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As SAP’s representative to the AIA’s (Aerospace Industries Assocation) Supplier Management Council, I had the priviledge of attending their winter meeting recently, hosted by Boeing in St. Louis. There were 450 attendees across as many companies. The Supplier Management Council is a unique forum where prime-contractor company representatives and suppliers (of all sizes) come together to discuss supply-chain issues and to develop solutions. It was no surprise that the main theme of this year’s event was the impending U.S. budget sequestration and the potential impact to the industry if not averted by further legislative agreements. The AIA acts as the industry’s lobbying arm to the U.S. government and there were plenty of requests for all industry companies to take a very active role in soliciting their representatives for a resolution. The budget agreement last September called for a $487B reduction in U.S. defense spending over the next 10 years, and the sequestration effect would another $600B of cuts, which the AIA (and the DOD) is on the record characterizing as “catastrophic” for the U.S. A&D industry.

All of this budgetary uncertainty is likely to impact the decisions of A&D companies around technology investment and business model transformation. In some cases, the impact will be to delay, and in others we will see acceleration in order to use the technology to meet the challenges. SAP is focused on understanding the market condition these companies are in so that we can deliver on the value drivers they will be focused on. The AIA SMC meeting was useful in developing a better understanding of what some of these value drivers are.

Managing risk in the A&D supply chain was the top headline as a value driver throughout the meeting. Jack House, VP Supplier Management for Boeing Defense, Space and Security manages $15B of annual procurement. He called out the top inflection points for the industry as 1) Globalization, 2) Headwinds and tailwinds in the market (Defense reductions vs Commercial growth), and 3) Supply chain risk management. Globalization is being driven by the need to tap new markets, to develop new capacity, and to access new technology and innovation. It presents the challenges of adding much more complexity to the supply chain and introducing more shocks or disruptions to the supply chain. The Headwinds of defense budget reductions are combining with an increasing regulatory burden to make the defense business much more challenging. We will see much more M&A activity (as well as divestitures) as smaller companies are either gobbled up or flee the defense market, which will make future sourcing that much more difficult. Boeing’s response is to “double down” on flawless program performance, focus on affordability (taking all un-necessary costs out of the business), eliminate sources of variability, and better manage subtier risk. Even the growth in the commercial sector ($4T or 33,000 new aircraft needed in next 20 years) presents a problem to Boeing as it will suck capacity from their defense supply base. Boeing’s Karl Jeppesen, VP Procurement Contracting and Risk Management, called out supply chain risk management as his major focus. Key supplier risks of concern include 1) financial risks due to local economic conditions at a supplier (like access to credit), 2) continuity risk (natural disasters, etc), and 3) strategic risk (like M&A, capital investment, uncertainty). Even the DCMA is starting to question the OEM’s knowledge of these risks and how they will percolate up to impact program performance and defense readiness.

A Supply Chain Leadership panel, comprising members from Lockheed (Dan Pleshko – VP Global Supply Chain Operations), Boeing (Karl Jeppeson), Alcoa and a couple of smaller suppliers, addressed the response to defense reductions and commercial growth. Lockheed Martin declared that the focus is now on preserving the bottom line, not top line growth. All the money in the past was spent on business development and new program engineering. Not anymore. Boeing  spoke about their focus on process innovation, as opposed to product innovation, and a major focus on supply chain risk management. Counterfeit parts in the A&D supply chain is a major focus of the group, and it has committees dedicated to addressing the issue and potential solutions. Boeing’s Jack House called 2012 the year of counterfeit parts and described it as one of the most compelling issues of the day. Counterfeit parts are generally faked or remanufactured electronic or fastener commodity products produced in China, then sold on the gray market and then bought by lower tier suppliers from unauthorized distributers. These components find their way into mission critical weapon systems and commercial aircraft and present significant quality issues. Distributers are seeing counterfeits every day and (the good ones) are resorting to extensive testing programs for the parts they sell (time+cost). Raytheon’s Greg Bradfield (Corp Director for Mission Assurance & Supplier Quality) said they used a risk based approach to address counterfeit parts, calling attention to the need to better manage brokers, distributers and other sources of supply. “Conflict minerals” is another focus, as the regulations to enforce reporting are very onerous. The regulation prohibits use of certain key minerals mined from countries (like Congo) associated with conflict and human rights abuses. Reporting by suppliers and OEMs is required by 1Q2013.

Booz & Company presented a detailed financial analysis of industry futures. Their conclusion is that procurement investment will be hit very hard under sequestration with a potential reduction of 45-55% between 2012 and 2017. But on the commercial side, they forecasted 37,000 new aircraft deliveries through 2030. For managing the supply base, they observed that efficiency at reduced volumes is the most critical for defense, and controlling cost growth while scaling is most critical for commercial. Their analysis also showed that suppliers are capturing more value and profit than the OEMs, which generated quite a groan from the audience. In their research of value streams, they discovered that OEMs and Tier 1s have lost awareness of supplier “should-costs”. In other words, they are way over-paying for purchased material based on the actual costs incurred by suppliers in production. While 30% of Prime’s cost is indirect, they found that actually 55% of the total value chain costs are indirect, and pointed out several cost reduction levers to focus on, saying Primes were managing overhead well but were letting suppliers “off the hook”. Again, more groans from the suppliers in the audience.

PriceWaterhouseCoopers had several principals from newly acquired PRTM present a very interesting analysis on supplier issues. At the OEMs we will continue to see transferring of risk down the supply chain, continued uncertainty in demand (including more in-sourcing pressure on services by DOD), increasing compliance requirements (inlcuding the counterfeit issue plus IP protection) and reduced supply chain visibility. From the Tier 2 & 3 suppliers perspective, they will see more risk transfer from their customers, intensified pressure on cost/lead time/performance, limited visbility to major shifts in demand (poor info flow from OEMs systems) and incresed volatility of demand. Commercial drivers will include concerns about rate readiness (must get SC right), productivity and innovation (composites and MRO), competition (from global plus M&A) and R&D (shared risk).

Outside of the meeting, I had an opportunity to tour the F-18 factory. It was definitely all about final assembly with nary a machining tool in sight. My tour guide was kind enough to confirm that yes indeed they use SAP’s MES system (CAMS) for controlling production and I saw various familiar screens on terminals while walking around. I asked him if the software was a help or hindrance in implementing their lean initiatives (which have been significant lately), and he said it was a major help. He was proud that when MHI from Japan came to tour the factory, they said they wanted to adopt Boeing’s systems and processes for their own production, which is a high compliment from a Japanese manufacturer.

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  1. Mike Golden

    Berry,

    Great post!  I think a key take away from this is that US based defense contractors need to shift some focus over to key emerging markets that aligned with Washington.  these being India and the Americas.  This way they can continue to grow their export products as those emerging markets need to replace outdated equipment in the near term. 

    Are there any articles on this potential growth area for US defense contractors?

    Mike

    (0) 

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