Opinion: OEMS Increase Production, Squeeze Suppliers

By Kevin Michaels
Source: Aviation Week & Space Technology
November 25, 2013
Credit: Boeing

Economics teaches us that duopolies are generally bad for consumers and good for suppliers. Recent experience in the aerospace industry would suggest the opposite: Boeing and Airbus have engaged in significant price competition with profitability levels well below those of their own suppliers.

Both OEMs have charted a course to rectify the situation and achieve double-digit profitability. The EADS “Vision 2020” strategic plan includes a specific goal to achieve 10% earnings before interest and taxes (EBIT) by 2015. Boeing has openly discussed its goal to shift the current playing field where its suppliers earn 15-20% margins, while Boeing posts only upper single-digit margins and must absorb much of the risk for new programs.

The duopolists are using similar tactics to achieve this goal. The first is to increase production rates. Aircraft OEMs make most of their money from production (not the aftermarket), and higher production rates reduce unit costs and provide a broader base for investment amortization. An added benefit is that higher rates make life difficult for new entrants such as the Bombardier CSeries or Comac C919. Why else would Boeing recently announce 737 MAX production rate increases for 2017, a staggering four years in advance?

A second tactic is to squeeze suppliers. Boeing's ironically named “Partnering for Success” program is a major initiative to reduce supplier costs and prices. Boeing has spent much of 2013 requesting major price concessions from its key suppliers. Boeing CEO Jim McNerney says: “If a certain group is not working with us . . . they'll be on a no-fly list. They will not be allowed to bid on new programs at Boeing.” Airbus has embarked on a similar cost-cutting endeavor.

Supplier cost-reduction is particularly important given the aggressive pricing strategies being followed to keep 737 and A320-family production lines humming until the reengined variants arrive mid-decade.

Boeing and Airbus are also pursuing reduced labor costs through decentralization. Both OEMs are shifting away from single-site dependency for aircraft production and development. Airbus is building a new facility in Alabama to complement its Tianjin, China, factory, and Boeing is expanding its production capacity in South Carolina and must now decide where to locate its 777X facility, pending union negotiations in Seattle.

Engineering activities are also being decentralized. This not only allows OEMs to tap global talent pools and reduce the risk of work stoppages, but also increases leadership's capacity to keep labor and benefit costs in check by creating an internal market.

Finally, both OEMs are seeking expanded service revenue. Services are traditionally more profitable than production; this is one of the reasons that sub-tier OEMs earn higher margins. One explicit goal from EADS Vision 2020 is for services to reach 25% of its business by 2020, versus today's 10%. This implies a stunning €20 billion ($26.8 billion) in service revenue within seven years! Boeing is also targeting aftermarket service revenue growth. Hence both companies are taking on greater roles in the aviation aftermarket with new value propositions such as Airbus's Flight Hour Services and Boeing's GoldCare. They are also aggressively pursuing acquisitions.

Comments On Articles