Leading aircraft manufacturer Boeing (BA +2.47%) is seeing robust demand for its jets, and is aggressively working to boost production rates. Ideally, this should have been great news for part suppliers, but it's actually traumatizing them as the jet maker is seeking heavy discounts. What's led Boeing to take such a firm stand with its suppliers?
Boeing 737-300 (D-ABXS). Source: Wikimedia Commons
Growing rivalry and price pressure
While commercial aviation is booming with opportunities, it's also inviting increased competition both from big and small players. Airbus (EADSY +6.15%) is currently dominating the single-aisle-airplane space with 60% market share. This market is expected to soak up more than half the industry deliveries in the next two decades, which means tremendous growth, and an equally strong contest for a wider market share.
Both Airbus and Boeing are ramping up their production rates, and in 2017, they are together expected to make as many as 138 jets a month. Airbus plans to boost the single-aisle A320 production by around 10%.
Smaller players Bombardier and Embraer are also eyeing better market share, and are stretching to churn out higher jet numbers at competitive rates to attack the likes of the two biggies. Bombardier has scheduled CSeries deliveries with passenger capacity of around 110-140 in the latter half of 2015. Embraer is also designing its second generation E-Jet that is expected to enter airline service in 2018, with seating capacity for more than 110.
Embraer ERJ-170-100LR (OH-LEE). Source: Wikimedia Commons
Aircraft makers are also facing pricing pressure from airlines. Airlines are struggling with cheaper fare rates and high fuel costs, and thereby adopting the hard way of negotiating prices with aircraft makers. So, not only is Boeing's market coverage getting threatened by Airbus, it's also experiencing pricing pressure from both smaller rivals and airlines.
Keeping costs under check
To compensate for the price cuts, Boeing has to work hard on reducing costs to maintain margins. More than two-third of aircraft manufacturing costs are that of component parts. Vendors earn significantly higher operating margins of nearly 16% on an average -- way above what Boeing and other aircraft makers make from selling airplanes.
Hence, Boeing senses that discounts from vendors could mean massive cost reduction for it. It wants to take advantage of the fact that it works with multiple suppliers and can draw them in a price contest to get the best rates.
In return, the aircraft maker is ready to help suppliers improve their overall efficiency, boost volumes and control costs. CEO McNerney is quite confident that vendors would gain from the company as it could offer "the biggest volume opportunity in the aerospace business over the next 10 or 15 years".
Boeing means business
McNerney has clearly conveyed his message to the vendors that if they do not cooperate, they could become a part of the "no fly list" and be barred from future work, while "someone else may have that opportunity". However, since the discounts requested by the Chicago-based company are quite steep, only one third of the suppliers are participating as of now.
GM Nameplate, which makes around 1.6 million signs and placards for Boeing planes, has been asked to speed up production and give price discounts in the range of 15% to 20%. And it's not just the small vendors, Boeing has not even spared long time supplier United Technologies (UTX +2.24%). When United Technologies couldn't accommodate Boeing's demands, the latter promptly shifted the manufacturing of landing gear work for the 777 to Heroux-Devtek. Boeing is one of the largest non-governmental customers of United Technologies, and together with Airbus, accounted for 32% of the company's OEM revenue in 2013.
Boeing 777-200 (N7771). Source: Wikimedia Commons
Boeing COO Dennis Muilenburg said that as a result of the cost reduction measure, the company has already started saving cost in both commercial and defense segments, and could see double-digit cost decline in supply chain.
Foolish takeaway
Boeing is registering decent sales and profit numbers, but the rising dominance of Airbus, and ambitious targets of Bombardier and Embraer could affect the company's market presence while price pressure heats up. It's imperative for the aero giant to increase volume while working on the cost front to establish future growth amid current challenges. Even if Boeing settles on a lesser discount than presently coveted, it should save the company a solid chunk and have a fair impact on its overall results and market expansion plans.
