Recommendation report for Airbus - Essay Example

Recommendation report for Airbus Executive Summary: Airbus has recently been having structural and functional problems with its big jets, while its smaller jets are less competitive in the market, especially as compared to its major competitor, Boeing. While the A380 passenger jet was intended to carry Airbus to new heights of success, the problems that are being faced by this jet are actually dragging down the performance of the entire European consortium as a whole (Economist, 2006). Moreover, the A350 EWB may not be competitive in the marketplace against Boeing’s extra wide aircraft model because of an inferior structural design. This report will reflect upon various aspects of Airbus management, sourcing and supply chain and how they are impacting upon the company’s performance. It will also provide policy recommendations for the Company to follow during the next five years. The Airbus Company: This report relies on a series of news report from The Economist, and the content of these reports are briefly summarized below as follows: EADS is the parent company of Airbus and was a contractual arrangement between France and Germany which was geared towards providing a strong rival for the American aircraft company, Boeing. A flagship jet development was initiated – the A380, which was to provide stiff competition for Boeing’s long haul jet. (The Economist, 2006: In the end, it was a fight......). The reality however, was that the company was beset with problems all along. The costs incurred by Airbus are in Euros, however the aircraft are priced in dollars in the open market; as a result, the Company suffers because production is no longer competitive with its sales figures registering losses arising out of differentials in exchange rates. The Company has also developed the A350 EWB aircraft to compete effectively with Boeing extra wide aircraft version – the Boeing 787. The Boeing 787 was initiated five years earlier, it has a more advanced structural design which allows passengers to travel much more comfortably. It appears that Airbus has a challenge with this aircraft as well, in order to refine structural designs to make the aircraft more competitive with the Boeing model. Other issues for Airbus to deal with include the effective negotiation of a contract that included both private and public parties. The lack of effective communication in contracting was one of the aspects that hindered its implementation and caused delays to arise in production of the aircraft, leading to losses and some cancelled orders for Airbus’ aircraft. Contract management, negotiation and supplier quality management: One of the important aspects that Airbus has to consider in framing its policy over the next five years is contract management, because thus far, it has not been able to effectively manage them. A part of the problems Airbus is facing now have to do with a botched French deal that went wrong. EADS, the parent company of Airbus came into being through the disposition of 37.9% of Airbus shares that were owned by a French public sector enterprise, Aerospatiale, to a private investor, Noel Forgeard. While the deal was originally intended to provide Airbus with a long term, French private sector shareholder to aid the process of privatisation, it has proved to be a botched up job that has aided the downfall of Airbus (The Economist, 2006: botched privatisation). The problems arose when Forgeard sold his shares to Daimler in Germany, thereby disturbing the equity stake and ownership percentages of the French Government, acquired through disposition of its ownership in Aerospatiale. Furthermore, the original intent behind the formulation of EDAS was to provide strong European competition for the American giant Boeing, but fluctuations in exchange rates have not proved favourable to the Company’s sales in the market. It appears likely that some of these problems could have been addressed if the contracts had included certain provisions; for example stipulating that ownership of Forgeard’s shares were to remain within France. The disturbance in share ownership percentages has also interfered with the effective operation of the production contracts, because it has allowed higher levels of bureaucracy and red tape to plague operations and impact negatively upon the operations of the Company. As Jurong and Caldwell (2008) point out, when a public client works with a private contractor on complex long term infrastructure projects, there are large sums of money as well as a long time period involved, hence a strategic capability needs to be developed. These long term contracts are complex, especially when they involve public and private enterprises and it raises issues in relation to developing and renewing the skills and capabilities that are likely to be required in the performance of the contract. According to Jurong and Caldwell (2008), successfully executing these public-private partnerships also pose the challenge of learning and the extent of learning may determine outcomes. Since facilities management services are increasingly being outsourced to external suppliers in other countries such as China, this has caused the development of a new kind of service industry with its own culture and contracting practices. In a study carried out by Kadefors (2008) using Swedish consultants, clients and service providers, the findings suggested that facilities management contracts that were outsourced required different kinds of contracts to be drawn up which would reflect the nature of the interactions that were to take place between the parties to the contract and would vary considerably depending upon the quality and volume of work (Kadefors, 2008). Boeing appears to have taken this into account in formulating its contracts with suppliers in China and Japan to manufacture its aircraft, including its extra wide body design. In the case of Airbus however, the contractual arrangements may not have adequately taken into account, differences in culture between its European parties. When contracts are well specified, they can foster a higher level of cooperative, long term, trusting exchange relationships, because various aspects of tasks are properly articulated and this helps in preventing misunderstandings and ensuring that all parties understand the tasks required (Kadefors, 2008). It also appears that contract related communication is very important because it enables relationship building, facilitating and coordinating knowledge flows. In the case of Airbus, the contract between the public entity Aerospatiale and Airbus, with Legardere as the principal private shareholder, was not well formulated, although it was intended to serve as the kind of contract that the French called noyau dur. (The Economist, 2006: A botched privatisation). Three limiting factors were identified, i.e., (a) limited access to certain information (b) uncertainties that could not be captured through forecasting methods and (c) flawed assumptions underlying the cash flow projections. Limited access to information demonstrates how a failure of contract related communication and improperly drawn up contracts can hamper effective procurement arrangements. The other limitations also highlight the fact that formulating and negotiating contracts must be an extensive process and can be a learning experience, where difficulties are highlighted and solutions need to be found. (Argyres et al, 2006). When the contract is between a public sector enterprise and a private entity, such as for example Airbus, where the contractual arrangement is between Aerospatiale and Legardere, asymmetric learning that takes place, with the private party appearing to be in a better position to acquire, embed and renew their learning. Two kinds of learning take place: (a) strategic learning or double loop learning (Argyris and Schon, 1978) and (b) operational learning which is single loop and project based; the authors (Argyris and Schon, 1978) have suggested that in the case of long term projects, best results can be obtained when both are combined. The Airbus contract does not appear to have allowed adequate scope for learning and modifications to be carried out in accordance with the learning. Due to a lack of coordination between the two countries involved in the contract, as well as changes arising out of fluctuations in the exchange rates, billions of dollars have been lost. If the contract had been formulated in such a manner that it had provided scope for learning to take place and for modifications to be made to incorporate the learning, then it could have possibly avoided many of the delays that occurred; for instance setting out deadlines for work completion and providing alternate strategies to be followed in the event of occurrence of contingencies. The negotiation of Airbus contracts also appears to leave much to be desired. What was perceived to be a deal that would be favourable in strengthening the representation of the private sector in Airbus went sour when Lagardere started selling his EADS shares to the German company, Daimler Chrysler. (The Economist, 2006: A flurry of deals). This upset the delicate Franco-German balance, from the 25% being held by the French Government and Lagardere versus the 22.5% now being held by Daimler Chrysler, which could lead to more bickering in the future. If the negotiation process had been improved such that the private investor was not allowed such a high level of power and flexibility, it might have been possible to avoid the sale of shares which occurred. Supplier issues: Anand et al (2008) have carried out a study using a dynamic model of a procurement contract between a supplier and a buyer over two period demand scenario. In this study, the authors have eliminated most of the classical reasons for inventories, but the buyer’s strategy in maintaining an equilibrium would be to maintain inventories and the supplier would not be unable to prevent this. Airbus has not been as successful as Boeing, because the latter has streamlined its supplier base so that inventories are not compromised, which in turn aids in timely delivery and completion of production schedules for development of aircraft. Suppliers are placed in an excellent position with long term contracts, because they are guaranteed a steady client and source of income for the entire duration of the contract (Jurong and Caldwell, 2008). Further, according to Burnetas and Gilbert (2001), higher procurement costs need to be counter balanced by the benefits of ordering decisions that are based upon better availability of information about potential demand for the product or service being procured. As noted in an article in “The Economist” about Airbus’s jumbo sized problem, the problem with demand in the case of Airbus is the overloading of its factories, i.e., orders placed for aircraft may extend to a six year period for delivery.(Economist, 2006). For Airbus customers, the long waiting period for delivery of aircraft has impacted adversely on ordering decisions, hence Airbus could only offset this by offering significantly lower costs as compared to Boeing and other competitors. But in order to ensure that it is able to achieve production at lower costs, it may be necessary for the Company to also consider outsourcing some of its manufacturing activities to developing countries, where skilled labour and infrastructure facilities are available to achieve supply chain advantages at lower cost. One of the countries being used by Boeing to obtain skilled labour and production facilities at low cost is China. It may be noted that Airbus and Boeing have been the main suppliers of jets thus far. But China’s foreign minister, Xu Guanhua, has set out one of the major research priorities for the country as being the development of a wide bodied passenger aircraft (Economist, 2006). China has been a major supplier of parts for aircraft, such as doors and wing panels for the 737, wing ribs for the 747 and rudders for the new 787 (Economist, 2006). The country is already making small and medium sized aircraft that are based on Russian designs, together with fighter aircraft and helicopters. It is now keen to enter the market for jets. Although China has not yet evolved to the stage where it is in a position to manufacture jets that could compete with those produced by Airbus and Boeing, nevertheless it is rapidly developing capabilities to build large aircraft. In accordance with the views expressed by AeroStrategy, a consultancy firm, the question is not whether China has the capability to produce these large aircraft, but rather, whether it can produce it to the scale and reliability that are associated with Airbus and Boeing. (Economist, 2006: China hopes to build wide bodied airliner). AeroStrategy has identified two key areas that may play a significant role in whether or not China is able to achieve the challenge of matching up to major competitors such as Boeing and Airbus in the production of large jets – these key areas are operational performance and reliability. Where supply of parts to Boeing from China is concerned, the operational performance and reliability appear to be working, because it has enabled Boeing to ensure that production is on schedule, although there may be other negative aspects that could also arise. Where the question of procurement contracts arises in developing countries such as China for example, one of the major issues that could negatively affect operational performance and reliability of products is corruption, especially where it concerns funds available from the World Bank for such purposes. Where procurement is concerned, it is a major activity with about 30,000 contracts passing for review and funding by the World bank every year in 1990. (Westring, 1991). The World Bank does not specifically include the curbing of corruption as one among the bank’s purposes and functions. But reducing the incidence corruption is nevertheless, one of the goals that may be noted from the measures implemented by the Bank. Its Articles of Agreement specifically prohibit the bank and its officials from taking non economic considerations into account in arriving at its decisions (Shihata, 1996-7). The World Bank, in a report, has identified that the United Nations has developed a Declaration against Corruption and Bribery in International Commercial Transactions (World Bank, 1997). This Report set out four strategic goals that spell out the World Bank’s policy on anti-corruption and one of them is to add the voice of the World Bank to the existing international efforts that have been undertaken to reduce corruption (Tung, 2002). Entering into contracts with suppliers in other countries, especially developing countries may therefore necessitate an examination into the potential for corruption and steps may need to be taken to ensure that contractually, the scope for corruption in acquisition and disposition of World Bank loans is reduced. Worldwide sourcing: As stated above, one of the reasons for Boeing’s success and the competitive advantage it enjoys in the marketplace has been sourcing supplies from other countries such as China and Japan. Boeing works with several independent contractors in America while international firms in countries such as Japan and Italy are working as its risk sharing partners in manufacturing its new 787 which is very successful. The Company has used sub-assemblies into its factory at Seattle from sources in Japan and China, while it has also sold one of its factories to a Canadian firm from which it buys fuselage sections at a price lower than what it incurred in producing its own parts (The Economist, 2006:Louis Gallois takes over as boss of Airbus). This is a trend that is being used by many Companies and may be a wise one for Airbus to emulate as well, because China is rapidly emerging as a supplier of inexpensive yet quality based products. As Kadefors (2008) has indicated, both public authorities and private companies are increasingly outsourcing facilities management services to external suppliers. Allaz and Vila(1993) have demonstrated that companies that maintain higher inventories as a manufacturer correlate strongly with reduced sourcing costs on a per unit basis. They showed that when the trading period increases, the supply chain is more productive and its output closely approximates the output from the centralized supply chain. BAE Systems has been a sleeping partner in Airbus since 2001 and owns a 20% share in the Company. BAE is a partner in America’s Joint Strike Fighter programme, however since Congress has been blocking the access to the software codes that are required, this has limited industrial participation by British companies in a large procurement project (The Economist, 2006: “A flurry of deals….”). Recommendations for the next five years: One of the major problems Airbus needs to overcome is its factory overload, which delayed the period for delivery of aircraft, i.e., about six years. Since there is also an unprecedented demand for passenger jets, Airbus is losing out on its market and therefore needs to supplement its production facilities to complete pending orders quickly, so that it can tap into the growing demand for passenger jets, especially from countries such as China during the next five year period. In tackling the back log of production, the Company may also benefit from sourcing it our partly, to countries such as China and Japan. The Company has tried to address this problem by developing a new plane that will cost about 13.3 billion dollars to develop (The Economist, 2006: Airbus launches a new plane). This is part of a restructuring program where the potential loss of 4.8 billion Euros from the profits at EADS arising due to production delays has been the spur for launching this program. This is an expensive option; moreover, it involves a long term incubation period while the plane is being developed to fit a niche market and in the meantime, Airbus is losing out on other sections of the market, i.e., for medium sized aircraft. While the development of the A340 is potentially a good option for the Company to follow as a long term policy that may yield results in the form of increased demand, the existing problems are likely to be better addressed by refining the contractual processes of the Company in such a way that the terms are beneficial to the Company. As opposed to the development of the A340, it appears likely that the A350 EWB offers a much better option from the perspective of gaining profits in the long term, because wide bodied aircraft are likely to be the trend in the future. The A350 EWB is intended to be a competitor for Boeing’s wide body Boeing 787. At the outset, it must be noted that Boeing’s 787 is already a sales phenomenon, receiving 630 firm orders before the plane’s actual roll out. (The Economist, 2006:Europe’s aviation giant is fighting back). Airbus’ machine is five years behind Boeing and moreover, it is based on a less advanced structural design whereby CRP panels are hung on a titanium frame which in turn, would make it less pleasant to fly in and more difficult to maintain. If the A350 EWB aircraft is to be successful in the market, then it is vital that the Company invests in research to improve the structural design and enable it to develop a better aircraft that could effectively compete with Boeing’s version of the same aircraft. Airbus is losing a great deal of mileage in the market due to its failure to adequately take into account the prevalence of globalization and the need to outsource some of its production activities, as well as procuring supplies from countries that are better equipped to manage them. In failing to do this, it is losing out on the gaining of a competitive advantage through lower costs for supplies and labour. On the basis of the analysis provided above, the following are the major recommendations for the next five years: (a) Airbus focuses upon setting up of a research and development unit to study the structural flaws in the design of its extra wide base design of the aircraft in order to assess how this design could be improved. Boeing’s extra wide base aircraft is already rolling out and has garnered a large number of orders. If Airbus is to compete effectively, it needs to refine its structural design such that the passenger traveler experience is improved; if possible to a standard better than Boeing’s. This could serve as effective promotional material to promote the new aircraft A350 EWB when it eventually rolls out. (b) Airbus needs to explore the potential for outsourcing production segments to countries such as China. For example, it could seek to enter into a long term contractual arrangement with China to enable it to produce its first aircraft under a joint arrangement with Airbus, thereby securing the advantages of low costs and skilled labour, while also providing China the opportunity to achieve its objectives. (c) Airbus also needs to work upon ironing out the problems in its A340 model and ensuring that it is produced in a more cost effective manner by carefully examining the reasons for the delays, problems and escalating costs. It also needs to enter into an effective promotional campaign to ensure that it creates a good market for its products and secures orders before the aircraft are actually rolled out. References: Argyris, C., and Schon, D, 1978. “Organisational Learning”, Addison Wesley, Reading, MA. Allaz, B., J. L. Vila. 1993. “Cournot competition, forward markets and efficiency”, Journal of Economic Theory, 59(1): 1-16. Anand, K., R and Anupindi, Y. 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