Equipment and capital goods manufacturers have increasingly re-discovered new and growing revenue opportunities that reside in added services and service parts sectors related to in-service equipment. Such opportunities are especially pertinent across commercial or defense focused aircraft which have operational service that spans many years of service. However, when an industry dominant such as Boeing decides that it wants to take more control as well as revenue cut of all service parts, the financial implications and subsequent impacts will reverberate among all key suppliers.
Today’s edition of The Wall Street Journal reports such an implication as Boeing elects to secure a new source of revenue beyond building aircraft. (Paid subscription required) The report indicates that whereas in the past, Boeing’s largest suppliers such as Spirit AeroSystems or Rockwell Collins could sell respective manufactured parts directly to airline and aircraft operators for in-service service replacement needs, the OEM elected in late February to prohibit suppliers from directly selling proprietary service parts, along with suspending licenses to suppliers to sell any such proprietary parts to its customers. The WSJ characterizes this development:
“It is the most aggressive move to-date in Boeing’s year-long effort to assert control over distribution-and the resulting revenue- of parts.”
According to the report, Boeing is looking to nearly triple revenues associated with commercial and defense aviation parts and services business by 2025.
Supply chain teams in these sectors know all too well that margins on service parts can far exceed those for original equipment production needs. According to the WSJ, it can be upwards of 4X more than what Boeing pays for the part to support initial production. Suppliers will often forego margins on supply contracts to a customer such as Boeing with the expectation that multi-year margins can be garnered in service parts needs over the operating life of an aircraft model.
In a highly regulated industry such as commercial or defense focused aircraft, certain structural or key operating parts have designated service-life provisions which must be adhered to, thus assuring ongoing component stocking and service part demand needs.
The WSJ report further links these moves to Boeing’s ongoing Partnering for Success initiative addressing added cost control opportunities among existing suppliers. According to the report:
“Boeing also prohibited some suppliers from being given new work or withheld regulatory approvals for parts until revised (supply) contracts were complete.”
The report cites a Credit Suisse aerospace industry analyst as indicating:
“The economics of being a Boeing supplier could be facing their greatest challenge yet.”
While airlines themselves have become increasingly concerned by the rising prices of service parts charged by suppliers, by our Supply Chain Matters lens, this revised strategy by Boeing does not necessarily address nor mitigate that trend. It obviously takes away profitability opportunities for suppliers while adding yet another intermediary in the service parts supply chain.
One of the most promising service management opportunities related to commercial and defense focused aircraft resides in the leveraging of Internet of Things (IoT) focused technologies that would allow operating equipment the ability to communicate service and replacement needs based on operating environmental conditions. Rather that static, fixed maintenance schedules, the opportunity is for the equipment itself to self-diagnose its parts replacement needs.
Many original equipment manufacturers are thus positioning to take advantage of such technologies in new service focused business models. That includes aircraft engine producers such as General Electric and CFM International. With this latest move by Boeing, a new participant is added to the overall business model, a participant that must share the same technology tenets being promoted in automated performance monitoring and service dispatch. Add the notion of IoT platform providers positing for their portion of the overall business model via platform adoption and subsequent dominance, and the picture begins to turn to one we have witnessed before with breakthrough technology. Every participant attempting to position for leveraged control of a promising new business model while target customers have to determine what all of this implies for added efficiencies or cost savings.
The dilemma of commercial aircraft supply chains that presented multi-year order backlogs and insatiable demand for more fuel-efficient technology-laden new aircraft has met the reality of more educated and aggressive airline customers, coupled with rapidly changing economic times. These forces are inserting their influence on aircraft pricing, delivery expectations and operating service needs.
Boeing is now responding to these needs by aggressive supply chain cost and headcount reductions, and now, demanding its proportional cut of service parts revenues. In essence, like too many supply chain dominants, the picture is again moving the need of cost reduction or added revenue needs down the supply chain.
More and more, the notion of we are all in this to share industry growth opportunities together reverts back to the supply chain dominant as the ultimate long-term benefactor.
Respective suppliers will obviously have to determine their own response strategies. Larger suppliers will be able to find means to remain resilient to such changes while smaller suppliers may feel the bulk of the pain. In the long-run, the party that ultimately controls the customer relationship along with product and process design ends up to be the eventual winner.
As far back as 2014, Supply Chain Matters provided commentaries relative to the defective air bag inflator crisis that was impacting multiple global automotive brands. Even then, the product recalls involving airbag inflators supplied by Takata Corp. of Japan were estimated to be in the millions.
In an October 2014 posting, Supply Chain Matters echoed business media reports that brands such as Honda, were undertaking steps to seek out alternative suppliers, not only to provide augmented supplies of air bag inflators required to retrofit millions of recalled vehicles, but also to become a replacement supplier for current and future production needs. We noted that rival air bag suppliers that could benefit from the ongoing crisis included Autoliv, DaicelKey Safety Systems and TRW Automotive Holdings, which at the time was being acquired by German based ZF Friedrichshafen. We further pointed out that switching suppliers that support one or several global product platforms is somewhat more challenging from a timing perspective.
Flash forward to today and specifically a recent Bloomberg Businessweek report titled: The Company That Came out on Top After Takata’s Air Bag Mess. The report indicates that largest automotive-safety parts company in the world has successfully been able to step in and respond to the Takata focused crisis. This supplier actually began supplying air bags as far back as 1980. Amid the current wave of product recalls, Autoliv produced inflators are noted as emerging relatively unscathed in the crisis.
The overall scope of the defective air bag inflators is massive, with upwards of 60 million recalled vehicles on a worldwide basis. Noted is that about 28 million Takata air bag inflators have been recalled in the U.S. alone.
Autoliv expects to produce 20 million replacement inflators since alternate production began in 2015, and extends through 2017. Once more, the supplier indicated to Bloomberg that it had won about half of all frontal air bag orders for newer cars last year. This supplier is forecasting sales growth of 7 percent annually, a fairly healthy rate for a lower-tiered automotive supplier.
Once more, Bloomberg points to Autoliv’s newer focus on the supply of more sophisticated safety components for autonomous vehicles such as radar, vision sensors and other crash avoidance safety systems ranging from standard sedans to luxury vehicles. According to a recent Boston Consulting Group study, within the next decade, one in eight cars sold around the world will have autonomous features. Bloomberg reports that Autoliv components are contributing to autonomy features in cars like Daimler’s new Mercedes-Benz E-Class, which can steer itself in auto-pilot mode, brake in emergencies and evade obstructions. The company is also reportedly partnering with Volvo AB in a project called Drive Me that aims to have 100 self-driving cars on the roads in Gothenburg, Sweden next year.
In essence, this alternative supplier is not only benefitting from its abilities to step-up and respond to an immediate industry defective component crisis, but indeed, positioning from a product design strategy perspective to be a preferred supplier for future safety systems in multiple branded global vehicle platforms.
We have called reader attention to the ongoing Autoliv case study because it provides an ongoing example of how a major supply crisis and safety snafu can indeed lead to another supplier’s opportunistic gain. More importantly, thinking beyond the tactical crisis window at-hand with a focus on what will be the alternative technology.
Earlier this month we alerted Supply Chain Matters readers to the unfortunate filing of bankruptcy by retailer Sports Authority. Characterized as one of the largest sporting-goods retailers, the chain has been weighted down with debt from a prior leveraged buyout a decade ago. Today, business media has added a more disturbing development to this ongoing bankruptcy process, one that by our lens has significant ramifications for supplier collaboration practices within retail as well as other consumer goods focused supply chains.
In its bankruptcy filing, Sports Authority indicated $1.1 billion in debt that included $717 million in bank loans and over $200 million in trade debt owed to suppliers. As is a common practice in retail supply chains, suppliers had consigned inventory to this retailer, expecting payment when the goods were sold to consumers.
This week, the retail chain filed lawsuits with more than 160 of these suppliers challenging supplier claims to consigned inventories. According to a published report from The Wall Street Journal, upwards of $85 million in shoes and other gear that are currently on the shelves in retail stores and are at-stake. The supplier lawsuits are apparently a means to challenge who gets the bulk of compensation when consigned goods are sold in store closings or in discounted sales. According to this report, Sports Authority is owned by a private equity group as well as a consortium of banks that are apparently seeking to test defects in inventory consignment agreements.
Suppliers themselves have demanded that the retail chain stop selling these consigned goods because of their belief that they hold ownership to the inventory. Accordingly, lawyers for the retailer are invoking what they believe are unique powers defined under bankruptcy laws.
Yesterday, a court ruling from a judge instructed Sports Authority to comply with supplier demands to return the consignment inventory and reinstate arrangements that existed before bankruptcy filing. Lawyers for Sports Authority apparently are willing to comply with the judicial decision but also continue with the supplier lawsuits as a means to reclaim the monies later if their lawsuits are successful.
While we are not lawyers nor profess to interpret laws, this development struck a nerve within our supply chain management lens, thus we are alerting our readers to this development.
As our industry supply chain readers are well aware, consignment inventory or vendor managed inventory (VMI) practices are fairly common practice in consumer goods focused and other select industry supply chains. They were designed as a response by suppliers to assist key customers in their inventory and cost-of-goods sold (COGS) financial objectives. In essence, suppliers holding inventory ownership until goods are sold is a means of lower cost inventory financing for the buyer. Challenging such practices under the umbrella of bankruptcy protection is an ominous sign, one that if successful, will by our view, reverberate across multiple supply chains and muddle inventory ownership practices. Further, it represents a new low by private equity firms in challenging successful established business practices for singular gain. It literally challenges the notions of win-win supplier collaboration practices.
How all of these developments turn out is a matter of time and interpretation by courts. However, we wonder aloud whether this effort, regardless of final outcome, provides a longer-term setback in joint inventory management practices.
We welcome the views of our readers either through comments associated to this commentary or by direct email.
© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.
In January, Supply Chain Matters called reader attention to Chipotle Mexican Grill’s bold adherence to staunch standards for high quality, ethically based food ingredients served at its various restaurants. Chipotle boldly suspended the use of pork sourced from an unnamed regionally based pork supplier evoking broad media headlines. According to Chipotle, a routine audit discovered that the supplier violated declared humane-based standards for the housing of pigs with access to the outdoors. The restaurant chain, which was decisive in its decision to stop supply, indicated that this was the first time it had suspended supplies because of a violation of standards.
This week, the restaurant provider reported financial results for its third quarter that somewhat disappointed the investment community by indicating that future growth would be modest through next year, as opposed to the double-digit growth rates of quarters past. For its latest quarter, Chipotle’s same stores sales growth was a modest 2.6 percent, far below the nearly 20 percent growth rate of a year ago. The recent number further reflects across-the-board price increases on menu items.
Wall Street attributes this declining sales trend as a reflection of growing competition from competing outlets, the need for more workers, and problems securing inbound ingredients that meet the high standards of an ethically based supply chain.
In a prior April blog commentary, we observed that consumers are now, more than ever, interested in knowing where their food originated, the ingredients within food and how food is produced with sustainable methods. Well known producers, food service providers and suppliers such as Hershey, Nestle, MacDonald’s, Tyson Foods, Costco, Yum Brands and others have all embarked on initiatives directed at curbing the use of antibiotics in animals, artificial food coloring within food, and higher quality standards for suppliers. This week, sandwich chain Subway, the largest U.S. restaurant chain by number of outlets, joined this chorus, announcing plans to eliminate antibiotics use in all U.S. meat supplies over the next several years. In 2016, the chain will introduce turkey and chicken raised without antibiotics with plans to address antibiotic free pork and beef supplies down the road.
That commentary in April was triggered by a Wall Street Journal report indicating the increasing need among consumers for more organic foods is literally: “hampering the growth of one of the hottest categories of the U.S. food industry.” Farmers, dairies and ranchers face significant costs and risks in attempting to convert from conventional to organic farming or animal production techniques. “While organic produce or livestock can command prices as high as three to four times that of conventional food, farmers generally have to sell their food at conventional prices during the transition.”
Supply Chain Matters increasingly believes that as more food producers and restaurant chains require and transition to the use of such ethically sourced and organically grown foods, the time to transition the entire food supply chain will be a perplexing problem. Chains such as Chipotle who were pioneers in the sourcing of healthy food could well have their near-term growth plans constrained by the reality of constrained supply. There is a classic excess demand and restricted supply condition occurring as the supply chains attempt to transition from conventional to more organic and sustainable food supplies.
This condition will present added challenges for food sourcing and purchasing teams and buying cooperatives. Ranchers, farmers, poultry and meat producers require adequate time to transition to a more healthy food supply, and that comes with the need for the financial flexibility to fund such a transition. Providers who have practiced organic food standards since their inception understand this need, and took the time to work collaboratively and financially with food suppliers to build-up adequate supply through long-term buying commitments. With more and larger global players now demanding organic and antibiotic-free supply in far larger volumes, the demand and supply equation likely becomes chaotic without added collaboration, training, financial and buying incentives. Buying scale could cloud needs for stronger and more responsive supplier relationships.
The takeaway is that food purveyors cannot just buy or dictate their way into organic, more-healthy supply contracts. This will take time and it is rather important that providers, consumers and investors understand such realities, and develop the patience and understanding that the global food supply chain does not transform itself overnight.
We would appreciate hearing from readers residing in various tiers of existing food supply chains.
What are reasonable expectations for transition?
What added financial incentives are required?
Whom do you consider to be a leader in these efforts?
The Wall Street Journal reports that two major Apple suppliers are locked in a fierce battle for control of Taiwan based Siliconware Precision Industries, known as SPIL. (Paid subscription required) This skirmish places Apple as having to be attune to its ongoing relationships among two rather important key suppliers.
The battle centers around a new component-packaging technology termed system-in-package or SiP which is essentially a number of integrated circuits enclosed in a single module (package). SiP can support all or most of the functions of an electronic system, and is typically used inside a mobile phone or consumer device such as Apple’s iPhone.
According to the report, SPIL currently supplies SiP services in small volume and is seeking to roll out this technology on a far broader scale in 2017. The report cites Bernstein Research as indicating that Apple alone will account for $3.1 billion in SiP component orders this year, and that amount could double by 2017.
The two existing Apple suppliers vying for control of SPIL are Advanced Semiconductor Engineering (ASE) and none other than contract manufacturing services provider Foxconn, through its parent, Hon Hai Precision Industries.
ASE is noted as the world’s biggest chip assembler, recently acquired a 25 percent stake in SPIL. In late August, SPIL announced a deal to collaborate with Hon Hai Precision that included a share swap that would afford the contract manufacturer a bigger equity stake and more voting clout than ASE. The WSJ opines that because Foxconn has an existing close collaborate relationship with Apple and its product design teams, SPIL has a better chance for leveraging expanded Apple business. Further noted is that collaboration with SPIL aides in Foxconn’s goals to diversify into lower tiers of the high tech supply chain including semiconductors.
From our Supply Chain Matters lens, we concur with the WSJ that this ongoing battle for emerging supplier control very much underscores the importance that Apple’s scale and business potential has for key suppliers. It further underscores how existing close relationships with key suppliers can influence future strategic supply decisions, particularly when such influence extends to the influence of future product design. In this specific case, individuals within Apple’s strategic sourcing and iPhone product design teams will have to eventually play the role of peacemaker.