Page 3: The business becomes more competitive
During the 1950s and 1960s, aircraft manufacturers operated in a relatively stable environment. Airlines, such as BOAC and Air France, were largely government-owned and would buy their aircraft outright from the manufacturers, meaning that producers had little financial responsibility for the aircraft once they had been sold.
However, during the 1980s, the environment changed. Airlines were subject to a process of privatisation and many new airlines entered the market. A new era of competition had arrived as customers could now choose which airline to fly with. The newer airlines sought flexibility. They did not want to tie up the assets in their balance sheets in expensive aircraft and they also wanted to have the flexibility to expand, e.g. by trading in a leased 100 seater aircraft for a 200 seater. Rather than buy aircraft they sought to lease (or rent) them.
This new market environment, therefore, created the opportunity for a new form of organisation – leasing companies (owned by financial institutions, often in partnership with aircraft manufacturers). The leasing companies bought the aircraft from the manufacturers and leased them to airlines. However, to make the arrangement work, aircraft manufacturers like British Aerospace, guaranteed the lease payments. If an airline went into liquidation, then British Aerospace would continue the payments to the leasing companies. British Aerospace was typically contracted to guarantee payments to leasing companies for up to 18 years - covering the normal economic life expectancy of an aircraft.
The economic crash of 1992
The Gulf War of 1992 contributed to a major economic downturn which had a profound impact on the leasing arrangements. In the late 1980s and early 1990s, a number of new airlines had taken out short-term leasing contracts for British Aerospace aircraft. When a number of these airlines failed at the same time, and other existing carriers were exercising their options to terminate leases, British Aerospace was confronted with a difficult situation.
British Aerospace was now producing aircraft which it was unable to sell and was having to stockpile. New aircraft off the production line are referred to in the industry as ‘white tails’ because they have not been painted in the livery of new owners. In addition, a large number of leased aircraft were returned to British Aerospace, some of which were only a few months old. In 1992, British Aerospace had 118 jets and 428 turboprops in its lease portfolio - 30% of these were idle and another 30% under threat.
In terms of asset management, British Aerospace was in a crisis situation. Large amounts of capital were effectively doing nothing. The Company took the dramatic step of making a one billion pound provision in its accounts (the largest in UK corporate history) against the potential liabilities resulting from its obligations to leasing companies. At this time, British Aerospace’s share price collapsed to 98p.