By Alwyn Scott
NEW YORK (Reuters) - The world's largest plane makers are soaring these days, fueled by historic demand for new jets that has cranked up their factories to record speeds.
But booming sales of aircraft, far from being a bonanza for suppliers, are spurring brutal competition between Airbus Group NV
GM Nameplate is one such company. The 400-employee Seattle firm makes the signs and placards posted on everything from overhead bins to emergency exits: about 1,500 signs per plane, or 1.6 million a year to Boeing alone.
As Boeing sped up jet output by 40 percent over the last three years, it not only asked GM Nameplate to turn out more signs. It also wanted a 15 to 20 percent price cut, said Paul Michaels, director of GMN Aerospace, the aircraft division.
"That's huge," Michaels said.
Boeing also wanted GMN to show it was able to meet faster production speeds, and that it had the financial health to stay in business. The company spent a week with two Boeing coaches going over its factory. Michaels says he now expects to hit the price target in 2016 and ultimately to be better off. But "it was very nerve-racking at first."
The price pressure has left many small-tier suppliers grappling with whether to invest and grow, sell to big players or simply fold.
"It's forcing suppliers to say either I'm in the game or out of the game," said Christian Schiller, managing director at Cascadia Capital, a Seattle investment bank. "They can't just stay still."
He and others predict buyouts in the sector will rise this year as pressure grows, even though prices for small companies already are relatively high.
Since suppliers provide more than two-thirds of a jetliner's content by value, they are obvious places for Boeing and Airbus to find cost savings. But squeezing too hard could cause production snarls and hurt an industry that is struggling to keep up with rising demand.
RISING OUTPUT, FALLING PRICES
Airbus last week said it will notch up production of its single-aisle A320 planes by nearly 10 percent, matching a similar move by Boeing. Both companies also are building many of their double-aisle plans at faster rates.
By 2017, Boeing and Airbus will be churning out a staggering 138 new jetliners a month. Smaller plane makers Embraer SA
As thousands of suppliers gear up, Boeing and Airbus are pitting them against each other in price competitions to drive down supplier prices more than in the past, suppliers say.
Boeing says it will put companies that don't cut prices on a "no fly" list that bars them from future work, while rewarding those do with the chance to bid on more work.
Both plane makers also are vying for a piece of the spare parts market, demanding royalties on parts that are sold directly to airlines and never enter their factories.
Demanding lower prices in exchange for sales is a well-known tactic in other industries. Big retailers like Wal-Mart Stores Inc and Costco Wholesale Corp are famous for it. But the large price cuts now hitting suppliers are new, and are landing hard in an industry where sales volumes are relatively low.
Boeing and Airbus also make far less money selling finished planes than suppliers earn from selling parts. Boeing's jetliner business, for example, made an operating profit of 10.8 percent last year, compared with an average of about 16 percent for suppliers. Airbus' commercial aircraft profit was 4 percent.
"Plane makers have a legitimate gripe," said Tom Captain, head of the global aerospace and defense consulting practice at Deloitte.
To some extent, aircraft makers are victims of their customers, the airlines. Planes are technical marvels that operate with great precision and safety, but the flying public still demands fares that cost less than a good hotel room, and jet fuel costs are likely to remain high. So airlines are driving hard bargains to pay as little as possible for jets.
Boeing is selling some jets more aggressively, since Airbus has gained 60 percent of the market for new single-aisle planes, a market that represents more than half of the new planes to be delivered over the next 20 years.
Boeing recently launched an internal campaign to fight for market share, opening itself to more negotiations over price. But that requires driving down the cost of building planes.
Boeing and Airbus also are making their own operations more efficient, as they press suppliers to do the same, and are offering to help.
"It's not going away," Boeing supply chain vice president Stan Deal said of its cost-cutting program, Partnering for Success. What's most important to Boeing, he said, "is maintaining or gaining our long-term competitive advantage."
FEAR OF BANKRUPTCY
Of course, many suppliers also are benefiting from the boom. Larger companies and those with proprietary products say they have more leverage to push back against price pressure. Even when margins fall, larger volume can compensate and boost total profit.
Still, concern is rising because many smaller suppliers lack the capital and access to talent to make the price concessions plane makers are demanding.
"Some suppliers will have trouble and may not be able to step up to the challenge and thus go out of business, or sign contracts they cannot deliver on," said Captain, of Deloitte.
A 2011 study by PricewaterhouseCoopers of more than 100 aerospace suppliers found that 20 percent were at high risk of being unable to keep up with rising production and had relatively weak financial strength.
The pressure has increased since then, said Scott Thompson, head of PwC's U.S. aerospace and defense business. Suppliers that make commodity products, such as GM Nameplate, are most at risk of losing work to rivals, since they face the greatest number of competitors.
The risk to Boeing and Airbus is biggest from "sole-suppliers", since any slip there risks fouling up the plane makers, Thompson said. And because aerospace has relatively low volume compared with automobiles, there are many sole-supplier arrangements.
"It's absolutely a risk," Thompson said. "You have one supplier that has a problem. It can really have a significant effect on the supply chain."
Even Boeing is having difficulty keeping pace. Its 787 factory in South Carolina has failed to finish fuselage sections on time. It is hiring contract workers and sending unfinished pieces to its larger factory in Washington to ease the bottlenecks.
WHEN AUTOMAKERS SQUEEZED
Consultant Dave Bender has seen this pressure before. In the mid-2000s he worked as a vice president at GDX Automotive, a major supplier of rubber window seals to Detroit automakers. Back then, one of the Big Three threatened to put GDX on a "no-bid" list unless it cut prices. "I don't care if I bankrupt you," Bender recalls the auto executive saying.
Many suppliers did go out of business, he said. GDX was eventually acquired by a bigger company.
A decade later, he saw something similar from plane makers as president of Crane Aerospace & Electronics, a Crane Co
Bender said his team could sometimes resist price cuts on products Crane designed, since the plane maker would have trouble finding other suppliers. And if Crane cut prices, it asked to bid for other work as a quid pro quo. Boeing allowed it. "That puts pricing pressure on the current guy and allows us an opportunity to get in," Bender said.
But when its own contracts came up, Boeing and Airbus would make Crane compete against other companies on price.
"They're pretty sharp about this," said Bender, who left Crane last year. "They may give you the business in the end, but they're going to get your price to come down."
Boeing also asked Crane to pay royalties on replacement parts it sold. "They know that some suppliers make very good margins on their aftermarket business," Bender said, "so they're trying to get their piece of it."
Boeing said charging royalties on products that use its intellectual property help it "recover a portion of the value of our research and development."
TAKING A BUYOUT
Increasingly, Boeing is asking suppliers to do design work, requiring a significant investment in engineers and time.
Under this new model, often called "pay to play", suppliers might have to wait months to see revenue from their investment. If an aircraft is delayed, like the Boeing 787 and the Airbus A380, that could drag out years.
Some have struggled to make those contracts pay off. Spirit Aerosystems Holdings Inc
Others can't make the leap. Paul Van Metre and his partners in a Bellingham, Washington, machine shop said they couldn't stomach borrowing more money to expand and bid on more complex jobs for Boeing.
So a few weeks ago they sold their firm, Pro CNC, to an Irish company, TruLife, which makes prosthetics and wanted to diversify.
"We didn't have the resources, and we didn't want to put our personal guarantees on even more machines," Van Metre said.
The Pro CNC sale is one of a rising number of acquisitions of aerospace suppliers. The huge demand for jets has made the suppliers attractive targets for bigger firms that want to lock in capacity and skilled workers.
Many owners, particularly in Washington, are near retirement and don't have the cash, or the personal desire, to invest and grow, said Schiller of Cascadia.
He just signed two companies that are looking to sell for that reason. Companies are selling for eight to ten times pre-expense earnings, he said, nearly double the levels two years ago.
In that environment, the price and investment pressure from Boeing and Airbus, he said, "is a catalyst for them to say, 'We're going to check out.'"
(Reporting by Alwyn Scott, editing by Edward Tobin, Peter Henderson and Ross Colvin)