Commentary by Simon Young & Neil Hampson
Shareholders have reason to be pleased with the recent profit performance of many of the lower tier Top 100 aerospace and defence suppliers. Shrewd acquisitions and market positioning have helped companies such as the UK's Meggitt and DRS of the USA outpace the industry average. These strategies have seen them focus on high-margin sectors, where a technology niche is coupled with long-standing equipment supply contracts, often with a high aftermarket content.
However, for several Tier 2 and Tier 3 supply chain companies there could be some bitter medicine still to swallow. Defence spending has peaked and lucrative re-supply contracts are thin on the ground as ageing platforms are withdrawn. Additional cost pressures as a result of more streamlined contracting processes are stretching the time over which companies would traditionally expect a return on investment. All this means that suppliers at this level are having to look more carefully at their cost bases across group structures in order to keep margins at a level shareholders have become used to.
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In manufacturing terms, most forward-thinking Tier 2 and Tier 3 suppliers have followed the example of the big primes and begun implementing "lean" processes to cut waste and improve productivity. They will also have reduced the amount of working capital they have tied up, by implementing better inventory management and more mature relationships with their customers and suppliers, and may have outsourced some manufacturing to low-cost regions.
However, these actions alone are no longer enough. The challenge for the more visionary chief executives is often unlocking additional synergies and value from "decentralised governance" company structures that have encouraged the formation of silo mentalities in divisions and business units. This has seen the emergence of new forms of corporate organisation with a beefed-up role for head office in IT, strategy, human resources and, most importantly, purchasing. Some, such as Crane Aerospace & Electronics, have centralised most functional organisations and processes, but for others too much of a shift to the centre is seen as disruptive to an often rapidly changing organisation.
The question is: 'How can we unlock additional value from the business without significant organisational upheaval - at least in the short-term?' The answer lies in two areas of purchasing: materials and commodities that support the manufacturing process and indirect services.
Opportunities involve varying degrees of complexity, resources and payback. That may mean finding a catalyst that can deliver savings, without encroaching on an organisation's structure, and operate 'under the radar' from more mainstream direct purchasing, where resistance from divisional and business unit heads can be expected. In indirect services and manufacturing support, this can range from IT, healthcare and travel, through to industrial gases, consumable tooling, freight and logistics.
Companies are finding that where significant numbers of business units are involved and there is little central purchasing in place, savings from combined spending can be as much as 10%. This sort of result can be achieved with little impact on current structures apart from minor central coordination or investment in resources. And it may break down barriers to more group-wide cooperation. To many, the next step will be exploring where group synergies can be achieved in the more protected areas of direct manufacturing purchasing.
Aerospace companies tend to have complicated - and often unique - direct purchasing processes, developed to deal with the complexities of the supply chain. These include: the location of manufacturing plants and key trusted suppliers, manufacturing lead times and national export restrictions. At first glance, the prizes to be had from harmonising purchasing across business units look compelling. But achieving these in a complex manufacturing environment is far from easy.
Nevertheless, there is massive global spending on materials - metals, optics, composites and rubber - machining or casting and electronic components. Savings can really matter to business results in the short to medium term. Where customers and markets allow, evidence from aerospace, defence and automotive sectors suggests that rationalisation of nationally-sourced machining or electronic components could bring savings of 5-15% in the shorter term. Also, in the longer period, low-cost sourcing initiatives in eastern Europe and Asia could reap savings as great as 50% on complex castings and machining, taking into account ancillary costs. It is anticipated that manufacturing costs will remain competitive in Asia until at least 2020.
For lower-tier manufacturers striving to keep or boost profitability, these changes are prompting new thinking about business models that have, until now, proved successful. These companies are having to explore with renewed vigour the value that can be extracted from their cost bases. In the long term, this will involve central and functional rationalisation. But to improve business performance in the short term - without major organisational design and change management - it is purchasing, starting with indirect and then migrating to direct spending, that will be the focus in the next few years.
Simon Young is a director in the performance improvement consulting group at PricewaterhouseCoopers and Neil Hampson is a partner in the strategy group at PricewaterhouseCoopers.
Source: Flight International
