Monday, June 1, 2009
Supply Chain: Problems and Solutions
In the current downturn, various links in the supply chain are in tension as they struggle to maximize profit. When the cloud lifts, what shape will the system be in? It all depends on how companies are addressing their problems today.
The commercial aviation supply chain is under pressure from vigorous airline cost-cutting and low traffic demand. The various links in the chain are trying to cut costs yet expand their reach, although not always in ways that are best for the overall system. Aggressive outsourcing bids have reduced maintenance, repair and overhaul (MRO) margins, especially on the airframe side. Visibility into lower-tier suppliers is less than clear. And the top suppliers on new aircraft programs are flexing their muscles to the detriment, some say, of airlines and their MRO suppliers.
On the brighter side, MROs still have room to grow and opportunities to cut costs and improve performance. But closer alignment of goals with the airlines is necessary, according to industry analysts. And top suppliers may need to change their tack. Viewed as a new class of monopolists, the big component original equipment manufacturers (OEMs) are driving up the cost of repair and overhaul even in the depths of the recession, according to some MROs. "Because it’s a monopoly market... you have to purchase spare parts from the same guy, and also repairs," says Gunther Kruse, vice president of corporate purchasing for Lufthansa Technik (LHT). "Some people have a cash stream for over 15 years that’s almost predictable for them." Even in a situation like the present, when "the passenger isn’t there anymore, we still have to pay." It’s mainly a question of the component manufacturers’ price structure, he says.
The current crisis is putting pressure on inefficient business models. But it’s also an opportunity to get things right, business consultants say. "Knocking 10 to 15 percent out of your cost base vs. 2 to 3 percent — that’s the type of thing that will be required," says Chris Spafford, a partner with Oliver Wyman. Mark Ozenick, practice leader, aerospace & defense for the Thomas Group, agrees. Simple cost reductions should not be the sole part of one’s strategy, he adds. Bad as it is, the "pink slip atmosphere" produces an openness to change that should be used to implement Lean or other efficiency initiatives.
At the center of the aftermarket supply chain are the MROs. The outlook for North American airframe MROs, given their current single-digit margins, is unpromising without major changes, according to Spafford. Although maintenance outsourcing by North American carriers has grown in recent years, aggressive cost-cutting demands have threatened the sustainability of mode of proceeding.
Spafford advocates changes, such as contract incentives, to the relationship between airlines and airframe MROs. Now contracts typically impose liquidated damages, or financial penalties, for holding a plane late, but there is no "carrot" for consistently delivering planes early, he says. If an MRO can consistently deliver planes early, so that an airline can plan around it, both sides should benefit financially from this alignment of goals. That would increase MROs’ ability to invest in new equipment and strengthen their performance. Spafford argues that a mutually aligned relationship such as that between Lufthansa and LHT can be replicated between other companies.
Spafford also advocates component pools, where airlines get almost immediate cash infusions and MROs get a return on invested capital. This practice is common in Europe, and LHT has increased its parts pools, offering "the entire spectrum of parts down to consumables," says Kruse. Nevertheless, parts pooling is not common in North America because of insufficient investment, unique maintenance programs, lack of parts commonality and the reluctance of engineering groups to participate for reliability reasons, Spafford says.
MROs Vs. OEMs
Perhaps the greatest challenge in the commercial aviation supply chain, from an MRO perspective, is the realignment that has occurred between airframe and component OEMs. In the past, buyers of new Boeing and Airbus airplanes had access to data that allowed them or their MRO providers to maintain and overhaul components independently. But because of the airframers’ rationalization of their supply chains, reducing the number of players, the airplane makers may have negotiated away the rights to component intellectual property (IP) in exchange for favorable upfront terms. So it’s tougher for airlines and MROs to find the technical data to overhaul a component, making the process much more complex than it was in the past. While the IP shift may have accelerated new aircraft development and lowered purchase prices, it has come with a "sustained, longer-term cost by making it more difficult for MRO providers to perform some of their work," says Lon Chaney, TIMCO vice president for corporate planning and pricing.
LHT agrees. "Many suppliers are in fact monopolists [and] continuously expand their roles in the aftermarket," making relationships increasingly complex for MROs, Kruse says. "The liberty to make ‘make or buy’ decisions on parts repairs is more and more limited by [restricted] access to the required documentation," he adds.
This situation is at the root of "unjustified cost increases for our airline customers," Kruse says. LHT is trying to inject more competition into the supply chain through its parts manufacturer approval (PMA) and surplus activities. "We don’t like the OEMs being in the repair business and they don’t like us to be in the manufacturing business," Kruse says. But being part of an airline group gives LHT a "lever" to obtain necessary documentation for repairs, he says. "We are much better off than an independent."
TIMCO offers the example of overhauling a composite flight control, such as an elevator, to illustrate the IP problem. Previously, an MRO could get the data required to build test equipment or tooling, but "this is not always the case today," Chaney says. A provider can still do repairs, via the structural repair manual, without going back to the manufacturer. But an overhaul, where there might be a need to change the skin and have a form made, might not be possible because you don’t have the IP. It would seem that some component OEMs don’t want to sell MROs the data because they want to provide and control the overhaul services themselves, he suggests. "The real question for an airline is how do you find that happy medium, where you can buy a reasonably priced aircraft, but also safely and efficiently maintain it without finding out that the initial transaction drove a sky-high, long-term cost."
Kruse is calling for the adjustment of the "entire [component] pricing system in the industry." There are 15 to 20 big OEMs who are setting the pace of progress, he says. "They try to keep their margins at a constant level, whatever comes" and usually react to crises by reducing R&D investments. "There needs to be more of a balance in the industry, so that risk associated with transporting passengers and goods is distributed throughout the supply chain." But it’s questionable whether there’s enough pressure to force the component OEMs to adapt their structures and cost levels to what the airlines can afford, Kruse says.
LHT keeps close tabs on its suppliers, especially those that combine annual list price increases with bad overall performance, Kruse says. LHT meets with its top 15 or so suppliers — accounting for about half its purchasing volume — while monitoring smaller suppliers through "supply relationship managers." While LHT has "bonus/malus" (reward/penalty) systems in place, mainly for delivery performance, "more risk sharing along the supply chain" is in order, Kruse says.
Visibility into Tier 2 and lower-tier suppliers is also an issue. The "overnight" scarcity of raw materials used in engine blade coatings and quality problems with bearings in recent years are examples of problems that can arise, Kruse says. While LHT, as an MRO, "generally has very little visibility into this segment," he notes, "we are prepared to play a different role and actively challenge the OEMs for more transparency." LHT, for one thing, imposed penalties, so the OEMs "became very vigilant." And supply issues that were related to a raw materials price increase were lessened by the current economic crisis, which reduced demand. But the industry remains very sensitive to the performance of rather small partners in important parts of the supply chain, Kruse says.
Meeting the Challenge
Offshore sourcing is one way for MROs to cut costs. TIMCO, for example, the largest independent, third-party heavy maintenance supplier in North America, is doing this with a twist. Last year it formed a partnership with COOPESA in Costa Rica to provide a lower-cost alternative for North American (particularly U.S.) airlines that are using or seeking a Latin American solution. The partnership, which will provide airframe MRO services for narrowbody aircraft, could reduce labor costs by more than 20 percent on high-volume contracts, according to the company.
The unusual side of the deal, according to TIMCO, is that the American company will establish the contracts and provide management oversight, using onsite TIMCO employees. "One of the reasons a lot of airlines have been reluctant to explore sources of supply in Central America and points south has been the concern about quality," says Len Kamerski, TIMCO’s vice president of marketing and business development. TIMCO is trying to show customers that this service will provide all the integrity they would expect from a North American source of supply, he says.
In the first phase of the partnership, TIMCO has worked with COOPESA to establish maintenance practices and protocols. "Lean initiatives, including extensive process mapping and waste reduction, have been implemented to increase efficiency and throughput," Chaney says. The companies have also installed a new fire suppression system and new hangar doors. The first customers are expected in coming months.
TIMCO has also expanded materials management service "every year for all types of operators," from low-cost to legacy, Chaney says. "If you’re not providing a service enhancement, you’re losing your competitiveness." Low-cost carriers (LCCs) have been outsourcing materials management for some time, but legacy carriers are increasingly moving in this direction as well. "The large operators now are turning much higher dollar volumes of purchases over to us," Chaney says. "In the case of a C-check, for example, there may be 30 components on an aircraft that have to be changed out and overhauled per a time limit," he adds. The carrier may provide a list of approved suppliers with whom they have pricing agreements, and TIMCO will find the best deal for these components, managing them "from aircraft to aircraft." These purchases generally include hydraulic and pneumatic components and larger structural components for controls such as elevators and ailerons. But most carriers prefer to handle wheels and brakes, landing gear, engines and avionics through their existing commodity contracts.
With legacy carriers, there’s still a mix between external and internal control, Chaney says. Airlines use so much Skydrol in line maintenance, for example, that they prefer to provide the fluid themselves. The degree of outsourcing also varies with aircraft age. Some legacy operators with large, aging fleets are locked into insourcing, to a certain extent, because of their investments in test and overhaul equipment and large inventories at base and even line locations, he says. "On the line, operators that have outsourced work at a location seem generally to procure key items and safety stock, but will look to the provider to manage the inventories." But TIMCO is adding to its line maintenance portfolio and sees the area, along with line materials management, as a potential growth avenue. In the last year it has doubled the number of TIMCO-owned line service locations.
Parts distributors are the bedrock of the supply system. One of the largest, Aviall, moves parts for some 230 suppliers. The Dallas-based company has parlayed its understanding of demand and its status as part of the Boeing brand to prosper even in the recession.
Aviall’s business model and systems are built around creating forecasts and aggregating demand, says Ed Dolanski, senior vice president of operations. The ability to use historical data and "forward-looking statistics" in the market to consolidate demand and build an up to 18-month forecast of what parts are needed drives suppliers’ risk virtually to nil, he claims. Forecasts are based on "solid orders" and are attuned to manufacturers’ lead times. "So, if they produce it for our purchase order, I’ll take it," Dolanski explains. Aviall boasts a 99.7 percent fill rate on forecasted parts across the company, he says. The company stocks more than 100,000 OEM parts worldwide.
Charles Elkins, senior managing director or marketing and supplier services for Aviall, helped lead an April 21 tour of the company's facility in Dallas, Texas.
Not surprisingly, Aviall directs 95 percent of its capital spend to maintain and enhance its IT capability. Its ability to predict demand cycles is particularly important to its engine support business, which typically involves engines in their "twilight years" of production or out of production. A recent exclusive deal on GE’s CF34-3 engine provides Aviall the lifetime contract for the distribution of the system’s unique, non-life-limited parts.
Aviall also has increased its responsibilities as a repair broker. Its new Part 145 operation receives parts from customers operating Boeing-built airplanes, classifies them and sends them out to qualified repair companies. On return, Aviall inspects the parts under the Boeing quality system, approves the repairs and forwards the parts to the customers. This service is run as an extension of Boeing’s material management business. It could be a growth opportunity, if another airframer should seek similar service.
Software and Services
A variety of products and services are available to help manage the supply chain. For example, MCA Solutions provides service, planning and optimization software either through perpetual licenses or hosted service. The application focuses on functions such as the forecasting and positioning of parts, says Tim Andreae, senior vice president of global marketing. MCA numbers Rockwell Collins and Bombardier among its commercial aviation customers.
Rockwell Collins chose to purchase the software, which it uses as its primary aftermarket planning system, Andreae says. According to a "case study" on the Collins application, the avionics company cites features such as strategic inventory planning across a multi-tiered distribution network; forecasts, using historical demand, installed base and causal data; dynamic asset management; and "what-if " scenario planning. Collins uses the application at more than 27 locations, including a global distribution center, U.S. service centers, international subsidiary maintenance sites and mobile calibration vans. The software helps the firm manage the supply chain for more than 100,000 consumable materials and more than 5,000 repairable assets.
Exostar, an electronic data interchange (EDI)-type network connecting more than 40,000 companies — including aerospace giants — provides a portfolio of on-demand business applications for real-time visibility and other supply chain management functions. Much attention is also paid to security and identity assurance that would hold up legally, according to Peter Scott, vice president of supply chain solutions.
Boeing started using Exostar with the 787 four years ago in order to get visibility into Tier 1 and Tier 2 suppliers. The software sends out alerts based on exception management. It allows users to add as many tiers as they want, although "Tier N visibility for everything is just not worth it," Scott says. Typically, you want visibility into your high-spend, long-lead time vendors. In the future, however, Exostar hopes to sign up Tier 1 and Tier 2 suppliers, themselves, to provide them visibility into their supply chains.
Exostar allows visibility into key checkpoints in the supply chain, based on electronic documentation, such as advanced shipping notices. After manufacturers enter their schedules and suppliers concur, the "system simply bubbles up exceptions," Scott says. Users can also look at how much inventory is stocked at particular nodes or chart trends such as the percentage of suppliers that ship on time only 75 percent of the time. The Web-based "dashboard" can also be configured to provide performance reports.
The network further allows manufacturers and their supplier teams to form virtual working environments, where they can securely exchange documents, create project plans and have meetings, Scott says. BAE Systems, for example, uses the system for maintenance review boards in which U.S. and U.K. government agencies participate.
‘Brute Force’ Management
For industrial scale supplier visibility, there is DNBi Supply Management, a Web-based service from Dun & Bradstreet (D&B) that allows parts users to monitor the financial, regulatory, legal (lawsuits, liens, judgments), geopolitical and other potential risk areas of suppliers down the chain. The system also looks at more conventional information such as order accuracy and on-time delivery, based on aggregated data. DNBi Supply Management helps aerospace and defense companies understand where they have suppliers at risk, explains Jim Lawton, D&B vice president and general manager for supply management solutions. A lot of customers, he says, have 50,000 suppliers but may have fewer and fewer employees managing them. How do they know which suppliers to focus their time on? DNBi relies on a financial database that tracks the fortunes of about 140 million companies worldwide, with about 1.5 million updates daily. The software uses predictive analytics and financial modeling to help a manufacturer, for example, identify which small subset of his 50,000 to 100,000 suppliers is at risk. Some customers get information feeds every six hours, based on information changes. D&B is good at predicting, Lawton says. "We project 92 percent of all U.S. bankruptcies at least six months in advance." In a majority of cases, he claims, one discovers a bankruptcy only after it occurs. If the item supplied by the at-risk company is vital to the customer’s product or service, it is important to know of the supplier’s weakness in advance. Otherwise extremely expensive, though very common strategies might have to be deployed, such as acquiring the supplier or paying all its bills, so it can continue operations. Extra time could give the user the opportunity to craft a less drastic form of intervention. Users can apply the D&B service to help select suppliers as well as monitor their health and performance. Clients can also receive email alerts and reports, dealing, for example, with suppliers by program, category or geography.