Prepared for a Cliff?

How prepared are you for a sudden, dramatic decline in demand?  Is it even on your radar?  Most of us think of demand in terms of waves that slowly rise and ebb, although I've also experienced a sudden drop in demand.  So sudden that I began planning for a quick facility shutdown at the same time I was still hiring.  I learned a lot from that experience, and now take immediate, aggressive action to understand even slight demand downturns.

Demand cycles, and especially rapid downturns, become even more difficult to understand let alone predict when they are due to unforeseen circumstances.  Remember when the Detroit Three auto CEO's committed the faux pas of the year by arriving in Washington, hat in hand, on their corporate jets?

Vilified for their role in the auto-industry meltdown, executives at Detroit's "Big Three" haven't done the corporate-jet business any favors either.  Their unfortunate decision to take private planes to Washington for their first senatorial drubbing was a gift to critics of corporate excess.

In one day an unrelated industry was changed.  Actually several industries, but the executive aircraft business is the poster child.

Negative publicity makes this downturn different from the last. In the slump following the Sept. 11, 2001 attacks, disruptions due to tougher airport security provided some justification for investing in a set of wings. In 2007, three-quarters of Fortune 100 companies disclosed personal use of corporate jets by chief executives, up from 59% in 2004, according to Equilar, an executive-compensation research firm. "Now, any display of wealth is negatively perceived," says David Strauss, an analyst at UBS.

Poof!  In reality, the industry was a bit in decline already, thanks to the trials of the financial markets.

A UBS index that tracks business-jet industry conditions has plummeted to 13, an all-time low and well below the 50 mark indicating stability. U.S. takeoffs and landings fell an estimated 19% year-on-year in October. That is particularly grim for servicing firms -- grounded planes don't need much maintenance -- and airstrip operators. Stocks of manufacturers such as Bombardier and General Dynamics have dropped by between 30% and 40% this year, broadly in line with the S&P 500-stock index.

It gets worse.

But while investors have clearly recognized that the peak is past, they may still be too optimistic on the depth and duration of the downturn.The critical factor is backlogs. Even if new orders slow, the preceding boom means plane makers have hundreds of deliveries scheduled over the next few years. But backlogs aren't money in the bank.

In UBS's latest industry survey, 36% of respondents said financing had dried up, compared with just 6% in September. If financing remains closed for an extended period, order backlogs will begin to evaporate and more used planes are likely to enter the market, pressuring prices. In UBS's worst-case scenario, deliveries fall 41% to 650 planes, excluding very light jets, by 2011 (its base case forecasts a 25% drop).

And that was before the Detroit Three fiasco.  I hate to think about how analysts are now revising their forecasts.

I believe there are valid reasons for corporate aircraft, such as security and the time value of executives.  But it is also like a drug and becomes a habit very difficult to kick.

My first experience with a company jet was a little amusing.  I was a newbie engineer working for a small division of a large telecom, which owned a flock of jets.  Apparently the tax man was a little concerned about whether the aircraft were being used for business purposes, so to make them feel better the company put out a "clarifying memo" saying they can be used for any business purpose that "makes sense."  So the next month when I had to fly to a remote factory I called the ultra fine print number on the memo... and voila!  A jet was ready and waiting the next day at a nearby airfield.  What a great way to visit the factory.  Until a week later when my boss explained what "makes sense" really means, what the politics of the letter were, and what the budget impact was.  Oh well.

But back to the point of this post.  Do you have a sudden, unexpected demand meltdown on your planning horizon?  What would you do?  I know some automotive suppliers that might want to think about this concept.

Comments

[Robert Anderson]

I am glad you are referring to the US auto makers as the Detroit 3 and not the Big 3 since that would include Toyota and they are not standing in line with their hats in their hand, asking for money.

With regards to the layoffs issue, it would be hard for many employees to separate layoffs due to improvements from layoffs due to economic conditions since Lean ultimately results in fewer people 'needed' in the production process. Any decrease in orders (volume) will also translate to needing fewer people which was already reduced due to process improvements. When the time comes to consider your position, the cause will be irrelevant and not categorized.

[Michael Lombard]

Even Toyota has to be prepared for a downturn. Did you see the New York Times lead article from today (12/22/08)? Toyota will lose money this year for the first time since 1938!

I imagine Toyota had a contingency plan all long knowing them. But I wonder if after all these years of record-breaking profits they really expected to have to use it?

The NY Times article mentioned Toyota is cutting costs by unplugging hand dryers. Huh?