What enlarged role could suppliers and manufacturers play as airlines look to outsourcing as a cost control mechanism? Kevin P Michaels and William D Angeloni of the Canaan Group explore the possibilities.Airline suppliers have already endured a tumultuous decade - order boom followed by order bust, complicated by the constant pressure of continually shifting customer needs. Unfortunately for them, there is no rest in sight. The twin challenges of liberalisation and privatisation continue to trouble the airlines, moving many to consider radically reviewing their operations.

Outsourcing - retaining only those activities that are value-added or confer competitive advantage while relegating the rest to outside specialists where possible - is becoming increasingly attractive for companies of all kinds. Management consultant Peter Drucker is not alone in predicting that within 10 to 15 years companies may contract with outside suppliers for all work that does not add value.

For airlines the prospects of enhanced asset productivity and cost reductions of up to 25 per cent of operating costs, plus non-economic benefits like flexibility and market access are attractive.

What will be the consequences for suppliers if airlines restructure along these lines? Airline needs will certainly change - in some cases dramatically. New approaches to providing products and services will be called for. New competitors will emerge as well. Partnerships and alliances will become obligatory. In other words, the supply chain may well be transformed. For suppliers, success in this new world will hinge on understanding how the airline of the future will be organised and what its requirements will be.

Can today's airlines really restructure to this extent? Consider another transportation business - the US railroad industry.

Deregulation in 1982 led to increased competition, resulting in severe cost pressures. Railroad operators restructured their organisations accordingly; they now focus on asset productivity and flexibility, lease the bulk of their equipment, and outsource most heavy maintenance from outside suppliers. Railroad equipment manufacturers, in turn, have become major suppliers of leasing and maintenance services. Leasing companies have expanded their service offerings to include engineering and design.

The environment has become so fast-moving that equipment is designed for a maximum life of 15 rather than 25 years or more. The railroad industry example illustrates just how increased competition can lead to the relocation of business activities along the supply chain.

Competition in aviation today is creating similar pressures that are likely to relocate business functions to their most efficient source of supply. The typical airline organisation could change considerably as non-value-added activities are more frequently contracted out to efficient and specialised suppliers. Which of the four basic kinds of airline business activity - asset management (ownership of equipment and facilities), maintenance, operations and marketing - offer the best candidates for outsourcing?

Airlines should put greater reliance on outside suppliers for asset management in the years ahead. The outsourcing of aircraft ownership (for example aircraft leasing) has been growing steadily for a decade and similar thinking is now being extended to other major asset groups such as spare parts inventories, information technology resources (IT), and facilities. The economics can be compelling. For example, airlines currently spend about $8 billion per year to hold and manage about $35 billion in spare parts inventory.

Massive savings could result from turning ownership over to suppliers that specialise in inventory management and can achieve scale economies through pooling. KLM for this reason recently established a goal of owning no spare parts inventory. A similar case can be made for outsourcing IT, which accounts for the dramatic growth of companies like Electronic Data Systems. Besides savings, a good reason to minimise asset ownership is flexibility. It will be increasingly difficult to predict what assets - from aircraft to computers - will be required 5 or 10 years hence. The weak balance sheets of most airlines will also make it difficult to purchase new assets. As a result, airlines will more often turn to asset management specialists that have product specialisation, scale, and access to an international pool of capital.

Maintenance has been a topic of debate for years. Economic analysis would suggest that few operators should be overhauling their own engines and components or performing heavy checks on their own aircraft. Throughput of at least 50 engines per year per engine model is needed to justify full engine maintenance capability in-house. Few operators today achieve this volume. Airlines, which have long lacked sufficient or accurate 'make-buy' information, are becoming increasingly aware of the total cost of the maintenance function - not just direct maintenance expenditures but also indirect costs such as purchasing, quality control, and engineering.

Continental, after taking full account of these expenses, recently closed its Denver and Los Angeles facilities and is outsourcing large portions of its maintenance requirements. Savings of up to $200 million a year are expected.

Operations, which accounts for about half of an airline's expenses, also offers the potential for sizeable cost savings. The industry has already seen the growth of specialist suppliers like Caterair, Ogden Aviation Services, and Flight Safety International for catering, ground handling, and training. While the outsourcing of high-cost flight and cabin crew operations has been limited, this too is beginning to change. JAL is expected to reduce total costs per flight by 8 per cent through wet leasing aircraft and crews from Japan Air Charter. Even state-owned Alitalia is wet leasing aircraft and crews from Ansett Worldwide Aviation Services. International and regional codesharing arrangements are a way of outsourcing entire flights. Delta Airlines is effectively outsourcing short, thin routes to its regional airline partners ASA, Comair, and Skywest.

Marketing will probably see the least outsourcing. Certain activities found today at an airline's core will probably still be there tomorrow: network management (scheduling, route planning revenue management, pricing); branding; and customer management (for example frequent flier programs). Even so, some non-value-added marketing activities may be worth outsourcing.

It is clear that important changes in airline organisation are both desirable and possible. Despite structural impediments such as labour relations and aeropolitics, change is already underway. Airlines will retain business activities where they gain advantage from competence or scale. But outsourcing will become increasingly the pattern for success.

What does airline restructuring mean for suppliers? First, there will be a reallocation of roles and responsibilities along the supply chain. Business activities, particularly those pertaining to asset management, maintenance and operations, will migrate to organisations that provide the most value. Some airlines may choose not to own assets and will look to suppliers to fill this role. Others may farm out significant portions of their operations or maintenance.

These trends will present new opportunities for suppliers, for example:

1 Original Equipment Manufacturers (OEM) could progress to becoming key providers of for-profit engineering services.

2 Flight crew training companies may offer flight crew leasing services.

3 Subsidiaries spun off from large airlines could become major suppliers in their own right.

While particular outcomes are difficult to foresee, it is safe to say that business opportunities will exist for suppliers that can improve an airline's cost position and flexibility.

A second implication is that airline needs will change. As airlines grow leaner, they will seek fewer but more intense relationships with their suppliers, favouring larger, well-integrated firms with broad service offerings. This will motivate suppliers to extend their range of capabilities through both internal growth and external alliances. As a result OEMs may be expected to bundle products and services from other suppliers, while more aircraft power-by-the-hour arrangements could require a coalition of OEMs, leasing companies, and maintenance suppliers. The heavy cost of initial spares provisioning is also likely to drive growth in rotables leasing, requiring finance, repair, inventory management and stock disposal capabilities.

Airlines' increased reliance on suppliers means value will be placed on long-term commitment to the industry, stability, scale, and a proven ability to remain competitive through investment in technology and people.

Third, new types of suppliers will appear. In many cases, non-traditional providers from outside the industry may be most competent to meet changing needs. Electronic Data Systems has entered into a joint venture with Lufthansa to provide IT services, capitalizing on the partners' respective skills in information services and airline operations. Similarly, it is conceivable that a major manufacturer of heavy plant machinery such as Caterpillar, which has the integrated logistics skills to deliver a part anywhere in the world in 24 hours, may take over a supplier or even an airline's warehousing and logistics functions, to capitalise on the new business opportunities. New types of suppliers mean new competition. To win these conflicts, today's suppliers must identify and adopt the 'best practices', wherever they are.

Fourth, suppliers must find new ways of managing their own 'extended enterprise' to improve productivity and responsiveness. As airlines move to more efficient organisational structures, they will expect the same of their suppliers: business activities that are not value-added should probably be outsourced. Bombardier, for example, has entered an agreement with FedEx Business Logistics Services to provide spare parts distribution services to its Canadair Challenger operators. Suppliers also need to improve the processes between firms in their extended enterprise to cut costs, reduce lead times, and improve responsiveness. A significant overlap exists in many parts of the supply chain. Suppliers, like airlines, need to eliminate it.

Finally, the formation of partnerships and alliances will become indispensible. Airlines require low-cost, flexible, and responsive suppliers to achieve their objectives in a competitive and rapidly changing world. At the same time, larger, broader-based companies will best meet airlines' needs for stronger supplier partnerships. This dichotomy - large yet responsive, broad-based yet low-cost - will require most specialised suppliers to form strategic partnerships that create seamless, effective 'virtual' companies with the required combination of scale and efficiency. Opportunities will also exist for alliances that can offer turnkey packages, for example, integrating maintenance and operations activities for airlines.

To position themselves for maximum advantage, suppliers must develop a detailed understanding of their customers' economics and underlying needs as they relate to their products and services. Suppliers must also realistically assess their core competencies and how they fit the emerging set of requirements. Where gaps exist - and there will be many - a decision must be made whether to develop a needed competency or seek a partnership with another firm. If a supplier has any doubts it can provide customers with world-class service, it should probably look for a partner that can.

In many cases, there will be opportunities to shape the development of the supply chain, to 'create your own competitive space'. Today's financially-oriented airline management is open to new ways of doing business and new forms of relations with their suppliers. Proactive providers could have an important influence on their needs and actions.

Caterpillar's product support competence, for example, has allowed them to develop a strong relationship with their customers that leaves little room for unmet needs or other competitors. Similarly, Boeing's new service levels for spare parts delivery (shipment anywhere within 24 hours) could have a significant influence on airlines' inventory management and maintenance needs.

The aviation industry is changing. The growth of outsourcing - a response to historic forces - will fundamentally alter the airline business. What they in turn ask of, and how they relate to, their suppliers will greatly change as well. Successful airline suppliers will anticipate these trends and lead the way.

Kevin P Michaels and William D Angeloni are management consultants with The Canaan Group, an aviation and aerospace consultancy with offices in both Park City, Utah and London.

Source: Airline Business