Lessons in A&D and Auto Supply Chain Strategy, Part 1: Supply Chain Challenges
by KPMG’s George Odden & Vincent Pavlak
In July 2010, Vincent Pavlak, a partner in KPMG LLP’s Transactions & Restructuring service group, contributed an article to Defense Industry Daily, titled, “Lessons from the Automotive Supply Chain: Surviving a Downturn.” At the time, the automotive industry was enduring one of the worst economic periods in history, and there were concerns that the aerospace and defense industry could suffer a similar fate. Ultimately, the automotive suppliers that endured the downturn have emerged stronger, due in part to critical efforts undertaken during the crisis. Meanwhile, the aerospace and defense industry has experienced a post-crisis divergence of paths, with commercial aerospace companies enjoying a resurgence parallel to the automotive industry while the defense sector has suffered declining revenues and prospects. Despite differing outlooks now facing each industry, supply chain enhancement presents opportunities for increased competitive advantage for aerospace, defense and other industries across varying economic cycles.
Part 1 deals with the key challenges facing these industries’ supply chains.
Highlights from the Global Manufacturing Outlook
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In the aftermath of the economic crisis, each industry – automotive, commercial aerospace and defense – faced enhanced uncertainty risk. Since then, each of these industries has experienced divergent paths and issues, with the automotive and commercial aerospace industries operating within an improving economic environment, and the defense industry facing a declining environment. Notwithstanding, leading organizations within each of these industry verticals have been focused on reviewing their supply chains to position themselves for operating efficiencies and sustained competitive advantage.
In fact, management and efficiency within the supply chain remains a top concern for global manufacturers across industries. According to the Economist Intelligence Unit’s Global Manufacturing Outlook, which was sponsored by KPMG International and conducted in November 2012, 26% of all respondents stated that risk, reliability, and flexibility in the supply chain are one of their business’ biggest challenges over the next 12 – 24 months. For A&D participants, the response rate was even higher, with 32% of respondents confirming that supply chain risk, reliability, and flexibility were the biggest challenges – the 2nd most cited challenge overall for these participants.
The increased scrutiny on the supply chain is likely enhanced by recent events within both the automotive and A&D industry. Perhaps the most memorable automotive supply chain interruption in recent history was the March 2011 earthquake and ensuing tsunami in Japan. This natural disaster resulted in significant disruptions to many manufacturing entities’ production, including the shutdown of a Japanese supplier that was the only global producer of a pigment used in paint, causing certain major automotive OEMs to restrict specific vehicle colors for a period of time.
Within the A&D industry, managing the supply chain poses a challenge for participants large and small, with evidence presented by Boeing’s initial production of the 787. As cited in the Wall Street Journal, Boeing executives say:
“…their heightened sensitivity to the supply chain stems partly from the many troubles Boeing had in producing its first 787 Dreamliners, which depend more heavily on parts made outside of Boeing than other jets. Boeing delivered the first of the new jets more than three years late partially because of its failure to manage its supply chain early on.”
Top supply chain challenges
While supply chain difficulties can take many forms as highlighted by the above stories, participants in the Global Manufacturing Outlook identified four top challenges facing their supply chains:
1. Aligning operations to real-time fluctuations in customer demand.
2. Supplier performance in terms of risk, reliability and quality.
3. Ensuring sufficient supplier capacity to meet demand.
4. Lack of information and material visibility across the extended supply chain.
Challenge #1 – Alignment
The toughest alignment involves real-time or short-term fluctuations in customer demand. Whether customer demand is on an increasing trend such as in automotive or commercial aerospace, or a declining trend such as in defense, adapting operations and cost structure can be a significant challenge.
There is a trend among companies that want to increase collaboration with supply chain partners to proactively address demand changes. For example, many are seeking to implement a “demand-driven supply chain” model, which focuses on better aligning their planning, procurement, and replenishment processes to actual consumption and demand changes. By automating processes and reducing information latency, companies can:
- Reduce operating expenses;
- Act on real-time demand insights;
- Identify potential inventory shortages or overages; and
- Improve sales performance and customer satisfaction.
The greatest challenge for adopting this model may be philosophical, given the historical industry practice of guarding information due to lack of trust between supply chain partners.
The ability of A&D companies to efficiently partner with suppliers is increasingly critical, as recently emphasized by Rolls Royce Chief Executive Officer Andy Page: “Aerospace has a very deep supply chain and first tier suppliers have to have the ability to manage second tier suppliers.” Page also emphasizes cost control as a pivotal skill. This is especially true in periods of demand uncertainty, such as the one currently being experienced by the defense sector.
As collaboration efforts improve and the pace of business increases, it’s anticipated that there will be a continued movement and interest in demand-driven supply chain models. Further, once these models are proven effective, increased participation will follow.
Challenge #2: Performance
Supplier performance includes risk, reliability and quality.
There is heightened awareness throughout organizations of understating potential risk and resiliency in the supply chain. In fact, there are additional new technology solutions that are being developed to assist with the monitoring of the supply base from a diverse set of criteria.
A critical component to a company’s supply risk process that is often lacking is a complete, 360 degree view of supply risk. Often, there is a focus on one element such as financial performance, quality, or delivery metrics. Further, there are frequently separate departments within an organization tracking their own supplier metrics, but not linked with other groups throughout the company.
One key component to developing a leading supply risk process is to compile the most critical internal data into one system. Combining this data with external factors such as country risks, currency risks, and regulatory risks, can provide a complete supplier risk profile. While it’s not practical to identify and mitigate every potential risk, being armed with data and having a process to address the most likely and significant risk elements is sound practice.
Lastly, while focusing on risk mitigation within the supply chain is often given priority, it’s important not to lose focus of the importance in understanding the resiliency within the supply chain.
In practical terms, it means understanding the time and process to recover from a supply chain disruption.
Understanding supplier performance, especially in terms of financial risk, could become more critical for participants with a heavy reliance on the defense sector. As certain segments experience decline, this could ultimately impact the supply base revenue and profit performance. Understanding this impact on the ultimate risk for the supply base could lead to additional financial distress, bankruptcies or consolidations, as entities look to merge operations to achieve scale.
Challenge #3: Capacity
Sending representatives to the supplier site to perform a detailed analysis of capacity and product launch readiness, while working collaboratively with the supplier on solutions, is now common practice. However, it’s imperative that site visits focus on detailed capacity studies and seek to understand various aspects of the supplier operation, including other customer demands; future business requirements; sufficiency of capital / equipment; labor force; and supply chain management.
it’s likely that if the industry were to move more toward the demand-driven model, this would also create more visibility and allow for quicker reaction to capacity issues in the supply chain.
The automotive industry’s focus on increasing sales volume has caused struggles within the supply chain as they try to keep up with demand in certain segments. This is exacerbated by the fact that one really needs to understand capacity throughout the various tiers of the supply chain to have a true picture of capacity constraints.
Since capacity issues can have a multitude of negative consequences such as loss of revenue, unhappy customers, and delay in speed to market, automotive OEMs have been taking action to ensure that they have sufficient information to understand their supply base capacity needs / demand.
Challenge #4: Visibility
The Global Manufacturing Outlook also noted that most companies have little visibility beyond their tier one suppliers. In fact, the largest proportion of respondents indicated having limited tier one supplier visibility, and no visibility into the tier two level and beyond. A&D respondents indicated experiencing even less supply chain visibility overall, with a higher number of A&D companies reporting “no” or “some” visibility compared to the whole, while fewer A&D companies report “enhanced” or “complete” visibility.
This lack of visibility into the supply chain makes it more challenging to reduce risk, which can result in increased cost and inefficiencies within the supply chain. Furthermore, as evidenced by several natural disaster incidents, without visibility into the supply chain, it becomes increasingly difficult to assess the impact and/or recover from unplanned disruptions. For example, if a company is unaware that a tier two supplier is located in an earthquake danger-zone that supplies a critical product to the ultimate finished goods, there is an inherent risk to the supply chain.
A key takeaway is that companies may decide there are no viable options to mitigate a potential risk; however being caught surprised is not acceptable in today’s global business environment. Further, as supply chains and operations continue to expand beyond the US, supply chain visibility becomes increasingly challenging but potentially more critical to understand.
A lack of understanding of other cultures, business practices, and distant locales has often led to public embarrassment, regulatory issues, fines, and other actions as US-based entities expand globally.
One example of regulation impact on supply chain participants within the US are the conflict minerals rules of the Dodd-Frank Act, which mandate SEC entities to disclose in their financial statements the use of certain metals derived from the Democratic Republic of Congo (DRC) anywhere within its supply chain. Regulations like this have led companies to spend time and resources developing and documenting a process to understand sourcing of components throughout its entire supply chain.
Tomorrow – Part 2: Supply Chain implications, trends, and opportunities…
Vince Pavlak is a Partner in KPMG LLP’s Transactions & Restructuring service group. Based in Detroit, MI, he has more than 19 years of experience leading a diverse group of supply chain advisory projects. Vince specializes in the manufacturing and automotive sector.
George Odden is a Managing Director for KPMG Corporate Finance LLC. Based in Phoenix, AZ, he is a skilled aerospace and defense professional with more than 18 years of experience. A decorated veteran, George served as a lieutenant in the US Navy.
Use the links above to contact them. Taylor Miller, Senior Associate, KPMG Corporate Finance LLC; Aaron Racey, Director, Transactions & Restructuring, KPMG LLP; and Jack Williams, Manager, Transactions & Restructuring, KPMG LLP also contributed to this article.
