TransDigm

"Productivity TransDigm’s productivity directive is focused on keeping annual growth in aggregate cost below inflation, year in and year out. This doesn’t sound as revolutionary or as flashy as Lean or Six Sigma, but the general goal is easy to understand and communicate down to individual product lines."

"THE THREE VALUE DRIVERS TransDigm is remarkably consistent in the application of what it calls its three value drivers: (1) value-based pricing, (2) productivity, and (3) profitable new business."

"Value-Based Pricing For some that have looked at TransDigm over the years, the concept of value-based pricing is perceived as equivalent to leveraging monopoly positions to aggressively raise prices to unfair or excessive levels. However, it’s worth noting that the company’s overarching pricing strategy isn’t particularly unique vis-à-vis other peers in the aerospace supply chain. In fact, when the Department of Defense audited TransDigm’s pricing in 2018, it revealed that several industry peers were also raising prices on comparable products. Everyone raises prices; TransDigm just has a purer portfolio and is more focused on extracting appropriate value commensurate with the types of parts that it produces. For every part, TransDigm is maniacally focused on earning an appropriate economic return. That means that as older planes are retired and production runs of spare parts become less frequent and more challenging to predict, TransDigm demands that it be compensated, not just for the direct cost of the part, but for the costs of keeping production lines “hot” with skilled labor and working machinery. The company takes reliability seriously, and it expects to be paid for delivering a high-quality, usable part quickly. This mentality of driving an appropriate level of value out of every order is ingrained in the product line managers across the company. But how long can annual price increases approaching 5 percent really last?"

"The company does not entertain business development efforts unless they offer a clear path to profits. There are no exceptions. Even with these strict principles, the company has been broadly successful in its new-business generation efforts. It has gained share on most next-generation aircraft and has done so with a tightly managed R&D and capital expenditures budget. Wasted effort is kept to a minimum. TransDigm understands the difference between good parts and great parts, and it deliberately built a portfolio of companies that could compound the maximum amount of value over time. There are other aviation businesses that fit the TransDigm profile, but in many cases, they’re not employing the same principles to the same effect. Often there are fantastic product lines within larger companies, but the manager that runs them is on autopilot because his or her business is an upper-quartile performer in a sea of mediocrity. TransDigm doesn’t allow that to happen. All of its business units drive price, increase productivity, and win new business. The culture, the principles, and the compensation structure simply don’t tolerate good if it comes at the expense of great. NOT AS EASY AS IT LOOKS A few years after TransDigm went public, the market gained familiarity with the TransDigm story, and the investment banking world was buzzing about a copycat firm running the TransDigm playbook in the private markets. The company was called McKechnie Aerospace and was nicknamed TransDigm 2.0 by investors."

"TransDigm’s 2018 acquisition of Extant, a company that acquires intellectual property rights to “dying” lines of old aircraft parts that companies decide they no longer want. Picture this: A business line manager at a large company looks at the list of products in her business unit and says, “I could grow this operation’s revenues faster if I could get rid of the stuff that’s shrinking.” She finds products that go on older aircraft no longer in production, where inventory turns slowly and innovation is scant. If she gets rid of these parts, her business’s overall growth rate goes up over time, and her inventory goes down. Depending on how she’s being paid, which most often is by sales growth, she’s a hero. There’s only one problem with this picture: these products often have the highest potential profit in the portfolio. They have the best pricing power, and they require little or no ongoing investment. The fact that managers were allowed to sell such product lines to Extant is crazier than anything TransDigm has ever done."

"TransDigm aspires to generate annual growth at a level that it characterizes as “private-equity-like.” This equates to 15 to 20 percent over a number of years. The belief is that if the business can consistently generate that type of growth, sizable stock returns will follow. And at TransDigm, stock awards comprise a large share of overall employee compensation. The company is convinced that in order for the business model to work, those in charge of executing the strategy need to be compensated as owners. If managers effectively execute to the plan, they are compensated with stock that has the potential to appreciate well beyond the initial value of the bonus. I know TransDigm “retirees” who still have younger children and not a single strand of gray hair. They came in early, worked hard, were appropriately rewarded by the company, and then left with their riches."

"Lessons from TransDigm •   Even good businesses can always be better. •   Know your unique advantages and always focus on maximizing them. •   Simple goals create focused outcomes. Complex goals breed confusion. •   Cash and capital structure are often overlooked tools for enhancing value creation. •   M&A strategy should almost never stray from core competencies. •   Employees should think and be compensated like long-term owners. •   Bottom-up management can be far more effective than top-down management."

"In the event that an appropriate M&A deal is not available, TransDigm doesn’t reach; it simply pays out its excess cash as a special dividend and waits for the right deal. These"

"With capital allocation and capital structure, TransDigm realized that a business built with a high degree of recurring revenue from spare parts, pricing power, low volatility in input costs, and limited capital requirements could shoulder a higher debt load than an average business. The extra capital raised could be deployed toward the acquisition of other parts manufacturers that fit TransDigm’s model."

"And at TransDigm, stock awards comprise a large share of overall employee compensation."