India Aerospace: Poised for Takeoff Emerging markets are prime growth targets for the aerospace industry

The global aerospace industry experienced tremendous growth from 2004 until 2008, with a compound annual growth rate of 8 percent and passenger traffic increasing by 9 percent per year. Orders for commercial aircraft peaked at 2,500 in 2007, the largest number ever recorded in the sector. The economic slowdown in 2008, however, brought with it a 50 percent drop in aircraft orders for major manufacturers. Analysts are now more cautious, predicting growth in the foreseeable future of 4 to 5 percent per year.

North America is the largest market for the aerospace sector, however, growth rates are expected to slow as companies cut back on production and focus on improving profitability. The majority of new industry growth will come from emerging economies, such as China and India, which are expected to grow at 8 percent a year. They are capturing a larger share of the aerospace outsourcing pie, thanks to significant cost advantages over developed countries in component manufacturing, design and engineering services, and maintenance, repair and operations (MRO) services.

The Industry Takes Off Although still nascent—overall, just 0.25 percent of the global industry— India’s civil aviation sector has swelled by nearly 20 percent per year since 2004. Unlike the aerospace industries of China and Brazil, where initial growth was driven by large government investments, growth in the

Indian industry is largely due to offset agreements that compel aircraft companies to use Indian-based suppliers (see sidebar: India’s Offset Policy). More spending on defense and the offset policy presents an unprecedented opportunity for companies in India’s aerospace sector. The Indian aerospace and defense budget is expected to be $100 billion over the next 10 years, which means a minimum of $30 billion to $50 billion to comply with the offset policy. This could generate $11 billion to $18 billion in design and engineering services and $19 billion to $32 billion in component manufacturing. (Already, contracts worth $30 billion generating an offset of $10 billion are in process and are expected to complete by 2012.) Additionally, MRO services are expected to generate $1 billion annually by 2014. Major global players such as Boeing, EADS and Lockheed have set up partnerships with Indian companies

Success in India’s aerospace industry requires a gradual approach, focusing on components and smaller aircraft, and building scale and expertise through partnerships.

FIGURE 1: Aviation value chain Manufacturing value chain Design • Design infrastructure and services – CAD – Prototyping • Research – Aerodynamics – Engine and fuel – Communications • Testing infrastructure and services – Wind tunnels and model testing – Engine and rocket testing facility • Flight testing • Other engineering services (IT)

Component manufacturers Tier-1 suppliers • Power plant and propulsion devices • Avionics • Landing gear assemblies • Wing assemblies

Services value chain Aircraft assembly

• Superstructure • Fuselage or body • Empennage or tail assembly • Final assembly

Leasing and financing • Financing purchase • Leasing on a net, full service basis, or sale and leaseback basis

Sales and distribution • Dealerships • Sales offices

MRO services • Spare parts • Service and maintenance • Regular inspections and overhaul • Systems enhancements

Tier-2 suppliers • Electrical power systems • Flight controls (rudder, elevator, yoke) • Hydraulic systems • Escape systems (ejection seats) Tier-3 suppliers • Castings and forgings • Precision machined parts: tubes • Fasteners, bearings and standard parts • Others (wiring harness)

to provide aero-structures, avionics, software, MRO and other equipment and services. Boeing and Airbus have an estimated $3 billion in offset obligation based on sales of jets to stateowned carriers, and an MMRCA (medium range multi-role combat aircraft) deal estimated to be worth $11 billion has spurred major players

Source: A.T. Kearney analysis

to set up offset partnerships. The aerospace value chain comprises activities ranging from design and assembly to, ultimately, MRO services (see figure 1). As OEMs and tier-1 suppliers struggle to improve profitability, tier-2 and tier-3 products will likely shift to emerging markets such as India and China.

India’s Offset Policy In 2005, India introduced an offset policy for defense industry procurement. The policy mandates foreign aircraft OEMs, such as Boeing and Airbus, to outsource a minimum of 30 percent of a $60 million-plus defense contract to India-based companies. The 30 percent portion of the contract can be for infrastructure, technology sharing, or to source components and services. The policy has been expanded to include state-owned airline, Air India. More policy changes are expected to keep up with industry trends.

India’s Place in the Value Chain The Indian aerospace supply base is fairly new. While Indian companies have a significant advantage in engineering and design, they do not yet have the capabilities to handle highend design and development. The government-owned Hindustan Aeronautics Limited (HAL) operates across the value chain, however, no other Indian company boasts integrated capabilities. The following outlines the opportunities in the four areas shown in figure 2. Design. Several Indian information technology firms have been operating in the aerospace sector over the past few years, with HCL, Infosys, TCS and Wipro leading the pack. These firms have been providing lowend design and integrated software

FIGURE 2: Opportunities in Indian aerospace

Design High end

Component manufacturers

Aircraft assembly

• Design of complex aero-structure, aero-engine components

Tier-1 suppliers

• Final assembly

• Power plant and propulsion devices

• Fuselage or body

• Avionics

• Design optimization, mission-critical software and embedded systems for avionics and aircraft product life-cycle management

• Landing gear assemblies

• Empennage or tail assembly

• Testing infrastructure and services • CAD design and documentation • Procurement assistance

Low end

development services to major aircraft companies. Indian IT firms, however, are expected to develop their capabilities to offer higher end complex design services in the near future. Companies such as Taneja Aerospace are already gearing up to emerge as aircraft design and development houses. Opportunity. Top Indian IT companies are investing in hardware and software infrastructures to undertake complex research, design and development projects from major global OEMs and tier-1 firms. With companies such as Infosys, Wipro and HCL rapidly improving their skills, this segment is likely to show the fastest growth. Component manufacturing. Indian companies are primarily tier-3 suppliers. Most manufacture parts per specifications provided, with limited focus on design and development. Further, there are few companies in this segment, as the component industry is still fairly new. With more business expected to flow into India due to

• Wing assemblies Tier-2 suppliers • Hydraulic systems • Flight controls • Electrical power systems

MRO services • Engine component MRO (typically done by engine supplier) • Airframe component MRO • MRO for other tier-1 components • MRO for tier-2 and tier-3 components • Line maintenance and modifications

Tier-3 suppliers • Castings and forgings • Structural sheet metal components • Wiring harness and other cabling

offset agreements, tier-1 and tier-2 players will no doubt have a larger role in the global aerospace value chain. The emergence of Indian suppliers with integrated tier-1 and tier-2 capabilities will allow global aerospace companies to leverage India as a lowcost option, thus increasing their ability to honor the offset agreements. India’s skilled labor wage rates are 60 percent lower than the United States and Europe. Key to cost savings is the ability to develop manufacturing processes using more labor than automation while ensuring quality standards. For example, one tier-2 components supplier offers a 15 to 30 percent cost advantage to supply landing gear components due to a labor intensive manufacturing process while delivering similar quality levels. In aircraft assembly, our assessment indicates a potential cost advantage of 15 to 25 percent. Opportunity. We expect the manufacturing of small structural components—brackets and hinges,

Current positioning of the Indian supply base Source: A.T. Kearney analysis

wiring harnesses, mountings, blades and vanes—to be the key growth area in this segment. This is similar to the evolution in the Chinese aerospace supply base, which leveraged joint ventures with Boeing and Airbus to supply $1 billion in components from 1995 to 2008. Aircraft assembly. HAL is the only company with complete aircraft manufacturing capabilities, and Taneja Aerospace is ramping up to compete in the segment. To meet industry demands, several private firms plan to enter the market both organically and via mergers and acquisitions. Moreover, several automotive firms may enter aircraft component manufacturing. Tata, Mahindra, MRF, Lumax and Minda have already announced plans to do so. Opportunity. As the Indian supply base matures, two or three aircraft manufacturers are expected to emerge by 2012, but they will likely be in the lower complexity general aviation market. Recent announcements

FIGURE 3: Indian companies venture into the aerospace sector Company

Alliance partner

Segment

Nature of alliance

TATA

Boeing

Defense aircraft components

• Signed memorandum of understanding (MOU) , February 2008 • Initial orders of $500 million • Planned production in Nagpur SEZ*

Sikorsky

Chopper cabin manufacturing

• Signed MOU (February 2008) • Tata Advanced Systems (TAS) to manufacture S-92 helicopter cabins in India

Piaggio Aero

Aircraft manufacturing

• Purchased 33 percent stake (August 2008) • Tata to market turboprops in India • Taj Air establishes service center in India

Epic

Aircraft manufacturing

• Purchased 50 percent stake (December 2007) • Company builds small business jets • Plans to market aircraft in Middle East

EADS Socata

Aircraft manufacturing

• Initiated discussions (June 2008) • Company plans to co-develop business jets • Planned investment of $200 million

Lufthansa Technik

Boeing EADS Socata

Aerospace component manufacturing

• Established MOUs (August 2007) • Boeing, EADS to source components • Planned investment of $104 million in setting up facility

Mahindra

Plexion

Aerospace design

• Acquired 88.41 percent stake • Company provides computer-aided engineering services to the aerospace sector

National Aerospace Laboratories (India)

Aircraft manufacturing

• Initiated running contract to develop jointly a five-seat aircraft

Kingfisher Airlines

*Special economic zone

by Tata, Mahindra and Kingfisher are indicators in this direction. These are expected to be joint ventures or partnerships with established foreign partners (see figure 3). MRO services. Current MRO setups in India are based on joint ventures with established OEMs, engine manufacturers and global MRO firms. While some airlines, Air India, for example, have developed in-house MRO capabilities, much of their work is outsourced to service providers in foreign locations. Opportunity. The 13 percent annual growth in commercial fleet has attracted many foreign and Indian private firms to the MRO sector.

Source: A.T. Kearney analysis

Developing MRO facilities involves initial investment of more than $200 million. The upside, however, is that the availability of low-cost skilled labor offers a significant advantage for airlines. For example, the Air IndiaBoeing MRO facility in Nagpur expects to save $2 million a year per aircraft (see figure 4). We expect India’s aerospace industry to move toward providing highend capabilities in designing complex structures, manufacturing sub-assemblies, aircraft assembly and MRO services. We also expect large global companies to move into India due to the availability of low-cost skilled labor and the offset obligations. Over the

next decade, this could result in $4 billion to $6 billion annually in design, engineering, component manufacturing and MRO services.

Achieving Scale Size is key to India’s aerospace and defense strategy. There are several ways the industry can pursue growth: Attract an “anchor” OEM. A major player would bring much-needed scale to India’s component design and manufacturing sector, just as Embraer did for Brazil‘s aerospace industry. Embraer’s entrance in 1969 spawned about 30 firms doing aircraft assembly and component manufacturing for commercial and military aircraft, and

FIGURE 4: Aviation MRO sector is in a growth phase Commercial aviation MRO (US$ million, 2004-2014)

10%

405 12% 17% 20%

1,065

New partnerships in MRO sector

7%

Modifications

12%

Airframe

Foreign company

Indian company

Location

16%

Line maintenance

Boeing

Air India

Nagpur

19%

Components

Malaysia

GMR

Hyderabad

Lufthansa Technik

GMR

Hyderabad

EADS

Air India

Delhi

Sabena

Taneja Aerospace

Bangalore

Pratt & Whitney

HAL

Bangalore

8%

46%

Engine

43%

2004

2014 estimated

helped Brazil become a major exporter in the aerospace sector. Today, Embraer has 130 customers in 30 countries and is Brazil’s second largest exporter. We expect the entry of large Indian groups into this segment to create a scenario

Source: A.T. Kearney analysis

similar to that of China’s, providing the scale, expertise and investment appetite to establish and run a complex engineering enterprise.

Establish aerospace clusters.

India could replicate China’s strategy

China’s Aerospace Timeline India could emulate China’s gradual approach to establishing its aerospace industry. The following highlights China’s timeline:

1956-1960: Companies set up with government support across value chain (starting with components of military aircraft)

1960-1975: Initial focus on military aircraft production with gradual accumulation of design and production capabilities

1977: Entered utility aircraft manufacturing: in-house design and development of piston aircraft

1998: In-house design and development of passenger turboprop aircraft 2000: Global expansion, entering alliances with Boeing and Airbus to supply components (to leverage low-cost manufacturing capabilities)

2007: Leveraged in-house capabilities to enter regional jet manufacturing. Poised to enter production of small, regional jets for international markets through alliances.

and establish aerospace hubs to help consolidate the industry and build scale. China established a conglomerate of aviation industries (AVIC) in 1993, made up of roughly 200 stateowned firms, including engine and component manufacturers, aero-structure designers, and assemblers. Formed to improve coordination and utilization of resources, AVIC was subsequently split into two, AVIC I for commercial aircraft and AVIC II for helicopters, trainers and general aviation aircraft. Employ a technology transfer strategy. Aerospace is among the most complex and engineering-intensive industries in the world. Most parts are proprietary in design and specific to an aircraft program. A close partnership with a tier-1 supplier is essential for development, especially in the initial stages. With this in mind, India can take a page from China’s and Brazil’s playbook and pursue a large aircraft

manufacturing joint venture. In China, for example, the evolution of tier-1 component manufacturers has been primarily through joint ventures (see sidebar: China’s Aerospace Timeline). Several Chinese manufacturers joined forces to build composite parts for Airbus and for other Chinese aircraft manufacturers. Similarly, in the 1970s Embraer used joint ventures with foreign partners (Piper was

one) to obtain technical competence and penetrate markets more rapidly. Embraer has also developed several risk-sharing partnerships with key international aerospace companies.

Develop Capabilities, Gradually Indian companies entering this sector should build their capabilities gradually. A balanced approach similar to

China’s, in which it moved from military aircraft to utility aircraft and then regional aircraft is likely to be the most successful. The experience of other emerging economies, such as China and Brazil, indicates that adopting a gradual approach—focusing on components and smaller aircraft—combined with building scale and expertise through partnerships, will be key for success in India’s aerospace industry.

Authors R Venkatraman is a vice president in the Gurgaon office. He can be reached at [email protected]. Manish Mathur is a principal in the Gurgaon office. He can be reached at [email protected]. Bhavya Kishore is a consultant in the Gurgaon office. She can be reached at [email protected]. Rohan Rijhwani is a consultant in the Gurgaon office. He can be reached at [email protected].

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