Capital Investment Practices Upset Gas Turbine Industry Competitive Advantage Structure

by Roger H. Hayes, Huffman Corp.

As a supplier of capital goods to each segment and tier of the global gas turbine industry, we have a distinctive perspective on who does the best job of investing for competitive advantage.

The buying practices among the original equipment manufacturers’ (OEMs’) first-, second-tier and aftermarket imitators manifest remarkably contrasting economic results.

A confluence of technology and business practices is altering substantially the competitive advantage among gas turbine manufacturers.

The OEMs and some first-tier suppliers seem highly vulnerable to attack from vendors and imitators better at adopting new technology and using more effective investment practices to achieve new extremes of competitive advantage.

Our market niche is gas turbine gas path part manufacture and repair processes’ replacing traditional machining. On average, these parts make up about 30 percent of the OEM cost of a new turbine engine and about 80 percent of the ongoing cost of ownership maintenance. The OEMs’ revenue model gives customers the engine, then sells them the repair parts. Typically up to 75 percent of the gas turbine OEMs’ profit stream comes from the overhaul, repairs and spares aftermarket.

That makes the OEMs’ profit structure vulnerable to changes in traditional barriers to entry for parts manufacture. Rapidly improving technology and better investment practices are accelerating cost and investment advantages to unprecedented levels.

A second-tier supplier invested in new technology capital equipment to grind vanes (nozzles). The supplier used effective investment procedures to achieve an 80 percent throughput time reduction using one-third the capital compared to its first-tier customer, also a customer of ours.

Instead of 100 minutes per part, they spend 20 minutes per part. Instead of six setups and three machines, they do all in one setup and one machine.

They use one-fifth the labor and no longer require a skilled operator but can use available labor. Their customer, the first-tier supplier, uses the same basic equipment but with 10-year-old process technology, never having upgraded to current technology.

The OEM uses 30-year-old technology and has the highest cost of all. This extreme investment and productivity disparity seems amazing within the same supply chain and among competitors. Still, it gets worse.

A segment of this market for flight gas turbines is rapidly growing: the parts manufacturing authority (PMA). It stands for an FAA approval process for a reverse engineering company to make an “equal to” product as the OEM and then sell it to end users in competition with the OEM in the aftermarket.

While a few OEMs reverse engineer competitors’ parts, many smaller companies and start-ups invest in new manufacturing technology to enter the spares market successfully and swiftly. Instead of the OEM just outsourcing the cost reductions, they also are seeing new entrants using the same investment cost advantages and improved return on assets to compete directly with themselves.

How can a $4 million start-up take on a $40 billion OEM and soundly beat it at its own game? The answer to that question is what the rest of this article is about.

While better technology is a huge component of competitive advantage, the investment process used by the second-tier companies or the PMA new entrants earns them the enormous competitive advantage.

Smaller companies are more effective investors than larger, global corporations, but not always. Sometimes islands of wise investors exist in big companies, too.

The following are seven characteristics of companies that succeed in cost reduction and return on assets on capital equipment:

1. They shop or don’t shop. The successful are always looking for something that can help them make better products, faster, cheaper and safer using fewer assets. In good times or bad, they have travel expense budgets to stay abreast of the latest technology. They travel to competitive suppliers. The unsuccessful shop by written proxy and perennially have no expense budgets to travel to suppliers. They typically make drive-by, shooting-style investments during market highs.

2. The successful invest rather than just purchase. The successful are intensely aware of desired outcomes to create competitive advantage and make high returns on investments that are their primary goals, not just how much they pay. The successful seek and will pay for value and move quickly when high value is proven. The unsuccessful mistakenly believe they are buying capital equipment and so mistakenly concentrate on reducing price often to the exclusion of and detriment to increasing value or timely returns on investment.

3. The responsible executives are involved in investments or not involved. In highly successful investments, the profit and loss, return on assets and cash flow executives responsible are actively involved in driving the transaction teams. In the unsuccessful companies, the key executives hand off and delegate decisions to the nontraveling purchasing departments usually measured on cost savings, rather than timely returns on assets.

4. The successful try before they buy; the unsuccessful try after they buy. The successful companies insist on funded demonstrations of the process capability before purchases at their own expense. They fund 5-10 percent expense of the end capital purchases to prove investments before committing. They want to know in advance that investments will succeed, or they don’t invest. They avoid failures. In confidence, they share their performance goals with prospective suppliers and collaborate on lessons learned for achievement. The unsuccessful do not pay for upfront proof, may seek free demos and intentionally stay distant from collaboration with suppliers on their intended outcomes. They discount and ignore suppliers’ full, industrywide experiences and instead are more do-it-yourselfers.

5. The successful check credentials and references. It’s amazing how thoroughly and unabashed successful investors are in getting broad, unfiltered, market feedback on potential suppliers. How did a potential supplier work through problems with existing customers during and after the sale? Broad reputation counts. Is a supplier ISO-9000 certified, and has the investor audited its system? The unsuccessful assume any vendor listed as a potential supplier is competent, in lieu of reputation or systems checks. The unsuccessful believe verbal and written anecdotal responses from sales literature and personnel without direct experience or third-party verification.

6. The successful are balanced contrarian investors, continuously investing when opportunities present themselves, often when markets are at low ebb instead of high. The unsuccessful just buy at peak economic times or for new programs, and outsource for lower labor cost, or move old technology to low labor but distant suppliers, ignoring actual cost, quality and market responsiveness requirements.

7. The successful deal with suppliers on a succeed-succeed basis seeking long-term relationships after purchases. When the high returns on investment (ROC, ROI or ROE) are proven in advance of investments, successful companies permit vendors fair prices and terms. This encourages good service after taking ownership. The unsuccessful investors play by win-lose transactional rules and, regardless of value received, dictate onerous terms, often provoking co-dependant, post-investment service relationships, which instigate burdensome ongoing maintenance and service expense at the cost of productivity and real return on assets.

These are the principal investment practices we see generating industry-altering economic advantages for some capital goods investors.

While there are occasional islands of successful investment by large OEMs or even first-tier suppliers, the tide is definitely in the favor of the usually smaller and wiser second-tier suppliers or PMA investors. We see a competitively altering tsunami headed toward the gas turbine industry that spells a major shifting of competitive power based on the OEMs’ inability to efficiently keep pace with higher competitive advantage offered by new technology and better investing practices.

Author

Roger H. Hayes is president of Huffman Corp. Reach him at rhayes@huffmancorp.com.

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