ARTICLE

August 2004

‘Virtual Supply Chains’ Could Help Bridge Manufacturing Gaps

by Steven G. Zylstra and Dennis Thompson

The Defense Department has immediate needs for thousands of products for which no domestic supplier can be found. Further, about a third of spare-parts shortages for Navy and Air Force aircraft and engines are attributed to “manufacturing issues.”

Because America’s manufacturers do not fully meet the need, defense agencies and their prime contractors are turning to foreign manufacturers to fill the gap. As natural a step as this may seem in today’s global economy, it has left the U.S. reliant on nations that could suspend production or cancel delivery as the result of policy disputes.

To understand the current situation, it is helpful to explore both ends of the manufacturing supply chain—the defense prime contractors and original equipment manufacturers (OEMs) at the ordering and receiving end, and the smaller manufacturers who traditionally have served as their vendors at the supply end.

For the last two decades, OEMs have been withdrawing—sometimes gradually, sometimes precipitously—from much of the direct manufacturing aspect of their industries. Prior to that, large manufacturers preferred to fabricate and assemble most elements of their products internally.

The automotive industry pioneered the shift to outsourcing functions, with vendors responsible for production and delivery of most components. The development and refinement of electronic commerce provided an important impetus for the new approach, as it gave faster tools for communication and collaboration to OEMs, and some of their main tier-one vendors.

It has taken the better part of 20 years, but the new model, with its promise of more efficient resource allocation, has become the rule rather than the exception. It is now the norm in defense industries as well. OEMs remain responsible for the broad design of their products, for research and development for final assembly. They are system architects and system integrators. But once they hand off the specs to their vendors, smaller companies manage most of the manufacturing.

So it is fairly easy to see why the country’s largest manufacturers alone cannot meet America’s defense needs: They no longer are primarily direct manufacturers.

At the other end of the equation, small and mid-sized manufacturers have been under prolonged pressure from the primes and OEMS in their quest for better prices and fewer vendors to enhance efficiency.

Small manufacturers—those that employ fewer than 500 people—represent 90 percent of firms contracted in leading defense sectors. Such companies, historically the backbone of defense procurement, receive 21 percent of prime contracts and 41 percent of all subcontracts the Pentagon awards to businesses.

Small businesses have spent the last decade eliminating waste from their systems, adding value for customers, adopting lean manufacturing principles and improving their processes in dozens of other ways, only to find that many of their heretofore best customers continue to source much of their work in lower-cost countries.

Those small manufacturers that have survived have grown tentative, unsure if they can justify investment in new product development or improvement, because in the current environment, they cannot predict what the return on their investment might be.

Many small and mid-sized producers are reluctant to pursue government work with its customary months of idle time awaiting qualification, contract reviews and initial payments. Just as significant, an alarming number of manufacturers have not invested in technology upgrades, depending instead on legacy systems that allow them to putter along. This tentativeness on the part of manufacturers helped to produce our so-called “jobless recovery,” when companies waited as long as they could to create and fill positions for fear that the economy would relapse.

Large defense primes and OEMs no longer manufacture, and small firms are no longer interested in supplying them and probably could not, even if they desired, because their technology infrastructure is insufficient. This is an impasse that, left unattended, will worsen.

One way to solve this problem is to “go virtual,” that is, to develop virtual manufacturing enterprises—integrated, collaborative virtual supply chains—that facilitate productive working relationships between defense primes and OEMs on the contracting side and small manufacturers on the supply side.

Virtual entities created for just this purpose would serve as a bridge or interface—both physical and electronic—between top defense contractors and their vendors. This may seem analogous to the role of chief subcontractor in the more traditional supply chain model, but there are important differences.

First, bridge organizations would be charged with recruiting and qualifying vendors and distributing contract specs to them. In the upward stream, bridge entities would be responsible for assuring quality and on-time delivery. Invoicing and payment also would flow through the bridge organizations, and all these functions would happen electronically.

Such virtual supply chains would help address the problems on both sides of the procurement equation. Large primes and OEMs would have the luxury of dealing with only one subcontractor—the VME—for any project, which would be an enormous savings in time and energy for them that also would assure an orderly, manageable process from RFP to completion.

Through the bridge, primes and their suppliers could collaborate, in real-time, on such critical tasks as design, drawing and modification. The virtual enterprises could ensure that an OEM contracts with a single, usually large tier-one vendor performing at the top of many supply chains feeding complex components.

Virtual manufacturing enterprises would be well positioned to respond to the demand surges that war often brings and to realign supply chains as circumstances dictate. Participating manufacturers would not necessarily play a role in every contract it awarded. Participation would be project-driven, with suppliers selected for their project-related capabilities, capacities and strengths.

For their part, small and mid-sized manufacturers would be less inclined to avoid defense contracts or bid them through the roof as a hedge against expected delays and disruptions. They could live without immediate, expensive IT upgrades required to secure defense work, because bridge entities would maintain multiple platforms that could interface with all vendor systems. In addition, the lengthy qualification and payment processes in the defense procurement system would be shortened significantly, since bridge entities would coordinate and expedite those functions.

Virtual enterprises could build an internet capability through a blend of off-the-shelf software and customized technology. The costs for the necessary hardware, software and integration resources are significant, but given the scope and volume of the potential contracts involved, this investment seems reasonable.

The VMEs also must be promoted, through seminars, white papers, trade show displays, news conferences and special events.

Finally, bridge organizations need to engage local universities as partners to complement a small handful of full-time staff. Staying lean should allow bridge organizations to price their bids competitively, and teaming with universities will assure that they have expertise and prestigious partners.

Southwestern Pennsylvania is preparing to launch a virtual manufacturing enterprise, called the Doyle Center for Manufacturing Technology, named for U.S. Rep. Mike Doyle. A proof-of-concept project is under way with a branch of the armed forces and a tactical aircraft manufacturer to develop a virtual supply chain for components of a new jet engine. The VME will be operational in 12 to 18 months and up to scale in 36 months.

The VME model could be deployed quickly on a national basis through the network of centers in the Manufacturing Extension Partnership, the nationwide system of regional centers that have assisted nearly 100,000 small manufacturers.

Virtual supply chains can provide the nation’s small and mid-sized manufacturers with the wherewithal they need to become agile, technology-enabled, low-cost suppliers.

At the same time, virtual supply chains will energize the procurement process, which has been so bureaucratic and cumbersome.

Steven G. Zylstra is the president and chief executive officer of the Pittsburgh-based Doyle Center for Manufacturing Technology. Dennis Thompson is the executive director of the Doyle Center.

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