Aerospace and defense companies thrive by engineering aircraft that can cruise through turbulence and by building battlefield-hardened weapons systems. But now their biggest challenge may be how well they can weather the currency-market wind shears that have pushed the U.S. dollar into a nosedive—and position themselves for its next eventual ascent.

Dealing with currency fluctuations in the industry used to be fairly straightforward. A weak dollar was good for U.S. exports and bad for imports; the opposite was true for contractors in Europe and Asia. Companies struggled through by making price adjustments, currency hedging and enlisting some government support.

The situation is vastly different today. The dollar is at or near its all-time low against other currencies. Because the industry is now much more global, the business implications are more complex. In commercial aviation, most companies' international activities go far beyond simply selling finished products and aftermarket services abroad. On some new programs, entire product development and supply chain operations are based overseas. On the defense side, international teaming arrangements are becoming more common. Offset agreements, long a prerequisite of overseas sales, are becoming much broader in scope, with specific requirements for technology transfer and production of high-value components.

As a consequence, currency markets have become the aerospace and defense industry's newest battlefield. They will test a generation of industry executives that has had little experience planning and managing in this type of environment. It may be tempting for managers of companies battling today's strong dollar headwinds to fall back on short-term expedients. But simple price reductions and overhead cost-cutting will leave a company stalled should the dollar continue to weaken. Firms benefiting from the weak dollar should know that the tables will eventually turn, and that now is the time to prepare. Executives who manage the currency challenge effectively stand to emerge as much stronger competitors when the dollar gains strength again.

Beyond the opening to make operational improvements in the business, there is another powerful opportunity at play. Currency exchange dynamics can be actively managed as a strategic issue and be used as an important tool for addressing global growth objectives. Most aerospace and defense companies now expect to get a significant portion of their growth from outside their home country. By thinking globally, and by making decisions that reach beyond individual sales campaigns, companies can use offset requirements as opportunities to build flexibility across their supply chain. Those that act boldly and quickly to capitalize on these broader trends will become stronger competitors.

The impact of the declining dollar has hit European firms especially hard. Airbus calculates that a 10% rise in the value of the euro translates to a 1-billion euro ($1.46-billion) hit to operating profit. Rolls-Royce has estimated that a 7% dollar decline shaves roughly £40 million ($78.4 million) off its bottom line.

For those A&D companies struggling to take the right steps in this weak dollar world, history provides some lessons. We can look at the patterns of activity followed by U.S. industrial companies that once suffered from a strong domestic currency and see similar actions being repeated by some of their European and Canadian counterparts today. By the same token, many U.S. companies are enjoying the benefits of an enhanced competitive position, without taking advantage of the opportunity to make long-term structural changes to prepare for when the currency situation turns around.

In the mid-1980s, the situation was reversed. The dollar's climb to an all-time high against other currencies put leading U.S.-based industrial and technology companies like Caterpillar and Xerox at a disadvantage to foreign competitors. Hit by the combination of the strengthening dollar and a sharp economic downturn, Caterpillar's sales outside the U.S. plunged from $5.2 billion in 1981 to $3 billion in 1984. Xerox's market share fell from a position of significant strength to virtual parity with a handful of Japanese competitors.

To counter the adverse currency effects, these companies swiftly acted to cut prices sharply, and reduced capacity and operating expenses by shuttering plants across the U.S. Even more important were actions they took to transform their supply chains and their strategic alliances. Caterpillar moved production overseas, using plants in Europe and partners in Japan and South Korea to supply Africa and the Middle East, and forged teaming arrangements and joint ventures with companies in Asia. Xerox reduced its supply base by an order of magnitude, from roughly 5,000 suppliers to less than 500.

These companies and others also took steps to redesign their core strategies and business models. Xerox restructured its business units and changed its product focus to become a supplier of "office systems" rather than stand-alone copiers and supplies. Caterpillar renegotiated its labor agreements to add more flexible contract terms with employee unions.

On the other side of the dollar's steep climb in the 1980s, Japanese carmakers made deep changes that are paying off handsomely today. They invested heavily to build development capabilities, manufacturing facilities and a network of suppliers across the U.S. The investments helped counter political pressures on them to increase domestic content—the auto industry equivalent of offset requirements. They are now in a position to take full advantage of currency fluctuations in almost any market they serve, by importing cars to the U.S. or exporting them abroad as conditions warrant.

The exchange-rate gap that the aerospace and defense industry faces today looks likely to be even longer-lasting than the situation in the 1980s. Many companies based in non-dollar countries are taking short-term actions to limit the damage, notably cost-reduction efforts to squeeze budgets and maintain returns on invested capital. Other firms are taking a broader and more sophisticated approach, and using the situation as an opportunity to prepare for an even more global future.

Taking far-reaching steps to reduce costs and rationalize its assets, Airbus launched its Power8 program, which the company estimates will result in savings of at least 2 billion euro annually by 2010. Thales, the French avionics manufacturer and defense systems developer, has implemented a sophisticated currency-hedging mechanism, financing foreign currency-denominated assets with loans in the same currency as the assets themselves. Such techniques have helped partially buffer Thales's income statement from the sliding dollar's effects.

Companies are finding other ways to stabilize volatile currency swings by diversifying their supply chains and making them more flexible. Defense systems supplier Goodrich Corp., for example, has reoriented its global supply chain strategy to focus on low-cost production sources for all markets. Some of Goodrich's complex subassemblies are built in China now, and more of its manufacturing footprint is shifting to other countries in Asia and to Mexico.

Finally, some industry leaders are using the currency challenge to make broader changes to their business models. CAE Inc., the Montreal-based developer of flight simulators and training systems, has used the spur of a strong Canadian dollar to adopt a comprehensive restructuring plan and is taking steps to speed up its processes, improve efficiency and continue to expand its global reach.

The competitive lesson for all A&D executives is that leading companies in the industry have begun to incorporate currency exchange considerations into their overall strategies, plans and decision-making processes. They are considering currency exchange dynamics not only in their sales and service operations, but in their strategies for program management, value chain participation, sourcing, operations footprint, risk management and financing.

Meanwhile, a significant number of contractors currently enjoy the financial benefits spurred by the weak dollar, with record earnings and high returns to shareholders over the past several years. Unfortunately, they run the risk of enjoying the windfall without preparing for a future A&D market where a new set of stronger and more global competitors exists. It is precisely in these flush times when U.S. companies should take stock of their competitive position and separate what is sustainable from what is "artificial," or currency-enabled. Starting with a few simple questions can help:

• What is our company's global economic "footprint" and its effective "balance of trade" across borders? How will this balance affect the company as currency values shift?
• How sensitive are our future growth and earnings projections to currency exchange fluctuations?
• How can we address our strategic goals—for growth, diversification, mergers and acquisitions and supply chain flexibility—given exchange-rate swings?
• To what extent are we asking our business units to account for currency exchange dynamics in their decision-making and planning processes?

Coming up with specific answers to these questions need not be a distraction to the normal rhythm of running the business. In fact, currency effects serve as an occasion to revisit international business-development and supply-chain decisions in need of review. But not knowing the answers may be an early indicator that a company is living on borrowed time. The winners emerging from today's weak-dollar environment will be more global, better able to diversify risk, faster at making decisions and have dramatically more efficient processes and cost structures.

If the dollar remains weak for some time to come, they may also end up owning many more of those "less expensive" U.S. businesses.

Michael Goldberg is a partner with Bain & Company in Los Angeles and leader of the firm's global aerospace and defense practice. Harlan Irvine is a Bain partner in Chicago.