IBM Global Business Services White Paper

Aerospace and Defense

New trajectories for the aerospace and defense industry

Attacking new opportunities while simultaneously driving greater efficiency and agility will define the immediate future of aerospace and defense companies

New trajectories for the aerospace and defense industry

IBM Global Business Services

Today, aerospace and defense (A&D) companies find themselves at potentially perplexing crossroads. On one hand, shrinking defense budgets, an increasingly aggressive competitor set, and riskier market conditions are pushing companies to focus on protecting profit margins. On the other hand, business and technological innovation is setting the stage for new modes of providing services to customers, changing how revenue is earned, and using sophisticated information technology strategies to make products and operations smarter. Given the simultaneous drive for profitable operations and innovation, where does the savvy A&D company invest? The answer lies in being able to do both, and doing so might require some new operating trajectories that enable the organization to expand offerings and business models while executing with more efficiency and flexibility, all with improved profit margins. This should drive a new wave of critical conversations on business model innovation and smarter products, achieving smarter operations, becoming a globally integrated enterprise, and engaging in new ways with suppliers and customers. The outcomes of these explorations should manifest in a new view of the future and an intelligent plan to achieve it.

Depending on the final deficit reduction plan deployed after the 2012 elections, there is nearly $500 billion on the chopping block over the next 10 years or more. Reduced defense budgets will force corporations to dramatically change their business operating models and processes. With the DOD emphasis on fixed fee pricing models, A&D companies may be forced to change their mindset to keenly focus on program management and execution, versus providing the most features on products. Being able to execute whats good enough while maintaining mission assurance will be more important than delivering the best weapon in the galaxy. Likewise, quality and meeting objectives on time and on budget will be critical as programs fall under increased scrutiny from DOD buyers, and significant penalties are imposed on A&D companies that do not achieve targets. With shrinking budgets and new constraints in pricing and regulation, it is likely the competitive landscape will change. Mid-tier suppliers that cannot survive the smaller margins and increased cost of business will likely experience a wave of mergers and acquisitions, with the possibility of exit strategies in many cases. This will impact the prime suppliers significantly as the reduced number of sub-prime suppliers concentrates supply chain risk, but it may also open new opportunities for both new contracts and new acquisitions. Globalization and emerging markets may be both a blessing and a curse to A&D primes. Most primes are expanding their global sales and operations to offset US defense budget declines, some looking to move 25-30% of their business to foreign sales. This increasingly requires a global presence with local participation in relevant countries, each with different requirements for regulation, safety, language, partnering and so on. Direct and indirect offsets become an area where new knowledge is needed, particularly in emerging economies.

The imperatives for rethinking todays operational strategies

For A&D companies, the playing field weve known for the past decade is going to be changing significantly. Several megatrends, such as declining defense budgets, globalization and shifting markets, and a changing competitive landscape, will force A&D companies to change many of the key ways they operate today. Some of these changes will require marginal improvements in productivity and focus; others will represent more significant, difficult transformation.

New trajectories for the aerospace and defense industry

U.S. defense budget 600 500

$Billions

400 Actual 300 200 100 0 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Presidents scal 2012 plan Fiscal 2013 plan Budget caps under sequestration Note: Base discretinary Defense Department budget in scal 2012 dollars.

Source: Center for Strategic Budgetary Assesments

Fiscal year

Figure 1: While uncertain at the moment, defense spending may decrease depending on what plan is adopted.

Primes may find offsets working to their advantage when looking to expand supplier and subcontractor networks. Smaller firms, though, may have increased struggles with rapidly changing offset regulation, and may struggle with emerging global subcontractors due to the advantages local offset regulation creates. Whether small or large, all A&D primes will require a deep understanding of ITAR and the US Arms Export Control Act laws, in order to expand global operations while ensuring measurement and compliance of core operations, subsidiaries, and suppliers.

A shift to the commercial product lines?

With domestic defense budgets shrinking and demand for commercial aircraft and defense products rising in developing countries, A&D executives will need to develop new strategies for their portfolios of products against these two categories. In both defense and commercial aircraft, the shift seems to be for more affordable products that perhaps have fewer features. More affordable products wont just be about limiting what is delivered; it will also put pressure on reducing costs throughout the supply chain and manufacturing processes. Following customer demand trends is vital, but the competency to act on demand trends is probably the more important capability. This puts a focus on the basics of both businesses: being able to turn manufacturing operations quickly; smartly managing suppliers; building efficiencies within the supply chain; and gaining more visibility to customers future demand.

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Threats and challenges from within

As external forces like the supply chain and government customers are adding pressure, the mandates and challenges within A&D companies are also whipping the demand for change. Within A&D companies, business is becoming increasingly complex as they look to secure new revenue, preserve existing revenue streams, satisfy customers, maintain mission assurance, streamline operations, build efficiencies, and refocus business operations to align to demand. Years of cost-plus contracting by the government has perpetuated this complexity without consideration of the cost impact or long-term sustainability. Many A&D companies are also dealing with rising amounts of data from their transactional, manufacturing and planning systems, often without a clear view of how to manage and leverage it effectively. Most also deal with complicated business portfolios that have grown diverse, fragmented, and misaligned as systems were added over the years or patched in through merger and acquisition activity. With global operations, this problem becomes magnified over different geographies. Many A&D company executives are flying blind or managing by intuition in running their business, which increases the level of risk of non-compliant financial, operational, and ITAR-related events across the enterprise. Leaner and compliant operations will require more visibility and measurement across programs to succeed. The mantra that what gets measured, gets done should initiate more focus on metrics, dashboards, and operational analysis across the A&D enterprise.

Number of investments by Top 50 Global A&D companies in international markets (2000-2008) Coutry/ Region India US Russia UK W.Europe China Mexico CEE S.Korea Middle East N.Africa Other R&D 7 6 5 3 3 2 2 2 2 1 1 1 35 Coutry/ Region China India Mexico US Russia UK W.Europe Middle East N.Africa CEE S.Korea Other Manufacturing 13 11 8 8 6 3 3 3 3 2 2 1 63

Source: PricewaterhouseCoopers, Flight International

Figure 1: R&D investment trends point to both increased globalization of A&D investments as well as a continued appetite for innovation.

Opportunities in innovation and growth

As A&D companies seemingly need to enforce a strict diet of cost control and process discipline, there are simply too many exciting opportunities for innovation in todays informationand technology-accelerated world. There are new opportunities to pursue new business models, improve product performance and differentiation, and fulfill on operational mandates in new ways. This is largely driven by smarter technologies such as instrumentation (such as sensors and RFIDs), improved interconnectivity and integration, and powerful advanced analytics.

New trajectories for the aerospace and defense industry

In terms of business model and product innovation, there is growing demand for A&D companies to convert to new service models, where streaming data available from aircraft and equipment provide advanced insights into operating condition, performance, and repair prediction. On the shop floor, manufacturing execution systems are improving how inventory is managed, ensuring quality goals are met, and increasing visibility across the entire value chain. Opportunities for collaboration with customers and suppliers are advancing in sophistication and scope. Management is using advanced analytics and their data assets to understand the pulse of the organization in real time, to drive better decision-making. Its an exciting time to innovate, but more importantly this innovation can help overcome the external and internal challenges A&D organizations face. They neednt be seen as risky expenditures in competition with cost control demands, but as powerful tools in the pursuit of profitability in challenging times. And the drive to innovate may not be voluntary as customers demand it and competitors attempt to set the pace of change. Those who invest in a downturn are quite likely to be recognized and rewarded when the defense cycle returns to prosperity. The DOD will likely have a long memory of its partners that invested for the future. So: whats next?

New operating trajectories: four strategic discussions to have now

As A&D leadership review their strategic agendas for the coming months and years, they should tune their conversations to the upcoming challenges internal and external pressures will present. But instead of leaning on traditional cost control levers such as blunt workforce reductions, divesting business lines, or limiting R&D and other investments, they should open up their view to new approaches to becoming efficient, high-performing and effective. They should also view innovation especially that which is driven by new technologies and information insights not as distracting or ill-timed investments but instead as essential tools in shaping their futures. These create four strategic discussions to have now with your leadership team:

Business model innovation and smarter products

Extended enterprise visability integration and collaboration

New Trajectories for A&D Companies

Smarter operations and manufacturing

Realigning to be a Globally Integrated Enterprise

Figure 3: Strategic discussions for leadership teams.

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Each of these topics could be deep-dive discussions around dozens of strategies, practices, technologies, and activity. We touch a couple of the general points as a platform to begin the conversation for A&D leaders.
Business model innovation and smarter products

With an imperative to change, the boldest place to consider is in core business model innovation and delivering smarter products. Today, there are new applications in instrumenting assets and products to have them collect data from sensors, location awareness devices, and RFID-type tags. They can be deployed in the aircraft or weapon system, in the customer repair environment, on the manufacturing floor, and throughout the global supply chain. Interconnecting this information and combining it to create new insights is now becoming more common, broader in scope, and vastly more sophisticated.
The emergence of strategic performance improvement (SPI) As A&D companies look to improve their business models towards more profitable and sustainable margins while likely dealing with harsher operating conditions, many are look to SPI initiatives to make a change. Different from traditional down-sizing or cost cutting approaches, SPI examines each area of the business for opportunities to improve P&L and balance sheet-driven performance issues; identify cost reduction opportunities that align to strategy; optimize current revenue streams; and exploiting existing growth opportunities. It does this while emphasizing the importance of people issues and change management. SPI doesnt seek to change strategy or pursue new product lines, but instead focuses on doing what the company does already but just much better.

Many companies are leveraging fast and focused innovation by using accelerated processes that let operators experiment, trial, and validate with minimal investment risk. Some of the hotter areas are in predictive analytics and advanced condition monitoring (ACM), where the performance of products their health, reliability, and uptime are optimized by analyzing repair history data and matching that with real-time condition monitoring, to fix break-downs before they happen, optimize repair supply inventories, and overall provide more value to military and transportation clients. Through the emergence of this new capability, new business models can be formed. For example, many are seeing that the client relationship shouldnt end with the delivery of the aircraft or weapon system, but instead turn into an ongoing service business where the A&D companies manages the predictive maintenance program through ongoing collection and analysis of asset data and providing service maintenance systems that integrate with the clients infrastructure. This flips the traditional model on its head, to one where clients are no longer looking to buy parts but instead asset performance. Power by the Hour models where the uptime and usage of a vehicle is measured and priced are becoming more common, as are performance-based logistics, again, where outcomes are measured, not materials or repair resources. Some in the industry are discovering both successes and failures, with the DOD itself sending mixed signals about how it will embrace these models. While these types of new business models grow in sophistication and maturity, newer ones are sure to arise, their creation only awaiting an emboldened and clever product managers action. New business models may also including penetrating new markets such as entering adjacent industries with similar manufacturing schemas or entering emerging economies that are currently under-served. Many primes are making these plays to offset forthcoming defense budget reduction.

New trajectories for the aerospace and defense industry

Smarter operations and manufacturing

Realigning to be a globally integrated enterprise

As A&D companies look to get leaner and more effective, the heavy operations of the value chain such as manufacturing, order management, inventory management, and logistics will be key areas of focus. Organizations are now instrumenting their manufacturing infrastructure with sensors to gain greater visibility of floor operations. This creates opportunities for advanced manufacturing and supply chain control rooms that monitor productivity, clear stoppages before they happen, speed equipment turnarounds, and even proactively monitor employees actions for safety and regulation compliance. One trend is the integration of systems from top floor to shop floor, meaning that core enterprise resource planning (ERP) systems that help in planning finance and HR are connected to inventory planning systems, manufacture execution systems (MES), distribution tracking, enterprise warehouse management, and even customer relationship management (CRM) and sales systems. These systems are used in concert to improve manufacturing performance across the entire value chain, as well as provide synoptic cross-enterprise views for different types of decision-making. Manufacturing optimizations are being deployed today that focus on using analytics, information technology, and process redesign to rethink and improve the effectiveness of manufacturing operations, focusing on faster manufacturing with higher quality. Metrics-based approaches are being used, where process key performance indicators (KPIs) are monitored continually through operational analytics dashboards, to watch everything from inventory control to customer service. As A&D companies look to their strategic discussions on sustainable profitability, the manufacturing operation in all its aspects should be analyzed for places to use technology to make it smarter.

In manufacturing and beyond, there often exist countless other business functions that are not as connected, aligned, or otherwise optimized. This may include procurement, distribution, finance, human resources, sales, marketing, and IT. Often these groups grow in organizations in silos, ineffectively speaking to each other, often using different data formats and standards, and duplicating efforts across geographies and business units. These issues are often rampant in organizations with multi-national footprints and especially those that grew from years of merger and acquisition (M&A) activity. The disparity of the groups is often reflected in a jumble of an IT portfolio, where duplicative, disconnected, or otherwise maligned systems drive cost without providing optimum value. In many organizations, finding facts about the business to make decisions is a chore in itself. The information is often unavailable, inaccurate, or difficult to put together. Different departments may use different data definitions and may even claim to have their own versions of the truth. The decision maker, especially at the leadership tier, must often fly blind, making best guesses on information that is unreliable, potentially wrong or even simply out of date. The best organizations are pursing the vision of a globally integrated enterprise or GIE. They find areas for synergy, collaboration, and integration across all of their functional departments, including standardizing processes; standardizing and improving enterprise data; integrating reporting, measurement, and analytics; and simplifying the corporate IT application portfolio. The globally integrated enterprise that integrates systems of systems and software will be pointed towards success.

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From the upside, this makes organizations more nimble and flexible, with the ability to get a consistent set of facts to make decisions, improve the speed and accuracy of decisions, gain visibility to the entire enterprise to take actions that may have multi-department dependencies, and quickly pounce on new opportunities when they arrive. From the cost reduction or avoidance side, becoming a globally integrated enterprise enables companies to reduce redundancy and rework, create global delivery capabilities for common routine and repeatable work, leverage the unique skills of different geographies, and often reduce corporate and administrative overhead across divisions and departments. Technology offsets are likely to be required, with global sales further expanding the need to operate globally, in other words, companies will need to operate more consistently while being in more diverse places. GIEs do more with less cost. They are leaner, smarter, and more agile. For A&D companies seeking to simultaneously invest in innovation while working under tighter governance and cost controls, GIE-type strategies are prime targets for helping to achieve these goals.
Extended enterprise visibility, integration and collaboration

On the customer side, opportunities exist for greater collaboration and visibility, both in customer demand and repair of pipelines and inventories, as well as customer visibility into the A&D organization. As mentioned earlier about new business models, the ability for an A&D supplier to provide proactive, predictive maintenance services over the lifetime of a product will require much closer data integration. This will require technology integration and new tools, but will also require new processes, new data standards and coordination, and rigorous data governance programs to ensure quality, security, and performance. When increasing collaboration and visibility with suppliers or customers, its often the case that the fundamental nature of the relationship between the parties may need to change. Instead of a guarded vendor-buyer relationship, companies need to forge strategic partnerships, where trust and mutual benefit are valued above negotiating power or commodity pricing. Two organizations must be able to justify long-term investments in creating collaboration platforms and integrating data with confidence in the prospect of a long-term relationship. This type of alignment must stretch well beyond the codifications of technology and include strategy, culture development, new attitudes and behaviors, and in general a new organizational mind-set. While often difficult to achieve, the value generated from strategic partnerships can be enormous.

With a potential shrinkage of the supply chain and the risk that a smaller supplier base brings, integration, visibility, and collaboration with vendors will improve supply chain and operational performance and reduce risk. A&D companies should examine their extended enterprise strategies and adopt new ways to have vendors integrate into A&D value chains. This could include increasing inventory and supply visibility, promoting data standards with suppliers, pursuing vendormanaged inventory, and deploying other information tools to reduce supply shocks and the risks they entail. Organizations should leverage Ease of Doing Business supplier dashboards to improve risk and quality overall. In some situations, A&D companies should consider vertically integrating key lower-tier suppliers if significant program risk seems palpable.

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New trajectories for the aerospace and defense industry

Next steps: Envisioning the future and building the roadmap

These four trajectories provide the basis for new strategic conversations for A&D leadership. While energetic exploration, learning, and debate are a must, leaders should also take some formal, purposeful actions to advance their operational strategies. Some of these actions include:

Conclusion
May you live in interesting times is the oft-quoted Chinese curse, which says that adversity and challenges can create situations that are much more interesting than when things are just cruising along without issue. This couldnt be truer for todays and tomorrows A&D industry. While the expected challenges will cause some short-term pain, they open us all to a period of change, one where exciting things like new business models, new ways to improve margins, and innovation emerge to those who act. Adversity is also beneficial for industry leaders and those that are proactive in dealing with challenge; while the laggards fall when faced with poorer market conditions, good companies strengthen their positions. Understanding this, A&D leaders should find the new strategic conversations about their business the new trajectories a very interesting and exciting endeavor.

Engage with external parties to learn what the industry is doing at large, discover the best practices that work (and those that dont), and leap into a new knowledge of the state-of-theart in A&D business trends Assess in detail current opportunities and challenges within your own operation, in the context of examining the applicability of the four strategic trajectories discussed earlier Define a strategic vision for how the company will operate in the near and distant future Build a prioritized roadmap of work activities such as resources, investments, milestones and timing to achieve the vision, at both the project level and the enterprise level Justify changes through a robust financial business case

For more information

To get started and learn more about IBM Global Business Services, please contact your IBM representative, or visit the following website: ibm.com/services/us/gbs/industries/aerospacedefense

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Author
Mike Matthew A&D Business Solutions Professional, Global Business Services mikematthew@us.ibm.com

Contributors
John Burt Partner, GBS NA Aerospace & Defense Industry Leader, Global Business Services jburt@us.ibm.com Glenn Reis Associate Partner-Industrial Sector-Aerospace & Defense, Global Business Services gvreis@us.ibm.com

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