The following is excerpted from the 21st annual Teal Group Business Jet Overview, which offers a look at the market and where it’s going. Constant 2011 dollars are used for comparison purposes.

Looking Up From the Market Trough
After suffering from apocalyptic numbers in 2008 and 2009, the business jet market spent 2010 and 2011 (so far) convalescing, but with few signs of a complete recovery. Key economic health indicators are sending mixed messages, and the fundamental market trend signs remain depressed. However, there are hopeful prospects for a deliveries recovery in 2012.

Meanwhile, as a result of this downturn, the industry is experiencing a transformation in terms of how the market is structured. We’re moving toward an industry that favors larger planes.

Signs of Life
After growing at a record 17.6% compound growth rate between 2003 and 2008, business jet deliveries fell at an even faster rate. Output dropped by 22.7% in 2009, with another 6.8% drop in 2010. This year looks set to be flat with 2010.

This market drop is hardly surprising given the unpleasant trauma the world economy suffered in 2008/2009. In fact, 2009 was the first year since World War Two that the world saw no economic growth. In fact, the world economy shrank by just over -1%. U.S. corporate profits fell at a precipitous rate. From an annualized peak of $1.653 trillion in the third quarter of 2006 profits fell to $995 billion in the fourth quarter of 2008, with not much of a recovery in the first half of 2009. Typically, deliveries of new jets begin to fall about 12-24 months after profits fall. This market bust cycle fit the normal historical pattern.

Used aircraft pricing is down across the board, but one positive development concerns the part of the fleet that’s on the market. Used aircraft availability peaked at record levels, with 16.3% of the fleet (well over 2,000 jets) up for sale by May 2009. The second half of 2009 saw steady improvement in this key metric, and while 2010 saw that progress stall out, we’ve seen better numbers this year. As of March 2011, we’re at a 13.5% availability level.

Typically, when 13% of the fleet is on the market that’s been a clear sign of a serious market downturn. The current level is unprecedented and indicates a severe oversupply problem. However, one possible explanation of this high number is that companies and individuals are putting their aircraft up for sale as a demonstration of frugality, either to politicians or to stockholders, but with no actual intent to sell the plane. That’s the only possible silver lining in a dark (but improving) quantitative cloud.

Other indicators of market health also experienced terrible declines, although they too are starting to improve. Business jet utilization in the U.S., as measured by cycles (takeoffs and landings), fell by double-digit rates for ten consecutive months. February and March 2009 cycles were down by a disastrous 30% relative to one year ago, although by May 2009 this number had recovered slightly to a 26.7% drop. Numbers in 2010 saw respectable 10% to 20% increases relative to one year ago.

A Good-News Indicator, With Caveats
Corporate profits are the most accurate leading indicator for business jet demand. As noted above, these took a beating in 2008 and 2009, but they’ve come roaring back. However, there are several important caveats that introduce an element of caution to any forecast for a jet delivery uptick based on this indicator.

First, the good news. Corporate profits have not only recovered to pre-crisis levels; they are setting new records. According to the U.S. Bureau of Economic Analysis (BEA), 2010 numbers show profits of over $1.6 trillion. And these profits look particularly good as a percentage of GDP. Profits hit 11.25% of GDP in the second quarter of 2010, the highest percentage of profits for the economy since the fourth quarter of 2006.

Since aircraft delivery rate changes typically trail corporate profits changes by 12-24 months, the good news is that in theory, we might see a production increase as early as mid-2011. The bad news is that this time, there are serious complications to this rosy corporate profits outlook.

The first complication is that these corporate profits do not resemble the broader economy. Unemployment is still quite high. The economies of the developed world — especially the U.S. and Europe — are only growing at an anemic pace. The IMF is projecting Eurozone growth this year of around 1%. In the U.S., GDP growth in the first quarter of 2011 fell to a mere 1.8% at an annualized pace.

But most of all, key equities markets have not recovered in line with corporate profits. Like corporate profits, the Dow Jones Industrial Average (DJIA) can be used as a leading indicator of business jet deliveries. And, the DJIA has much in common with the most important indicator of business jet market health: used jet availability numbers. The DJIA, like the broader economy, closely resembles an old-fashioned square root sign. There was a sharp up front drop, followed by a recovery, creating a mini-V. But this V then turned right, creating a flat line plateau. Both the DJIA and those used jet availability numbers took a turn for the worse, made a rapid partial recovery, and are now making slow progress toward a full recovery.

As for corporate profits, while their recovery has vastly outpaced the DJIA recovery, that might not be an indicator of the economy’s sustainable health. Instead, companies are making money because they have slashed costs. This means mass layoffs and countless plant closings. The modest increase in consumer and business demand over the past year has benefited increasingly lean and very productive companies.

Meanwhile, the corporations generating these profits are reluctant to spend on anything. Like those equity analysts, they have turned quite pessimistic, and are clearly concerned about a double dip recession, prolonged sluggish growth or anything that would threaten their ability to access lines of credit. Unable to voice concern about a double dip (no CEO wants to help cause a downturn), they are blaming the Obama Administration (rightly or wrongly) for being anti-business (all the while generating record profits). Investment in business jets is an extremely low priority.

In conclusion, corporate profits are something of an anomaly, given the broader economic uncertainties. Given this disconnect between profits and all the other economic indicators, Teal Group believes there are ample reasons to be conservative and forecast a flat 2011, with no deliveries uptick until 2012. There is a chance that corporate profits will prove to be paramount. But it’s more likely that the economy needs another 6-12 months to recover, and that businesses need another year to feel confident enough before making major investments, such as business aircraft. This is a three-year downturn.

The economic indicators discussed above, of course, are all U.S.-based. Yet this is now a global industry, with deliveries outside the U.S. now constituting well over half the market (compared with over 70% in the U.S. just ten years ago). This change is having a profound influence on the character of the market in terms of segment growth (and shrinkage) trends.

Unprecedented Bifurcation
Historically, the business jet market could be split in half by value. The top half consists of jets costing $25 million and more (in 2011 dollars). The bottom half consists of jets costing less than $25 million.

Historically, these two halves rose and fell in tandem, more or less. Over the past 20 years, in aggregate, both halves stayed roughly equal in size. Yet this market downturn has seen a major change in the relationship between these two segments.

Deliveries in the bottom half of the market declined between 2008 and 2010 by a remarkable -57.1% by value. This represents the worst decline of any aerospace market in the present downturn. It was much worse than the decline suffered by the majority of world economic markets. Yet deliveries in the top half of the business jet market actually grew slightly, by 1.5% by value. In fact, Dassault, the one company that plays exclusively in the top half of the jet market, was the only manufacturer to increase output in 2009 relative to 2008.

The most obvious explanation for this bifurcation lies with the greater economic sensitivity of the customers involved. The bottom half of the market is generally more dependent on small- and mid-sized businesses that are more sensitive to an economic downturn. The bottom half also depends more heavily on mature markets, such as North America and Europe. The faster growth economies in Asia and the Mideast have held up better, and customers there have a preference for higher-end products. Also, high-end jets have generally better exposure to the government market, which tends to be much less cyclical.

Since bottom half jets depend on a customer base that’s more economically sensitive and North American/ European, it’s also safe to say that they depend more heavily on third-party finance. These bottom half market customers are much less likely to pay for jets with cash and are also less likely to have access to robust credit lines. They are also less likely to be based in emerging markets with relatively strong government-backed financial institutions. The credit collapse is the biggest difference between this downturn and previous downturns, and therefore is the best explanation for the unique bifurcation the market is seeing today.

Clearly, big jets are now the big market driver. This is ironic, given the tremendous hopes accorded to the many very light jet developments proposed or delivered over the last decade. The big question, of course, is how permanent is this situation? After all, if both the top and bottom halves (or, what used to be halves) recover and then grow at the same rate, the market will look very different.

Nearly three years into this downturn, it’s clear that the market continues to favor top end aircraft. Pricing in this segment has generally held up better than in the lower and middle segments. Anecdotal information points consistently to a generally healthier sales outlook for the top half jets. High-end jet utilization (defined by the FAAas long-range jets) held up better in 2009 than for smaller jets, falling by just -15%, compared with -19% and -20% for short- and medium-range jets, respectively. Used aircraft availability numbers reflect this too. By August 2010, just 10.2% of heavy jets were up for sale, compared with 14.5% for medium jets and 16.7% for light ones.

The business jet market will recover to its 2008 high point. This will be a slow process, and it won’t begin until 2012. But the most notable lasting legacy of this downturn will be a structural shift towards the high end of the market. What was once the top half of the market by value will from now on be the top 60% to 65%.

If the bottom half of the market has shrunk in relative terms (and for five to ten years or so in absolute terms), then there’s less work for everyone, a recipe for structural overcapacity that would impair profits. After all, five (or more) players in a shrunken space is a recipe for price competition.

This raises another question. The bottom half of the business jet market might no longer offer the volume and profitability needed to support the current industry structure. We could see mergers, divestitures or any other changes needed to bring capacity in line with demand. If the market does not begin to recover in the next year or two, it’s also quite likely that the industry sees a few product line retirements.

Then again, as the horrible market health numbers we saw in last quarter of 2008 and the first half of 2009 continue to stabilize, the bottom half of the business jet industry can also consider itself lucky. It avoided serious financial carnage. All the players were traumatized, but remain intact.

Have Attitudes Changed?
The usual business jet market health indicators and delivery outlook numbers indicate that we’re still in a downturn, but these are temporary problems. Only two possible events threaten the future of the business aircraft market: an end to world economic growth, or an end to the link between that growth and business jet utilization. The first is a very remote risk. There may be a risk of a double dip recession, but no serious forecaster is suggesting that the world has reached the limits of growth.

The second is a somewhat overstated risk. It’s clear that the business jet industry is facing cultural headwinds. Key politicians in both U.S. political parties have criticized business jet users, and there have been some high-profile events that have cast a pall over business jet ownership. The CEOs of Chrysler, Ford and General Motors came under heavy criticism for taking private planes to Washington to plead for aid money. GM promptly terminated leases on seven Gulfstream jets.

Similarly, Citigroup, the recipient of billions in U.S. government funding during the financial crisis, was pressured to cancel its order for a Dassault Falcon 7X. “The notion of Citigroup spending $50 million on a new corporate jet, even as it is depending on billions of taxpayer dollars to survive, does not fly,” Senator Carl Levin (D-MI) said on his website. Citigroup also put two older Falcon 2000EXs on the market, although this might be an example of jets that are put on the market but with no actual intent to sell.

Not long after, both Cessna and Hawker Beechcraft began advertising campaigns intended to defend the image of corporate aviation. Cessna president Jack Pelton pointed to the pressure on executives to avoid private aviation, saying, “That stigma is a factor we’ve never experienced in the past.”

Yet it isn’t really clear that the market hasn’t seen this cultural antipathy before. History is replete with anti-business jet pronouncements during recessionary times. In 1987, the movie Wall Street was popularly viewed as putting bankers and their private jets to shame. In the last downturn, one newspaper article commented that, “sales of business jets, once the ultimate status symbols, have cooled with the U.S. economy… The sleek stratospheric board rooms have come to represent corporate greed for some, and for others are simply no longer affordable.” (USAToday, Feb. 11, 2003). That was a few months before the fastest growth spurt in the history of the business jet market.

It’s also noteworthy that in March 2010, Ford took three of its five business jets off the market. That’s notable for two reasons. One is that no politicians or pundits paid attention to this development, and the company seems to think that business jets are useful tools for a global corporation. The second is that they claimed they couldn’t find buyers, which is nonsense. You can always find buyers; it’s just a question of the price. This strongly suggests that Ford put their jets on the market to look good to the public, but they asked unrealistic prices. They knew the outcome, and they still have their jets.

Why the Future Still Looks Bright
Although business jet ownership and utilization has been equated by many with excess and abuse, the extraordinary transformation of the business aircraft market over the past 14 years has been closely linked with corporate profits. The composition of these profits indicates encouraging trends too.

It is impossible to state empirically that one type of profit is more conducive to business jet demand than any other. But it’s notable that manufacturing profits have made the strongest leap of all the business sectors. U.S. manufacturing profits leaped from $53 billion in 2001 and $48 billion in 2002 to $317 billion in 2007 and $240 billion in 2008. The strength of the U.S. economy in 2003-2008 had almost as much to do with manufacturing as it did with financial services. Profits in that segment were stronger but flatter, going from $228 billion in 2001 and $276 billion in 2002 to $450 in 2007 and $309 billion in 2008.

There’s a very strong likelihood that U.S. and other developed country manufacturers are prospering because they are transforming themselves into product integrators. That means they are farming out labor-intensive production to work in developing countries, keeping higher value integration, development and marketing for themselves. The establishment of new facilities in less developed areas increases the attraction of private aviation. And of course the profits that result from a successful new manufacturing strategy is also good for business jet demand.

This hypothesis is boosted by business jet demand in Europe. Just as U.S. companies are likely to transplant production to Latin America, European manufacturers are looking to new European Union Entrants in Eastern Europe, as well as Turkey, for lower-cost manufacturing. These Eastern European countries lack the excellent public infrastructure — airlines and trains — that have traditionally hobbled business aircraft demand in Western Europe. Companies setting up shop in Eastern Europe are increasingly looking toward private aviation. In 2001, only 10.7% of the global business jet population was domiciled in Europe. In 2010, Europe’s share of the world fleet was 16.3%.

Meanwhile, economic development in emerging markets is gradually boosting business jet demand from customers in many of those countries too. Relatively high commodity prices are further increasing demand, particularly in Latin America and the Middle East. Markets outside of the U.S. accounted for 23.5% of the fleet in 2001, rising to 34% in 2010. In 2008-2010, most business jet manufacturers reported a majority of sales from outside the U.S.

Asia remains largely quiet as a source of demand, for reasons of geography, politics and excellent airline service, but there are signs that this could change. Due to its economic growth, poor infrastructure and great geography, China could emerge as a huge market as its air space rules are liberalized. But as of 2010, the country has only about a few dozen business jets in civilian use.

If China opens its airspace, there would likely be profound consequences for demand in the rest of Asia. Many Asian manufacturers in higher-cost economies such as Singapore, Japan and Taiwan look to China as a source of lower cost manufacturing sites. Basically, Asian businesses located in high-cost manufacturing countries could emulate their U.S. and European equivalents, looking to private aviation as they follow an integrator model of manufacturing.

In short, despite today’s difficult market conditions and negative short-term jet deliveries outlook, there are solid reasons to assume that this market will recover. In fact, there could even be more solid growth drivers ahead if the world’s economies continue their trend toward globalization.

Richard Aboulafia is vice president, analysis with the Teal Group. He manages consulting projects in the commercial and military aircraft field and analyzes broader defense and aerospace trends. He advises aerospace companies and financial institutions on aerospace market conditions. Aboulafia writes and edits Teal Group’s World Military and Civil Aircraft Briefing, a forecasting tool covering over 135 aircraft programs and markets. He also writes publicly about aviation and defense. He has a regular column in AIAA’s Aerospace America. Before he joined Teal Group in 1990, Aboulafia analyzed the jet engine market at Jane’s Information Group, served as an aerospace industry consultant for an international trade advisory company and supported research projects at the Brookings Institution. He has a Master’s degree in War Studies from King’s College, University of London and a Bachelor’s degree from George Washington University. He can be reached at [email protected].