From coping with the COVID-19 pandemic to financing eventual recovery, many aerospace and defence supply chains are under pressure. Complicating the picture are a number of sector-specific issues that require companies to take rapid action to reduce risk, resolve immediate issues and reset for the future. Even factoring in some post-pandemic recovery and the ramp up of Boeing 737-related activity, it is expected to take some time before the sector reaches pre-crisis levels of activity. Add longer term trade uncertainty with Brexit to the picture, and supply chain issues look more prevalent and longer lasting than initially anticipated.
Identifying and mitigating risks in your supply chain
Greater globalisation of supply chains, while providing benefits in terms of cost, can also increase complexity and reduce visibility over suppliers. This is heightened by the number and complex interdependent tiered nature of relationships within A&D supply chains. While an aero engine manufacturer is a key part of the overall manufacturing supply chain, it will also, effectively, have its own specialist supply chain producing individual components.
Global supply chains have also adopted digital technologies and are vertically integrated. Again, while this can generate efficiencies, it can also make it more difficult for the business at the top of the supply chain to spot any potential risks quickly, be they financial or operational, and take immediate action. Without early identification and swift mitigation, such risks can prove substantially disruptive and costly.
Specialisation can reduce flexibility
The added challenge for the A&D industry is that the technical, safety and security aspects of their work mean that supply chains are often specialized and require suppliers to be pre-qualified. This process can be both costly and time consuming, creating barriers in terms of both sourcing new suppliers and exiting existing relationships.
National security requirements may also limit the choice of or dictate the use of particular suppliers, further restricting manufacturers’ options to flex their supply chain. In a highly regulated industry, onboarding new suppliers can also be more challenging.
Over the last decade, the use of collaborative agreements, based on risk and revenue sharing arrangements, have become common across many elements of the sector’s supply chain, including development, production, manufacturing and after-market activities. This has been beneficial for manufacturers in terms of incentivisation and capital expenditure. But it also adds strain when demand drops – as we are seeing now due to the COVID-19 pandemic – because the impact spreads down the chain, putting more pressure on the weaker links.
Before we move on to those external pressures, it is worth noting that, while historically, many suppliers may have enjoyed higher profits, many of them have entered the current market turbulence with weaker balance sheets and less support from those further up the chain.
Market pressures intensify
With airlines globally expected to post a collective loss of US$84bn in 2020,1 the impact of the COVID-19 pandemic on the commercial aviation sector has been devastating. Airlines have responded aggressively by cutting variable costs through, for example, reducing flights to slash fuel costs and restricting flight hours to reduce the need for maintenance checks. Airlines also intend to use current pressures as an opportunity to retire old aircrafts sooner and consolidate operations around fewer aircraft types. Manufacturers have been hit hard, with aircraft deliveries dropping by 55% in 2020,2 with a forecast of 4,000 fewer aircraft in circulation by 2030.3 While the defence sector has not suffered a fall-off in demand, many manufacturers and suppliers within the A&D sector serve both markets. The danger here is that suppliers, already weakened by lower demand from the commercial aviation sector, are unable to fulfil their commitments to defence companies.
Add to that the physical problems of maintaining production during the pandemic, from entire factories being closed or repurposed to social distancing slowing production. And with continued uncertainty over the global economic outlook, suppliers’ liquidity is now becoming an increasing concern.
Even as the positive news of vaccine approvals boost equity markets and raises hopes of a return to something close to normality, the pressures on A&D supply chains do not necessarily lessen. Those companies relying on government support may find it tapering off, just at a time when they need to spend more to resume or increase production.
Changing dynamics add turbulence
The impact of the COVID-19 pandemic may also change the type of planes being produced, favouring fuel efficiency (electrification) and shorter trips. Original equipment manufacturers (OEMs) anticipate that, in the future, airlines may demand a higher volume of planes that are smaller, fly shorter distances and are more fuel efficient. While narrow-body aircraft deliveries are expected to be 20% lower on average in the next four years, wide-body deliveries are forecast to be 30% lower on average over the same period.4 This may put further pressure on supply chains as they realign to changing market dynamics.
As businesses seek to reduce production costs, they are looking to increase automation and embrace new technologies, from artificial intelligence to additive manufacturing of parts. Such transformation is expensive, however, and many suppliers will require external investment or new ownership in order to keep pace.
In such an environment, we anticipate that OEMs and suppliers will act to safeguard the supply chain by taking over and consolidating some of their lower tier suppliers. Private equity groups may also see opportunities in the sector. Those most at risk of takeover may be particularly exposed to commercial aerospace markets, operate in more commoditised sectors and have lower access to capital.
Building a clear picture
Given the factors already described, doing nothing is clearly not an option. But, given the multitude of complex and interlinked factors, deciding what to do can be challenging.
The approach outlined below can help to identify problems with specific suppliers, while also ensuring the overall effectiveness of the supply chain:
- The first stage is to anticipate and prevent problems by developing the risk management framework and reporting procedures needed to gain greater visibility over suppliers.
- Monitoring the financial health of key suppliers will also help to build a better picture of risk within the supply chain, with independent business reviews carried out where a more in-depth appraisal of key suppliers is needed. From this information, it will then be possible to develop strategic options for mitigating risk in the supply chain and active management of individual supplier distress or failure.
- Armed with this insight, it will be time for hands-on problem solving, connecting with the supplier and assessing all possible areas of concern, ranging from quality problems to logistics disruption and from workforce shortages to working capital issues.
Taking action to reshape supply chains
Where action is required, it will be vital to deploy professionals with real-world supplier trouble-shooting experience to lead change and project management programmes. As the list of potential issues indicates, it is likely that multiple skillsets – from finance and operations to IT – will be required, so it is important to leverage a broad expertise and knowledge network. This will provide a wider range of options, from performance improvement to optimising working capital and from acquisition to joint venture.
Making sure that all the actions taken with individual suppliers contribute to the organisation’s overall objectives is clearly also crucial, so decisions on acquiring, divesting or digitising certain elements of the supply chain must be made in relation to strategic drivers.
Once the above actions have been taken, the task is not over. Supply chains are dynamic, multi-faceted ecosystems that are continuously changing and need constant monitoring.
Root cause analysis will not only identify the individual problems but can also flag whether the underlying issue may affect other parts of the supply chain. Any solution can then be leveraged to prevent further disruption, ensuring a healthy and resilient supply chain is maintained.
As the sector begins to look beyond the COVID-19 pandemic, there is an opportunity to not only deal with immediate problems but also reshape supply chains for the future. This will enable A&D companies to respond more effectively to changing demand and new technologies, while positioning themselves to benefit from post-pandemic recovery. How will you ensure a resilient supply chain for the now, next and beyond?