The global aviation industry is primarily a duopoly of two players: Boeing (NYSE:BA) and Airbus (EADSY). Competition between the two is intensifying with every passing day. While the American giant leads in the widebody sector, thanks to the Boeing 777 and the Dreamliner 787, the European player reigns the narrowbody segment with its A320 airliner.
Boeing is encountering severe competition from peer Airbus as the latter offers heavy price discounts to win orders and crush the dominance of the former. The severe price competition between the two has compelled Boeing to take actions to lower costs and save profitability margins. So what’s the major cost component of an aerospace giant that can be reduced? Find the answer.
Cutting Component Cost
More than 66% of the entire cost borne by an aircraft manufacturer is that on component parts. This indicates that if Boeing can somehow manage component parts at a lower rate, it would considerably reduce the cost and help it fight the growing rivalry and price competition from Airbus. Boeing would be able to offer its jetliners at a lower rate without compromising on margins. In fact even after giving discounts to the airline, Boeing would manage higher profit margins.
- Warning! GuruFocus has detected 5 Warning Signs with BA. Click here to check it out.
- BA 15-Year Financial Data
- The intrinsic value of BA
- Peter Lynch Chart of BA
So the company has initiated a “partnering for success” program with its vendors under which it’s asked part suppliers for massive discounts of as high as 20%. The aircraft major would help supplier gain efficiency in the process so that their costs go down. The main purpose of the program is to get discounts on component parts. If a supplier rejects to give the rate cut, it would be added to the “no fly list” of Boeing and would be barred from receiving future contracts from the jet maker.
This measure undertaken by Boeing clearly shows how desperate and serious the jet maker is to lower its costs. The company’s also said to be in talks with component supplier Mercury Systems (NASDAQ:MRCY) and is considering to purchase the entire unit.
Mercury Systems is the component vendor of digital signal and image processing systems. In addition to this, it provides big data and other software services to Boeing, Northrop Grumman (NYSE:NOC), and Lockheed Martin (NYSE:LMT). The company has a market value of around $440 million. It has employed Evercore Partners to carry out the sale process and expects to get around $500 million.
According to sources that requested anonymity, the auction for Mercury Systems is still in the nascent stage and there’s no certainty that Boeing would be part of it. If Boeing actually acquires Mercury Systems, not only would it help saving costs, but expand Boeings footprint in the commercial aviation market as well. The Chicago-headquartered company would be able to cut down costs incurred on purchasing software and data processing systems
When asked about the matter, Boeing spokesperson preferred keeping mum on matters such as divesture, acquisition, partnering as it involves huge speculation.
Food For Thought
The aerospace market is offering huge opportunities to industry players, both big and small. The industry has an encouraging future outlook and Boeing’s poised to make the most of it. How serious is the company in acquiring Mercury Systems isn’t known. But obviously it looks like a good proposition, given that it wants to lower operating costs.
While the company’s seeking to cut costs, it might assess more acquisition opportunities. It would be interesting to watch how Airbus reacts to such steps of dear rival. Would Boeing purchase Mercury Systems, or discover another route of meeting cost targets? It remains to be seen how the two players tackle the situation as in an oligopoly every action necessarily faces a reaction.