Dear Performing Suppliers - April 25, 2012

What does it take to compete and win business in today’s aerospace and defense supply chain?

We’ve talked about 100% on-time delivery and 0 PPM quality performance. Our customer keynotes have focused on what our customers expect from us. Our LinkedIN surveys tell us that 100% on-time and 0 PPM are a given and customers are looking for a higher level of integration across the supply chain – they’re looking to us to collaborate to solve supply chain issues that they cannot solve on their own.

This report looks at the level of urgency that SEA suppliers have to improve their performance to these goals and discusses the consequences of ignoring the hard facts.

On-time Delivery

Why is there such a drive by the OEMs and Tier Ones to achieve 100% on-time delivery? Do they really require it? Is it really achievable?

Our customers have been working on speeding up production for over 10 years now. All new programs talk about run rates of one aircraft every 3 or 4 days at maturity. Costing and pricing was developed using those assumptions. There are massive costs if they do not hit those targets.

What happens when you increase speed on a production line from 4 weeks to 4 days? The entire concept requires reconfiguration of the assembly line and the supply chain. Suppliers must deliver direct to production or “Point of Use” and assembly must flow continuously – stopping costs millions of dollars. The cost of a delivery problem increases and the cost of poor quality increases – and those costs have not been calculated into the price of the aircraft. What happens when your customer looses money? They pass the cost back to you! What is a “Chargeback”?

Can we achieve 100% on-time delivery? In the past we achieved it using inventory. More finished goods waiting for delivery meant we could adapt and adjust to our customers demand variations. But holding inventory costs money – approximately 18-20% per year. That means every $1,000,000 in inventory you have costs at least $180,000 per year. That’s 18% of your profit going out the door. What’s the sound of that much profit leaving the building?

So inventory is not a financially viable way to achieve 100% on-time. So how else can we do it?

It’s too late to argue that it can’t be done. Too many companies are doing it already. They’ve worked gradually over time – step by step – implementing improvements all over the entire business. Their lead times are lower, their cycle times are lower, their suppliers are more responsive, and their costs are lower. Through the constant investment of time and effort, by creating an expectation that their performance will improve every month, they have managed to make it so.

And the evidence says that these companies are thriving and capturing more business than anyone else. They are more competitive and it’s beginning to show.

What is the Cost of Less Than 100% On-Time Performance? Simple – what is the cost of losing one program or one customer? Is it $1,000,000, $2,000,000 or more? What is the lost contribution to margin when you loose a revenue stream? We’ve seen many companies lose business this year because of poor performance. It’s usually more than a “speed bump.”

PPM Quality

Why is quality such a big issue with OEMs and Tier Ones?

As production lines speed up, point of use delivery means there is no extra part in the pipeline. You may have noticed the same thing about aircraft at the airport – one fails and they don’t have another one standing by anymore.

Our customers have setup their production process assuming perfect quality. Why would they do that when they know that we haven’t achieved perfect quality? Because the alternative involved them stocking more inventory and was too expensive.

But now that means that a bad part could potentially shut down a production line and cost our customer millions. Why take that risk? Well they don’t plan to take that risk. They want their suppliers to take that risk. How? By making us stock more inventory at our own expense and instituting charge backs for quality issues.

In fact, you may have noticed that they have begun asking us to stock more finished goods in the past five years either by stocking distributors where we continue to own the inventory, or by consignment shipments to the customer where we own the inventory until they use it, or just simply by asking us to stock a certain number of units extra at our own expense. All of this because we haven’t achieved perfect quality. In other words, less than perfect quality – “0 PPM” – is now at our expense. And if we’re too far off, we’ll lose the business as well as in the example of on-time delivery.

What does it cost to deliver less than perfect quality? Again, just calculate the cost of losing a program or customer. What is the expected loss in contribution to margin from that program or customer? Again, this is more than a speed bump.

The Cost of 100% On-Time and 0 PPM

Let’s see if we can calculate the cost to a company of achieving 100% on-time and 0 PPM quality. It’s certainly not a small amount of work. Let’s say you have 100 employees just to keep numbers easy. And let’s say you’re following the SEA Roadmap because that’s a known quantity. We know that companies who diligently implement the SEA Roadmap including lean and six sigma strategies usually invest between 2 and 5% of available labor. Let’s take the high end and say 5%. That’s five full time people at roughly $50,000 per year each and then let’s throw in a full time lean facilitator as well at $80,000 per year.

Now we’re up to $330,000 and this includes all the training and kaizen events needed to improve operations. But let’s say we also have another $50,000 in outside expenses – SEA membership, some consulting, etc. So we’re up to $380,000 per year. Who in their right mind is going to spend that kind of money?

Now just to be absolutely certain that we’ve covered everything, let’s double it to $760,000. We’re sure that is more than enough to cover the cost of continuous improvement and lean implementation – a serious effort. But more than that, it may take your company 3 years to achieve the results we’re talking about – so $2,280,000 is the total price tag for 3 years. How can you possibly justify spending that kind of money?

Well let’s say that because you’re not competitive you lose one program worth merely $1 million per year to your company. Prevent a loss of only $1 million per year and in three years you’ve paid for your improvement effort. Gain one new piece of business of $1M per year because you’re more competitive, you not only paid for your improvement but you’re up $3M. Point is, it’s not hard to pay for improvement and we haven’t even considered the other factors that finance improvement yet. That’s why leaders like Jack Welch put so much attention on the rate of improvement and how many people were trained and working on it – you can never spend too much money on improvement because it leverages so much more to the bottom line!

Now let’s look closer. This 100-person company will usually be operating around $100,000 in revenue per employee – a $10 million company with a gross margin of roughly 30%.

Above are two scenarios. The first is what happens if you don’t make any improvements. On the one hand you have no cost, but call that “investment,” but on the other hand if your performance doesn’t improve you increase the risk of losing business and every time you lose $1M in revenue you lose $300K in gross margin contribution and that’s about 10% of your total gross margin. (remember gross margin pays the overhead and the owner’s salaries.

In the second scenario, we examine the picture that most SEA suppliers have seen. Better performance leads to sales increases and they create more capacity with their lean efforts and therefore gross margin goes “ballistic.”

Do the numbers. Even spending $760,000 per year (I intentionally inflated this to make the point that you cannot spend enough to make improvement a bad investment) to get leaner, can pay for itself almost immediately and save your business from being gradually chipped away by the changes in the supply chain.

A Sense of Urgency

The greatest problem that we see right now is the lack of a sense of urgency about making these improvements.

Let’ review some of the performance summaries from some of the best suppliers we know on the following page.

What you’ll notice overall:

• On-time delivery is not showing significant improvement and just barely makes the grade for bronze level performance.
• Inventory turns – the absolute best measurement for lean progress shows no significant improvement and even some backsliding as our customers drive us toward more inventory to solve delivery problems.
• Sales per employee shows very little progress.
• PPM shows some improvement but is still generally in the silver range.
• The “benchmarks” on each chart show the best performance in that category. We know it is possible because others are doing it.

Conclusion

Although these companies perform and even outperform most companies in the industry, they are still seriously below the industry standard 100% on-time and 0 PPM and they don’t show significant improvements over the space of several years. When we look at expenditure of available hours, we see they are mainly at or below 2% of available labor.

So although these companies have made significant investments, by in large it appears they are still juggling multiple priorities and not giving a high priority to how well their performance is or is not improving.

Meanwhile in the past two years, the customer base and it’s requirements have changed significantly. Charge backs for quality issues are appearing more and more while inventory solutions to less than 100% on-time performance are becoming extremely expensive.

If our pace of improvement continues at its current rate, I predict that many companies will get surprised by losing business because a competitor has spent more time and money faster in order to gain the performance advantage. Unfortunately we have already witnessed this exact thing happening.

How does a company get out in front of this? Isn’t it time that you as a leader answered that question?

It used to be the big ate the small. Now the fast eat the slow.
Geoff Yang, Redpoint Ventures

The Toyota Production System is what people try it when they are desperate.
Taiichi Ohno

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