While commercial aerospace was severely hit by a historic drop in air traffic during COVID-19, we are now seeing signs of demand recovery. As borders open and travel restrictions relax in most of Europe and other parts of the world, airlines are getting closer to their prepandemic flight schedules.
The restart of air operations and travel activities raises many questions in the European commercial aerospace industry: What are the air travel trends shaping the industry? What will the changes in air passenger behavior (for both business and leisure) entail, not only for major airlines but also for other aerospace players and their stakeholders? What are the near-term and long-term business risks and opportunities for individual industry players?
History has shown that following an economic crisis, aircraft construction eventually returns to its precrisis way of operating and sales figures. Given that the current economic crisis was precipitated by a public health crisis, might we see changes to the industry that persist long into the future?
These myriad open questions reveal the intense uncertainty associated with both what aircraft demand patterns will look like as COVID-19 restrictions relax and which trends OEMs, suppliers, and other companies in the industry’s value chain should be aware of to navigate the industry’s recovery and future landscape.
Against this backdrop, this publication provides fresh insights from the latest McKinsey research (see sidebar “Insight sources for this white paper”) into how the COVID-19 recovery and emerging new market trends will impact the European commercial aerospace industry and discusses how European commercial aerospace players can start preparing for the future industry landscape.
We have distilled five key insights from our research and survey on the commercial aerospace industry and its post-COVID-19 prospects, which will be discussed in detail in this publication:
- Slow growth. It will likely be another two years before airline passenger revenue creeps past pre-pandemic levels.
- Supply chain challenges. Aerospace executives expect increased vertical integration of the supply chain and see the related matters of material and staff availability as challenges to the industry’s ability to meet the growing demand.
- Overhauls in business and design. In the interest of economic viability, both business models and the aircraft themselves will take on a new shape in order to accommodate shifts in customer demand.
- New entrants. Players from outside of the traditional commercial aerospace sector can be expected to disrupt the market in areas such as urban air mobility (UAM), with new aircraft designs, including vertical take-off and landing (VTOL).
- Focus on sustainability. There is an observable increase in the industry’s focus on sustainability as an opportunity, and sustainable aviation fuel (SAF) is widely seen as the likely dominant solution until 2040, followed by hydrogen for non-wide-body applications.
- Structured survey conducted among European commercial aerospace top executives from 15 major OEMs and suppliers, representing over €60 billion in revenue in 2019 (Exhibit 1). The OEMs and suppliers cover large European markets, such as France, Germany, Italy, and the United Kingdom, and are representative of the supply chain, as they include both OEMs and tier-one suppliers
- Proprietary airline demand forecast model, connected to our McKinsey Global Institute COVID-19 scenarios
- Global manufacturing and supply chain survey, conducted in collaboration with the McKinsey Global Institute, which surveyed more than 1,000 top executives across all industries
- Survey of 4,500 end customers in six key markets on the use of advanced air mobility (AAM)
- Additional research conducted by McKinsey’s Aerospace & Defense research team
1. Key aspects of the current and future commercial aerospace market in Europe
In addition to a brief description of the industry’s pre-COVID-19 market structure and size, this chapter discusses not only how COVID-19 has impacted the industry and possibly recovery routes, but also shows the extent to which recovery could be affected by the restricted ramp-up readiness of the European supply chain. The resulting overview provides a sketch of the industry’s market situation and the context in which the five central trends discussed in chapter 2 are expected to evolve.
1.1 Market structure and size of the European commercial aerospace industry before COVID-19
The commercial aerospace supply chain in Europe is not focused on the European market, as European aircraft are sold to international customers and European suppliers can be found, for example, in both the Airbus and the Boeing supply chains. European players contributed a combined revenue of $146 billion in 2019.
Suppliers can be split into several categories: aerostructures, engines, avionics, interiors, and other aircraft systems. Each category has specific dynamics, featuring different market concentrations, specializations, as well as original-equipment aftermarket distributions. The categories can be segmented into different tiers, ranging from subsystems to materials. Many tier-one suppliers are strong players in several categories. Tier-two players are more specialized on a particular category, while tier-three companies are mainly highly diversified materials providers. Around 40 percent of aircraft costs are driven by the aerostructures category, in which OEMs (along with some strong tier-one players that are closely aligned to OEMs) hold a big stake. The second-biggest category is engines, representing around 38 percent of an aircraft’s total cost, with four players controlling the majority of the market. The other categories represent less than 10 percent.
1.2 COVID-19 has tangibly impacted the commercial aerospace industry in Europe
Air traffic plummeted in 2020, and revenue passenger kilometers (RPK) dropped by 68 percent, from 8.9 trillion to 2.9 trillion (Exhibit 2).
Our proprietary modeling features various economic and pandemic scenarios. The base-case scenario, which is currently the most likely scenario as judged by a panel of over 1,000 global executives, is based on the assumptions of a virus recurrence in some countries, slow long-term growth, and a muted recovery.
According to this base-case scenario, we expect to see an increase in RPK from 3.4 trillion in 2021 to 7.1 trillion in 2022, achieving approximately 80 percent of 2019 levels. RPKs are unlikely to reach 9.1 trillion before 2023, which would be just above the pre-pandemic level of 8.9 trillion.
In a more optimistic case, assuming greater global effectiveness in controlling the virus, pre-COVID-19 levels would already be achieved by 2022. In contrast, the pessimistic case sees demand below 2019 levels until 2024.
Orders, deliveries, and production rates have all taken a hit as COVID-19 caused a historic slowdown in air travel. Global commercial aircraft deliveries dropped in 2020 by 46 percent to $57 billion. Putting this into perspective, it has been the sharpest annual decrease since the start of the records in 1960s—leading to the lowest level since 2005.
Reacting to the crisis, companies across the value chain have taken significant action to reduce rates and variable costs, reorganize logistics and production, and improve cash positions. This resulted in relative stability of the supply chain with few bankruptcies. However, our survey suggests that 57 percent of companies perceive they did not manage to use the crisis as a chance to significantly reduce breakeven through structural adjustments. In light of the technological disruptions on the horizon, the low share of successful structural adjustments is especially striking.
1.3 There are already signs of a recovery, with the prospect of reaching and exceeding pre-COVID-19 figures by 2025
We are currently seeing the first signs of recovery for air traffic demand. July 2021 available seat kilometers (ASK) figures for narrow-body aircraft and regional jets were back to 71 percent of May 2019 levels. By contrast, wide-body ASKs remain below 40 percent of 2019 levels (Exhibit 3).
This divide is also supported when taking a deeper look at different types of flows. Notably, for intraregional flights, we expect close to full recovery as early as 2022. Currently, at 35 percent of its pre-COVID-19 RPK levels of intraregional flights, Europe is lagging behind North America and Asia, which are at 76 percent and 51 percent, respectively. However, overall air traffic demand will still be hampered by the low level of interregional flights, which is currently at 20 percent of pre-COVID-19 levels (Exhibit 4).
Deliveries of new aircraft are unlikely to reach pre-COVID-19 levels before 2024 (Exhibit 5). For narrow-body aircraft, we expect to see annual production rates of approximately 1,200 units by 2022, on par with the peak in 2018, and then a continuous rise to above pre-COVID-19 levels in 2025. In May, Airbus called its suppliers to be prepared for a production increase of the A320 Family. Based on this announcement, the current monthly production rate of 40 aircraft is expected to increase slightly to 45 in the last quarter of 2021. For the second quarter of 2023, a monthly rate of 64 has been announced, which is already 20 percent above the 2019 average. For 2025, rates of up to 75 aircraft are being evaluated.
However, for wide-body aircraft, we expect a stagnation at two-thirds of the pre-COVID-19 level (which was 20 per month) for the foreseeable future.
1.4 Promising prospects are clouded by considerable doubts about the ramp-up readiness of the European supply chain
Due to the positive industry outlook from a demand perspective, it is crucial to understand whether the industry will be able to supply the market. A clear majority of executives is concerned with their supply chain readiness. About 50 percent mentioned material availability and supply chain issues as major obstacles to a fast ramp-up. Approximately 30 percent were concerned with employee availability and capability.
Further, aerospace executives see a variety of potential obstacles to general business recovery: tariffs and other political regulation, insufficient cash availability for investments, and climate concerns regarding aerospace. Accordingly, when asked about their mid- to long-run market expectations, quite a few executives mentioned portfolio diversification and balancing existing business toward other industries.
2. Five market trends will inform the future of the commercial aerospace value chain in Europe
Based on our own analyses and the industry expertise, as well as insights from leading industry experts and proprietary survey results, we have identified five trends that can be expected to significantly impact the commercial aerospace value chain in Europe and reshape the industry’s future landscape. These trends are related to structural shifts in the market, consolidation of the supply chain setup, aerospace & defense (A&D) executives’ expectations and agenda setting for the future compared to that of other advanced industry and manufacturing industry executives, expectations of a clear change in the dominant alternative propulsion system by 2030, and widespread doubts concerning the benefits of AAM- and VTOL-related growth opportunities.
2.1 A shift in air travel demand is spurring changes to both aircraft design and business models
The acute COVID-19 crisis—particularly in the early days—had a clear impact on overall aircraft production as demand for airline travel plummeted to nearly zero. Monthly production of commercial passenger aircraft in 2020 was less than two-thirds of what it was in 2019. As demand recovers, and the longer-term impact of COVID-19 on travel demand is assessed, it also appears that a shift in travel routes will change the production share of each aircraft type. Specifically, we see narrow-body aircraft growing in size, from around 70 percent of all aircraft produced prepandemic to about 80 percent through 2025 (Exhibit 6).
Longer-range narrow-body aircraft are challenging the established structure
Due to the slow recovery of interregional traffic caused by the pandemic, production of traditional wide-body aircraft is not expected to return to prepandemic levels in the foreseeable future. Instead, they are being replaced by larger (longer-range) narrow-body aircraft, which allow for more cost-effective transatlantic and intercontinental operations. With these new designs, narrow-body aircraft production is expected to exceed prepandemic production levels in the coming years.
The market potential for longer-range variants of narrow-body aircraft has created demand across airlines. Airbus’s A321LR and XLR are among the larger variations of narrow-body aircraft that OEMs are building and that may be positioned as the new intercontinental aircraft fundamental to an airline’s success. Operators may also seek to replace current regional jets with sustainably propelled regional planes in order to cope with increasing regulation, for example, fuel taxes and CO2 limits.
Rethinking the business case for middle-of-the-market aircraft
Further, OEMs are revisiting the business case for middle-of-the-market aircraft. An alternative to the new middle-of-the-market aircraft program could be to invest in a new narrow-body aircraft program. OEMs need to think carefully about how to position their offering in order to capture most of this new market while cannibalizing less of their narrow-body aircraft offering. A middle-of-the-market aircraft can provide a market entry point for new carriers and puts stress on the existing hub-and-spoke system established by legacy carriers.
2.2 The supply chain setup is expected to further consolidate, partly driven by PE activity
While the supply chain—across tier-one, tier-two, and tier-three players—is facing economic distress amid lower production levels, government support such as short-time work schemes and loans, are helping suppliers survive. Nevertheless, players in the aftermarket are especially impacted by changes to operating fleet size, the mix of aircraft, and the fact that the average fleet age will remain static over the next three years.
Given this, a strong potential for consolidation can be seen across the supply chain. Further down the supply chain, there could be significant consolidation or horizontal-integration opportunities for tier-two and tier-three suppliers, as several are facing economic distress. Vertical integration, by contrast, is less of a priority, as the industry is still in crisis mode. However, some large suppliers have distributed prepayments to keep their networks running, which could turn into consolidation further down the road. This may also be the reason why, within our sample of surveyed executives, more than 85 percent expect vertical integration of the supply chain to increase.
What is more, the European A&D market is clearly more fragmented than the US market and could thus offer value creation opportunities through targeted consolidations. Accordingly, 80 percent of survey participants expect M&A activity to increase and 50 percent of respondents see PE investment as a primary M&A driver ahead of the tier-one horizontal integration. And, while tier-two and tier-three horizontal integration and tier-one vertical integration are also considered likely, views on the OEM integration strategy are rather split, with 20 percent of survey participants ranking it first and 40 percent ranking it last. With new programs expected in the next years, preference of OEMs for larger suppliers as dependable, financially sound partners for long-term investments is also a supporting factor for further supplier market consolidation.
2.3 A&D executives approach several priority areas differently from their peers in other manufacturing areas
In order to assess the sentiment in supply chain and manufacturing, we conducted a separate C-level survey. This one was global and covered not only commercial aerospace but the complete manufacturing sector (for details on the survey, see sidebar “Manufacturing C-level survey”). Thus, the survey results allow us to compare what we see in A&D with other advanced industries and with manufacturing companies overall.
In the following, we discuss surveyed A&D executives’ perspectives on the future competitiveness of their industry along five dimensions and in comparison to the perspectives of executives in other advanced industries, as well as those representing the overall manufacturing industry:
Productivity. Overall, manufacturing companies have positive expectations regarding the productivity of their employees in the next three years (Exhibit 7). Numbers for A&D are in line with the overall market, but are slightly better than advanced industry peers. Ninety-two percent of A&D companies believe that employee productivity will increase. This was split approximately in half between a 1–2 percent and a 3–4 percent increase per year, with 10 percent expecting more than a 5 percent productivity increase per year.
Willingness to invest. Asked about the overall capital investment budget for manufacturing and supply chain operations, answers clearly indicated a COVID-19 drop, but also the willingness of companies to get ready for the future. While 81 percent of A&D companies said that they increased their budget between 2018 and 2019, the number dropped to 5 percent between 2019 and 2020, with 84 percent of A&D companies decreasing their budget. For 2021 and beyond, 52 percent of A&D survey respondents say they expect an increase, while 35 percent expect a further decrease. In comparison, A&D had a larger share of companies with a growing budget pre-COVID-19 and a larger share of companies with a decreasing budget during COVID-19 compared to other advanced industry companies and the overall market. High representation at both ends of the budget spectrum suggests a high level of diversity in A&D.
Productivity drivers. Asked to name the productivity drivers expected to have the most positive effect on their companies’ profitability in the next three years, A&D survey respondents pointed to two with significant frequency: “digitization, artificial intelligence, automation and technology enablement, and analytics” and “resilience and operational agility” (Exhibit 8). Both were chosen at a higher frequency of 15–20 percentage points by A&D companies than by advanced industry or other companies. In contrast, people and organization, and operations were ranked comparatively low by A&D companies. Slightly less than one in four A&D companies mentioned ESG (Environmental, Social, and Governance) as one of the top two productivity drivers, and this was true for advanced industry respondents as well.
Investment in digitization and automation.1 Even with the significance they place on digitization and automation as productivity drivers, A&D companies were just as likely (at approximately 50 percent) to reduce investment in this area during COVID-19 as other advanced industry companies, and they are no more likely than other advanced industry companies to increase investment in the near future. However, as the survey asked respondents to report on and predict changes to their level of investment, it is still possible that A&D companies did and will make larger investments in digitization and automation than their peers from other advanced industry sectors.
Investment in resilience and agility.2 Here we see again the same picture. Resilience and agility is a productivity driver which received high value from A&D companies, and investment in this driver grew for more than 80 percent of companies between 2018 and 2019. However, almost half of the A&D-affiliated respondents reported a decrease in their companies’ investment in this area between 2019 and 2020. COVID-19 forced many A&D companies to underinvest in one of their priority areas, but a stronger financial picture may be allowing them to make up ground lost over the last year. Looking ahead, barely more than one in ten A&D companies say they will reduce investment in this area, and about two-thirds are expecting to increase investment. Still, A&D companies are a little less likely than their other advanced industry peers to increase investment in resilience and agility.
2.4 A large majority of aerospace leaders view SAF as the dominant alternative propulsion system in 2030, regardless of airplane type
In 2020, aviation accounted for approximately 3 percent of the world’s carbon emissions. Through various initiatives, airlines have committed to a 50 percent reduction in their CO2 emissions by 2050. OEMs have also announced their different approaches to sustainable aviation. While some are focusing on conventional turbofans using SAF, others are also exploring hydrogen as a fuel alternative.
The momentum to change this reality and move toward sustainable aviation continues to rise globally, and customer pressure, government mandates and regulation, and economics are accelerating this shift. Customers are highly concerned about CO2 and fully expect the industry to make a shift toward carbon neutrality. In a survey of more than 5,000 customers from 12 large aviation markets, 31 percent consider flying less due to climate change. Forty-five percent believe that governments should definitely introduce or reinforce policies to reduce airline CO2 emissions—even if this increases costs.
Eighty-five percent of OEM and tier-one executives surveyed believe that they will be required to provide full transparency of their carbon footprint along their supply chain in the next five to ten years (Exhibit 9). Half expect that they will make carbon footprints a key criterion when choosing suppliers.
Given the expected growth in demand, however, incremental efficiency gains in aerodynamics, lightweight construction, and fuel consumption (even the ones in the order of 2 percent per annum, which are seen as highly ambitious), as well as the fielding of SAF, will not prevent further increases in emissions. As SAF is rather a question of certification with only very little changes to the aircraft design, operations, or infrastructure, it is a viable short-term option. More than 80 percent of the aerospace leaders surveyed believe SAF will be the dominant alternative propulsion system in 2030, regardless of airplane type. For 2040 and beyond, 80 percent see SAF continuing to dominate for wide-body aircraft. For narrow-body aircraft and regional jets, only about 50 percent believe SAF will dominate, while the other half see hydrogen as the dominant new sustainable fuel. For private aviation, the split is equal between battery-electric and SAF as the dominating system.
While SAF will play a clear and significant role in aerospace in the near to medium term for cutting up to 100 percent net CO2, it only delivers a climate impact reduction of 30 to 60 percent. Achieving the target of at least a 50 percent climate impact reduction by 2050 will require new propulsion technologies and fuels. Hydrogen delivers a 50 to 90 percent CO2 reduction, and renewable electricity cuts both CO2 emissions and climate impact by 100 percent. Airbus has announced its ambition to develop the world’s first zero-emission commercial aircraft by 2035. Its three zero-emission “concept” aircraft—known as ZEROe—are all hybrid-hydrogen aircraft. This means they are powered by modified gas turbine engines that burn liquid hydrogen as fuel. Players in the commercial aerospace value chain should begin investing in SAF and hydrogen-enabled aviation to ensure they are positioned well for changes in consumer demand or regulatory requirements.
2.5 While the FAM industry’s funding has accelerated dramatically, aerospace executives and customers remain skeptical and cautious
AAM consists of several pillars: urban air mobility (UAM), unmanned aerial systems (UAS, “drones”), UAS traffic management (UTM), and sustainable aviation. Together with the new supersonic aviation, it forms the future air mobility (FAM). AAM market value is expected to grow and could reach between $300 billion to $500 billion by 2040. The main sources are (1) intra-urban mobility, such as airport transfers, inner-city commuting, touristic trips, and short business trips, (2) intra-urban mobility, such as visiting friends or family outside of the city, commuting from outskirts to the city center, and (3) logistics air transport, such as goods transportation and last-mile delivery.
To date, more than $10 billion has been invested in the FAM industry. Funding has accelerated dramatically, with nearly half of the total funding (more than $4.5 billion) coming in just the first half of 2021. Eighty percent of funding is directed toward passenger AAM; the remaining is allocated to cargo, sustainable aviation, and supersonic companies. In addition to increases in overall funding, the size of each deal is also increasing.
What is more, the sources of funding are changing. FAM funding was historically generated from venture capital but has transitioned to other sources such as SPACs and internal R&D in the last two years. Strategic investors are playing bigger roles with automotive OEMs (for example, Toyota and Daimler) and airlines (for example, United and Japan Airlines) increasingly vying for a share of the industry. Many of the leading FAM projects are also backed by aerospace strategic investors. Airbus, for example, is internally funding the development of the City Airbus eVTOL aircraft.
While investors and other industry stakeholders are excited about AAM’s potential, the consumer view is less clear. We asked 4,500 customers in six key markets whether they would use an AAM vehicle instead of their current transport mode to meet various mobility needs, such as commuting, going to the airport, and leisure. Whereas respondents in India and Brazil expressed relatively high levels of interest in using AAM (40 percent and 30 percent, respectively), affirmative responses for customers in Germany and the United States were below 20 percent (Exhibit 10).
Surveyed executives provided a mixed picture on the potential of VTOL aviation for their own companies. And, just as the customer response to AAM is low in general, aerospace companies themselves are not yet convinced that they will benefit from any growth opportunity that comes from VTOL. Our survey showed an even split across representatives who believed that their company would benefit from VTOL, those who were not sure, and those who were relatively certain that their company would not capitalize on the VTOL opportunity.
3. Getting started: a self-assessment
The commercial aerospace supply chain in Europe is gearing up for recovery. The increased demand for single-aisle aircraft, in particular, means that large parts of the European commercial aerospace supply chain are moving back into more financially viable operating points, and the recent announcements from Airbus to potentially produce above the peak rate of 2019 supports this optimistic outlook.
As the sector’s prospects brighten and new major industry trends emerge, players might begin to think about the restructuring steps their organizations want to take and assess their readiness to ramp up. While a few organizations have already invested heavily in restructuring and preparing for the COVID-19 recovery and beyond, most are still at an early stage. At this critical inflection point, the sector’s players—regardless of whether they are OEMs or occupy some other link along the supply chain—can benefit from taking an honest diagnostic of their state of preparedness for the opportunities and challenges ahead.
Key questions for starting an organization’s (self-)diagnostic of their ramp-up readiness include:
- Are our operations and preceding supply chain ready to deliver the expected rate increases in the single-aisle market? Do we have resilient and agile operations in place?
- Did we sufficiently streamline our fixed-cost base in the last 18 months? If not, which additional opportunities should be addressed?
- How can we best prepare for OEMs’ future products and programs? How can we best position our organization for a shift in the product portfolio?
- Where do we need to invest to increase our level of competitiveness and leverage digital- and automation-related opportunities? Apart from volume growth, what will our key drivers of increased productivity be?
- What is our strategy on key trends such as future/urban air mobility and increased transparency on CO2 emissions in the supply chain? How can we effectively address newly emerging markets and competitors?
- What are our opportunities for M&A along the value chain? What sources of funding should we be looking for to prepare for the next wave of growth?
The answers to these diagnostic questions can help uncover which strategic, organizational, and technological hurdles need to be addressed first, and lay the foundation for success in the commercial aerospace industry of the future.
