TransDigm: Value-Based Pricing Strategy

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Could you just provide some context to when you first joined TransDigm and the responsibilities that you had?

I joined TransDigm back in 2000. Prior to that, I worked with DuPont, in their aerospace division, the Vespel group and I worked with General Electric, so I’ve had experience with large organizations, prior to joining TransDigm. I was just finishing my master’s degree, when the opportunity to join TransDigm, as a senior design engineer, came up. I was actually a part of the AeroControlex group and as TransDigm went from being a privately held organization, going into their IPO, it was around the 9/11 time frame and just after those years, there was a lot of consolidation. It afforded me the opportunity to move from the engineering role into a product management marketing role.

From that point, my career expanded, going from product line management to director of sales and marketing of some of the most recent and early acquisitions. Then, ultimately, to president of one of their operating groups, CEF Industries. It really afforded me an opportunity to grow with the culture and to be one of the ambassadors of the TransDigm culture and bring that into new acquisitions. It was a very interesting time and I’m really grateful for the opportunity that I had, to work with that team.

So you were part of this integration team, SWAT team, that goes in and embeds the culture on these new acquisitions?

That’s correct. One of the first things that people aren’t really aware of when you think about TransDigm and their culture and their acquisition strategy and model, that all starts before they actually purchase the company. When companies are fed into that acquisition funnel, meeting certain criteria around particular markets, meeting certain criteria around financials and intellectual property or technology, those fall into the funnel. But then there’s other aspects of the business, where doing that initial due diligence and interaction with either bankers or some other executive team of those potential acquisitions, we’d start to determine and develop an understanding of whether or not that company really could fit within TransDigm’s overall culture.

It’s really interesting. They almost have this strategy of a private equity team, building out various portfolios and various platforms. You will hear that a lot, in private equity and at TransDigm; probably one of their keys to success is that they behave in a very disciplined and almost, I would say, unemotional way, in a lot of their acquisitions.

Can we walk through the process, from start to finish? Assume that we’ve acquired a business. How does TransDigm approach introducing the culture to the new acquisition?

Two things. Number one, they do a very thorough review of the incumbent leadership. There are product line acquisitions and there are company acquisitions. On a product line acquisition side, they will identify an internal team that will, subsequently, absorb that product line. That product line may come with an operating location that was part of another organization and they identify people within that operating location, such as shop supervisors, people that are in materials or inventory, those sorts of things that they view as key to helping to usher the culture within that product line.

In a company acquisition, they will do a very similar thing. They review the operations manager, engineering manager, accounting team or financial controller, and HR, assessing whether the team aligns with their vision, which is quite simple. They want companies that are customer-centric, focused on understanding their customers’ needs. They also want people who act like owners, taking responsibility for the business. Lastly, they want individuals willing to take measured risks—whether in technology, expanding market share, or similar areas. If the existing team members demonstrate alignment with these principles, they’ll be retained.

One of the key things about the TransDigm culture is that it’s really more about decentralized leadership, versus centralized leadership. As I said, I’ve worked with DuPont, GE and even, more recently, working with Triumph Group and that’s one thing that became very noticeable about the difference in culture. TransDigm will have an operating company president or a site leader, that has a lot more authority than in other organizations, like GE or DuPont or United Technologies, where they understand the concept of a reversible decision, versus an irreversible decision. They make it pretty clear that, if you’re doing something that’s going to damage the intellectual property ownership of the company, if you’re doing something that is going to change the overall contractual relationship with a major customer like Boeing or Airbus or General Electric, those things need to be discussed up the chain, all the way, sometimes, to the CEO level.

Other decisions around pricing, around particular business programs or particular aircraft programs, those are reversible decisions, so the local people have a lot of autonomy, in terms of the ability to decide what new business they are going to take on and what new business they aren’t. 

It’s interesting because that even plays a role in how TransDigm operating companies do work with each other. There isn’t a corporate mandate to say, we have an electric motor company, so all of our companies that need electric motors will buy from our own internal suppliers. You may buy from a competitor, to one of the other TransDigm divisions, because that competitor has a technology or a solution that doesn’t exist internally. Or maybe the two align where an internal group wants to enter into a particular technology and the other group has an enabling program that allows that to happen. Those things happen organically and naturally and it’s not a forced sort of decision making. That’s really the underlying culture.

Are acquisitions only split between product line acquisitions and whole business acquisitions? For example, Esterline was a company acquisition. They also acquired Kirkhill, from Esterline, a few years back, so that would have been more like a product line acquisition?

For instance, I think with Tactair, they acquired a product line which was the cargo automation and handling systems that are utilized in the cargo aircraft; the rollers and the electromechanical system that provides that cargo handling, within FedEx, UPS, those sort of customers. Well, that was a product line acquisition. They identified a candidate, an internally existing TransDigm business that could absorb that. Yes, those are some of the decisions that they make, when they’re looking at various businesses, whether it’s a product line or an entire business. If you think about the McKechnie acquisition, where they bought a number of companies, that was one of the first very large, broad acquisitions that they did. The McKechnie Group also had a number of fastener businesses in the UK and Europe that really didn’t fit within TransDigm’s portfolio. So they quickly acquired it and then divested that fastener business to Alcoa.

Again, they’re very aware of what businesses their model can add value to and what businesses they can’t. They’re very pragmatic about that.

Let’s work through the process. You’ve bought a business, you’ve gone in, changed the culture, you’ve introduced this new operating structure, what are the changes in the cost structure you make? 

Often, when you look at a product line, or you look at a business, some of the things around efficiency that are quickly able to be realized, are around inventory. 

A lot of businesses run very fat, in terms of inventory. Inventory is usually tied up in work in process. You have bits of unfinished goods, sitting in one location, then three processes forward, there’s another lot of inventory, of the same actual product, in a different state of completeness. They quickly come in and rationalize what kind of finished goods they want to have. 

Most of the companies that you see in aerospace don't spend as much time as TransDigm does thinking about where finished goods should be stored in order to be more flexible.

Let’s just take an example of a pump. You’ve got a pump that you’ve designed. You’re going to have castings and housings that go into it. You’re going to have gear or gerotor pumping elements that go into it. Then you’re going to have electronics that go into it. You can either store the casting level in the total raw material side or you can store it at the final pump assembly. The way that that thought process works is, going back to that customer focus and customer facing philosophy, if you need to sell finished pumps directly to airline customers, there’s value in having finished goods at the highest inventory value, which is a finished, tested pump, ready to be installed on an aircraft. There may not be as much value in keeping sensors, switches and castings, because no airline shop can do a repair of your unit, to that inventory level. 

A lot of times you go into businesses and they keep inventory at these very low levels thinking, okay, when I receive an order, then I’m going to do all the necessary steps to make that into the final part. That’s unnecessary costs; both variable and fixed costs are driven up by that business philosophy for how you run your shop.

By having it at the highest level you feel that your inventory value went up from $5 million to $15 million of finished goods, after I’ve put the labor and everything else into it. But that $15 million inventory will turn much faster than that $5 million, where you need to add in all that work anyway. That’s just a simple example but there are other examples where they will say, okay, there are a lot of shops that do repairs on these units, so having finished units is not the best place to hold inventory. We need to supply sensors and castings and other material, to the marketplace, to the airlines, to the MRO facilities. Therefore, keeping the inventory at that other level is actually higher value. Again, it increases inventory turnover. That’s a very simple example of what they do in terms of working capital.

Don’t these companies understand that or what do they do wrong?

It’s really interesting because you would think that most of that type of thought would happen at a mom-and-pop shop, right? But no; you go into the big places, like the Esterlines and the McKechnies and even the Eatons and the Goodrichs of the world, and you find that they haven’t rationalized their inventories. They haven’t rationalized their inventories, in terms of aligning them to how the market procures the product. You think about GE aerospace and then, it was Rockwell, which was Collins, which was UTC, all that stuff, they were all similar to TransDigm, made up of many various acquisitions, over years and years and years. Everyone that took that acquisition thought that the prior management must have figured it out and that it’s as efficient as it needs to be. The larger your organization gets, the further away from the value stream decisions are being made. The real goldmine of what the TransDigm culture allows and how it operates so efficiently, is that by being decentralized, they move decisions to the closest point of the value stream.

So now, I have a product line manager that is responsible for the margin expansion, the revenue expansion and the development of new business streams, for a particular value stream. Whether it’s a product line, whether it’s a business unit, there is some person responsible for performing this type of analysis. Then that discussion happens at the operating group president level and then that discussion happens at the executive vice president and COO level. People will probe that new paradigm or that decision that they want to make to move inventory from a particular position, to another new position. There will be probing questions, but those questions aren’t to say, you shouldn’t do this. The questions are, okay, how is the value going to be changed by making these changes in the way we operate our business? It’s truly collaborative and it’s truly open.

What’s the extent of the change that you’ve seen in the financials, typically, when you do clean up the inventory, for example?  

Just throwing out round numbers, EBITDA expansion just from those sort of things, or working capital, you can see double digit changes; 10%, 20% changes in freeing up working capital, creating more profitability, expanding revenue. Because, again, some of these larger businesses have always had these very old distribution agreements, where they rely on a distributor, like Aviall, which is now Boeing Global Services, Satair, which is now Airbus and the other distribution partners, to give them customer-facing marketing information. They hold the inventory for a lot of these other businesses. TransDigm takes an active role in that. They’ll say, okay, even though you’re my distribution partner, I’m going to tell you what parts I want you to hold. I’m going to tell you what parts will no longer be available to the market. For a lot of distribution partners, that’s pretty unheard of and they’re often set aback. That rationalization is usually double digits, especially in the first five years of an acquisition.

The next area that they are very focused on, in the first five years of an acquisition, is where is the pricing for their products. Actually, that’s usually the first vision. Understanding how the products go to market. There is an OEM portion of that, there is a direct to airlines portion of that and then there is a direct to MRO maintenance providers portion of that. They look at the three paths to market and, again, they go through similar rationalizations.

OEM, to TransDigm, is pretty strict and people like Honeywell follow this; people like UTC follow this; people like GE Aviation and Rolls-Royce follow this, very strictly, as well. OEM, in their minds, only relates to a product that will go onto a new airframe, rolling off the production line. That is the definition of OEM. If an OEM, like Boeing, is procuring a product and it’s not utilized for a new airframe, it’s not OEM; it’s aftermarket. 

So the other thing that TransDigm is very strict about doing, is understanding what’s called pass through or leakage, to the aftermarket. They will go to their OEM customers, because again, they have a relationship with the airframers, so they know how many engines rolled off Rolls-Royce’s engine line and how many of those engines were actually utilized on A320s or A350s. Then they will go to the OEM that they have, as their supply chain to the market and say, okay, last year, 10 aircraft rolled out. That means that 20 engines were OEM. You purchased 42 engines’ worth. Therefore, there is a difference between the pricing for the 20 engines that were OEM, for new airframes and the remaining 22 engines that you procured.

Often, they will go in and fix contracts, fix pricing, and establish two tiers. One tier for an OEM, for brand new engines and another tier for the OEM doing aftermarket work. Basically, what happens is, they level the playing field, so the MRO shop, the airline and the OEM doing that service work, almost have price parity which, for a lot of businesses, immediately raises the revenue and profitability. They were, basically, allowing the OEM to have 100% share in that and they had zero percent share in that aftermarket.

Why do the existing companies have that structure?

I never could understand that. Even when I moved to Triumph Group, I couldn’t understand that, either. I don’t know.

They let the OEM (Boeing and Airbus) own part of the aftermarket?

Yes. Recently, in aerospace terms, 2008 to 2012, Airbus and Boeing went on a very rigid campaign, to change their contracts, to remove two-tier aftermarket pricing from a lot of their OEM contracts. But prior to 2008, the language didn’t even exist in many of the contracts that said, regardless of the in-market use, you will sell all products to me at a fixed price. That didn’t even exist in some of the contracts but yet, people allowed them to procure spare components at production OEM prices. That put a big strain on a lot of the supply chain and that’s why some of the businesses were available. They couldn’t maintain and support their business, when it made a big switch from in-production aircraft to out-of-production aircraft. Now, instead of manufacturing for 150 aircraft per year, you’re manufacturing for three aircraft per year being produced but yet, 300 aircraft per year are being serviced in the aftermarket. But you can’t contribute; you can’t participate.

That put a huge financial strain on a number of people in the supply chain. Those are some of the reasons that people just walked away from different product lines or businesses, because they deemed them to be unprofitable but they didn’t understand why. They weren’t really digging in.

Effectively, what you’re saying is that, historically, the OEMs were purchasing parts for those aircraft or airframes, in production. They were purchasing double, so they could then go and serve the shops and the airlines, in the aftermarket, and either reprice or keep the same price, but capture that profit?

They repriced the parts. The really difficult thing to comprehend is, in the aftermarket, there are published price lists. I’ll just throw in an example, like Ryanair or Southwest, with the big fleet of 737s. They’re going to be able to cut a deal with Boeing and Aviall and get preferred discounting, but it’s nowhere near what the supply chain signs up to be on a Boeing airframe. When you think about OEM and you think about aftermarket decisions, in terms of strategy for OEMs, versus aftermarket, on the OEM side, people fail to think about qualification cost, engineering costs. A lot of the supply chain absorbs that, to participate on a program like 787, to participate on a program like A350. That frees up working capital, frees up investment that Airbus or Boeing would have had to qualify the hydraulic system fully, because sub-components of that system were qualified by their supplier partner.

So the aftermarket is really where you, basically, recuperate the landed cost that you put in, in order to be on that platform. It’s not that they’re just giving a free revenue stream. The problem is – and that’s where companies get into issues, especially in aerospace – whether you are dealing with a casting supplier, an electronic supplier or an engineered product supplier, like TransDigm, Triumph or Emitech, you have an investment upfront, to get on that airframe. Now, your program, when you’re pricing it to the OEM, is priced in a way that almost has a depreciation schedule for how you recuperate those initial costs and then turn profitable for the program. Profitability doesn’t happen when a plane ships to the first airline customer. Everyone starts to get profitable five years, eight years, after introduction of service.

You can think about industrial and automotive in a very similar way. There’s a big automotive aftermarket parts market.

In terms of how this works then, TransDigm is not just jacking up the prices across the board. They go and they say, right, this is the OEM price and, actually, this is the aftermarket price and that’s going to be repriced now, so I can recuperate my engineering outlay and costs and capture some of that margin that, otherwise, the OEM would capture?

Correct. They’re, basically, asking for an equitable split.

What does the airframer say to that?

Imagine, if I’ve been doing this all of the time, I’m pretty shocked. But then when we sit at the table and it’s really understood and explained, they don’t have a leg to stand on often and that’s why you see them being very successful at doing that sort of repricing and doing that levelling. They know the people on the other side of the table and, initially, when TransDigm was just growing as a player in the aerospace market, it was tough for a lot of people to take. But over the years, they know the people at Boeing, they know the people at Rockwell, and they know the people at Airbus. So when the guys know that they bought the business, they already know what’s about to happen. Okay, our free ride is over. We’re going to actually have to come to the table and equitably split up the pie.

What could they do? Do you think there could be some backlash or some risk to the TransDigm model, if the airframers decided they were not going to have this anymore?

There could, but here’s the problem, especially right now, in this new Covid environment. 

The supply chain in aerospace is actually an inverted pyramid. I recall this from early on in my career, when I was working with one of our legal partners. She said, really, aerospace contracts are an enigma to me. The way they’re written, basically, the supplier seems to be an indentured servant to the OEM. But yet, the supplier is the one that holds all the cards in the agreement so you almost want to be that indentured servant, because the OEM can’t get rid of you. 

Imagine, on the systems that TransDigm participates in, Boeing having to go and requalify. The qualification cost, the development of a new supplier. All of that cost and the bigger issue that people sometimes overlook; the risk of failing qualification.

Those barriers make it very difficult for the OEMs to walk away. As I said, in today’s post-Covid world, you have a 737 MAX and their engineers are spending all their time working that. They’ve just laid off 16,000 engineers. Insourcing, which was a threat, post-Covid, and when Boeing had a very nice cash purse, of billions of dollars on their balance sheet, that looked like it could be a threat; maybe there would be an insourcing philosophy in Boeing, to remove problem suppliers or suppliers that don’t deem to be aligned with the Boeing philosophy around working together, partnering for success.

That was actually a threat at one point, but today, I don’t believe it exists. I believe Boeing is in a very tough spot now. They have to have their suppliers healthy and viable, in order to return back to production. They don’t have time to look into various suppliers.

The other element that TransDigm keeps a very high level of focus on is delivery and quality. When they buy a business, they immediately work on that business having above 95% compliance to the schedule of orders. It goes back to that whole working capital thing. I’ve figured out where my inventory needs to be, to be as flexible as possible, to meet my customer order demand. Now, I’m meeting my customer order demand, so that means that I’m not having inventory just sitting around, of no value, and I can reduce the amount of inventory that I have on hand, because I’m performing on delivery. 

Regarding quality, I don’t have turn backs, I don’t have recalls from the field and those sorts of things. That makes Boeing and Airbus less likely to say, you know what, we need to look into this supplier. We need to do something about this particular company; we need to find an alternative. They don’t have time because they’ve got other suppliers that are actually a problem. They aren’t delivering or what they are delivering has a very high fallout rate.

If price is the only thing that you are concerned about it becomes a non-issue and, actually, Boeing looks at it and says, wait a minute, I’m actually getting value for this because I don’t have TransDigm parts in inventory, on our shop floor. We get them when we need them; we don’t hold inventory for them. That’s working capital that Boeing, Airbus, Eaton, Rockwell Collins, whoever, doesn’t have to have, so that’s worth something. The quality and no turn backs, that’s worth something.

Again, that philosophy around being customer focused, thinking about how you deliver their orders, how you are doing on their quality. Having your engineering and technical teams being able to respond quickly, for either new programs or existing programs, to support the customer. That customer focus takes everything else and puts it in a different perspective. Sometimes people think that when TransDigm buys this business, it’s going to be a problem. Nowadays, you will hear, TransDigm bought the business, well at least we won’t have to worry about that set of products anymore.

How does the conversation go with the OEM? Let’s say, you buy a business, everyone realizes what’s going to happen now, with TransDigm. They know the model, the strategy. How does that negotiation go for aftermarket pricing?  

It’s case by case. In some cases, they can capture the whole aftermarket. In other cases, there will be an equitable split. That’s the beauty of the business model of having a decentralized leadership. You have people that have the time and intellectual space and capacity to actually sit down and go through a logical review of what the different business-model options would be. Whereas, if you go to some other companies, that discussion happens at executive vice president level and they don’t even know what they’re giving up and they don’t know what they’re gaining. They’re at such a high level, they’re looking at the balance sheet and they may have destroyed the profitability of a product line.

For some of those smaller parts, you can get the 50%, 60% changes, in the aftermarket and, in other parts, you’re going to get smaller changes, potentially?

Right. Sometimes, on OEM contracts, they’re participating. That goes back to what we were talking about earlier. 787, A350, those types of things. The people participate, to make the plane affordable for the airline to take it, but then they understood that, over the five-year, eight-year schedule, there would be a break-even point and then there would be profitability and so that’s how they maintained those sorts of relationships.

Let’s talk about the aftermarket. How does the airline and the MRO shop look at the price changes for aftermarket parts?

For them, here’s the beautiful part that people really aren’t paying attention to when they do the analysis around TransDigm. There’s often very minimal change, because now TransDigm is just getting the price that the OEM was getting in the aftermarket, directly to them. To the MRO shop and airline, they’re just thinking, I’m just getting my parts.

I’m just paying TransDigm now and not Boeing.

Right. I’m not buying it from Honeywell; I’m buying it from TransDigm now. A lot of that is invisible, to a certain extent. The other thing you think about, for airlines, their three top costs are jet fuel, labor, and food. Everything else is fourth stream and most of the parts that they’re supplying aren't $50 million systems. They’re maybe $10,000 parts, down to $200 parts, down to $50 filters and things. For a lot of this stuff, the procurement people at the airline or MRO shop are not even raising the interest of the procurement manager, let alone the VP of procurement.

Again, the organizations that you are dealing with are larger and with more centralized leadership. If it doesn’t hit certain thresholds it never even shows up on their radar. No one is saying anything to them.

Does TransDigm not aim to change the price materially higher, from what the OEM was charging, or the existing aftermarket price? 

That analysis really goes back to what they do, in terms of the life cycle of an aircraft. 

In-production aircraft have a particular price and the amount of price they raise is single digits. Out-of-production but operating aircraft get a mid-range type of price increase. Then totally out-of-production aircraft get a very large price increase because, often, you are making a one off. 

It’s not that they are just arbitrarily doing this price increase. It goes back to what we talked about earlier in that supply chain piece. If you’ve got to make castings for a Fokker 100, you’re going to pay a lot of money for those castings, then you’re going to spend a lot of money machining three or four castings. You’re going to spend a lot of money putting those through the testing and getting the fixtures back up and certify them. People have these thoughts around arbitrary pricing but there’s a logical reason around why that happens. That’s why you have companies that exist, like Ontic. They purchase out-of-production product lines from various OEM aerospace manufacturers at different places in the supply chain. They know that serving and servicing these operating fleets that have been out of production for a number of years requires special contracts, special relationships, special supply chains, that most OEMs, after you get to a certain point, can’t do it efficiently.

I think the DoD had the audit of TransDigm around the pricing. It’s really not just, you buy the asset, you ramp up the prices across the board? It’s this value-based pricing approach that they take, where it depends on the OEM, the aftermarket agreement, the product, the life cycle of the platform, where the aircraft is and the logical pricing, across the board?

Correct. That’s why, if you think about all those things that people were making accusations around, you notice that none of that went anywhere, because there is a clearly documented, clearly understood methodology for how these things happen. There is no arbitrary nature. It’s difficult for large organizations to understand that. If you’re talking to a Lockheed Martin or you’re talking a Boeing Defense, they can’t understand that because they don’t have people that are solely responsible for thinking about things like that. The only way that they apply those things is through these arbitrary, top-down methodologies and what TransDigm does is bottom up.

I would say, if you think about their business, they’re probably run in a less efficient way from a managerial standpoint. They have more people than some other organizations but the jobs that those people hold and the functions that those people perform far outweigh the value that they bring to the business. These other businesses have these armies of people that are just doing reports and big data analysis and no one ever asks that bottom-line question. Why do we keep eight million resistors in inventory? We don’t even make circuit assemblies, any longer. We only use a resistor if there’s a quality turnback. So why are we keeping these? I don’t know; we always kept those.

So there’s things that, basically, in these large, bureaucratic organizations, disappear out of people’s minds. There are behaviors, there are purchases, there are management philosophies that become automatic and they become bad habits. We’re kind of circling back to the beginning, about your culture thing. What happens is, when they talk about the culture being that the people act as owners, it’s actually taking the cover off of those sacred cows, those old paradigms that people just thought that you couldn’t question why we did this. You couldn’t question why these product flows occur in our plant. You couldn’t question why our plant was laid out the way it was. All of that stuff is open and all of that stuff is investigated. Instead of just talking about it, they empower the team to do stuff.

Go from one plant to another plant, within TransDigm, they may be laid out totally differently. One plant may use group technology and cellular manufacturing. Another plant may use single piece flow. Another plant may do batch processing. All three of them decided on their own and showed the team what financial gains – whether it’s increasing on-time delivery, which increases the revenue and profitability – whatever it is, they showed the management team how that change was going to affect the business and they said, go and do it. Not just go and do it, but go and do it and we’re going to measure it, quarter over quarter, month over month. Then once they see that it’s stuck, it’s part of their operation. Now, that’s the new paradigm going forward. 

What’s interesting is, their name TransDigm, most people actually have no clue when they think about that. It’s a transition from one kind of paradigm, to another. 

It’s astonishing how energized people that have been in an organization for a number of years become when you actually go and sit down and empower the shop floor lead, the stockroom lead, the quality inspector lead and allow them to implement programs that they believe will make a difference in the business and reward them for it, it really is.

What do you think is the biggest risk to the value-based pricing method?

The biggest risk, honestly, is TransDigm handing off its various leadership reins and when people like Nick Howley move into other roles. When I was there, Nick Howley was COO, Doug Peacock was chairman. Ray Laubenthal became COO – he was president of AeroControlex – and then, most recently, they’ve just moved to Kevin Stein, who came from outside, at PCC. I believe the biggest risk is that they start to lose that culture. As they get larger, the culture is very hard to manage because it’s decentralized leadership and decentralized decision making.

There’s a lot of work that the people at the middle layer - executive vice presidents and regional divisional controllers and those sorts of people - there’s a lot of work they have to do, to understand what’s happening for the portfolio companies that they are responsible for managing. They spend a lot of time in meetings and visiting plants and getting into a lot of detail. As that business grows, the natural inclination is to remove that workload off senior management by centralizing decision making. You know what, I’m going to make all these decisions so I don’t need to talk to all you people anymore and go polling and combing through all this detail. I believe the biggest risk is going to a centralized culture.

As TransDigm gets bigger, it becomes harder to drive incremental EBITDA via acquisition. And, as TransDigm buys bigger businesses, you are potentially encroaching more into the OEM’s profit pool. How do you look at the tension between the OEMs and TransDigm as it scales?

Honestly, from some of the interactions I’ve had with the senior people at Boeing, senior people at Airbus, they actually view TransDigm better than they view Honeywell and United Technologies. TransDigm is customer focused and makes sure that the operating units really do perform at a world class level. That doesn’t happen at some of the Honeywell sites; that doesn’t happen at a lot of the UTC sites. 

Airbus went through that A320neo nacelle insourcing program because they were so upset with United Technologies at the time, which controlled the nacelle, the thrust reverser with Wolverhampton, and the geared turbofan engine from Pratt & Whitney. They had a fully integrated single supply chain they had to deal with for the A320neo but their customers and Airbus were livid about the servicing levels. So the customers forced Airbus to insource. That gave Triumph Group and TransDigm the opportunity to supply product in the schema that were participating in the ecosystem with Airbus and Bombardier Belfast and all those people, exclusive to UTAS.

It’s interesting because some of the airframers are actually starting to have a different perspective about TransDigm as they start to manage larger organizations. A lot of people thought the model works fine, but there are all these little small companies and they are, more or less, a PE firm, with a bunch of platforms. But now they’ve grown out of that and they’ve still been successful. People thought the model was over before the Esterline purchase. After Esterline was purchased you hear things in the industry about people being happy with Esterline, under TransDigm, and weren’t happy with Esterline standalone.

Let’s take the price out of the equation. Let’s take the revenue growth that you get from price; what does the part unit growth look like, for these companies over the long run? 

Let me give you the overall model of that. For the companies they purchase and own, TransDigm’s value statement is that their three value drivers are price, productivity and profitable new business. 

That’s the third leg that’s being worked on, that you just mentioned, looking at unit growth and those sorts of things. They’re looking for profitable new business so they’re getting on A350, they’re getting on 787, they’re getting on the A220, which used to be C-series. They’re on those forward platforms like future vertical lift. A number of those forward platforms, they’re investing heavily in engineering. They buy these companies, get rid of middle management, and get rid of fat that is unnecessary. But they do hire more engineers and people that are responsible for driving a refresh of the platform.

If you look at the lifecycle, they’re on in-production aircraft. They’re on aircraft that are in operations but in declining production. They’re on aircraft that are out of production and still being operated. They’re on aircraft that are very old and still operating. They participate in the full value stream, the full lifecycle of the aerospace industry and, again, the decentralized management philosophy allows them to by product line, by revenue stream, by value stream, understand what needs to be done in order to guarantee the future production of that revenue stream. Every now and then there’s something that happens where technology changes in such a way that it just basically destroys a revenue stream, similar to how the computer did to the typewriter.

Let’s just use AdelWiggins as an example. AdelWiggins makes these hose clamps and fuel isolators for metallic-winged aircraft. AdelWiggins invested heavily, went through an engineering process and made fuel isolators for composite aircraft. They kept their fuel-isolator line, which should have been a declining product line. You can look at particular businesses, such as AeroControlex. It’s basically a buggy whip type of business; that’s what you would think. But they’re in the new electrical passenger doors, passenger slides, access panels, lavatory systems; they’re participating in all that stuff, whether it’s mechanical or has gone to electric. They invested in engineering to be able to do that otherwise those product lines should have died years ago.

One of the things that I believe is that a lot of analysts look at the business. They are very anecdotal, but they don’t spend enough time to actually question their theory. The theory that the model is going to run out because it’s not based on a refreshing or continued ability to supply into the aerospace marketplace, that’s just wholly untrue. It’s borne itself out with a number of the businesses.

Talk to me about your time at Triumph when you were competing with TransDigm.

It was quite interesting because, honestly, there’s only a few intersections where Triumph and TransDigm – and in aerospace in general – compete. Usually, everyone is in an individual swim lane. The example I gave, with AeroControlex and the cable business, whether it’s a push/pull ball-bearing cable or the wire rope cables, Triumph group has an identical business called Triumph Mechanical Solutions. Whether that’s in engine controls, portable water systems, lavatory systems, they have an identical product line. But the two businesses really compete on very specific systems. We’ll see each other every now and then but TransDigm is hard to beat, I’ll be honest.

We had a latch on a product line that competed against Hartwell, a TransDigm subsidiary. They were very similar products but the customers had a higher regard for the engineering team at Hartwell than the engineering team at Triumph Group. We had a hard time selling because we had to sit down and do engineering workshops with the customers.

With the OEM?

Yes, with the OEM, to get them comfortable that we know what we’re doing. Whereas with Hartwell, everyone was on a first-name basis. They only bought from Hartwell. Every now and then, we’d be able to displace them. Triumph leadership was quite surprised that TransDigm spent the kind of resources on engineering that they did to win lines. For example, they would embed a team for four months on a new program. We’d have our engineers flex between two and three programs. TransDigm would think this is a critical program for us; that engineer is totally dedicated to that customer, to that program, until we win it. TransDigm had the money to do that.

And TransDigm has the scale and capital to allocate resources to new product lines. 

Right. That decision was being made by the people at Hartwell. Nick Howley or Kevin Stein, they didn’t hear about that at all. The executive vice president may have heard about it, in a footnote on a monthly report. At Triumph Group, with this more centralized leadership, the VP of business development is talking to me about what we need to do. I was like, TransDigm are already there. If you keep talking to me, we won’t have an opportunity.

It’s interesting how it all goes back to this culture at TransDigm and being close to the customer and being decentralized. It organizes the institution in a way that makes it very hard to compete with, if you’re not organized that way.

It is very hard to compete with because the people you are competing with have a command to detail that you can’t have. When I was at Triumph Group, I was Vice President of Business Development for the entire billion-dollar integrated system portfolio. I’m parachuting in on the A320neo engine program and I’ve got to read all these documents on another program. The people that I’m up against, that are at the customer, work for Hartwell, a subsidiary of TransDigm, not at the group level. They work for Hartwell. That is the only thing that they have to read; that is the only thing that they have to know. Details inside of the procurement specification from Bombardier, they’ve talked about this in exhaustive detail, whereas myself and my team are working on many different programs. 

When we speak about it like this, it makes no sense that you’d organize in a centralized manner. Why have a centralized org structure in aerospace if these are the challenges? 

Right, but that’s the standard in business worldwide. Most businesses operate like a military operation, with a command-and-control mindset. They see the CEO as the one pulling the levers and turning the knobs. The biggest thing Nick Howley did when I was at TransDigm—whether I was a product line manager or president of an operating group—was ask probing questions. He never pretended to know the details of what you were doing or the specifics of the market you were discussing. Instead, he’d ask probing questions: Why are you approaching it this way? Is there another way to achieve this without doing something else? His questions always focused on the information being discussed, never straying into unrelated areas. He didn’t try to be the smartest person in the room. He would come in and work collaboratively with the team. Everyone felt comfortable sharing everything, even the 'dirty laundry,' as it was called at TransDigm. The biggest leadership sin there was omission—failing to share important information, either out of fear or because it wasn’t politically convenient. 

They created a culture of open conversations that I haven’t encountered in other businesses. They discuss difficult topics and tough decisions in a way that’s rare elsewhere, which makes them something of an enigma to other companies. Back in the early days of TransDigm, around 2005, people used to speculate that a company like Honeywell or UTC might acquire them. We would joke that they’d run from any acquisition attempt because they didn’t understand the business and didn’t want to look foolish. The big companies always shied away because they couldn’t fathom working this way.