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Evolution of Outsourcing in the A&D Industry (Era of Outsourcing 3.0) and how to stay relevant

Evolution of Outsourcing in the A&D Industry (Era of Outsourcing 3.0) and how to stay relevant
Sam Swaro - Associate Vice President | April 24, 2019
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Fresh out of graduate school, I landed in the Aerospace & Defense (A&D) outsourcing industry, allowing me to experience firsthand three decades (90’s, 00’s and 10’s) worth of an exciting journey. As I reflect upon the evolution of outsourcing in the Engineering/IT space, especially in the Aerospace and Defense Industry, it is evident that the evolution from Outsourcing 1.0 to 3.0 has been a remarkable one.

In this article, I will walk you through the transformation of outsourcing in the A&D industry and why Engineering/IT services providers need to recognize the clear pattern of change in A&D client’s outsourcing behavior and adapt to the new age of outsourcing to stay relevant in the approach they take to A&D clients.

In the early 2000s, unlike Automotive and other early adopters, the aerospace industry was a laggard when it came to outsourcing work to cost advantageous countries like India, China, Poland, Mexico, and Russia. Despite its relative cost advantages, the late 90’s and the mid-2000’s saw a very slow push from the aerospace industry to expand sourcing to emerging markets.

The following unique factors were behind the delay in outsourcing engineering services for the aerospace industry to emerging markets, such as India and China:

  1. Complexity of technology and processes involved in developing a mission critical on-board product.
  2. The high levels of quality and safety requirements.
  3. Strict industry regulations.
  4. Intellectual property protection.
  5. Dual-use technology complexities (same technology being shared for military and commercial platforms).

An A&D Tier-I company that comes to mind as one of the pioneers of outsourcing to low cost countries like India is Honeywell. Honeywell Technology Center (HTS) was built in mid-1900’s in India. Apart from Honeywell, there were no other A&D Tier-I companies that had a presence in India in terms of technology outsourcing.

Outsourcing 1.0 (late 90’s to mid-2000’s) explained – During this period, Tier-I A&D 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 skilled labor force like mechanical drafters or embedded software verification engineers with a certain level of DO-178B guidelines awareness. (DO-178B is a guideline dealing with the safety of safety-critical software used in certain airborne systems. Although technically a guideline, it is (or was) a de facto standard for developing avionics software systems).

During outsourcing 1.0, most of the Tier-I aerospace & defense 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 DO178B-based software testing, primarily using low cost as the only value proposition was a hero in the eyes of client. The service provider as the ‘Single Sourcing Partner’ would get a red carpet treatment from departments of the client organization. The biggest losers during this period, quite obviously, were the local high cost service providers.

Outsourcing 2.0 (mid-2000’s to almost early 2010’s) explained – Outsourcing 1.0 lasted for about five to six years in the A&D outsourcing domain. During mid-2000’s, the following seven major trends were seen in most of the Tier-I A&D companies –

  1. The parent A&D companies found out ways to compartmentalize work packages (segregate commercial work from military work; segregate restricted work from non-restricted work, which are export compliant; define clear scopes), which could be outsourced or offshored to low cost service providers.
  2. During this phase, the preferred outsourcing partners in low cost countries grew in leaps and bounds.
  3. The setup of local Captive Design Centers (wholly owned Offshore Design Centers) by a few airframe manufactures and their Tier-I/II suppliers started to gain traction in these low-cost countries.

    Two primary internal drivers for A&D Companies to open their own Captive Centers were –

    1. 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.
    2. Intellectual property concerns over current offshore service providers.

    A big perception of offshore service providers amongst the A&D industry was their apparent lack of measures taken to protect OEM and Tier-I IPs. However, in reality, this was not the case since these service providers were mandated to be ISO/IEC 27001 compliant. (An information security standard, part of the ISO/IEC 27000 family of standards, which provides measures that the companies must take, starting form Desktop to the Perimeter and the IT Infrastructure). This ended up working in the favor of captive centers.

    The main external driver for A&D companies to open their own captive centers was showing their commitment to emerging countries and their governments through these investments.

    The initial intent of captive centers was to only work on high-end projects, but this did not pan out as they had intended. There was an inability to scale, but mainly there was a lack of a knowledge base to execute mission/safety/life critical Design Assurance Level (DAL) level A/B/C/D projects. Since high level projects require excellent technical expertise and depth on certain domains (for e.g., flight display, flight controls, electric systems, landing gear, transponders, etc.), captive centers were unable to obtain the right resources to carry out these initiatives.

  4. 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.
  5. During this period, A&D companies also started outsourcing many functions beyond core engineering, like Supply Chain management, manufacturing engineering, project management/project engineering as a service, technical publications, field services and mechanical engineering (drafting, modeling, migration from 2D to 3D etc.).
  6. By the end of the year 2012, a few offshore captive design centers could not scale up (for instance, the Thales India Center), so they had to sell their centers to offshore service partners. However, many offshore captive centers of A&D companies such as Rockwell Collins, Goodrich, Eaton, Safran, etc., started to find their recipe for success and could scale up (around (1,500+ FTE) by taking low-end work and allowing the effects of economy of scale to kick in. Therefore, Indian service companies continued to see these captive centers as a serious threat to their business, and refrained from any sort of partnership.

By the end of the Outsourcing 2.0 phase in the aerospace & defense industry, the parent companies, were outsourcing to their offshore partners and to their captive centers. These 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, to the A&D companies but were not that successful.

Outsourcing 3.0 (mid-2010’s till date) explained –

By late 2014 to early 2015, most of the A&D parent company’s (US & European based) offshore captive design centers were on their ramp up phase. In the market place (parent company as the end client), they started working in similar fashion to any other offshore services vendor/partner – by willing to take up any work that was available from their US-host companies. US and European OEMs (Air Frame Manufacturers and Tier-I/II System companies) 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 (software, mechanical and electrical engineering), manufacturing engineering, technical publications, PLM data migration, ERP implementation, and project engineering, etc. During this phase, service providers who aligned with the captive centers started experiencing renewed growth in their business. The acceptance of the captive design centers increased tremendously in this phase, and were no longer being looked to as competition (by the traditional low cost service providers), but rather as an extended engineering/IT arm of the parent A&D company.

Top 10 trends in the Outsourcing 3.0 era, since early to mid-2010’s onwards –

  1. Clear mandate from A&D parent companies to work directly with their offshore captive centers.
  2. Captive centers are working with their parent companies just like any other supplier or vendor, and are willing to take up any available work to scale up.
  3. Offshore service providers who collaborated with captive centers are thriving and working very closely as an extended team.
  4. Captive centers have only been around for a decade or so, but have acquired considerable system knowledge in certain domains, systems and subsystems, leveraging the growing body of expertise to move up in the value chain.
  5. Offshore service providers are also trying to move up the value chain by acquiring certain skillsets/capabilities inorganically through mergers and acquisitions (M&A’s).

    Recent examples of few M&As:

    • 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.
  6. Change in the US Presidency in 2016, the looming specter of BREXIT, and growing populist movements across the globe, have added a new angle to the A&D outsourcing landscape. Buying local has become one of the key initiatives across all segments and industries, including the A&D companies. Offshore-based companies have started opening more global engineering delivery centers across geographies to make sure that they can deliver from their onshore centers (in the UK, USA, Australia, NORDICS, and EU).
  7. Cost pressure on offshore suppliers (to deliver more for less) and a greater focus on quality (1st time right without any compromise or escapes). This change in the expectations is coming from the top of the value chain (airframe manufactures, example, Boeing’s “Partnering for Success” initiatives impact was felt across the supplier base).
  8. Airframe manufacturers also joins the race by opening their Captive Centers, an example being the Boeing India Engineering and Technology Center (BIETC) in low cost countries. 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.
  9. To support populist movements like Make in India: Boeing and Tata announce joint venture to produce Apache fuselages and similar joint venture deals in China.
  10. Large acquisitions in the Tier-I/II space (example, Rockwell Collins acquiring ARINC and BE Aerospace, and then in turn being acquired by UTC; Safran acquiring Zodiac Aerospace; mergers of Harris and L3). Boeing is also trying to insource their in-house system development initiatives to negate threats from traditional large suppliers like UTC, Honeywell and GE, etc.

    Again, AvionX announced their new avionics manufacturing division in partnership with Safran to develop an Auxiliary Power Unit.

    These dynamics will lead to a void in the Tier- II/III space, which means that the large A&D companies will have to offer solutions at a systems level. They will also have to look for partners who can design, develop and manufacture subsystems (like developing just a Line Replaceable Unit (LRU), a Controller Unit, a display unit etc., ensuring a design to build offering). This, in turn, will create a huge market for traditional engineering service providers to move up in the value chain and offer turnkey solutions to Tier-I A&D companies, and in some cases, to the Airframe Manufactures.

The same offshore service providers who got the red carpet treatment in early 2000 are no longer enjoying such benefits. Companies offering similar generic low end services and cost arbitrage as the driving differentiating factor, no longer suffice since Offshore Captive Centers have similar benefits and pricing

In the Outsourcing 3.0 environment, here are the top five initiatives the offshore service companies should take to stay relevant while growing their topline and bottom-line–

Position yourself as a Total Solution and Value Based Solution Provider rather than just a Time & Material labor provider.

  1. Hire local in respective geographies, deliver from local centers (near-shore centers), and deliver more for less through commitment and a result driven approach, leading to higher productivity.
  2. Partner closely with captive centers to continue to get a piece of low end engineering/IT outsourcing work that A&D parent companies continue to source to their captive units. On top of this, take up a high-end turnkey projects, and 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 and value-based solution provider rather than just a time and material labor provider. Be willing to take risks 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 (digital, IOT, Artificial Intelligence, Machine Learning, Model Based Design, Multi-Core Certification etc.).
  5. Joint bidding and GTM strategies with clients and taking on more responsibilities and risks to help them win new business in different parts of the world.

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