TransDigm Case Study
In January 2017, TransDigm, a US leading original equipment manufacturer of aerospace components, became the focus of a critical report that accused the corporation of “potential waste, fraud, and abuse.” Indeed, for years, the company has been a success, as evidenced by its revenue and non-GAAP EBIDTA compound annual growth rates of 20% and 24%, respectively. Thirteen years after its founding, in 1993, the company went public, and by 2017, its stock price had increased tenfold. Yet, the report read that impressive numbers and figures were concealing the reality of losing organic growth. Allegedly, TransDigm was hiking the process to make up for the losses but found itself in trouble when President Trump expressed the intention to reduce expenses on defense aviation procurement. This paper critically appraises TransDigm’s value creation model and gives recommendations for overcoming current challenges.
Value Creation
From the very beginning, TransDigm’s business model has been built upon the so-called “value-focused strategy” principles. They had a unifying goal of offering the corporation’s shareholders “private equity-like returns with the liquidity of a public market.” Products have always been central to Transdigms’s value-creating strategy. Ninety percent of all sales are proprietary designs, which means that the company owns and protects its blueprints. As of 2016, TransDigm had a diversified market presence split almost evenly between the commercial aviation aftermarket (37%), defense aviation (30%), and commercial original equipment manufacturing (OEM) aftermarket (29%).
Product pricing is built upon the value-based strategy, or, in other words, the consumer’s perceived value of the product. As one of the three main value drivers, product development is not solely achieved through new designs. In fact, TransDigm is quite aggressively buying new businesses whose total count now amounts to around 1,200. However, not all projects and business operations are equal because the corporation is always looking for ways to drive down the expenses. At the same time, by acquiring multiple businesses in the same industry sector, TransDigm is becoming a monopoly in charge of setting prices and ramping its revenues.
Acquisition Plan Sustainability
One of TransDigm’s most significant business decisions was its acquisition of Arkwin in 2013 for $268 million. The question arises as to whether this acquisition is sustainable, given that it was done through debt. Debt financing is pretty common in the business world and not inherently negative or positive. In TransDigm’s case, Arkwin’s acquisition meant taking a step toward even greater leverage in the aviation sector due to the company’s size. Moreover, Arkwin’s sales and EBIT figures showed overall profitability, which, in the future, promised sustained cash flows and, hence, debt repayment. Another argument in support of the acquisition is the acquired corporation’s flawless reputation and lack of publicity regarding the new ownership. This implies that while TransDigm’s image is imperfect due to price hiking and monopoly accusations, Arkwin is unlikely to find itself under attack for affiliation. Lastly, a big attraction of debt financing is the reduced principal and interest payments on a business loan. Business expenses resulting from Arkwin’s acquisition may be classified as business expenses, which means that their deduction from TransDigm’s income at tax time.
Current Challenges
As of now, TransDigm is facing challenges that may compromise the vitality of the corporation in the future. Firstly, TransDigm has long been accused of monopolizing the sector and then making single-handed decisions regarding price increases. The positive differences in prices averaged 5-11.2%, with a maximum of 76% for certain equipment. As reports have shown, price surges have been linked primarily to TransDigm’s acquisition of businesses. Before the acquisition, the annual increases were 5.8%, but after the acquisition, they spiked to 11.2%. Previously, the corporation kept a low profile by obscuring its ownership of subsidiaries. Therefore, price increases by certain companies were not linked to their owner and went under the radar. The problem is, though, that today price manipulations are becoming more obvious, which does not add to customers’ willingness to continue buying TransDigm’s products and services. The situation escalated to explicit demands for more audits to identify overpayment due to TransDigm’s dubious business practices. It could be that the corporation’s reputation will eventually be ruined, and the familiar model for creating shareholder value will no longer be of use.
Conclusion and Recommendations
Overcoming the current challenges will require fostering accountability across the parent company and subsidiaries working closely with the Department of Defense (DoD), which has been the main source of criticism and accusations. Firstly, TransDigm should not resist benign audits, and if any anomalies in pricing and payments are detected, the corporation should not delay action. Secondly, the 2006 Code of Conduct and Business Ethics might have to be reviewed to adjust to the present situation. Even though TransDigm states commitment to “honesty, integrity, and ethical behavior,” it does not always translate into business practices. As a radical but potentially necessary measure, TransDihm might have to start submitting uncertified cost or pricing data to the (DoD) to support prices on contract bids (The National Defense Industrial Association, 2019).
Reference
The National Defense Industrial Association. (2019). Defense pricing and costing issues new memo on TransDigm. Web.