Kurt Baes, Willem Romanus, Mattias Banck of
Arthur D. Little
The
aerospace and defense (A&D) industry today struggles with a duality:
defense-driven segments take hits due to significant governmental budget cuts, while
commercial aircraft manufacturing is enjoying double-digit growth. Commercial
aircraft deliveries at Airbus and Boeing grew by a CAGR of 7.5% between 2010
and 2015, with both companies registering record annual deliveries in recent
years. Nevertheless, the commercial aircraft value chain is under stress: only
half of the manufacturing firms in the chain show healthy profitability growth,
and European players especially have struggled to enhance shareholder value.
Which strategies should players take to surf the growth wave?
Commercial aircraft manufacturing: steady
and strong growth, sizeable order backlog
Air
traffic growth and the replacement of ageing fuel-inefficient aircrafts are
driving the global commercial aircraft market. The two major OEMs, Airbus and
Boeing, estimate an industry CAGR of around 5%, requiring 30,000-35,000 new
passenger aircraft and freighters at a value of US$ 4.4-4.8 trillion in the
period 2013-2032. As of the end of 2015, order backlogs were at record highs
with Boeing at 5,795 and Airbus at over 6,700, representing a combined backlog
of 8-10 years’ production.
Strong top line growth, disappointing
returns
Despite
the promising revenue growth, not all aircraft manufacturing companies are able
to sustain or grow their EBIT margin in pace with top line growth. During
2008-2012, for example, almost half of the companies suffered from
profitability erosion during their growth (see figure).
The
European manufacturers have struggled the most. The 2009 downturn was triggered
by the high volatility of key business factors such as oil prices, economic
recession, exchange rates and financing terms, affecting airlines and thus
client orders. Due to the economic climate and hedge rate deterioration,
European EBIT margins remained low in 2010, and only started recovering
steadily from 2011 onwards. Although the 2008-12 EBIT margins indicated a
recovery, in reality the 2012 coefficients of variation in Europe (92%) and US
(63%) nonetheless indicated high levels of variability, resulting in two types
of players: “industry winners” and “struggling suppliers”.
Risk-margin imbalance drives supplier
base rationalization
Segmentation
of the supply landscape into tiers reveals that EBIT margins tend to increase
when moving upstream (see figure below). This situation creates tension: OEMs
and first tier suppliers bear higher risks, but don’t reap the higher returns.
Since such an imbalance is not sustainable, and OEMs and first tier players
want to change the game.
Aircraft
manufacturers face increasing supply chain complexity, must provide new,
cutting edge offerings in a highly competitive context, and face severe cost
pressure, not least due to the rise of the low cost model, increasing industry
consolidation and the concentration of buyer power that this entails. To regain
acceptable margins, they actively take measures by refocusing on their core
competencies: aircraft design, final integration and marketing & sales.
Consequently, first tier suppliers are pushed to expand their offering, into
integrated solutions. Also, OEMs actively reduce their number of suppliers; as
setting up these partnerships is time intensive and comes at high cost it is
only done very selectively.
In
response, tier 1 suppliers adopt similar strategies, and a ripple effect
translates throughout the entire value chain of tier 2, 3 and 4 suppliers. The
ingredients of change are similar, and create a new context for each type of
player.
Characteristics
of this new playing field require players to:
§ Have the ability to provide
integrated (sub)systems or solutions
§ Take risks by sharing product
/ solution development costs together with the client
§ Invest more time into managing
client relationships, and building tailored value propositions per client
§ Provide global solutions,
leveraging a global footprint in terms of supply and manufacturing as needed
§ Structurally and fiercely
reduce cost
Combining
all of the above is difficult. Yet, the supply base reduction wave leaves
little choice, and has led many players to make price concessions, negatively
impacting overall profitability. Yet, winning companies manage to capture
growth while enhancing their profit margins.
Supplier of the future: a dual challenge
Two
key strategic dimensions are crucial for any future supplier in order to stay
competitive:
1. Ability to deliver greater
volumes efficiently: Manufacturers should be able to sustainably respond to
growing orders / increasing production rates
2. Ability to adapt to a more
complex offering: Manufacturers should be able to handle increased
sophistication and integration
“Suppliers
that do not agree to cut their prices will find themselves on the outside” – Jim
McNerney (CEO Boeing)
Both
major OEMs are actively taking measures to tackle the unnatural risk/margin
balance in an attempt to reach double digit profitability levels. In this
context, they are cutting costs, increasing production levels and exploring
service revenue streams. Furthermore, OEMs are continuously squeezing their
suppliers to reduce contract prices. For example, Boeing’s “Partnering for
Success” initiative aims at reducing its suppliers’ prices and has already been
applied for determining the supplier base of the 737 MAX program. As stated by
Boeing’s CEO Jim McNerney, suppliers will have to cut prices or will find
themselves on the “no-fly” list, excluded from future programs.
Source:
Aviationweek, Seattle Times
The
first challenge relates to “lean”: putting in place leading edge operations
that are capable of reaching maximum efficiency with minimum investment. Doing
“more of the same” at a rock-bottom cost position directly addresses one of the
key concerns of the OEMs and tier 1 suppliers: being able to follow the high
growth pace of the industry, despite the stressed-out supply chain, while
maintaining a low cost position to remain competitive.
The
second challenge relates to diversification into other airplane
parts/components. As the supply base is being reduced, players need to
gradually expand their offering, both in depth (e.g. into systems and solutions,
into assemblies and sub-assemblies) and breadth (e.g. wider product range,
broadening of the materials on offer). This diversification is costly: it
typically comes with new services such as design and development of new parts
or modules, as well as creation of new capabilities related to these new
products offered by the firm. Keeping down the cost of this additional
complexity is difficult, with many firms failing or suffering flatter than
expected learning curves. In turn, this negatively affects the margin.
In
order to become/remain a supplier of the future, it is essential to address
both challenges. Easier said than done: the high number of companies not being
able to translate revenue growth into EBIT growth proves the difficulty of this
transformation, triggering the next question: how to successfully enable the
transformation?
How to make the transformation?
Most
commercial aircraft component / system manufacturers need to undergo a one- or
two-step transformation (see Figure below). This transformation addresses both
challenges mentioned earlier, which in practice implies demanding requirements
in terms of process and product/service capabilities. Addressing these
requirements is essential to make the transformation happen.
On
the vertical axis, the ability to deliver greater volumes efficiently can be
achieved through optimizing, mastering or re-thinking the core company direct
and support processes. Therefore, the following process-related demands will
need to be addressed:
§ Deployment of a competitive
infrastructure (asset base), able to meet current and future demand
§ Implementation of a “LEAN and
flow-oriented” philosophy throughout the whole organization
§ Continuous development and
effective maintenance of required production capabilities
§ Sustained advantage in the trend
towards “modularization”, i.e. more automation, integration and standardization
§ Relentless focus on cost
leadership
§ Development of a global
presence/company span
On
the horizontal axis, the ability to adapt to a more complex offering can be
achieved through constantly optimizing, reinventing and balancing the
product/service offering and product mix. In order to do so, a number of key
levers deserve top management attention. These include:
§ Process excellence for
engineering and R&D. This includes the incorporation of a “flexible and
agile” mindset throughout all direct and support functions
§ Continuous capability
development
§ Pro-active search for new
growth opportunities (e.g. active pipeline management of leads, new
applications, new offerings, …)
§ Development of strategic
product platforms to focus commercial and innovation efforts on what a company
is good at and wants to be known for (its core specific materials, technology
or applications, depending on the type of player)
§ Sustained focus on technology
leadership in development, related manufacturing etc.
§ Value adding
partnerships/collaborations
While
Jobbers and Innovators need to transform along a single axis, Strugglers face
the challenge of going through a two-step transformation. With the ambitious
timelines the OEMs have set to rationalize their supply base, the timeframe is
short and triggers a risk for the Strugglers to get paralyzed by an overload of
too many simultaneous changes. Therefore it is critical for these struggling
companies to focus on the right priorities and plan their transformation step
by step. Eventually, Strugglers too can gain real competitive advantage and
become Sustainable leaders.
Safran
– The road to becoming a Sustainable Leader
Since
2010, Safran is observably developing itself as a Sustainable Leader. By
focusing on both strategic challenges, Safran succeeded in positioning itself
as a key industry player and enhancing both its top- and bottom line
performance. For example, between 2011 and 2014, Safran’s aircraft equipment
division registered a margin growth CAGR of 22%, relative to a revenue CAGR of
13% (source: company annual reports).
As
stated by Jean-Paul Herteman (CEO), Safran has put considerable effort in
unifying the group and striving for cost leadership (e.g. the consolidation of
support functions). Furthermore, joint ventures/collaborations were being set
up and targeted start-ups/companies were being acquired to ensure Safran’s
position on the product/service innovation frontier (e.g. electrical taxiing
system, in collaboration with Honeywell).
Conclusion: no choice but transformation
Against
a backdrop of high volatility affecting many industries, commercial aircraft
manufacturing seems to be enjoying important growth in the short term. However,
not without a key challenge: finding out how to translate revenue growth into
EBIT growth, while facing increasing competitive pressures that are driven by
supplier base rationalization and overall cost reduction. With almost half of
the commercial aircraft-manufacturing suppliers having struggled to capture
revenue growth profitably in recent years, the hurdles to overcome are
significant.
This
Viewpoint highlights a dual challenge: a supplier of the future will not only
be able to handle greater volumes efficiently, but will also need to provide a
more complex offering. In order to successfully respond on these challenges,
industry players need to address corresponding process- and product/service-related
demands, implying a one or two-step transformation.
Especially
for the latter, an important risk of “change paralysis” should be managed. The
ability of the organization to absorb the change can be a real growth-blocker.
Prioritization and effective planning are essential to guarantee success.
In
conclusion, the industry outlook may be bright, the challenges painfully real,
but one thing is sure: suppliers in this industry have no choice… but
transformation.
Arthur D. Little: a key partner
As
the world’s first consultancy, Arthur D. Little has been at the forefront of
innovation for more than 125 years. We are acknowledged as a thought leader in
linking strategy, technology and innovation.
Arthur
D. Little has performed significant transformation programs with a number of
key players in the industry in order to secure growth and boost profitability.
Key areas on which we have helped our clients in the commercial aircraft
industry to transform include:
§ Operations strategy and
operational excellence: defining industrial vision, defining and selecting
optimal operations models, improving productivity and on-time delivery,
reducing working capital and cost levels
§ Sourcing and supply chain:
assessing and improving purchasing value excellence, adapting organizational
setups and processes in order to manage increased complexity and higher stress
levels in the supply chain
§ Process and organizational
design: defining lean organizations, optimizing headcount (short/long term),
redesigning processes, cultural change
§ Technology and innovation
management: defining innovation strategies and processes, developing product
and technology strategy maps to support innovate for growth &
competitiveness programs, build innovation capabilities
§ Global transformation: turning
local or regional companies into true global players, by setting out future
blueprints in terms of industrial structure, organization setup, and key
enablers
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