Prompted by a doubling of fuel prices, a slowing economy and decreasing fares, SAS Group sent a letter to suppliers in late May requesting a 10% price reduction for goods and services. The company plans to strengthen relations with suppliers that help out with price cuts. The initiative is part of SAS's Strategy 2011, which will see a cutback in the number of suppliers.
Patrik Knutsson, chief purchasing officer, believes price reductions are possible in many but not all areas. He does not expect them in fuel prices but hopes for drops in maintenance costs. "As a procurement officer, I believe price is always the most important factor," he says. "Now we need to work through our process more thoroughly."
Knutsson acknowledges that not all suppliers will be able to contribute lower prices. "Some are in tough situations themselves. But they can make a positive response in many different ways, for example by prolonging the payment period."
The airline will not alter procurement processes, but by 2011 the program of consolidating suppliers will be pressed. "It may be that we buy more from suppliers that contribute than from those who do not contribute, and we could change some supplier relationships," he says, noting that SAS will honor current contract obligations.
By late June the carrier was starting to receive formal responses to its request. It has goals for savings from both suppliers and internally but Knutsson declined to specify them. He expects to begin implementing necessary changes after summer when he has received all responses.
"It is obvious that pressure on airline costs translates to suppliers," observes Frank de Reij, corporate procurement officer at KLM. His airline will continue to minimize total cost of ownership rather than simply price. "Our general strategy is cost of ownership, and I strongly believe that will stay unchanged," he says.
This puts pressure on KLM suppliers to drive costs out. Yet the airline is willing to pay a slightly higher initial price for a lower cost of ownership. De Reij expects to drive ownership costs down in several areas.
With fuel so expensive, weight reductions become very important, so KLM looks for lighter equipment that will save money over a five-, 10- or 15-year writeoff period. "Lighter equipment can bring dramatic fuel savings, and it goes hand in hand with reducing emissions," he says.
Three important areas for weight reductions are apparent in the selection of seats, inflight entertainment equipment and catering dollies. There are also potential savings in cargo and baggage equipment. De Reij is willing to change suppliers to get lighter equipment, but KLM generally aims for strategic supplier relationships "so we will try to work with our suppliers and urge them to come up with equipment along those lines."
Some prices come down simply due to slack demand, and KLM may get reductions here. With a number of airlines cutting flights and traffic slowing, there is intense pricing pressure on ground- and passenger-handling firms. "But we must be careful not to push too hard on these suppliers so that they will be able to survive the downturn," he acknowledges.
Air France KLM is implementing a strategy to exploit the leverage of its combined spending power. De Reij expects this to pay off in some price reductions by year end. The carrier is not deferring procurement, but inventory management is becoming increasingly important.
INTEGRITY & VALUE
Delta Air Lines works like KLM, focusing on total ownership costs. Supply Chain Management VP Shawn Anderson wants lower prices, but also looks for quality, terms, delivery and total value.
Delta has reviewed all supplier relationships as part of a major restructuring since early 2002. "But we also focus on integrity," Anderson says. "If we have made a commitment, we make sure we honor it. If a contract allows us to test the market, we will do that."
He sees some progress, even on fuel. If prices go up with markets, Delta wants fuel suppliers to provide more reliable delivery or work with it on risk management. "Anything that adds value," he explains. "We do that with all our suppliers. We expect everyone in the value chain to take waste out through innovation. Sometimes it is price and sometimes it is work scope, fewer hours for the same services. With technical providers it is reliability."
The airline has been aggressive in sourcing its parts from OEMs, PMAs and surplus markets. "We are absolutely going back to those options and working them again," Anderson emphasizes. He says the hardest prices to get down are for basic commodities like fuel, metals and food. Only an economic slowdown will help here, and maybe not much if stagflation returns. Other commodities besides oil are increasing in price. According to a recently released report from the Air Transport Assn., the cost of maintenance materials rose 20% in the first quarter.
TIT FOR TAT
Nordam President Kenneth Lackey has seen strong pricing pressures since 2001 and his company has changed some procurement practices. "Customers are very demanding, so we have to be very demanding," he says. But suppliers' ability to meet commitments also counts heavily, especially in tight markets for titanium, adhesives, composites and glass core. "Composites have really been a struggle, as the manufacture of business jets is going full speed ahead," he says.
The supply chain has passed cost increases upward, so Nordam has moved toward global outsourcing and consolidating suppliers to get better prices. It now does engineering in Singapore, manufactures in Asia and is opening a plant in Mexico.
"Now suppliers come to us to get out of contracts and pass through fuel charges," Lackey points out. "When a contract expires it is extremely difficult to get it renewed at the same price. You are starting to get inflation baked into the system."
Nordam tries to save money on noncommodities like phones, office materials and hotel rates. "Sometimes we are able to negotiate a better price for ancillary services," says Lackey, who does not see slacker demand on the horizon. Airbus and Boeing production lines are going strong and the wind turbine industry uses composites too. "Everyone wants materials that are lighter and stronger, just like aviation."
"The whole supply chain should be working on ways to reduce the cost of the supplier," stresses Nathan Dalton, VP-business development at Wencor. He follows the latest news about aircraft groundings, particularly 737s and MD-80s over the next 18 months. "We are trying to figure out how that will affect us," he says. "But that has not hit hard yet. We are still getting work from airline customers."
Wencor is feeling price pressure from customers. "We have to respond in a way that we can compete, stay alive and make a little bit of money," Dalton says. That's tough because inflation is affecting purchases, including specialty metals and seals. "We have to pass at least some of that along, and we were able to pass some of that along," he says. He notes engine-makers have been raising part prices 5%-8% per year. "It is hard to say if they will be able to get away with that now."
Wencor is willing to see margins shrink, but only so far. "Customers take you down to the mat and say here is the point we have to get to. We will go down because we value their business, but there are points we cannot afford to go to."
Rising raw material costs are the big challenge for Wencor-manufactured parts. The company also distributes standard parts, but Boeing and Airbus have full order books for those parts. Dalton says, "They manage capacity with price." Declining demand will relieve price pressures, but it has not happened yet. "Airlines are still flying planes," he says. "Schedule reductions come in fall 2008 and 2009. And there is a lag in MRO anyway." Eventually, fewer MD-80s in service means carriers will not need so many MD-80 parts. Smart airlines may release some parts in anticipation of reduced requirements. He expects that to happen soon, but it has not happened yet.
Wencor offers DER repairs and PMA parts and Dalton expects airlines to exploit these low-cost choices. DER and PMA business increased significantly following 9/11, with United Airlines, Delta, American Airlines and Air Canada making more use of the aftermarket. He says carriers now may push their overhaul shops to exploit this market more actively.