The global aerospace and defense (A&D) business landscape is experiencing
substantial disruption driven by a keen focus on innovation and digital transformation, and geopolitical situations such as the unknown implications of Brexit. Despite some upcoming uncertainty, demand for commercial aerospace and defense in 2018 finished with a continued, optimistic industry outlook. Both the commercial and defense sectors witnessed robust growth—a rare market situation as these markets have historically and empirically known to be counter-cyclical.
The growth of commercial aerospace is primarily being driven by the increasing number of passengers, which in turn is leading to expansion initiatives. A Deloitte research estimates the commercial aircraft order backlog to be at its peak standing at more than 14,000 orders, with about 38,000 aircraft expected to be produced globally in the next two decades. Growth in the defense sector is being driven by rising geopolitical tensions, natural recapitalization cycles, greater high/low mix of assets, focus on aligning solutions to local requirements, and the increased demand for affordable, off-the-shelf equipment. Additionally, the recent recovery in defense budgets of major economies is expected to push the growth of the defense industry in 2019 and beyond.
Given this background and from the perspective of manufacturers, suppliers, and technology experts, the A&D industry is likely to experience the following trends in 2019:
Continued digital transformation but with a focus on low-risk innovation with trusted partners
Standing at a meager 4.1%, the A&D sector has one of the lowest innovation intensity percentages (the percentage of sales earmarked for R&D). With new technologies including robotics/autonomous systems, artificial intelligence, additive manufacturing, and sensor technologies taking center stage, the industry will see an increased push toward the adoption of digital innovation. However, the A&D digital-innovation strategy will follow a disciplined approach where trusted partners will be sought to develop low-risk solutions that balance the inherent complexity of new technology adoption with the need to increase capability at the lowest possible costs.
One of the significant challenges to innovation in the A&D sector is that the industry is not rewarded for internal R&D as much as consumer-oriented markets. With a much smaller customer base (relatively speaking), high-risk investments do not always pay off as there are fewer potential end users, and gaining scale is often a challenge. Digital transformation is one such area. Despite efforts to more closely adopt commercial technologies and standards into the sector, the process is slow and use cases are still limited. While there is a massive opportunity over the next several years, the near-term focus for 2019 will be on developing the right technologies and finding test cases to prove a scalable concept.
The focus in 2019 will shift further toward artificial intelligence (AI), augmented and virtual reality (AR/VR), data analytics, advanced sensors, and IoT. Data analytics is most likely to emerge as the most important “digital” solution for 2019 for the end-user community as the use case is proven, implementation costs are relatively low, and the amount of data being created by the industry is overwhelming. More capital-intensive solutions such as AI and AR/VR will take more time to scale as the technologies and use cases continue to develop and mature.
However, from an internal-process perspective, we will see greater growth in the digital domain as there is less risk involved in adoption. 2019 will see significant investment in the concept of connected factories. This is closely tied to the broader trend of Industry 4.0, which is pushing ever-increasing automation onto the shop floor. With the drive to continue to lower production and total ownership costs, the ability to link manufacturing centers and make processes and tools more efficient will push the adoption of “connected” technologies within manufacturing centers, driven using IoT solutions and “cyber-physical systems.”
While end-users in the air and on the battlefield may seek greater innovations, the nature of the industry will force a more risk-averse strategy and slow adoption of technologies that are taking off in other markets. That said, one area will see early adoption is the factory floor, with cost and efficiency providing a significant competitive advantage as the industry seeks to do more with less.
Transformation of legacy systems with attention on the SWaP-C concept
Closely aligned with the yearning for innovation is the constant need by the sector for ongoing enhancements in reducing the size, weight and power, plus cost (SWaP-C). This is critical to safeguarding that legacy equipment will last longer while minimizing the need to purchase new platforms, which are significantly more expensive. 2019 will see a sustained drive to design and deliver specialized aerospace and defense equipment with the SWaP-C concept. This will result in a continued focus on COTS/MOTS (commercial off-the-shelf/modified off-the-shelf) solutions combined with ground-breaking design.
SWaP-C is pertinent across the Intelligence, Surveillance and Reconnaissance (ISR) and electronics capability spectrum—from radar and electro-optical and infrared (EO/IR) to communications and avionics to electronic-warfare systems.
SWaP-C design allows smaller platforms to carry more progressive systems and sensors at lower costs. In the past, large and expensive platforms were the only way you could carry advanced sensors and equipment. Now we are seeing a greater capability being delivered by smaller systems. For example, small-unmanned vehicles can now carry advanced radar and imagery equipment, which a decade ago required large manned aircraft.
Product modernization requires an understanding and management of existing product limitations, prioritizing upgrades, and handling end-user issues with units already in use. The equipment and design upgrades in the A&D industry will be based on analysis of alternatives, engineering change management and configuration control, availability of right parts from the OEMs, critical safety reviews, and adherence to regulatory compliance. It has also opened the market to new entrants who can focus on less bespoke systems with slightly less capability, but provide more value for money, especially in markets outside the US where costs are a key driver.
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Not since the 1990s have we seen such a large focus on consolidation. This cycle is being powered by rising cost pressures, need to access new technologies and proof of concepts, emerging global opportunities and threats, and stakeholders’ demand for value.
There has been substantial M&A activity in the A&D industry, especially in the past two years. Deal valuation has remained high for quality acquisitions, and that will likely carry over into 2019, mainly due to pressure from OEMs on suppliers to reduce costs and increase production rates—possible only with a consolidation of fragmented supplier bases. Furthermore, large organizations will continue to acquire small to mid-sized players, with the main thrust on increasing their R&D interests in new technologies.
History has shown that first movers in any industry consolidation gain the highest returns on investment. This is largely a result of fortune favoring the bold. First movers typically take the best assets off the market, while followers need to add capability and scale to match, but tend to overpay for lesser assets to maintain that competitive position. 2018 saw a rash of first movers, but there are still plenty of “good” deals that can get done in 2019, at still-strong multiples.
Without a doubt, the direct challenge for the commercial aerospace industry is to deliver on the order backlogs that continue to be at record levels. Similarly, the defense industry is adapting to a change in global demand that seeks greater capability for lesser costs. The evolving trends and technologies will bring transformation and opportunities, but will also present new challenges. Industry must adapt to these shifts in demand, technology, and requirements, while managing costs and an increasing focus on ownership of more of the supply chain through organic and inorganic investments.
The evolving market dynamics in 2019 call for an ecosystem of suppliers who are in sync with the technological developments impacting the A&D sector. Strategic repositioning and engagement with reliable partners to take part in these new trends and overcome new encounters will be critical to optimize market share, become more competitive, and fill internal-capability gaps while at the same time addressing new markets and opportunities.
John Kenkel is vice president and head of strategy & marketing for Cyient.