NEW YORK: Confronting a post-recession “new normal” environment likely to be characterized by prolonged anemic demand, shrinking defense budgets and resulting brutal competition for market shares, companies in the aerospace and defense industry need to move quicker and more decisively to master disciplined program management, supply-chain optimization, “lean engineering” and overhead cost control. That’s according to a study released today by AlixPartners LLP, the global business-advisory firm.
The AlixPartners 2010 Global Aerospace & Defense Review finds that although original equipment manufacturers (OEMs) and suppliers globally performed surprisingly well in 2009, posting overall industry growth of 2%, companies (and their investors) should not expect the same conditions to continue. The study, in fact, highlights several major headwinds, including:
- Aircraft deliveries down globally, while aircraft orders, which dropped 70% in 2009, have only partially recovered.
- The European debt crisis and a sluggish U.S. economy hampering both passenger and cargo demand.
- All signs pointing to big defense-spending cuts ahead, as both the Pentagon and defense ministries around the world face the fallout from the recent financial crises and sputtering local economies.
- Continued weak business-jet demand, due to still-fragile corporate profits and a “politically incorrect” image forged during the auto-bailout hearings of 2009.
- Ongoing operational issues, such as the continued inability of OEMs to effectively manage integration with Tier 1 and Tier 2 suppliers, the failure of OEMs and suppliers alike to master lean engineering, and the inability of all parties to perfect efficient, effective program management.
“The aerospace and defense industry is facing a turbulent ride going forward,” said Phil Toy, a managing director of AlixPartners and co-leader of the firm’s global Aerospace & Defense Practice. “The commercial sector faces a global economy that’s uncertain at best. Business jets face an even tougher environment, while also still trying to shake the ‘politically incorrect’ stigma of a year ago. On the military side, the Pentagon is actively looking to trim costs at every turn, given that the interest payments on the national debt alone are on track to equal last year’s defense budget. And meanwhile, the ongoing debt crisis in Europe is yet another overhang likely to keep a lid on aviation demand, while also making credit more costly for airlines and business jet buyers.
“The industry made it through 2009 remarkably well compared to most other industries,” he continued, “because the major players reacted quickly to cut production capacity. Also, of course, U.S. defense spending continued to be strong in 2009 and so far in 2010, largely due to supplemental spending authorizations for the wars in Iraq and Afghanistan. However, because of the financial crisis and our lingering fragile economy, pressures on defense budgets will be intense going forward, which should prompt primes and non-primes alike to move now to optimize their cost structures. Overall, given the uncertain demand outlook in most sectors, the A&D industry needs to perfect the operational processes and business models it’s taken on in recent years and really make them work. Right now, that’s not the case, and as a result, the industry has a large number of structural inefficiencies that other industries have already mastered.”
Kinks in their global supply chains are one of the biggest issues pressuring aircraft manufacturers, according to the study. It notes that delays in high-profile aircraft programs, such as the Boeing 787, the Airbus A380 and A400M, and the Lockheed Martin F-35, have caused operational and financial pain for suppliers who, in turn, have pressed for financial compensation for delays outside of their control – stipulations increasingly built into supplier contracts of late.
The study also finds that the MRO (maintenance, repair and overhaul) sector of the industry continues to struggle. In addition to reducing variable costs as volumes have declined, MROs will need to shed 16 to 22 cents in fixed, structural costs for every dollar of revenue lost in order to restore margins to earlier levels. Excess capacity in North America will continue to be a problem, it says, especially as airlines expand the use of low-cost MRO shops in emerging markets.
Meanwhile, MRO demand in China, India and the Middle East is predicted to grow 7% to 10% per year over the next decade, reflecting expected growth in the aviation demand in those markets. The study finds that North American and Western European MRO providers can erase much of their cost disadvantage through aggressive performance improvement efforts. Nonetheless, the weak outlook for independent MRO operators in developed markets will accelerate industry consolidation and M&A, says the study.
“Both strategic and private-equity owners would be well advised to remember that when it comes to M&A in this industry, the ‘M’ is a lot more important than the ‘A’,” said Dave Fitzpatrick, a managing director in AlixPartners’ Aerospace & Defense Practice. “The industry is entering a period where budget limitations and cost management are the name of the game, including what you might call a ‘new’ New World Order defense budget in the United States, one whose size is a long, long way removed from Cold War-era budgets. Companies in the defense and commercial sectors that adopt new strategies to meet these new challenges will be the winners over the long haul.”
On the program-management front, AlixPartners finds that true design-to-cost practices are still rare in the aerospace industry and that the number of RC overruns is as high as NRC overruns today.
In engineering, AlixPartners says that many aerospace and defense companies today are spending up to 200 engineering hours per part, compared with about 21 to 28 hours for many companies in the auto industry, an industry also building highly complex products. It also finds that while many companies have partially adopted the principles of lean engineering, there is much “slippage” when those principles are actually put into action in programs, leading to far too many engineering and production changes.
Regarding supplier management, the study asserts that, as suppliers assume more responsibilities in new programs, a paradigm shift is needed in the OEM-supplier business model – where, among other things, program engineering and design-to-cost exercises are conducted collaboratively and early in the design process. Proactive supplier management is especially critical, it notes, when OEMs expand their supply bases to include suppliers in emerging markets.
“OEMs have typically conducted new program development through a sequential process, where suppliers aren’t brought in until near the end of the conceptual design phase,” said Toy. “But given the pressures in today’s environment, these cycle times need to be cut by 40% or more. That means OEMs need to truly master integrated product development and mutually-beneficial collaboration approaches, while suppliers need to be open to cost- and innovation-sharing in exchange for bigger pieces of new programs and earlier involvement. In the process, everybody should be working toward the overarching goal of being competitive in what looks like a dramatically changed world ahead.”
AlixPartners is a global business-advisory firm offering services across four main disciplines: enterprise improvement, turnaround and restructuring, financial-advisory services and information-management services.
