Integrated Value Chains In Aerospace and Defense

Managing relationships and complexity up and down the value chain

he aerospace and defense industry is enjoying its strongest market ever, according to the 2007 AviATion Week A&D Programs Conference. Demand by the worlds airlines continues to increase, government defense spending is at its highest in decades, production is at record levels, the roll-out of new commercial and defense aircraft continues unabated and more innovative technology is required at a faster-than-ever pace. Given these dynamics, the industry is compelled to move toward more integrated value chainsbuilding collaborative partnerships between manufacturers and suppliers to capture significant opportunities in competitive advantage. The challenge, however, continues to be managing relationships and complexity in execution.
The phrase strongest market ever could suggest that todays aerospace and defense industry (the A&D ecosystem) is demonstrating the bottomline value of collaboration, rapid innovation and speed to marketall essential earmarks of value chain integration.1 Collaboration and tighter integration among manufacturers and suppliers, with a systems integrator at the lead, is said to create a more networked, cooperative and productive structure and drive success in the market. As these organizations become increasingly networked, both virtually and globally, mutual success will hinge upon their ability to gain a competitive advantage from their respective value chains. Yet being networked into even a simple supply chain does not mean being integrated into a value chain. There is a fundamental difference
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between a networked supply chain and an integrated value chain. In an integrated value chain, the coordination of external interfaces is just as important as the coordination of internal interfaces, and technology innovation is a shared responsibility among all partner companies. A.T. Kearneys recent survey of the A&D industry suggests that value chain integration is neither universally accepted nor widely practiced. partnerships in the A&D value chain are often viewed on a continuum from transactional supplier or customer to fully integrated strategic partner (see figure1 on page 2). prime integrators, those farthest along in value chain integration, have partners in most steps of the value chain. Tier-one contractors have partners in several steps of the value chain. Tier-two and -three contractors, those that do not have plans

Value chains are defined as all the interactions that create and add value in the process from innovation, new product development and raw material supply to finished product and lifecycle support.

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to partner in most steps of the value chain, tend to serve their immediate downstream tier only. The same research shows an anomaly. some firms see their business as predominantly an independent participant in a networked process. Increasingly, as companies move upstream into higher tiers, their perception steadily narrows to focus on fulfilling orders from the next lower tier rather than understanding their role up and down the value chain. such an anomaly is a potent threat to an industry value chains ability to meet its cost, performance and schedule objectives. The success of any one organization within the industry depends

critically on the performance and capabilities of others many others, in most cases. As always, the weakest link can destroy the chain.

Market-Centric innovation
Companies are asking their customers what they want and need. The task is to develop and deliver the product to market and wow the customer and definitely before the product has become obsolete. But the customer-driven quest for innovation extends far beyond what was once a deciding differentiator, an individual businesss core competency or technology. The profound com-

Figure 1 Assessing value chain partnerships in aerospace and defense*

Transactional supplier or customer

Fully integrated strategic partner

20

40

60

80

100

40 Tier three Tier two

60 Tier one

80 Prime integrator

Transactional supplier or customer

Pursues mainly buy-sell relationships, with little or no collaboration Focuses on costs and quality Does not have formal contracts with partners Maintains hierarchical relationships along the value chain

Fully integrated strategic partner

Collaborates with partners and seeks strategic alignment Aligns organization to a value chain approach Values flexibility and offers incentives to promote it Develops relationships along the value chain

*Companies were evaluated on a scale of 0 to 100 to calculate the degree of integration in the value chain. Source: A.T. Kearney

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plexity of todays products and systems means that no single firm has the technological, financial and risk-bearing capability to develop a new airliner or jet fighter, for example, on its own. To try to do so without teaming across the value chain would severely constrain the depth, breadth and speed of innovation. Todays A&D customer, the end user, demands: More innovation Greater flexibility to incorporate emerging technologies over the systems life Faster time to market Managed risk and cost-effective outcomes Longer-term product support and service With this in mind, organizations are moving across the integrated value chain in an effort to meet their customers needs for more innovative products. physical location is becoming increasingly less important as businesses seek strategic partnerships with global firms offering best-ofbreed technology. The primes are definitely among the integration leaders. They have mostly moved away from transactional relationships to assume more of a value chain integrator role. They are among the most sophisticated relationship managers in the group, taking into account a balance of trade among partners. however, many upstream suppliers still look at the value chain as a series of discrete suppliercustomer relationships, viewing each transaction as a separate instance of buy and sell. The transactional business, as our survey identifies it, defines a supply chain simply in terms of buy and sell transactions at the commodity level. realize that although upstream participants may tend toward the commodity end of the value chain, they can be costly bottlenecks. Alcoas inability to supply 3/16-inch titanium fasteners, one of the smallest and least-costly parts on Boeings new 787 Dreamliner, was part of a cascading series of
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production pushbacks. one lesson: In a sophisticated, global, virtual supply chain, the lack of visibility, integration and sophistication far upstream can prove as troublesome as problems with a hightech, advanced downstream participant. As customer requirements percolate through the different tiers of the supply chain, we believe sustained business growth will be earned by moving from a transaction-based supplier or customer to a strategic partnership, especially at the lower tiers of the value chain.

Complexity is the issue

strategically driven partnerships are not without complexity. usually, a large number of participants are involved in an integrated value chain, ranging from strategic partners to transactional commodity suppliers. relationships among the participants are multifaceted: one organization might be buying from another company, selling to it, selling with it, competing against it, and engaged in a joint product or service relationship all at the same time. The word coopetition, or cooperative competition, sums up these complex relationships. As one survey respondent noted, even at our tier of the supply chain, we are committed to being an integrator, but we must also keep our manufacturing know-how. Just understanding the wide spectrum of sometimes contradictory relationships at an enterprise level can become an issue. Managing the many attendant interdependencies and risks becomes more difficult, too. risks are exacerbated as companies try to implement lean supply chain concepts such as reducing inventories and tightly synchronizing order-to-delivery times. Visibility among the participants and across the value chain becomes increasingly challenging as system interfaces grow more complex. While prime integrators can impose their systems to some degree, they cant realistically do so for all supply chain participants.
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on the military side, complexity is compounded due to the International Traffic in Arms regulations (ITAr) and other regulations that impose constraints on supplier eligibility and information that can be exchanged across supply chain participants. These restrictions also tend to limit the open and collaborative product development style that has become vogue in other industries.

is the integrated value Chain Universal?

The days of the vertically integrated behemoths are over. But have companies within the A&D ecosystem successfully achieved an optimal, integrated value chain characterized by fully functioning partnerships? The answer is yes and no. We say yes because some companies are focused on the ultimate customer and use the value chain as the lens through which they see the complete process and their unique role in it. operating on this inclusive perspective, they can anticipate changeby seeing it before it gets to

them and adopt new, fresh and flexible strategies. such organizations embrace their role and position in the value chain and use it to their advantage as a competitive differentiator. We say no because some companies too many, we suggest continue to work the old transactional system while maintaining an almost myopic focus. unable to see any farther than their loading docks, they just dont appreciate the potentially disastrous bullwhip effect up and down the value chain of, for example, a late arrival from their suppliers or a late delivery to their customers (see figure 2). such organizations are not committed to the value chain concept, by decision or default. over the long term, their performance or lack thereof will drive them from the chain. An important common dimension exists within both answers. A shortage of commodity parts at one end of the value chain or a complex technical problem at the other extreme can have the same potentially stultifying effect on produc-

Figure 2 The supplier bullwhip effect

Supply fluctuations are magnified as they progress down the supply chain. A little snap of the curve at the supplier end ripples down toward the customer in successively higher peaks and wider troughs.

Tier-three supplier (raw materials or piece part manufacturer)

Tier-two supplier (component manufacturer)

Tier-one supplier (sub-system integrator)

Prime integrator

Customer

Source: A.T. Kearney

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tion and delivery to the customer. Best-practice companies develop solutions commensurate with the nature and level of the value chain participant relationship. for example, they may adopt intermediary strategies to deal with possible commodity-level issues at one end while adopting strong partnership management approaches for the most complex, expensive and time-consuming issues at the other end (see sidebar: Best Practices in Integrated Value Chains on page 7). for example, Boeing is managing such a spectrum-spanning situation now, with its fastener shortage at the commodity level and its wing-box design at the most sophisticated level of the Dreamliner integrated value chain. participants committed to todays truly integrated value chain are alert to a number of interrelated factors. Its one thing to espouse value chain integration; its another to be an effective systems integrator attuned to needs such as: Bringing new technologies rapidly to bear in complex systems Managing and controlling costs, schedule and performance Focusing on core competencies Moving beyond the traditional position in a system lifecycle Incorporating (or at least considering) foreign sub-assemblies and components to assure access to foreign markets

Putting More value in Your value Chain

An organization that perceives its role as purely transactional is in an awkward position when business as usual can no longer be the path forward. In the complex A&D ecosystem, business growth requires aligning the organization to a value chain concept and building relationships up and down the value chain. With this in mind, the following are proven approaches that A&D companies can take to add value to the value chain.
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integrate product design and development with supply chain functions. realize the fundamental difference between immature and mature technologies. The more mature the technology, the less complexity and the fewer changes in specifications with a concomitant risk of obsolescence. A program committed to fruition on the basis of immature technology (it worked in the lab, it will work on the production line) will be subject to continual change. usually, the customer will continue to augment, add, modify and otherwise keep the design target moving, which requires the virtual supply chain to be continually flexible. And more often than not, the longer the development cycle, the more likely the technology will be obsolete by the time its ready to go to market. We worked with a north American hightech equipment manufacturer having problems with on-time deliveries to its customers, whose needs changed quickly. With our assistance, the firm developed an integrated value chain based on two-tier product design criteria high commonality, lower cost and low commonality, higher cost. We advised the firm to leverage its local, more responsive suppliers of critical components to increase its flexibility and to maintain longer lead-time relationships for suppliers of predictable, more costly components. As a result, ontime delivery increased to 90-plus percent within six months, and order lead times dropped from six to eight weeks to two to three weeks. The overarching message: Improve your value chain design. If either your strategy or the competitive environment has changed and your value chain design hasnt, then its time for a redesign. This process enhances the firms ability to identify and establish its distinctive supply chain role as prime integrator, sub-system integrator, original design manufacturer (ODM) or tier-one, -two or -three contractor at the product or service value chain stages.
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improve supply chain competency. engage engineering-savvy people who understand supplier technology road maps and how the pieces must integrate into a highly functioning supply chain. simplified transaction processing is essential to an integrated value chain. In the purchasing function, for example, paper-based, individualapproval systems can consume valuable management time and can result in costly bottlenecks. one client reduced its purchase order (po) processing time from 30 days to less than one day by converting to electronic catalogs. The catalogs contain frequently ordered supplies from approved suppliers at verified prices, and, in many cases, the automated approval process is linked to budgeting tools. using the catalogs frees the firms buyers to focus on strategic issues instead of managing each transaction. significantly, some firms are reducing their manual efforts by linking their sales catalogs with their buy-side catalogs. When a sales order is placed, an order to the corresponding supplier is triggered automatically if the on-hand supply has reached predetermined levels. electronic catalogs, linked IT capabilities and transaction support provide sustainable benefits: our client reported that 95 percent of its purchases were being done electronically and po processing times dropped to less than a day from almost a month. Customer satisfaction scores almost doubled. increase supply chain visibility. An agreement with a strategic partner can facilitate information sharing, enable technology and increase communications. In contrast, an agreement with a transactional supplier can require little more than efficient transaction execution and helps assure supply reliability. strategic partnerships, therefore, require intense monitoring and managing of all participants. one original equipment manufacturer (OEM) that outsourced significant elements of the value chain to third-party suppliers had initially structured all its agreements in a series of typical sourcing relation6

ships, basing its service level agreements (slAs) on plans to measure the suppliers performance. This one size fits all approach led to sub-optimization of the overall supply chain. By restructuring agreements to make them appropriate to the suppliers role, it improved alignment among the suppliers and enhanced the supply chains performance. on-time delivery increased from 70 percent to more than 95 percent. Within the slA, each business must now also identify the partnerships value chain governance and operational principles, including intellectual property sharing and project management. establish solid governance structures. The best governance structures provide clear responsibilities, accountability and integrated performance metrics, while recognizing they cannot be entirely dictated by the prime. Collectively, these structures must drive system cost, schedule adherence and performance, and create individual and collective accountability for end-product results. They must also recognize that the degree of commitment and ownership may vary widely among participants. for example, the $250 billion, nine-nation development of the Joint strike fighter (Jsf) F-35, involving Lockheed Martin, Northrop Grumman, BAE (SYSTEMS) and scores of other global suppliers, relies on performance metrics that change from qualitative to quantitative over the life of the project. Designed to cover several major drivers of overall system availability mission capable rate, aircraft availability and mission reliability the metrics are tied to a decade-long series of specific milestones along the Jsf development and production lifecycle. The goal is a system that initially provides a series of qualitative evaluations of each suppliers plan to participate in the program. As the plan matures, the system switches to a quantitative evaluation of each suppliers performance. Developing metrics that help each partner measure its successesand identify the lack
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Best Practices in integrated value Chains

In a complex environment, survival often depends on embracing the roles, responsibilities and opportunities of an integrated value chain. A handful of companies in the A&D industry understand how real integration (and all it means and requires) can put more value in the value chain, and therefore are in a position to achieve a sustainable competitive advantage. We recognize best-practice companies as those that do the following: Monitor and manage both immediate and upstream suppliers. Best-practice firms rarely cede management of upstream supply chain participants to their immediate suppliers because they understand the risk. henry fords attempt at vertical integration was intended to minimize risk and maintain control over the production process, from raw materials procurement to product delivery. Boeings highly publicized setbacks with the production of its 787 Dreamliner exemplify the difficulties when upstream participants do not meet cost, performance or schedule objectives. A tendency simply to assume that component manufacturers will find raw materials by taking an its their problem, not mine attitude can intensify value chain risk. Boeings setbacks also emphasize how product complexity can create its own set of problems when bringing new technology to market. Find the optimal balance and supporting governance processes. proper governance can reduce supply chain management complexity while providing risk management and mitigation capabilities. relationships and governance processes that swiftly identify issues and work cooperatively at resolving them are essential. fostering a spirit of give and take is key, because all suppliers, whether upstream or downstream, will need support at some time. Manage internal and external interfaces. There is no substitute for rigorous management of internal interfaces such as customer service, engineering, supply chain and manufacturing, as well as external interfaces. This is in contrast to the firm that must deal with isolated functional silos and internal departments working at cross purposes. Much of the problem we have with business complexity today is around internal cooperation and lack of communication, said a survey respondent. for example, an engineer today has to work more closely with commodity sourcing, contracting and program management. Devise ways to simplify. rather than manufacturing products at low volumes that arent attractive to many commercial offthe-shelf suppliers, best-practice companies build modules (rather than individual parts) that can be used in various designs. While commonality is a way to manage complexity, it is a significant challenge in the often high-complexity, low-volume A&D market. however, opportunities for commonality frequently exist by creating visibility into cross-program parts, components and sub-systems, and incentives for reuse. Do not submit to the pressure to win on technology. Bestpractice companies do not apply technology that is still under development or unproven. Thus, they do not have to guess at a supposed (or hoped for) supply base capability to support the technology. engage the supply chain function early. leaders engage the entire supply chain before the product development and design function is well down the path toward producing the product. And they make certain the supply chain function has the technical or supply market knowledge to offer a thorough and current understanding of supply options, supplier r&D roadmaps, and production and supply chain risks. leaders also understand that they must manage the timing and quality of development and engineering interfaces as closely as the flow of physical goods and materials. Develop strategic partnerships. such partnerships enable technology innovation, provide for greater information sharing and assure more frequent communications. Working within these strategic partnerships, best-practice companies efficiently migrate cutting-edge, technologydriven products and systems from design to production by supporting collaboration across the value chain.

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thereofrequires addressing the implicit need for a way to evaluate and adapt to integrate new partners and separate existing ones. At the same time, each participants metrics must ensure that system-level performance goals are met. If any supplier fails to perform, then all suppliers will suffer. A sophisticated exception reporting system is mandatory. employ risk management tools and capabilities. external suppliers are critical elements in your integrated value chain, which means managing and mitigating risks must be a central focus. our studies reveal that as much as half of the value chains cycle time is consumed by suppliers. The best tools provide for early alerts far upstream in the supply chain while avoiding bullwhip effects. for that reason, one electronics manufacturing services (EMS) supplier moved manufacturing to China to be closer to its electronic components sources. At the same time, some EMS firms implemented just-in-time manufacturing, switched to batch processing and synchronized their production with component manufacturers to respond quickly to changes in the market and customer demand. In this case, the firm also benefited from lower labor costs for assembly work. By shipping directly to customer warehouses, EMS suppliers reduce the length of the integrated value chain and cycle time, while in many cases eliminating wait times. Moreover, some EMS suppliers are establishing product development labs closer to their customers r&D centers to develop and roll out product innovations faster than ever.

How Does Your Role Align with Your Future Business Strategy?
look up and down the chain. You will see an array of partners who coalesce around and are driven by the following values: knowledge of what the customer wants. Know your role on the continuum in relation to your specific customer and the ultimate customer. If you can continually bring a unique product or service to a partnership, it can probably sustain your business into the future. But you must be very good at it, and you cannot be satisfied with the status quo. Past dealings or history of the relationship. If your company has been a reliable member of the value chain, your prospects for continued business are excellent. But a word of caution: If a customer asks for products or services beyond your capabilities or quality standards, dont overextend or jeopardize your future. say no. Prospects of winning future opportunities by partnering. let customers know where you are in the market and on the continuum. They must know your capabilities and intentions. If you want to stay small, you will need to demonstrate how you can uniquely contribute to innovation, competitive differentiation and superior cost or performance to make your other value chain partners successful and your company indispensable. If you want to grow, youll have to commit to change. You need to begin the process of transforming your value chain gaining a sustained competitive advantage in the process.

Authors
Randy Garber is a vice president in the San Francisco office, and can be reached at randy.garber@atkearney.com. Charles Withrow is a manager in the San Francisco office, and can be reached at charles.withrow@atkearney.com.

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A.T. kearney is a global strategic management consulting firm known for helping clients gain lasting results through a unique combination of strategic insight and collaborative working style. The firm was established in 1926 to provide management advice concerning issues on the Ceos agenda. Today, we serve the largest global clients in all major industries. A.T. kearneys offices are located in major business centers in 34 countries.
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