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Staying aloft through a product recall

AIRPLANE MANUFACTURERS are used to delay and have learned to roll with them -the Boeing 787 and the Airbus 380 were both delivered several years behind schedule — but recalls are a rare event: Jimmy Carter was in the White House the last time the US Federal Aviation Administration (FAA) grounded a commercial airline model.

The public relations challenges of coping with a recall like the FAA’s 17 January grounding of Boeing’s Dreamliner are well known, but the role working capital management plays in getting through such a setback is less well understood. Yet smart planning can play an equally important role in mitigating the financial risk of an unexpected stoppage of sales.

Going with the flow

One of the difficulties for an airline manufacturer is that unlike many manufacturers facing recalls, stopping the line is not really an option.

Cash flows and liquidity are planned with precision at a commercial airline manufacturer. Rather than act as the sole provider of multi-billion dollar development costs, airline manufacturers try to fund development incrementally through customer “down-payments” and “stage payments,” which are required to secure deliveries as of specific dates. Typically, delivery schedules have been agreed far in advance. Order books may be filled for as long as ten years ahead of delivery, which helps to keep the cash flowing smoothly.

A total of 844 Dreamliners have been ordered so far. Fifty have been delivered but are temporarily out of service. With the manufacturing pipeline stretching so far ahead, neither the suppliers nor the aircraft manufacturer can afford a long disruption. As each plane reportedly sells for at least $115m, steady funding is crucial. This smooth flow may be particularly important these days, now that aeronautic supply chains are increasingly global, and decisions made at headquarters resonate far beyond the company’s manufacturing plants.

As a result, although the FAA has stopped delivery until an issue with a faulty battery can be corrected, planes are still being built. Five new planes are still being completed every month, according to the Wall Street Journal, and parked on company fields in Everett, Washington and North Charleston, SC, awaiting clearance from the FAA. As Boeing and its partners try to resolve the battery issue, Boeing will continue to wait for final payments on the completed planes. Inventory will continue to build and ongoing payments to suppliers will hurt Boeing’s cash flow.

Risk mitigation

Several important financial lessons can be drawn from Boeing’s experience, whether or not you’re in the airline business:

• It can happen to you. The airline industry is incredibly safe: commercial flying is so safe now that a passenger might fly every day for 14,000 years without an accident. Despite that record, one battery problem has now grounded a fleet. Companies should prepare for the unexpected.

• Share your risks. Boeing’s situation would be worse if it hadn’t pursued an innovative risk-sharing model with its suppliers. Instead of producing the whole airplane at its own plants, a small number of large, Tier 1 suppliers (e.g. engines, landing gear, flight control systems) were subcontracted to design and build large sections of the aircraft, which they then shipped whole to Boeing and Boeing essentially snapped them together.

These “risk-sharing” (Tier 1) suppliers are also responsible for making investments in product development, tooling, testing and pre-production costs. This arrangement was designed as a win-win that improves supplier margins in the long run (and it may be a very long run: both the Airbus 320 and the Boeing 737 have been in production for over 25 years) as it reduces the aircraft manufacturer’s risks and financial exposure during development and the first years of production.

• Cash matters. Despite the risk that the Dreamliners will stay grounded for several more months, Boeing’s stock is just down 3%, in part because investors believe that the $13.5bn in cash and short term investments the company has on the books and its $3.5bn in free cash generated in the fourth quarter of 2012 can absorb the losses associated with the model’s grounding for a long time: some analysts estimate that even a six-month grounding would just result in a $1.5bn loss.

Welcome to the new normal

But perhaps the most important lesson is the crucial role strategic working capital management can play in the survival of a company – and how carefully it needs to be monitored in a capital-intensive business, a lesson Boeing took to heart during the turbulence of the credit crisis of 2008.

During the crisis, Boeing Treasurer David Dohnalek began holding daily meetings, to keep an eye on emerging risks and opportunities. After the crisis subsided, people began to ask when things would go “back to normal.” His answer, according to Treasury & Risk magazine: “This is the new normal.” The same might be said of the importance of active financial management today, particularly for a company in a capital-intensive industry.

Craig Bailey is a senior manager at REL, a Hackett Group Company

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