of the fleet. But still I think there is a big market for the narrow-body fleet, especially on the 737 NGs and A320 – which are the 5B and the 7B engines – which are very popular and very reliable. They will still be flying for many, many years and there’s some potential there on the shop visits, but on the other hand we know that the OEM is already preparing themselves for the LEAP MRO.

{audio:0:18:51} Certain facilities have already stopped with CFM MRO to get to the LEAP MRO. That means that they are introducing less CFM shop visits, so they are getting or becoming available for the others.

{audio:0:19:05} Are they using the same facilities to do LEAP?

{audio:0:19:12} Let’s say there is the installed base of the CFM56s that haven’t had a shop visit or two yet, so they’re not going to have space to come in for the shop visit if they’re now used as LEAP capacity.

{audio:0:19:27} Yes. Certain facilities are unique only for LEAP, but others from Safran will stay on the 5 and 7. For instance, on -3 and 5C, that’s completely finished. On -5A it’s limited to the facility in Mexico.

{audio:0:19:48} Is there no terms or conditions in the airline MRO contract that requires them to have certain shop visits? I’m thinking about post COVID, where airlines are scrambling, keeping cash, using their own parts, switching out an engine to a new aircraft. Is there anything that can prevent them doing that that means they have to have a shop visit? How have they structured these contracts?

{audio:0:20:20} No. Of course for power by the hour, they are mostly profitable for 10 or 15 years, but if they are not flying. There are no shop visits, there’s nothing to pay. There are also sometimes flexibilities in the contracts for a phase in and phase out activity, so they can phase out a certain part of the fleet or they can phase in a certain part of the fleet.

{audio:0:20:45} How does the pricing work for the CFM56 time and materials? Is there anything agreed up front? How do you draft those up?

{audio:0:20:56} You have two types of contracts. The T&M contract which exists out of three main parts: materials which is approximately between 60% to 70% of the shop visit costs, labor is around 10% to 20% of the shop visit costs and repair between 20% to 30% of the shop visit costs. In general, these are the three main elements of shop visit costs which are covered by the contract. Those things are integrated into a pure T&M with a Not To Exceed (NTE) or a Fixed Price (FP), with clearly defined inclusions and exclusions. For instance, FODs or even LLPs are excluded because it’s high value cost.

{audio:0:21:52} So it’s very, very important when you negotiate a T&M contract on Not To Exceed or Fixed Price basis, that you define the inclusions and exclusions very carefully because, most of the time, it’s very difficult to compare them between the MROs.

{audio:0:22:09} Most of the airlines then send out tenders for one-off or multiple shop visits (e.a; 2 to 5)  Most of the time, this is for small airlines. Generally, bigger airlines go for a two, five or ten year contract on PBH basis, which depends on fleet size, fleet age and things like that which determine how the airlines will decide how to proceed. The younger the fleet, the more PBH contracts exist. The older the fleet, the more time and material contracts exist.

{audio:0:22:42} Because, in the first 10 years, you mostly go through a big airline, a big contract where you have multiple aircrafts covered. After those 10 years, the airline itself can decide to go for a new fleet and then the older aircraft is going to be returned to the lessor and he will  lease it again to somebody else. But he will not be able to lease it to a big player, so it’s getting scattered out.

{audio:0:23:14} A big fleet gets scattered out to smaller airlines and those smaller airlines, they don’t work with PBH from T&M. Even MRO refuses to accept them on a PBH basis. Therefore, for instance, if you have only two, three or five aircraft, it doesn’t make sense to offer a PBH contract.

{audio:0:23:32} You mentioned how material costs were 60% to 70% of the T&M contract. How do you reduce that material cost for the airline? What are the core drivers of that?

{audio:0:23:45} The core drivers there are that you can do as much as possible repair development. If you have internal repair capabilities, that can really reduce the repair cost. If you subcontract it, you lose a lot of margin because the margin will be taken by the repair facility. On the material side, if it’s LLPs it’s quite difficult. You have to go through the new LLPs or you can buy used serviceable material on the market. This is the second aspect where you can reduce your costs as much as possible. It’s possible because there are so many aircraft getting phased out and retired so the engines are coming on the market for parts.

{audio:0:24:35} The supply of that serviceable material can also help determine the pricing.

{audio:0:24:42} Yes. Most shops have their own sourcing team or maybe even buying unserviceable or other engines for teardown to supply their own material. Of course, you have a lot of traders or brokers that support this kind of activity for used serviceable material. On the OEM shop side, it has changed slightly because, in the past on the CFM side, they did their own sources with several providers, but that changed when CFM Materials was created. CFM Materials is the prime serviceable parts provider for the OEM MRO shops and for others as well; not only the OEMs.

{audio:0:25:24} How do you think that serviceable material supply will change over the next five years, given the disruption that we’ve seen from COVID?

{audio:0:25:32} Due to COVID and the changes in the fleets going on right now, I think it was also announced that there is going to be a lot of phased out aircraft, teardowns and things like that. That material comes back onto the market so, in the next year, there will be more than sufficient serviceable material on the market, especially for CFM purposes. Everybody is looking for good, serviceable units for teardown purpose so that they have sufficient material available when the market picks up again.

{audio:0:26:08} There are some particular phase-outs which are very interesting and that’s the one from, for instance, Southwest Airlines. They have the biggest fleet on 737-700 and they are getting phased out now. That means there’s a lot of CFM56-7B material that is coming on the market. There’s going to be a huge amount of 7B here, so these things have a huge influence on the availability of material. Next year, there will be a positive impact on the shop visit cost due to the availability of used parts.

{audio:0:26:40} That hurts the MRO margin for the likes of Safran or CFM?

{audio:0:26:46} Indeed that will impact the prospects of that, but I think their focus is moving towards LEAP now instead of keeping on the CFM material.

{audio:0:26:58} I was reading a slide from their recent presentation and I can’t remember the exact numbers but it’s something like 50% or 60% of the 56s haven’t had a shop visit and a portion more haven’t gone in for their second shop visit. So do we just write off these shop visits in that they’re just not going to happen because airlines are going to upgrade their fleets, they’re moving to LEAP? Is that completely lost revenue for CFM or Safran?

{audio:0:27:31} Yes, you could think of it like that. I think you’re referring to the CFM56-7B. It has been a great engine, I think the best engine ever built. Why? Because the EGT margin is so big, it stays a very long time on the wing. Certain engines even reach up to 50,000 hours before the first shop visit which is enormous and hits the first LLP limiter during the first shop visit, so it’s a phenomenal engine.

{audio:0:27:57} But the negative impact is that there are less shop visits so less revenue on your material. Indeed, a product can be successful but, on the MRO side, it can also have a negative impact on the expected revenue. It could be that certain engines don’t have a second shop visit. They will just be retired because you have to think about it as a financial project. If the engine is accumulating revenue during its lifetime and had its first shop visit, that’s fine, it’s getting paid but the revenue collected could be that much that he says I’d like to keep it and not do the shop visit anymore.

{audio:0:28:41} I will retire the aircraft and retire the engine. I’ll keep the money and I will use the money for buying a new aircraft because the revenue is there. Lessors are having that complexity to study each time saying, should I repair the engine, replace it or retire it? It’s always a puzzle.

{audio:0:29:04} It’s also tricky for CFM on Safran because they’re in this place where they want the shop visits to make the economics work for this 56 but then also they’re rolling out LEAP and also want LEAP to start growing. How do they look at that and manage that challenge?

{audio:0:29:28} Indeed. There were less shop visits on CFM56 when LEAP was introduced. On top of that, we had some issues with the LEAP-1B on the MAX. The MAX was grounded for quite some time so production was there but they were not flying. That means if you are not flying there are no shop visits because they are getting extended or postponed. COVID has had a considerable impact on the cashflow from the OEM. I’m not only seeing CFM, but also other OEMs have been impacted in that sense. But particularly for CFM and the LEAP side, it was a big challenge to create the optimized phase-out of the CFM56 new production and the LEAP introduction on the new engine.

{audio:0:30:23} On top of that, you have to rely on the MRO side. Of course, on the MRO side they had to focus more on LEAP because they have to support it,  as they are the OEM and they have to support their own product. Additionally, on CFM56, you have so many shops in the world there is more than sufficient capacity to cover them. It doesn’t have to be only the OEM.

{audio:0:30:50} You have to consider that, for the OEM, its prime target on getting revenue is new material sales; it’s not shop visits. It doesn’t matter who does it, as long as he sells new material, that’s fine. The shop visits are good to do in-house because they need to gain experience, feel the engine and be fully aware how it works and how it goes to support their customers. The MRO activity is not their prime business. It’s the new engine sales, new material sales and the MRO side is, let’s say, a supporting element.

{audio:0:31:30} How much of that 70% of the cost of T&M contract is new material from the OEM versus other suppliers?

{audio:0:31:44} Certain materials are new, like consumable expendables, but that’s the minority. That’s not the biggest chunk. The biggest chunk is generally the LLPs. As these parts are scrapping out on all the engines in the same way, it’s sometimes very difficult to get that serviceable material because every engine has the same problem. Therefore, I think the core material is the biggest aspect of the revenue on new material. It’s difficult to state how much of a percentage. From that 60%, it could be from 20% to 40% of that is new material. It could be more, it could be less depending if you’re doing a lot of internal repairs or not, if you have that repair capability or if the material is available.

{audio:0:32:34} On the LLP side, it’s the same thing. If you don’t find  used serviceable  materials, you have to go for new material, but it’s very straightforward. You cannot extend the life of an LLP, so replacement is required.

{audio:0:32:46} You mentioned it’s roughly 20% to 30% potentially LLPs?

{audio:0:32:53} No. What I’m saying, the 70% of the material cost in general, most of the time that’s excluding the LLPs because it has a massive impact on the shop visit cost. Most of the time, in the material contracts, LLPs are excluded because it impacts the shop visit cost. It can even double the shop visit costs.

{audio:0:33:16} But these are the most expensive parts?

{audio:0:33:18} Exactly. But they are straightforward. Even before the engine goes to the shop, most of the time you know already which ones are going to be replaced; so  customer knows it in advance. Some airlines anticipate that saying, for example if he has a shop visit in two years. You need serviceable materials with a certain  potential. He’s looking in advance and buys some in advance, so when the shop visit happens, he already has the LLP material available. If he doesn’t do that, and you wait until the end, he’s forced to buy new material and it will cost him much more.

{audio:0:33:52} Also this LLP revenue for Safran has been extended far in the future because the planes are not flying.

{audio:0:34:01} Yes, indeed. The A320 and the 737, so the narrow body fleet, are back up flying again. It’s the wide body fleet that was more impacted and are flying less. You can see in countries like China, domestically, everything is up and running again; not up to 100% but on the narrow body fleet it’s flying again. There are some positive tendencies on the narrow bodies but indeed there will be a delay on the shop visits. There will be an impact on the workload in several shops.

{audio:0:34:38} What was CFM’s approach to suppliers for the 56 versus the LEAP? I believe the LEAP is more dual source than the 56? Have they changed their strategies in terms of how many suppliers, what kind of suppliers?

{audio:0:34:54} Yes. On CFM56, they had more suppliers for their accessories and things like that and they had some issues. They had some single source providers on CFM which sometimes ran into some problems. On LEAP, they have reduced the number of suppliers. I don’t know the numbers exactly, but they’ve been reduced and those providers have more responsibility towards supporting the program. There is a change on that.

{audio:0:35:27} I’ve got it here; it says 80% of suppliers are common with the CFM56 but also 85% of the parts are actually double sourced or dual sourced at LEAP.

{audio:0:35:40} Yes. That’s a strategy decision from the OEM that they’re going in that direction and saying they want to have less suppliers with more responsibility so that the OEM itself is less impacted and more into claims and production problems and things like that. For material, they have double sources.

{audio:0:35:59} Let’s exclude the LLPs for a moment. Of the 70% material cost, roughly how much of the engine is sourced from suppliers versus manufacturers themselves?

{audio:0:36:15} You have to understand that referring back to  CFM, the core material is  being produced by GE themselves. I’m not talking about accessories (LRU) or QEC parts, purely the core of the engine; that material from A to Z gets produced by the OEM, by GE. The Fan , LPT and the gearbox, that’s getting produced by Safran. They are producing that one completely from scratch.

{audio:0:36:48} That’s the majority. What is left? QEC and the accessories (LRU) which they don’t manufacture themselves. They are produced and controlled by other OEM’s like Honeywell, BFGoodrich .

{audio:0:37:06} Is that all fixed pricing with them, as well? For the shop fitters, if they had to source some parts from Honeywell, is that all agreed in terms of the pricing for the aftermarket?

Safran: CFM56 & LEAP MRO

Former Sales and MRO Director at Safran

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Geert van Damme

Former Sales and MRO Director at Safran

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Safran: CFM56 & LEAP MRO (August 8, 2021)

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