Aerospace & Defense Industry Searches for Solid Ground

• Jeff Caruso, Senior Managing Editor, CSC

Summary:

Aerospace and Defense Companies Prepare for Sequestration

Negotiations on Capitol Hill to avoid the fiscal cliff and mandated cuts to defense-related aerospace programs have the full attention of industry executives as the countdown enters its last days.

While Congress and the president go toe-to-toe on a final, long-term deal to avoid sequestration, uncertainty over the impact of a potential widespread shutdown has cast a shadow over the industry.

Fear of a sharp decline in aerospace spending may be one reason for the strong response to the 11th annual Aerospace and Defense Market Survey conducted by CSC and Aviation Week and Space Technology magazine. However, as CSC executives and AW&ST editors discussed in a recent CSC Town Hall, the fiscal cliff is only the most recent challenge that awaits the industry.

Anthony Velocci, editor-in-chief of AW&ST, says aerospace budgets are shrinking anyway. “Whether the fiscal cliff is taken and sequestration occurs, or not, the aerospace and defense industry is going to face significant cuts,” he says.

The largest companies have the cash reserves needed to endure industry ups and downs. Small suppliers stand to bear the largest share of the burden that uncertainty and cuts create.

Companies are pursuing multiple top-line strategies to counter reduced defense spending. Tim Ellis, CSC vice president and industry executive for aerospace and defense, says international opportunities in the Middle East and China are drawing attention.

That strategy carries significant opportunity, as well as risk. Velocci says companies must enter China very carefully. “China is committed to building its own aerospace and defense industry, and it’s not constrained by elections every four years,” he says. This puts China’s long-term interests at odds with companies that want to serve the current market.

AW&ST Managing Editor Joe Anselmo agrees. Companies that rush into projects in China without measures to secure their intellectual property are taking a major risk. “It’s the world’s fastest growing aviation market, and companies are under a lot of pressure to increase profits,” Anselmo says. “I’d stop short of using the word ‘reckless,’ but companies need to go into the Chinese market with eyes wide open.”

On the bottom line, companies continue to wring more from less. Ellis says, “Every conversation includes ‘How can I take cost out of my operation?’” Ellis says companies continue to focus on integration efforts that reduce stovepipes, along with improvements and extensions to supply chains that help leverage existing capital even further.

Despite a gloomy outlook on the defense side of the industry, significant growth on the commercial side promises to offset some of the shortfall. Other industry trends bode well for suppliers in North America. Airbus and Boeing are both ramping up production to meet growing demand in civil air markets. New entrants from China, Japan and Russia are expected to create growing demand for second- and third-tier suppliers.

The Southeast region of the United States is expected to benefit from an ongoing shift in aircraft production and supplier manufacturing. Right-to-work laws in Southern states are creating an attractive climate for the industry. Boeing’s 787 assembly plant in South Carolina and the arrival of Airbus in Alabama are developments that will have a significant positive impact on regional economies.

Mexico is also a growing location for aerospace manufacturing. Unlike China, Mexico has no ambitions to build an aircraft industry and is close in proximity, making it an attractive region to work with.

Beyond market concerns, the industry report reveals an important structural challenge the industry faces as companies seek to replace retiring workers with new engineers.

Velocci says aerospace and defense companies today are willing to talk about workforce issues, a significant change from years past. Ellis believes that acknowledging those issues is a positive trend because aerospace and defense companies face stiff competition for new employees.

“We’re not producing the number of engineers we need, and when we do, they’re going to Google, Apple and other ‘cool’ companies,” Ellis says. Velocci says those companies are also more attractive because they are helping new employees pay off large student loan debts, a tactic that aerospace and defense companies have not yet matched.

Despite the present challenge of sequestration and future challenges, Anselmo feels the future of aerospace and defense remains largely positive.

“We’ll get through sequestration and on the other end of it, growth will return,” he says. “You don’t see any major companies pulling out of the U.S. defense market – and for good reason. It’s the world’s largest, and it will remain so for a long time.”