The industries most directly and immediately affected by COVID- 19 are aviation and aerospace, as borders were shut and lockdowns across the world ensued. Lufthansa announced that it is burning through €1 Million an hour and flying just 1 per cent of its usual passenger numbers. It has also furloughed 90,000 of its 135,000 employees. This is but one of the world’s estimated 800 commercial airlines globally; the trade body Iata predicted a 48 per cent fall in traffic this year and if it proves correct, at least seven years of airline passenger traffic growth would be wiped out in 2020, according to consultancy Cirium. Airlines are looking to cancel or postpone aircraft orders on a massive scale.
What is the effect of this on manufacturers such as Boeing, Airbus, Bae, Lockheed – to name but a few – whether we are speaking of commercial or defence products? The answer is that these companies are struggling with the uncertainty of future demand. In fact, Airbus chief executive Guillaume Faury has told the 133,000 employees of the company that Airbus has lost a third of its business in a matter of weeks. He stated: “We’re bleeding cash at an unprecedented speed, which may threaten the very existence of our company.” Meanwhile, Boeing has announced “that it plans to cut its workforce by 10 per cent, as the coronavirus pandemic slashed global demand for jets and forced the manufacturer to lower production rates for nearly its entire portfolio of commercial planes.”
The Effect on Supply Chains
If that is the situation for the aerospace manufacturers themselves, what can be said of the supply chains? As we know, supply chains are key to the ability of aerospace and defense organisations to function efficiently and effectively. These chains are incredibly complex, being made up of several tiers of different types of suppliers. Included are scores of original equipment manufacturers (OEMs), prime contractors and integrators, repair and overhaul providers (R&O), small parts suppliers, maintenance support through to the customers whether commercial or military. To make this even more complex, over the past few decades both the supplier and customer base have become global in nature. Supply chains have adopted digital technologies, are vertically integrated and operate on a just in time basis. This makes management of supply chains difficult in the best of times, but what happens when the global system of trade fractures as it has now due to COVID-19?
COVID-19 hit suddenly, without much warning. Companies, as well as Governments, were ill-prepared for its overwhelming impact on infrastructures and almost overnight, supply lines were impacted as Asia, Europe and then the Americas begun to feel the effects of the pandemic. Countries reacted by closing borders and within, people went into lockdown. Nothing functioned as it ordinarily should. Given the extent to which aviation and aerospace companies had integrated global supply chains the results are devastating. Moreover, since it is very common for companies in the aviation and aerospace supply chain to also supply the defense industry, the damage happening today in the aviation sector is highly likely to spill over into the defence industrial base through defence supply chains.
Over the past decade, there has been an emphasis on risk-sharing partnerships in supply chain contracting. The mantra was collaborative agreements based on risk and revenue sharing arrangements. This covered development, production, manufacturing and after-market activities. But this means that the pain of what is now happening due to COVID -19 has also been spread amongst a larger group of companies. Suppliers in developing countries are particularly feeling the pain and their employees have been severely affected. What is interesting is that supply chain management over the past few decades has been focused on cost reduction and outsourcing. As security of supply is becoming the focus due to COVID-19 supply shortages, is that all about to change? Will security of supply now trump cost, as the focus in supply chain management
The added challenge for the aviation and aerospace industries is that their supply chains are often specialized and require companies to be pre-qualified. This qualification process takes a period of time to achieve and can be costly. Often, customer requirements and specifications inhibit the use of certain suppliers, further narrowing the supply chain. National security requirements might also limit choice of suppliers and where offset requirements dictate the use of particular suppliers, the manufacturer is further inhibited. It is therefore not a matter of simply moving on to someone else.
So what is it that companies should now be doing to deal with their supply chain pain, recognizing that when they emerge from this, they will want their supply chain, not only to survive, but to be capable of returning to normal capacity rapidly if demand requires it.
Building Resilient Supply Chains
The first and immediate impact will be reviewing legal positions to have a view of what obligations exist. Here, legal principles such as force majeure, frustration, material change and impossibility all play a role. The governing law of the contract will be critical in formulating this analysis. To assist, Bird and Bird, an international law firm specializing in aviation and aerospace matters, has developed a handy 10 step guide reviewing key contract clauses under English, French, German, Italian and Polish law:
Going forward, what can this crisis teach us about building more resilient supply chains?
A supply chain’s ability to respond to and recover from disasters such as COVID-19 is determined not only by the type of event, but also by the nature of the supply chain system put in place. Traditionally, managing risk was an exercise of identifying risks that may affect a company and its supply chain and then managing those risks in a piecemeal manner. The focus was on short-term recovery. The nature of the system did not need to be taken into account, as it was largely operating in the same manner over a long period of time, and the parts were not interdependent.
Today, given increasingly complex and interconnected supply chains, the traditional approach is no longer effective. The focus now has moved from managing a risk to managing a system. This means risk can no longer be fully understood in terms of a specific event such as an earthquake, fire or even a pandemic, but in terms of an overarching system – also called “systemic risk”. This means moving risk management from an event approach to a resilience approach. The first looks from the outside in (how the risk will impact on the system – event-centric), whereas the latter looks from the inside out (how the system will respond to the risk – system-centric). Going forward from this crisis, we need to concentrate on a system-centric supply management approach. Supply chains have to become more resilient.
Resilience looks at how a system deals with change; it is system-centric rather than event- centric. A whole-of-system approach can be understood in terms of the types of risk that might enter the system (an input view of risk) versus the types of disruptions that might occur (an outcome view of risk).
An input view of risk does not categorise risk in terms of high or low probability or magnitude, the way an outcome view of risk would. It tries to understand possible events in terms of knowledge about the risks. An updated means of categorizing risk has been described as: “completely novel (such as space weather (meteor showers, solar flares), modern (such as climate change or cybercrime), infrequent (such as pandemics), spasmodic (such as earthquakes and volcanoes) and traditional (such as business and infrastructural risks).” The knowledge about a category of risk contributes to helping businesses respond to it when it happens. It is relatively easy to build resilience into a system in order to prepare for spasmodic and traditional disruptive events which are better known, but less so for the other categories. Building resilience into a system that has little or no knowledge about novel, modern or infrequent disruptive events is difficult. The only way to build in such resilience is to work at understanding more about these types of disruptive events and build in a certain degree of redundancy based on the unique characteristics of such events. This is precisely what supply chain management now has to do respecting COVID-19 risks, which are increasingly known.
A whole-of-system approach to managing risk looks at large numbers of commonalities between the different categories of risk. For example, you can compare earthquakes to a pandemic, flood or another event. The initial responses will share certain commonalities: the need for short-term housing/hospitals; the need for hot food, water and medicine; the need for infrastructure to work, such as water systems, power and technology; the need to communicate clearly in a timely manner; the need to make alternative arrangements for transport. Resilience can relatively easily be built into a supply chain system to manage these short-term local disasters. However, as supply chains become more interconnected and complex, dependencies can lie unseen and untested, only to become apparent when a key link in the supply chain becomes broken and alternatives have not been identified. This is when supply chain resilience becomes critical.
COVID-19 is at the moment demonstrating this fact. It is a global pandemic – with all that this implies for workforces, manufacturing capability, supply of raw materials and parts, disruption of transport systems and closed borders. It is, however, rapidly becoming a financial crisis as well, as employees are furloughed, demand drops dramatically, revenue dissipates, banks refuse or are unable to lend and Governments begin to incur massive debts. This puts immense strain on supply chain maintenance and their ability to recover once the crisis is over.
A possible way to identify key dependencies is to follow critical flows in the system and work out how they might be disrupted and how those disruptions might best be reduced. This concept allows for identification of multiple risks and shocks. Here, the opportunity is to follow the flow of goods and services to assess the supply chain risks to the entire system. Resilience can be added in to deal with several independent or connected events such as a pandemic and a hurricane occurring simultaneously and adding in global risks such as a financial crisis.
A resilient supply chain is fundamental to delivering core products and services over long periods in times of stress. A resilient system is much more than natural disaster management or epidemic management. It requires an understanding of where the overall system is weakened by events and how it might be strengthened to cope with them.
PRACTICAL STEPS
So how in the light of COVID-19 and what we are now learning, can we make supply chains in particular for the aviation and aerospace industries, more resilient?
The World Economic Forum is a 6th April 2020 publication (www.weforum.org/agenda/2020/04/supply-chains-resilient-covid-19) looking at supply chain disruption due to COVID-19 makes several excellent recommendations for making supply chains more resilient. I have added in several additional tips from my own experience.
1. Move away from paper to digitization.
The need for a physical presence to deal with physical assets has proven to be a major issue when personnel are required to come to an office. With lockdown, many businesses have been shut throwing the supply chain into disarray. Digitizing limits the points of failure in a supply chain and allows operations to continue even when there is a lockdown.
Recording contracts on digital ledgers in blockchain helps to achieve this. Participants can verify and audit transactions securely. It replaces the need for trust, as documents are stored on a secure ledger. Records on the digital ledger cannot be altered retroactively.
2. Dealing with data privacy
Suppliers are reluctant to provide information to customers, because they fear losing commercial advantage if confidential data about operations, pricing and sourcing is shared. In a crisis situation, this is however disruptive as it does not permit flexibility and continuity of supply.
Blockchain with private or public permissions allows suppliers to audit data-sharing permissions directly on their blockchain node. This also permits data to be securely distributed to others, as needed in the blockchain network.
3. Blockchain can also provide financial flexibility and security
Blockchain can also be used to help with financing needs and institute supply chain finance programmes. Suppliers are paid sooner and can replace more costly supply chain finance arrangements, because payment occurs automatically, when required performance parameters are triggered in the system.
Payment commitments on the blockchain can replace Letters of Credit, pay suppliers automatically and insulate from supplier bankruptcy.
4. Blockchain can also be combined with collaborative dispute mechanisms
COVID-19 has shown how quickly legal obligations are impacted and the need to be flexible and restructure them through collaboration, rather than confrontation.
Allowing for structured negotiations with a neutral, or mediated settlements, rather than immediately looking to litigation to resolve disruption to legal obligations becomes a necessary tool for survival of supply chains. Most contracts don’t have to be terminated, but simply renegotiated.
5. Build greater redundancy into your supply chain
Review the weaknesses this crisis has demonstrated in your supply chain community and the reasons for it.
Take from lessons learned and build greater flexibility into your supply chain to permit for redundancies be this geographical, financial, supplier specific, alternate or substitute products.
6. Build supply chain considerations into the design phase
Supply chain management was not typically part of the design consideration for products, unless a very specialized and unique part was needed.
Sourcing was left up to the purchasing function after the design was completed. This will likely now change with sources of supply and supplier security being key to successful delivery. Closer integration in this respect will become critical.
7. Better awareness of downstream supplier activity
Supply chain management downstream has largely been outsourced by primes, who have not wanted to be burdened with this task and put that obligation on tier 1 and tier 2 suppliers.
Given the criticality of the supply chain system needing to function throughout to ensure supply security, this will be a function that requires greater oversight at the prime and tier 1 supply level.
8. Supply chain management oversight
Increasingly companies have left much of their supply chain management with the purchasing function to oversee, with little oversight from operational management.
Given that supply chain security has become critical to the overall functioning of the enterprise, operational management will need to become more integrated in the process and take on more of an oversight role. Operational management will also need to ensure that allocation of risk within the supply chain contracts is “flowed up” in the upstream contracts, or if not “flowed up” is at least is a known priced risk for the prime.
9. Discuss supply chain resilience with customers
Customers are key to the supply chain, so an in-depth discussion respecting sourcing of products and flexibility of supply is crucial.
Discussing topics such as security, cots , cost and need for specific specifications might permit a greater flexibility and range of suppliers to be used in the future.
10. Begin making changes now to ensure survival of supply chains long term
Implement changes now when there is a crisis, in particular looking at supply chain finance programmes to support suppliers in financial need. This might even take the form of acquiring an equity stake in the supplier or ensuring critical IP.
Thinking outside of the traditional box and being flexible in approach, will be critical for those companies that emerge with their supply chain relatively intact.
The World and international trade will be deeply impacted by COVID-19 and will by necessity be forced to change. Supply chains will be forced to become more resilient, in order to provide businesses with security of supply. That factor, more than cost, will now drive supply chain design, management and integration. No more so than in the Defence, Aviation and Aerospace Industries.
Wolf Von Kumberg
BA, LL.B, LL.M, FCIArb
Independent Arbitrator & Mediator
(London & Washington DC)
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