2008 AVIATION WEEK A.T.

KEARNEY A&D SUPPLY CHAIN STUDY 1

Aviation Week- A.T. Kearney
2008 Aerospace & Defense Value Chain Study
A.T. Kearney Executive Summary
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 2
With strategic partnerships more critical than ever, A&D
industry finds ways to meet customer demand for
speed, innovation and quality through integrated value
chains

The aerospace and defense industry is enjoying its strongest market ever, according to the 2007 Aviation
Week A&D Programs Conference: Demand by the worlds airlines continues to increase, government
defense spending is at the highest in decades, production is at record levels, the roll-out of new commercial
and defense aircraft continues unabated and more innovative technology is required at a faster-than-ever
pace.

Could it be argued that the strongest market ever presents convincing proof that the aerospace and
defense industry (the A&D eco-system) has learned the worth of speed to market, rapid innovation and
collaboration -- essential earmarks of value chain integration?

According to our recent industry survey, however, the concept is not universally accepted within the A&D
eco-system although other industries, most notably High Tech, Consumer and Automotive, have more fully
embraced the notion. We define value chain as all the interactions that create and add value in the process
from innovation and new product development to raw material supply to finished product and lifecycle
support.

The success of a company within the A&D eco-system depends more critically than ever upon the
performance and capabilities of others many others, in most cases. Open collaboration and tighter
integration among manufacturers and suppliers, with a systems integrator at the lead, is creating a more
networked and cooperative structure. As companies become increasingly virtual and global, competitive
success depends on the will and the ability to configure and execute their value chains optimally.

At the same time, competitive pressures are intensifying. They include reduced barriers to entry, rapid
market globalization, shortened product lifecycles, increasing technological complexity, downward pricing
trends and escalating profitability demands. Shareholder expectations anticipate continued growth and
profitability. The demands made by systems integrators reflect ever-changing customer requirements and
their pushing an increasing share of risk exposure to original equipment manufacturers and suppliers along
the chain.

Supplying customer-required, technically-complex products in a short period of time in a competitive
environment while meeting shareholder expectations makes close, strategically-driven partnerships
crucial. The driver is the customer, the end user, who is demanding:
more innovation
less time to market
longer-term product support and service

As these requirements percolate from the customer throughout the different tiers of the supply chain, we
believe sustained business growth will be earned by moving from a transaction-based vendor or contractor
to a strategic partnership. The transactional business, as our survey identifies it, defines a supply chain
simply in terms of buy and sell transactions.

Time was when new product innovation was developed solely within Research and Development (R&D).
An engineer had a great idea, developed it and, more often than not, sent it to the federal government with
the hope that it would meet some need or that an application for it could be found.

But that was then; innovation now is market-centric. Companies are asking their customers what they want
and need. Then the task is to develop and deliver the product to market -- before its obsolete. Most
frequently, the customer-driven quest for innovation extends far beyond what was once a deciding
differentiator, the business core competency or technology. The profound complexity of todays products
and systems means that no single firm has the technological, financial and risk-bearing capability to
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 3
develop a new airliner or jet fighter, for example, on its own. To try to do so without teaming across the
value chain would severely constrain depth, breadth and speed of innovation.

Today, organizations are moving further up the integrated value chain to meet the customers need for a
more innovative product that can be delivered to the market faster than ever, with the capacity to provide
longer-term product support and service. Businesses are seeking strategic partnerships with global firms
offering the best in breed technology; physical location is becoming increasingly less important. The key
objective? To meet the customers need for innovation through collaboration.

Fortuitously, these strategic partnerships often lead to long-term business relationships and engagements.
Customers seeking support for the life of the product can provide a long-term (and stabilizing) revenue
stream for the organization with the capability to offer maintenance, repair and overhaul throughout the
products lifecycle.

Although the days of the vertically integrated behemoths are over, have companies within the A&D eco-
system successfully achieved an optimal, integrated value chain system characterized by fully-functioning
partnerships? The answer is yes and no.

We say yes because some companies are focused on the ultimate customer and use the value chain as the
lens through which they see the complete process and their unique role in it. Operating on this inclusive
perspective, they can anticipate change by seeing it before it gets to them and are in position to adopt
new, fresh and flexible strategies. Such organizations embrace their role and position in the value chain
and use it to their advantage as a competitive differentiator.

We say no because some companies too many, we suggest continue to work the old transactional
system while maintaining an almost myopic focus. Unable to see no farther than their loading docks, they
just dont appreciate the potentially disastrous bullwhip effect up and down the value chain of a late
arrival from their suppliers or a late delivery to their customers. Such organizations are not committed to
the value chain concept by decision or default. Over the long term, their performance or lack of it
will drive them from the chain

The organization that perceives its role as purely transactional is in an awkward position where business
as usual cannot be the path forward. To foster long-term growth, companies need to adjust their mind sets
and their strategies, taking into consideration their program role and position in the industry. At the same
time, they must embrace emerging business models that are more conducive to innovation and responsive
to rapid change while being sensitive to co-opetition and intellectual property risks.

Some of the key characteristics for a company to remain competitive in todays emerging A&D eco-system
include:
focusing externally
executing a customer driven product strategy
leveraging a capital and cost efficient infrastructure
proactively developing (and participating in) integrated programs that foster collaborative relationships
embracing new information requirements to provide real-time visibility at all levels of the value chain

Figure 1: A&D Eco-System Value Chain
Collaborative
Virtual
Synchronous
Adaptive
Agile
Demand
Generation/
Sales
Innovation/
New Prod
Dev.
Source Make
Deliver/
Return
Requi red Capabi l i ti es
Across the Val ue Chai n Ecosystem
Innovation/ New Prod Dev.
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 4
Are A&D Eco-System Value Chains Optimally Configured?
In a recent A.T. Kearney and Aviation Week survey of A&D companies, we learned that partnerships in a
value chain can be viewed on a continuum from transactional supplier to fully integrated strategic
partner.

The survey shows that although prime integrators have mostly moved away from transactional relationships
and have assumed more of a value chain integrator role, upstream suppliers still view the value chain as
discrete supplier-customer relationships. Prime integrators are the most sophisticated relationship
managers in the group taking into account a balance of trade between partners. Upstream suppliers are
likely to look at relationships as discrete buy and sell transactions.

Figure 2: The Value Chain Partnership Continuum]


None have achieved a fully integrated value chain; Prime Integrators are farthest along in value chain
integration

Prime integrators say they have partners in most steps of the value chain. Partner flexibility in the
innovation, sourcing and life-cycle support phases of the value chain is most important to them.

Tier 1 contractors say they have partners in several steps of the value chain. Partner flexibility in the
innovation and life-cycle support phases of the value chain are most important to them.

Tier 2/3 contractors say they do not have plans to partner in most steps of the value chain. Partner
flexibility in manufacturing, sourcing and delivery is most important to them.

Our key findings:
1. Companies partner substantially in each step of the value chain, but degree of partnering
diminishes upstream. Prime integrators are seen as and expected to exercise partnership integration,
while Tier 1 contractors partner to a lesser degree. Tier 2/3 respondents indicated no partnership, except
in one step of the value chain.


2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 5
Percentage of companies who currently have partners in each of the value chain steps















Percentage of respondents

2. In spite of the prevailing wisdom of looking beyond sole suppliers to achieve better value chain
performance, companies do not engage in competitive sourcing unless directed by their
customers. Although overall customer pressure ranks first, the most important factor for Tier 1
suppliers is competitive market intensity. Prime Integrators pass on price pressure from upstream
customers, but do not proactively work on selecting partners with lowest costs.

To what extent is each of the following factors a driver that influences the decision on competitive
sourcing vs. using a sole supplier?



















Percentage of respondents that answered this question



100%
50%
75%
100%
100%
75%
100%
20%
40%
50%
80%
40%
60%
33%
0% 25% 50% 75% 100%
Innovation/ Product
Dev
Source (e.g., RFP,
Purchase)
Deliver (Outbound
Logistics)
Post Delivery
(Maint./Sustainment)
Prime Tier 1 Tier 2/3
14%
29%
43%
14%
36%
57%
43%
21%
36%
21%
0% 25% 50% 75%
Ease of market entry from
competitor
Availability to substitute products
Customer pressure (e.g., cost,
changing req)
Supplier pressure (e.g., volume,
cost, quality)
Competitive market intensity
High Driver
Medium Driver
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 6
3. Companies seek long-term contract arrangements primarily for pricing. In new programs, an
estimated 75 percent of the suppliers are incumbents, indicating a strong preference for working with
known entities. Prime Integrators say the most important factor in seeking long-term contracts is the
partners performance capability. One Tier 3 contractor cited trust as the most important, but most Tier
1/2/3 participants said cost is most important.


What are the top 3 reasons you seek long-term agreements?





























Percent of respondents











4. A majority of Prime Integrators manage their dual roles as both a supplier and customer to other
companies in a unified fashion, but less than half the Tier 1/2/3 contractors follow suit.
Relationship management becomes less sophisticated and less is required the more a company moves
upstream in the value chain.





31%
15%
15%
8%
15%
8%
8%
8%
8%
23%
15%
15%
15%
15%
15%
8%
8%
23%
8%
23%
8%
8%
0% 20% 40% 60%
Better Pricing
Lock Up Existing Technology
Lock Up Performance Capabilities
Enable Continued Access to Markets
Secure Innovation Capabilities
Mutual Trust
Compatible Cultures
Strategic Alignment
Minimize Contracting Costs
Minimize Systems Integration Costs
Others
Most Important
Second-most Important
Third-most Important
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 7
How do you balance your role as both a supplier and customer to other companies?















Percent of
companies in
each segment
that do not
manage the
relationship
Percent of respondents that answered this question(1)




5. Companies consider Technical Expertise the most critical partner capability; Information
Technology is not considered critical. Almost all survey participants (85 percent) said the ability to
identify partners who meet technology/process capability requirements is important. None ranked IT
capability as critical in the selection of a value chain partner.


Technical Expertise
Process Expertise
Resources
Information Tech.
Risk Sharing
Compliance
Access to Markets
Political Influence
Innovation/ NPD Source
Make
Deliver
Return
Lifecycle
Critical
What partner/supplier capabilities are most critical at specific steps along
the value chain?
Note: The color gradient plots the average response of all participants for each capability/value
chain step pair
Not
Critical
Demand Gen/
Sales
50%
21%
29%
29%
7%
14%
0% 30% 60%
Do not
manage buy
Integrated
scorecards /
Gai n and ri sk
shari ng across
Peri odi c revi ews
wi th partners
Si ngl e
Partnershi p
Not appl i cabl e
25%
60%
50%
0%
25%
50%
75%
Pri me Ti er 1 Ti er 2/3
Partner
capabilities
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 8


6. Top partner integration requirements are technology development and strategic alignment.
Survey data suggests that technology development and strategic alignment are key thresholds. Once
a potential value chain partner overcomes both, other factors are considered. Operating processes rank
behind technology development and strategic alignment. Neither information systems integration nor
compatible cultures are considered important.























What are your top three partner/supplier integration requirements?
21%
14%
29%
7%
29%
14%
14%
14%
7%
7%
14%
7%
29%
14%
36%
43%
0% 25% 50% 75%
Forecasting and
Planning
Operating
Processes
Technology
Development
Information Systems
Transaction
Processing
Compatible Cultures
Strategic Alignment
Most Important
Second-most Important
Third-most Important
Percent of respondents
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 9
7. Quality, Cost and Service Performance are the top three reasons for replacing an incumbent
partner. In choosing a partner for a new project, an incumbent has a distinct advantage: incumbents
are selected three times out of four. Cost and service performance are next, according to the survey. In
replacing an incumbent, the overwhelming reason is lack of quality. Access to markets, customers or
intellectual property and the maturity of a potential partners value chain processes were not considered
important.






















What are your top three drivers for replacing an incumbent?
21%
57%
14%
7%
14%
43%
7%
36%
7%
21%
7%
21%
7%
36%
0% 25% 50% 75% 100%
Cost
Quality
Service
Performance
Capacity
Constraints
Order-to-Delivery
Cycle Time
Technical
Capability
Participation In
Competitors Bids
Most Important
Second-most Important
Third-most Important
Percent of
respondents
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 10
8. Partner/Supplier steering committee is the most used approach for governance of the value chain.
Most prime integrators and Tier 1 contractors consider a clear and effective governance model to be
important, as opposed to 50 percent of Tier 2/3 contractors.





Our survey tells us an effective integrated value chain is composed of partners who coalesce around and are
driven by:
Past dealings or history of the relationship. If your company has been a reliable member of the value
chain, your prospects for continued business are excellent. But a word of caution: If a customer asks
for products or services beyond the capabilities or quality standards of your transactional company,
dont jeopardize your future. Say no.
What the customer wants. Our survey demonstrates the value of knowing your role on the continuum
in relation to your customer and the ultimate customer. If you can continuously bring a unique product
or service to a partnership, it probably can sustain your business into the future. But you must be very
good at it, and you cannot be satisfied with the status quo.
Prospects of winning future opportunities by partnering. Let customers know where you are in the
market and on the continuum. They must know your capabilities and intentions. If you want to stay
small, you can; if you want to grow, youll have to commit to change. You will need to demonstrate
how you can uniquely contribute to innovation, competitive differentiation and/or superior cost or
performance in making your other value chain partners successful and making yourself indispensable.
If that is your choice, youll need to begin the process of transforming your value chain.


15%
46%
31%
8%
46%
15%
15%
15%
31%
8%
23%
15%
0% 25% 50% 75% 100%
Collaborative Forecasting and Planning
Partner/supplier Steering Commit tee
Prime int eract s only with Tier 1s, and
upstream participants are managed direct ly
by Tier 1s
Prime interacts directly wit h all Tiers as
needed whether relationship is cont ractually
defined or not
Most Important
Second-most Important
Third-most Important
What are the top three approaches that best characterize
the governance model for your largest revenue-generating value chain?
Percent of respondents
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 11
Begin to transform your Value Chain
Based on our experience with helping clients develop an optimized integrated value chain unique to their
industries and competitive environments, we believe a firm wanting to transform its value chain must focus
its initial efforts in these areas:

1. Identify the product or service demand and define the needs as they are aligned with your overall
business strategy. We worked with a North American high-tech equipment manufacturer having
problems with on-time deliveries to its customers. Its foreign-based suppliers, chosen on the basis of
lower costs, hindered the firms ability to be responsive and flexible to rapidly changing market
demand. While better planning and coordination seemed a logical solution, accurate forecasts were all
but impossible as customer demand changed quickly. We helped the firm develop an integrated value
chain based on two-tier product design criteria--high commonality, lower cost and low commonality,
higher cost. Because all suppliers could not meet the firms increasing demands for speed, cost and
custom configuration within 2-3 weeks lead time, the value chain was modified to this differentiated
model. We advised the firm to leverage its local, more responsive suppliers of critical components to
increase its responsiveness and flexibility and to maintain longer lead-time relationships for suppliers of
predictable, more costly components. Supplier performance management became a key senior
management priority and a critical competency. As a result, on-time-delivery increased to 90+% within
6 months and order lead time dropped to 2-3 weeks from 6-8 weeks. The direct, overarching message:
Improve your value chain design. Make certain that goods are moving at the right pace to support your
current business strategy and current business environment. If either your strategy or competitive
environment has changed and your value chain design hasnt, its time for a redesign. This process of
value chain redesign enhances the firms ability to identify and establish its distinctive supply chain role
-- integrator, sub-system integrator, ODM, Tier 1/2/3 -- at product or service value chain stages.

2. Find best partners who align most closely with your goals and capabilities. External suppliers are
critical elements in your integrated value chain; our studies show that as much as half of the value
chains cycle time is consumed by suppliers. For that reason, many electronics manufacturing services
(EMS) supplies have moved manufacturing to China to be closer to their electronics components
sources. At the same time, theyve implemented just-in-time manufacturing, switched to batch
processing and synchronized their production with component manufacturers to respond quickly to
market changes and customer demand. In this case, the firm also benefited from lower labor costs for
assembly work. By shipping directly to customer warehouses, EMS suppliers reduce the length of the
integrated value chain and cycle time, while eliminating wait time in many cases. Moreover, some
EMS suppliers are establishing product development labs closer to their customers R&D centers to
develop and roll out product innovations faster than ever.

3. Structure agreements to enable required capabilities appropriate to the spectrum of relationship.
An agreement with a strategic partner can provide for greater information sharing, enable technology
and increase communications. In contrast, an agreement with a transactional supplier can call for little
more than efficient transaction execution and help assure supply reliability. An Original Equipment
Manufacturer (OEM) who had outsourced significant elements of the value chain to third party
suppliers structured all its agreements in a series of "typical" sourcing relationships with Service Level
Agreements (SLAs) based on plans to measure the suppliers' performance. This one size fits all
approach led to sub-optimization of the overall supply chain. Through restructuring agreements
appropriate to the suppliers role, better alignment among the suppliers was achieved and the supply
chains performance improved; on-time delivery increased from 70% to more than 95%. Within these
SLAs, each business also must identify the partnerships value chain governance and operational
principles, including intellectual property sharing and project management.

4. Establish connectivity and IT decision and transaction support. Simplified transactions processing
is essential to an integrated value chain. In the purchasing function, for example, paper-based,
individual-approval systems can consume valuable management time and result in little, if any,
quantifiable savings in time or money. A global client firm reduced its purchase order (PO) processing
time from 30 days to less than one day by converting to electronic catalogs. The catalogs contain
frequently ordered supplies from approved suppliers at verified prices and, in many cases, the
automated approval process is linked to budgeting tools. Using the catalog frees the firms buyers to
2008 AVIATION WEEK A.T. KEARNEY A&D SUPPLY CHAIN STUDY 12
focus on strategic issues rather than manage each transaction. Significantly, some firms are reducing
their manual efforts by linking their sales catalogs with their buy-side catalogs. When a sales order is
placed, an order to the corresponding supplier is triggered automatically if the on-hand supply has
reached pre-determined levels. Electronic catalogs, linked IT capabilities and transaction support
provide sustainable benefits: Our client reported a shift resulting in 95% of its purchases being done
electronically and a drop in PO processing time to less than a day from almost a month. Customer
satisfaction scores almost doubled.

5. Develop metrics to determine how each partner will measure success. The $25 billion, nine-nation
development of the J oint Strike Fighter (J SF) F-35, involving Lockheed Martin, the Boeing Co., and
scores of other global suppliers relies on performance metrics that change from qualitative to
quantitative over the life of the project. Designed to cover three major drivers of overall system
availability Supply Delay Time, Maintenance Delay Time and Uptime -- the metrics are tied to a
decade-long series of specific milestones along the J SF development/production lifecycle. The goal is a
system that initially provides a series of qualitative evaluations of each suppliers plan to participate in
the program. As the plan matures, the system switches to a quantitative evaluation of each suppliers
performance. Developing metrics that help each partner measure its successes and identify the lack
thereof requires addressing the implicit need for evaluating and adapting to integrate new partners and
separate existing ones.

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