In today’s commercial aircraft production industry, Boeing is being pushed to tighten the pressure on their suppliers in order to produce higher volumes of fuel efficient planes at lower costs. There are multiple forces at work within the industry that are causing OEM’s such as Boeing to place a microscope over their supply chain configuration. Diminished government spending has led to a sharp decrease in sales in Boeing’s Defense, Space and Security market segment, representing their second largest revenue stream. The decline of this segment, coupled with airlines demanding aircraft at lower costs, has required that Boeing lower their operating costs by making significant changes to their supplierrelationships and margin strategy.
Though the aforementioned market conditions are unfavorable to Boeing, there are further reasons why Boeing has decided to rethink their supply chain strategy. Deloitte’s recently released 2014 “Global Aerospace and Defense Industry Outlook” calls for yet another record year for commercial aerospace growth. This projected growth in global production is a result of airlines seeking to swap out older planes for more modern, fuel efficient models. Furthermore, the need to accommodate growth in passenger travel demand in the Middle East and Asia Pacific regions is also contributing to the projected increase in commercial aircraft production. Therefore, not only are declining market segments cause for internal strategic alignment, but other increasing market segments provide even more reason to increase profitability by renegotiating supplier contracts.
Historically within the Aerospace & Defense Industry, operating margins for OEM’s are very low when compared to their suppliers’. Boeing has maintained margins around 10% with its suppliers, while top tier suppliers typically make 15% and lower tier suppliers about 20%. This is unexpected considering the OEM carries the brunt of the risk with adherence to promised dates of delivery and promises of cost reductions to consumers. Seeing that Boeing carries a majority of the risk in the production of commercial aircraft, they have laid out a plan to increase their operating margins to be more in line with their suppliers’. This is yet another reason Boeing and others within the industry are opting to rationalize their supplier base and re-negotiate supplier contracts.
To address the margin structure issue with suppliers and the various other market conditions previously listed, Boeing has launched an initiative they have called their “Partnering for Success Program” in which they are targeting supplier margins that are historically higher than their own and pushing for cost savings. This new program is being implemented with suppliers as Boeing redesigns the 737 and 777 jets, two of their largest running programs. Boeing has indicated that discounts between 15 – 20% will be the starting point for these contract talks which they began in 2013. Thus far, as of mid-February 2014, about one third of contractors have locked in volumes at the requested discounted prices and the rest of the contractors are either still in talks or trying to wait for the program to go away, according to Boeing CEO Jim McNerney. To date, this effort has spawned several billion dollars in committed savings across Boeing’s supplier base.
Though programs like this generate massive savings figures, there are some potential downsides in over-valuing cost efficiency and ending supplier relationships when they are not willing to meet aggressive cost requirements, such as awarding contracts to inexperienced suppliers. For example, Boeing awarded the landing-gear contract on the 777X jetliner in 2013 to Heroux-Devtek Inc., a Quebec based manufacturer and repairer of aerospace and industrial products. This company had no prior experience manufacturing the required landing gear systems for commercial planes and had sales of $233 million in 2013. To put his into prospective, United Technologies, the company who makes the landing gear for the current 777 model posted sales of $63 billion and has extensive experience and knowledge working with Boeing in commercial aircraft production. Switching this work from United Technologies to a company such as Heroux-Devtek Inc. is a testament to Boeing’s commitment in lowering their cost of production and ending relationships with suppliers who are not willing to get on board.
Boeing’s “partnering for success” program seems to be paying dividends with the savings locked in thus far and they continue to ensure quality by enforcing their rigorous standards with new suppliers. However, companies who are long time partners of Boeing continue to resist this unavoidable change in their operating margin structure and as a result Boeing has adopted the mantra of the “no fly list” of companies that are not willing to cooperate. With Boeing’s massive operation and volume potential, as a supplier, you would want to avoid being put on this list.