AFTER THE turbulence of the past few years, it would be reasonable to assume that the world aerospace industry is ready to sit back and enjoy the long-awaited recovery. The assumption could not be more wrong, however.
If anything, the pace of change has begun to accelerate as corporations in Europe, the USA and beyond manoeuvre to secure their position in a rapidly changing world.
The point is illustrated by even a brief glance across the rankings in this year's Aerospace Top 100 - a league table of the world's largest aerospace groups compiled by Flight International and Booz¥Allen & Hamilton, a leading international management and technology consultancy based in the UK.
The ranking shows that while some companies have indeed begun to make better profits on the back of recovering markets, the improvements are still suspiciously patchy given the upswing, and that, far from settling down, there has been no let-up in the stream of merger and acquisition activity.
The short answer is that the predictions of the past four years seem to have been proved correct. Although the industry's frenetic restructuring may have been prompted by recession, it was not simply a reaction to depressed markets, but the start of a more fundamental, and arguably overdue, re-ordering.
"The current level of consolidation is no longer to do with the drop in demand. We're well past the point where it was being driven by the recession," says Ian Godden, lead aerospace consultant with Booz¥Allen in Europe.
"We're now at a turning point," he adds, predicting that the dramatic shifts which have taken place so far across the industry are only the opening skirmishes in a broader restructuring of the world league and, arguably, in the way that the aerospace sector does business.
A SEARCH FOR SCALE
The most obvious lesson so far has been a redefinition of the scale needed to be a world-class player. For a decade or more, Boeing had stood head and shoulders above other major aerospace corporations with sales of around $20 billion a year. In 1995, with the consummation of the marriage between Lockheed and Martin Marietta, it was joined by a giant on a new scale.
Lockheed Martin grew again this year with its acquisition of the bulk of Loral. That puts the group on course for sales of around $27 billion. Boeing's own recent agreement to buy up Rockwell's aerospace interests will also bring it close to that mark, as well as giving further weight to a defence business which had begun to look undersized.
Other budding US giants could soon join them on the top tier as the consolidation rolls ahead. The point is illustrated by a rough calculation of how the league table is likely to look after the latest round of acquisitions are absorbed (see table below). That leaves groups such as Hughes Electronics, McDonnell Douglas and Northrop Grumman possibly only a merger away from the top of the ranking.
Godden argues that $20 billion is fast becoming the new sales benchmark for would-be leaders among the prime civil-aircraft builders and defence contractors. Only a few years ago it was $10 billion. That means that while some rise, others such as General Dynamics and now Rockwell will decide to quit the aerospace race, leaving perhaps only two or three major corporations in contention and perhaps a similar number in Europe.
He admits that, as consultants have been fond of pointing out over the years, size in itself is not necessarily a virtue. In a world of fewer programmes, however, and tighter budgets, it is difficult to ignore the potential gains of improved efficiency, better use of resources, shared research budgets and even greater security that scale can bring. Customers themselves appear to feel more comfortable dealing with giants rather than minnows.
EUROPE BEGINS TO ACT
So far, much of the running in the big league has been made by the USA, but Europe too is beginning to act. The proposed merger of Aerospatiale and Dassault would propel the new company toward the top of the rankings. It would be a remarkable change of policy for France not to forego the opportunity to take such a lead.
Some form of merger between British Aerospace and Daimler-Benz Aerospace could create a second European giant, although the politics are less certain. The position is likely to become clearer during the talks over establishing the Airbus Industrie consortium as an independent company. That in itself would create a group with sales of around $10 billion and growing fast. A similar merger of French, German and UK defence interests would build a military giant on an even larger scale.
As the prime contractors continue to grow, Godden believes that scale is also being redefined for the first tier of equipment suppliers. After its recent spate of acquisitions (and a few disposals of non-core units), AlliedSignal is already on course to top the $5 billion mark, and Godden argues that others will begin to follow.
Even among the smallest suppliers, there appears to be a drift upward in size. A couple of years ago the entry level to appear in the Top 100 ranking was not much more than $100 million. Today is twice that much.
Perhaps a third identifiable trend is for a new scale to apply among the regional and corporate aircraft producers of around $2 billion or more. The likes of Bombardier are already there, and the coming together of ATR and BAe's regional-aircraft businesses into the Aero International (Regional) consortium has added another sizeable player.
If this consolidation is no longer being driven by weak markets, then Godden argues that it is being spurred on by rising expectations from customers (whether airlines or governments), translating into an industry-wide drive for shorter lead times, lower costs and improved reliability.
"The pressure is being put on for those who remain in the industry to be much better performers in operational management," says Godden. "In aerospace, we're nowhere near a world-class performance yet," he argues, adding that in addressing issues such as supply chain management, aerospace is still "light years behind" other industries. The automotive market, which has already been through years of turbulent change, provides a good example.
Aerospace products, for example, still tend to be unique - from the cockpit through to the landing gear. By contrast, car makers, coming under extreme pressure to lower the cost of their product, have made a virtue out of using standard equipment. As a result, the automotive-equipment sector is rapidly consolidating around a handful of global players.
Godden estimates that the cost of using a myriad of unique products from different suppliers adds around 20% to the cost of a civil aircraft. It is a burden which he believes is already under attack as a new breed of aerospace management begins to take a fresh look at the way the sector does business.
"There is a journey that the industry has now embarked upon which will improve customer value to the point where the customer can actually afford to buy a lot more," he says.
Some signs of improving operational management are already beginning to show through in some, although not all, the 1995 corporate results listed in the Top 100 ranking.
A good scattering of companies have managed to increase operating margins. Perhaps more importantly, some are now beginning to show significant improvements in their return on capital employed (ROCE) - a measure of how profitably a company is using its assets. For shareholders, ROCE is a key test of whether their cash is wisely invested.
"Anything below 15% ROCE, and you are getting into dangerous territory where investors could argue that their cash was better used in other industries," says Godden. Above 20%, investors should start to take notice.
Some aerospace operations are now breaking through this 20% barrier, and the improvements are coming from across a range of different countries and industry sectors. Godden points to MDC and Sundstrand in the USA, Canada's CAE, Smiths Industries of the UK and France's Arianespace.
The only notable exceptions come from Germany and the Netherlands, where companies have been grappling to bring down their high cost levels - a task worsened by the free-fall of the US dollar, although that is now easing.
The optimism naturally comes with some caveats. Operating profits are quickly boosted if a company decides to ease back on investment and run a business for cash. Others may be dressing up operations ready for a sale. Yet some companies appear to be managing to raise their returns while continuing to maintain a steady spend on research and keep up with capital investment.
It will take another year or two before the true extent of the improvement begins to become clear, but Godden believes that if returns on capital can be maintained at 20% or above, then investment should soon begin to pour back into the aerospace industry.
Managements which have been intent on caretaking rather than expanding their aerospace businesses during the recession, may then look to invest in the sector. The flip side is that companies which still cannot make the sums add up may choose to quit.
As ever, the most difficult choices lie with those mid-range, multi-product companies which are too big to be small niche players but not big enough to be first-tier suppliers. Once these companies begin to consolidate in earnest, the world aerospace ranking will change indeed. Perhaps we too will have to consolidate by trimming down to a Top 50?
Source: Flight International