What the world's aerospace industry leaders are thinking: Implications for the supply chain

What the world's aerospace industry leaders are thinking: Implications for the supply chain Midlands Aerospace Alliance Annual Conference Derby, 18th March 2014 Robert Thomson Partner robert_thomson@rolandberger.com

Every year Roland Berger conducts a survey of senior executives within the Aerospace & Defence industry across Europe Description of survey Survey responses from more than 100 senior managers 70 firms represented, covering a range of business segments Examples of participating companies Coverage of different positions on the value chain, from OEMs to Tier-1, Tier-2 and pure service providers Approximately one third of the participants are CEOs 2

In the civil sector, six key challenges were identified in our 2013 survey Key challenges in the civil aerospace sector 1 2 3 4 5 6 Globalisation, and management of a global supply chain Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation 3

In Defence, the principal concern of 86% of respondents was reduced government spending Key challenges in the Defence sector Misc. / other 14% 86% Reduced government spending 4

In the civil sector, six key challenges were identified in our 2013 survey Key challenges in the civil aerospace sector 1 2 3 4 5 6 Globalisation, and management of a global supply chain Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation 5

1 GLOBALISATION Globalisation is a three stage process during which markets and industries become more geographically integrated Principal characteristics of globalisation 1 Internationalisation 2 Multi-nationalisation 3 of trade of production > Trade in goods and services across borders > Not a new phenomenon > Establishment by firms of production facilities outside their country of origin > Transfer of production technologies and knowhow > Capital flows in foreign direct investment Geographical distribution of innovation > Location of R&D facilities outside company's country of origin > Establishment of local networks to tap into new sources of innovation > Development of technologies for world markets (not just local customisation) Drivers of increased globalisation > Fewer tariff barriers > Free capital movements > Reduced communication costs > Lower transport costs 6

1 GLOBALISATION Aerospace companies in our survey expect an increase along all three dimensions of globalisation Share of activity outside Western Europe [%] 1 2 3 Internationalisation of trade Multi-nationalisation of production Geographical distribution of innovation +15% 40% 55% 30% +10% 40% 20% +10% 30% Current Target Current Target Current Target 7

1 GLOBALISATION To date, Aerospace has been one of the least globalised industries OED ranking of industry sectors by degree of globalisation 1 Computers 10 Petroleum refining 2 Basic chemicals 11 Textiles 3 Pharmaceuticals 12 Basic metals 4 Electronic equipment 13 Minerals 5 Non-electrical machinery 14 Aerospace & other transport > Two thirds of computers are manufactured in Asia > Half of car production is now in Asia > 2% of civil aircraft are assembled in Asia 6 Electrical machinery 15 Food 7 Automotive 16 Furniture and wood 8 Other manufacturing 17 Paper & printing 9 Plastics & rubber 8

In the civil sector, six key challenges were identified in our 2013 survey Key challenges in the civil aerospace sector 1 2 3 4 5 6 Globalisation, and management of a global supply chain Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation 9

2 PRODUCTION RAMP-UP Production rates continue to climb for established programmes, particularly narrrowbodies Production rates, 2010-16 [no. of aircraft] Narrowbody Widebody 600 A320 120 A330 500 100 B777 400 B737 80 300 60 200 40 100 20 0 2004 2006 2008 2010 2012 2014 2016 0 2004 2006 2008 2010 2012 2014 2016 10

2 PRODUCTION RAMP-UP In addition, the planned ramp-up of 787 and A350 is very fast by historical standards Production ramp-up, Years since EIS [no. of aircraft] 787 A350 180 Boeing 787 180 150 150 Airbus A350 120 120 90 Boeing 777 90 Airbus A330 60 Boeing 787 60 30 Boeing 767 Boeing 747 30 0 0 Y1 Y3 Y5 Y7 Y9 Y11 Y13 Y15 Y17 Y1 Y3 Y5 Y7 Y9 Y11 Y13 Y15 Y17 Forecast production rate Historical production rate, Boeing 787 Historical production rate 11

2 PRODUCTION RAMP-UP These combination of higher production rates and new programme 2 Production ramp-up is generating concern about capacity in the supply chain Production rates continue to climb for established programmes, particularly narrrowbodies Production rates Production rates, 2010-16 [no. of aircraft] Narrowbody 600 500 400 300 200 A320 B737 Widebody 100 20 2 Production ramp-up 0 0 In 2004 addition, 2006 2008 the 2010 planned 2012 2014 ramp-up 2016 of 7872004 and 2006 A350 2008 is very 2010 2012 fast 2014 by 2016 historical standards Ramp Production up ramp-up, of new Years since programmes EIS [no. of aircraft] 787 A350 180 150 120 90 60 30 0 Y1 Y3 Y5 Y7 Y9 Y11 Y13 Y15 Y17 Boeing 787 Boeing 777 Boeing 787 Boeing 767 Boeing 747 180 150 120 120 100 Forecast production rate Historical production rate, Boeing 787 Historical production rate 90 60 30 0 Y1 80 60 40 Y3 Y5 Y7 Y9 Y11 Y13 Y15 ACQG-LON-MAA-2014-04.pptx Y17 Airbus A350 Airbus A330 A330 B777 10 > Current level of production is approximately 36% higher than the pre-911 industry peak > Corresponding strength in other markets (e.g. Industrial Gas Turbines) placing further pressure on the supply chain > The effect is a search for new suppliers to generate: Extra capacity Security of supply Lower cost ACQG-LON-MAA-2014-04.pptx 11 12

In the civil sector, six key challenges were identified in our 2013 survey Key challenges in the civil aerospace sector 1 2 3 4 5 6 Globalisation, and management of a global supply chain Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation 13

3 NEW ENTRANTS New competition from emerging markets seen as having the biggest potential influence on industry structure in 2020 2013 survey: "What factors will determine the shap of the industry in 2020?" New competitors from emerging markets 28% New OEM business model 26% New end customer requirements 21% New technolgoies 18% Entry of new competitors from outside A&D 7% 19 14

3 NEW ENTRANTS New entrants from emerging economies (C919, MS21, ) will reverse the trend of the last 25 years Regional aircraft production, 1989-09 [no. of units] 450 400 350 300 250 200 150 100 50 0 Exit of Shorts Exit of Fokker Exit of Saab 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Fairchild Dornier Raytheon BAE Saab Fokker Shorts Bombardier Embraer Exits of BAE & Raytheon Exit of Fairchild Dornier 15

3 NEW ENTRANTS Innovation is seen by established companies as a key lever to defend against the new entrants Importance of innovation in the next decade relative to the past Less important 9% 91% More important Characteristics of innovation > Innovation is expected to become a key differentiating factor for Western companies relative to emerging competitors for which: Operational performance (OTD, OTQ) is progressively approaching Western standards Lower costs provide a competitive advantage > The main objectives of innovation are: Increasing the value of products/services to customers (25%) Reducing costs (24%) Reducing time to market (17%) Source: Roland Berger "Top Management Issues radar 2012" Survey 16

In the civil sector, six key challenges were identified in our 2013 survey Key challenges in the civil aerospace sector 1 2 3 4 5 6 Globalisation, and management of a global supply chain Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation 17

4 NEW PROGRAMMES All the major new airframe and engine product strategy decisions have been taken in the last 10 years, and are now in development Engine options by airframe Airframe Engine options Airframe Engine options Airbus A318-321 Airbus A320-NEO Airbus A330 Airbus A340-500/600 > Trent 500 Airbus A350 Airbus A380 Bombardier CSeries COMAC C919 > CFM56 > V2500 > (PW6000) > PW1100G > LEAP-X > CF6 > PW4000 > Trent 700 > Trent XWB > GP7000 > Trent 900 > PW1500G > LEAP-X Boeing 737-6789 Boeing 737-MAX Boeing 747-8 Boeing 767 Boeing 777 Boeing 777-X Boeing 787 Irkut MS-21 Mitsubishi MRJ > CFM56 > LEAP-X > GEnx > PW4000 > CF6 > RB211-524 > GE90 > Trent 800 > PW4000 > GE9x > GEnx > Trent 1000 > PW1400G > PW1200G Source: Teal Group, Roland Berger 18

4 NEW PROGRAMMES Few new aircraft programmes combined with the industry demographics may result in a dramatic loss in experience Age profile of employees in the Aerospace & Defence industry 2008 age profile 2028 age profile >65 5% >65 5% 55-64 19% 55-64 19% 45-54 33% 45-54 14% 35-44 21% 35-44 5% 25-34 16% 25-34 22% <24 6% <24 35% Due to retire in the next 20 years New recruits required to replace existing employees Source: Teal Group, Roland Berger 19

In the civil sector, six key challenges were identified in our 2013 survey Key challenges in the civil aerospace sector 1 2 3 4 5 6 Globalisation, and management of a global supply chain Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation 20

5 FUTURE SUPPLY CHAIN STRUCTURE The airframe OEMs have been on a long-term journey towards outsourcing more work and becoming large system integrators Aircraft system > Design and integration inhouse > Systems outsourced 5 6 Low cost providers and emerging countries Risk sharing > Tier-1 suppliers provide complete systems > R&D costs are supported by the supplier Subcontract aircraft systems Equipment > R&D, design, production & integration inhouse 2 1 Reduction of the number of suppliers Outsource component manufacturing 4 3 Develop partnership with large suppliers Early involvement in studies > Suppliers are invited to participate in the aircraft basic or detailed design Value chain position Financial considerations Reduce equipment cost Reduce system cost Reduce investment 21

5 FUTURE SUPPLY CHAIN STRUCTURE However, the varying degree of success of their endeavours is resulting in a number of ongoing questions Questions for OEMs What activities are really core for an OEM to undertake? What should RSP 2.0 look like? Which activities can be better performed in the supply chain? How do you differentiate your products if all airframers are sourcing the same systems? How do you reconcile the requirements of different internal departments? Programme, Procurement or Engineering 22

In the civil sector, six key challenges were identified in our 2013 survey Key challenges in the civil aerospace sector 1 2 3 4 5 6 Globalisation, and management of a global supply chain Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation 23

6 OEM PROFIT IMPROVEMENT Improving profitability naturally leads to a focus on the largest costs, which often reside in the supply chain Operating profit components and drivers Constrained pricing Revenues Unconstrained pricing Operating profit Procurement Costs Supply chain/logistics Assembly In-house production Development Indirect 24

6 OEM PROFIT IMPROVEMENT There is a trend towards more sophisticated joint OEM-supplier improvement plans Potential support actions to address OEM-supplier relationships Internal ways of working monitoring (permanent customer representation) Intrusive Joint Improvement Plan (JIP) Coercive Internal ways of working monitoring (KPIs) Strengthening of contractual requirements Non-intrusive Internal ways of working monitoring (audits) Ad hoc joint plateau Systematic feedback to suppliers Reinforcement of incoming inspections/quality checks Ad hoc onsite support Supportive Source: Roland Berger 25

Conclusions 26

CONCLUSION In conclusion, some reasons to be cheerful, and a number of threats to be concerned about Defence 1 1 Decreasing defence spending Civil Aerospace Globalisation, and management of a global supply chain > Some reasons to be cheerful Deliveries at an all-time high (and more to come?) New programmes in development 2 3 4 5 6 Production ramp-up and rate readiness Threat of competition from new entrants Implications of few new aircraft programmes Future supply chain structure (RSP 2.0) Improving profitability and cash generation > A number of threats about which to be concerned Global competition in the supply chain New entrants, favouring local suppliers Limited number of new programmes OEMs focusing on reducing supply costs 27

CONCLUSION UK-based Aerospace suppliers need to reflect on how long they will compete in future in a global market Implications for suppliers Short term Ensure cost base is competitive Medium term Exploit current (but transient) barriers to new entrants Long-term Focus on innovation > Lean operations > Secure access to low cost manufacturing and sourcing > Ensure perfect operational performance (OTIF, OTQ) Essential pre-requisite > Target specific stages of product lifecycle, e.g. Development, NPI Strangers & aliens > Product focus (e.g. large or high value) May not be sustainable in the long-term > IP generation as source of long-term, sustainable competitive advantage > Must be constantly refreshed through reinvestment > Business model innovation can play a role (e.g. core vs. non-core debate for OEMs) Long-term focus 28

Roland Berger Aerospace & Defence Competence Centre STRATEGY / M&A Corporate Strategy and Business Unit Strategy Services and Support Strategy Marketing / Business capture Mergers & Acquisitions / Alliances Corporate / BU Organisation Redesign A&D PRACTICE > 25 senior industry specialists > 50 clients operating globally > 500 projects in A&D completed since 2000 > Experience at all supply chain levels > Network of other stakeholders Post Merger Integration R&D Efficiency / Product Policy and Innovation Programme Management Efficiency OPERATIONS Supply Chain Optimisation Purchasing and Supplier Management Optimisation Manufacturing Performance Optimisation 29