On the Dark Side of Strategic Sourcing: Experiences from the Aerospace Industry
Author(s): Christian Rossetti and Thomas Y. Choi
Source: The Academy of Management Executive (1993-2005) , Feb., 2005, Vol. 19, No. 1
(Feb., 2005), pp. 46-60
Published by: Academy of Management
Stable URL: https://www.jstor.org/stable/4166152
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The Academy of Management Executive (1993-2005)
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? Academy of Management Executive, 2005, Vol. 19, No. 1 On the dark side of strategic sourcing: Experiences from the aerospace industry Christian Rossetti and Thomas Y. Choi Executive Overview American manufacturing has undergone dramatic changes during the last two decades. Manufacturing firms were re-engineered, downsized, and restructured. Employees were dismissed, divisions were scrapped, and subsidiaries were spun off. As a consequence, outsourcing to external suppliers increased significantly, which in turn resulted in the increased saliency of strategic sourcing and its economic implications. Strategic sourcing integrates the buying firm’s strategic decisions with those of its key suppliers, thus promoting trust and decreasing transaction costs. However, a dark side of strategic sourcing has emerged. Some firms established long-term contracts with their suppliers, set up mutually dependent relationships, and then began to strangle suppliers with relentlessly short-term, cost-driven decisions. As a result, the buying firms and their suppliers have now become competitors in the same market. Simply put, there is serious long-term risk associated with firms becoming strategically integrated with suppliers and then mistreating them for short-term gains. This paper demonstrates that misapplying the tenets of strategic sourcing can result in the disintegration of the existing supply chain and weaken the buying firm’s long-term competitiveness. The anthology of American business is laden with accounts of strategic blunders. The firms featured in these stories missed opportunities, misjudged competitors, developed losing strategies or, in some cases employed poorly executed winning strategies. Toward the end of 1990s, we began ob- serving the tell-tale signs of a strategic blunder in the aerospace industry. Although original equip- ment manufacturers (OEMs)’ had implemented strategic sourcing during the past decade, their long-established supply chain was coming apart- suppliers were selling their wares directly to the buyers’ customers.2 We refer to this phenomenon as “supply chain disintermediation,” and it has widespread and broad economic implications for the industry.3 We were disheartened that the core tenets of strategic sourcing had been misapplied. Contrary to the OEMs’ rhetoric surrounding long-term rela- tionships and co-prosperity that underscore strate- gic sourcing, in many instances their supplier relationships were marked by infidelity. The disin- tegration of the relationships seemed particularly poignant given that OEMs’ outsourcing had in- creased substantially, including their reliance on suppliers. The stage had been set for close rela- tionships, but it was marked by gamesmanship and deception. Consider the fact that these OEMs are large multibillion dollar companies (e.g., Boe- ing, Airbus, General Electric, and Honeywell), which are the major providers of airframe, propul- sion, and auxiliary units, and the suppliers are typically small companies traditionally regarded as being at the mercy of these large buyers. How- ever, when faced with the OEMs’ strategic sourc- ing initiatives, segments of the aerospace supply base are reacting atypically. Many suppliers are deciding to short-circuit the decades-old aero- space supply chain and supply aftermarket re- placement parts directly to the buyer’s customers. The aftermarket has long been regarded as the OEMs’ sacred cash cow and was strictly off-limits to the suppliers. Our goal is to explain how the misapplication of strategic sourcing can ‘lead to unintended conse- quences for the buying firm’s competitiveness- 46
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2005 Rossetti and Choi 47 vis&i ~~Misapplication of Strategic Sourcing xzs as*g t~~~~~~~~ Short-term perspectivie .-*.gS ~~~~~~A Dishonesty s a K~~~~~~~~~~~ Overyly simplistic views >Y ;>y ~~~~~~~~~~~What Happened a?> A Infidelity -*S . . . . … . …… ………. ..A Increased. *&.9 ~~~~~~~~~~~~~~~~~~~~~~competition < Promise of Strategic f aS g3 ~Sourcing gaiziaAga ~~~~~~~~~What Did Not Happen b A Productive . % < >XG ~~~~~~~~~~~~~~~~~~~~~rel at io ns h i p s ~~~~~~~~A Improved a ~~~~~~~~~~~~~~~~~~capabilities i;tb FIGURE 1 Overall Framework what we refer to as the dark side. From our per- spective, the dark side had been steadily casting its shadow over the aerospace industry for some time. Indications have been present in aerospace trade magazines as well as in academic publica- tions, and corroborating evidence has been found in the Federal Aviation Administrations (FAA) da- tabases, court records, and even supplier web- sites.4 Our own study conducted during the past three years confirmed our suspicion that there are dangers associated with replacing strategic sourc- ing with short-term price-based decisions and sac- rificing relationships for short-term profits. Al- though strategic sourcing promises reduced costs and increased efficiency, it is also true that with more outsourcing the implications for missteps be- come greater. Figure 1 illustrates how the initial promises of strategic sourcing became unfulfilled and led to unintended consequences when the te- nets of strategic sourcing were misapplied by the aerospace OEMs.5 First, we describe the historical context under which original strategic sourcing initiatives were planned. Next, we describe the promises of strate- gic sourcing and how major OEMs in the aero- space industry began implementing it. We then identify misapplications of strategies and their negative consequences. Finally, we discuss how corporate strategies should be modified to account for the changes that have occurred in their supply chains. The Aerospace Supply Chain in a Historic Context Fifty years ago, the aerospace industry, like most industries during this period, was vertically inte- grated. OEMs began outsourcing first to increase capacity during the war years and later when the introduction of jet aircraft increased demand for new aircraft. Although parts may have come from a variety of suppliers, they were shipped through the OEMs, as depicted in Figure 2. OEMs used this practice to ensure quality and to control distribu- tion channels. Because the FAA requires that the company authorized to manufacture a part is en- tirely responsible for its quality, OEMs inspected most parts they outsourced. Forcing suppliers to ship all parts to the OEM ensured that its custom- ers, the aircraft operators, did not interact with the suppliers. By separating suppliers and customers, OEMs were able to effectively control their supply chain for decades.6 Like most complex, high-performance products with high intellectual value, the majority of an aerospace product’s cost is in its design. However,
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48 Academy of Management Executive February Supplier Operator Supplier Oeao Supplier Oeao FIGURE 2 Historical Supply Chains the market has never been willing to pay for the high design cost. Consequently, the OEMs entice the market to buy their new products by selling at or near cost; they then recoup their investment through aftermarket profits. This business strategy is commonly referred to as the “razor and blade” model, wherein the manufacturer gives its razors away in order to lure the buyer into paying for high-margin replacement blades. However, the payback period for aerospace products is longer and riskier. In general, a new commercial aircraft product breaks even about ten years after its intro- duction. This risky practice is highly dependent upon achieving a critical mass of products (e.g., engines) in the field and then maintaining high margins on aftermarket parts. Although aircraft operators have enjoyed the low markup on new products for over 30 years, they begrudgingly accepted the high prices they pay for spare parts. However, when commercial airline de- regulation took place in the early 1980s and profits were replaced with losses, the airlines became inflamed. Even as their customers were going bankrupt, OEMs continued their aftermarket mark- UpS.7 Clearly, there was a high demand for less- expensive spare parts, and some suppliers were tempted to satisfy this demand. However, the OEMs kept them in check through government reg- ulations and threats of retaliation. Suppliers bold enough to enter the aftermarket arena usually lost all business with the OEM whose part they were selling. Furthermore, aftermarket suppliers often found themselves in court for copyright infringe- ment or patent violations.8 There were also incentives to remain loyal, how- ever. Even when OEMs frequently switched suppli- ers, there was enough business for everyone. Also, in the early 1990s, even when military budgets were cut and commercial airline revenue declined, suppliers’ revenues were maintained because of the OEMs’ increased outsourcing.9 One supplier described this period as the era of “happy, fat, and stupid.” Although the industry was unraveling, suppliers were unaware of the implications.10 Then, as the industry recovered in the mid-1990s, the OEMs discovered a new method to manage costs-strategic sourcing. As OEMs initiated stra- tegic sourcing, margins and revenues for suppliers declined. Thus, the “happy, fat, and stupid” mem- bers of the aerospace supply base went bankrupt, were bought up, or woke up.” Promise of Strategic Sourcing For aerospace OEMs, the rate at which outsourcing was being practiced grew exponentially in the late 1990s. Typical American manufacturers outsource between 50 and 70 percent of the total value-add of their products. To those outside supply chain man- agement this percentage may seem high, but many executives continue to push their strategic sourcing groups to find more opportunities outside the company.’2 Increased outsourcing is particularly attractive to upper management because it improves many of the metrics that stock analysts use to judge company performance. As corporate pay has be- come increasingly intertwined with stock perfor- mance, activities that improve analyst ratings take the forefront in executive initiatives. The effect that outsourcing has on financial ratios is straightfor- ward-shedding specific assets allows a company
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2005 Rossetti and Choi 49 Table 1 Strategic Sourcing Initiatives: Definitions and Outcomes Strategic Sourcing Initiative Definition Intended Outcomes Supply Base Rationalization Reduction of the total number of suppliers * Decreased resources needed to manage suppliers * More focused relationship building Commodity Management Matching corporate needs for parts of similar 0 Increased understanding of supply markets processes and materials with the changing for given commodity capabilities of the supply base. 0 Decreased supplier’s internal cost due to improving economies of scale * Closer technical relationship between buyer and supplier Spend Consolidation Increased dollar spent on purchases from one 0 Increased purchasing leverage supplier * Increased interdependence between buyer and supplier Global Sourcing Exploiting global markets for improved * Decreased cost per part capabilities, such as low-cost labor for the * Increased competition in supply market manufacturing of labor-intensive parts Sole Sourcing Agreements Purchasing a product or family of products * Lower prices from suppliers from one supplier 0 Increased interdependence between buyer and supplier Long-Term Agreements An understanding that buyer-supplier * Improved quality, delivery and price due to relationship will extend over several years supplier’s buyer-specific investments or indefinitely * Expectation of trust and co-prosperity between buyer and supplier JIT Purchasing Minimization of supply lead time 0 Reduced level of inventory * Increased supplier responsiveness to increase return on assets (ROA) and return on investment (ROI), and decreasing the head count increases revenue per employee.13 However, there is more to outsourcing than sim- ply creating a leaner firm. An important part of the equation is the firm’s ability to decrease the costs of outsourced goods relative to those produced in- house. If the buying company is large enough, it can simply use its market pressure to force suppli- ers to decrease their prices. It can also threaten to source in low cost markets overseas. Reducing in- ternal costs is much harder, and can involve union negotiations, a costly layoff, or new internal pro- cesses. Renegotiation is free, fast, and effective. The ease of reducing prices is not the only motiva- tion. Reducing prices decreases costs of goods sold, which has a tremendous effect on earnings. With high price to earning ratios, reducing the price of purchased goods by 5 percent can theoret- ically increase the company’s stock by as much as 200 percent.’4 Basically, the more the buying firm outsources and the harder it pressures its suppliers, the greater the potential for a stock increase-in the short term. A general impression among the exec- utives is that strategic sourcing initiatives promise 5 to 15 percent cost savings. And for the most part, these initiatives deliver.’5 As more companies re- ported the effects of their strategic sourcing initia- tives, the practices have increasingly gained favor with the Fortune 500.16 But strategic sourcing is more than simply reduc- ing input prices. It is designed to align the capa- bilities of the supply base with the buyer’s market opportunities. This is usually accomplished through the implementation of several analytical and operational initiatives, as shown in Table 1. One of the important intended outcomes is a stra- tegic partnership between a buyer and a supplier that will maximize their collective market pres- ence and profitability.17 In addition to the defini- tions of different strategic sourcing initiatives, Ta- ble 1 lists the intended outcomes associated with each initiative. Misapplication of Strategic Sourcing As evidenced in Table 1, almost all strategic sourc- ing initiatives intend to establish a closer buyer- supplier relationship. This improved relationship is facilitated by using a smaller number of suppli- ers and the expectation of long-term relationships. Table 1 also shows that promises of long-term re- lationships are not enough. The majority of the cost savings are gained through increased efficiencies caused by better communication and trust. These
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50 Academy of Management Executive February can only happen in a close working relationship. Simply put, a close working relationship pays rent because the buyer and the supplier reduce the cost of safeguards and the cost of transactions.’8 During the process of implementing strategic sourcing, however, many OEMs in the aerospace industry seem to have focused on the short-term issues. They sacrificed long-terms costs for short- term price targets. They overlooked the fact that the cost savings are derived from having a close working relationship with suppliers. And because their attention was consumed by short-term issues, they failed to apply a basic tenet of commodity management-to keep abreast of the changing supply market and the regulations that governed it. Short-Term Cost Targets at All Costs The purchasing literature warns of sacrificing competitive priorities for short-term cost gains. We observed that long-term cost implications were overlooked, corporate objectives and market con- siderations were ignored, and quality was pushed aside. The major cause of the misapplication of strategic sourcing is the pressure placed on the purchasing department to deliver year-over-year price reductions. Purchasing and commodity man- agers stated that the goals were set with the im- plicit understanding that price reductions must be met by any means.19 One commodity manager said, “Promotions are based entirely on reaching PPV (purchase price variance) targets.”20 Another said, “It looks like my bonus is in question; I didn’t reach my price targets this quarter.” Long-term aspects such as overall efficiencies and the costs of switching suppliers were not included in the commodity manager’s reward structure. After re- viewing the financial analyses used to justify over a dozen sourcing decisions, we confirmed that many important costs were not included. In many cases, when these costs were included, the wrong decision had been made.2′ Management’s reward structure based on PPV can do much more than increase the total operat- ing cost; it can lead purchasing managers to ne- glect corporate interest. For example, one commod- ity manager’s corporate office attempted to shun a few suppliers that were entering its aftermarket. However, when one of these suppliers offered the required PPV and promised to meet future cost reduction targets, this manager did not think twice about striking a deal with the supplier. Akin to aiding and comforting the enemy, this commodity manager was supporting behavior that his com- pany perceives as a threat. In another example, a commodity manager was willing to make cost- quality tradeoffs in order to achieve the purchase price variance. This commodity manager went against the high-quality requirements of the aero- space industry and used a supplier with inferior quality but a price 20 percent lower than other competitors in order to achieve his year-end PPV objective. Turning a Blind Eye to Relationships: Long-Term Expectations, Short-Term Reality The desired outcome of strategic sourcing is to improve the buyer’s competitive priorities (cost, quality, and delivery), and much of this is accom- plished by creating an environment where the sup- plier trusts the buyer. According to the tenets of strategic sourcing, this trust is based on the expec- tation that relationships with a smaller number of suppliers would be more intimate, improving in- formation sharing, understanding, and communi- cation. Once buyer-supplier relationships move from short-term spot exchanges to long-term serial exchanges, suppliers are willing to work with the buyer to improve transactional efficiencies and re- duce the time it takes to move a product’s market.22 Therefore, lower costs are based on long-term in- creased efficiencies, not simply short-term price reduction. When practiced with the sole aim of reducing the short-term purchase price, these initiatives create dissonance between buyers and suppliers. Accord- ing to our discussions with suppliers, strategic sourcing and commodity management have irre- trievably damaged buyer-supplier relationships. We often heard from both the suppliers and buyers that “the entire aerospace supply chain is entirely cost focused.” The aerospace industry that for years competed on capabilities now competes al- most exclusively on year-over-year price reduc- tions.23 It appears that long-term relationships now exist in name only.24 With incentive structures pegged to year-over- year PPV, commodity managers are not motivated to form truthful and honest buyer-supplier relation- ships. For example, OEM representatives enter ne- gotiations stating that volumes will increase. They promise that relationships will last, while knowing that if a better opportunity presents itself, they will switch suppliers. In other words, suppliers that trust these words and increase their dependence on the buyer are punished instead of rewarded. One seasoned supplier manager concluded, “Only a sucker would take a commodity manager’s words at face value.” In the end, trust, which is the bed- rock of strategic sourcing, becomes the stumbling block for suppliers.
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2005 Rossetti and Choi 51 Sourcing with Eyes Wide Shut Due to the complexity of their products and the repercussions of failures, the FAA has played an important role in the development of aerospace supply chains. The strict regulations of the FAA have prohibited many manufacturers from enter- ing the aerospace industry. However, as airlines increased pressure on the FAA to improve compe- tition in the aftermarket, the amount of part man- ufacturing authorities (PMA) granted has in- creased dramatically.25 With recent regulatory changes, a PMA is almost assured for reputable aerospace suppliers, particularly if they have ex- perience producing a part or similar parts, as is the case with existing OEM suppliers. Although the OEMs knew about the changes, they failed to real- ize that their suppliers could become their compet- itors far more easily.26 An important component of the PMA certification process is testing, and here the OEMs missed the emergence of important new alliances between aircraft operators and parts suppliers. If an OEM wants to change a part’s design it must assemble a special test platform and then equip it with expen- sive telemetry. Contrarily, if an aftermarket sup- plier has reverse engineered a part, it can simply contact an airline and ask for a test vehicle. Air- lines are more than willing to provide a reputable supplier with a vehicle to test its newly reverse engineered part, especially if the airline has a fleet of vehicles that regularly require this part for routine maintenance and repair. The airline can then be assured savings of a 20 percent to 90 per- cent on this part if testing is successful.27 What Happened We now consider what actually happened because of the effects of misapplied strategic sourcing-the outcomes of the changing supply chains in the aerospace industry. Supply Chain Disintermediation Faced with this new reality of increasing instabil- ity and decreasing profits, suppliers are doing something that was unimaginable ten years ago. Suppliers are being pressed to play a high-risk game by entering their buyer’s aftermarket sales business. Suppliers that once had long-standing relationships with aerospace OEMs are now emerg- ing as competitors. Airlines, that for years endured near-monopoly OEM pricing practices, are eager to purchase suppliers’ aftermarket products and aid their full-fledged market entry. As shown in Figure 3, after years of channel dominance, the aerospace original equipment manufacturers are losing con- trol of the supply chain that they built. The cost of disintermediation is great. From the perspective of the OEMs, if suppliers take $1.00 of aftermarket share, this is the equivalent of taking up to $1.40 of their revenue.28 However, there is a secondary cost, which could be more important to the OEM’s long-term survival than the loss of im- mediate revenue. Operators that are able to reduce maintenance, repair, and overhaul (MRO) costs, will be able to greatly extend the profitable use of their existing aircraft. Operators retire airplanes for a variety of reasons; however, at certain point MRO costs rival the equipment’s revenue genera- Supplier ——————————————————— Operator Operator Operator FIGURE 3. Emerging Supply Chains
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52 Academy of Management Executive February tion capabilities. If operators can decrease this cost substantially, new equipment sales will de- crease. This will delay the cycle of new sales and ensuing aftermarket sales, causing a delayed but large ripple through the aerospace OEMs’ revenue cycle. Disintermediation certainly represents a funda- mental structural change to the supply chain. It has created new relationships among the players. Prior to the implementation of strategic sourcing, buyer-supplier relationships may have suffered from the inefficiencies associated with competitive buyer-supplier relationships. The buyer-supplier relationships that evolved now suffer from some- thing much worse-antagonism is usually present among the fiercest competitors. Not only are the suppliers concerned with their own well being, they also associate their competitive priorities with the buyer’s downfall. Suppliers as Competitors Suppliers that enter the aftermarket are potent competitors to the OEMs. These PMA competitors often have lower overhead, greater knowledge of the parts they produce, and better customer ser- vice. For example, suppliers are able to offer shorter order lead time for the aircraft operators. When OEMs implemented just-in-time (JIT) prac- tices, they pushed inventories upstream. For this reason, one supplier called such practice “Just Isn’t There.” Consequently, when an operator orders a part, most OEMs quote their supplier’s lead time, on average six to 14 weeks. The OEMs then contact the suppliers to check if they have the part in stock. However, if the supplier is selling in the aftermar- ket, it may not be responsive to the OEMs. The supplier may wait and see if the aircraft operator contacts it directly for an order, promising it in 24 to 48 hours, compared to the six to 14 weeks offered by the OEMs. Suppliers also have an enormous price advan- tage over their OEM counterparts. Development time for a new aerospace product can be up to five years and can represent 80 percent of the total cost associated with producing the first unit. In con- trast, a suppler can reverse engineer a part in less than five weeks. One engineer stated that the OEMs face the same challenge as “Columbus in search of the new land.” The OEM takes all the risks ensuring that the new design will function according to its intended specifications. Reverse engineering is “just following the route already mapped by the OEM.” With its lower overhead, lower risk, and minimal research and design, PMA suppliers have a 20 percent to 50 percent price advantage over the OEMs. Industry experts esti- mate that an airline can save 30 to 40 percent of its MRO expenses by switching to PMA parts.29 As competitors, the suppliers also have in- creased market flexibility. A supplier often manu- factures parts for multiple OEMs in its area of expertise. A supplier that decides to sell in the aftermarket typically has experience manufactur- ing a variety of different parts. Whereas an OEM will only supply parts that service its own equip- ment, the supplier may enter all of the OEM after- market parts arenas with equal opportunism. Also the OEM has to hope that its new program will be successful, but the supplier has the luxury of wait- ing to see which aftermarket part has the greatest demand. This situation creates a risk for all the OEMs, since suppliers appear to view aftermarket entry as a new business model. Our conversations with suppliers lead us to believe that once a sup- plier realizes aftermarket margins, it will switch its entire business plan. It is doubtful that a sup- plier will enter the aftermarket of only some of the OEMs and not the others. Monopoly Sources Because the OEMs have taken the supply base rationalization to an extreme degree, many have inadvertently created monopoly sources. In es- sence, they have eliminated competition in the supply base. Worse yet, they have rarely fostered good relationships with these remaining sources. A cost-cutting focus has led to poor relations with suppliers that have become more powerful. Fur- ther, in the last 10 years, many existing aerospace suppliers have been bought by companies outside the industry. These new owners, who have diver- sified revenue streams, are able to say “No.” We heard stories of suppliers threatening not to supply a part or demanding price increases in the face of industry deflationary pressures. For exam- ple, one supplier that had an exclusive long-term agreement with an OEM for a particular part learned that the OEM was in the process of trans- ferring the part to a foreign supplier. The supplier immediately stopped all outbound shipments and retrieved all in-transit orders. This supplier effec- tively shut down the OEM’s production and dis- rupted its entire supply chain. These more power- ful suppliers are also able to use new negotiation tactics. Instead of complaining about price reduc- tion demands, they can simply threaten to enter the aftermarket. Rather than face aftermarket com- petition, the OEMs may be willing to allow a price increase or at least keep prices constant.
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2005 Rossetti and Choi 53 Increased Switching Costs and Loss of Flexibility One commodity manager told us of a particularly difficult buyer-supplier relationship in which his firm owned the tooling for a specific part. When the commodity manager attempted to secretly transfer this part to another supplier, the supplier became suspicious and purposefully kept inventory levels very low. In the end, the OEM was never able to obtain enough buffer stock to give it the time to both remove the tooling and bring another supplier online. If the OEM wanted to switch to another supplier, it would have to pay the nonrecurring engineering costs for a second time. Physical assets are not the only hindrance to part transfer in the emerging aerospace supply network. One of the dangers of outsourcing is the loss of internal manufacturing knowledge. One ex- perienced buyer lamented that “in the old days” he could walk down to the shop floor with a machined part and find “a half dozen machinists” capable of explaining the manufacturing process. Currently in this company, if a buyer wants information on manufacturing time or processes he/she has to contact a supplier or go to an internal consultant, and it can take weeks to receive information. Dispersion of Intellectual Property The control of intellectual property also has been compromised as suppliers gain product design ca- pabilities. As design for manufacturability (DFM) entered the supply chain management lexicon, suppliers became more intimately involved in the design process. However, OEMs did not always respect the supplier’s design efforts. One supplier complained that an OEM would allow suppliers to design parts and then take their designs and bid them out to competing suppliers. Suppliers that expected to become the sole source for a part found that their design work had been performed pro bono instead of quid pro quo. In response, suppli- ers now protect their designs. Suppliers utilize the same copyright and intellectual property state- ments that are found on the bottom of OEM prints. If the OEM decides to use this design, it must source the part with that supplier or pay a royalty. Another aspect of the suppliers’ increased tech- nical skills is their abilities to reverse engineer parts. Aerospace OEMs helped to develop much of the technology surrounding three-dimensional la- ser scanning. This technology allowed the OEM to check the exact dimensions of a part before instal- lation or sales. As suppliers became more respon- sible for quality control, this technology migrated to the supply base. These scanners are now linked to computer-aided design (CAD) and computer- aided manufacturing (CAM) software. A would-be supplier can now produce a three-dimensional im- age and the inputs required for computer-aided machining in a matter of hours. With the help of metallurgical labs, a supplier can reproduce a part in a matter of weeks that at one time may have taken the OEM years to design. To counteract the proliferation of reverse engi- neered parts, one OEM is considering patenting all current and future designs. This would allow OEMs another vehicle to protect their intellectual property, and it brings up another problem with the current strategic sourcing initiative. In the pur- suit of lower labor costs, many strategic sourcing groups are placing intellectual property in coun- tries that do not protect such information. The Far East, notorious for its disregard of intellectual property, is now a hotbed of aerospace global sourcing. As repair and overhaul businesses blos- som in this region, demand for locally produced replacement parts should increase substantially. Aerospace OEMs may be traveling the same path that American semiconductor manufacturers followed 20 years ago. By outsourcing to less ex- pensive Japanese suppliers, American semicon- ductor manufacturers helped build an industrial and national rival. Within five years American in- dustry was under attack. The aerospace industry may face a similar fate with China. Given the Chinese government’s interest in building an aero- space industry, the country’s cost advantage, and rarely enforced intellectual property laws, out- sourcing to China may actually increase competi- tion in the long run. What Did Not Happen There are unfulfilled promises of strategic sourc- ing. They can be captured in two broad catego- ries-lack of close working relationships with sup- pliers and diminished competitive advantage. Close Working Relationships with Mutual Trust The much-anticipated mutual benefits and co- prosperity of buyers and suppliers never material- ized. The following example highlights the extent to which mutual trust and a sense of co-depen- dency have been lost. This story involves a sup- plier that reduced year-over-year cost reductions through clandestine aftermarket sales. Even though the supplier made low margins on its parts, it continued to drop prices year-over-year. This sit- uation allowed the supplier to continue to increase its technical knowledge of the OEM’s parts in this
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54 Academy of Management Executive February commodity. The OEM did not realize that the sup- plier was covering the year-over-year price reduc- tions by selling the same parts on the aftermarket. We found it interesting that a supplier was now using the same tactic that the OEMs practiced with the airlines-the supplier was selling its parts to the OEM at cost or below in order to make large profits in the aftermarket. The loss of relationship also extends to raw ma- terial suppliers. When one OEM used internal and external manufacturing sources, it maintained a very good relationship with its raw material sup- pliers. In many instances the OEM provided the raw material, and the external source was com- pensated for the value it added to the product. This arrangement ensured that the OEM maintained control over the supplier. However, as the OEM passed more responsibility for procuring raw ma- terials to the suppliers, it eventually lost contact with these raw material suppliers. As a result OEMs have found it more difficult to switch sup- pliers. When an OEM puts a part out for bid, all prospective suppliers contact a limited number of raw material suppliers for prices. Information flows up the supply chain to the existing supplier informing it that its product is now up for new bids. It can then adjust its tactics toward the OEM- increase price, decrease supply, or begin selling on the aftermarket. Maintaining Competitive Advantage As we stated earlier, aerospace products contain a very high intellectual asset component. OEMs have spent decades improving designs as well as skills. When OEMs outsourced complex parts with greater frequency, often they would still design the part but would allow the prospective supplier to design the manufacturing process. As was dis- cussed before, more calculating suppliers began patenting the processes they had developed. Con- sequently, when an OEM wants to switch suppliers for a part with a patented process, it has three choices: pay a royalty to the supplier; have another supplier develop the process; or develop the pro- cess internally. All three choices can cost more than the total savings realized from transferring the part, essentially reducing the competitiveness of the OEMs. For example, when an OEM discov- ered that its supplier was shipping parts to an aftermarket parts distributor, it attempted to re- move all parts it sourced with this supplier. How- ever, one part halted its effort. The supplier had developed the manufacturing process and owned the patent on it. The OEM estimated it would cost atpproximately $1 million to re-develop the process and increase the capabilities of a new supplier. The supplier, knowing that the part was to be re- sourced, increased prices by 50 percent over a six- month period. Clearly, the diminished product and manufac- turing design capability of OEMs is sure to dam- age competitive advantage. However, the loss ex- tends further. In their search for the lowest price, commodity managers regularly make liberal tradeoffs regarding price and quality. The effect that these decisions have had on the competitive advantage of OEMs has serious implications for two key areas of its business. First, internal and external costs of deficient quality decrease the OEM’s manufacturing capabilities. However, and possibly more important, the quality tradeoff in- creases competition from the suppliers. OEMs have always been able to tout quality in design and manufacturing as justification for their higher prices; PMA parts are still considered inferior to those provided by OEMs by a majority of operators. If OEMs continue to make tradeoffs regarding price and quality, PMA suppliers will eventually gain the reputation of having the quality advantage. Now What? Aerospace Industry and Beyond For the executives in the aerospace industry, we want to make it clear that the supply chain disin- termediation has occurred and that they must pick up the pieces and move on. Failed relationships, be they personal or long-standing business deal- ings, bring mixed reactions and emotions from those involved. Some people deny the problem, some question it, and some accept it. We saw the same reactions from managers in OEMs. A number of managers said, “They [referring to parts suppli- ers] would not dare [to bypass the OEM and sell directly to the aircraft operators].” A vice president said, “They are in enough trouble already, and I don’t think we have to worry about them.” The most realistic observation was made by a commodity manager who said, “At least 60 percent of my sup- pliers are in the aftermarket.” We now make a few suggestions specifically for the executives in the aerospace industry first. Then, we broaden the discussion and consider the implications for the aerospace industry and other industries (e.g., automotive, high-tech, and phar- maceutical). Emergent Strategies for Aerospace Industry Accept the Fact that the Supply Chain Disintermediation Has Occurred The first step in addressing a problem is admitting that there is a problem. The supply chain disinter-
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2005 Rossetti and Choi 55 mediation is certainly a problem that OEMs cannot ignore. When we examined the FAA databases, the number of companies currently engaged in some aftermarket activity shocked us. Approximately 70 percent of engine PMA parts are manufactured without an OEM license agreement and 20 percent of Boeing parts are manufactured without an OEM license agreement.30 Unfortunately, aerospace OEMs appear to be un- able to develop a unified strategy to counter this problem. Many vice presidents of supply chain management are still looking for the lowest possi- ble price. Also, aftermarket sales groups seem con- tent to maintain market share rather than to ad- dress the problems that led to its deterioration. Supply chain management is supposed to unify inbound, internal, and outbound activities to achieve the greatest value for the customer. It is imperative for OEMs to acknowledge that their inbound and outbound market behaviors have caused supply chain disintermediation. Realize that Suppliers Are Practicing a New Form of Competition When previously faced with limited cases of dis- intermediation OEMs treated these threats as they would other market infringements, by openly chal- lenging them. Since disintermediation is now more widespread and OEMs typically do not know which suppliers are engaged in it, they must em- ploy new tactics-open warfare will not work when fighting a guerilla war. As evidence of their need to change, OEMs con- tinue to use the old practices of legal action, ban- ishment, and government intervention. Legal ac- tions can be employed only when violating suppliers can be detected. However, detection is not easy because suppliers use front companies, multiple shipping addresses, and secrecy to sur- round such practices. Even if the supplier has vio- lated multiple copyright laws, legal action can take years, but the OEMs’ profits are affected im- mediately. Furthermore, the old practice of banish- ing competitive suppliers only causes them to sub- stitute the lost revenue with increased aftermarket activity. Several OEMs are lobbying the FAA to introduce new regulations in an attempt to strengthen PMA regulations, but they are being met by stiff resistance from aftermarket suppliers and aircraft operators. Form a Closer Coalition with Aircraft Operators We have noticed some recent changes in the OEMs’ aftermarket business strategy-many are entering the service sector to capture the service component of aircraft operator MRO spending. New alliances are being formed between OEMs and aircraft operators, and we recommend that they engage in more of these alliances. These alliances or new service arrangements allow aircraft operators to focus on their core com- petency-passenger and freight transportation- and allow the OEMs to extend their natural capa- bilities. The worst position the OEMs can take regarding this arrangement is again to focus on short-term profits and sacrifice the long-term gains. With the suppliers turning their backs on OEMs, it has become more critical that OEMs fos- ter good relationships with the aircraft operators. We were alarmed to observe a program that charged longer than expected rental fees to oper- ators that agreed to borrow a replacement compo- nent. Rather than informing the aircraft operator how long repairs would take, the OEM would later inform the operator that it had to order the parts from the supplier and it would take 8 to 14 weeks. The OEM was double-dipping-they continued to charge high prices for the repair parts and re- ceived rent for the replacement component. In or- der to repair relationships, OEMs must stop these practices. Build a Relationship with Final Consumers- Airline Passengers OEMs should also consider building relationships with aircraft operators’ customers-the general public. By doing so, at least in the context of rela- tionship arrangement, OEMs would be creating another form of disintermediation to their advan- tage by bypassing the aircraft operators in reach- ing out to their customers. A lesson from pharmaceutical manufacturers and a high-tech company such as Intel may be applicable. When drug manufacturers were wor- ried that HMO cost directives were driving doctors’ pharmaceutical decisions, they changed their mar- keting plans. Instead of marketing drugs to doc- tors, they switched to the ultimate consumers. When Intel realized that the personal computer market was becoming a commodity, it differenti- ated itself by advertising to the end customer di- rectly. Aerospace OEMs could consider touting airlines that use their aftermarket parts and exposing those that use other sources for spare parts. Con- sumers might think twice about flying an airline that continuously uses the cheapest parts on the market. This strategy would allow OEMs to gain some control over the final customer in the supply chain as they lose control in the upper links.
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56 Academy of Management Executive February Implications for Aerospace and Beyond To be sure, the strategic blunders we have identi- fied are not confined only to the aerospace indus- try. The increased reliance on suppliers has been the general trend across all industries,3′ and so has been the unilateral mandate to drive down the suppliers’ prices year after year.32 We have ob- served it in the automotive industry as well as in high-tech industries such as semiconductors, cell phones, or computers. A marketing director of a major supplier in the automotive industry la- mented recently that his company is considering selling the automotive parts unit because it is no longer profitable given the forced year-over-year 5 percent cost reductions. A purchasing manager at a large cell phone company boasted that his com- pany has the target of 20 percent annual cost sav- ings. If there was infidelity in the way the suppli- ers were managed in the aerospace industry in the name of strategic sourcing, there was also infidel- ity present in other industries. Strategic Sourcing Is More Complex Than It Appears In the rush to implement strategic sourcing, many firms are taking a much too simplistic, “one size fits all” approach. Sourcing groups are quickly di- viding goods into commodities, evaluating their current suppliers, consolidating purchases, and heavily leveraging their new purchasing power. Firms can blindly seek the promises of strategic sourcing without understanding the risks and the skills required. When high amounts of outsourcing and uncertain environments are involved, strate- gic sourcing entails more complex tasks. It re- quires detailed analysis, long-term contingency planning, and a certain degree of introspection. For example, consider a large buyer of carbon fiber products that recently implemented strategic sourcing. It began by consolidating its suppliers and eventually it consolidated all its purchases to one supplier. The intent was to get close to one supplier and then drive down prices. The opposite situation ended up happening. Less than one year later this buyer found itself in a monopoly sourcing situation. It lost the leverage it had as a large buyer and ended up negotiating higher prices and better terms for the supplier. Indeed, the effect of moving large amounts of purchases can be wide- spread and not always favorable. These kinds of considerations differentiate tactical purchasing from strategic sourcing. Implementing strategic sourcing correctly requires answering complex questions. For example, “Will our sourcing plan change the supply market?” “How should we re- act?” “How will our suppliers or companies in re- lated industries react to a change in our plans?” Managers must be ready to incorporate the follow- ing: . Changes in the industry that support a commod- ity (such as market concentration, pending leg- islative/regulatory changes, the latest technol- ogy); . Financial trends (such as mergers and acquisi- tions, detailed financial analysis of suppliers and customers-including aftermarket custom- ers and equity-based strategic alliances); and . Possible reactions of current suppliers and com- petitors to the new sourcing strategy.33 This last point brings up an important consider- ation. Remember the supplier that was using af- termarket sales to compensate for year-over-year cost reductions? Increased market share and prof- its were not its only motivation. The company’s representative mentioned revenge. Sometimes im- plementing a sourcing strategy requires more than a good plan. It may require changing the way a company does business with its suppliers. Good Buyer-Supplier Relationships Pay Rent With Wall Street’s preoccupation with quarterly numbers, initiatives that are not easily quantifi- able are typically not respected. A good buyer- supplier relationship as a strategic initiative may sound too soft and even “un”-strategic. However, make no mistake a good buyer-supplier relation- ship pays rent. A recent study of the North Ameri- can auto suppliers revealed that these suppliers preferred to do business with Japanese automobile manufacturers. The suppliers said that these man- ufacturers treated them with more respect. Be- cause of this the suppliers were more willing to work on special designs and work toward decreas- ing total costs, not just prices.34 As was discussed, it reduces transaction costs and mitigates risks. Furthermore, when properly implemented, strate- gic sourcing also provides an opportunity for the buyer to reevaluate the firm’s needs and capitalize on the capabilities of current and future suppliers. At the same time, harnessing the full capabilities of a supplier requires a long-term, trusting rela- tionship. Such a relationship is characterized by give-and-take attitudes, free-flowing technology and information, and the knowledge that neither party will be taken advantage of. How much rent a buyer-supplier relationship eventually pays de- pends on how good the relationship iS.35 By the early 1990s, the aerospace industry was ready for these kinds of relationships. OEMs had
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2005 Rossetti and Choi 57 passed quality control technology, design, and process skills to their suppliers. As suppliers be- came more capable, they, in turn, shared new de- signs with the OEM, allowing the OEM to use fewer engineers, decrease design cycle times, and re- duce manufacturing costs. However, the supplier’s worst fears were confirmed (e.g., proprietary de- signs accompanied by requests for prices were being passed to their competitors). They realized they were investing in a relationship with an un- trustworthy partner; subsequently, whatever trust had been built up was erased. Trust allows firms to plan for the future of a relationship because: * Engineering resources are fully committed to the buyer’s problems because suppliers are focus- ing on the buying company’s problems rather being distracted with other customers “just in case” the relationship deteriorates; * Inventory policies can be optimized facilitating postponement policies and transferring risk to the party best able to manage it; * New product cycle times can be reduced be- cause suppliers can purchase equipment with- out worrying about lengthy contract negotia- tions that might not work out in their favor; and * Learning increases as suppliers no longer hold back key information to use as leverage in rene- gotiations.36 The benefits from these high levels of coopera- tion are priceless. Honda and Toyota have been able to reduce the cost of manufacturing their best- selling product lines, Accord and Camry, respec- tively, by over 25 percent during the mid-1990s. One senior executive at Honda confided that most of the cost reduction ideas came from the suppli- ers. In fact, when Honda selects a new supplier, it evaluates carefully the supplier management’ at- titude. The same executive stated, “If suppliers lack quality practices or anything else, we can help them. But if they lack a good attitude, we simply cannot build a good relationship with them.” Simple Metrics and Unilateral Actions Lead to Unintended Consequences Simple metrics applied in isolation create prob- lems. A simplistic approach to strategic sourcing creates problems. Together, when simple metrics are applied to the simplistic approach to strategic sourcing, problems become worse. This is what happened when the aerospace firms became pre- occupied with annual price reductions as the pri- mary metric after implementing strategic sourcing. We saw how a price-based metric created incen- tives that led a local manager to act against a corporate mandate regarding a supplier, to over- look quality requirements, and to use an overseas source without considering the logistics costs and IP risk issues. To overcome these problems, strategic sourcing metrics should be linked to activities that promote corporate value and efficiencies. It would be a mistake to confine the activities of strategic sourc- ing within the walls of a procurement department. This sort of realization is slowly sinking in. We know of at least one firm that has been working hard to diversify its sourcing metrics and integrate them with the rest of the organization. The vice president of supply chain management at this firm stated: “If we are going to call ourselves supply chain management, then our management incen- tives should reflect this.” In this firm, managers from sourcing, logistics, and manufacturing have co-dependent metrics with zero-bonus clauses. That means that if one group does not reach its goals, no one gets a bonus. Multidisciplinary in- centives can help ensure that strategic sourcing is implemented as it was intended. Unfortunately, the problems we have identified in the aerospace industry run much deeper. In an effort to rapidly decrease the firm’s costs of goods sold, assets, and working capital, buyers from mul- tiple industries (e.g., automotive, consumer elec- tronics, consumer goods, and retail) have incorpo- rated Draconian unilateral cost reduction methods. Many initiatives include one or all of the following supplier requirements: * Forced year-over-year price reductions that started at 3 percent but have risen to over 5 percent, and in some extreme cases are as high as 40 percent; * Forced 90-day to 120-day payment terms, through which large buyers are using their smaller and less capable suppliers to increase their cash flow, instead of trying to balance risk and cost of capital across the supply chain; and . Forced inventory levels, where rather than hold- ing inventory themselves, large OEMs are insist- ing that suppliers hold the majority of safety stock, increasing the suppliers’ costs and risks rather than sharing it.37 When faced with increased risks, suppliers will start looking for new sources of more secure prof- its. As seen in the aerospace industry, the supplier may figure that cheating on contracts, disinterme- diation, selling the buyer’s technology, or leaving the industry entirely are better options than con- tinuing to do honest business with the buyer. Uni- lateral pressure combined with “you are only as
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58 Academy of Management Executive February good as your latest quote” is no way to build good supplier relationships. A Civilized Divorce and the Dark Side of Strategic Sourcing “A civilized divorce is a contradiction in terms…. There is no winning in this. It’s only various de- grees of losing.” (Gavin D’Amato, played by Danny Devito in War of the Roses) Strategic sourcing initiatives are in essence ways of forming lasting relationships with suppli- ers that are most capable of meeting the buyer’s long term strategic needs. Similarly, dating, court- ing, and engagement are ways of finding a life- long partner. They are both designed to learn the prospective partner’s capabilities, long term inter- ests, and trustworthiness. In the end, a relation- ship based on co-prosperity is formed, whether a marriage between two people or a long-term agreement between two companies. Although the parties may enter into the relationship hoping for “forever,” sometimes the relationship ends. People grow apart. A firm’s strategic directions can change. But when one party enters into a relationship with dishonesty, divorce is inevitable. As seen in Table 2, for those buyers that choose the dark side of strategic sourcing, their relationships never have a chance. When buying firms forge a close relationship with their suppliers and offer long-term agree- ments, they set in motion a potentially beneficial venture that would offer them the intended out- comes as illustrated in Table 1. However, the path of implementation of strategic sourcing can take a detour when buyers are swayed by the short-term gains at the expense of long-term gains. As buying firms increase outsourcing they become more dependent upon suppliers for their specific manu- facturing capabilities. If strategic sourcing is mis- applied, buying firms inevitably lower these capa- bilities through poor sourcing decisions. Worse still, they will invite competition into their market as aerospace buyers did regarding their lucrative aftermarket. Disillusioned suppliers will begin to refuse to tolerate broken long-term agreements. They will say “no” to unfair practices. They will seek revenge and then a civilized divorce will truly be a contradiction in terms. Those buyers that have cho- sen the dark side may be able to radically change directions. Unfortunately for them, at this point they may need to be content with a lesser degree of Table 2 Shedding Light on the Dark Side Strategic Sourcing Initiative Misapplication What Happens Managerial Considerations Supply Base Rationalization The supply base is reduced to Buyers face new more powerful Understand the supply market and the point where supplier suppliers suppliers’ reactions to strategic competition disappears sourcing initiatives Commodity Management Simple metrics like PPV are Commodity managers neglect Incorporate broader metrics that adopted as sole measures the buyer’s long term better reflect corporate goals commodity managers interests for short term performance results Spend Consolidation Spend consolidation creates Suppliers enter the aftermarket Use spend consolidation to highly captive suppliers to remain profitable or leave increase supplier efficiency and that are soon driven to zero the industry guard against supplier profits bankruptcy Global Sourcing Intellectual property and Intellectual property is lost and Make use of global sources for suppliers’ designs are suppliers no longer share new capabilities and respect passed to global sources design capabilities supplier’s talents freely Sole Sourcing Agreements Sole sourcing partners are Suppliers’ quality/flexibility Ability to form a good chosen solely on price capabilities and relationships trustworthiness are discounted Long-Term Agreements False promises of long term Trust is destroyed and Use LTAs to reduce transaction contracts are made to get suppliers are unwilling to costs and promote co-prosperity the lowest price engage in future business based on trust JIT Purchasing Suppliers are forced to absorb Smaller suppliers leave the Balance risks between partners to risks such as holding industry and remaining improve the entire supply inventory and cash flow suppliers mitigate risks by chain’s competitiveness management entering the aftermarket or selling intellectual property
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2005 Rossetti and Choi 59 losing. How much less will depend on how well they heed the lessons from the aerospace industry. Acknowledgments We are grateful to the managers at various aerospace compa- nies who have shared their insights and experiences with us. This paper has been greatly improved, thanks to the helpful comments and suggestions by the editor and two anonymous reviewers. We are indebted to the Institute for Manufacturing Enterprise Systems (IMES) at Arizona State University and Na- tional Science Foundation (DMI-0075293) for partial funding of our study. Endnotes 1 Examples of original equipment manufacturers in the aero- space industry include Boeing, Airbus, Bombardier, GE, CFMI, Pratt & Whitney, Rolls Royce, and Honeywell. These companies manufacture airframes, engines, auxiliary power units, etc. 2 We conducted our study with two of the largest OEMs; their annual revenues were greater than $5 billion in 2001. In total 33 individuals were interviewed using a semistructured protocol. The semistructured interviews focused on current strategic sourcing initiatives and their effects on supplier relationships. Interviews ranged from 30 minutes to three hours, often involv- ing follow-up meetings, conversations, and correspondence. Notes were transcribed and coded and organized according to major themes, practices, and outcomes. Whenever possible, secondary data (e.g., cost analysis, memos, purchase orders, presentations, etc.) were collected and analyzed. This work represents specific stories that exemplify recurring themes we found in our original and follow-up study: broken trust, dishon- est communication, and supplier opportunism. ‘Supply chain disintermediation refers to suppliers bypass- ing their buyers (OEMs) and selling directly to the OEMs’ cus- tomers-aircraft operators such as American Airlines, Lufthansa, etc. The following articles highlight this problem: Sparaco, P. CFMI warns of bogus parts. Aviation Week & Space Technology. 19 March 2001; MTU, Snecma form engine ventures. Aviation Week & Space Technology, 8 April 2002; A. T. Kearney, Engine Parts PMA Survey – 2003. http://www.aviationtoday.com/ reports/avmaintenance/papers/PMASurvey2003.pdf. Seidenman, P., & Spanovich E. PMAs pushing OEMs for share of spares market. www.aviationnow.com. 4Phillips, E. H. MRO operators want to help airlines manage assets. Aviation Week & Space Technology. 14 April 2003; Web- site examples include: http://www.heico.com, www.pma-sales. com, www.wencor.com. 5 This paper focuses on the relationship aspects of strategic sourcing rather than outsourcing or the make-or-buy decision. For a detailed discussion of mistakes in outsourcing, see Bar- themly, J. 2003. The seven deadly sins of outsourcing. Academy of Management Executive, 17(2): 87-100. ‘Prior to the loosening of FAA regulations governing parts manufacturing authority (PMA) in the mid 90s, it was extremely difficult for airlines to purchase parts from sources other than OEMs. The AT Kearney PMA study (op. cit.) shows that OEMs still control roughly 85 percent of aftermarket sales. The 15 percent that PMA suppliers currently posses is only a recent market phenomena. 7 Major airline bankruptcies included Branniff, Continental, and Frontier. However, the regional airlines suffered greater losses. Between 1979 and 1981 there were 12 Chapter 11 filings. Between 1982 and 1984 there were 34 filings (Air Transport Association: www.air-transport.org). ‘There are numerous examples in the state and federal court dockets. The following cases highlight the risks suppliers faced if they decided to enter the aftermarket without the consent of the OEMs. Boeing Company, Appellant, v. Sierracin Corpora- tion and Sierracin Glass Transparencies, Inc., Nos. 52649-4, 52884-5, 52937-0 (Consolidated Cases) Supreme Court of Wash- ington; United Technologies Corporation, Pratt & Whitney Divi- sion v. Turbine Kinetics, Inc, et al. No. CV 95-0548324-S, Superior Court of Connecticut, 1996. 9 The early 1990s saw rampant outsourcing in the aerospace industry and layoffs at the major OEMs. For further information see Aircraft. Encyclopedia of Global Industries. 3rd edition. Gale Group, 2003; Aircraft Engines and Engine Parts. Encyclopedia of American Industries. 3rd ed., Gale Group, 2001. 0 Mecham, M. Aircraft engine makers wait out slowdown in orders, spare parts sales. Aviation Week & Space Technology. 11 June 1991. “1 Additional information can be found from the following sources-the Commission on the Future of the United States Aerospace Industry, Minutes of the Fourth Public Meeting, Au- gust 22, 2002; Stundza, T. 1999. Aerospace purchasing gets over- hauled. Purchasing. 126(9): 66-73. 2The following articles provide general as well as aero- space examples of trends in purchasing: Carter, P. L., Carter, J. R., Monczka, R. M., Slight, T. H., & Swan, A. J. 2000. The future of purchasing and supply: A ten-year forecast, Journal of Supply Chain Management, 36(1): 14-27; Trent, R. J., & Monczka, R. M. 1998. Purchasing and supply management: trends and changes throughout the 1990s, Journal of Supply Chain Management, 34(4) 2-12; Morgan, J. 1997. What the advisory board sees- analysis from the field, Purchasing. 122(10): 29-32; Anonymous. Study endorses commercial practices. Aviation Week & Space Technology 19 August. 1996: 21. ‘3 This point has driven the majority of strategic sourcing initiatives of the past five years. 14 At the time of this study the stock prices of large aerospace manufacturers were trading up to 30 times earnings. By de- creasing costs immediately increased earnings could be lever- aged by high price-to-earnings (P/E) ratios. In theory, the stock price can jump substantially. An analysis of the effect of pur- chasing on stock price can be found in Dobler, D. W., Burt, D. N., & Lee, L. 1995. Purchasing and supply management: Text and cases, 6th.ed. New York: McGraw-Hill. 5 Velocci, A. Strategic sourcing mostly a neglected opportu- nity. Aviation Week & Space Technology, 1 April 2001: 70. 16 Strategic sourcing is treated in several textbooks and mul- tiple articles. See Monczka, R., Trent, R., & Handfield, R., 2001. Purchasing and supply chain management. New York: South Western College Publishing; Kraljic, P. 1983. Purchasing must become supply management. Harvard Business Review, 61(5): 109-17; Smeltzer, L., Manship, J., & Rossetti, C. 2003. Strategic sourcing and negotiation planning: an integration of processes. Journal of Supply Chain Management, 39(4): 16-26; Ellram, L. & Carr, A. 1994. Strategic purchasing: a history and review of the literature. International Journal of Purchasing and Materials Management, 33(2): 13-20. 1 Multiple authors have proposed that supply chains com- pete rather than companies. One of the more forceful arguments can be found in Fine, C. 1998. Clockspeed – winning industry control in the age of temporary advantage. Boston: Perseus Books. 18 Hahn, C. K., Kim K. Y., & Kim, J. 1986. Costs of competition: implications for purchasing strategy. Journal of Purchasing and Materials Management, 22(3): 2-7; Rungtusanatham, M, Salva- dor F., Forza C., & Choi, T. Y. 2003. Supply chain linkages and operational performance: a resource-based view of the firm’s
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60 Academy of Management Executive February perspective. International Journal of Operations and Production Management, 23(9): 1084-1099. 9 Typical commodities in the aerospace industry include electrical components, electrical assemblies, small machined parts, fasteners, pumps, hydraulics, composite material, and bearings. This practice is highlighted in Dobler, et al. op. cit. 20 Purchase price variance, as a performance metric, tracks the change in purchase price for a good during the evaluation period. Multiple companies in the aerospace as well as other industries have adopted this metric in an effort to reduce the price of purchased goods. However, this metric does not account for the total cost of purchase-a shortcoming that is warned of throughout the sourcing literature. 21 During the course of our research we were able to review sourcing decisions in detail. Many of these decisions did not include some important factors: logistics costs, engineering costs, tooling costs, adequate evaluation of a supplier’s quality management, and the risk of supply chain disintermediation. For a detailed example of the methodology that was used to calculate a component of these costs see Zeng, A. Z., & Rossetti, C. 2003. Developing a framework for evaluating the logistics costs in global sourcing processes: An implementation and insights, International Journal of Physical Distribution & Logis- tics Management, 33 (9):785-803. For a more general summary of cost management tools see Ellram, L. M. 1996. A structured method for applying purchasing cost management tools. Inter- national Journal of Purchasing and Materials Management, 32 (1):1 1-19. 22A recent study of the U.S. auto industry found that U.S. auto-parts makers prefer Honda and Toyota to G. M., Ford, and Daimler-Chrysler. The study concluded that parts makers were more willing to share designs and work to reduce long-term costs with these Japanese suppliers because they were treated like partners. Kelly, Susan. U.S. auto-parts makers prefer Honda, Toyota study, Reuters (Chicago), 1 August, 2004: Reuters. For an explanation of Toyotas supplier network see Dyer, Jeffrey H. 1996. Specialized supplier networks as a source of competi- tive advantage: evidence from the auto industry. Strategic Man- agement Journal, 17(4): 271-91. 23 Recent benchmarking studies by the Institute for Supply Management revealed that approximately 70 percent of all aerospace suppliers and buyers reported that cost is their num- ber one competitive priority. See ISM 2002 Benchmarking Study at www.ism.org. 24 One of the most important aspects of buyer-supplier coop- eration is whether the supplier expects the relationship to last into the future. See Heide, J. B., & Miner, A. S. 1992. The shadow of the future: effects of anticipated interaction and frequency of contact on buyer-seller cooperation. Academy of Management Journal, 35(2): 265-92. 25 Parts Manufacturing Authority comes under the Code of Federal Regulation (CFR), Section 14. The certification process can be found at http://www.faa.gov/certification/aircraft/. 26 In 1992, Aviation Week & Space Technology, one of the leading publications tracking the industry, mentioned compro- mises between the FAA, suppliers, and OEMs. OEMs originally viewed the compromise as a mechanism to facilitate greater outsourcing, not as a method for instilling competition in the aftermarket: Ott, J. FAA seeks industry assistance in improving parts approval process. Aviation Week & Space Technology, 21 January 1992: 30; Ott, J. Twin task forces battle bogus parts. Aviation Week & Space Technology. 15 March 1993: 33. 27 The following PMA development alliances were an- nounced by the HEICO Corporation, one of the largest PMA suppliers: HEICO Corporation enters into agreement with Delta Air Lines, Inc., Feb. 27, 2003; United Airlines, Inc. and HEICO Corporation enter into strategic relationship, May 28, 2002; AMR Corporation and HEICO Corporation form joint venture; Alli- ance formed by AMR and HEICO to accelerate development of new FAA approved replacement parts, May 24, 2001 from http:// www.heico.com/. 28 Conversations with commodity managers, airline manag- ers and A.T. Kearney, op. cit. 29 We examined the quotes from PMA suppliers to a regional airline and the savings were similar to those found in the A. T. Kearney study, op. cit. 3 FAA Databases can be found at http://www.faa.gov/ certif ication/aircraft/. 31 Carter et al. 2000 op. cit; Trent & Monczka. 1998, op. cit. 32 ISM 2002 Benchmarking Study op. cit. 3 For an introduction to many of the analysis techniques behind strategic sourcing see Krajlic, J. op. cit., Smeltzer, et al. op. cit., and Porter, M. E. 1980. Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: Free Press. 3 Kelly, S., op. cit. 3 We refer the reader to the previously cited empirical works of Dyer (1996) and Heide and Miner (1992). These works stress the importance of a long-term perspective in supply base de- velopment. The reader may also wish to examine the subject area of parallel sourcing as demonstrated in Richardson, J. 1993. Parallel sourcing and supplier performance in the Japanese automobile industry. Strategic Management Journal, 14: 339- 350. 36 We refer the reader to two research articles demonstrate the importance of good relationships from an operations man- agement perspective. The first examines research and develop- ment from the supplier’s perspective: La Bahn, D. W., & Krapfel, R. 2000. Early supplier involvement in customer new product development: A contingency model of component supplier in- tentions. Journal of Business Research, 47(3): 173-90; The second examines relationships from the buyer’s perspective: Monczka, R. M., Peterson, K. J., Handfield, R. B., & Ragatz, G. L. 1998. Success factors in strategic supplier alliances: the buying com- pany perspective. Decision Sciences, 29(3): 533-577. 37 For the methods Toyota uses to create and maintain effec- tive buyer-supplier relationships see Dyer, J. H. & Nobeoka, K. 2000. Creating and managing high-performance knowledge- sharing network: the Toyota case, Strategic Management Jour- nal, 21(3): 345-367. Thomas Y. Choi is a professor at the W. P. Carey School of Business at Arizona State University and is director of Global Supply Chain Management Certificate Program. His work has appeared in the Academy of Management Executive, Harvard Business Review, and Business Horizons – where he received a Best Global Business Paper Award. He has done work with Honda, DaimlerChrysler, Motorola, and LG Electronics among others. Contact: thomas.choi@asu.edu. Christian L. Rossetti is a doctoral student at the W.P. Carrey School of Business at Arizona State University. His work has appeared in the Journal of Supply Chain Management and the Journal of Physical Distribution and Logistics Management. He has worked in strategic sourcing and logistics services in aero- space and other industries. Contact: christian.rossetti@asu.edu.
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