Boeing Reestablishes In-House Avionics Unit for Production

Boeing has re-established an new in-house avionics unit to “pursue the development and production of avionics and electronics systems” for its commercial aircraft. The interesting word in Boeing’s announcement last week is “production” as it implies that Boeing will be moving into the business of potentially producing the boxes that comprise the cockpit instrumentation and aircraft controls. According to Boeing CEO Dennis Muilenburg, the move is part of a “strategy to build targeted vertical capability.” The Implications of the New Strategy Does this mean that Boeing will soon be a competitor to Honeywell and Rockwell Collins? The answer is at least to some degree is yes. Historically, prior to the development of the 787 Dreamliner program, Boeing had an in-house unit, Boeing Commercial Electronics, with 1,200 engineers, that designed electronic controls for its airliners and had a plant in Texas that built the hardware with another 1,200 employees. But with the 787, Boeing’s strategy was to hand off work to Tier 1 suppliers responsible for subsystem designs, thereby reducing Boeing’s costs. Unfortunately, that strategy proved to be nearly fatal to the company, as the Tier1 systems integrators failed with on-time performance and quality, resulting in delays and the eventual grounding of the aircraft due to battery fires. That disaster, and the subsequent $30 billion price tag for the 787 program, disrupted Boeing’s product strategy, causing them to re-engine rather than replace the 737 and 777 models. This negatively impacted a competitive advantage that should have resulted in a superior competitive position across the board vis-à-vis Airbus to the parity situation we have today, with Airbus stronger in narrow-bodies and Boeing stronger in wide-bodies (for now). The simultaneous move to new technology and outsourcing at the same time crippled the 787 program. Many observers believe that outsourcing could be feasible, but needed to be developed on an existing aircraft with proven technologies first. Handing a new technology concept to a vendor unfamiliar with systems integration of that scale was a recipe for difficulties, and Boeing paid dearly with the grounding of the 787 fleet once it finally reached service three years late. A Financial Imperative? So why is Boeing moving in a new direction? Boeing has realized that its suppliers make more significant margins than it does in the aftermarket, and wants to grow its aftermarket share and services business. But with components made by someone else, they also make the spare parts and associated revenues when it comes time to replace or overhaul a component. Boeing’s new unit will develop systems for all of Boeing, not only the commercial aircraft side. With a goal to grow Boeing’s overall service business from $14 billion today to $50 billion within 10 years, that growth cannot be achieved with third parties supplying virtually every component. Why avionics? If the future of flight is to be autonomous controlled or pilot-less aircraft, the ability to reduce crew sizes (will we see single pilot plus autonomous operations), Boeing needs to be at the forefront of those developments. The avionics, which control navigation, operation of flight controls, communication and aircraft information systems on board, are an integral part of the aircraft operational and financial performance. Moreover, with health management systems being integrated into components and producing “big data” for predictive maintenance and performance optimization, Boeing needs to be the “system integrator” of that data. By placing proprietary requirements for each piece of avionics to integrate with the Boeing data requirements, Boeing can tailor the design of each component and, given its intellectual property content, control the aftermarket. Avionics and sensors feed “big data” and Boeing can control that process through its own IP. It is quite likely that additional Boeing-manufactured avionics will be aboard the “797”, scheduled for entry into service in 2024. While this will not include the manufacturing of cockpit systems and radios, it will likely include elements to integrate and report on the controls and avionics that manage aircraft systems, as well as on the health of key components and their performance. The Business Unit The new unit, headed by Allan Brown, formerly program director for the Missile Defense National Team, has 120 people and will grow to about 600 when fully staffed in 2019. This is about half of the engineering talent that was on staff prior to the 787 program, and about a quarter of the total when manufacturing personnel are counted. As a result, we don’t expect to see too many Boeing-branded black or blue boxes in the avionics bay. Without the addition or acquisition of a factory, large production of components other than software is unlikely. What is important for Boeing is having its own intellectual property in the avionics and electrical system. Michel Merluzeau (who leads the separate research unit of AirInsight at AIR) has emphasized to us that “this issue of IP, and services will profoundly reshape the role of the aircraft OEM and the relationship it will now seek to have with its supply chain”. Boeing can then place a Boeing part number on the component, and will control the aftermarket for that product. With aftermarket margins higher than margins for the aircraft itself, Boeing would then insert itself into a lucrative revenue stream over the life of the aircraft. Will Boeing Manufacture Components? The physical parts that make up the component may or may not be produced by Boeing. It is quite unlikely that Boeing will produce computer chips and electronic circuit boards, but it can design and contract them, and since it is Boeing’s IP, take the full mark-up on spares parts that the component OEMs currently enjoy. If it is a Honeywell or Rockwell Collins part, then they take the bulk of aftermarket profits. The Competitive Imperative Our AIR colleagues remind us that the aircraft business has become more and more competitive in recent years, and trends are such that it is likely to become even more about disruptive advantages in the future. Airbus and Boeing seem to be contesting every deal, despite being a duopoly, with discounts routinely near 50% of list price, up from 30% a decade or two ago. With Bombardier and Embraer nipping at the lower end of the narrow-body market, competition is intensifying. Longer term, with COMAC entering the market from China, margin pressure on initial aircraft sales will increase dramatically. The answer for aircraft OEM’s is to take back some of the IP on the aircraft and specify, rather than outsource the design, of those components. This opens up the aftermarket and a lifetime, rather than a one-time, income stream. The strategy ties well with Boeing’s goals to increase revenue for Services down the road, as increased content is one element necessary to accomplish that goal. A Competitor is Showing the Way Embraer, in Brazil, is unique among the OEMs in that it writes its own fly-by-wire software, and operates an IT university in conjunction with the company to train future software developers in house. That has provided it an advantage as vendors have been slow to deliver on fly-by-wire programs at Boeing, Airbus and Bombardier in recent years. Embraer, by contrast, writes its own code and has been on-time and on-budget, thanks to close cooperation with its product design engineers and avionics hardware suppliers. The Bottom Line Big data, and its analysis and benefits for predictive maintenance and cost savings, requires integrated information, large mainframes and data stores, and algorithms that predict performance and indicate the optimal time to remove or replace a component. Tying in those systems with service and support, to have a part at the right airport at the right time to optimally repair an aircraft can save the airlines maintenance cost while eliminating flight cancellations and revenue losses. That is valuable, and a service that won’t be provided free of charge. This represents a large potential revenue stream for Boeing that is an annuity for the life of the aircraft, and a key element in their strategy to increase services revenue and as AIR suggests , can turn into a positive discriminating factor for the operator looking to lower costs and optimize aircraft operations. There are key elements of avionics capability that need to be kept in-house, and Boeing has discovered that certain capabilities are a key element to long-term financial success. It is quite difficult for an outside avionics vendor to incorporate all of the design elements for these new functions and innovations without being an integral part of the team and on-site. Avionics engineers need to be closely integrated into product design teams and define the data collection, integration, and analytical specifications to ensure that all of the elements of big data seamlessly work together. Having an internal capability makes that possible. The Bottom Line This represents a major shift in outsourcing policy for Boeing, recognizing that the pendulum swung too far with the 787 program, resulting in costly delays and design flaws. Restoring internal expertise in this area should result in a smoother 797 program. Boeing is learning from past decisions, out of financial necessity, and taking the appropriate steps to ensure a stronger financial future and aftermarket revenue stream.

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