Scale and Innovate Boeing Gets Squeamish

It starts at the top for any merger. United Technologies and Rockwell Collins are seeking common ground for a synergistic merger. It will roll two chief Boeing suppliers into one, thus possibly losing supplier competition with Boeing's supplier base.

“The combination gives us the ability to both scale and innovate,” Greg Hayes, chief executive officer of United Technologies, told analysts on a conference call Tuesday, a day after the deal was announced.

Examine what industrial product scaling means and the innovation component that could be lost with one less competitor than a merger will create. Boeing argues that a competitive nature will be lost halving the innovative component after a merger. 

The United Technology CEO, says it gives them the "ability", suggesting they don't have the ability at this time to scale and innovate. With that sentiment, United Technology is stating it can't compete without a merger. Scaling is a simple concept when considering a complicated merger. See article below by Josh Lowry

Scaling: 

This week, I was asked, “What does ‘scale’ the business mean?”  “Scale” is an often used in business and can have different meanings depending on the context.  Some common examples include: “Are we operating the business at scale?”  or “Are we taking advantage of the scale of our business?”  or “Can the product scale-up or scale–down depending on demand?” or “Does the business scale?”  or “We are currently scaling-out the team.”   Below is my attempt to put some structure around the term “scale” for these common scenarios.

Are We Operating the Business at Scale?

Operating the business at scale means allocating and optimizing resources to drive the greatest results and volume across market segments.  Are marketing and sales working together to generate demand and close business?  Are closed deals being transitioned to services/support to be nurtured?  Are partners being leveraged to multiply the company’s marketing, sales and services efforts to reach new customers and displace the competition?  Operating the business at scale is about optimization, not duplication, of efforts.

Are We Taking Advantage of the Scale of Our Business?”

Scale is another word for size. Companies can leverage their size by negotiating exclusive dealings, favorable terms and volume discounts with other organizations. Partnering with large businesses can also provide companies with access to national and world-wide markets to sell products and services. In addition, keeping costs low or unchanged while increasing sales volume provides companies with the opportunity to further decrease prices – new customers, more marketshare – without sacrificing margin (economies of scale).

Can the Product Scale-Up or Scale-Down Depending On Demand?”

Many industries have periods during their calendar/fiscal year where they experience increased customer demand for products and services (e.g., retail industry during the holiday season).  Core infrastructure offerings from organizations like Amazon Web Services enable retailers to increase server capacity (scale-up) when customer demand is high without having to invest in new hardware. Retailers can then reduce server capacity (scale-down) during normal operating periods.  These types of offerings/products let companies pay for what they need, when they need it.

Does the Business Scale?

Companies that scale have operating leverage.  They can growth revenue with minimal or no increase in operating costs (e.g., administrative, sales, etc.).  To illustrate: In Year 1, company delivers $10M in revenue with $1M in operating costs.  In Year 2, company delivers $12M in revenue with $1M in operating costs.  Company scales because it grew revenue by $2M without increasing its operating costs.  This is common with software and other technology companies who develop IP at an early stage and subsequently monetize it at low marginal costs over time.

In contrast, if company’s operating costs increase by the same amount as its revenue, the business does not scale.  That is, if company requires its operating costs to increase by $2M in order to grow its revenue by $2M, the business is not scaling.  Consulting firms like Accenture and McKinsey & Company are prime examples of organizations that do not scale.  This is because there are a fixed number of billable hours in a day, so they have to add consultants on a one-to-one basis to grow revenue.

A common way companies scale is through channel partners. Companies multiply their marketing, sales and services efforts with partner resources in exchange for a percentage of the margin. For example, if company has ten direct sellers, it is limited by the reach of those ten sellers. However, if company partners with a reseller with 50 sellers, company has increased its sales force (in theory) by 500%. Sharing 30% of the margin is less expensive than the cost of hiring an additional 50 sellers.

Companies also use marketing to scale the business.  Marketing enables companies to effectively (results) and efficiently (cost and speed) communicate to customers with the right message at the right time.  Marketing also helps generate customer demand and drive pipeline velocity for sales, which reduces selling costs.  Driving customers and prospects to one-to-many events (e.g., product launches, solution roadmaps, etc.) is a common way to scale with marketing. For example, it is more efficient to sell to 500 CEOs at once than it is to sell to them separately.

We Are Currently Scaling-Out the Team

Once a company has developed a repeatable sales model, the next logical step is to invest in headcount to accelerate (and scale) the business. In software, this means adding sellers/territories within geographies to localize the business. For example, if company has developed a successful, repeated sales model in Seattle, WA, it can grow (scale) revenue by implementing the same sales model in San Francisco, CA. In the restaurant industry, it is the same theory for selling new franchises. In the retail industry, it is the same theory for opening new stores.

All contents copyright © 2012, Josh Lowry.  All rights reserved.

The bottom line for the argument is enhanced scaling goes with the merger and Boeing has reservations with both the innovation and scaling comment coming from United Technologies.

Innovation is the big item bothering Boeing. It believes competitive innovation makes for better choices for its best and lowest cost systems or parts offering from a variety of suppliers rather than one post merger mega supplier. Losing just one mega supplier to a merger hurts its future chances for having the best and lowest cost option for systems and parts.

In defense of the innovative function, Leonardo Da Vinci worked in a virtual vacuum when he drew up a flying machine. His innovation was off the charts without competition. However, Boeing argues having multiple helicopter makers makes Boeing compete for the best version for the lowest cost and that innovative function should scale down to its suppliers as well. 

Dissolving one company as a result of a merger will hurt the aviation industry as a whole as it would have only one innovator and not two supplying aviation's inventions.

There are two sides to every argument, United Technology and Rockwell Collins want to combine for financial and other stock value reasons, but both have reached a size issue in the world of aviation. There are only so few producers of aviation supplies with this scale in the world. Boeing can't simply go to a garage size innovator and then compete on the world market place using a DIY touch screen from a former techno-junky coming from a garage. 

It isn't scalable to bring these types of innovators up to speed for the size of Boeing's industrial output. In order to compete Boeing would have to hire 10,000 divergent techno-junkies and house them under one roof in hopes management can rope them into making a new avionics suite. 

Its a problem of scalability and innovation when the supplier source is so few and scalability becomes so large. Boeing will press forward making it difficult for a supplier merger of this scale. In other words, its a not so simple. A passenger seat delay can bring both the mega aviation manufacturers to its knees. Just ask Airbus how its production is going while waiting for new seats to be delivered from Zodiac. 

The supplier is over-whelmed and there is no other supplier option in site. Boeing is risk adverse and a merger will increase the supplier risk with rising costs and lower supply options when delivering for its own airline customers.