Since 2004, the aerospace industry has seen a rapid growth in demand for new commercial aircraft, fuelled by a more buoyant global economy and rapidly increasing demand from developing economies such as China. Military aircraft output is also increasing, and is largely reliant on the same supply base. As demand for aircraft grows, all major manufacturers are looking to increase production rates to take advantage of this period of high demand.
When production increases, the implications for the whole supply chain are significant, but the impact has been most noticeable among lower-tier suppliers. Following the recent recession in the industry, many small suppliers finally exited the business, a result compounded by the fall in defence aerospace spending in the late 1990s. Those manufacturers that remained significantly downscaled their operations and are now striving to deal with a number of major issues if they are to rise to the current challenge and deliver increased output at the agreed price and quality levels.
Firstly, the ability to generate the funds needed to increase production capacity and invest in new technologies and new product development processes is now a major issue for most lower-tier companies. Many suppliers are struggling to ramp up production in an environment where the new, more streamlined, contracting processes of the primes are increasingly changing the return on investment profile for current and future contracts. For major suppliers, this process is long established and Tier 1 companies have gradually modified their business models to sustain margins. But lower-tier suppliers have been largely shielded from a contracting environment requiring risk and revenue sharing and annual price reductions.
Many have historically relied on shorter return profiles for new programmes and a more lucrative aftermarket revenue stream from legacy aircraft. These contracts, and airframes, are gradually being phased out, reducing cash available for reinvestment in current or new programmes. Meanwhile, future original-equipment support contracts are less lucrative – requiring guaranteed costs and reliability for the contract duration. There are signs that some early “new model” contacts have proved to be less than profitable, evidenced by the fact that the Tier 2 supply base has the largest variability in financial performance – with many of the best performers, but also many of the worst.
Secondly, reducing manufacturing cost is becoming an increasing priority for suppliers. In a marketplace where there is increased competition from lower-cost manufacturing regions, suppliers are having to adopt increasingly sophisticated low-cost sourcing strategies – requiring difficult make versus buy decisions that drive production of a significant proportion of components. In products where long-term reliability is crucial to operational effectiveness and aircraft safety, the issue of maintaining quality control is a significant one.
Additionally, as most contracts are based on the US dollar, smaller suppliers have been hardest hit by the volatility in currency markets in the last two to three years. Companies have adopted leaner approaches to manufacturing, the management and generation of working capital and on driving out cost of indirect procurement.
Thirdly, the pressure on availability of raw materials, particularly metals, is making an impact on the cost of manufacturing for all suppliers, but is of particular concern for the smaller companies that cannot match the buying power of the larger buyers. Although it appears that metal prices may have peaked, demand from developing countries for specialist metals and alloys has driven prices to new highs. In a seller’s market, where demand is outstripping supply, smaller companies struggle to absorb the higher prices in the cost of products and, in some circumstances, are finding it increasingly difficult to source supplies of specialist metals.
In the current environment of a recovering supply chain that is struggling with the investment, cost management and raw material issues required to increase capacity, maintain reliability and reduce cost, there is an increasing need for the primes to understand and mitigate risk in their supply chains. There is evidence that the major manufacturers are investing to maintain stability in the supply chain by assisting key suppliers to increase productivity. Some are conducting capacity reviews with key suppliers to help identify and manage risks associated with increasing volumes, maintaining performance during capacity upgrades or managing quality during supplier re-sourcing. Others are assisting with the procurement of commodities.
It is clear that the business model for suppliers is changing and that larger manufacturers are adopting a more partnership-orientated approach towards the management of their supply chain – similar to processes that have been prevalent within the automotive industry since the mid-1990s.
NEIL HAMPSON & SIMON YOUNG?LONDON
Neil Hampson is a partner in the Valuation & Strategy Group of PricewaterhouseCoopers.
Simon Young is a director in the Performance Improvement Consulting group of PricewaterhouseCoopers.
Source: Flight International