Why Vertical Integration Remains Popular In Aerospace

By the time the Farnborough International Airshow begins, Boeing’s plan to buy Spirit AeroSystems—and Airbus’ takeover of the latter’s related aerostructures work—will be the largest acquisition in aerospace and defense so far this year. Not surprisingly, closing the potentially $8.3 billion deal will take time, partly due to the need to figure out financing.

It will also take time because integrating the Wichita aerostructures leader back into Boeing will be complicated. Of course, a large acquisition is always challenging, but Spirit provides the majority of Boeing’s 737 narrowbody, significant parts of all the manufacturer’s other commercial aircraft and many of its military aircraft.

• Vertical integration brings control but at a cost
• Insourcing/outsourcing pendulum is swinging again

Acquiring Spirit was the last thing Boeing wanted to do—until the Jan. 5 door-plug accident on an Alaska Airlines 737-9 exposed the fragility of its manufacturing web. Now the OEM is betting its future on buying Spirit—and so is the rest of the Western aerospace industry.

“This potential acquisition raises as many questions as it does answers, but it highlights the importance Boeing is now placing on addressing challenges in its supply chain,” states a Fairmont Consulting Group paper published in March on the proposed acquisition and what it means for suppliers.

From Seattle to Toulouse, a wave of begrudging and belated vertical reintegration is crashing over the airframe and aerostructures segments—and to limited if more enthusiastic degrees, in other pockets of aerospace and defense.

Industry insiders and advisors debate how far this will go and which segments will be most affected. But change is happening, and it is somewhat surprising. For decades, divesting and outsourcing business assets and their accounting costs have been the modus operandi for industry’s largest players. Taking on hard assets was rarer. Now the question for many observers is: Do the Airbus and Boeing aerostructures reintegrations represent a trend, anomalies or exceptions that make the rule?

“I think Spirit’s a one-off,” Aerodynamic Advisory Managing Director Richard Aboulafia says. “They were so uniquely dependent and vulnerable because of their exposure to the 737 MAX and to Boeing and to not [having] a very big defense side.” Still, “this has to happen,” he says of the Spirit takeover.

“Spirit was never properly set up to stand on its own,” Melius Research analysts Rob Spingarn and Scott Mikus write in a March investor note. The note recounts how, following the merger with McDonnell Douglas in the late 1990s and the commercial manufacturing downturn after 9/11, Boeing pursued an asset-light model that prioritized return on net assets.

“By selling Spirit in 2005, Boeing effectively jettisoned its Wichita union workforce that was being paid high Seattle-level wages and turned a fixed cost into a variable cost,” Spingarn and Mikus write. “The idea was that Onex, Spirit’s new owner, would then pursue non-Boeing work and lower Spirit’s cost structure by de-unionizing it.

“The problem for Spirit was that aerostructures is, at best, a capital-intensive, low-margin part of the aerospace supply chain with little to no aftermarket,” the note states. “At its worst, aerostructures have negative margins and bleed cash. Essentially, Boeing transferred its undesired cyclical exposure to Spirit, leaving the latter too dependent on high commercial OEM volumes.”

It is hard to find anyone who disagrees. The survival of Spirit AeroSystems is vital to the industry, but it requires an entity with a large wallet to step in, retired Airbus Americas CEO Barry Eccleston recently told a Jefferies audience. Boeing is best suited and well motivated, in part because it has seen the error of too much outsourcing.

Eccleston asserted that the value of vertical integration became evident a decade ago as the rival OEMs pursued different approaches to supply chain management. After Boeing spun off Spirit in 2005, Airbus tried but failed to do the same. Not only were Airbus subsidiaries Premium Aerotec and Stelia Aerospace never sold, but they were reorganized and reintegrated into Airbus proper. Along the way, the manufacturer’s leadership declared aerostructures a core capability for future aircraft products (AW&ST May 3-16, 2021, p. 19).

It is not a surprise that Eccleston has argued that vertical integration will give Boeing more control over its destiny, regardless of the cost of turning Spirit’s operations around. The reintegration also will provide some stability for industry at large.

For their part, current Boeing leaders see the error of their predecessors’ ways. “I’d point back to comments that [Boeing CEO David Calhoun] made in January around how Boeing more than 20 years ago probably got a little too far ahead of itself on the topic of outsourcing,” Boeing Chief Financial Officer Brian West said in March. “And [Spirit] is probably the example.”

Interestingly, Boeing in April quietly bought back the St. Louis defense aircraft factory it once owned, which was most recently under the GKN Aerospace brand. The site has roots in the days of McDonnell Douglas, from which GKN reportedly bought it for $79 million in 2000 in a move to become a strategic supplier for Boeing fighters and other defense programs.

To many observers, the St. Louis deal had more to do with Melrose Industries, GKN Aerospace’s private equity owner since 2018, which tried to force Boeing to buy an asset that was more important to the OEM. Like Spirit today, GKN was a major aerostructures provider that nearly fell apart before being bought out. By 2022, Melrose had announced a massive consolidation of GKN, with plans to cut GKN Aerospace’s global site presence to 33 plants by 2023 from 51 in 2019. That likely would have been bigger news to industry insiders at any other time, but amid today’s Boeing-Spirit developments, it is almost forgotten.

The opinion that aerospace outsourcing went too far in the first quarter of this century is certainly popular in some circles. Recent participants in industry supply chain conferences, including Aviation Week’s A&D SupplyChain Americas in January, have discussed the topic, often to nodding heads in the audience.

Having witnessed the shortfalls of outsourcing, many marquee players in new space and advanced air mobility have pursued business and operational plans with vertical integration as their proverbial North Stars. Many want to own the intellectual property chain of their offerings, from design to the product and adjacent revenue streams to the vehicle’s maintenance, repair and overhaul.

Yet even in the newer segments of aerospace, not everyone sees the issue the same way; it has remained a point of debate since recovery from the COVID-19 pandemic began (AW&ST May 17-30, 2021, p. 12).

The two clear front-runners in the U.S. air taxi market—Joby and Archer—both are developing piloted, four-passenger electric vertical-takeoff-and-landing (eVTOL) vehicles with a goal to launch commercial service in 2025. Both companies plan to start by offering airport shuttles in partnership with major airlines, and both are manufacturing their aircraft in partnership with global automotive companies.

But when it comes to their specific manufacturing strategies, the two companies have staked out sharply different paths. Joby is a vertically integrated OEM that develops most of its own components and systems in-house, while Archer is relying on a roster of Tier 1 legacy aerospace suppliers.

Both strategies come with trade-offs. Developing components in-house allows Joby to optimize for its specific aircraft and to have better control over integration, giving it a higher-performing vehicle at market entry. But Archer’s strategy of relying on legacy aerospace suppliers gives it a leaner business model with lower capital investment costs and, all else being equal, a lower certification risk that the company believes can translate to a quicker path to market.

That difference in strategy is evident in many layers of the two respective aircraft. For example, while Archer is using more commonly produced cylindrical battery cells, Joby is relying on pouch cells, which are novel and harder to certify. Similarly, while Joby is using additive manufacturing and composites to build its vehicle, Archer is sticking to traditional aerospace materials, which it expects regulators will greenlight more quickly.

Joby founder and CEO JoeBen Bevirt points to technology companies like Tesla and SpaceX as examples of the benefits of vertical integration, which he says allows them to manufacture high-performing, state-of-the-art systems while avoiding some of the headaches associated with relying on a web of suppliers.

“When you’re building hardware, there is no substitute to being vertically integrated with the rate of progress that you’re able to deliver and the quality of the products that you’re able to create,” Bevirt tells Aviation Week. Being vertically integrated has “enabled us to build a dramatically better performing aircraft that is quieter, faster and most importantly, safer,” he says. “When your engineers are steeped in the design, manufacturing and testing of the components, you get better, safer and more reliable designs.”

But Bill Johnson, an analyst with Single Seat Consulting, argues that air taxi startups will be best served by using horizontal integration to maintain their core competencies in manufacturing.

“Perhaps it is most telling that legacy aviation has no truly vertically integrated company,” Johnson observes. “To me, that is a huge signal that it is too broad a task to execute well. In the end, I imagine Joby will divest of some of their operations and become less vertically integrated.”

On that note, while the pendulum of outsourcing versus vertical integration may be swinging toward the latter, GE Aerospace CEO Larry Culp, Jr., has no intention of rolling up suppliers just as a business strategy. As the aerospace and defense segment’s newest and highest-profile pure-play OEM and large defense prime—and a darling of Wall Street—Culp’s company has the license to go vertical but will not.

“I’m not suggesting that we wouldn’t look at opportunities to bring part of our supply chain in-house, but that is a theme—whether because of the Boeing-Spirit rumor or some of the things that have happened at the behest of private equity—to me, that’s not strategy,” Culp told Aviation Week in March on the sidelines of the company’s investor briefing (AW&ST April 8-21, p. 24). “That’s just reacting to some investment bankers putting forward the most recent popular idea. I’ve never been a fan of allocating capital on the basis of that.”

Still, whether they seek an opportunity or their hands are forced, large industry players clearly are open to vertically integrating. It is happening even without being called out as a specific capital allocation plan because, ironically, it is also more of the same.

Fairmont Consulting argues that Boeing’s acquisition of Spirit will not represent a fundamental change in its supply chain strategy. Boeing has been performing selective insourcing since the 787 program, including on the 737 MAX nacelle inlet lips and 777X wings. At the same time, after ingesting Spirit, it would not be surprising for Boeing to spin off businesses to generate cash and retire debt.

While the pendulum swings, the bottom line remains the same.

Spingarn and Mikus of Melius note that by owning Spirit, Boeing could save $900 million annually on the 737 program by eliminating the profit Spirit should make at the targeted production rate of 50 aircraft a month. “From an economic perspective, this is a make-buy decision for Boeing,” they say.

Boeing’s formal proposal to buy Spirit will have to get the nod from Spirit’s shareholders and gain regulatory approval and customer acquiescence for the transfer of contracts for any business not divested under the plan. Timelines for all of this remain to be determined.