Are Risk Sharing Partnerships the best Procurement Strategy for Aircraft Manufacturing Companies?

Given the situation in Global Aerospace with 'Risk Sharing Partnerships' changing the financing of new developments - should we consider those words, with a case study in mind? Airbus have been looking to the future with the next generation single Aisle some 10 years away, with Boeing considering a middle of the market aircraft. Both have relied on Risk Sharing, and Partnerships. But do the Partners really share risk?

Ultimately an airline wants to contract with the airplane manufacturer and have little else to worry about in getting delivery of the aircraft, and a single point of focus for all maintenance and support. However, with todays economics the development of a new aircraft can reach ￡13bn for an Airbus A380, so requires a shareholder appetite for a lot of risk to ensure the business case works with a break even point some decades later - so the likes of Airbus and its competition take a position with their suppliers to sell the business case to them and their shareholders in return for exclusivity. 

It didn't always have to be this way, when Airbus was more in the hands of governments with 'Golden shares' and subsidies were frowned upon - Launch Aid* allowed a 'Build to Print' supply-chain and procurement strategies could play the multi-source competitive model. Well we are into new territory with more and more aircraft appearing to be certified with incremental developments, with new engines, performance improvements from Aerodynamics - like Sharklets, and shorter take off performance for airfields like in Rio.

(* Boeing has continually protested over launch aid in the form of credits to Airbus, while Airbus has argued that Boeing receives illegal subsidies through military and research contracts and tax breaks.)

We also have a more global model for the likes of Airbus and Boeing who use their commercial divisions product to create off-set credits for military sales. Because many of the world's airlines are wholly or partially government owned, aircraft procurement decisions are often taken according to political criteria in addition to commercial ones. Boeing and Airbus seek to exploit this by subcontracting production of aircraft components or assemblies to manufacturers in countries of strategic importance in order to gain a competitive advantage overall.

It is worth going back to the principles of Risk Sharing Partnership that has been more recently employed on Airbus A350-900/1000 and Boeing B787, and comparing this with the 'Build to Print' model where an aircraft Original Equipment Manufacturer (OEM) would purchase goods and services from suppliers at contracted prices, the development and design costs would be born in a contract from the OEM. 

The suppliers and vendors would receive purchase orders from the OEM and often they (the suppliers and vendors) would be just one of several " Approved Sources " for supply or even " Suggested Sources " for supply and thus have to continually - over the life of a program - compete with others for the OEM's business.

The OEMs developed the component and system specifications and passed them over to their procurement offices so that appropriate suppliers and vendors could be located and contracted to provide whatever was being sought for purchase.

For new technologies, a closer relationship between the OEM and the supplier was needed to facilitate development and to ensure successful integration of components and sub-systems into the OEM's final product, verify its performance and certify that it met regulatory requirements.

It was partially the desire to achieve this greater cooperation between the OEMs and their key suppliers which first led to the shifting of the relationship from being one of 'Purchaser & Supplier' to one of 'Risk sharing Partners'.

From the 'Purchaser & Supplier' perspective, the supplier was often contracted to develop new components or sub-systems exclusively for the OEM. The rights to these "Source Controlled' products typically being assigned over to the OEM by contract. The suppliers thus charged a premium price and it was up to the OEM to sell the final product in sufficient numbers - as a result of the lower margins - needed to achieve success with the programs. Vendors of existing well established component products, on the other hand, retained their rights and sold their products to the OEM at competitive market prices.

The " Risk / Reward " model gives the suppliers, who are now "Partners", exclusive rights to supply their product to the OEMs while maintaining their technical rights over the product which they are contracted to develop and supply. This new relationship also allows them the opportunity to incorporate the newly developed technologies into other similar products which they are then free to sell to other OEMs.

More over, the supplier (now a Partner) is responsible - as the 'Sole Design Authority' - for the component or sub-system which they will provide and thus its development and certification. This is considered a superior approach to apportioning responsibility because after all, the supplier is the subject matter expert for the product or sub-system they are tasked with supplying.

The challenge here is that for Airbus and Boeing, a failure of a 'Risk Sharing Partner' to perform has the chance to harm the Aircraft OEM reputation, even if liability can be flowed down for delay or quality issues. This has been seen to be the case in A380, A400M, B787, and the overall effect is that Risk transfer is not happening, and underlying this the 'partnering' approach turns more contractual and litigious.

Risk can be said to be the likelihood of the occurrence of a hazard. In this case from the financial point of view, the hazard is that the OEM will not be able to sell into the market place the number of units it anticipated in order to justify the business case for the program being launched. The risk for the partner is thus less than that for the OEM because the partner can leverage the technologies developed by incorporating them into other products and selling those other products to other OEMs.

It is thus on the above basis - as well as taking into account many other factors - that the reward side is negotiated, whereby each partner will receive a portion of revenues derived from the sale of each OEM product. Contracts are of course way more complicated than described above. Partners may in part be compensated for development cost when they supply deliverables during the course of the development (design services, prototypes, information, etc., all not contractually defined as part of the risk sharing effort while at the same time other aspects of the aforementioned might be).

Its been said that the OEM / supplier relationship typically lead to suppliers making 15 to 20 percent profit on their product but due to stiff competition, market share was small. The Partnership Model was thought to allow the successful suppliers to increase their market share despite giving up some of the profitability on each component sold and to further reduce the risk associated with participating in failed programs.

The OEMs traditionally were said to make between 4 and 8 percent profit on the final product and from their point of view, risk sharing was anticipated to facilitate a lowering of cost for them and thus increase the profitability of each final product (unit) sold. The strategy may seem to be something born out of Game Theory and may even spark thought of the Nash Equilibrium - "the best result comes from doing what's best for yourself and for the group as a whole".

Today we have a Global Supply Chain business model which has served to introduce many new players into the market place. It has lead to the lowering of production cost but has also given rise to huge development cost overruns - so far more often than not - as well. 

It has allowed the OEMs greater opportunity to distribute risk through out the supply chain, yet the end result is still the same, those who play the game well are successful in reaping the rewards that they seek and those who don't may eventually perish.

It occurs that this tried and not completely successful model will be called into question with the developments of the Widebody derivatives - Airbus A350 -2000, and Boeing 777-stretch.