Supply Chain Squeeze: Aerospace OEM’s Rolling Out Template Used in Auto Supply Market for 30 Plus Years
The following article was written by Joseph Geraghty and published in the Dayton Business Journal.
Taking a cue from automotive companies, the new world of aerospace manufacturers include efforts to aggressively reduce costs by squeezing the supply base for price reductions while also pressuring suppliers for improved quality, increased production, and enhanced service.
This growing trend among aerospace OEMs helps them to maintain or grow market share, deliver more fuel-efficient competitively-priced planes for an overall goal of improved OEM profitability and long-term viability.
Evidence of this trend can be found in the roll out of Boeing’s “Partnering for Success” program in 2013. Boeing’s program attempts to reduce supply-base costs by 15% or more. Failure to comply with the proposed “partner agreement” may result in a supplier’s exclusion from future bid lists.
Airbus and other aircraft manufactures are pushing the supply base for reduced prices and other cost saving initiatives, too. OEM initiatives include developing mega Tier 1 suppliers, which will provide large assemblies or full complement of products, and/or design-sharing or development capabilities. These mega suppliers could then consolidate aerospace suppliers underneath them as Tier 2 or Tier 3 suppliers. Reduced SG&A costs, freight savings, and economies of scale also result in greater cost savings to OEM’s customers.
The shift in the aerospace supply industry, like the automotive industry’s transformation over the past thirty years, may yield improved quality and billions of dollars of savings. Several strategies used by automotive companies included: supply base consolidation under mega Tier 1’s, long-term supply agreements offering price reductions, out-sourcing major design elements, Tier 1’s driving a culture of cost-sharing ideas to reduce overall supply costs, and others are being transitioned into the aerospace industry.
But what if the OEM’s push too hard or suppliers fail? Not to worry. The aerospace OEMs have other devices in their tool box to manage extraordinary supplier circumstances. And, they don’t have to look beyond the automotive industry as the prime example of how those distressed supplier management tools work.
If a critical supplier is pushed to the brink by these changes, OEM’s can roll out complimentary agreements to the in-place supply agreements called the “accommodation agreement” and “access and security agreements” tailored to each supplier situation. Agreements are negotiated to ensure near-term supplier performance and continuity of supply to the customer. The primary goal is to avoid the immediate shut-down of the OEM production lines but also to provide time and capital to address the supplier’s circumstance or achieve a desired outcome for the constituents.
The aerospace OEMs have adopted those agreements and are introducing them to their distressed suppliers. Our firm has been engaged in several aerospace situations where these agreements formed a new basis on how suppliers and OEM’s collaborate. Here’s how they work:
Each accommodation agreement and access and security agreement is tailored to individual suppliers’ circumstances. These agreements assist distressed-supplier constituents (supplier, lender, customer, management, ownership) in controlling and potentially resolving supplier distress in which OEM’s are unable to secure immediate, near-term supply, or if supply shutdowns would cause significant damages to the OEM.
Agreements are typically entered into by the distressed supplier, its lender(s) and its major customer(s), which could be OEMs or Tier I suppliers. Agreements provide protections to the supplier and its lender(s) on certain “collateral” while ensuring customers’ access to production facilities to ensure continued supply of production while a recovery plan is developed or implemented. Protected collateral could include accounts receivable and inventory that may be the collateral underpinning of the secured loans between the supplier and lender.
The customer’s motivation to enter into an accommodation agreement is typically driven by the associated risk presented by the supplier’s and the customer’s ability to mitigate those risks. This dynamic provides certain leverage for lenders and suppliers to secure enhancements to the commercial relationship and time to fix the business or resolve its distressing circumstances.
These automotive supply-industry agreements have transitioned to aerospace and other industries where there are few OEMs and large supply bases.
There are many factors that must be considered when assessing the amount of leverage that exist in a particular supplier situation including:
- Single-source supplier of at least one component for at least one customer;
- Technical-service provider to the OEM or key-service provider;
- Ease at which customer-owned tooling can be moved;
- Complexity of suppliers’ products including time necessary to approve a new supplier, FAA and other certifications;
- Customer concentration and the interrelationship of the supplier to other suppliers and customers whose operations would be impacted by a supplier failure; and,
- Specific intellectual property owned by the supplier.
As a result of these agreements, the lender and suppliers enjoy significant value enhancements on the collateral. These enhancements may include protection against customer set-offs, secure inventory buy-back arrangements, potential pay-down of supplier loans based upon expedited OEM payment terms, and opportunity to sell other collateral such as equipment at greater than liquidation values.
Further, the parties enjoy a controlled process to monitor the supplier but also allow time for the supplier to execute its business plan and, hopefully, improve its value proposition. In other words, through this process and related agreements, the parties to the supplier potentially avoid catastrophic failure damaging all the parties to the supplier. Suppliers may be able to effectively resolve their distressing challenges and improve to a stable, reliable supplier.