Buoyant aerospace and defense industry fueled by commercial aircraft and rise in defense spending: according to AlixPartners annual global A&D study

• The global aerospace and defense industry remains buoyant, enjoying 3.8% revenue growth year-on-year in 2016, alongside healthy profit margins of 8.8%. However, profits are down 1% from 2015 due mainly to aircraft OEMs and issues in engines and cabin segments for some selected suppliers.  The commercial aerospace industry profit pool has also declined. Macro-economic factors for the industry from GDP growth to oil price, raw material and interest rates remain favorable compared to historical levels.
  
  
• Commercial backlogs are still at record highs of over 13,000 aircraft, with OEMs focused on ramping up volumes. Orders declined last year, but given the huge backlog level, there is no short-term production availability, so this decline is natural.
  
  
• Global defense spending has been growing slowly the last couple of years, and is expected to accelerate. The new US administration has signaled a desire to boost defense spending. We expect a resurgence in European defense spending, with a great focus on European self-defense and renewed French-German leadership in Europe.
  
  
• Despite the overall positive trends, helicopters and business jets continue to suffer heavily, with markets down 15-20% vs 2014. The primary causes are more hostile macroeconomic conditions affecting the oil and gas industry, a lack of new military helicopter programs in Europe and lower business confidence

Paris, London – In its latest Global Aerospace and Defense study, AlixPartners, the global advisory firm, today reveals the key trends in the industry.  Overall the sector is performing well, driven by the performance of commercial aircraft industry and defense sub-sectors.  However, the study warns that the European defense sector needs to be better integrated if it is to avoid a trend that ends up with ‘buy American’ as the only option.  European leaders recognise the need for greater independence from the US, with NATO’s call for defense spending to account for at least 2% of GDP expected to be more widely adopted.

In commercial aviation, European legacy network carriers need to pursue significant restructuring to survive the intense pressure of low cost carriers.  While these problems are not new, carriers in the Middle-East are also experiencing heavy stress after aggressive organic and external growth, highlighting the scale of the challenge and competitive intensity. 

Commercial aircraft manufacturing is also becoming increasingly competitive, with new players entering the field, but the current duopoly of Airbus and Boeing is still way ahead.  Finally, AlixPartners expects the pace of digital transformation to pick-up over the next 12 months, allowing new breakthroughs in operations and services, but being successful on this journey will require strong leadership, investment and cultural change.

Eric Bernardini, Global Industry Lead for Aerospace & Defence at AlixPartners said,

“Over the last 12 months the global aerospace and defense sector has benefited from the strong performance of commercial aircraft manufacturers and a rise in defense spending. The current US administration’s defense and foreign policy should result in increased spending by the US government and the pressure to meet the two percent GDP target by NATO members is likely to drive increased spending and open opportunities for more agile European defense companies. Evolving security threats means that the European defense industry must develop more affordable, interoperable, and quick-to-market solutions for the battlefield and the counter-terrorist agencies. Major disruptions are affecting the Space sector, with the entire value chain being challenged and re-invented.

“Looking ahead, we don’t expect the commercial aircraft duopoly of Airbus and Boeing to be heavily threatened in the near future, it will probably take another generation of new aircraft. However, an acquisition by the Chinese of Bombardier C Series would create a serious threat.  The profitability of airlines increased slightly in 2016 but is going to decline again in 2017. European legacy operators, in particular, will need to keep improving their business model quickly to match their low-cost competitors’ success.  We expect significant restructuring over the coming years.

“Companies have no excuse for missing the opportunity offered by digital transformation as the new frontier for the A&D industry, enabling them to further push the envelope on both operational performance and new services.”

The future of European defense: consolidation and agility is the key to staying competitive

In an environment where global defense spending is increasing AlixPartners believes there is a unique opportunity for the players involved. A greater focus on European self-defense, first noted in 2016, has increased with recent political events such as the election of President Trump, the Brexit vote in the UK, and the renewed “entente cordiale” between France and Germany. Several countries, including France and Germany, have committed to a boost in spending, while prolonged conflicts in Ukraine, the Middle-East and the South China Sea continue to stimulate spending by countries in the region. In 2016 both the EU and the US increased spending by 2%, marking the first time since 2011 that world military expenditures have grown in two consecutive years.

In light of this trend, key European players in the sector are looking to ensure they remain competitive to fend off the increasing propensity to “buy American” as has already happened in Eastern Europe, particularly Poland, and is being replicated in Western Europe.  The result is likely to be some consolidation and rationalization of portfolios that would address the number of redundant products in the market (e.g. Aircraft Fighters, Ships, Helicopters, Military ground vehicles).

Airlines: flying high on low cost fuel

Global airlines have benefitted from low fuel prices with profitability up in 2016 to a peak level of 8.8%, resulting in a profit pool of over $60 billion.  However, profits are expected to decline by 10% in 2017, but still staying well above the historical average.

While there has been significant convergence between the European network carriers (NWCs) and the low-cost carriers (LCCs) in terms of both product and service amidst a competitive fare environment, some of the key structural differences in their operating models continue to drive unit cost gaps.

A prime example of this is the better use of assets. AlixPartners’ research has shown a narrow-body daily utilization gap of 30% (6.9 flight hours / day vs 9.0 flight hours / day) for LCCs v NWCs. In addition to this the LCCs operate a fleet which is half the age (5.7 years vs 11.9 years), and therefore drives fuel burn and maintenance cost advantages.

One answer is short-haul connectivity collaboration - an idea that has been much talked about, but are both sides ready to take that step? Ryanair says they are but on the other hand network carriers such as IAG and Air France are launching their versions of low cost long haul flights with Level and Boost respectively. This however does not prevent the restructuring and labour negotiations that are needed to close the cost gap compared to low cost carriers for those that have not already done so.

Crowded market for newcomers in commercial aircraft

The single-aisle airliner market is getting more crowded. Although the Boeing 737 MAX and the Airbus A320neo are by far the dominant offerings in the segment, a host of new competitors have thrown their hats into the ring recently, on top of the Bombardier C Series, with maiden flights from the Irkut MC-21 and Cormac’s C919 last month. Newcomers are now capturing 8% of the backlog.  However, the question remains – are these challengers credible?

For China, the C919 is seen as a stepping stone into the commercial aircraft market after difficult efforts on the regional segment with the ARJ21 and a strategic state investment – the cost of which is not a primary factor. The cost of production is key, however, along with performance. The C919 will need to combine the cost advantages of Chinese production while also matching the performance of the latest generation aircraft such as the A320neo and B737 MAX.

The credibility of the C919 support and services network and operating model will be also key to commercial success, especially beyond the Chinese market where the decision-making process is not necessarily only business driven.

Of the other new entrants snapping at the heels of the Airbus-Boeing duopoly, the Bombardier C Series is a high performing aircraft and most likely to challenge the status quo. But questions remain over whether Bombardier can overcome its financial troubles and get a stronger order book to secure a real foothold in the market.  A joint Chinese-Bombardier effort on the C Series would be a serious threat to both Boeing and Airbus.

The digital leap for A&D: hard to ignore but difficult to embrace

Digital transformation opens many avenues, but there are numerous challenges unique to A&D that have to be overcome first. Programs that last for decades, modest production volumes, extremely technical and complex products and a highly regulated environment make this digital transformation difficult to undertake. At the same time, new generation airplanes are producing an exponential rise in the amount of data, which is poorly leveraged today, but offers a strong asset for future business that cannot be overlooked, such as services linked to predictive maintenance.

However, far from being curbed, major players in the sector are deploying large-scale projects and investments. Among prominent initiatives there is GE’s 3D printing acquisitions and Predix digital platform push, Boeing's Black Diamond initiative and Airbus’s digital transformation program launch, along with its ties with Silicon Valley.

Beyond the capital expenditure required, the process of digital transformation in the sector really begins with a strong top management vision and the ability to trust and rely on start-ups or pure digital players in a more open and innovative model. This openness to outside influence is key but will require real change in the culture of the industry. Secondly, adopters will need to be forward thinking, looking beyond just the technologies to be can deployed to the opportunities they offer for the business. Ultimately however, for aerospace and defense to capitalise on the full benefits that digital transformation can provide, significant investment is required and very thorough change management for organizations to embark on this exciting path.

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