July 30, 2012
With commercial aerospace booming and defense markets cooling, business leaders in the sector are searching for a recipe to guide their actions in these uncertain times. Given the cyclical nature of aerospace and defense markets, it would be natural to look to the past for clues as to which strategies have worked in similar times. But this time is different. To succeed in this environment, companies will have to master new skills, become more agile and develop more affordable products than at any time in the past.
Both commercial aerospace and defense are inherently cyclical markets. Growth in the commercial aerospace market tracks global economic growth, with a short lag, historically following a 10-11-year cycle. We currently find ourselves in Year 13 of a commercial aerospace boom, the longest in recent memory. Some analysts are claiming there will be no protracted down cycle this time, as Middle Eastern and Asian airlines pick up the slack from those in traditional developed markets. Other analysts, however, are much less optimistic, saying you only recognize a bubble once it has popped.
Spending on commercial aerospace and defense tends not to be connected, which is why many A&D companies like to have both in their portfolio. Defense is also cyclical, but is driven by threat levels (actual and perceived) rather than economic cycles. The last two cycles for defense spending both lasted around 20 years. We now find ourselves in the early stages of a downturn in global defense spending.
Surely, we have been here before: Commercial aerospace booming, defense trending downward. What can we learn from historical patterns? The last time we saw commercial aerospace booming and defense struggling was at the end of the Cold War. But that is not relevant because the underlying drivers of activity then and now are surprisingly different.
Affecting commercial aerospace today, airline profits are down, oil prices are high, and global economic growth is anemic. Curiously, these are factors normally more associated with a commercial aircraft down cycle. And in today's defense environment, the threat has not dissipated, as it had at the ends of the Korean War, Vietnam War and Cold War. There is no obvious peace; we still find ourselves in an uncertain and dangerous world.
With the fundamentals so out of alignment with market conditions, we are living in an unstable equilibrium. What's an A&D executive to do?
In commercial aerospace, everyone is talking about the problem of overstretched supply chains, but with all of this uncertainty, the real challenge for commercial players is to improve their agility, to enhance their ability to respond flexibly to changes in the market. Companies that have succeeded in doing this in other sectors have typically shortened their lead times substantially in order to be more responsive to shifts in the market. For example, personal computer lead times have been compressed from 14-21 days in 1990, to only two days in 2010.
In defense, companies are already looking for new pockets of growth, in segments like UAVs and cybersecurity and in international markets. But everyone is chasing the same set of opportunities. So competitive intensity is high. Since not everyone will be able to build successful businesses in these areas, some companies are beginning to rationalize their portfolios. In the good years, the rising tide lifted all boats and everyone benefitted. Good companies did well. Average companies did well. Even poor performers were able to reap the fruits of a strong market. In a flat or down market, only strong companies perform well. As a result, now is the time to exit segments and individual businesses that are underperforming.
The real management challenge is to push for affordability. In the world we have been living in, a slightly better product at a higher price was almost always a winner. In the new, more austere world, a good-enough product at a lower price is increasingly attractive.