China could become the world’s largest commercial aviation system by the middle of the decade. Up to recently, Western suppliers were integral to the Asia giant’s aerospace development, and the relationship was mutually beneficial. But with the new Biden administration potentially following the former Trump administration’s more-adversarial approaches, and with Comac’s C919 hitting new milestones, a new era is dawning on the trans-Pacific paradigm.
In this episode of Check 6, Aviation Week Senior Business Editor Michael Bruno talks with consultant Alex Krutz of Patriot Industrial Partners about what suppliers need to think about now for the future of U.S.-China aerospace.
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Here is a rush transcript of the Check 6 podcast for March 24, 2021.
Michael Bruno: Welcome to the Aviation Week Check 6 Podcast. I'm Michael Bruno, senior business editor at Aviation Week. And I have the privilege this week of being joined by Alex Krutz, managing partner at Patriot Industrial Partners. Alex, thank you.
Alex Krutz: Hi, Michael. Thanks for having me on.
Michael Bruno: So Alex, we're here to talk about China, and there's a lot going on with China these days. We don't know whether it's a cold war. We don't know whether it's going to be a lukewarm war between the United States and China. I think we can all basically agree that we hope it's never a hot war.
Michael Bruno: But no matter what happens, the relationship between China and the United States seems to be entering a new era. We have a new President here in the United States, and the policy still remains to be determined. But we're coming to the audience the day after the Biden administration and the Chinese leadership held a high-level meeting in Alaska, and from the publicly provided statements, that was not an easy meeting for either side. There was a lot of blunt conversations going on.
Michael Bruno: So what I want to talk with you today about, Alex, is what does this mean for the aerospace and defense supply chain? Because unlike with the Soviet Union and the Cold War of the last century, we've got two ecosystems, or then we had two ecosystems, and now we only have one ecosystem between the two countries that have been pretty intertwined. So several questions for you coming, Alex. But before we do that, I want you to take a moment and just introduce yourself and tell everybody a little bit about your career.
Alex Krutz: Yeah, great. Thanks, Michael, and thanks for having me on. This is a very interesting topic for the aerospace industry on a very macro level, right? But just a little background. Patriot Industrial Partners is an aerospace and defense advisory firm that elevates business performance, manufacturing strategy, value creation, and business transformation.
Alex Krutz: Just a little background on me. I've been a consultant for tier ones and twos on operational turnarounds and with private equity groups on value creation, planning, and execution. So before starting Patriot Industrial Partners, I worked for Raytheon Technologies, Pratt & Whitney, GKN Aerospace, and various other businesses in general management operations and supply chain roles. A pretty diverse experience set, spanning across engines, APU structures, composites, complex assembly and machining, and even C-class high-volume components.
Alex Krutz: So I have a pretty good reach into the supply chain and understand a lot of the inner workings, especially at the tier-two, tier-three, and middle-market level. So I think a lot of that is going to be especially relevant to this Chinese-American discussion when it comes to supply chains and longevity over the next 20, 30 years and how that ends up working out as kind of that maybe now dual ecosystem, right?
Michael Bruno: Indeed. Yeah, absolutely. I think the Chinese issue is going to be one of the biggest issues facing aerospace and defense certainly for the next 10 years and probably for a good chunk of the century. So let's dive into it. In my mind, in order to think about where the US and Chinese and aerospace relationships are going, you kind of have to step back for a moment and see where we've been. If you look at China around the year 2000, the start of the new millennium, not a big demand for Western aircraft at the time. According to the facts and figures, it was only about 2% of deliveries at the time.
Michael Bruno: But by about 2018, it is responsible for about a quarter of the backlogs at Airbus and Boeing. From early 2009 to 2018, growth in air travel in China, the demand just zoomed. 10% year-over-year growth. You've got a changing Chinese economy. They're going from exports to consumption-based with their own consumers. Of course, the urbanization of the population there. 25% of the population lives in cities.
Michael Bruno: They've got more income, and all of that means more discretionary spending and more of a desire to travel. Hence, the growth in air travel demand. Rising wages and an aging population, all of that helps drive consumption. Aviation market growth drivers, just a large middle class. It's got the largest middle class, and a statistic... The largest middle class in the world. And a statistic that always boggles my mind, Alex, their middle class is about the size of the US population alone, which is just sort of mind boggling.
Michael Bruno: Finally, if you look at their commercial airline fleet, they've got about 3,700 aircraft today, 1,200 alone in the big three airlines. And they've got airports. There's some interesting statistics out there about new airports, a couple of them popping up every six to nine months over there. In 2013, China only had about 183 airports, and by mid 2019, they had more than 230. So lots of people who want to go places, lots of airplanes, and lots of airports for them to land in. And that's just within China alone.
Michael Bruno: So Alex, help me paint a picture here of the Western supply chain in China going into the trade war that emerged under the previous Trump administration and before COVID-19. Despite being state-run, China's aerospace sector depends a lot on Western aero suppliers, right?
Alex Krutz: Absolutely. I think there's some rough figures on the C919. About 60% of American companies supplying to the C919 currently. There's about 30% are from Europe or other Western-based countries, and really kind of a small gathering of domestic Chinese or Chinese-American joint ventures. So that's kind of the compilation. So there is definitely right now a very heavy dependence on American and Western suppliers for components and systems for the aircraft.
Michael Bruno: So the US aerospace supply chain is about a hundred years old, but China's is far, far younger than that, but they're rapidly catching up. Tell us a little bit about this whole notion of transfer of knowledge, and why is it so central to how the two sides have worked together up to now?
Alex Krutz: Yeah, and that's a really good point. The American supply chain has been around for a hundred-plus years, and that's where suppliers have been able to develop complex stack-ups in engines and elastomer seal, mixing in compounds and composite assemblies and the black magic that happens in autoclaves. So those are all things that have developed over many, many years in the American supply chain and manufacturing and design and technology.
Alex Krutz: So I think to answer your question, it's probably been about 20 to 25 years of concentrated joint ventures, where Chinese suppliers will create a joint venture with primarily American companies and start to gain some of that knowledge, albeit it might be on generation-old, maybe two-generational technology. But nonetheless, it's kind of a step up of the technology. Instead of building into it, they kind of step into maybe an older technology and can learn from there.
Alex Krutz: And I think that also we have to recognize that over this last two decades, there's now a much senior... And back to your middle-class comment, right? There's a more seasoned group of engineers, right, that have gained experience and knowledge through work visas to other countries, to the US or into the West. Also, education in Western universities, right? So, 20 years ago that was just getting started, and now you have some of those that may be going into the graybeard era of what they're doing within those JVs or those domestic suppliers for growth. So those have been the two things. And this shorter, call it quarter century versus an entire century is really important to kind of keep in mind.
Michael Bruno: So here we are now. We're at this critical point. And I don't just mean politically with the new US administration and the inheritance of the trade war and conflict with China from the Trump administration. But there's a lot going on within the Chinese aerospace sector all by itself, right? We've got some real milestones that were recently achieved with the C919.
Alex Krutz: Yeah, absolutely. I mean, we talked about it a little bit earlier with the design approval last year. But one of the things that's really low on the radar right now is that they've made a commitment, and I know that there has been some schedules that have slid, but they want to deliver their first airplane to a Chinese carrier by the end of this year, right? So they have some very aggressive goals. Do they meet that? I'm not sure, but they're well on their way to do that, right? So that's definitely something to keep in front of us.
Michael Bruno: So you go from there, what's happening in the Chinese aerospace sector with the C919 and just the general development, the seasoning of their own supply chain, as you addressed. You take a step up. You look at the government action. So the Chinese like to work on the five-year plans. The 12th five-year plan from 2011 to 2015 really defined aviation as a pillar for China's future, and they started inviting investment. They not just invited foreign partners to come work with them, but also they were hiring, hiring lots of Westerners to come in and help those companies too.
Michael Bruno: And by 2015, there's a change of attitude, and there's a new government headed by Xi Jinping, and the 13th five-year plan from 2015 to 2020 brought even more significant changes. This is where the whole Made in China by 2025 really starts to emerge. And you see China trying to develop some of its own technology bases and functional capabilities to roughly a peer level of the United States just as an economic driver for the economic goals that it wants to achieve.
Michael Bruno: Now, we have a whole new five-year plan that's emerging. They've certainly got a more nationalistic attitude. There's crackdown on dissent, many could say, whether it's the Uighurs in western China or Hong Kong. There's certainly more control being exerted by the government. But nobody expects them to back away from this drive to be a major aerospace provider. So Alex, here we are. China's a rising power in transition, but the Chinese aerospace sector will face a huge transition by itself, it seems.
Alex Krutz: Yeah, absolutely. I mean, if you think about, they've had long-term plans for domestic carriers and the supply chain for their aerospace industry, but in that five-year plan, they made it very formal, right? Said made in China. And I think there's some figures out there that says they've invested or have developed the industry with like $70 billion to date, and that's probably going to increase because it's now been formalized. Whether it's through a nationalistic kind of approach or just wanting to satisfy their domestic demand for flying, I think that that's going to only get accelerated, right? So we have to really be thinking about that.
Alex Krutz: But to the point you just made, if we look at the aircraft right now, it's really structures-related when it comes to domestic Chinese, and that's... I don't want to call it easy, but that's the logical first step, in metal bending and in that fuselage work. And then I'd kind of see the interiors next, right? And I think that there has been recently some info out there about Thompson, a subsidiary now of the AVIC, COMAC kind of conglomerate. Albeit that's out of Ireland, I believe it's still Chinese owned, and there's a definite share of technology even to their domestic suppliers. So it appears that the interiors is well on its way. And again, seats are a bit different than cabins and lavatories and other types of systems, but nonetheless, it appears that second category is well on its way.
Alex Krutz: Then there's really three categories left, right? The mechanical systems, kind of electronics, avionics, and then the engine systems, right? And if we look at that third and fourth category of mechanical and electric systems, avionics software, which is very complex, it's possible that they could have decent to good technology for those by the end of this decade. And then I'm sure we'll chat about the engines, which are highly complex and a much more detailed and in-depth of a discussion. But it's very possible that a good amount of the systems could be developed by the end of this decade.
Michael Bruno: So yeah, the engines are really interesting because obviously they're the anchor that's been weighing everything down and about the big bugaboo that's really been haunting the Chinese when it comes to aircraft development. That's not really surprising, but they are getting better. And they've been partnering with Western providers to learn more. And time has passed. They are learning more.
Alex Krutz: Yeah. If you think of the newer engines' life cycles... Older engines typically lasted 30, 40 years, but as we've been doing these derivatives, they've been lasting about 20 years, right? And so if they're on maybe a generation or two older technology, that's probably an engine that might last 15 years. And typically, that maybe gets three to four major overhauls in its life. Most likely, if the Chinese are able to develop a good power plant technology, maybe it gets five or six teardowns, right? So they're maybe pulling it off the wing more to service it, to put better hot-section components in.
Alex Krutz: So there's a way to get to that reliability, the cost, its performance. It may not be economically or financially in their best interest, but they probably will be able to develop something that... Again, you get creative, right? More overhauls, more care, swapping out. They'll be able to do that. Or maybe it has a shortened life compared to maybe its peers out there in the current marketplace, but they will be able to get an engine on there.
Alex Krutz: And again, there's quite a bit of difference between military engines and commercial engines, but they have the technology with their fighter aircraft, right? So I'm pretty sure that they'll be able to translate that. But again, they may have to subsidize some of the cost with some creative applications in service, if you will.
Michael Bruno: So a lot of partnerships, as we were talking about, with Western companies to help the Chinese get to the point where they're at, that's certainly been the level of play for the last 20 years or so. But the next 10 years could look a lot different for Western suppliers compared with the last two decades, it seems. What do you think, Alex?
Alex Krutz: Yeah. So there's probably going to be maybe a bit less of a focus on the IP side and those information sharing or exchange and probably more on the contract side, because I would see that from a supply-chain perspective that COMAC would start looking at... Instead of those initial small quantity buys that you do in the R&D or the development of your six or eight initial aircraft, they're going to start looking at larger volumes. So I think that's where probably American companies that do, or even Western companies that do work with China will really need to start thinking about their contract negotiations and how they can gain security from the source of supply that they may be providing here in the future because, again, up until now, it's been small-unit buys to get through this R&D in their initial... I think it's six to seven airplanes that they have. But now suppliers will have to go into negotiation for longer-term commitments, if they haven't already.
Michael Bruno: And then it just seems that the whole structure of relationships could be set to change. As I mentioned at the top of the podcast, you've got the potential for what is right now a united system or a single ecosystem to potentially bifurcate between a Chinese ecosystem and a US ecosystem. Here in America, we still have these standing restrictions that the Trump administration put in at the last minute, basically a bunch of blacklists that the Trump administration tried to roll out. Now, it's not really clear what do those blacklists mean, and how exactly is the Biden administration going to interpret them? But certainly, the intent was there to make it a little bit harder or to at least make Western suppliers think twice about working with Chinese companies.
Michael Bruno: So here we are sitting on the precipice of a bifurcated system maybe, Alex, between the US and China. And then there's the idea that Europe and the Airbus maybe could be taking a different approach from the United States compared with China. So it just seems there's a lot going on there and a lot to think about what the mix is going to be like for the next decade.
Alex Krutz: Yeah. There's really kind of three things going on, and I think you'd probably agree also Russia and its play in there in the C929 is probably a small piece, but probably almost irrelevant. So I would start there. And I definitely don't see that COMAC would split their focus away from the single aisle to go develop a wide body, which is a whole different set of economics and technology, right?
Alex Krutz: So then it really gets to your question, right? It's really about the US and Europe. And from a broad perspective, and I'm no economist, but I would say that probably the US, whether it was Trump or even this administration, probably takes a little bit harder of a line from that military end-user, the MEU, kind of position. So I think that it'll be used or leveraged in what's needed for the discussions at those very kind of global or country-to-country standpoint.
Alex Krutz: But I think that there's probably going to be a little bit less, from what it appears, on the European side, maybe because their MEU type restrictions are a little bit less and they're maybe a bit less concerned about that. So I think that, probably naturally, there's going to be a bit closer of a connection between the European side and China and maybe just a little bit more of a spread with the United States, regardless of the administration, just because of kind of the MEU nature.
Michael Bruno: So whether the systems become bifurcated and we have competing ecosystems or whether there's a way to stay united but protect everybody's interests, that all kind of remains to be seen. But there's a lot for the supplier base to be thinking about. So, Alex, what do, as suppliers, need to be thinking about now in regards to Chinese work?
Alex Krutz: So I would say that there's probably about four things that I would kind of mention here. I think number one is, and we talked a little bit earlier about being cautious about minimal ship-set orders, right? So now they're locking in the design that they did in November. They're going to try to deliver their first plane. So within the next year to two, they're going to start some small-level production, right? So the COMAC team is going to have to buy hardware, ship that hardware in some larger volumes. It may not be much, but it's more than the development amounts that they've done up until today.
Alex Krutz: So I think US suppliers should be cautious that if they're getting those orders, they should be looking at it from trying to leverage that conversation with slightly higher volumes. So that way, they can get some returns on their invested energies that they've probably done over the years.
Alex Krutz: I would say number two is investment in R&D and innovation, right? So that's back to that 100 years versus quarter century. This is definitely not the time over these next couple of years, putting COVID and the challenges aside [to ease off R&D]. But just generally as an industry, we should really be focused on R&D and how we can continue to develop really competitive systems for next-generation aircraft. And probably the last two items I would say is focusing on factory of the future. It's a little bit more of an Air Force concept from Dr. Roper's previous administration and service.
Michael Bruno: Will Roper, the former Air Force-
Alex Krutz: Yeah, Will.
Michael Bruno: ... Acquisition Chief.
Alex Krutz: But the principle of what he said really resonates at least for me as a manufacturer and supply-chain guy, is how can the supply base really make modular and future-focused factories, right, that can be more nimble, could introduce products more quickly? You don't have to really rely on very large run volumes. So a little bit more nimble and cost effective at the lower volumes.
Alex Krutz: And that's probably the last point, right, is the US supply base needs to... Not only from the COVID impact of having lower volumes on the narrow bodies for the coming years, but if the COMAC C919 does enter the market in the years to come, that's obviously going to take a piece of that segment away that you had talked about earlier with the Chinese market. That if the domestic Chinese supply chain does develop, that's a small piece that will start to go away. And that ultimately shrinks the share potentially of Boeing and Airbus, so US suppliers will be ultimately affected by that. So lower volumes, we need to understand that and be prepared for that. And again, back to how we become nimble with focused factories and some of those improvements with R&D that we talked about.
Michael Bruno: Well, thank you. That is terrific. And unfortunately, we're out of time. We're going to have to wrap up this edition of Check 6. I want to thank you, Alex Krutz of Patriot Industrial Partners, for this stimulating talk about China and the future of aerospace work there. Hey, Alex, if people want to follow up with you, how do they find you?
Alex Krutz: Yeah. So you can find me on LinkedIn at Alex Krutz or at my email, [email protected].
Michael Bruno: Excellent. Well, thank you again. And thank you, listeners, for joining us. Please join us at Aviation Week again soon for another edition of Check 6, which is available for download on iTunes, Google Play, Spotify, and Stitcher. Have a great rest of your day. All right.
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