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2013 Global Aerospace & Defense Outlook

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KPMG’s 2013 Global Aerospace and Defense Outlook report explores the challenges and opportunities present in today’s A&D market and offers some practical and forward-looking insight for players around …

KPMG’s 2013 Global Aerospace and Defense Outlook report explores the challenges and opportunities present in today’s A&D market and offers some practical and forward-looking insight for players around the world.

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  • 1. 2013 Global Aerospace & Defense Outlook
  • 2. © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 3. About the survey This Global Aerospace and Defense Outlook is part of KPMG’s 2013 Global Manufacturing Outlook Survey. Data was collected by the Economist Intelligence Unit in November 2012 and accompanying analysis was provided by senior KPMG A&D leaders from across KPMG’s global network of A&D practices. A total of 335 senior manufacturing executives participated in the survey, of which 17 percent came from the A&D sector.The views reflected in this Global Aerospace and Defense Outlook include those from 14 large OEMs (“large OEMs”), defined as companies with revenues of US$10 billion or more, and 43 medium-sized organizations (“suppliers”), defined as companies with revenues of between US$500 million and US$10 billion. Forty percent of the A&D respondents identified themselves as being based in North America, 32 percent inWestern Europe and 19 percent in Asia. Almost half (43 percent) of all A&D respondents held C-Level positions within their respective organizations with a further 41 percent representing SVP/VP/Director or Head of department roles. © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 4. These have not been easy times for the aerospace and defense (A&D) sector. On the commercial aerospace side, backlogs have hit record levels and projections show that growth is not likely to let off anytime soon. For the defense sector, the picture is somewhat more challenging as governments slash defense budgets to balance the public books. But with continued economic uncertainty ahead, it seems clear that organizations in both the aerospace and the defense sectors will need to undergo a paradigm shift if they hope to enhance their margins, retain their balance sheet strength and grow their competitive advantage. This Global A&D Outlook report provides ample evidence that some of this necessary change is already underway. Large A&D OEMs (original equipment manufacturers) were 30 percent more likely than the industry average to say they would be cutting back or delaying planned investments and almost 10 percent more likely to say they would exit unprofitable product lines in the next 2 years. Some may say this is simply a“hunker down” mentality; others would suggest these organizations are focused on trimming fat and growing their core business to prepare for the future. Success for some is in“repurposing” their existing products, services and business models laterally into adjacent markets.The next few years should also see a rise in the number of A&D organizations expanding into new global regions. This sector report – reflecting the views of the vast majority of the sector’s large OEMs and suppliers from around the world – dives into the challenges and explores the opportunities present in today’s A&D market and offers some practical and forward looking insight for players around the world. To discuss these – or any other issues currently facing your A&D organization, I encourage you to contact your local KPMG member firm or one of the contacts listed at the back of this publication. Foreword Doug Gates Global Head of Aerospace and Defense © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 5. Continued emphasis on managing costs Renewed focus on the supply chain Achieving growth in new markets Conclusion How KPMG can help 2 5 8 10 11 Contents © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 6. Continued emphasis onmanagingcosts A&D executives around the world are heavily focused on reducing their cost base. And rightfully so: with almost 80 percent of large OEM respondents saying that growth over the next two years will likely top out at an anemic two percent, it seems clear that any additional bottom line growth will need to be realized off the back of further cost reductions. It’s not surprising, therefore, that more than half (53 percent) of all A&D respondents said that reducing their cost structure would be their top strategic priority for the next two years.The emphasis on cost cutting is particularly keen within the large OEM segment of the market where more than seven in ten respondents put cost cutting as a top priority. But with most of the “low-hanging fruit” of cost optimization already plucked, many sector executives are now starting to re-examine their structures and business models to identify sustainable opportunities for eliminating costs. Almost half of all A&D respondents said they will exit unprofitable or non-core product lines and business units while more than a quarter said Over 2% reduction 1-2% reduction 0.1-0.9% reduction No growth0.1 to 1.9% growth All A&D respondents Large A&D OEMs 2-3% growthOver 3% growth A&D companies predict 0-2% growth 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 4% 0% 22% 14% 36% 79% 15% 7% 11% 0% 8% 0% 2% 0% Source: Economist Intelligence Survey, Nov. 2012 Q: What is your outlook for the global economy over the next 12 to 24 months? Select one. More than half of all A&D respondents said that reducing their cost structure would be their top strategic priority for the next 2 years. 2 | 2013 Global Aerospace & Defense Outlook © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 7. A&D companies exiting unprofitable or non-core product lines and businesses Sharing functions and/or facilities with other organizations Acquiring suppliers to stabilize input costs Exiting unprofitable or non-core business units Exiting unprofitable or non-core product lines Cutting back and/or delaying planned investments Reducing labor force/costs All A&D respondents Large A&D OEMs 0% 10% 20% 30% 40% 50% 60% 40% 36% 27% 57% 41% 50% 41% 43% 37%36% 38% 36% Source: Economist Intelligence Survey, Nov. 2012 Q: What are the priority areas of cost-control that you will pursue over the next 12 to 24 months? Select top three. they would cut back or delay planned investments. Interestingly, the large OEMs were more than twice as likely as the sector average (or, indeed, the wider cross-sector sample) to point to reductions in investment levels, suggesting that it may be some time before investment truly starts to percolate down through the sector. Yet while – on the surface – the data seems to indicate an era of sluggish growth and reduced investment, the underlying trends suggest that the sector will likely emerge from the uncertainty stronger and more profitable than before. Further consolidation, for example, should lead to more resilient supplier networks; the divestment of non-core operations should ensure that future capital is focused on areas that can deliver long- term value; and cuts in investment levels should lead to more joint ventures and cooperative approaches to sharing both costs and risks. 2013 Global Aerospace & Defense Outlook | 3 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 8. Generally speaking, Brazil’s A&D sector is influenced by two main government departments: the Civil Aviation Secretary (Secretaria da Aviacao Civil) and the Ministry of Defense (Ministerio da Defesa). The Secretaria da Aviacao Civil is largely focused on facilitating the process of transferring airport concessions and privatizations to the private sector and has recently made good progress with the granting of concessions for three major airports: Guarulhos in Sao Paulo (Brazil’s main passenger airport),Viracopos in Campinas (Brazil’s main cargo airport) and Brazilia (the national capital). Plans are already in place for the next round of concessions which should include Galeao in Rio de Janeiro. But while the concession process is going well, it has had an impact on the aerospace sector, particularly within the regional carrier business. The Ministerio da Defesa commands the largest government budget with operating budgets of BRL57 billion (US$28 billion) and an investment budget of BRL8 billion (US$3.9 billion).Yet while the defense ministry may have a wide range of projects now under their direction, foreign defense players will find entering the market to be a challenge without the benefit of local partners. One particular area of opportunity for the defense sector, however, is in the provision of security products and services. As Brazil prepares to host the FIFAWorld Cup in 2014 and the Summer Olympics in 2016, these services will be in high demand. Jarib Fogaca Aerospace and Defense Sector Leader KPMG in Brazil KPMG Insight Enhancing cooperation to drive cost savings While many A&D sector leaders seem keen to “stick to their knitting” by focusing on the core business and reducing investment, the reality is that more fundamental cost cutting measures will be needed to raise margins and navigate through the current market uncertainty. Yet as I travel around the world speaking with sector executives, I often find that many of the opportunities for cost reduction that are already commonplace in many other manufacturing sectors – shared services, collaborative supply chain platforms and consolidated infrastructure, to name a few – have yet to be widely adopted within the A&D sector. Taking advantage of these proven opportunities will require A&D organizations to focus on improving collaboration across both their internal structure and their wider supplier network. And while this may occasionally add some complexity, the cost and risk-sharing advantages can often be significant. Getting there, however, will not be easy. Executives will need to encourage a transformative paradigm shift where sacred cows and ingrained ways of working are challenged and walls are broken down to encourage greater collaboration. Relationships up and down the supply chain will need to be enhanced, likely with the help of enabling IT platforms. New processes and governance models will also be required, particularly where sensitive data is being shared between divisions and partners. Those that are able to navigate through these complexities, however, should emerge as not only fitter and more cost-effective organizations, but better able to take advantage of new cost reduction opportunities that arise in the future. Doug Gates Global Head of Aerospace and Defense KPMG Insight 4 | 2013 Global Aerospace & Defense Outlook © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 9. all.This is a particular challenge for the sector’s large OEMs who – in their transformation towards end-product integrators – have largely contracted the supply risk out to theirTier 1 suppliers and, as a result, have lost visibility into the more distant part of their supplier network. Given the current cost pressures and ongoing demand volatility in the market, we expect to see further consolidation within the A&D supplier networks. Indeed, our survey finds that – of the A&D respondents representing sector suppliers – four in ten said that their organization’s goal in pursuing transactions was to reduce exposure to input price volatility and dependence on third party suppliers. The A&D sector will need to place a much higher focus on improving supply chain integration. Renewedfocus onthesupplychain If events of the past year have made anything clear, it is that the A&D sector will need to place a much higher focus on improving supply chain integration. Delivery delays in the aerospace sector, demand volatility in the defense sector and increasing incidences of supply chain disruptions across the board have shown that greater visibility and cooperation will be needed. But according to our survey, A&D organizations have far less visibility into their supply chains than peers in other sectors. Only around a quarter (27 percent) of A&D organizations said they had visibility past theirTier 1 suppliers (versus 41 percent of non- A&D respondents) while nine percent said they had no supplier visibility at Significantly less visibility into their supply chains No visibility – little to no Tier 1 supplier visibility Some visibility – limited Tier 1 supplier visibility, but not Tier 2 and beyond Enhanced visibility – Tier 1 supplier visibility and some Tier 2 supplier visibility Complete visibility – Tier 1, 2, and beyond suppliers visibility 0% 10% 20% 30% 40% 50% 60% 70% 7% 9% 4% 57% 63% 49% 29% 23% 32% 7% 4% 9% All A&D respondents Large A&D OEMs All manufacturers Source: Economist Intelligence Survey, Nov. 2012 Q: How much visibility of supply and capacity information do you have across your suppliers and logistics partners? Please select one. 2013 Global Aerospace & Defense Outlook | 5 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 10. But while, for the most part, the large OEMs will cheer any transactions within the supply network that will lead to greater security of supply and lower costs, none of the large OEM respondents to this survey indicated a desire to purchase suppliers themselves. Where the large OEMs do need to focus, however, is on removing any obstacles slowing supply chain signals from moving around their supply chain network. Already almost half of all A&D suppliers report encountering significant challenges in aligning operations to real- time fluctuations in customer demand while a quarter point to problems with ensuring sufficient supplier capacity to meet existing demand. 0% 10% 20% 30% 40% 50% 60% All A&D respondents Large A&D OEMs Significant challenges in aligning operations to real-time fluctuations in customer demand 26% 21% Ensuring sufficient supplier capacity to meet demand 14% 21% Lack of skilled talent to manage supply chain execution/ planning 35% 36% Supplier performance in terms of risk, reliability and quality 49% 43% Aligning operations to real-time fluctuations in customer demand 9% 29% Inadequate IT systems for supply chain visibility, planning and execution 9% 21% Lack of information and material visibility across the extended supply chain 2% 0% Inefficient supply chain tax structure Source: Economist Intelligence Survey, Nov. 2012 Q: What are the top challenges facing your supply chain? Please select top two. 6 | 2013 Global Aerospace & Defense Outlook © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 11. Becoming truly demand-driven As A&D organizations look to become leaner and more cost efficient, a growing number are starting to move towards”demand-driven” supply chains where all planning, purchasing and replenishment are aligned with actual demand at the furthest point of consumption. But with the vast majority of A&D respondents (71 percent) saying that they still rely on forecast demand for at least part of their manufacturing, purchasing and replenishment decisions, it is clear that more can be done within the A&D sector to establish multi-tier visibility and eliminate information latency across the supply chain. To achieve this, A&D organizations will need to shift their thinking away from traditional“supply chains” and instead towards the concept of highly integrated “supply networks” where multiple tiers of companies are working off the same shared view of total demand and total available supply with common processes and metrics. The promise of integrated value chain networks has already been achieved successfully in several other industries, and the advancement in technology solutions has only made this integration easier. Indeed, experience has proven that the best-designed demand- driven networks are those developed in collaboration with key suppliers/ customers and rolled out through an iterative approach with continuous process improvement measured against a shared benefits model. Business leaders should note, however, that this is often an emotional journey replete with its own highs and “valleys of despair”. But those that are able to manage the transition effectively will find that demand-driven approaches may allow A&D organizations to leapfrog their competitors and sustain a competitive differentiation for an extended period of time. KPMG Insight Rob Barrett Managing Director, Advisory, KPMG in the US Amit Gupta Partner, Advisory/ Management Consulting, KPMG in the US 2013 Global Aerospace & Defense Outlook | 7 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 12. While cost cutting may be front and center for the A&D sector, growth also remains a key priority. Of those A&D respondents who are experiencing a resurgence in innovation, most are expecting to do this by enhancing existing product lines and services rather than focusing on breakthrough “disruptive” innovation. In part, this speaks to the high capital costs that are often associated with breakthrough innovation. But it also indicates that a greater emphasis will be placed on exploiting potential market adjacencies over the coming years. And while almost a quarter say they will invest in new innovation, the vast majority of this investment will likely be focused on areas that will help differentiate their products by, for example, reducing their price points, delivering dramatic improvements in product quality over the lifetime, developing environmentally friendly products and services, and creating better technology platforms. In much the same way as organizations are focused on exploiting potential market adjacencies to stimulate growth, many A&D organizations are also clearly seeking to grow through transactions. Almost a quarter (23 percent) of respondents from the A&D sector and 44 percent of large A&D OEMs said that any transactions their organizations pursued would likely be aimed at expanding into new product segments or increasing their geographic coverage, indicating that some investment will be flowing into new growth areas. Given all of this, we expect to see an increase in the number of partnerships and joint ventures being developed within the sector as organizations seek to shore up their capabilities in new markets and deliver compelling new value propositions from existing service offerings. And while some of these will be traditional tie-ups between suppliers and integrators, we also expect to see new collaborations forming between A&D organizations and non-aligned industries such as telecoms or consumer electronics. Achievinggrowth innewmarkets Expect to see an increase in the number of partnerships and joint ventures being developed. 8 | 2013 Global Aerospace & Defense Outlook © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 13. Achieving success in new market entry While key global economies are scaling down their defense expenditure, many emerging markets – such as India – are looking to do the exact opposite.This is good news for the industry as new investment will not only offer new growth opportunities but should also lead to increased levels of modernization, the implementation of new technologies and the passing of much needed reforms. However, some challenges remain for foreign participants. For one, current FDI limits (26 percent in India1 ) within the sector are dampening investment but – for the most part – these are expected to be addressed in future. Foreign companies will have also noted recent policy changes announced by the Indian Ministry of Defense that place a strong emphasis on indigenization and domestic procurement.2 As such, external participants will want to focus on local brand building rather than simply setting up a sales presence and bidding on contracts. So while the replacement of the Indian defense forces’ outdated platforms may be a high priority, it will be those that demonstrate established relationships and long-term partnerships with the local industry that stand the best chance of winning in the long run. Those embarking on an emerging market strategy should therefore start by taking a good look at their investments in each target country and assess the strength of their local relationships and capabilities versus the comparative strength of local market competitors. Neelu Khatri, Head of Aerospace & Defense KPMG in India KPMG Insight 30% 44% Expand into new product segments or increase geographical coverage All A&D respondents Large A&D OEMs 48% 56% Maintain critical mass or increase market share (eg, targeting core business segments/ geographies) 20% 0% Reduce exposure to input price volatility and dependence on third party suppliers A&D companies to grow through transactions 0% 10% 20% 30% 40% 50% 60% Source: Economist Intelligence Survey, Nov. 2012 Q: Which of the following describe your organization’s goals in pursuing transactions? Please select one. 1 http://www.livemint.com/Companies/oFSyiqFgw6SV4WXzohMyrK/India-to-stick-with-26-FDI-in-defence.html?facet=print 2 http://www.livemint.com/Home-Page/qOsh8IhMjSkHB9DNnlg8cP/Defence-procurement-policy-overhauled.html 2013 Global Aerospace & Defense Outlook | 9 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 14. Conclusion As this Global A&D Outlook illustrates, today’s global marketplace represents a world of opportunity for aerospace and defense companies. But along with opportunity comes an evolving set of challenges including: • the growing need to partner with customers and suppliers to better reduce development costs and share risks • the complexity of identifying and divesting of non-core assets • the drive for greater visibility deeper into the supply chain • an ongoing effort to identify and capitalize on growth opportunities by leveraging existing technologies into aligned industries or regions; and • how best to maximize R&D investments to respond to changing customer demands. To prosper in this type of environment A&D companies must seek new approaches that will help them navigate the challenges above and take advantage of the opportunities that lie ahead. So while both the data and KPMG professionals experience in the market suggest that the heady days of double digit growth and unfettered optimism in the A&D sector may have passed, we continue to see many opportunities for large OEMs and suppliers to manage costs and drive growth within today’s environment. Yet given that all signs point to slow measurable growth for the sector in the near- term, the advantage will go to those that are able – and willing – to harness these new opportunities and explore new avenues for growth.Those that do not (or cannot) will ultimately find the next few years to be very trying indeed. 10 | 2013 Global Aerospace & Defense Outlook © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 15. How KPMG can help As a leading professional services firm to aerospace and defense companies, KPMG is committed to helping clients plan for the future. Nearly 1,500 Global A&D partners and professionals provide industry-specific experience and work closely with you to navigate the evolving complexities of global operations and value chains, and unlock value for your organization, customers, and stakeholders. KPMG professionals help A&D clients transform challenges into opportunities with cross-functional industry knowledge, open collaboration, and an insightful approach that’s tailored to each client’s situation and needs. KPMG’s Audit,Tax and Advisory professionals support aerospace and defense clients with deep technical and industry experience, and provide actionable operational, financial, and regulatory insights that help you cut through complexity. 2013 Global Aerospace & Defense Outlook | 11 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
  • 16. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accu- rate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2013 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: 2013 Global Aerospace & Defense Outlook Publication number: 130278. Publication date: June 2013 kpmg.com/socialmedia Global Aerospace and Defense Leadership: Additional contributors and country leaders: Jeff Dobbs Global Sector Chair, Diversified Industrials +1 313 2303 460 jdobbs@kpmg.com Doug Gates Global Head of Aerospace & Defense +1 404 222 3609 dkgates@kpmg.com Kai C.Andrejewski Aerospace and Defense Sector Leader KPMG in Germany +49 211 475 7900 kandrejewski@kpmg.com Glynn Bellamy Partner KPMG in the UK +44 121 6096170 glynn.bellamy@kpmg.co.uk LuisAlejandro Bravo Aerospace and Defense Sector Leader KPMG in Mexico +52 555 2468360 labravo@kpmg.com.mx Ken Drover Lead Partner, Defense Center of Excellence KPMG inAustralia +613 92 88 6623 kdrover@kpmg.com.au Jarib Fogaça Aerospace and Defense Sector Leader KPMG in Brazil +55 19 2129-8700 jfogaca@kpmg.com.br Jean-Luc Guitera Partner,Aerospace and Defense sector KPMG in France +33 155 686962 jguitera@kpmg.fr Andrew Jackson Partner KPMG in the UK +44 20 76941923 atp.jackson@kpmg.co.uk JaYoung Jo Aerospace and Defense Sector Leader KPMG in Korea +82 2 2112 0640 jjo@kr.kpmg.com Neelu Khatri Head ofAerospace & Defense KPMG in India +91 124 3074000 neelukhatri@kpmg.com Grant McDonald National Sector Leader,Aerospace & Defense KPMG in Canada +1 613 212-3613 gmcdonald@kpmg.ca Marty Phillips Global Head of Management Consulting for Diversified Industrials +1 678 525 8422 mwphillips@kpmg.com Laurent Des Places Partner,Aerospace and Defense sector KPMG in France +33 155 686877 ldesplaces@kpmg.fr Alex Shum Head of Diversified Industrials KPMG in China +86 212 2122508 alex.shum@kpmg.com Michele Hendricks Global Executive for Diversified Industrials KPMG in the US +1 203 406 8071 mhhendricks@kpmg.com Martha Collyer Senior Marketing Manager KPMG in Canada +1 416 777 3505 mcollyer@kpmg.ca

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