White paper AEROSPACE & DEFENSE USA

[Thruster87]

A LOOK AT THE HORIZON

 

SUMMARY

 

Aerospace today is effectively is a tale of two industries. The commercial sector is brimming with vitality and surging upward. In stark contrast are the businesses who serve government customers; they face a highly uncertain future in the near to mid-term—so much so that the ability of enterprises to manage through extraordinarily difficult conditions during the next few years will be tested to an extent not seen in more than a generation.

 

Orders and production of new commercial air transports is at historic highs. While this record-level of activity could slow temporarily mid-decade, stubbornly high fuel prices and healthy traffic growth, especially in Asia/Pacific, will continue to fuel demand for at least the remainder of the decade for the newest airplanes that offer the lowest operating costs.

 

Market forecasters have long predicted that airlines in Asia/Pacific would outpace the rest of the world in the demand for new aircraft. And it is now becoming increasingly clear just how explosive the growth will be during the next 20 years. The projected numbers are staggering, implying that Airbus and Boeing will have all the production volume they can handle and then some. The numbers also imply the potential for substantial revenue and earnings growth for all suppliers.

 

But there is a darker side to this halcyonic image; the challenges will be every bit as daunting as the production rates that manufacturers will need to sustain—no small feat in itself, given the overall performance of global supply chains on major aircraft development programs in recent years.

 

To reap the rewards, manufacturers will need to achieve and sustain what may be unprecedented levels of productivity. They also will need to demonstrate a high level of flexibility so they can adjust their production rates, as required. This is especially true for lower-tier suppliers, who historically have proven to be weak links in commercial supply chains. Boeing, pushing for double-digit profitability, will insist on deep supplier concessions in return for access to future aircraft programs. Airbus may follow suit, although there were no firm indications of such action on Airbus’ part as of the end of the first quarter in 2014.

 

OEMs also will face agonizingly difficult choices over whether to re-engine certain older models, as in the case of the A380, or invest huge amounts of money in new designs. Errors in judgment could cost both builders sizeable market share and put them at a financial disadvantage for years, constraining their ability to invest in new product development.

 

In addition, all Western suppliers must anticipate serious competition from China and possibly Russia, although they too will experience their own challenges developing new aircraft and winning certification. Chinese and Russian forecasts of first flights and initial deliveries should be considered unreliable guesstimates, at best. All the same, the two countries, working both solo and in partnership, are apt to introduce clean-sheet models, with technology newer than what was available when Boeing launched the 787.

 

For all its industrial and technological prowess, Japan seems to be content to remain a major supplier to other commercial airframe OEMs. Posing more of a long-term competitive threat are Brazil and Canada, depending on the innovation, manufacturing process improvements and marketing savvy they can bring to future product design and development. Western suppliers will need to figure out how to protect intellectual property and market share in the face of growing pressure to forge more industrial partnerships, especially with China.

 

Then there is the perennial question surrounding program execution—that is, how skilfully will OEMs be able to produce derivatives and next-generation models that offer improved life-cycle costs, versus finding themselves yet again over-promising and under-delivering to customers who have demonstrated less tolerance for suppliers unable to bring products to market on time and on cost?

 

Manufacturers who successfully meet these challenges will ride an enormous wave of business, although there will be no letup in the pressure of all players to strive for step changes in efficiency across their operations.

 

Boeing expects the Asia/Pacific fleet to nearly triple in size, to 14,750 aircraft, by 2032. Of this number, nearly 13,000 will be new airplanes. About 75% will be for annual growth in air travel (about 6%) —including the rapid proliferation of low-cost carriers—while 25% will be to replace aging equipment. Altogether, Boeing expects Asia/Pacific airlines to account for 36% of the world’s new aircraft deliveries by 2032, with China taking nearly half. Total value: nearly $2 trillion. Airbus forecasts for new aircraft demand are comparable.

 

On a more sombre note is the near- to mid-term outlook for defence contractors, although there is this encouraging note: The value that the Department of Defence is placing on government-funded R&D for technologies critical to national security—and DoD’s expectations for industry to maintain healthy levels of company-funded R&D in select technologies—suggests that there will be substantial business opportunities up for grabs in certain markets when weapons modernization resumes in earnest.

 

Until then, suppliers will face an extremely challenging future as they attempt to adjust to three business/political realities: 1) sequester-driven cuts in programs, particularly during the next two years 2) uncertainty in program funding, with Congress being the biggest wild card, and 3) the next phase of the Pentagon’s affordability, or “Better Buying Power,” initiative.

 

While some of the biggest challenges that defence contractors face is beyond their control, there is much that companies can do to improve their business prospects.For example, they could shorten the time it takes to develop contract proposals. Excessive timelines put execution-year and follow-on dollars at risk. OEMs also could encourage their suppliers to do a better job of preparing contract proposals, with an emphasis on reducing costs that otherwise would be reflected in those proposals. All contractors in general would do well to consider this assessment by Lt. Gen. Charles R. Davis, Military Deputy in the Office of the Assistant Secretary of the Air Force (Acquisition): “All programs that struggle are doomed to do so before the contract is signed.” Expendable overhead can range from 30-60% of contractor costs.

 

In addition, companies could focus more on mature technologies to help contain costs. There are three areas where contractors should be concentrating on innovative technology and processes.

 

Mitigate current threats or emerging ones, such as countering weapons of mass destruction.

 

Exploiting commercially available technologies.

 

Building modularity into weapons systems to improve their affordability.

 

Developing technological surprises for existing or potential adversaries.

 

Finally, expect DoD to differentiate between companies who are trying to reduce costs and those who are not. The two groups will not be treated equally. From DoD’s perspective, the biggest opportunity for cost savings is in sustainment.