Aerospace and Defense Outsourcing 3.0
Straight out of grad school, I landed in the aerospace and defense outsourcing industry, and I have experienced firsthand the last three decades of outsourcing.
Straight out of grad school, I landed in the aerospace and defense outsourcing industry, and I have experienced firsthand the last three decades of outsourcing. When I reflect upon the evolution of outsourcing within the industry, progression from outsourcing 1.0 to 3.0 is remarkable.
But engineering and IT services providers have largely failed to recognize the clear pattern of change in outsourcing behavior and adapt to the new age to stay relevant.
In the early 2000s, unlike the automotive industry, aerospace lagged behind when it came to outsourcing work to cost-advantageous countries like India, China, Poland, Mexico and Russia. Despite the clear opportunities for savings, the late 90s and the mid-2000s, saw a very slow push from the aerospace industry to expand sourcing to emerging markets.
There are a few factors unique to the aerospace industry that explains this delay: the complexity of technology and processes involved in developing a mission critical on-board product; the high levels of quality and safety requirements; strict industry regulations; intellectual property protection; and dual-use technology complexities for military and commercial service platforms.
A tier 1 company that comes to mind as one of the pioneers of outsourcing to low cost countries like India is Honeywell. The Honeywell Technology Center (HTS) was built in the mid-1900s in India. Apart from Honeywell, there were no other tier 1 aerospace and defense companies that had a presence in India at that time in terms of technology outsourcing.
Outsourcing 1.0 (90s-mid 2000s)
During this period, tier 1 companies were exploring low cost options to stay competitive and gain OEM platform market share in the commercial space. The primary benefit of outsourcing was the low hourly wage rates and the availability of a low-skilled labor force like mechanical drafters or embedded software verification engineers with a certain level of DO-178B awareness — a guideline dealing with the certification of safety-critical software used in certain airborne systems. Although technically a guideline, it is a de facto standard for developing avionics software systems that was updated to DO-178C in 2012.
During outsourcing 1.0, most of the tier 1 companies were new to the concept of outsourcing to low-cost regions and did not have a structured vendor management system in place. Any low-cost service provider with vanilla service offerings like DO-178B-based software testing, primarily using low cost as the only value proposition was a hero in the eyes of clients. The service provider as the single sourcing partner would get red-carpet treatment from departments of the client organization. The biggest losers during this period were the local high-cost service providers.
Outsourcing 2.0 (mid-2000s-2014)
During mid-2000s, the following seven major trends were seen in most of the tier 1 aerospace and defense companies:
1. The parent companies found ways to compartmentalize work packages. This included things like segregating commercial work from military work and segregating restricted work from non-restricted work, which could be outsourced or off-shored to low cost service providers
2. During this phase, all the preferred outsourcing partners in low-cost countries grew by leaps and bounds.
3. Wholly-owned offshore design centers were established by a few airframe manufactures and their top suppliers in these low-cost countries. Two primary internal drivers for aerospace and defense companies to open their own captive centers were:
a. Being able to take up high-end design work and deliver out of their own offshore centers while outsourcing low-end/low-complexity work to their offshore partners and vendors
b. Intellectual property concerns.
4. The initial intent of captive centers was to only work on high-end projects but this did not pan out as they intended. Part of the problem was an inability to scale, but mainly there was a lack of knowledge base to execute any mission-critical design assurance level (DAL) A/B/C/D projects. High-level projects require excellent technical expertise and depth on certain domains, such as flight displays, flight controls or electrical systems. Captive centers were unable to obtain the right resources to carry this out.
5. All offshore companies saw these captive centers as a threat to their business. They kept them at arm’s length and made no effort to collaborate on any level.
6. During this period, aerospace and defense companies also started outsourcing a lot of functions beyond core engineering, like supply chain, manufacturing engineering, project management/project engineering as a service and technical publication.
7. By the end of the year 2012, few offshore captive design centers could scale up so they had to sell their centers to offshore service partners. However, many companies such as Rockwell Collins, Goodrich, Eaton and Safran started to find their recipe for success and could scale up to big numbers of workers by taking low-end work. This allowed the effects of economy of scale to kick in and provide the required operational efficiency. Therefore, Indian service companies continued to see these captive centers as a serious threat to their business and refrained from this sort of partnership.
By the end of the outsourcing 2.0 phase, the parent companies were outsourcing to their offshore partners and to their captive centers. The parent companies were treating both equally and awarding projects to the best bidder, which was working out well for the offshore service providers. The offshore services companies were also trying to move up the value chain and provide complete turnkey solutions, including manufacturing, but were not that successful.
Outsourcing 3.0 (2014-Present)
By late 2014, most of the U.S. and European aerospace and defense parent companies’ offshore captive design centers were in their ramp-up phase. In the marketplace, they started working in similar fashion to any other offshore services vendor/partner by taking up any work that was available from their host companies. Western manufacturers obliged, with their C-level executives encouraging this captive strategy.
By this time, work was being outsourced from various domains such as core product development mechanical and electrical engineering and technical publications among others. During this phase, service providers who aligned with the captive centers started seeing growth coming back in their business. The acceptance of the captive design centers increased tremendously in this phase. Captive design centers are no longer being looked as competition by the traditional low-cost service providers, but just as an extended engineering/IT arm of the parent company.
Top 10 trends in the Outsourcing 3.0
1. Captive centers are working with their parent companies just like any other supplier/vendor, willing to take up any available work to scale up.
2. Offshore service providers who partnered with captive centers are thriving and working very closely as an extended team.
3. Captive centers have only been around for a decade or so but have acquired considerable system knowledge in certain domains.
4. Offshore service providers are also trying to move up the value chain by acquiring certain skill sets and capabilities inorganically through mergers and acquisitions.
Recent examples of such mergers and acquisitions include:
• Cyient acquired Rangson to provide volume manufacturing
• HCL acquired Butler Aerospace to provide more onshore (US) services in the manufacturing engineering space
• Tech Mahindra acquired Aerostaff Australia and Gippsland Aeronautics to beef up their capabilities in component manufacturing etc.
5. Change in U.S. presidency in 2016, Brexit and growing populist movements across the globe added a new angle to the aerospace and defense outsourcing landscape. Buying local has become one of the key initiatives across all industries. Offshore companies started opening more global engineering delivery centers across all geographies to make sure that they can deliver from their onshore centers.
6. Cost pressures on offshore suppliers and a greater focus on quality. This change in the expectations is coming from the top of the value chain. For example, the impact of Boeing’s “Partnering for Success” initiative was felt across the supplier base.
7. Airframe manufacturers also joined the race by opening their captive centers, an example being the Boeing India Engineering and Technology Center. This has been highly successful with Boeing on its way to creating more than 5,000 jobs in India in a couple of years’ time, with Airbus already employing 6,000 at their similar facility in India.
8. To support populist movements like “Make in India,” Boeing and Tata announced a joint venture to produce Apache fuselages and similar joint venture deals in India.
9. Large acquisitions, such as Rockwell Collins acquiring ARINC and B/E Aerospace and then in-turn getting acquired by UTC. Safran acquiring Zodiac Aerospace and the mergers of Harris and L3 are also great examples. Boeing is also trying to insource their in-house system development to negate threats from traditional large suppliers like UTC, Honeywell and GE. Recently, AvionX announced their new avionics manufacturing division in partnership with Safran to develop an auxiliary power unit. These market dynamics will lead to a void in the tier 2 and 3 space, which means all these large aerospace and defense companies will offer solutions at a systems level and will look for partners who can design, develop and manufacture subsystems. This will create a huge market for traditional engineering service providers to move up in the value chain to offer turnkey solutions to tier 1 companies.
The same offshore services providers who got the red-carpet treatment in the early 2000s are no longer enjoying such benefits. Companies offering similar generic low-end services and cost arbitrage as the driving differentiating factor no longer suffices, since offshore captive centers have similar benefits and pricing.
In the Outsourcing 3.0 environment, here are the top five things the offshore service companies should do to stay relevant while growing their top and bottom line.
1. Hire local, deliver from local centers and deliver more for less through a commitment and result driven approach, showcasing it through much higher productivity.
2. Partner closely with captive centers to continue to get a piece of low-end engineering/IT outsourcing work aerospace and defense companies continue to source to captives. On top of this, take up high-end turnkey projects. Deliver end-to-end solutions where clients only provide specifications and the supplier delivers accordingly with minimal supervision.
3. Position yourself as a total solution provider rather than just a time and material labor provider. Be willing to take risk during the early phase of an engagement and make it an output-based payment plan for the client.
4. Invest along with your clients in new technologies such as digital, internet of things, artificial intelligence, machine learning and multi-core certification.
5. Joint bidding and GTM with clients. Help clients win new business in different parts of the world by taking on more responsibilities and risks.