Author: Tronserve admin
Wednesday 4th August 2021 10:32 AM
Aerospace Suppliers Should Brace for Headwinds
As OEMs try to cut costs, check your long-term agreements for areas where you might be vulnerable.
In case you missed it, a Boeing 747—the “Queen of the Skies”—recently set a record by flying across the Atlantic from New York to London in under 5 hours at over 800 mph. The record was set with the aid of a significant tailwind of approximately 200 mph.
Tier 1 and 2 aerospace suppliers (in both engine and airframe) also have benefited over the past several years from a significant OEM demand tailwind. Dozens of articles have been written about the record boom in the commercial airspace market due to the huge growth of global passenger travel. The outlook remains strong, assisted by airline travel costs being lower due to industry innovation and productivity improvements.
There are clear signs from the OEMs, however, that headwinds are coming for suppliers--and these signs were occurring even before the coronavirus effects on the economy and air travel took hold.
Although a great deal has been written about the 737 Max and massive cash and profit pressures on Boeing, the predictable result is Boeing’s cost squeeze on suppliers. Engine OEMs, such as Rolls Royce, told suppliers at the end of last year that they were cutting orders on short notice. Western suppliers also will face pressures due to the expansion of aerospace manufacturing, both overseas and here in North America, as new plants, machinery and a highly trained workforce are now online and new capacity additions continue to be announced.
Historically, parts were procured purchase order to purchase order, or sole sourced on long-term agreements, and the competing manufacturer for that work was in the next town over or in Western Europe. Presently, on the newer high-volume programs, parts are awarded to multiple suppliers on long-term agreements, with market share determined largely on pricing and the competing supplier(s) often being in Eastern Europe and/or Asia.
In the old days, the supply chains in these emerging locales carried a risk premium, meaning OEMs would order a greater percentage of their requirements from the more experienced, albeit more expensive Western supply chain. In recent years, the skills gap has closed significantly, the emerging suppliers are becoming increasingly dependable in terms of quality and on-time delivery, and the OEMs (which are under significant cost and earnings pressure) are awarding greater part shares to Eastern European and Asian suppliers (at least in the commercial arena). In fact, Boeing and Airbus have shifted aircraft production to Asia to account for the growing demand.
Things also are changing at the OEMs themselves. Not too long ago, armies of OEM purchasing agents and supplier development personnel were cutting deals with suppliers on a huge array of new engines. Many of the new engines in the commercial programs are now flying, and the development phase is mostly in the rearview mirror. OEMs will make some internal cuts and redeploy many into component and subassembly cost-cutting programs. OEMs will be challenged internally to develop cost-out programs implementing lean manufacturing, while initiating the same influences within the supply base. Cost targets will become a key factor both in OEM awards and the ability to maintain cost competitiveness.
These factors will be part of an imminent pricing correction in the parts market over the next 12-24 months as OEMs are driven to reduce costs through supplier rationalization, vertical integration and continuous improvement programs through the supply chain. The industry will continue to see “marriages” orchestrated by OEMs between suppliers and private equity-owned suppliers. And OEMs will continue to reduce the number of suppliers by focusing on proffered supplier partnerships that promise to offer a more honed pricing structure.
Where should aerospace suppliers focus their attention? Simple: the lifeblood known as the OEMs’ long-term agreement (LTA). Any aerospace business executive will agree that the OEMs enforcement of both business and legal terms is inconsistent at best, particularly when they need their suppliers to perform. However, when OEMs need to reduce costs, the easiest way to do so is to enforce the many provisions that have been on the books for years using the dreaded “LTA look back” strategy.
Here are places to look the next time you are reviewing your LTAs or bidding on business:
Force majeure: As the coronavirus pandemic grips the world, it is still too early to tell whether OEMs or for that case, suppliers, will need to exercise these “unforeseeable circumstances” clauses in order to address labor and raw material shortages. The key is to be proactive and to document the issues before a dispute occurs if possible.
Cost-savings provisions: There is a lot of emphasis on seeking cost reductions through “joint efforts” by engineers of the OEMs and suppliers. Make sure the language in your LTAs gives you room to develop process changes that will improve your margins while providing a nominal cost cut to your OEM. Savings that are achieved solely through the efforts of the supplier should accrue solely to the supplier. In a long-term agreement with fixed (or declining) pricing, those cost reductions in process are necessary to offset increases in costs for labor, electricity, medical costs, etc., over the course of the contract. Savings that are realized through “joint efforts” can be shared.
Quality and delivery metrics lookbacks are common. Be prepared for a formal letter scrutinizing your metrics with a dollars’ penalty included. Some suppliers negotiate a “statute of limitations” on these lookback periods.
Materials cost increases are often enforced by OEMs. Review the distinction between an OEM directed-buy agreement or supplier purchase and the risk of materials cost increases.
Scrap is a popular lookback item, sometimes defined and sometimes not. The OEMs argument is that they paid for the raw materials; therefore, why should they not get a monthly check for the scrap value?
Indemnification: The dreaded indemnification clause where suppliers put their business on the line: Watch out for provisions that allow for the collection of attorney’s fees in a dispute between the supplier and the OEM (as opposed to a third party). In addition, many newer long-term agreements include overreaching provisions that effectively indemnify the OEM for European REACH requirements and third-party litigation related to intellectual property infringement, but these risks should not reside with the contract manufacturer that is making parts to the OEM specifications.
Volume guarantees: While the comfort of being granted an LTA may be reassuring in the moment, OEMs will second source and put out to bid parts far in advance of the LTA expiration date—often leading to renegotiation of existing business. These headwinds are manageable for Tier 1 and Tier 2 suppliers with careful planning, but the days of flying 800 miles per hour appear to be over.