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Ways to Effectively Address Supply-Chain Risk Laid Bare by COVID-19

By Karen Haywood Queen Contributing Editor, SME Media

When the COVID-19 pandemic hit, many aerospace and defense manufacturers realized they were not resilient enough to withstand the resulting challenges in their supply chains. In many cases, the pandemic brought to light problems that already existed, including over-reliance on single-source suppliers, too few suppliers, too much emphasis on the lowest bidder and a lack of visibility into the entire supply chain, industry leaders said.

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Mitigating the reliance on single-source suppliers is a key issue to consider moving forward, said Thomas Derry, CEO of the Institute for Supply Management. Above, he speaks with Janet Yellen, former Federal Reserve chair at the ISM2019 conference in Houston.

“Prior to COVID-19, manufacturers focused on being lean, efficient, just in time,” said Dave Chesebrough, VP of divisions at the National Defense Industries Association (NDIA). “What that introduced, unwittingly, was a great degree of fragility. Manufacturers didn’t have the ability to work through the disruption. Just-in-time manufacturing depends on production scheduling where materials or parts are delivered to the assembly line just when they are needed. If that supplier is unable to do that, it shuts the whole assembly line down.”

Avoid single-source supplier trap

Institute for Supply Management CEO Thomas Derry said the pandemic exposed the extent we are reliant on single-source suppliers. “One of the main drivers in efficiency of supply chains is to get down to the minimum number of suppliers and leverage your spend volume, directing as much as you can toward the supplier who can provide the best possible price,” he said.

The A&D sector carries more inventory than other sectors, and for that reason it was not hit quite as hard as other manufacturing sectors when supply lines frayed or broke, Derry said. But mitigating the reliance on single-source suppliers is a key issue to consider moving forward, he added.

“We all knew about the Chinese New Year and the interruption that comes with that,” Derry said. “We didn’t anticipate the extension of that Chinese New Year holiday by several weeks or a month by the outbreak of the coronavirus. We didn’t anticipate not being able to replenish our stocks.”

The pandemic made problems resulting from the paucity of suppliers even more clear.

Since 2011, 20 percent of aerospace and defense companies have left the sector, according to a federal inter-agency report, “Assessing and strengthening the manufacturing and defense industrial base and supply chain resiliency of the United States.”

“Today, we rely on single domestic sources for some products and foreign supply chains for others, and we face the possibility of not being able to produce specialized components for the military at home,” the report reads.

Build more risk awareness

Diversifying your pool of suppliers is not easy because non-disclosure agreements may not cover you fully against leaks of intellectual property. But it’s a worthwhile goal to avoid idle factories for months, said Maurice Kugler, professor of public policy in the Schar School of Policy and Government at George Mason University and a former senior economist at the World Bank.

“Long-term, continual attention needs to be paid to the defense supply chain to ensure that it remains healthy and vibrant and continues to attract new entrants,” said Wes Hallman, the NDIA’s senior VP of strategy and policy.

Despite the risks of relying on single-source suppliers, diversifying the supply chain may not always be possible, said Sam Jacobs, associate managing director with the cyber-risk practice of Kroll, a division of Duff & Phelps.

Manufacturers may, however, be able to hedge their bets with better planning and awareness of the risks, he said.

“We have to be honest with ourselves,” Jacobs said. “There will likely always be single-source suppliers in the supply chain for a certain kind of business, one producing products and services on the leading edge. If you’re making chewing gum, if you’re making a highly commoditized, low-tech product, you might be in a position where you can make a concerted effort to diversify your supply chain and weed out those single-point failures. But if you’re making a highly technical, highly integrated weapons system, there are going to be some components where the supplier you have is the only one—because it’s a leading-edge component and they’re the only ones who have figured out how to make it at cost and scale.”

Manufacturers need to be keenly aware of the potential disruptions from problems at a single-source supplier, he said. “Knowing the guys who make this highly specialized radar chip are the only ones who could make it, companies need to plan accordingly, knowing that they’re not going to be able to diversify and understand when in the future diversification might potentially be an option.”

To build and protect the sector, more government incentives are needed, Hallman said.

“The government is not the most fabulous customer to deal with,” he said. “The government makes the rules and is judge, jury and sentence for the enforcement of those rules. It’s a tough customer to deal with.”

Plan for hard-to-find replacement parts

Another supply-side issue is the ability to repair and maintain older equipment that relies on components that may no longer be manufactured, since most other products that use micro electronics are constantly updated, Chesebrough said.

“The micro-electronics industry is mostly driven by consumer demand for iPhones and other electronic devices,” he said. “Some of the older micro processors are based on older technology and suppliers are going to stop production of those parts. How do you keep an older system going?”

“When something goes out of production and yet is still in service in the military, how do we qualify alternate sources of supply to provide the part necessary to keep that system going?” Chesebrough said. “Everyone points to the B-52 bomber as an example of a system kept in action longer than its intended life cycle.”

According to its manufacturer, Boeing, the first B-52 flew Aug. 5, 1954, and the continuously upgraded plane may fly well beyond 2040.

To remedy running out of replacement parts, the Department of Defense is considering options, such as lifetime buys of parts, Chesebrough said. “That sounds good but how do you justify the impact of a lifetime buy of a part when you don’t know how long you’ll need it?”

Another challenge for products with long life cycles is the increased risk of counterfeit components creeping into the supply chain, Derry said.

Do more vetting

On the demand side, COVID-19 impacted aerospace and defense in two key areas, Kugler said.

For months, “travel ground to a halt,” he said. “There was no demand for travel. That means airlines are going to revise their orders of new airplanes. They are all going through a new process, scaling down and revising their budgets. This impacts heavily on the producers of airplanes.”

In turn, airplane manufacturers don’t know how much, if any, components to order from their suppliers, Kugler said. Some of those relationships may be severed.

“What happens here in the United States in the aerospace and defense industry impacts suppliers,” he said. “It’s not evident you can pick up where you left off after a year or two like nothing has happened.”

Also on the demand side, countries that may have wanted to bolster their defense capacity may have had to divert spending to unemployment and public-health benefits during the pandemic, Kugler said.

Manufacturers are learning from the pandemic and adopting new supply-chain plans and policies for the future.

“That was a lesson learned for our supply-chain community,” Chesebrough said. “Manufacturers had an unwitting reliance on parties that were somewhat not trustworthy in terms of not being prepared or as resilient, or not paying attention to the attributes of their own operation that would make them trustworthy in this type of situation. Now they’re rethinking how to construct their supply chains, who should be a trusted supplier. They’re vetting and monitoring their supply-chain partners.”

Consider just in time for just some parts

As with single-source suppliers, manufacturers won’t completely back away from just-in-time manufacturing but they will approach low inventory levels in a more customized fashion so they can meet obligations to their clients, Jacobs said.

“I don’t think we’ll see a widespread retreat from just-in-time delivery. But I think the pandemic will cause manufacturers who have been treating everything as just in time to adopt a more tailored approach to parts of their supply chain where they need to,” he said. “If you know that (a delay at one supplier) is going to immediately halt your delivery to the final customer, it’s time to consider preparing some inventory that helps mitigate that blow. If it’s an immediate work stoppage, a manufacturer needs to consider how many days of insurance they would like to buy with inventory. For example, if the manufacturer can continue delivering for two weeks after the supply stops, is that enough to meet obligations?”

Review contractual arrangements

Moving forward, aerospace and defense companies must understand and rank the severity of supply-chain risks, industry experts said.

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Manufacturers can’t depend on their subs to monitor subs farther down the chain, making the use of supply chain mapping tools necessary, said Wes Hallman, senior VP of strategy and policy at the National Defense Industries Association. Above, he speaks at the 2020 NDIA Tactical Wheeled Vehicles Conference, in Austin, Texas.

“Understand the severity of that risk. Start with a review of your contractual arrangements with that supplier,” Jacobs said. “What are the obligations and incentives in the contract? Understand what are their obligations in the event of a disruption and whether or not those obligations provide sufficient risk protection. That’s the beginning: Which company bears the risk if the supplier can’t meet their obligations? If that supplier can’t continue delivering, how is that going to affect the rest of the production process? It’s important to understand the relationship well and to negotiate those incentives or disincentives specific to that situation.”

Use mapping tools to go deep and rate partners

Manufacturers need to completely map their supply chains, using one of the many supply-chain mapping tools on the market, he said.

“Primes have a good idea of their subs,” Jacobs said. “But they don’t have a good idea of their sub’s subs. It can go many levels down. When one of those unknowns breaks in the chain, like it has in the course of the last few months, that breakage reverberates all the way up the chain.”

Put another way, manufacturers can’t depend on their subs to monitor subs farther down the chain, Hallman said.

“The more we talk about this, the more everyone realizes that you can’t just depend on the one company and have no visibility to the one below that,” he said. “There needs to be visibility across the entire supply chain so manufacturers can invest in mitigating those vulnerabilities.”

A&D manufacturers need to map and rate their supply chain partners based on several key factors, including performance, price, timeline delivery, security and resiliency, Jacobs said. Once a company has mapped its supply chain, the job isn’t done. As conditions and partners change, that mapping must be continuous.

“We frequently see clients who don’t have any sense at all of the cyber hygiene of their suppliers,” he said. “But a successful cybersecurity attack on one of their suppliers is just as much a risk as a successful attack on the client.

“Once we’re past the pandemic, people need to remember the frustrations and challenges of a broken link in the supply chain. From a cybersecurity perspective, people are accepting the risks that accrue to their suppliers in the supply chain. But they don’t have to. I’ve counseled many of our clients: ‘Take a look at the cybersecurity health of your major suppliers so you can understand the risk that accrues to you’.”

Use care when investing abroad

Another area where A&D manufacturers should be careful is in international investments and involvement.
“Some semiconductor technology, especially navigation-related or computer-related, is deemed too critical to national defense to be allowed to be acquired by foreign firms,” Derry said.

There may be a renewed call for additional “buy American” measures beyond the Defense Acquisition Regulations System, to ensure that a certain percentage of the A&D supply base is kept within the U.S., he said.

Specifically, reliance on foreign companies for microelectronics has been a concern of the Department of Defense, Chesebrough said.

“Our electronics division has been working with DoD on the issue of trusted microelectronics,” he said. “How does DoD assure itself that the microelectronics that its suppliers are purchasing in their supply chains are trustworthy?”

Even more critical, manufacturers should keep in mind that the Committee on Foreign Investment in the United States (CFIUS) closely examines foreign investments and can stop deals from going through and even force companies to reverse acquisitions, mergers and investments that have been completed, said Jacobs, the subject matter expert for the firm’s CFIUS practice.

“The government has indicated that they intend to take a keen and close look,” he said. “They can come after what seems like a good financial decision and order the parties to unwind the investment, irrespective of the cost. There are definitely instances where the national security risks that CFIUS identifies as arising from the transaction must and can only be mitigated by unwinding the transaction. That doesn’t mean foreign investment can’t be successful. But firms that are considering foreign investment need to understand the implications of a CFIUS review.”

“We can be confident that we’ll see a fair amount of consolidation as we begin to come out of this economic slowdown that this pandemic has caused,” Jacobs said. “There will be plenty of opportunities for aerospace and defense manufacturers to consider foreign investments as a path out of financial difficulty—merging with a foreign company or taking investments from a foreign company.”

Manufacturers need to make sure their suppliers haven’t become acquired by foreign entities in ways that will cause them to run afoul of CFIUS, Chesebrough said.

“The nature of that foreign ownership makes the supplier a little more untrustworthy,” he said. “That creates concerns up to the highest level of the DoD.”

Understand value of resilience

In the future, resilience may outweigh pricing and other factors.
“There’s a classic tradeoff in efficiency/lowest cost and resiliency,” Derry said. “Often, resiliency comes at the cost of some cost efficiency. One way aerospace and defense companies have been walking the tightrope between is to develop regional supply networks so as not to be reliant on one long sequential line from China to the rest of the world.”

For example, some A&D manufacturers are sourcing components from Mexico and are seeing the benefits of a lower transportation costs, low labor costs and a highly educated labor force, he said. “Aerospace and defense is ahead of other sectors in beginning to regionalize its supply chain for those reasons.”

Added Chesebrough: “We’re seeing a greater emphasis now on the realization that supply chain risk management has to be taken seriously up and down the supply chain. The prime contractors have to work with suppliers and suppliers’ suppliers to make sure there is resilience in production capacity all the way down to piece parts. That’s coming in crystal clear focus. The business relationship can no longer be, ‘Who can produce this part at the lowest possible price?’ Manufacturers have to look at it in terms of resiliency of supply.”

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