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Lessons in A&D and Auto Supply Chain Strategy, Part 2: Focus on Competitive Advantage

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by KPMG’s George Odden & Vincent Pavlak In July 2010, Vincent Pavlak, a partner in KPMG LLP’s Transactions & Restructuring service group, contributed an article to Defense Industry Daily, titled, “Lessons from the Automotive Supply Chain: Surviving a Downturn.” At the time, the automotive industry was enduring one of the worst economic periods in history, […]

by KPMG’s George Odden & Vincent Pavlak

In July 2010, Vincent Pavlak, a partner in KPMG LLP’s Transactions & Restructuring service group, contributed an article to Defense Industry Daily, titled, “Lessons from the Automotive Supply Chain: Surviving a Downturn.” At the time, the automotive industry was enduring one of the worst economic periods in history, and there were concerns that the aerospace and defense industry could suffer a similar fate. Ultimately, the automotive suppliers that endured the downturn have emerged stronger, due in part to critical efforts undertaken during the crisis. Meanwhile, the aerospace and defense industry has experienced a post-crisis divergence of paths, with commercial aerospace companies enjoying a resurgence parallel to the automotive industry while the defense sector has suffered declining revenues and prospects. Despite differing outlooks now facing each industry, supply chain enhancement presents opportunities for increased competitive advantage for aerospace, defense and other industries across varying economic cycles.

Part 1 looked at supply chain issues and imperatives for aerospace & defense (A&D). Part 2 looks at some implications, trends, and opportunities.

A&D and Automotive: Implications & Opportunities

Supply chain implications

Supply visibility

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Like their automotive counterparts, original equipment manufacturers (OEMs) in both commercial aerospace and defense are in the midst of reviewing their supply chains. Of particular interest among defense organizations is the reduction of costs in light of muted and/or declining top-line projections, while aerospace companies are eager to minimize hiccups as increased demand stokes concerns about capacity. Visibility into the supply chain is thus of key importance, among other focus areas.

While limitations of visibility into the larger supply network impact every industry to varying degrees, A&D companies are particularly affected by a lack of information flow in the supply chain. Overall, this lack of transparency in the supply chain results in decreased ability to identify cost reduction opportunities and impairs the ability for organizations to detect and resolve potential production bottlenecks.

The defense industry is acutely sensitive to transparency challenges as it faces the ongoing perils of US budget sequestration and an opaque view of future international defense spending. Companies in the defense supply chain are particularly exposed to demand volatility, and while enhanced supply chain management would prove advantageous amidst such uncertainty, transparency and partnership between defense OEMs and smaller suppliers appears lack-luster.

Visibility across the supply chain may become more difficult for OEMs to achieve as they allocate costs and manage risks down the supply chain, potentially damaging relationships with and jeopardizing the survival of smaller suppliers. There is hope, however, that suppliers who survive the downturn will emerge stronger through their efforts much like the automotive sector in 2008 and 2009.

Key Trends: The Power of Leverage

Since July 2010, the outlook for companies within the aerospace and defense (A&D) industry have diverged significantly. Commercial aerospace entities, along with their automotive counterparts, have benefitted from resurgent demand, while defense-focused players have suffered under the weight of declining defense expenditures and subsequent supply chain pressures.

Largely dependent on government budgets, organizations within the defense industry have been significantly impacted by declining defense spending by key government entities. US defense outlays are illustrative of this trend, with total national defense outlays declining by approximately 8.2% between FY 2010 and FY 2013. This trend is expected to continue in FY 2014, with a US Department of Defense (DoD) President’s Request of $526.6 billion in base budget authority (which is likely to land at $497 billion in the wake of sequestration and the Ryan-Murray budget deal), in contrast to an initial President’s Request of $620.9 billion in FY 2013. With the addition of approximately $80 billion in overseas contingency operations expenses, the 2014 DoD budget will be down only slightly compared to 2013; but, it still represents a continued defense spend reduction that corresponds with US troop drawdown from approximately 180,000 troops in Iraq and Afghanistan in FY 2010 to 38,000 troops in FY 2013.

Defense budget reductions have not been restricted to the US, but have been modus operandi across many key government entities, including those in Europe, where combined expenditures represent approximately 19% of global defense spending. In a recent December 2013 report, the European Defence Agency – the body of EU member states dedicated to increased cooperation and development in defense – indicated that in 2012, aggregate defense expenditures among the 26 (then) member states decreased to their lowest level since 2006.

Decreases in defense expenditures are expected to continue through 2018, causing justifiable consternation among industry players both large and small. According to an EADS (recently rebranded as the Airbus Group) internal memo, management projects that by 2018 company defense orders will fall by approximately one-third. As defense contractors address challenges surrounding the continued likelihood of declining revenues from government clients, increased pressures are being felt in the supply chain as defense contractors attempt to push costs and uncertainty risk downward.

While the defense sector endures its own unique set of challenges, the commercial aerospace sector is in the midst of a resurgence. Similar to the automotive sector in supply chain capacity demands, the aerospace sector has benefited from record-high book orders. In 2013, Boeing delivered 648 aircraft – the highest number on record in industry history – while Airbus estimated its aircraft deliveries to reach a milestone 620 by year end.

As demand increases in the aerospace sector, the increasing leverage held by suppliers, especially those closer to the first tier, serves as a common theme between aerospace and automotive sectors.

Automotive industry developments


Source: KPMG LLP Vontik Database

Today, the automotive industry in the US has experienced significant growth since the recent economic downturn, with US automotive sales volumes increasing from a low of approximately 10 million units in 2009, to a forecast near 16 million units in 2013. Recent automotive metrics have also shown similar improvement in profitability and debt ratios throughout the automotive supply base.

However, while the automotive community is optimistic, new challenges are emerging. In fact, one of the more common issues the automotive supply base is currently experiencing is keeping up with the increased volumes, which has resulted in capacity shortages. Within a short period of time, industry leaders witnessed a shift from suppliers starving for volume and automotive OEMs having their choice of suppliers and price, to leverage returning back to the supply base.

Further compounding the volume ramp-up is the dramatic increase in the number of new vehicle launches that the automotive OEMs will be undertaking across the globe over the next 24 months to bring fresh product to market first. The magnitude of new launches is staggering, as automotive OEMs around the world are forecasting over 800 launches in 2014 and 2015. Further, as some automotive OEMs continue the migration to global platforms, the supply chain is becoming increasingly complex, especially as the OEMs grapple with the benefits of global design and scale, versus cost savings targets and local market demands that sometimes only locally sourced suppliers in certain regions can provide.

Opportunities for the A&D Sector

King Air 350

New ownership
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While a focus on supply chain to gain efficiencies and cost reductions would seem to be an effective strategy in any economic cycle, there are some additional opportunities that companies in the A&D sector might want to consider to promote future success and mitigate the impact of an industry downturn.

Revenue diversification presents a strong opportunity for companies with operations in both the defense and commercial aerospace markets, with resurgent aerospace investment a cushion against defense spend uncertainty. Revenue diversification may come from either niche buys that seek out new customers/opportunities or through a rigorous internal sales effort process (which might take slightly longer to effectuate). Rockwell Collins, the aviation electronics and communications provider, illustrates the opportunities inherent in this strategy: in 2010, the company derived 61% of its $4.6 billion in revenue from government systems (defense) sales, with 39% of revenue originating from commercial systems clients. In 2013, the company’s shift in focus from defense to commercial business was well-evident: 52% of the company’s $4.6 billion in revenues were derived from government systems, with 48% from commercial systems – an increase of 9 percentage points.

While the much-anticipated consolidation of A&D suppliers has yet to come to fruition, industry consolidation is another approach that may see increased activity in the future. The A&D sector saw a limited amount of consolidation in 2013, with a total of 158 announced transactions, as compared to 177 announced transactions in 2012. Among these were:

* $1.4 billion acquisition of Beechcraft Corp by Textron
* $550 million acquisition of Pratt & Whitney’s Aerojet Rocketdyne by GenCorp
* The $404 million acquisition of Goodrich’s Electric Power Systems division ($404 million) by Safran SA
* $208 million acquisition of Goodrich’s Pump & Engine Control Systems division by Triumph Aerospace Systems Group
* $1.4 billion acquisition of Arinc Inc. by Rockwell Collins – its largest acquisition to date.

Among other companies, TransDigm Group was particularly active in 2013, with the $150 million acquisition of GE Aviation’s Electromechanical Actuation division along with the acquisition of Arkwin Industries ($286 million) and Aerosonic Corp. ($38 million), with another $250 million acquisition for Airborne Systems expected to close in Q1 2014.

Additional strategies for A&D organizations to consider include the following: (a) divestiture of noncore assets/business lines to raise cash; (b) consolidation and/or closure of facilities, (c) development of a cost cutting plan should the need arise; and (d) differentiation of the value proposition to customers to remain relevant (technology, operational excellence, quality, etc.).


In July 2010, there was great concern across both the automotive and A&D industries after they emerged from the global economic crisis. Companies that survived learned valuable lessons, such as how to persevere through a difficult time; as a result, many organizations emerged even stronger than their pre-crisis state.

In the last few years, there has been clear divergence between the sectors, with automotive and aerospace industries experiencing great improvements while the defense sector faces increasing pressure to operate efficiently and effectively, and achieve their vision for long term growth.

While only time will tell if the memories from the 2008-2009 financial crisis will begin to fade, industry players are hopeful that companies won’t slip back into bad habits; it’s also clear that those companies seeking long term competitive advantage will proactively focus on supply chain efficiencies, in addition to diversification efforts, strategic acquisitions and detailed reviews of their cost structure, to ensure they position themselves to weather any economic cycle.


Vince Pavlak is a Partner in KPMG LLP’s Transactions & Restructuring service group. Based in Detroit, MI, he has more than 19 years of experience leading a diverse group of supply chain advisory projects. Vince specializes in the manufacturing and automotive sector.

George Odden is a Managing Director for KPMG Corporate Finance LLC. Based in Phoenix, AZ, he is a skilled aerospace and defense professional with more than 18 years of experience. A decorated veteran, George served as a lieutenant in the US Navy.

Use the links above to contact them. Taylor Miller, Senior Associate, KPMG Corporate Finance LLC; Aaron Racey, Director, Transactions & Restructuring, KPMG LLP; and Jack Williams, Manager, Transactions & Restructuring, KPMG LLP also contributed to this article.

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