Aviation Supply Chain Evolution - Key Trends and Impacts

We’ve all heard that the aviation supply chain is becoming strained, as a number of factors are placing pressure on suppliers, whether large or small. Five key trends are currently impacting the supply chain and creating additional stress for industry participants. Let’s examine them one by one. Capacity Growth The aviation industry continues to grow faster than the general economy. Passenger traffic continues to grow at about 5-6% per year, resulting in an increased demand for aircraft. The two major OEMs, Airbus and Boeing, are planning to increase their already record output levels to more than 60 aircraft per month each before the end of the decade, and the first inkling of potentially 70 per month by 2025 has now been mentioned. That level of growth, a significant increase from today’s level, will likely require capital investment for suppliers to keep pace. But the major OEMs will not guarantee production volumes to their suppliers, adding an element of risk to increased capital investment. In addition, both OEMs often prefer dual sourcing whenever possible, to ensure that production continues in the event of a disruption. Many suppliers today are facing a decision to increase capacity with no guarantee that they will retain their current proportion of production they have today. The added uncertainty can lead to decisions that constrain capacity and lead to potential shortages, as we’ve seen in recent years with some notable capacity shortfalls. The OEMs have Changed the Rules in the Middle of the Game Boeing’s Partnering for Success program with its suppliers is viewed by many in the supply chain as a 10-15% price cut to continue to participate or be considered for new Boeing programs. Boeing is well aware that many supplier margins, particularly system suppliers, are higher than those Boeing can achieve, and has taken actions to help level the playing field. Airbus is similarly looking at its SCOPE+ program to gain an additional 10% from its supplier base. When United Technologies initially refused to go along with Partnering for Success, Boeing moved the 777-X landing gear contract from 777 incumbent UTAS to Heroux-Devtek, a smaller Canadian supplier. That sent a message throughout the industry that Boeing was quite serious about cost reduction and supplier responsiveness. After that loss, UT has reached an mutual agreement with Boeing and both are playing by new, albeit tense, rules. As a result, suppliers are being forced to re-examine their manufacturing processes and productivity to maintain their existing margins and enjoy the benefits of capacity growth. Those who have adapted to the new rules are thriving, while those unable to produce productivity gains suffer with lower margins. Both Airbus and Boeing believe that they is more to be gained from the supply chain, and we know that Boeing now considers PFS to be an on-going process, with no goal line. The continuous pressure on the supply chain is now reflected during every contract renewal. The massive discounting by the OEMs directly results in cost pressures on the supply chain, and that discounting continues unabated as each campaign seems more aggressively fought than the last. Technology Changes Require Investment by Suppliers The recent revolution in materials technology have impacted the supply chain, as aircraft have moved from metal to carbon fiber composite construction. Today, next generation designs are moving away from thermoset composites commonly utilized today to thermoplastic composites that are easier to manufacture. The future bodes further changes as nanotechnology and carbon nanotube will become less expensive and easier to produce, further improving strength, weight, thermal resistance and durability of components. Suppliers can quickly find a part they have made for years from metal rapidly replaced by a new material, and will either need to adapt to new requirements for strength and weight, or be replaced by another entity. The result is that the supply chain needs to not only understand today’s materials, but tomorrow’s as well, and be prepared to abandon the old for the new as new programs are introduced. This is a lot to ask from a group of suppliers already under cost, personnel, and production pressures. The next generation of narrow-body aircraft will feature new materials technologies to provide the required economic advantage over today’s aircraft. But that will require investment by the supply chain to transition from today’s materials to tomorrow’s. Manufacturing Technology is Evolving Two major elements are changing in manufacturing. The first is information technology that drives automation and interfaces between the OEM and suppliers. Industry 4.0 technology requires suppliers to invest in software and automated equipment that is much more expensive than the prior generation of equipment. Today’s automated 5-axis machinery, with robotic feed of raw materials, can accomplish the required steps with minimal human intervention, and machine operators are being replaced by personnel trained in IT to program and operate advanced automated machining centers. The second major change in manufacturing is additive manufacturing. More commonly known as 3D printing, additive manufacturing enables components to be built up in unique shapes, rather than cut from a block of metal. While limited in scope today, the number of parts that are built using additive manufacturing process is growing as designers begin to think differently to take advantage of innovative designs that would be impossible using traditional manufacturing methods. Unique shapes can be built to optimize strength and weight relationships to optimize performance. GE Aviation is a leader in this regards, and on its Catalyst turboprop is replacing 855 conventionally manufactured parts with 12 additively manufactured parts, dramatically reducing complexity and cost while improving reliability. As the capability of additive manufacturing technology improves with additional lasers added, productivity will increase and costs will decrease. We fully expect a four-fold improvement in productivity over the next five years, and another four-fold improvement over the ensuing five years, bringing costs down and productivity up by an order of magnitude. Shifting Aftermarket Relationships The major OEMs want a larger share of the aftermarket pie, and there is now a bulls-eye on suppliers with aftermarket rights to sell spares directly to airlines. Boeing wants a larger share of the aftermarket, and just created a joint venture with Safran to participate in the APU market, traditionally held by Honeywell or UTC. Relationships are changing, and suppliers can expect contractual changes from the OEMs at their next renegotiations, as OEMs are seeking additional aftermarket revenues. Bundling of services with aircraft will be the new norm, and the true cost of an aircraft will be further masked from analysts. While we don’t expect aircraft to become a “razor and blade” business in which the aircraft price is reduced to obtain a lifetime of spares revenue, it is clear that the OEMs want to capture their share of those revenues and associated margins. The Bottom Line It has never been easy being a supplier in aviation. Today, capacity growth and technology changes require additional capital investment, while the OEMs are seeking concession from the supply chain that will likely result in lower margins. With the convergence of the five trends described above, the task has become a lot more difficult than in the past. Some smaller suppliers will find that consolidation may be their only alternative for survival, as critical mass will be necessary to maintain margins and minimize administration costs. Maintaining differentiation is more difficult as technologies are changing the rules of the game and automation enables “built to print” capabilities in machining centers and additive manufacturing technologies that reduce barriers to competitive entry. We expect a wave of mergers and acquisition among smaller players in the aviation supply chain between now and 2022 as the impact of the five trends described above, plus a more uncertain global trade environment, fully impact the industry.

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