Value of Flexibility in Aircraft Engine Maintenance Contracts
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htyn-kyaw14-sm-sdm-2026-thesis.pdf
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2.88 MB
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Adobe PDF
Checksum (MD5)
b659b70b974c2e0f1618b1949b55f384
Author(s)
Htyn, Kyaw Kyaw
Advisor(s)
de Neufville, Richard
Date Issued
February 2026
Publisher
Massachusetts Institute of Technology
Abstract
Airlines face many financial risks when acquiring high-value assets such as aircraft engines. Inevitable fluctuations in market demand, changing operational needs, and uncertainty about long-term reliability of new engines make the future costs of engine maintenance very uncertain. To manage these risks, airlines often contract with the Original Equipment Manufacturer (OEM) for maintenance at specified rates, particularly for newly marketed engines. Specifically, the OEM provides long-term Maintenance Cost Per Hour (MPCH) contracts. In effect, the OEM acts like an insurer: it assumes a range of risks and reduces the risk of buying its engines to airlines.
This thesis addresses the question of how to value the flexibilities associated with long-term maintenance contracts. To manage longer-term risks, these contracts often include various contractual flexibilities, such as options to exit the contract or extend its term. The questions are: what is the value of these options? How should we value them?
Airlines reasonably want to understand the value of these options, to help decide whether to extend their OEM contracts, or to self-insure and cover the risk themselves. Several analysts have proposed valuing these contractual options using traditional financial analyses. Their proposals are misguided and the contractual reality does not fit the assumptions of financial options analysis. The outcomes are path-dependent, the options do not exist in any market, and arbitrage-enforced pricing therefore cannot define a correct price. The value of the contractual options depends upon their probabilistic effect on the owners. As such, there is a need to estimate this value by detailed simulation of the economic effects.
This thesis evaluates the value of the contractual options by using “Engineering Real Options.” This approach embeds the options in a discounted cash flow model of their effect on the airlines over time and the range of possibilities. The thesis uses a hypothetical case study to demonstrate the process. It incorporates uncertainties in the Net Present Value (NPV) model and uses a Monte Carlo simulation to generate thousands of scenarios. Subsequently, it generates a distribution of possible outcomes and indicates how airlines would react rationally to benefit from the actual choices available.
The results demonstrate that incorporating real options in aircraft engine maintenance contracts can significantly enhance an airline’s ability to manage uncertainty and optimize long-term value. The options to transition from an OEM-managed MCPH contract to an external Time & Material (T&M) contract seem to yield the highest value, followed by the option to adjust the initial MCPH term. Conversely, the option to extend the decision window provides limited value, as engine reliability becomes sufficiently understood within the initial contract period. The analysis revealed that while flexibility may not increase expected NPV, it reshapes the distribution of outcomes by mitigating downside risks and preserving upside opportunities. This outcome is particularly valuable for risk-averse operators.
The study demonstrates the value of flexibility in contracting. By adopting engineering real options framework, users can better quantify the cost-benefit tradeoffs, optimize contract structures, and improve long-term decisions under uncertainty. This thesis illustrates a practical methodology to evaluate flexibility in engine maintenance contracts relevant to airlines, OEM, external MRO companies and financial stakeholders.
MIT Department
System Design and Management Program.
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