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MAJOR AEROSPACE MANUFACTURERS VIOLATE THE TRUST OF SMALL SUPPLIERS AND TURN THEM INTO FORMIDABLE COMPETITORS, NEW REPORT REVEALS

May 1, 2005

For more information, contact: Benjamin Haimowitz, HHaimowitz@aol.com

Infidelity in the aerospace industry runs deeper than the social habits of Boeing's recently departed CEO, a report in the current issue of the Academy of Management Executive suggests.

The article, "On the Dark Side of Strategic Sourcing: Experiences from the Aerospace Industry," describes how "gamesmanship and deception" by aerospace manufacturers in dealing with their suppliers have brought a "disintegration of the existing supply chain...with widespread and broad economic implications for the industry."

While the article focuses specifically on aerospace, it is likely, the authors say, that something similar is taking place in such other industries as automobiles, consumer electronics, consumer goods, and retail. The issue has also become intertwined with the ever-increasing practice of outsourcing abroad.

"The aerospace behemoths assumed they could indefinitely force the typically small companies in their supply chain to keep lowering prices," comments Prof.

Thomas Y. Choi of Arizona State University, who co-authored the report with doctoral student Christian Rossetti. "Instead they have driven suppliers to sell directly to the airlines, a practice long regarded as strictly off-limits.

In the process, the manufacturers have deprived themselves of fat profits on the sale of replacement parts -- profits on which they have come increasingly to depend."

Ironically, the whole debacle evolved out of the manufacturers' adoption about 10 years ago of strategic sourcing, which business gurus consider an enlightened approach to supply management. In strategic sourcing, the idea is for manufacturers to reduce the number of their suppliers and strengthen their relationships with those that remain.

"Unfortunately," says Choi, "the manufacturers adopted only half the

strategy: they reduced the number of suppliers, thereby raising the stakes for the survivors, then proceeded to squeeze them on price with the same intensity they had always done, if not with more."

In the words of the AME report, which entailed three years' worth of interviews and document reviews at two major aerospace manufacturers, "The stage had been set for close relationships, but it was marked by gamesmanship and deception."

With the aerospace firms' pegging purchasers' raises to their ability to wring year-over-year price reductions from suppliers, "commodity managers are not motivated to form truthful and honest buyer-supplier relationships,"

the article explains. "For example, [they] enter the negotiations stating that volumes will increase. They promise that relationships will last, while knowing that if a better opportunity presents itself, they will switch suppliers."

Another tactic that Rossetti and Choi uncovered was for manufacturers to "allow suppliers to design parts and then take their designs and bid them out to competing suppliers. Suppliers that expected to become the sole source for a part found that their design work had been performed pro bono instead of quid pro quo."

Trustful suppliers, in other words, that increased their dependence on the buyers were punished instead of rewarded. "In the end," the authors observe, "trust, which is the bedrock of strategic sourcing, becomes the stumbling block for suppliers."

As multibillion-dollar companies, the aerospace behemoths are likely to have had little fear of misleading the suppliers, which the AME authors describe as "typically small companies traditionally regarded as being at the mercy of these large buyers."

Instead the suppliers have turned the tables, "with widespread and broad economic implications for the industry."

Their ability to do so has been helped by the eagerness of straitened airlines to reduce the cost of replacement parts, for which manufacturers have traditionally extracted high mark-ups. Also of help is advanced technology that greatly facilitates the reverse-engineering of parts. As Choi and Rossetti put it, "A supplier can reproduce a part in a matter of weeks that at one time may have taken the [manufacturer] years to design."

To counteract the proliferation of reverse-engineered parts, manufacturers are considering patenting all current and future designs. But this may prove of little use in light of the increasing tendency of aerospace firms to outsource work abroad. "The Far East, notorious for its disregard of intellectual property is now a hotbed of aerospace global sourcing," the authors note, adding that "outsourcing to China may actually increase competition [for the manufacturers] in the long run."

Beyond the obvious moral lesson, the article offers an object lesson in the hazards of short-term thinking, even in a fast-moving industry. As the authors warn in conclusion, "Disillusioned suppliers will begin to refuse to tolerate broken long-term agreements. They will say no to unfair practices.

They will seek revenge, and then a civilized divorce will truly be a contradiction in terms."

The Academy of Management Executive, a peer-reviewed publication, is published quarterly by the academy, which, with about 15,000 members in 90 countries, is the largest organization in the world devoted to management research and teaching. The academy's other publications are the Academy of Management Review, the Academy of Management Journal, and Academy of Management Learning and Education.

Media Coverage:
Harvard Business Review. Avoiding the Dark Side of Strategic Sourcing. (Wednesday, June 01, 2005).
The Observer. An end to supermarkets' sweep. (Monday, June 20, 2005).

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