A report on the industry dynamics of the aircraft leasing sector; with a proposed entry strategy to the Chinese

market forAvolon - an Irish-based aircraft leasing firm.

ByJohn Byrne

Robert SmythYueqin Huang

Group 5

Date Submitted: 21/04/15

Table of Contents

1. Executive Summary

2. Company Background

3. Key Personell

4. Current Financial Position

5. Avolon’s Business Model Canvas

4.1 Customer Segments

4.2 Value Proposition

4.3 Key Activities

4.4 Key Resources

4.5 Key Partners

4.6 Customer Relations

4.7 Channels of Distribution

4.8 Cost Structure

4.9 Revenue Stream

6. Market Analysis

7. Diamond of National Advantage – China

6.1 Firm Strategy, Structure & Rivalry

6.2 Demand Conditions

6.3 Related & Supporting Industries

6.4 Factor Conditions

8. Five Forces Analysis

7.1 Degree of Rivalry

7.2 Buyer Bargaining Power

7.3 Supplier Bargaining Power

7.4 Threat of New Entrants

7.5 Threat of Substitutes

9. Market Entry Strategy

10. Implementation of Strategy

11. Pivotal Questions for Management

12. Conclusion & Recommendations

13. References

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14. Bibliography

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Executive Summary

At present, nine of the world’s top ten aircraft leasing firms are headquartered in

Dublin. Of the 8,000 leased commercial aircraft currently in service 4,000 are

managed from Dublin.

Avolon, one of the largest leasing firms in the world, operates a fleet of 251 aircraft

and is currently valued at €1.2 billion euro.

This report is an insight into the Avolon operation. We have rigorously analysed the

company’s business model and future plans in order to develop a winning market

entry strategy into the Chinese market. Our decision to focus our sights on China is a

result of a global analysis of industry growth and more importantly the shifting

industry demand.

The development of this strategy required us to perform an in-depth analysis of the

current industry parameters in China and the position of the Chinese economy itself.

From this analysis we have selected what we believe to be the best performing airline

in the industry, China Southern, to target for an asset-acquisition based mode of entry.

Further to our market strategy development we have also devised a set of

recommendations to the Avolon board of directors. These recommendations are a

result of our thoughts and opinions that we derived from our meeting with Avolon

senior executives. These recommendations are based on the topic of future

development and planning and it is our hope that the company will find these

recommendations relevant and useful.

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Company Background

Avolon is a leading global aircraft leasing firm, focused on acquiring, managing and

selling commercial aircraft. Avolon's stated objective is to invest exclusively in

modern fuel‐efficient aircraft that demonstrate the strongest long‐term value retention

characteristics.

The company was established in 2010 by Domhnall Slattery (CEO) and his two

partners Andy Cronin (CFO) and John Higgins (CCO). They were the core team from

RBS Aviation Capital – the aircraft-leasing department of RBS, who actually acquired

Domhnall Slattery’s previous aviation business International Aviation Management

(IAM) in 2001.

They were joined by several other high level managers from RBS such as Dick

Forsberg, now head of Strategy, Pat Hannigan, Tom Ashe and Ed Riley.

This is an experienced and respected team of industry experts and have a proven track

record through a number of industry cycles. They state themselves that their growth

and global platform is “underpinned by a clear set of corporate values, which are the

basis for how (they) run (their) business”.

In five years they have amassed a fleet totalling 251 aircraft of 13 different models.

They are operational in 51 airlines globally in 29 different countries and have 64 staff

spread across 5 offices, including Stamford, CT, USA; Singapore; China; Dubai and

with headquarters in Dublin. Avolon boast a portfolio of 30 lenders including Wells

Fargo, Citibank, Deutsche Bank and UBS. They were publicly listed on the New York

Stock Exchange in 2014 under the ticker symbol AVOL and at the time it was the

largest ever listing of an Irish founded company on the NYSE.

In November 2013, Avolon announced it had commissioned a documentary on the

history of Irish Aviation titled: "Pioneers and Aviators, A Century of Irish Aviation.

The documentary tells the story of the remarkable, pioneering individuals whose

vision, passion, successes and failures helped forge Ireland’s unique aviation

landscape.

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Key Personnel

On Wednesday 11th of March our group held a meeting with three of Avolon’s senior

managers (pictured above). The meeting lasted three hours and the following topics

were discussed.

Company history, founding members and initial growth.

Growing popularity of aircraft leasing and the strategic decisions required.

Current market characteristics and strategic responses to demand shift.

New market entry and financeability requirements (Debt/Equity Funding).

Regional distribution and focus on the Asia-Pacific region, in particular China.

Analysis of airlines and considerations involved in targeting lessees.

Analysis of Business Model canvas.

Discussion of pivotal management questions.

Future planning and development

Cross-cultural challenges and strategies.

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Current Financial PositionFigure: 1

Breakdown of RevenuesFigure: 2

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Business Model Canvas

A business model consists of four key interlocking elements (value proposition, profit

formula, key processes, key resources) that, taken together, create and deliver value

(Christenesen & Kagermann, 2008) and the most important to get right is the value

proposition.

Avolon’s business model is not unique in absolute terms, but they are extremely good

at what they do and provide a tangible representation of their value proposition

through expert delivery of service. The key to Avolon’s success is not only their value

proposition; it is the overall implementation of their strategy through a clearly

structured commercial infrastructure. This business model has been detailed below

using the framework of the business model canvas (Osterwalder, 2008).

Customer Segments

Put Simply, Avolon have three primary customer segments:

- Incumbent Airlines

- Capital lenders i.e. banks

- Other lessors

Incumbent Airlines:

Avolon’s primary customer segment is airlines looking for sale and leaseback

agreements for their assets. They target established air carriers with strong

backgrounds and stable reputations. They do not limit themselves specifically to one

region, nation or airline, however as minimising risk is a key factor in their overall

business strategy, it is vital for them to choose only airlines that are most strongly

positioned within their given markets. In the event that they enter into agreements

with smaller subsidiary airlines, it is important to Avolon’s overall strategy that these

airlines are underwritten by stable parent companies.

Banks & Capital Lenders:

As a separate customer segment, Avolon target capital lending companies that want to

enter into the aircraft-leasing market but do not necessarily have the infrastructure to

do so – namely the industry expertise and network connections.

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Other Lessors:

Another aspect of Avolon’s overall strategy is having high asset liquidity rate and

consistently maintaining this turnover rate. In other words, to ensure that Avolon

adhere to their own value proposition (having the best aircraft at the leading edge of

technology) they must ensure that they are always purchasing the newest aircraft. To

finance this they sell ageing leases as well as ageing assets to other lessors with

different value propositions.

Value Propositions

Avolon have a focused-differentiation strategy (according to Bowman’s Strategy

Clock, 1996) and target a clearly defined niche.

Airlines:

Avolon allow carriers to purchase aircraft for their fleet in a way that’s financially

viable for the airline, saving them the cost and risk associated with major purchases

from aircraft manufacturers.

1. Innovation

Avolon are only focused on the newest state-of-the-art aircraft. They position

themselves at the leading edge of technology.They are solely investors and are

not wedded to one type of aircraft, however the aircraft needs to have critical

mass in the marketplace. As the lead times are so long, it offers stability to

Avolon on the one hand, but also means that for new manufacturers it could

take up to a decade to bring in new aircraft – which is hundreds of billions in

cost.

2. Ubiquity

Despite dealing in the newest aircraft, Avolon only enter into leasing deals and

trade the most widely used aircraft. This ensures they adhere to their policy of

maintaining a high liquidity rate of assets – if a given aircraft in their fleet is

not widely used by many carriers (i.e. if it doesn’t have critical mass) in the

industry then Avolon will find it more difficult to trade the asset in the future.

If an asset has a wide operator base then it is much less likely to challenge the

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value of the asset. For example the Airbus A320 has a myriad of carriers, it is

an easy aircraft for which to acquire parts and there is huge, industry-wide

demand for the aircraft – all facilitating easy liquidation if necessary.

3. Quality

Avolon have sacrificed innumerable growth opportunities to hone in on and

uphold their high standards regarding the quality of their assets. This is a key

factor of their general value proposition and is basically what separates them

from the pack as they are not diluting their brand image.

In essence, they will only invest in, and ultimately offer their customers, the newest,

technology but proven to the industry.

Capital Lenders:

Avolon offer a well-established, proven platform for lenders looking to establish

instruments (leasing agreements) with other airlines but don’t necessarily have the

infrastructural means (industry expertise, client network/industry connections and

know-how etc.)

This creates value for the financiers insofar as they can establish an aircraft leasing

section of their business and have the confidence to outsource the activities to Avolon,

who are renowned experts in the field, without the absolute cost, risk or liability of

entering into a totally new industry.

Avolon perform all the necessary activities, and the lenders have the peace of mind

knowing their only duty is to provide the required capital.

Other Lessors:

Avolon extend value to other lessors, who have different value propositions to that of

Avolon (i.e. lessors looking to purchase older and thereby cheaper aircraft – which is

not what Avolon is interested in, so in effect these other lessors are not direct

competitors) by offering them competitive financing deals when selling on their

ageing lease agreements.

***

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Avolon has several key success factors (Daniel, 1961 McKinsey & Co.) in terms of

activities, resources and partners that are necessary to the successful realization of

its business model and effective implementation of its strategy.

Key Activities

Raising capital:

Avolon’s profitablity is primarily derived from its success in raising capital at

cheaper rates than its competitors. This means it is able to raise both debt and

equity capital for the purchase of assets at rates that are competitve in comparison

to its competitors. They are chiefly focused on the financing element of the

business than on the mechanical or technical aspect.

Trading Assets:

Avolon has the number 1 youngest fleet out of the top ten lessors worldwide.

Purchasing aircraft cheaper than competing lessors and the ultimate sale of the

assets at a profit further down the line is not only important to supplementing

revenue from leasing activity, but also for achieving their strategic goals of

ensuring high asset liquidity rates (turnover of assets) and maintaining their value

proposition of having the youngest fleet available to lessees. It should be noted that

Avolon perpetuate a 20% asset turnover rate and on average make a profit of

$3.5million per aircraft traded.

Securing Instruments:

Another key activity in which Avolon regularly out-performs their competitors is

the ability to secure deals with both lessees and capital lenders that their

competitors cannot. These deals could be in terms of leasing aircraft to particular

carriers that may be somewhat captious in nature or even in procuring competitive

rates from financiers that regard Avolon as a highly credible debtor, and would not

be as prone to lending to Avolon’s rivals.

Managing Debt:

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Avolon are one of the top 10 aircraft lessors in the market and this is evident from

the platform they both use and make available to lenders looking to enter the

aircraft leasing market. They are adept at optimising returns in this industry

through their vast expertise, network of clients, contacts and financiers and diverse

portfolio of clients mean that debt-finance providers know their capital investments

are safe.

Key Resources:

Personnel

One of Avolon’s most vital resources is its almost unrivalled industry expertise. Of its

core team, 10 of those left RBS’ aircraft leasing division in 2010 to establish the

company. Between them they have almost 160 years of industry expertise

Assets

Avolon, as referenced above, have the no. 1 youngest fleet out of the top 10 lessors

worldwide. This is another crucial element to their business model and value

proposition. According to Dick Forsberg, Avolon’s head of strategy, there are

approximately 20,000 commercial jets currently in operation worldwide, with about

8,000 less than 7 years old. Avolon operate entirely within this bracket.

In respect of the global fleet of aircraft, (or any fleet for that matter) the oldest aircraft

will be jettisoned first, as they are the least up to date, both technologically and in

terms of efficiency – this is logical. This means that there would have to be a massive

reduction in demand and accelerated obsolescence of aircraft resulting in a 75%

reduction in the global fleet before Avolon were to truly take a hit. Having said that,

in the highly unlikely event that this were to happen, the assets would still be useable.

The only major affect would be a drop in monetary value; so in reality, the airlines

would take the first hit.

Location

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There are two elements for which Avolon use location as a resource:

Domestic:

The aircraft leasing industry was started in Ireland by Irish man Tony

Ryan in the early eighties. The establishment of cross-border leasing

agreements, withholding tax treaties and other such arrangements (along

with a relatively low and stable corporation tax) gave Ireland first-mover

advantage in the industry. Aircraft leases were being put into operation

when very few other people in the world knew what aircraft leasing

entailed. This structure takes decades to replicate and as such Ireland has

since become the global hub for aircraft leasing firms with 55% of all

lessors being based in Ireland (according to the IATA). This provides

Avolon with easy access to any necessary expertise, infrastructure and

support that they might not otherwise have within the company.

International:

In terms of location on an international basis, Avolon also have offices in

China, Dubai, USA, Singapore. This permits them to offer support to all its

customers, regardless of where in the world they are located.

Financial

At inception Avolon was able to obtain start-up funding from 3 core equity-financing

firms of $1.5billion in order to begin operations. These were CVC Capital, Cinven

and Oakhill Capital Partners. Through sustaining profitability, growth and good

stakeholder relations Avolon have been able to retain a committed equity capital base

from its financiers.

Brand Reputation

Avolon’s brand reputation is an intangible representation of the aforementioned key

success factors and value propositions. Its differentiated strategy, which offers

premium service, as opposed to low-cost lease providers, ensures that they maintain

good customer relations across all segments – as well as through all elements of the

value chain (Porter, 1985).

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Growth of Airline Industry

The overall future growth forecast for the airline industry can almost be considered a

resource to the firm. The industry is expected to grow, not only in terms of passenger

numbers and overall freight, but also as the demand curve for the operation of aircraft

continues to swing heavily from purchasing to leasing, Avolon can expect a continued

growth in business.

Key Partners:

In addition to key activities and resources, Avolon has a pool of key partners that are

a quintessential part of the business.

Capital Lenders

With a portfolio of over 30 lenders, these capital lending firms are necessary for

Avolon to obtain both debt and equity finance for its own operations as well as

entering into strategic operations alliances with certain banks and lending associations

that don’t have the required platform to operate independently in the leasing market.

One major example of this type of agreement is the joint venture alliance that Avolon

have with major US bank Wells Fargo (WF). WF provide the necessary capital and

Avolon manage the debt by way of leasing activity.

Air Carriers

Avolon has clients spread all across the globe. Their highest distribution of assets is in

Europe, USA and the Asia Pacific, but they also have clients in Africa, South

America and Australasia. Some of their most notable clients include Virgin (Atlantic

and Australia), Air Berlin, Etihad, Air Asia, American Airlines and DHL to name but

a few.

Manufacturers

Airbus and Boeing operate an effective duopoly on the airline manufacturing industry,

thus contributing to over 90% of Avolon’s deliveries.

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Private Equity Firms

As previously mentioned, CVC, Cinven and Oakhill are Avolon’s core providers of

private equity. They are also listed on the New York Stock Exchange and this is

another source of equity capital.

Many of Avolon’s key resources, activities and partnerships are largely intangible and

developed through years of high performance within the industry. This ensures that

they stand the test of inimitability and durability. Given the strategic position in which

Avolon put themselves, the business model also stands the test of competitive

superiority, allowing their entire supply chain to create value for all stakeholders

(appropriability). In addition, given the conditions of the aircraft leasing market,

Avolon easily withstand the test of substitutability as well. (Collis & Montgomery,

2008).

Customer Relations:

Based on their position in the market and their overall brand reputation it is evident

that Avolon keep excellent customer relations, both with the airlines they service and

the banks for whom they provide a leasing platform.

Airlines

Airlines are offered full autonomy in terms of managing the asset. This means

that they are in full control of all aspects of operating, maintaining and

servicing the asset.

Customers are well integrated into the other aspects of Avolon’s business

model. If Avolon can obtain a competitive rate from a lender, this is in turn

passed on to the customer, although at a profit for Avolon. The manufacturer

then delivers the aircraft to the customer on behalf of Avolon, they do not

physically touch the aircraft.

Aircraft are personalised for the specific airlines. For example a Virgin

Atlantic aircraft will have the layout of a typical Virgin aircraft (number of

seats etc), it will be decorated like a Virgin aircraft, have the look and feel of a

Virgin aircraft. Even the pilots won’t know it is leased.

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Avolon have a diverse customer base, spread across the globe. With such

widespread operations in so many countries, on nearly all continents, it means

that there is support available to clients no matter where in the world they are

located.

Lenders

Avolon already have established relationships in the finance community, as so

many of the founding team came from the aircraft leasing division at RBS.

Their vast expertise translates to success in the market which means customers

are consistently satisfied.

Through borrowing for themselves (for their own activites) and through

effective and efficient debt management facilitating stable returns – i.e. doing

the grunt work so lenders don’t have to – Avolon have built up a stable

reputation in the lending community. This means lenders can have peace of

mind knowing they can take a step back and reap the rewards of their

investment without having to get embroiled in the focal activities.

Channels of Distribution:

In terms of delivery of aircraft, the manufacturers (usually Airbus and Boeing)

distribute the aircraft based on the orders made, so Avolon generally don’t physically

handle the aircraft.

Cost Structure:

Avolon have an extremely high fixed cost base, primarily focused on two elements:

1. Human Capital

Avolon provide competitive remuneration to their staff who have vast industry

knowledge. With nearly 160 years of combined industry experience, very few

competitors can rival this.

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2. Asset Acquisition

Aircraft, as expected, are expensive! Hence the acquisition of assets by Avolon

is a major expense for the company.

Variable Costs

Costs are value driven: The two primary influencers on variable costs to Avolon are

conditions in the capital markets and conditions in the airline industry.

Profit is derived from the difference between the rate that the firm borrow

money to finance the delivery of aircraft and the rate at which the firm leases

the aircraft to a given airline. Therefore the cost of debt-financing rates is very

important.

Costs are also influenced by industry conditions in the airline sector eg.

emissions regulations on new aircraft (or new engines); fuel prices which are

constantly fluctuating; passenger demand in a given region etc.

Scale is also a factor in determining costs i.e. the number of aircraft being delivered in

a given contract. Hypothetically, if Avolon purchase 100 aircraft, it will cost them

significantly less per aircraft delivered than if they were to only purchase 10.

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Revenue Streams:

As has been detailed above, it is clear to see from where Avolon’s revenue is derived:

Leasing Agreeements

Sale of Assets

Debt-Management Service Fees

Sale of Ageing Leases

Leasing agreements are Avolon’s core source of revenue. Customers are

willing to pay premium prices as they are getting the best, newest and most

widely used aircraft.

This core activity is heavily supplemented by the trading activity and turnover of

assets (i.e. the purchase and subsequent sale of aircraft – purchasing from the

manufacturer and sale of asset to a 3rd party within a few years).

In addition to this service fees are charged to capital lenders, which are another source

of income.

Each of these aspects are key to the prosperity and profitability of the company,

however leasing agreements are the primary source.

For a detailed breakdown of revenues see Fig. 2, page 5.

.

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Current Market ShiftFigure: 3

Boeing announces production forecast for next 15-20 years with an estimated value of

$4.8 trillion. Source: Capital Aviation.

Figure: 4

Airbus figures for same period. Combined together these two manufacturing giants

will produce an average of 269 aircraft per month for the next 17 years.

Source: Capital Aviation

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Current Market Shift

As we can see from this graphic the Asia Pacific region and China in particular will

be experiencing huge levels of growth in terms of air traffic over the next 15-20 years.

This growth combined with the increased production and more frequent availability of

newer fuel efficient aircraft is a clear justification of our strategic market entry into

the Chinese market and in particular China Southern Airlines. The next section will

outline our entry strategy and detail the factors that must be considered in any

strategic market entry.

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As we have focused our strategic plan on the Chinese market we have prepared a

Diamond of National Advantage, a framework introduced by Michael Porter, to

showcase how well suited China and the Chinese economy is to the aircraft leasing

industry.

Firm Strategy, Structure & Rivalry

China is home to a number of large, well run airlines. These include China Southern,

Air China, Cathay Pacific and China Eastern. Combined together these airlines

operate fleets that consist of approximately 1,280 aircraft. In 2014 alone these four

carriers served 299 million passengers. What makes these big carriers attractive is the

fact that they operate fleets that include a wide variety of aircraft, in terms of

manufacturers and size. This fits well with Avolon’s desire to maintain a wide spread

portfolio and to avoid focusing on acquiring a certain aircraft model or size.

Regarding cultural fit Chinese companies operate with a high level of long-term

orientation. Geert Hofstede's cultural dimensions study scored China at 87 meaning

that it is a very pragmatic culture. In societies with a pragmatic orientation, people

believe that truth depends very much on situation, context and time. They show an

ability to adapt traditions easily to changed conditions, a strong propensity to save and

invest, thriftiness, and perseverance in achieving results (Hofstede Center). All of

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these attributes are crucial in maintaining a professional work ethic and match well

with the fast paced, professional environment that is aviation financing & leasing.

Demand Conditions

With regard to demand in China, a report issued by KPMG Hong Kong states China

will require a further 5,000 aircraft over the next two decades with a large amount of

these being acquired through lease agreements. More importantly, Asia is driving

growth and shifting aviation’s center of gravity eastward. In 2010 about 33% of

passengers traveled on routes to, from or within Asia-Pacific. For North America and

Europe the equivalent number was 31%. By 2015 IATA’s passenger forecast

anticipates that Asia-Pacific will represent 37%, while traffic associated with Europe

and North America will fall to 29% (IATA 2012).

On average a Chinese person flies 0.2 times per year compared with 1.8 times in the

United States (IATA 2012). According to Tony Tyler, CEO of IATA, within the next

decade China is expected to reach the per capita income level of $15,000 at which

annual air travel becomes a possibility. This growth could generate an extra billion

potential travellers annually.

Related & Supporting Industries

Beijing is home to one of the worlds largest maintenance firms, Ameco. Founded in

1989 they currently employ 3,750 employees and play a crucial role in the Chinese

airline industry. Ameco also operates 6 smaller facilities dotted around China in

locations such as Shanghai and Guangzhou. The presence of a reputable maintenance

industry is a crucial factor that airline leasing companies must consider as they need

to ensure their assets are as protected and supported as possible.

Factor Conditions

In the Chinese economy there is a wide availability of capital and sources of finance

for leasing firms seeking to do business.  Generally most leasing firms are in

partnership with financial institutions and banks in their home countries however it is

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extremely beneficial to have domestic banks and institutions willing to provide

debt/equity financing.

The once heavily regulated airline industry has undergone radical changes. The

CAAC, Chinese Aviation Authority introduced in 2004 a set of new regulations that

heavily supported international private investment into the Chinese airline industry.

CAAC’s new regulations encourage private investment in key aviation infrastructure,

including domestic airlines, airports, and cargo facilities, as well as in services such as

fuel supply and storage, maintenance and repair, operations, catering, and distribution

systems (Worldwatch.org, 2005)

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This industry analysis will cover both the competitive forces at work in the Chinese

airline industry and the competitive forces affecting aircraft leasing in the industry.

We have covered both aspects, as we believe that significant changes to the Chinese

airline industry have great bearing on the leasing industry.

In the case of the Airline industry the buyers are taken as leisure & business

passengers. With regard to the leasing industry the buyers are the airlines seeking to

secure lease agreements on new aircraft. Fuel suppliers, aircraft manufacturers and

employees are taken as the suppliers to the airline industry. Suppliers to the leasing

industry are Banks and other Financial Institutions looking to provide both debt and

equity funding. The players are airlines and aircraft leasing companies.

Degree of Rivalry - The competitive environment is made up of several large airlines

such as Air China, China Eastern and China Southern and smaller low cost carriers

including Spring Airlines and China United Airlines. In general rivalry in the industry

is strong due to the size of the competitors and difficulties in exiting the industry.

Regarding the competitiveness between lessors there currently are 14 out of the top 15

companies who have assets with Chinese airlines. The competitive nature of both

industries is assessed as strong.

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Buyer Bargaining Power - With specific regard to the leasing industry the buyers are

the leasing companies customers, banks and airlines. The bargaining power of these

buyers is quite high as there are many lessors operating within the industry. As Porter

(2008) states buyers are powerful if they have negotiating leverage relative to industry

participants. This negotiating leverage is particularly strong for airlines. This leverage

that airlines possess comes as these large carriers are the only airlines who can

financially support long term leases and so leasing companies are attracted to them.

Looking at the industry from an airlines point of view the buyers in this are the

passenger customers. Price sensitivity is high due to the growth of online price

sensitivity sites. Airlines can defend against this sensitivity by differentiating their

service in ways such as focusing on additional features including more legroom and

inflight services. Switching costs for buyers are low which further strengthens their

position. To combat this airlines have introduced loyalty schemes. An example of a

popular loyalty scheme in the industry is the China Airlines Dynasty Flyer Program,

which sees return customers rewarded for their loyalty through air miles and other

value added services.

Supplier Power - As mentioned Boeing and Airbus are traditionally the two main

suppliers of aircraft. Although they are run separately they effectively operate a

duopoly over airlines especially with regards to larger aircraft such as Boeing’s 747

and Airbus’s A380.  Similarly to other industries around the world the Asian airline

industry is also supplied by smaller manufacturers. These include Bombardier and

Embraer. These aircraft manufacturers are suppliers to both the Airline industry and

the leasing industry and so play an important role in the competitive environment.

Considering there are only a miniscule amount of suppliers, their bargaining power

over airlines and aircraft lessors is extremely high.

Focusing solely on the Airlines companies, they employ a significant amount of staff.

For example Air China currently employ over 25,000 people. The bargaining power

of large groups of employees increases as they wield the threat of industrial

action/strikes. A threat which, if came to fruition, would have detrimental effects on

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the day to day service provision of airlines. Currently the Chinese Aviation Worker’s

Union has 360,000 active members (actfu.org, 2012). Fuel is a crucial input to the

airline industry and so fuel providers have a strong bargaining power over firms

operating in the industry.

According to Market Line the International Air Transport Association (IATA)

estimates fuel costs to have represented 31% of the total operating costs in 2013, up

$4bn over 2012 for the global airline industry (MarketLine 2013). However strong the

supplier’s powers are they are restricted by the unlikeliness of integrating forward into

the airline business, mainly due to excessive capital requirements and lack of

knowledge expertise. To combat the strength of the supplier power airlines in the

industry are forming strategic alliances or joining pre-existing alliances. Examples of

this include Air China and Shenzhen Airlines, two prominent Chinese carriers,

becoming members of the worldwide Star Alliance.

Threat of New Entrants

Entry barriers to the airline industry are especially high. If an entirely new airline was

to enter the market the start up capital requirements would be astronomical. However

there is always a consistent threat of existing airlines entering the market by launching

new services in the region. Distribution is not particularly easy, as new players need

to establish an online

booking system, and relationships with travel agents and other sales intermediaries. It

is also vital to obtain airport ‘slots’ for take-off and landing (MarketLine 2013).

The threat of new entrants into the leasing industry in China is assessed as moderate -

strong. This is due to the huge start-up capital requirements and the necessity of

human expertise. The threat, however, is driven up due to the possibility of

international lessors focusing their interests to the Chinese market. This is expected

given the huge forecasted growth of air traffic in the region and demand for aircraft.

John M. Timpany, Senior Tax Partner KPMG, stated in an interview with the Wall

Street Journal that ‘China will require 5,000 aircraft in the next two decades’.

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Other barriers to entry which could affect new entrants include industry regulation.

The Civil Aviation Administration of China takes responsibility for safety, security,

airworthiness, and related issues (MarketLine, 2013). A unique regulatory issue for

the airline industry is the prohibition of Cabotage. A MarketLine Advantage report

into the industry defines Cabotage as being the provision of domestic transport

services in a country by companies based in a different country. Airline Cabotage is

generally forbidden, unless explicitly permitted by an agreement between two or more

countries.

Threat of Substitutes

The threat of substitutes in both industries is relatively low. The main substitutes of

air travel are sea, rail and other land transport methods. Domestic flights which

account for over 90% of air passenger volumes in China (MarketLine 2013), can be

substituted with other methods such as land and sea travel. However considering

China covers such a large geographic area, air travel makes it easier to travel longer

distances in smaller amounts of time even factoring in waiting times.

Regarding the threat of substitutes to aircraft leasing, we would assess this threat as

low. The only alternative to leasing is for an airline to fully purchase an aircraft. This

strategy has become less popular due to the huge up-front costs and liability of such a

large purchase. Essentially, as Dick Forsberg (Head of Strategy, Avolon) put it,

‘airlines would rather not have large amount of aircraft on their books, it’s an

unnecessary move and very unattractive when compared with small payments over a

longer term’.

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New Market Entry Strategy

For any new market Avolon typically adopt an equity mode of entry, namely through

acquisition of assets (Pan & Tse, 2000).

The acquisition model adopted by Avolon is that of a hybrid, incorporating a

combination of both debt and equity financing; the former making up 75% of the

acquisition and the latter 25%. Financiability is central to both the business model and

overall strategy. As Avolon only have a limited pool of equity, they NEVER finance

solely through equity; it is always a 75:25 split. Again this is a strategic fit to their

policy of minimizing risk for optimal return. Whether the opportunity is market

driven or counterparty driven, the fundamental element is always financiability.

As is detailed in the business model canvas, Avolon also employ other equity modes

of market entry such as joint ventures, as seen in the example above with Wells

Fargo.

Contrary to what one might think, Avolon do not target specific regions, nations or

airlines as primary drivers for new market entry. They are driven by asset

classification and liquidity – i.e. aircraft – and a carefully crafted concentration-

distribution strategy.

The fact that they operate on a global scale is very important to their business as it

ensures they can maintain diversity – and ultimately spread their risk – across the

portfolio of assets. The airlines actually consider themselves as operators, rather than

owners, of aircraft in that they also want minimal residual risk. This is why they enter

into agreements with lessors in the first place.

Avolon follow where the industry demand goes, while at the same time ensuring they

do not oversaturate a particular region, nation or airline, as their whole strategy is

based on optimum returns on financing agreements at a minimal level of risk. In other

words they can’t lease to all the airlines in one region or country as it too risky and

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diversity across its pool of clients is vital. As the common idiom says “don’t put all

your eggs in the one basket!”

An example of this was Avolon’s recent investment in the Indonesian market. For a

single market, there was, in relative terms, heavy investment made, so Avolon are not

considering investing further resources in that country for the short to medium term as

it would not be a good strategic fit (Collis & Montgomery, 1995).

Before looking at any specific market opportunity for Avolon, there are several

generic factors to be considered:

1. Asset:

The best definition of a new market for Avolon is a “new asset type” For this reason

the asset is the most important factor for Avolon. Does the asset fit with Avolon’s

value proposition - providing the best, most diffuse aircraft for the best airlines.

They are always looking at how to transition from one set of aircraft models to a new

set. For example, with the launch of the Airbus A320neo’s (New Engine Option) in

2010, Avolon decided that that was where the future of narrow-bodied aircraft lay and

they embarked upon a strategy of transition from the previous generation of aircraft to

the newer generation over the following years.

2. Airline:

Another important aspect to consider is the carrier itself. Does the airline make sense

to Avolon’s concentration-distribution strategy? Is it a credible airline (with a good

credit history)? Is it a startup or an incumbent? Is it a parent or subsidiary company?

If it is a subsidiary, does it have a credible underwriter as a parent company? Avolon

will always take a deep dive into the performance of the airline, its credit rating, how

the airline is managed, its position in the market (i.e. is it a price maker or a price

taker) etc. before making a decision on whether or not to enter into an agreement with

the airline.

3. Structure:

The structure of the instrument also plays an important role. Some questions that need

to be answered are: Will the investment deliver the appropriate level of returns for the

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level of risk involved? What are the criteria regarding security deposits? What are the

repossession risks? (For example, given today’s conditions, flying domestically in

Russia there would be difficulties in repossession.) How good is the national

infrastructure? Is there a risk of material adverse change to either the region, nation or

airline? (For example in India, Kingfisher had leased aircraft from several different

lessors. They subsequently went bust and aircraft were grounded. As property rights

were not fully developed, lessors couldn’t access the aircraft as their claims on the

assets were not supported through the courts – yet they still had to obligations to

financiers to pay their debts.)

4. Time:

Given that it takes months, if not years, to complete the process of agreeing lease

terms to final delivery of the asset, time is another important consideration for new

market entry. When looking at entering a particular market an agreement is reached

with the lessor, the financier and the carrier based on one set of parameters.

At the time of delivery, which is usually 12 months down the line, these criteria could

be different depending on market or industry conditions. For example, if Avolon

agree to enter into a less traveled or less populated market it may be difficult to break

out later on (i.e. to sell on the instrument) and so they may have to take the hit. The

risk of adverse change must be low – i.e. the risk of the country going into recession,

the airline going bust, or even more extremes that can occur in developing economies

such as war, must all be low in relative terms for Avolon to consider entering the

market. However this can be difficult to ensure as no one can predict the future.

This might sound a complicated process, and in reality it is, however the fundamental

economics to note of any market entry is the financiability of credit:

The rate at which Avolon can borrow the money to finance delivery

The rate at which Avolon lease the asset to the lessee

And the difference between the two figures is ultimately the profit.

Opportunity

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The new market entry opportunity we have chosen for Avolon is as follows:

Target: China Southern Airlines

5 new aircraft, 1 per annum

Over the course of 5 years

Supplement this activity with the sale of lease agreements with Spring Airlines

Reasoning

Taking a deeper look at both China Southern Airlines and Spring Airlines will

give an indication as to why to target China Southern and jettison the

instruments with Spring Airlines.

China Southern Airlines:

China Southern is one of China’s “Big Three” airlines – along with Air

China and China Eastern, both of which are already part of Avolon’s

client portfolio. This would further spread their risk across the Chinese

market in the event that something happens to either one (or both) of the

other two “Big Three” airlines.

China Southern is the 6th largest airline in the world in terms of

passengers carried and kilometers flown per passenger.

It possesses the largest fleet in China and the 5th largest worldwide.

China Southern also boasts the most developed network of routes of any

Chinese carrier, offering diversity as well as an avenue for an expansion

of contract in the future, for different aircraft models.

There is a good strategic fit for Avolon with China Southern as they

have a history of acquiring the best, newest aircraft and releasing older

models. For example China Southern are the only airline in the world to

operate both the Airbus A380 and the Boeing 787-8 in its fleet. These

are the newest “Dreamliner” aircraft and considered to be the height of

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technological advancement and offer the best customer experience

within the industry.

Airbus have announced an industry-wide strategy to replace all current

models of the A330 with the A330neo starting in 2016.

China Southern have 32 A330’s, their latest version being the A330-300,

which are approaching 25 years of age. This is the industry average age

of retirement of the aircraft – and China Southern, in keeping with their

own value proposition, are set to replace all of these A330’s with the

newer A330neo.

Spring:

Spring Airlines have, in relative terms, a very new and young fleet, with

the average age of their aircraft being 3.5 years old.

Spring are quite a young company having started in 2004. They

currently have 51 aircraft. This, coupled with the average age of their

aircraft, suggest that they will not be expanding or upgrading their fleet

in the short to medium term future.

This does however make for an attractive lease to purchase from the

point of view of other lessors (those with different value propositions to

that of Avolon).

Selling this lease would be in keeping with Avolon’s strategy of

conducting asset-trading activity to supplement its core leasing revenue.

They average $3.5million profit per aircraft traded, along with

maintaining a 20% turnover rate of ageing assets.

Spring also operate a primarily domestic flight network. They have a

few international routes with Japan, Korea and most recently Singapore,

however China Southern boast a much more broad and diverse network

of routes (and therefore a more broad and diverse range of aircraft

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models).

In addition, for such a young airline, Spring have had numerous

political, legal and public relations issues in the last number of years.

Two of the more recent high profile incidents were: They were

threatened with government sanctions over pricing strategies and in

terms of PR they refused to allow 3 passengers who have HIV onboard

cancelling their tickets – they lost the subsequent legal battle.

These issues imply a risk of material adverse change in the future – i.e.

they could be hit with governmental sanctions or they could face future

court proceedings and ultimately could go bust.

In summation, when comparing the two airlines, Spring pose, in relative

terms, a much higher risk than China Southern. This is contrary to

Avolon’s strategy of optimal returns at minimal risk and so for this reason

Avolon should consider this strategy for growth in the Chinese market.

Implementation

This implementation plan should provide an appropriate platform to execute the new

market entry strategy.

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1. When

All airlines, not only China Southern, regularly issue requests for proposal

(RFP’s) for leasing agreements in order to get the best financing rates.

Following an RFP, Avolon can begin to draft leasing agreements with China

Southern from next year (2016) with a view to begin delivery of the assets in

the subsequent 12 months (2017).

As lead times are so long and both Boeing and Airbus are heavily booked with

orders for delivery for the medium to long-term, Avolon would look to deliver

1 aircraft per annum for the subsequent 5 years (2017 – 2022).

This is a fairly standard agreement in which Avolon engage. It would be

unusual for them to offer more than 10 aircraft to any one airline at a time.

This is in keeping with their distribution strategy.

In 2022, once the delivery of aircraft to China Southern has been completed,

Avolon can issue an RFP to sell the Spring Airlines lease. There would still be

a number of years to run on the lease, and as it is 5 years down the line (from

today) the average age of the fleet will be approximately 8 years. This ensures

that it is attractive for other lessors looking for older aircraft while at the same

time perpetuates Avolon’s strategy of selling on ageing instruments and

retaining the youngest fleet.

2. How

To ensure that they can optimize profits for themselves as well as passing on a

competitive rate of financing to China Southern, Avolon can utilize the

network of financiers and lenders, with whom they have established relations.

This will constitute 75% of the capital necessary to finance delivery.

For the other 25% required they can use their committed equity capital

provided by their private equity partners.

Having already agreed instruments with several Chinese partners, Avolon

have established a regional office in Shanghai. This is a prime location for

Avolon as, in geographical terms, Shanghai is situated in the middle of the 3

34

core Chinese commercial hubs: Beijing (further north), Shanghai (relatively

central) and Guangzhou (in the south).

In addition to this, the other two airlines of the “Big Three” Chinese airlines

that Avolon serve are located in each of these hubs; Air China are situated in

Beijing; China Eastern Airlines in Shanghai and China Southern Airlines in

Guangzhou.

This facilitates a customer support network for China Southern without

Avolon having to sacrifice support to its other major Chinese clients.

In 2022, after the final delivery of aircraft to China Southern, Avolon can issue

an RFP for the Spring Airlines lease. They can use their vast industry expertise

and relations with the debt-financing community to negotiate a competitive

deal to ensure they get a maximum return.

3. Scale

Once a successful and sustainable relationship has been developed with China

Southern, there is room for Avolon to expand this contract.

The size and classification of China Southern’s fleet allow for the expansion

on leasing agreements in relation to different aircraft models.

For example, Boeing are currently in the process of an industry-wide removal

from operation of their 737 fleet to be replaced with the 737MAX, starting

with first deliveries in 2018.

China Southern has over 150 737’s in operation with the 737-300 and 737-700

series to be replaced in the medium term future.

This is an example of just one asset model. Given that China Southern have a broad

and diverse range of models in their fleet and their value proposition ensures they

remain at the leading edge of technology (similar to Avolon) it can be said with

reasonable certainty that China Southern will be looking to upgrade several models of

their aircraft in the future - short, medium and long term – suggesting scalability and

room for growth with Avolon.

35

Pivotal Questions for Management

Having read and analysed the reading ‘The Power of asking Pivotal questions’ by

Schoemaker & Krupp (2015), we put two of these questions to members of Avolon’s

top management with whom we met in Avolon’s Dublin headquarters. We will briefly

look at each question and give a brief overview of the discussion that took place.

Q: How well do you understand the implications of broad market trends and less

visible undercurrents for your business and for upcoming strategic choices?

Dick Forsberg, Head of Strategy, explained to us that a large part of their business

depended on successfully following and taking advantage of market demand. In

recent years the demand has shifted eastward to the Asia-Pacific region and Avolon

have carefully altered their fleet distribution respectively.

Mr. Forsberg also touched on the importance of not over saturating the company’s

interests in any one market. He explained that while a heavy emphasis was placed on

China they still were focused on the United States as the average age of fleets were

increasing and this meant that in the near future newer aircraft will be required there

too.

Q: How thoroughly have you analyzed major externalities and future scenarios

that could significantly impact your business decisions?

A major step in the creation of a lease agreement is economic planning. Andy Cronin,

Chief Financial Officer, explained to us the rigorous process that occurs prior to

signing a lease agreement. He discussed the issue of country risk and how a country's

current economic state factors into their strategic planning. To help us understand he

gave examples of future scenarios that would have a huge effect on business.

Hypothetically lets assume Avolon had committed to a lease of three aircraft to a

Greek Airline five years ago.

There is an extremely high chance the current economic climate in a country like

Greece would pose a huge threat on the Greek Airline to make payments on time,

36

particularly if the airline in question was a legacy carrier or semi-state body. Similarly

when signing deals with Sub-Saharan African based airlines, the question of country

risk also comes into play. Future scenarios such as conflict & economic recession are

far more likely in these areas and so present a higher chance of impacting Avolon’s

business decisions.

Conclusions & RecommendationsHaving provided an in-depth analysis of Avolon and prepared what we feel to be a

concise market entry plan we will now provide three recommendations. These

recommendations are focused on improvements for Avolon’s current business model

and the improvement of future global operations.

1. We recommend that Avolon open further offices in either Europe or the USA to

facilitate better customer service to their customers in those areas. Currently

Avolon is placing a big focus on the east with offices in Dubai, China and

Singapore. We understand that these offices are crucial, however we do not believe

it is wise to appear to be neglecting the rest of the client portfolio.

2. We recommend that Avolon look at potentially hiring one or two Chinese aviation

experts in their Shanghai office, as to improve their presence in the region. We feel

that this is a smart strategic move and will drastically improve the company’s

further expansion in terms of cross-cultural and linguistic challenges. An

appreciation for culture is of major importance in China. A further development of

this idea would be to focus on hiring Irish business and Chinese graduates to be

deployed in the Shanghai office. The industry is growing at a substantial rate and it

would be invaluable experience for the company’s future leaders to be directly

present in the market.

3. Finally we recommend that Avolon deploy multiple lenses to connect dots from

diverse sources and stakeholders (Schoemaker, Krupp 2015). As with any growing

business it’s extremely important that Avolon seek second opinions on their

primary industry observations by engaging with the views of their customers and

strategic partners.

37

References

Reinventing Your Business Model; Mark W. Johnson, Clayton M. Christensen

and Henning Kagermann; Harvard Business Review, Dec. 2008.

Daniel, D. Ronald, "Management Information Crisis," Harvard Business

Review, Sept.-Oct., 1961.

Alexander Osterwalder (2004). The Business Model Ontology - A Proposition

In A Design Science Approach. PhD Thesis University of Lausanne.

Business Model Generation, A. Osterwalder, Yves Pigneur, Alan Smith, and

470 practitioners from 45 countries, self published, 2010.

Introduction to Aircraft Leasing (2014). Capital Aviation [Youtube]. Date

Accessed 28th March 2015.

Hofstede Centre. The Hofstede Centre: Strategy, Culture, Change. Available

at: http://geert-hofstede.com/china.html Accessed: 26th March 2015.

Chiu, Joanne (2014). Asian Companies Flock Into Aircraft Leasing. Wall

Street Journal Online. Available at: http://www.wsj.com/articles/asian-

companies-flock-into-aircraft-leasing-1415827382 Accessed: 23rd March

2015

MarketLine (2014). Industry Profile: Airlines in China. Available at:

http://advantage.marketline.com/Browse?nav=842+4294855287&q=aircraft

%20leasing. Date Accessed: 21st March 2015.

IATA (2012). Press Release: Use Aviation Strategically, 13th February 2012.

Available at: http://www.iata.org/pressroom/pr/pages/2012-02-13-01.aspx

Date Accessed: 29th March 2015.

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Worldwatch Institute (2005). China Opens up Aviation Market. Available at:

http://www.worldwatch.org/china-opens-aviation-market-bringing-potential-

environmental-challenges. Date Accessed: 30th March 2015

Morrison Forester (2004). China Moves to increase private and international

participants in Airports & Aviation. Available at:

http://www.mofo.com/resources/publications/2004/06/china-moves-to-

increase-private-and-international Date Accessed: 1st April 2015.

Bowman, C. and Faulkner, D. (1997), “Competitive and Corporate Strategy”,

Irwin, London.

Competing On Resources, Collis & Montgomery, HBR 2008.

Collis, D. J., and C. A. Montgomery (1995). "Competing on Resources:

Strategy in the 1990s." Harvard Business Review.

Porter, Michael E. (1985). Competitive Advantage: Creating and Sustaining

Superior Performance.

Yigang Pan and David K. Tse, (2000) The Hierarchical Model of Market

Entry Modes; Journal of International Business Studies.

Schoemaker, P.J.H. & Krupp, S. 2015, "The Power of Asking Pivotal

Questions", MIT Sloan Management Review, vol. 56, no. 2, pp. 39-47

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Bibliography

http://avolon.aero/

http://investors.avolon.aero/~/media/Files/A/Avolon-IR/financial-

information/2015/quarter-4/avolon-2014-annual-report-v3.pdf

http://english.acftu.org/template/10002/file.jsp?cid=124&aid=274

http://www.csair.com/en/

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BMGT 30290 Applied International Business Project GROUP PROJECT SUBMISSION – COVER PAGE

Spring 2015

Group number ___________ Word count ___________ (main body only, excluding table of contents, graphics, appendices, references)

Project title

___________________________________________________________________________

___________________________________________________________________________

___________________________

We confirm that:1. We are the original authors of this project report.2. This report does not contain any material taken from unacknowledged sources and

all material has been adequately referenced.3. This report has been prepared for assessment in this module and has not been

presented as course work in any other module.

Group Member Student Number Student Signature

We confirm our submission includes the following (please tick the boxes):

□ Standard cover page with honesty declaration and submission checklist.

□ All sources and references in Harvard style using endnotes.

□ Evidence (data) and logic supporting our insights and recommendations.

□ Copy of our presentation slides in an appendix.

□ A soft copy submitted via Blackboard Assignment Folder

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