    Best Practices: DOD Can Help Suppliers Contribute More to Weapon System
    Programs (Chapter Report, 03/17/98, GAO/NSIAD-98-87).

    Pursuant to a congressional request, GAO reported on whether best
    supplier practices can best benefit Department of Defense (DOD) weapons
    systems programs, focusing on: (1) best commercial practices for
    establishing, managing, and sustaining excellent supplier relationships;
    and (2) a comparison of these practices with those of DOD, selected
    prime contractors, and the supplier teams on two weapon system programs.

    GAO noted that: (1) best commercial practices, when analyzed in the
    aggregate, can be seen as the four traits that operate in a system that
    is self-sustaining because it provides mutual benefits to both the firm
    responsible for the final product and its suppliers: (a) the leading
    commercial firms embrace effective supplier relationships as a core
    business strategy and build organizational structures with skilled
    people to carry out the strategy; (b) leading companies use a rigorous
    supplier selection process to create a strong supplier base that they
    could more effectively manage; (c) they establish effective
    communications and feedback systems with their suppliers to continually
    assess and improve both their own and supplier performance; and (d) the
    firms foster an environment in which suppliers realized that more
    significant contributions were matched with significant rewards; (2) DOD
    and prime contractors were aware of such benefits and were implementing
    some of these practices; (3) however, experience on the Brilliant
    Anti-Armor Submunition program showed that it could be difficult to
    translate the desire for better supplier relations into tangible
    differences in the actual relationships among suppliers, prime
    contractors, and DOD; (4) in the program, the four traits did not
    comprise as powerful a system as was formed by the best commercial
    practices; (5) consequently, their performance was strictly limited to
    compliance with contract requirements; (6) in the Joint Direct Attack
    Munitions (JDAM) program, a more rewarding environment was created for
    suppliers even though improved supplier relations was not an explicit
    program objective; (7) nonetheless, the action taken by DOD on the
    program bolstered the support for supplier relationships and encouraged
    the suppliers to play a greater role; (8) DOD shares responsibility with
    the prime contractors for shaping the suppliers' environment; (9) thus,
    the role it plays on individual programs has a direct bearing on the
    sophistication of supplier relationships and the success of best
    supplier practices; (10) the supplier relationships on the Brilliant
    Anti-Armor Submunition program reflect DOD's traditional role of
    distancing itself from suppliers; (11) on the JDAM program, DOD was much
    more proactive and involved with the suppliers; (12) its pilot program
    mandate supported the program office's involvement in seeing that best
    supplier practices were used; (13) the ultimate success of this approach
    in producing a weapon that will perform as required remains to be seen;
    and (14) suppliers praised the approach for the relationships it
    fostered.

    --------------------------- Indexing Terms -----------------------------

     REPORTNUM:  NSIAD-98-87
         TITLE:  Best Practices: DOD Can Help Suppliers Contribute More to
                 Weapon System Programs
          DATE:  03/17/98
       SUBJECT:  Defense cost control
                 Comparative analysis
                 Internal controls
                 Department of Defense contractors
                 Defense procurement
                 Procurement practices
                 Interagency relations
                 Advanced weapons systems
    IDENTIFIER:  Brilliant Anti-Armor Submunition
                 Joint Direct Attack Munition
                 C-17 Aircraft
                 Tri-Service Standoff Attack Missile
                 Army Tactical Missile System

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    Cover
    ================================================================ COVER

    Report to the Subcommittee on Acquisition and Technology, Committee
    on Armed Services, U.S.  Senate

    March 1998

    BEST PRACTICES - DOD CAN HELP
    SUPPLIERS CONTRIBUTE MORE TO
    WEAPON SYSTEM PROGRAMS

    GAO/NSIAD-98-87

    Best Practices

    (707190)

    Abbreviations
    =============================================================== ABBREV

      BAT - Brilliant Anti-armor Submunition
      DOD - Department of Defense
      GAO - General Accounting Office
      IPT - integrated product team
      ISO - International Standards Organization
      JDAM - Joint Direct Attack Munitions

    Letter
    =============================================================== LETTER

    B-275845

    March 17, 1998

    The Honorable Rick Santorum
    Chairman
    The Honorable Joseph I.  Lieberman
    Ranking Minority Member
    Subcommittee on Acquisition and Technology
    Committee on Armed Services
    Unites States Senate

    As you requested, this report assesses whether best commercial
    supplier practices offer ways to improve the process the Department
    of Defense (DOD) uses to manage suppliers engaged in developing and
    producing major weapon systems.  It also determines how differences
    in commercial and DOD environments for managing suppliers affect the
    corresponding practices.  We make recommendations to the Secretary of
    Defense that are intended to help DOD improve the way it manages
    suppliers.

    We are sending copies of this report to other congressional
    committees; the Secretaries of Defense, the Army, the Navy, and the
    Air Force; and the Director, Office of Management and Budget.  We
    will also make copies available to others on request.

    If you or your staff have any questions, I can be reached at (202)
    512-4841.  The major contributors to this report are listed in
    appendix II.

    Katherine V.  Schinasi
    Associate Director
    Defense Acquisitions Issues

    EXECUTIVE SUMMARY
    ============================================================ Chapter 0

       PURPOSE
    ---------------------------------------------------------- Chapter 0:1

    Leading commercial companies have found that more cooperative
    business relationships with suppliers have improved their ability to
    respond to changing business conditions.  Such relationships have led
    to lower costs and have translated into higher quality, greater
    productivity, and shorter product design and delivery times.  The
    Department of Defense (DOD) also faces difficult business conditions
    in that it must find ways to modernize its weaponry more
    economically, for it continues to state a need to modernize weapons
    at a faster pace.  DOD has an opportunity to incorporate best
    supplier practices into the process it uses to acquire weapon
    systems.  In doing so, DOD may be able to respond more quickly to
    technological changes with shorter cycle times, reduced costs, and
    improved weapon system quality.

    The Chairman and the Ranking Minority Member, Subcommittee on
    Acquisition and Technology, Committee on Armed Services, requested
    that GAO assess whether best supplier practices can benefit weapon
    system programs.  Specifically, this report (1) identifies best
    commercial practices for establishing, managing, and sustaining
    excellent supplier relationships and (2) compares these practices
    with those of DOD, selected prime contractors, and the supplier teams
    on two weapon system programs.

       BACKGROUND
    ---------------------------------------------------------- Chapter 0:2

    The term "supplier" refers to a firm that provides goods or services
    that comprise part of a final product being made by another firm.  On
    a complex product such as an aircraft or a weapon system, suppliers
    can number in the thousands and are categorized into different levels
    or tiers.  For example, on a military aircraft program, the firm
    responsible for putting the complete aircraft together and delivering
    it to DOD--the final customer--is referred to as the prime
    contractor.  The firms that supply components or services to the
    prime contractor comprise the first tier of suppliers.  Firms that
    supply products to the first tier constitute the second tier of
    suppliers.  The tiers continue until the products being supplied
    reach an elemental level, such as raw materials, rivets, and bolts.
    Suppliers are typically responsible for the majority of a complex
    product's content, whether the item is military or commercial.
    Generally speaking, suppliers account for 50 to 80 percent of a major
    item's value.  Perhaps more importantly, much of the technical
    innovation incorporated into a new weapon comes from the suppliers.

    To gain insights into the dynamics of contracting teams in an actual
    program situation and to obtain the supplier's perspective, GAO
    conducted case studies of two munitions programs.  One program was
    the Brilliant Anti-armor Submunition, referred to as BAT, which is
    the older and more traditionally managed of the two programs.  It is
    a self-guided submunition that searches for moving tanks and other
    armored targets that it is intended to track and destroy.  The other
    program was the Joint Direct Attack Munitions (JDAM), which is a
    strap-on guidance kit that converts free-fall bombs into guided
    munitions.  JDAM is one of seven congressionally authorized Defense
    Acquisition Pilot Programs that were afforded early statutory and
    regulatory relief to test methods for streamlining the acquisition
    process.  The program has employed several acquisition reforms and
    has applied innovative supplier management techniques.

       RESULTS IN BRIEF
    ---------------------------------------------------------- Chapter 0:3

    The best commercial practices, when analyzed in the aggregate, can be
    seen as four traits that operate in a system that is self-sustaining
    because it provides mutual benefits to both the firm responsible for
    the final product and its suppliers.  First, the leading commercial
    firms embraced effective supplier relationships as a core business
    strategy and built organizational structures with skilled people to
    carry out the strategy.  Second, leading companies used a rigorous
    supplier selection process to create a strong supplier base that they
    could more effectively manage.  Specific practices included use of
    stringent supplier selection criteria, reliance on a manageable
    number of suppliers, maintaining some level of competition between
    suppliers, and periodic supplier base assessments against company
    goals.  Third, they established effective communications and feedback
    systems with their suppliers to continually assess and improve both
    their own and supplier performance.  These practices not only helped
    the firms' goals, priorities, and performance assessments to be well
    understood by all key suppliers but also helped the suppliers' ideas
    and concerns to be understood as well.  Fourth, the firms fostered an
    environment in which suppliers realized that more significant
    contributions were matched with significant rewards, which made
    suppliers more likely to invest their intellectual capital--their
    ideas--into the venture.

    DOD and prime contractors were aware of such benefits and were
    implementing some of these practices.  However, experience on the
    Brilliant Anti-armor Submunition program showed that it could be
    difficult to translate the desire for better supplier relations into
    tangible differences in the actual relationships among suppliers,
    prime contractors, and DOD.  In the Brilliant Anti-armor Submunition
    program, the four traits did not comprise as powerful a system as was
    formed by the best commercial practices.  Although practices found in
    the second and third traits--such as supplier certification, ratings,
    and a forum for meeting with suppliers--had been adopted, their
    impact on the Brilliant Anti-armor Submunition was blunted by
    weaknesses in central support and a rewarding environment.  The prime
    contractor's commitment to improved supplier relationships was not
    perceived by some key suppliers as much more than procedural changes.
    Some key suppliers did not feel they were encouraged to contribute to
    the product's design or that their extra efforts to innovate were
    encouraged.  Consequently, their performance was strictly limited to
    compliance with contract requirements.  On Joint Direct Attack
    Munitions program, a more rewarding environment was created for
    suppliers even though improved supplier relations was not an explicit
    program objective.  Nonetheless, the actions taken by DOD on the
    program bolstered the support for supplier relationships and
    encouraged the suppliers to play a much greater role.  Ultimately,
    the relationships with suppliers became central to the success of the
    acquisition reform initiatives being piloted.

    DOD shares responsibility with the prime contractors for shaping the
    suppliers' environment.  Thus, the role it plays on individual
    programs has a direct bearing on the sophistication of supplier
    relationships and the success of best supplier practices.  The
    supplier relationships on the Brilliant Anti-armor Submunition
    program reflect DOD's traditional role of distancing itself from
    suppliers.  This role can be traced, in part, to the fact that DOD
    has not articulated a particular supplier policy to guide program
    managers.  By default, DOD's concerns over interfering with the
    contractual relationship between the prime and a supplier have
    encouraged an arms-length approach to suppliers by managers.  Also,
    the Brilliant Anti-armor Submunition prime contractor believed that
    the system's requirements were made so specific by DOD that there was
    little opportunity to allow suppliers much voice in the design.  DOD
    disagreed that it had exerted such control.  On the Joint Direct
    Attack Munitions program, DOD was much more proactive and involved
    with the suppliers.  Its pilot program mandate supported the program
    office's involvement in seeing that best supplier practices were
    used.  As a result, high- performing suppliers were selected, all
    tiers of suppliers participated in meeting the program's priorities,
    and long-term benefits were offered to the prime contractor and its
    suppliers for good performance.  The ultimate success of this
    approach in producing a weapon that will perform as required remains
    to be seen.  Nonetheless, suppliers praised the approach for the
    relationships it fostered.

       PRINCIPAL FINDINGS
    ---------------------------------------------------------- Chapter 0:4

          SUPPLIER RELATIONSHIPS MUST
          HAVE CENTRAL SUPPORT
    -------------------------------------------------------- Chapter 0:4.1

    The commercial firms embraced effective supplier relationships as a
    core business strategy and built organizational structures with
    skilled people to carry out the strategy.  For example, Chrysler is
    organized into several product platform teams such as for large cars,
    small cars, and trucks.  The platform teams developed strategies for
    each product, coupled with commodity strategies that defined which
    product components were to be purchased from which suppliers.  These
    teams linked business objectives and performance factors with
    supplier relations.  In so doing, they replaced supplier
    relationships previously forged by individual business units.  The
    companies also created purchasing organizations to support their
    supplier management strategies.  It is a major undertaking for a firm
    to commit the resources to implement an active supplier policy.  Such
    a commitment is not based on altruism or a management theory; rather,
    the commitment comes from the desire to maintain a competitive edge.

    While commercial firms can act unilaterally to garner better
    relationships with their suppliers in weapon programs, DOD shares the
    responsibility for directing the programs with the prime contractors.
    Thus, if DOD does not encourage improved supplier relationships, the
    prime contractors may not have as strong an incentive to adopt best
    practices.  According to DOD officials, the traditional concern for
    violating privity of contract has distanced DOD and its program
    managers from supplier management concerns.  Privity refers to the
    direct relationship between the parties to a contract.  Thus, there
    is privity between DOD and the prime contractor but not between DOD
    and the prime contractor's suppliers.  However, experience with JDAM
    shows that privity of contract concerns do not prevent a program
    manager from taking a more active role in prime and supplier
    selection.  This more active approach during the competitive
    development phase set the expectation from the outset that supplier
    management would figure prominently into JDAM's success and DOD's
    selection of the prime contractor.  For example, DOD program
    officials used the actual performance of the suppliers and the prime
    contractors during a competitive development phase as a key factor
    for choosing the prime contractor and supplier team that would
    complete development and enter production.

          RIGOROUS SUPPLIER SELECTION
          CREATES STRONG SUPPLIER BASE
    -------------------------------------------------------- Chapter 0:4.2

    By concentrating on proven suppliers meeting stringent selection
    criteria, the leading commercial companies limited the number of
    suppliers, thereby reducing internal resources needed for supplier
    management and oversight.  Over a decade, Varian Oncology Systems
    reduced the number of its production suppliers from 1,100, which it
    considered unmanageable, to 345.  The companies selected suppliers
    using specific assessment methods, such as certifications and quality
    audits that identified the total cost of doing business, not just the
    sales price of the supplied product.  Total cost includes tangible
    factors, such as quality, and intangible ones, such as effective
    communications.  For example, DuPont assessed a supplier's technology
    edge, as well as price and the cost to the company if the supplier
    failed.  While building closer relationships with fewer suppliers,
    the companies included enough suppliers to ensure there was
    competition and a back-up source.

    Several defense contractors had reduced the number of suppliers and
    established criteria for selecting the best suppliers.  Since 1991,
    AlliedSignal Aerospace has reduced its supplier base from over 10,000
    to less than 3,000.  Also, DOD has placed new emphasis on using best
    value, which calls for using broader criteria than lowest price for
    selecting contractors.  Best value can include criteria such as
    quality and a firm's performance on past contracts.  Prime
    contractors had begun using best value in selecting suppliers, but
    some believed that price was still DOD's main concern.  Officials
    from one firm said that there was resistance at the lower levels of
    the services to applying best value.

    The BAT program experienced turnover in some key suppliers,
    suggesting difficulties in the selection process.  One supplier we
    met with was the third source chosen for that component, after two
    lower priced suppliers had faltered.  Another supplier was changed
    because program requirements had been revised.  In contrast, the DOD
    program office's involvement helped guide the selection of JDAM
    suppliers.  As a result of the DOD teams including key suppliers as
    part of their assessment of the prime contractors, one of the prime
    contractors later selected two new suppliers after asking the DOD
    teams to recommend better performers.  DOD offered its advice, but
    did not mandate changes in the choice of suppliers.

          AN EFFECTIVE COMMUNICATION
          AND FEEDBACK SYSTEM MUST
          EXIST
    -------------------------------------------------------- Chapter 0:4.3

    Leading commercial firms established a framework for communications
    with their suppliers that allowed for continuous feedback to improve
    the performance of both parties.  Suppliers knew whom to discuss
    suggestions or problems with because they had a single, authoritative
    point of contact.  Key suppliers were often included as members of
    teams and shared in decision-making and design ideas.  The companies'
    attention extended to performance of lower-tier suppliers primarily
    through communication with first-tier suppliers.  The companies' own
    commitment to optimal supplier relationships helped them to look for
    and expect the same commitment from their own suppliers.  In other
    cases, companies took a more "hands on" approach; Chrysler worked
    with first tier suppliers to jointly manage lower-tier suppliers,
    extending all the way to the raw material stage.  The leading
    companies interacted with key suppliers in close teaming arrangements
    that facilitated sharing information.  Commonly called integrated
    product teams, members worked together so that design, manufacturing,
    and cost issues were considered together.  Instead of a hierarchy,
    team members were encouraged to participate as partners in meeting
    project goals and to interact frequently.  Some companies colocated
    suppliers with their own people or set up central working facilities
    with suppliers.

    The companies regularly provided suppliers with feedback on their
    performance.  Performance was assessed formally through periodic
    reports and informally through team participation.  For example, Plow
    and Hearth provided suppliers with a quarterly performance summary
    that supplemented weekly meetings on supplier issues raised by
    merchandising, product returns, and inventory control staff.  When
    problems were identified, the company and the supplier worked
    together to develop corrective actions.  The companies provided
    technical assistance to their suppliers to help improve performance.
    Companies also solicited feedback on their own performance as a
    customer, recognizing the importance of being a "preferred" customer
    of the top suppliers.

    Most prime contractors said that they had processes for setting
    performance expectations, assessing performance, and providing
    feedback.  All of the prime contractors were using integrated product
    teams.  For some BAT suppliers, the presence of commercial-like
    mechanisms like these, by themselves, did not improve supplier
    relationships.  Some suppliers believed that engineers made design
    decisions without considering cost and schedule considerations.  One
    supplier said that its concerns over the cost and producibility of
    its own component were ignored in the program's production readiness
    assessment and cost estimate.  It noted that technical assistance
    personnel was sent by an upper-tier firm, but did not have the
    expertise to offer in solving problems.  JDAM suppliers were uniform
    in describing the program as structured in a way that encouraged
    communication.  A key factor was how integrated product teams were
    employed from the beginning--including the design phase--with DOD
    closely involved.  DOD helped create this situation by requesting
    team plans as part of the original request for contract proposals.

          A REWARDING ENVIRONMENT IS
          KEY TO FOSTERING THE BEST
          SUPPLIER RELATIONSHIPS
    -------------------------------------------------------- Chapter 0:4.4

    The best practices were sustained when a commercial firm created an
    environment in which it became an attractive customer.  Firms did
    this by not only rewarding superior suppliers with future business
    but by building partnerships, allowing top suppliers to participate
    in product planning and design, sharing business plans, and relaxing
    the procedures for doing business together.  Not all suppliers
    enjoyed these sophisticated relationships--commercial companies made
    distinctions in how they worked with different suppliers.  In turn,
    the key suppliers were willing to go the extra mile, commit their own
    resources to enhance prospects for future business, and comply with
    the rigor that the source selection and evaluation mechanisms
    demanded.  The suppliers' responses improved product output and
    reinforced the initial commitment that the product developer made to
    strengthening supplier relationships.

    Mutual trust--earned through action--was essential to creating this
    environment.  For example, Chrysler's relationships with some
    suppliers had evolved to the point that it no longer needed to make
    large investments in some key technology areas because of the
    relationships it had developed with some suppliers.  Instead, the
    suppliers made the technology investment themselves and had enough
    confidence in their relationship with Chrysler that they did not fear
    the long-term commitment that this entailed.  For its part, Chrysler
    trusted the suppliers to make the investments that would keep their
    vehicles competitive.  Both supplier and product developer saw their
    success as that of the final product and a continuing, mutually
    beneficial relationship.

    Defense prime contractors believe there are legal, regulatory, and
    budgetary obstacles to fostering such long-term relationships.
    Similarly, some key BAT suppliers did not see their environment as
    conducive to such relationships.  They viewed their role as only
    complying with the design requirements handed down to them by the
    upper-tier firms.  They believed that attempts to do more--such as
    offer design suggestions or make long-term investments--would not
    reap benefits.  Some suppliers believed no consideration was given to
    their years of working together when it came to the low-rate
    production contract proposal.  One supplier said it was required to
    submit a four-volume proposal for the low-rate production contract,
    detailing how its component would be designed, produced, and made to
    conform to quality standards, even though it had just spent the last
    6 years designing, documenting, and producing the component for BAT.
    The president of one supplier firm said that while he invested the
    firm's own funds for commercial tooling because of its long-term
    potential, he would not invest the firm's funds in BAT tooling
    because the return was too uncertain.

    In contrast, JDAM suppliers believed they were full participants in a
    long-term relationship with the upper-tier customers.  Through the
    joint effort of the DOD program manager and the prime contractor,
    these relationships were cultivated in the JDAM program without being
    stymied by the obstacles perceived by some prime contractors.
    Second-tier suppliers cited the importance of developing a strong
    alliance between the parties.  One supplier said the prime contractor
    held clear authority over the program, but the development of new
    solutions to win the contract was the result of great teamwork.  For
    example, one supplier was able to substitute commercial materials
    that differed in configuration from military materials but not in
    function.  The supplier worked with other first-tier suppliers, the
    prime, and DOD, and they agreed on an improved interface connection
    for the component.

       RECOMMENDATIONS
    ---------------------------------------------------------- Chapter 0:5

    GAO makes recommendations to the Secretary of Defense.  These
    recommendations are intended to strengthen DOD's support for better
    supplier relationships and to create an environment that encourages
    such relationships.  These recommendations appear on pages 63 and 64
    of the report.

       AGENCY COMMENTS
    ---------------------------------------------------------- Chapter 0:6

    DOD concurred with the views expressed in the report and all of the
    recommendations and also provided additional information on efforts
    to address the issues.  A discussion of DOD's actions appears on
    pages 64 and 65.  DOD's comments appear in appendix I.

    INTRODUCTION
    ============================================================ Chapter 1

    The Department of Defense (DOD) continues to state a need to more
    quickly modernize weapons for the armed forces.  It has a budget of
    over $40 billion for fiscal year 1998 to acquire and upgrade weapons
    and may not receive substantially more than that in future years
    unless savings materialize in other budget areas.  Therefore, it must
    find new ways to modernize more economically.  DOD has an opportunity
    to incorporate commercial supplier practices into the process it uses
    to acquire weapon systems.  In doing so, DOD may be able to respond
    more quickly to technological changes with shorter cycle times,
    reduce costs, and improve weapon system quality.

       SUPPLIERS PLAY A KEY ROLE IN
       DEVELOPING AND PRODUCING END
       ITEMS
    ---------------------------------------------------------- Chapter 1:1

    The term "supplier" refers to a firm that provides goods or services
    that comprise part of a final product being made by another firm.
    For example, a tire manufacturer would be considered a supplier to an
    automobile manufacturer.  In this case, the automobile manufacturer
    would be viewed as the "customer" by the tire supplier.  On a complex
    product such as an aircraft or a weapon system, suppliers can number
    in the thousands and are categorized into different levels or tiers.
    The term "subcontractor" is also used to refer to a supplier.

    In the case of a military aircraft, the firm responsible for putting
    the complete aircraft together and delivering it to DOD, the final
    customer, is referred to as the prime contractor.  Although the prime
    contractor may make some of the aircraft itself, it may buy major
    subsystems, such as engines, landing gear, and navigation equipment,
    from other firms.  The firms supplying these items and other products
    to the prime contractor comprise the first tier of suppliers.  Each
    of these firms, in turn, makes significant products for which it
    depends on suppliers.  For example, the engine manufacturer buys
    major engine components from its own suppliers; thus, it is a
    supplier to the aircraft manufacturer and a customer to the engine
    component suppliers.  The major engine component suppliers would
    comprise the second tier.  The firms that they buy parts from would
    comprise the third tier.  These tiers continue down to basic piece
    parts, such as rivets, bolts, common computer chips, and raw
    materials.

    Some firms are suppliers for one product and prime contractors for
    others.  Although the smaller firms tend to be found among the lower
    tiers on complex products, in the upper tiers it is possible for a
    supplier on a given product to be a larger firm than the firm
    assembling the complete product.  For example, it is possible for a
    large firm like Lockheed Martin, a manufacturer of major military and
    commercial end items, to supply components for a smaller firm's
    product.

    Suppliers are typically responsible for the majority of a complex
    product's content, whether the item is military or commercial.
    Generally speaking, suppliers account for 50 to 80 percent of a major
    item's value.  For DOD, this means that a large part of the money
    spent on building a new weapon system may actually be paid to
    suppliers.  Perhaps more importantly, much of the technical
    innovation that is incorporated into a new weapon comes from the
    suppliers.  According to the Aerospace Industries Association,\1

    much of the technical innovation comes from the suppliers at the
    lower tiers.  Studies of agile manufacturing techniques reinforce
    that much of a company's competitive edge will depend on its supply
    chain.

    Many leading companies recognize they must encourage the best
    suppliers to view them as valued, preferred customers.  Being a good
    customer may be a necessity because the supplier can be less
    dependent on the customer company than vice versa.  Suppliers are
    becoming increasingly powerful in dealing with customers because of
    their size or almost sole-source relationships.  Some suppliers can
    choose their customers or be inflexible about the product they are
    willing to supply.  Such is also the case for DOD, as evidenced by
    the recent withdrawal of many integrated circuit manufacturers from
    the military market.

    --------------------
    \1 The Association is a trade association that represents the leading
    manufacturers of commercial, military, and business aircraft,
    helicopters, aircraft engines, missiles, spacecraft, and related
    components and equipment.

       BEST SUPPLIER PRACTICES PRODUCE
       TANGIBLE BENEFITS
    ---------------------------------------------------------- Chapter 1:2

    We have reported that companies have become increasingly aware that
    they cannot do everything on their own.\2 Therefore, companies are
    rethinking their business relationships, such as developing closer
    relationships with strategic suppliers.  Companies have found that
    cooperative business relationships improve their abilities to respond
    to a changing economic environment by allowing them to focus on their
    core businesses and reduce costs in their business processes.  For
    example, since 65 percent of its automobiles is made by suppliers,
    Ford Motor Company realized that to reduce costs and improve quality,
    it would have to improve its relationships with suppliers.  In
    addition to lower product and administrative costs, exemplary
    supplier relationship practices can translate to significant company
    benefits such as higher supplier quality levels, greater
    productivity, faster product design and delivery times, and better
    supplier engineering and technological contributions, as the
    following examples show.

      -- Texas Instruments Semiconductor Group reduced its cycle time in
         obtaining manufacturing supplies by 25 to 40 percent and the
         number of material inspectors from 14 to 1 at one site and 15 to
         7 inspectors at another site.

      -- Honda claimed an 8 to 1 return on its supplier relationships
         investment with an average 48-percent increase in supplier
         productivity, a drop in the average parts per million defect
         rate from 900 to 200, and virtual elimination of cost overruns.

      -- Varian Oncology Systems saved about $10 million and eliminated
         half of its inspection staff.

    To the extent that opportunities to improve supplier relations on
    defense programs exist and are capitalized upon, the outcomes of
    weapon system programs could similarly improve.  Suppliers can
    contribute to resolving long-standing cost and schedule problems in
    major weapon system programs.  As the pace of technological
    improvement quickens, shorter product cycle times will improve DOD's
    ability to incorporate the latest innovations.  Better supplier
    relationships may lower investment costs, enabling the services to
    modernize at a faster pace with existing funding.  DOD believes that
    modernization should proceed more quickly and wants to increase the
    annual investment in procurement by $20 billion, but the money has
    been slow to materialize.  In addition, shorter weapon system
    development cycles could yield improved products and better
    capabilities to the military forces sooner.

    --------------------
    \2 Partnerships:  Customer-Supplier Relationships Can Be Improved
    Through Partnering (GAO/NSIAD-94-173, July 19, 1994).

       OBJECTIVES, SCOPE, AND
       METHODOLOGY
    ---------------------------------------------------------- Chapter 1:3

    The Chairman and the Ranking Minority Member, Subcommittee on
    Acquisition and Technology, Senate Committee on Armed Services, asked
    us to assess whether best supplier practices can benefit weapon
    system programs.  The objectives of this report are to (1) identify
    best commercial practices for establishing, managing, and sustaining
    excellent supplier relationships and (2) compare these practices with
    those of DOD, selected prime contractors, and the supplier teams on
    two weapon system programs.

    To identify firms considered among the best in the commercial sector
    regarding supplier relationships, we conducted literature searches,
    consulted data from past winners of the Malcolm Baldrige Quality
    Award, and met with experts in the area of supplier management to
    gather uniform information about supplier management practices and
    their effects.  We gathered information from the following commercial
    firms, which our research showed to be among the best in the area of
    supplier relationships:

      -- Motorola, Inc.  (wireless communication equipment manufacturer),
         Schaumburg, Illinois.

      -- Chrysler Corporation (automobile manufacturer), Auburn Hills,
         Michigan.

      -- Texas Instruments Semiconductor Group (semiconductor
         manufacturer), Dallas, Texas.

      -- Xerox, Inc.  (document production equipment manufacturer),
         Webster, New York.

      -- Honda of America (automobile manufacturer), Marysville, Ohio.

      -- Corning, Inc.  (glass product manufacturer), Corning, New York.

      -- Varian Oncology Systems, Inc.  (oncology equipment
         manufacturer), Palo Alto, California.

      -- Baxter Healthcare Corporation (medical supplies manufacturer),
         Round Lake, Illinois.

      -- DuPont (petroleum and other products manufacturer), Wilmington,
         Delaware.

      -- Plow & Hearth (mail order catalog company), Madison, Virginia.

      -- Toyota Motor Sales, USA, Inc.  (automobile manufacturer),
         Torrance, California.

      -- McKesson Corporation (wholesale distributor), San Francisco,
         California.

    We selected 6 companies from the top 50 DOD prime contractors to
    assess the degree to which defense contracting companies were aware
    of and were implementing best supplier practices.  These firms were

      -- McDonnell Douglas Military Transport Aircraft Division (acquired
         by the Boeing Corporation during the course of our review), Long
         Beach, California;

      -- Northrop Grumman Electronics and Systems Integration Division
         (acquisition by Lockheed Martin pending), Hawthorne, California;

      -- AlliedSignal Aerospace, Torrance, California;

      -- Honeywell Defense Avionics Systems Group, Albuquerque, New
         Mexico;

      -- Motorola Space and Systems Technology Group, Scottsdale,
         Arizona; and

      -- Boeing Space and Systems Group, Seattle, Washington.

    Some of these firms also serve as suppliers to other defense prime
    contractors and perform a significant amount of work for commercial
    companies.  Together, the companies receive billions of dollars in
    government contracts for goods and services each year.  We met with
    each firm and reviewed literature on their supplier management
    practices.  Interviews with knowledgeable officials at both the
    commercial and defense firms were a primary source of information.

    To obtain insights into the dynamics of contracting teams in an
    actual program situation and to obtain the supplier's perspective, we
    conducted case studies of two weapon systems currently in
    development.  Our case studies were performed on two munitions
    programs:  the Brilliant Anti-armor Submunition, referred to as BAT,
    which is the older and more traditional of the two programs; and the
    Joint Direct Attack Munitions (JDAM) program, which is piloting
    several acquisition reforms and has applied innovative supplier
    management techniques.  For each program, we discussed practices with
    the military service program office and the prime contractor and
    selected suppliers at the first and second tiers.  We concentrated on
    suppliers who were designing custom components for the end product.
    In the report, we kept suppliers anonymous--designating them with a
    letter--to guard against harming the contracting team.

          BAT PROGRAM
    -------------------------------------------------------- Chapter 1:3.1

    The BAT is a 3-foot long, 44-pound self-guided, submunition that,
    once dispensed, glides as it searches for moving tanks and other
    armored targets that it is intended to track and destroy.  The
    submunition began in 1984 as a classified program and progressed into
    the engineering and manufacturing development phase in May 1991.  It
    is an Army program and Northrop Grumman is the prime contractor.  The
    Army has funded efforts to develop a new version of the BAT, which is
    to improve performance against stationary targets.  It is expected to
    be fielded about 5 years after the basic BAT.  Figure 1.1 shows the
    BAT.

       Figure 1.1:  The BAT
       Submunition

       (See figure in printed
       edition.)

       The BAT program used more
       traditional acquisition
       practices.

       (See figure in printed
       edition.)

       Source:  DOD.

       (See figure in printed
       edition.)

    The BAT program has had some turbulence.  We recently reported that
    the submunition's test schedule appeared to be extremely ambitious
    and that testing uncovered several problems that required design
    changes, additional testing, and schedule delays.\3

    Subsequently, the low-rate initial production was rescheduled from
    December 1997 until December 1998.  An earlier delay (2 years)
    resulted from the Army's switch of BAT carriers, from the Tri-Service
    Standoff Attack Missile to the Army Tactical Missile System,
    according to the program manager.  Further, the number of BATs to be
    purchased was cut from 35,000 to 19,500.  Most recently, the Congress
    deleted all $85.2 million in fiscal year 1998 procurement funds and
    added $35 million in research and development funds in response to
    the program delay.  Including the improved seeker, these changes have
    increased development costs from $700 million to $1.2 billion and
    production costs by almost $7,000 per unit (all figures in constant
    1991 dollars).

    BAT was conceived and designed before major acquisition reform
    initiatives, such as the replacement of traditional military
    specifications with performance specifications, were implemented in
    1994.  Nonetheless, the Army believes BAT is ahead of other programs
    in applying acquisition reforms.  Northrop Grumman has nine
    first-tier suppliers for the major BAT components.  We interviewed
    five of the nine first-tier suppliers, five second-tier suppliers and
    the two additional first-tier suppliers competing for the seeker on
    the improved BAT.

    --------------------
    \3 Brilliant Antiarmor Submunition:  Opportunity Exists to Conduct
    Critical Test Prior to Production Decision (GAO/NSIAD-98-16, Oct.
    30, 1997).

          JDAM PROGRAM
    -------------------------------------------------------- Chapter 1:3.2

    JDAM is a strap-on guidance kit that converts free-fall bombs into
    guided munitions.  The program is jointly funded by the Air Force and
    the Navy.  The prime contractor is McDonnell Douglas, recently
    purchased by Boeing.  The program is in the last year of engineering
    and manufacturing development, with production planned for mid-fiscal
    year 1998.  DOD plans to buy about 87,500 JDAM kits at about $3.39
    billion, amounting to a program unit cost of about $38,700.  Figure
    1.2 shows the JDAM.

       Figure 1.2:  The JDAM System

       (See figure in printed
       edition.)

       The JDAM program used
       commercial-like practices with
       its suppliers.

       (See figure in printed
       edition.)

       Source:  DOD.

       (See figure in printed
       edition.)

    DOD views JDAM as a successful program that benefited from the
    application of commercial practices.  In this sense, it represents a
    departure from the traditional DOD approach to acquisition
    management.  JDAM is one of seven Defense Acquisition Pilot Programs
    that were afforded early statutory and regulatory relief under the
    provisions of the Federal Acquisition Streamlining Act of 1994 to
    test methods for streamlining the acquisition process.  This
    designation gave DOD the authority to manage these programs more like
    commercial programs.  According to DOD, the successful application of
    commercial practices enabled these programs to demonstrate
    significant improvements; it believes that these programs could
    reduce cycle time by 25 percent.  In addition to applying DOD's
    formal acquisition reform initiatives, JDAM has been cited as a
    program that placed an unusually strong emphasis on suppliers from
    the beginning.  We interviewed four of the first and five of the
    second-tier suppliers.

    In this report, we highlight best commercial practices in supplier
    relationships.  As such, they are not intended to describe all of
    commercial industry, all commercial practices, or to suggest that
    commercial firms are without flaw.

    We conducted our review between October 1996 and January 1998 in
    accordance with generally accepted government auditing standards.

    COMMERCIAL AND DOD SUPPLIER
    PRACTICES HAVE SIMILARITIES AND
    KEY DIFFERENCES
    ============================================================ Chapter 2

    The best practices of commercial firms recognized as industry leaders
    in the area of supplier relationships maximized the participation and
    contribution of key suppliers in developing, producing, and planning
    products.  We found that supplier relationship practices could be
    aggregated into four traits:

    Central support:  The leading firms made a strong commitment to
    optimizing supplier relations as essential to maximizing product
    success.  This was manifested by making sure that supplier
    relationships received central direction and support, including the
    services of an effective purchasing organization staffed by
    experienced and skilled people.

    Rigorous supplier selection:  A rigorous supplier selection process
    was implemented, which created a manageable pool or base of strong
    suppliers.

    Communications and feedback:  The firms created channels for open
    communication and continuous assessment of performance for both
    customer and supplier.

    Mutually rewarding environment:  The firms created an environment
    whereby the suppliers also benefited from superior performance.

    All of the commercial companies we contacted had all four traits, but
    individual practices differed.

    DOD and its prime contractors are aware of these practices and their
    benefits and are attempting to implement the practices in varying
    degrees.  However, on the basis of our meetings with prime
    contractors, we found that it can be difficult to translate the
    desire for better supplier relations into tangible differences in the
    actual relationships among suppliers, prime contractors, and DOD.  It
    is particularly difficult to create an environment in which suppliers
    for DOD programs believe there are true incentives for doing more
    than complying with the terms of the contract.  DOD's experience with
    JDAM so far indicates that it is possible to create a better
    environment for fostering mutual benefits between defense prime
    contractors and their suppliers.

       BEST PRACTICES ARE FUELED BY
       MUTUAL BENEFITS BETWEEN
       CUSTOMER AND SUPPLIER
    ---------------------------------------------------------- Chapter 2:1

    The leading commercial firms went beyond simple supplier
    relationships that were limited to the purchase of goods and services
    in return for payment.  Their relationships evolved to the sharing of
    information and interaction on a variety of business functions in a
    joint effort to make a better quality product more quickly and less
    expensively.  Both the firm responsible for the complete product--the
    product developer--and its suppliers benefited from the process.  The
    four traits we used to describe these relationships can thus be seen
    as the components of a self-sustaining system as shown in figure 2.1.

       Figure 2.1:  System of Four
       Traits Seen in Commercial Best
       Practices

       (See figure in printed
       edition.)

    The first three traits put the mechanisms in place to develop the
    desired relationships between the product developer and the suppliers
    of product components.  In essence, this is how the product developer
    created the system and communicated it to the different tiers of
    suppliers.  Together, the individual practices within these traits
    shaped and guided the relationships and developed a clear
    understanding of the product goals and business terms as well as
    effective conduits for assessing performance and communicating.
    These conduits were primarily face-to-face contacts with people who
    used agreed-on measures of performance.  They extended through all
    tiers of suppliers and were built upon stable, cooperative
    relationships.  The product developers saw to it that the system and
    the product's needs were communicated to all tiers of suppliers.

    It is the fourth trait that generates the energy in the system.  The
    practices within this trait created the "quid pro quo," that is, the
    realization by the key team members that they were all benefiting
    from the relationship and that more significant contributions were
    matched with significant rewards.  Essentially, the best practices
    emerged and were sustained when the product developer created an
    environment in which it became an attractive customer.  It did this
    by not only rewarding superior suppliers with future business but by
    building partnerships, allowing top suppliers to participate in
    product planning and design, sharing business plans, and relaxing the
    procedures for doing business together.  In turn, the suppliers were
    willing to go the extra mile, commit their own resources to enhance
    prospects for future business, and comply with the demands of the
    source selection and evaluation mechanisms.  They were also willing
    to invest their ideas and intellectual capital back through the
    system.  The suppliers' responses improved product output and
    reinforced the initial commitment that the product developer made to
    strengthening supplier relationships.  Mutual trust--earned through
    action--was essential to creating this environment.

       INCENTIVES FOR IMPROVED
       SUPPLIER RELATIONSHIPS MAY NOT
       BE AS STRONG FOR DOD PROGRAMS
    ---------------------------------------------------------- Chapter 2:2

    Supplier relationships on defense acquisition programs differ from
    the commercial sector.  In the commercial sector, the product
    developer decides how best to meet customer needs; in the defense
    sector, this responsibility is shared between DOD and the prime
    contractor, with DOD having the ultimate responsibility.  While DOD
    is implementing a number of reforms to make its acquisition process
    more commercial-like, its supplier relationships can be hampered by
    traditional acquisition practices.

    In a more traditional program, like BAT, the four traits do not
    comprise as powerful a system as is formed by the best commercial
    practices.  While a number of the practices that make up the middle
    two traits--such as supplier certification, ratings, and a forum for
    meeting with suppliers--have been adopted, their impact on the BAT
    program was blunted by weaknesses in central support and the quid pro
    quo environment.  The commitment of the prime contractor to improve
    supplier relationships was not perceived by some key suppliers as
    having been much more than procedural changes.  Part of the reason is
    that although DOD shares responsibility for determining what is
    important in managing an individual program, its traditional approach
    has been to maintain an "arm's length" relationship with prime
    contractors and have little involvement with suppliers.

    Regarding the fourth trait, some key BAT lower-tier suppliers did not
    believe they were encouraged to contribute to the design of the
    product or that their extra efforts to innovate were encouraged, or
    that business relationships were simplified.  Instead, they believed
    there was no basis for expecting the business relationship to extend
    beyond the contract in hand.  Consequently, their performance was
    limited to compliance with contract requirements, impairing the
    program's ability to take full advantage of the suppliers'
    intellectual capital, such as design or product ideas.

    The JDAM program office took a much more active role in ensuring that
    high-performing suppliers were selected, ensuring that all tiers of
    suppliers understood and participated in meeting the program's
    priorities, and offering long-term benefits to the prime contractor
    and its suppliers for good performance.  In short, it had bolstered
    the practices in the first and fourth traits.  At the time of our
    review, the program appeared to have fostered a system of supplier
    relationships that emulated best commercial practices.

    COMMERCIAL-LIKE MECHANISMS ADOPTED
    BY DEFENSE FIRMS CAN BE MUTED IN
    IMPLEMENTATION
    ============================================================ Chapter 3

    The defense prime contractors we met with recognized the need to
    adopt commercial-like practices to maximize the contributions of
    their suppliers.  To varying degrees, these firms had put in place
    the mechanisms or infrastructure to select the best suppliers and to
    establish the means for communicating and improving performance.
    Thus, the prime contractors were attempting to establish better
    supplier relationships in the areas we described as the first three
    traits of commercial best practices.  However, differences in whether
    suppliers actually perceived an improvement in the relationships on
    the individual BAT and JDAM programs suggest that how these
    mechanisms were implemented was as important as their establishment.
    Specifically, the mechanisms applied on the BAT program did not
    effectively reach or have the same impact on several second-tier
    suppliers as they did on JDAM.  To some extent, these differences
    could be attributed to the newness and increased latitude of JDAM as
    a pilot program and to its prime contractor being further along in
    adopting commercial practices.  Another key factor was the more
    traditional "arms length" role DOD played on the BAT program, as
    contrasted with the proactive role it played on JDAM.

       SUPPLIER RELATIONSHIPS MUST
       HAVE CENTRAL SUPPORT
    ---------------------------------------------------------- Chapter 3:1

          BEST COMMERCIAL PRACTICES
    -------------------------------------------------------- Chapter 3:1.1

    The leading commercial firms embraced effective supplier
    relationships as a core business strategy and built organizational
    structures with skilled people to carry out the strategy.  These
    firms provided central, consistent supplier policy direction and
    enforced specific practices across business units.\1 By so doing, the
    firms not only informed the different business units but also helped
    the units agree on implementing factors, such as supplier costs,
    selection, development, and long-term alignment of key suppliers with
    business goals.  The firms implemented their supplier strategies
    primarily by creating supplier management teams (often called
    commodity teams or internal councils).  These teams or councils
    linked business objectives and performance factors--such as quality,
    cycle time, and total cost initiatives--with supplier relationship
    activities.  In so doing, they replaced independent supplier
    relationships previously forged by individual business units.

    For example, Chrysler is organized around several product platform
    teams such as for large cars, small cars, and trucks.  The platform
    teams developed strategies for each product, coupled with commodity
    strategies that defined which product components were to be purchased
    from which suppliers.  Motorola has had a commodity team structure
    since 1982.  Motorola said they also established a central Supplier
    Management Council and three regional councils for the Americas,
    Europe, and Asia.  The councils followed the same mission and vision
    statements and shared decisions with each other to ensure consistency
    across the company.  The use of councils encourages people in all
    areas of the company to approach supplier relationships from a common
    understanding.  Collectively, the council and commodity structure
    forged unity and a willingness to share supplier information between
    business units and regions and a willingness to work together.  Some
    of Motorola's products are shown in figure 3.1.

       Figure 3.1:  Examples of
       Motorola Commercial Products

       (See figure in printed
       edition.)

       Motorola's council and
       commodity structure helps share
       information among different
       products.

       (See figure in printed
       edition.)

       Source:  Motorola.

       (See figure in printed
       edition.)

    Leading commercial companies generally created purchasing
    organizations to support their supplier management strategies.  Often
    a blend of centralized and decentralized operations, the purchasing
    organizations assisted line management on both a company-wide and
    business unit level.  These purchasing organizations were staffed by
    experienced and well-trained people who helped line managers consider
    multiple factors, such as product quality, total life-cycle costs,
    and technological capabilities, in deciding on which suppliers to
    use.  Commercial firms also supported their supplier management
    strategies by streamlining the supply ordering and distribution
    process and building a technological infrastructure to facilitate
    company and supplier business contacts and supplier base management.
    Internet sites, electronic commerce, electronic data interchange, bar
    coding and scanning, and advance shipping notices were some of the
    information technology applications companies used to make it easier
    for suppliers to conduct business with them.

    It is a major undertaking for a firm to embrace an active supplier
    management policy and to commit the resources necessary to implement
    the policy.  A firm's commitment to such an undertaking is not based
    on altruism or a particular management theory.  Rather, the
    commitment is based on the desire to maintain a competitive edge.  In
    our recent report on applying best practices to preparing weapons for
    production, leading commercial firms took a similar position:  best
    practices were adopted because they helped a firm succeed.\2

    --------------------
    \1 For purposes of this report, a "business unit" is an organized
    unit within a corporate firm.  Most major firms have divided their
    businesses into some type of strategic business units.

    \2 Best Practices:  Successful Application to Weapon Acquisitions
    Requires Changes in DOD's Environment (GAO/NSIAD-98-56, Feb.  24,
    1998).

          DEFENSE PRIME CONTRACTOR
          PRACTICES
    -------------------------------------------------------- Chapter 3:1.2

    The defense companies we visited had corporate policies regarding
    suppliers, but some firms were further along in establishing
    corresponding organizational practices than others.  McDonnell
    Douglas, the JDAM prime contractor, had a well-established supplier
    program.  Supplier importance was recognized in the firm's corporate
    philosophy and was designated as a core company competency.
    Well-documented problems with the C-17 aircraft encouraged McDonnell
    Douglas' Military Transport Aircraft division to revamp its quality
    and supplier selection program using best commercial practices.  The
    division also created nine commodity teams and sponsored a supplier
    management council.  Figure 3.2 shows the C-17 aircraft.

       Figure 3.2:  C-17 Cargo
       Aircraft

       (See figure in printed
       edition.)

       Problems on the C-17 program
       led to major changes to improve
       supplier relationships.

       (See figure in printed
       edition.)

       Source:  DOD.

       (See figure in printed
       edition.)

    Boeing Space and Systems Group's supplier base management program has
    as one of its goals, a common and consistent approach to manage its
    supplier base.  AlliedSignal Aerospace had Sector Commodity Teams
    managing specific commodities.  The teams were responsible for
    selecting partners and developing long-term agreements to be used by
    all purchasing organizations throughout AlliedSignal Aerospace.  The
    Northrop Grumman division responsible for BAT initiated procedures in
    September 1996 to formalize communication with suppliers and provide
    performance feedback.  The procedures reflected their corporate value
    statement, which states:

         We regard our SUPPLIERS as essential team members.  .  .  .  We
         owe our suppliers the same type of respect that we show our
         customers.  Our suppliers deserve fair and equitable treatment,
         clear agreements and honest feedback on performance.  We
         consider our suppliers' needs in conducting all aspects of our
         business.

          DOD POLICIES SILENT ON
          SUPPLIER ISSUES
    -------------------------------------------------------- Chapter 3:1.3

    Although DOD has devoted significant effort to reducing the cost of
    doing business with the government, it has not directed its policies
    at the types of relationships that exist between prime contractors
    and their suppliers.  Some DOD efforts may facilitate better supplier
    relationships, such as the use of teams.  While JDAM made use of
    these tools to help build good supplier relationships, focusing on
    suppliers as a means to make reforms work was an innovation of the
    JDAM program and not an explicit objective of the pilot program.

    According to an Aerospace Industries Association official, the
    significance of suppliers has tended to be overlooked.  He noted that
    until recently, the Association had not adequately considered
    supplier firms in its dealings, citing an example of how an
    acquisition reform that prime contractors support can have
    unanticipated consequences on suppliers.  Specifically, the Single
    Process Initiative gave prime contractors the opportunity to simplify
    quality assurance and other procedures in their own facilities.
    However, suppliers that worked for more than one prime contractor
    suffered as each contractor established its own processes.  In 1997,
    the Association expanded its membership to supplier firms and created
    a council to represent the suppliers' views.

    Similarly, while DOD is interested in whether its prime contractors
    choose capable suppliers, it has traditionally taken a hands-off
    approach to how prime contractors deal with suppliers.  DOD officials
    attributed this approach to a concern that direct dealings between
    the government and subcontractors would be contrary to the legal
    doctrine of privity of contract.

    Privity refers to the direct relationship that arises between the
    parties to a contract as a result of their mutual obligations.  Thus,
    there is privity between DOD and the prime contractor on a contract
    but not between DOD and the suppliers because there is no contract
    between them.  According to DOD officials, the traditional concern
    about privity of contract has distanced DOD and its program managers
    from supplier management concerns.  Although privity concerns might
    preclude communications that could imply a contractual relationship
    between DOD and a subcontractor or that would be inconsistent with
    the existing contracts, they need not be a barrier to other forms of
    communication with suppliers or to efforts to improve relationships
    between and among the government, a prime contractor, and suppliers.
    Moreover, privity concerns may be reduced by the parties agreeing
    that the government may have direct communications with suppliers.
    We believe such communication appears to have facilitated innovation
    and teamwork on the JDAM program.

    While the role played by DOD through the Army program office on the
    BAT program was traditional regarding supplier relationships, a very
    different role was played by the JDAM program office.  Officials were
    significantly involved in the JDAM effort from the beginning of the
    program, taking a much more open, hands-on role in dealing with
    potential prime contractors and their suppliers.  This approach set
    the expectation that supplier selection and management would figure
    prominently into program success and DOD's selection of the prime
    contractor.  According to DOD officials, the more active approach was
    taken because affordability was the top program objective.  DOD
    program officials visited and evaluated the performance of the
    individual suppliers to the two competing prime contractors.  They
    used the actual performance of the suppliers and the prime
    contractors during an early development phase as a key factor for
    choosing the prime contractor and supplier team that would win the
    competition to complete development and enter production.

    DOD's traditional reticence in guiding supplier relationships
    represents a significant difference in the environment defense prime
    contractors operate in compared with commercial firms.  Commercial
    firms are driven toward optimizing supplier relationships to gain a
    competitive edge in winning the customer's business and they can act
    unilaterally in garnering those relationships.  In the acquisition of
    weapon systems, DOD is the customer on the one hand and on the other
    it shares responsibility for managing and directing the program with
    the prime contractor.  Thus, if DOD does not encourage implementing
    best practices in order to get the best out of suppliers, the prime
    contractors may not have as strong an incentive as commercial firms
    to adopt such practices.

       RIGOROUS SUPPLIER SELECTION
       CREATES STRONG SUPPLIER BASE
    ---------------------------------------------------------- Chapter 3:2

          BEST COMMERCIAL PRACTICES
    -------------------------------------------------------- Chapter 3:2.1

    Leading companies used a rigorous supplier selection process to
    create a strong supplier base.  Specific practices included using
    stringent supplier selection criteria, relying on a manageable number
    of suppliers, maintaining or developing some level of competition
    between suppliers, and periodically assessing the supplier base
    against company goals.  A desired result of such a process was a
    strong supplier base that companies can effectively manage.  For
    example, Texas Instruments Semiconductor Group said their selection
    process meant there was a reliance on a few, very capable suppliers,
    a stronger relationship between the company and suppliers, and
    stronger business processes for both companies when they interacted.

    Knowing the importance of suppliers to their business success, the
    leading commercial companies used specific criteria to select
    suppliers and the supply chains they represented.  Companies selected
    suppliers based on needs for supplier backup, capacity requirements,
    competition needs, suppliers' product range, and the complexity of
    the product.  In their selection procedures, the companies weighed
    the total cost of doing business with each supplier, not just the
    sales price of the item.  The total cost of doing business included
    tangible factors, such as quality, and intangible factors, such as
    effective communications.  If the companies only considered lowest
    price suppliers, then their total costs might be higher because of
    quality, delivery, and service problems.  Using the total cost
    approach in conjunction with selecting a limited number of suppliers
    was seen as important to building more sophisticated supplier
    relationships.

    Another key selection criterion best practice companies stressed was
    comprehensive quality.  They expected their suppliers to have a
    comprehensive quality system, generally based on ISO-9000, the
    Malcolm Baldrige National Quality Award, or other quality standard
    systems.\3 For example, Motorola required all of its suppliers to
    show intent to apply for the Baldrige competition.  Xerox used a
    multinational supplier quality survey and an on-site assessment as
    part of its supplier selection.  As a result, many companies often
    replaced expensive incoming part or item inspection of selected
    supplies with supplier certification programs or the assurance of
    high performance capabilities through the supplier selection process.
    Baxter Healthcare Corporation, for example, developed a quality
    history for supplier certification.  By certifying the supplier's
    test methods, Baxter minimized its own product testing and eliminated
    some receiving and inspection functions.  Its plants did not have to
    wait for supplier shipments to be inspected or hold inventories
    anticipating poor quality materials or delayed shipments.

    The companies evaluated suppliers using assessment methods such as
    certifications, surveys, inspections, statistical process control,
    and quality audits.  The method varied by the importance of the
    product and how much performance assurance was desired.  Companies
    started by thoroughly analyzing their supplier base needs, drawing on
    information about business requirements, industry performance trends,
    supplier base performance and supply chain management, and potential
    suppliers.  Supplier evalutation techniques used by Dupont and Honda
    are described in figure 3.3.

       Figure 3.3:  Evaluation
       Techniques for Selecting
       Suppliers

       (See figure in printed
       edition.)

    Almost all the leading companies we contacted either had limited or
    planned to limit the number of suppliers that they relied on by
    concentrating on proven suppliers that met the selection
    requirements.  By relying on a limited supplier base targeted to
    companies' purchasing needs, companies could make better use of their
    internal purchasing resources, such as people.  At the time of our
    review, Toyota Motor Sales officials said they planned to reduce the
    number of suppliers providing goods and services, such as
    advertising, from 1,500 to about 1,000.  Of these, only 100 suppliers
    accounted for 80 percent of the company's indirect purchasing
    expenditures.  In 1986, Motorola began implementing its supplier
    reduction strategy, which relied on creating a base group of
    suppliers that stayed the same unless performance fell or new
    suppliers offered technological innovations.  Over a decade, Varian
    Oncology Systems reduced the number of its production suppliers from
    1,100, which it considered unmanageable, to 345.

    In reducing the size of the supplier base, commercial companies were
    careful to include enough suppliers for an item to ensure there would
    be competition and a back-up source.  These were not necessarily
    head-to-head competitions.  For example, Honda said they selected two
    suppliers that made the same product but targeted the product for
    different automobile models, such as one steering wheel supplier for
    the Honda Accord and another for the Honda Civic.  Several of the
    commercial firms also attempted to limit the business they did with
    an individual supplier to keep the supplier from becoming too
    dependent on any one customer.

    --------------------
    \3 ISO-9000 is the commercial standard for quality assurance.
    Independent, certified quality consultants conduct on-site audits of
    applicants and give approval.  The Malcolm Baldrige National Quality
    Award promotes awareness of quality excellence, recognizes quality
    achievements of U.S.  companies, and publicizes successful quality
    strategies.  Industry specific quality standards also are used, such
    as the QS-9000 for the automotive industry.

          DEFENSE PRIME CONTRACTOR
          PRACTICES
    -------------------------------------------------------- Chapter 3:2.2

    Several of the defense prime contractors we contacted had developed
    or were developing supplier selection practices similar to best
    commercial practices.  They had reduced the number of their suppliers
    and established selection criteria and categories to differentiate
    between types of suppliers.  For example, AlliedSignal Aerospace
    reduced its supplier base from over 10,000 in 1991 to less than
    3,000, increasing the volume of business with the remaining
    suppliers.  By reducing suppliers, Honeywell's Defense Avionics
    Systems Group reported reducing costs by reducing the number of
    buyers and quality managers required.

    DOD has placed new emphasis on the use of "best value" to justify
    selection of a contractor or supplier on a basis of more than lowest
    price.  This initiative is similar to the total cost approach to
    supplier selection used by commercial firms.  Some defense
    contractors recognized and were moving toward the use of best value
    in selecting suppliers.  Boeing's Space and Systems Group said they
    used historical performance data to determine overall best value by
    recognizing the penalties associated with late delivery and poor
    supplier quality.  Honeywell Defense Avionics Systems officials said
    they get best value in some commodities by reducing the supplier base
    to only preferred suppliers, then competing them on price.

    Some prime contractors were skeptical of whether DOD was really
    supporting the best value approach.  According to one firm, the
    government hurts itself by basing awards on the lowest bid.  It noted
    that the government does not necessarily get the best value product
    if the supplier is late or has low quality.  Another firm noted the
    incentive for a prime contractor to use best value in selecting its
    suppliers reflects the emphasis DOD places on best value in selecting
    the prime contractor.  Officials from this firm stated that although
    DOD may support a best value policy, resistance to that approach was
    still apparent at the lower levels in the services, particularly
    auditing agencies, which still focus on price differences in
    evaluating subcontracting practices.

          SHARP CONTRASTS IN SUPPLIER
          SELECTION ON BAT AND JDAM
          PROGRAMS
    -------------------------------------------------------- Chapter 3:2.3

    The different experiences with the selection of suppliers on BAT and
    JDAM pointed out the key role both the prime contractor and DOD
    played in establishing a strong, dependable team at the outset of a
    program.  The BAT prime contractor described the selection of its
    major suppliers as a targeted process, not part of an overall supply
    base strategy.  The JDAM program had a much greater emphasis on a
    commercial-like, long-term supplier strategy at the outset of the
    program.

    Of the 10 BAT suppliers we met with, 5 were original suppliers and 4
    were replacements for original suppliers that had trouble with their
    components.  Northrop Grumman reported one new supplier was added
    when the Army decided to use a different--and faster--missile to
    carry the BAT submunition, which required a different technology.
    Second-tier supplier F, the third BAT supplier for a particular
    component, stated that the two previous suppliers had good track
    records and lower bids, but after 2 years of development neither
    could produce the part within specifications.  A company official
    said it took the firm's experience and special processes to make the
    part within specifications.  On another component, second-tier
    supplier D was the back-up source until the first supplier "bowed
    out." If supplier D had been selected earlier, company officials said
    they could have used their knowledge in establishing the
    requirements.  Two other firms informed us that they became BAT
    suppliers after the original suppliers had failed.  One supplier
    official believed that a focus on procurement unit cost was the
    primary concern of the BAT program, rather than life-cycle cost.  He
    believed this became an impairment, particularly when decisionmakers
    make poor assumptions about costs that affect the rest of the
    program, such as how much a part will cost.

    Program priorities could influence the extent to which more supplier
    changes are made in the future.  For example, one of the first-tier
    suppliers competing for the new seeker in the improved BAT informed
    us that because of a very tight schedule set by the Army, the firm
    selected a second-tier supplier based on its ability to build a test
    article quickly--not on its ability to meet the long-term criteria of
    production capacity, delivery, and quality.  The first-tier firm said
    that they might consider using other suppliers in the next program
    phase.

    Program office involvement helped shape the selection of JDAM
    suppliers, emphasizing their potential for long-term success.  The
    DOD teams that evaluated potential prime contractors included key
    suppliers as part of their assessment and reviewed manufacturing
    capabilities and prime contractor business practices.  After the
    prime contract competition was reduced to two firms, DOD officials
    said that they met with officials from the firms and discussed what
    the teams had found at their suppliers.  As a result, one prime
    contractor selected two new suppliers after asking DOD program
    officials to recommend better performers.  DOD offered its advice but
    did not mandate changes in the choice of suppliers.  Nonetheless,
    DOD's demonstrated interest in supplier capabilities, particularly in
    terms of price, quality, and production capabilities influenced
    McDonnell Douglas' selection of suppliers.

    McDonnell Douglas officials described their selection of JDAM
    suppliers as an exhaustive, iterative, affordability-driven screening
    process.  The company used its Preferred Supplier Certification
    process, which emphasized supplier performance and key process
    controls at the factory and the business level.  Some suppliers were
    picked by the contractor to meet unique JDAM requirements, such as
    the high-volume requirements.  Others were used because of their
    performance and preferred supplier status.  Some dual sources were
    used to address component criticality and risk issues.  JDAM
    suppliers confirmed the rigor of the process.  Supplier M said that
    the process was much more involved than that of other weapon systems,
    typified by an intensive site survey process of first-tier suppliers.
    The review emphasized manufacturing, the supplier said, and forced
    the prime contractor and suppliers to think through JDAM from a
    design and production efficiency perspective.

       AN EFFECTIVE COMMUNICATION AND
       FEEDBACK SYSTEM MUST EXIST
    ---------------------------------------------------------- Chapter 3:3

          BEST COMMERCIAL PRACTICES
    -------------------------------------------------------- Chapter 3:3.1

    Leading commercial companies established effective communications and
    feedback systems with their suppliers to continually assess and
    improve both their own and supplier performance.  These practices
    helped the product developer's goals, priorities, and performance
    assessments to reach all key suppliers and for suppliers' ideas and
    concerns to be expressed to the product developer.

    Some leading companies designated an authoritative contact person as
    a single interface with suppliers so that suppliers trying to resolve
    day-to-day questions or problems were not passed from one company
    official to another.  For example, each Chrysler supplier had a
    Chrysler person knowledgeable about the supplier's business to
    contact for all supplier dealings for that commodity.  Typically, the
    leading companies also interacted with key suppliers in close teaming
    arrangements that facilitated sharing information.  Commonly called
    integrated product teams (IPT), members worked together so that
    design, manufacturing, and cost issues were considered together.
    Team members were encouraged to participate as partners in meeting
    project goals and to interact frequently.  In addition, some
    companies collocated suppliers with their own people or set up
    central working facilities with suppliers for working out issues such
    as how a product might be improved or be made less expensive.
    Motorola and Xerox saw such teams as a key vehicle for facilitating
    early supplier involvement in their products--one of their primary
    strategies.  Motorola said key suppliers had building access and came
    in many times during a week to work with Motorola engineers.

    To establish an objective basis for communicating about performance,
    the leading commercial companies set performance measures and
    expectations for each supplied product and service, using key
    elements such as quality, responsiveness, timeliness, and cost.
    These factors were consistent with the firms' selection criteria, and
    the product developer made clear to suppliers what these elements
    meant and how they would be used in business decisions.  Most leading
    companies also provided periodic "report cards" and met formally with
    their key suppliers to discuss issues such as performance evaluation
    results, comparison of the suppliers with their competitors on key
    quality measures, customer and supplier improvement strategies, and
    future business opportunities.  For example, Plow and Hearth reported
    sending suppliers a quarterly performance summary that supplemented
    continuous supplier feedback.  Also, once a week, Plow and Hearth
    officials representing merchandising, product returns, quality
    assurance, and inventory control discussed specific supplier issues.

    The customer and the supplier generally worked together to develop
    milestones, commitments, and deliverables for corrective action.
    Suppliers needing improvement met with Plow and Hearth for a
    "customer-supplier alignment," which clarified each other's services
    and problems and developed corrective action plans.  Commercial firms
    typically provided their suppliers technical assistance to help
    improve performance that was supported by sophisticated company,
    supplier, and industry information systems and reports.  Examples of
    such assistance included quality audits, benchmarking, training,
    newsletters, and direct help on production techniques.  Specific
    assistance provided by individual firms is shown in figure 3.4.

       Figure 3.4:  Examples of
       Assistance Commercial Firms
       Provided Their Suppliers

       (See figure in printed
       edition.)

    Commercial companies also extended their attention to lower-tier
    suppliers.  This level of attention was in recognition that
    lower-tier products accounted for a significant portion of product
    costs and significantly affected the final product's performance.
    Few companies reported direct involvement with lower-tier suppliers
    if they were satisfied with the first-tier supplier's supplier
    management processes and performance.  While not directly managing
    lower-tier suppliers, the companies had ongoing knowledge of these
    suppliers' efforts through communication and monitoring of first-tier
    activities.  More importantly, their own commitment to optimal
    supplier relationships helped them to look for and expect the same
    commitment from their own suppliers.  For example, Honda reported
    working with first-tier suppliers to develop self-reliance or the
    capability to effectively manage their own supply chains.  In other
    cases, companies took a more hands-on approach; Chrysler said they
    worked with first-tier suppliers to jointly manage lower-tier
    suppliers, extending all the way to the raw material stage.

          DEFENSE PRIME CONTRACTOR
          PRACTICES
    -------------------------------------------------------- Chapter 3:3.2

    Most of the prime contractors informed us that they had processes for
    setting supplier performance expectations, assessing supplier
    performance, and providing feedback.  McDonnell Douglas continuously
    measures supplier performance and reports to suppliers quarterly.  To
    remain a McDonnell Douglas preferred supplier, specific criteria for
    quality and delivery must be met.  For example, to remain a bronze
    supplier, the lowest level of preferred supplier, quality must be at
    98 percent or better, and delivery must be within the 15 days prior
    to delivery date at least 95 percent of the time.  AlliedSignal
    incorporates performance criteria in its agreements measuring cost,
    quality, delivery, and service.  It also publishes and shares monthly
    measures with supplier partners, along with how their performance
    compared to other commodity sector partners.  Boeing's Space and
    Systems Group had established a process for evaluating selected
    suppliers semiannually on performance factors that included cost,
    delivery, quality, and technical contribution.

    Similarly, Honeywell Defense Avionics Systems suppliers received
    monthly reports detailing their performance and were rated on
    quality, delivery, and any shortfall.  Honeywell also met quarterly
    with the executives of their top suppliers to discuss short- and
    long-term strategies and improvement plans.  Northrop Grumman
    formally discussed performance results biannually with suppliers,
    supplementing other sources of performance feedback.  The company
    recently began a supplier management program as a result of its
    Baldrige self-assessment that identified supplier management as an
    area for improvement.  In 1997, the firm initiated a Subcontractor
    Performance Assessment procedure and planned to give suppliers a
    color-coded score based on performance in 16 areas, such as
    submitting data on time, and performance of a supplier's subtiers.  A
    supplier performance assessment was to be used monthly to evaluate
    and document supplier performance on a variety of elements.  A BAT
    supplier was the first to be assessed under the new procedures.

    In 1995, the Secretary of Defense directed the services to apply the
    integrated product and process development and team concepts to the
    acquisition process.  The initiative established teams as the
    preferred method for DOD to perform acquisition functions.  This
    direction is consistent with the teaming that the leading commercial
    companies are doing.  All of the defense prime contractors we met
    with stated that they were using IPTs.  For example, Motorola said
    the Land Warrior program had many major development subcontracts,
    with a significant amount of new design, that were set up as teaming
    agreements.  Boeing described a long history using teams for both
    military and commercial programs.  Top suppliers are team
    participants and involved early on in the programs.  While BAT was
    initiated before the DOD directive on teaming, the program manager
    for Northrop Grumman said that the program has operated under a team
    concept since its beginning.

          BAT SUPPLIERS CITED PROBLEMS
          WITH COMMUNICATIONS,
          TEAMING, AND FEEDBACK
    -------------------------------------------------------- Chapter 3:3.3

    The BAT program's incorporation of commercial-like practices such as
    the use of teams and supplier rating systems received a mixed
    reception by BAT suppliers.  The experience of at least some
    second-tier suppliers on the BAT program suggested that the presence
    of commercial-like mechanisms alone did not improve supplier
    relationships.

    BAT has 10 IPTs, 1 for each major subsystem.  Program officials
    described membership as generally consisting of a team leader,
    engineer, subcontract administrator, business management
    representative, scheduler, quality person, manufacturing
    representative, and a government focal point.  Suppliers below the
    first tier were generally not involved.  Two suppliers believed that
    the team approach was working well.  First-tier supplier G said that
    there was a work process team in place at the beginning of its
    contract and the firm held weekly teleconferences with the prime
    contractor.  While engineers might call each other directly, most
    communication with the prime contractor was through the supplier's
    contract manager.  Similarly, supplier E stated that the IPT was
    central to the BAT program and had facilitated communication and
    problem solving.

    Other BAT suppliers found problems with how the teams operated, as
    depicted in figure 3.5.

       Figure 3.5:  Problems in How
       Teams Operated

       (See figure in printed
       edition.)

    Other suppliers suggested that improved communications between
    suppliers would have benefited the BAT program.  Supplier D said that
    design problems could have been avoided if it could have met with
    higher level assemblers.  It stated that instead of working together
    to solve problems, the firms resorted to defending their own actions.
    Supplier A noted that there was no forum for the suppliers to
    collaborate with other firms that were supplying components for the
    same section of the submunition.  The supplier believed that a few
    thousand dollars per unit could have been saved by exchanging
    physical space within the submunition to enable simpler packaging.
    Another second-tier supplier said that its first-tier customer sent
    technical assistance personnel, but they were not at all helpful.
    They noted that the technical people sent did not have the expertise
    to help and that their problem was much more sophisticated.

    Supplier I cited some key communication voids with the upper-tier
    firms.  This firm, which was responsible for a sophisticated and
    mission critical electronic component, believed that the design it
    has been given is not producible because of the limited opportunities
    to make design trade-offs as previously discussed.  Nonetheless, the
    firm was not a part of the Army production readiness review to assess
    the risks the BAT program faced in preparing for production.
    Moreover, the firm believed the cost of its component to be three
    times the cost the prime contractor included in the overall cost
    estimate, but it was not consulted about costs either.  Had
    communications been better, these problems could have been addressed
    already; instead, they may show up as surprises later in the program.

    Perhaps reflecting the newness of the Northrop Grumman rating system,
    several suppliers were not familiar with the new procedures or
    satisfied with the system's criteria and feedback.  Some of the
    suppliers believed that their ratings were lowered for decisions DOD
    or the prime contractor had made, which resulted in skepticism about
    the usefulness of the ratings.  Several examples follow.

      -- Supplier G said it received an overall poor rating from the
         prime contractor because BAT was behind schedule, caused by a
         stretch in the program--something the supplier had nothing to do
         with.

      -- Officials from supplier B believed the company's rating was low
         because of waivers that were necessary until the prime
         contractor decided on certain requirements.

      -- Supplier C said it received a low rating for waivers that were
         necessitated by the Army's change in the missile carrier for
         BAT.  The supplier said that the changes were not reflected in
         the rating criteria or the delivery schedule.  It was
         devastating to the firm, the supplier said, partly because
         personal bonuses were affected by customer ratings.

          JDAM SUPPLIERS IMPRESSED
          WITH THE EFFECTIVENESS OF
          COMMUNICATIONS AND FEEDBACK
    -------------------------------------------------------- Chapter 3:3.4

    JDAM participants uniformly described the program as structured in a
    way that encouraged communication.  A key factor was how IPTs were
    employed from the beginning--including the design phase--with the
    government customer (represented by the DOD program office) closely
    involved.  JDAM was one of the first programs to use these teams in
    all aspects of business.  DOD helped create this situation by
    requesting that IPT program management structures detail the plans
    for teams and subcontractor as part of the request for contract
    proposals.  The teaming approach was consistent with McDonnell
    Douglas' corporate view that it was a critical tool for developing
    products and working with suppliers.

    An executive-level team set the core strategy for the JDAM project,
    and other teams were organized around issues such as affordability
    and component design.  The executive team included vice presidents
    from McDonnell Douglas and the first-tier suppliers and focused on
    high-level programmatic approaches and pricing strategies.  The
    executives were not allowed to delegate their responsibilities to
    lower-level managers, according to two suppliers.  The executive team
    promoted affordability for the whole system rather than costs for
    individual suppliers.  According to supplier O, the team was
    instrumental in the decision to use a Lockheed Martin connector that
    was more reliable and cost-effective than a McDonnell Douglas
    product.

    JDAM suppliers we met with spoke highly regarding communications on
    the program.  This communication started with a clear understanding
    at all supplier levels of what the program's priorities were and the
    institution of open channels (primarily through the teams) for
    exchanging information and making trade-offs to protect these
    priorities.  Suppliers were considered integral members of the IPTs
    and fully participated in program decisions.  For example, supplier
    engineering, purchasing, and manufacturing people were involved in
    the design process, which a supplier described as an interactive
    process in which the product specifications were defined by DOD, the
    prime contractor, and suppliers.  One supplier observed that a key
    factor in the teams' success was McDonnell Douglas had put someone in
    charge at every level of the project who could make decisions and
    established a disciplined configuration control process.

    JDAM suppliers agreed to a rigorous assessment.  The foremost
    performance criterion was the achievement and continued maintenance
    of the average unit production price, quality, and schedule goals.
    McDonnell Douglas tailored corporate performance measures to JDAM and
    used a variety of methods to collect performance data.  Suppliers
    generally received monthly reports or program reviews for JDAM.
    Informally, the IPTs allowed for ongoing assessments and responses to
    problems.  Second-tier suppliers believed that the technical
    assistance provided by McDonnell Douglas and upper-tier firms was
    extensive and was facilitated by the IPTs.  According to one
    supplier, problems were not seen as weaknesses of its customer or of
    itself but as issues that should be worked on jointly.  Another
    supplier noted problems are cooperatively resolved, and that
    expertise was shared on both sides, consistent with the teaming
    philosophy.

    A REWARDING ENVIRONMENT IS KEY TO
    FOSTERING THE BEST SUPPLIER
    RELATIONSHIPS
    ============================================================ Chapter 4

    In our analysis, it was the fourth trait--providing a rewarding
    environment for sophisticated supplier relationships--that provided
    the energy for the other practices to work.  This last trait
    constituted the quid pro quo or the realization by both the suppliers
    and the product developer that they were all benefiting from the
    relationship in ways other than near-term monetary compensation.
    Through tangible action on the part of both the product developers
    and the suppliers, each learned that more significant contributions
    were matched with longer-term rewards.  The result was trust and
    commitment.

    The participants in weapon system programs may face difficulties in
    creating an environment that fully leverages the other practices to
    get the most out of supplier relationships.  As with the other
    traits, both DOD and the prime contractors play a significant role in
    fostering the right environment.  Defense prime contractors believe
    there are obstacles to fostering such long-term relationships.  As
    discussed in chapter 3, experience on the BAT program shows that
    despite the relaxation of some DOD requirements and the institution
    of individual best practices, such as IPTs, and supplier assessments,
    several key suppliers believed that their environment was unchanged.
    JDAM's more rewarding, commercial-like environment was created
    through an atypical, proactive approach by DOD and the prime
    contractor that cultivated supplier involvement.

       BEST COMMERCIAL PRACTICES
    ---------------------------------------------------------- Chapter 4:1

    The leading commercial firms we met with had created an environment
    in which both they and their suppliers were getting more from their
    business relationships than a good product for a fair price.
    Suppliers had become important to the conception and design of new
    products and the products benefited from their contributions.  The
    mutually rewarding nature of this environment are depicted in figure
    4.1.

       Figure 4.1:  Mutually
       Beneficial Aspects of a
       Rewarding Supplier Environment

       (See figure in printed
       edition.)

    As indicated in the figure, the interaction of the product developer
    and the suppliers in fostering a rewarding environment can be seen as
    a loop or cycle.  As discussed earlier, leading firms establish
    rigorous systems for selecting, rating, and communicating with
    suppliers.  Suppliers first had to see enough potential benefit to be
    willing to put themselves through this process.  In return for
    suppliers meeting these demands, product developers provided more
    sophisticated, long-term relationships that included more involvement
    with product design, business plans, and streamlined business
    procedures.  The suppliers responded by committing some of their own
    resources, including intellectual capital, to the longer-term
    business opportunities.  This response made for a better long-term
    product and reinforced the product developers' commitment to better
    supplier relationships.

          SUPPLIERS ACCEPT THE RIGOR
          OF THE PRODUCT DEVELOPER'S
          SYSTEM
    -------------------------------------------------------- Chapter 4:1.1

    The first steps in establishing the right environment for optimizing
    supplier relationships are taken by the product developer when it
    commits to fostering more rewarding relationships and puts the
    mechanisms in place to develop these relationships.  We described
    these as the first three traits earlier in this report.  Leading
    commercial companies are asking a lot from suppliers when they submit
    them to rigorous selection criteria, performance standards, and
    continuous assessments.  A potential supplier faces the potential
    denial of business if it fails to meet the selection criteria.
    Moreover, suppliers in undergoing the process are agreeing to be
    judged under criteria determined by product developers and that they
    may not be rated in the top category.

    Most commercial companies made some distinction among suppliers'
    performance.  For example, Baxter Healthcare Corporation said they
    designate some suppliers as preferred.  Supplier were designated
    preferred based on factors such as quality, delivery, service, and
    cost.  These were suppliers who also had exemplary continuous
    improvement practices and would work on a continuous basis to reduce
    both theirs and Baxter's costs.  A supplier's willingness to submit
    to such a system, therefore, is a significant step that is taken with
    the expectation that the customer's business offering is worth the
    effort.

          COMPANIES OFFER KEY
          SUPPLIERS MORE REWARDING
          BUSINESS RELATIONSHIPS
    -------------------------------------------------------- Chapter 4:1.2

    Leading commercial companies ask suppliers to meet high standards,
    then differentiate the types of relationships within their pool of
    suppliers.  Many treat key suppliers--those contributing the most to
    their product, such as critical parts or unique processes--
    differently than suppliers for noncritical or standard parts.  For
    example, one Corning division categorized suppliers and developed
    relationships with them based on the extent of their impact on the
    customer and performance.  Level 1 suppliers have a direct impact on
    customer satisfaction, level 2 suppliers are important to day-to-day
    operations but not directly linked to customer satisfaction, and
    level 3 suppliers provided commonly available products.  DuPont
    differentiated between alliance partners--suppliers with similar
    goals and objectives that wish to work with DuPont for mutual
    benefit--and all other suppliers.

    The more sophisticated relationships that commercial firms cultivated
    with their key suppliers included features such as participation in
    business planning, product design, and long-term agreements that
    operated with reduced procedures.  Relationships were also
    strengthened by an openness to suggestions and criticisms from
    suppliers as a way to improve the customers' performance.  For
    example, Texas Instruments formed alliances with some suppliers and
    involved them in planning long-term strategies and risk assessments.
    Company executives meet biannually to discuss their joint progress
    and emerging problems.

    Some leading companies recognize that key suppliers need accurate and
    timely sales forecasting and other business information to manage
    their own supply chains.  The companies develop processes to provide
    short- and long-term sales forecasts, helping suppliers anticipate
    the amount and timing of orders.  Motorola said a large number of
    suppliers participate in schedule sharing.  Under this program,
    Motorola electronically posts a 26-week schedule depicting forecasted
    usage of supplied components.  Varian Oncology Systems allows
    suppliers to dial into its manufacturing forecast for the next 12
    months, officials said.  They also share more detailed and sensitive
    information with suppliers who have closer relationships with the
    Varian.  Honda meets with many of its key suppliers in a top
    management business meeting to discuss performance, the supplier's
    financial situation, the definition of a fair profit, and the
    potential for expansion of Honda's business.

    Key suppliers were directly and actively involved in significant
    product decisions, including design.  Most often through the use of
    teaming arrangements, the companies encouraged the key suppliers to
    participate and provide input during the entire product life cycle.
    Some companies collocated suppliers with their own people or set up
    central working facilities with suppliers to share information and
    coordinate design and production activities.  For example, Chrysler
    reported that they select key suppliers early in a product's concept
    stage.  These suppliers joined a design team for a specific platform
    and made presentations to Chrysler management on product design,
    target cost, and the design and delivery schedule.  Officials from
    Varian Oncology Systems informed us that they had involved suppliers
    in design for the last 4 or 5 years.

    In some cases, contractual arrangements reflected the different
    relationships.  Contracts and agreements that guided strategic
    alliance or partnering relationships were less structured and
    generally lasted for several years.  For example, Corning contracted
    with its best suppliers for a 3- to 5-year period.  Also, once
    Corning determined a supplier to merit a "certified" or "preferred"
    rating, then its materials were no longer subject to incoming
    inspection.  Honda considered some key suppliers as suppliers "for
    life" and used only a purchase and sales agreement to conduct
    business with those firms, officials said.  These agreements did not
    include details on quantity, price, or the length of the agreement.
    At Texas Instruments, the commodity teams made some strategic
    supplier contracts virtually open-ended.

    Some leading companies' commitment to mutually rewarding
    relationships with suppliers was also demonstrated by their
    willingness to identify and take action on supplier issues and
    problems.  The companies used methods such as surveys, supplier
    meetings, and formal customer-supplier councils or supplier advisory
    councils to assess existing customer-supplier working arrangements,
    identify problem areas, and report back to suppliers.  Figure 4.2
    gives examples of how some of the companies we visited identify and
    take action on supplier issues.

       Figure 4.2:  Company Actions
       Taken to Solicit Supplier
       Concerns

       (See figure in printed
       edition.)

          SUPPLIERS RESPOND BY
          OFFERING MORE THAN A GOOD
          PRODUCT AND PRICE
    -------------------------------------------------------- Chapter 4:1.3

    Key suppliers responded to these more sophisticated relationships by
    investing their skills and expertise in making the end product
    better.  Their contributions were not limited to providing a quality
    component at a good price or to the contract's terms.  Often, the
    product developers and suppliers jointly identified cost drivers and
    used this information as a basis for target costing and cost
    reduction on specific products.\1 Honda said they involve key
    suppliers in target costing for its new car model designs and found
    that the suppliers could help Honda (1) evaluate Honda's component
    cost estimates and (2) pinpoint component cost differences, including
    those based on poor Honda design or use of obsolete technology.

    Perhaps more significantly, Chrysler's relationships with its
    suppliers had evolved to the point that it no longer needed to make
    large investments in some key technology areas.  Instead, the
    suppliers made the technology investment themselves and had enough
    confidence in their relationship with Chrysler that they did not fear
    the long-term commitment that this entailed.  For its part, Chrysler
    trusted the suppliers to make the investments that would help keep
    their vehicles competitive.  In this case, both supplier and product
    developer saw their success as that of the final product and a
    continuing mutually beneficial relationship.  Figure 4.3 shows a
    Chrysler product.

       Figure 4.3:  Chrysler Concorde
       LXi

       (See figure in printed
       edition.)

       Chrysler products depend on
       suppliers' research and
       development efforts.

       (See figure in printed
       edition.)

       Source:  Chrysler.

       (See figure in printed
       edition.)

    --------------------
    \1 Target costing involves determining the final price the customer
    will pay for the product, and then working backward to set fair
    prices for products, subsystems, and component parts.

       DOD PRACTICES
    ---------------------------------------------------------- Chapter 4:2

    The environment for defense programs is complicated by having more
    players than commercial products with the addition of DOD as a
    participant.  The environment for a given weapon system involves the
    interaction of DOD, the prime, and the suppliers.  Experiences with
    the BAT and JDAM programs illustrate some of the problems DOD and the
    prime contractors face in creating a rewarding supplier environment
    that encourages contributions, as well as potential solutions.  Some
    BAT suppliers viewed their role as only complying with the design
    requirements passed down by the upper-tier customers and limited
    their efforts to the existing contract.  They believed that to do
    more--such as offer design suggestions or make long-term
    investments--would not yield benefits.  In contrast, JDAM suppliers
    believed they were full participants in a long-term relationship with
    their customers.  Through the joint effort of the DOD program office
    and prime contractor, supplier relationships were cultivated without
    being stymied by the obstacles perceived by some prime contractors.

          PRIME CONTRACTORS SUPPORT
          OFFERING SUPPLIERS REWARDING
          RELATIONSHIPS BUT SEE
          OBSTACLES
    -------------------------------------------------------- Chapter 4:2.1

    Like leading commercial companies, most of the defense companies we
    contacted categorized their suppliers in various ways.  Some used the
    terms such as preferred, acceptable, restricted and/or other
    designations to denote different levels of supplier performance.  In
    general, the highest rankings were reserved for suppliers who
    consistently met quality, timeliness, and cost goals.  The defense
    prime contractors also attempted to tailor different relationships to
    different suppliers.

    Motorola officials informed us that their management of suppliers
    varied by categories.  Fewer than 10 percent of their overall
    supplier base fell into their "approved" category.  This category was
    significant because most of the products shipped from the approved
    suppliers were not subject to receiving inspection.  Similarly, the
    preferred supplier certification process at McDonnell Douglas was
    used to rate suppliers into three categories:  bronze, silver, and
    gold.  Supplier performance was measured in key areas, such as
    acceptance rate and on-time delivery rate.  Performance ratings
    ranged from "1" (process output does not meet customer expectations)
    to "5" (process output consistently exceeds customer expectations and
    positive trends have been documented for greater than 36 months).
    Preferred suppliers had to receive a 2.5 rating to merit the bronze
    category and a 4.5 rating to merit the gold category.  Only 9 of
    20,000 McDonnell Douglas suppliers had earned the gold rating at the
    time of our review, officials said.

    To better leverage the capabilities of suppliers, AlliedSignal
    Aerospace develops Sector Long-Term Agreements between AlliedSignal
    Aerospace and suppliers chosen as partners for up to a 5-year period.
    They document the pricing, terms, and conditions for selected
    products and require yearly performance improvements.  In return, the
    suppliers are guaranteed a stable business base with AlliedSignal.
    Honeywell Defense Avionics Systems consolidated requirements and
    forecast future needs for selected goods across its commercial,
    space, and military groups.  The company believed these actions would
    allow it to get better prices for these goods because of higher and
    more steady volume demands.

    The prime contractors cited some difficulties in developing more
    rewarding relationships with their key suppliers.  The process for
    AlliedSignal to set up its long-term agreements was lengthy and
    involved over 50 people to ensure compliance with government rules
    and regulations, such as the Federal Acquisition Regulations, before
    approval was granted, according to a government official.  Boeing's
    Space and Systems Group officials believed that because of the nature
    of government contracting and method of funding, they could not forge
    long-term agreements or partnerships with their suppliers or provide
    their suppliers with reasonable forecasts of future demand.  In
    contrast with their commercial business, the officials described the
    government contracting environment as low volume with unstable
    funding.  They cited as an example an order to deliver 11 F-22
    aircraft over a long period of time with no guarantee that the
    program would go forward.

    Motorola officials stated that while their commercial divisions have
    moved to beneficial relations with their suppliers, starting with
    early teaming in design, the way government does business would
    impede a movement to this type of relationship on defense programs.
    They believed that requirements regarding competition in contracting
    made it difficult for a defense contractor to make an initial
    commitment to a supplier.  Motorola stated that government pressure
    to continually compete suppliers worked counter to long-term
    relationships.  Honeywell officials stated that government
    requirements, though reduced under the Federal Acquisition
    Streamlining Act, were still complicated and confusing, for many
    commercial-type suppliers.  They noted that in their role as supplier
    on some programs, the prime contractor added as many or more
    requirements than DOD.

          SEVERAL BAT SUPPLIERS DID
          NOT BELIEVE THE PROGRAM
          FOSTERED REWARDING
          RELATIONSHIPS
    -------------------------------------------------------- Chapter 4:2.2

    Relationships on the BAT program were described by several suppliers
    as bureaucratic, without distinguishing between established, proven
    suppliers and new suppliers.  Some first-tier suppliers we contacted
    believed no consideration was given to their years of working
    together when it came to the low-rate production contract proposal.
    Supplier A said it was required to submit a four-volume basic
    proposal for the upcoming low-rate production contract, detailing how
    their component would be designed, produced, and made to conform to
    quality standards even though it spent the last 6 years doing those
    very tasks for the BAT component.  They said that although the
    low-rate production contract was essentially a re-buy of units
    already produced for testing, the prime contractor approached the
    next phase as if the program was back at the drawing board.  Supplier
    C said that the prime asked for information it already knew from
    years of working with the supplier.  Officials believed their
    company's high standards were unrecognized and wished their team
    could be allowed "to just do its job."

    A number of first- and second-tier suppliers were frustrated with
    their inability to participate more fully in the BAT program.  A key
    concern for several suppliers was nonresponsiveness to their
    cost-saving suggestions that involved design changes.  A supplier A
    official said that the prime contractor's stated desire for using
    commercial items was not backed up by action.  Although the company
    estimated cost savings of three or four to one using an industrial
    grade commercial part and was willing to guarantee the part for 20
    years, it was told there was not enough data to make the change.
    Supplier D officials stated the original design for its component had
    a costly scrap rate and was not likely to be producible at high
    rates.  The company invested its own funds to design an alternate
    part that met government specifications and could cut costs in half.
    However, the alternate part was not used because it challenged
    certain requirements.

    Some suppliers thought that the prime contractor was not serious
    about adopting acquisition reforms and other changes in the upcoming
    low-rate production phase.  Supplier B noted that although the prime
    contractor would say it removed some of the detailed military
    specifications from the program, the prime contractor had retained
    its own tight requirements anyway.  The supplier also stated that the
    low-rate production proposal contained requirements that had been
    waived during development.  Supplier A noted that the low-rate
    production contract referred to documents to be used as "guidelines,"
    which were military specifications.  Another supplier questioned why
    its component still needed government source inspection after passing
    its own ISO-certified quality manufacturing inspection and prime
    contractor inspection, considering that none of its products had
    failed the government inspection.  The supplier shared concerns with
    the prime contractor and the Army regarding the added cost and effort
    for retesting thousands of production components, but the prime
    contractor included it in its contract proposal.  Other suppliers
    believed that the continued use of military specifications limited
    their ability to contribute to the product and reflected the
    customer's lack of trust.

    The president of one second-tier company said that commercial firms
    kept suppliers more abreast of business plans and that he was
    confident that his commercial investments would pay off.  Because of
    the uncertain nature of defense contracting, the president explained
    that he had to look at each defense order as a stand-alone order,
    which was an expensive way to do business.  For example, he stated
    that while he invested the firm's own funds for commercial tooling
    because of its long-term potential, he would not invest the firm's
    funds in BAT tooling because the return was too uncertain.  He said
    that although the 19,000 BAT units planned for production were held
    out as a carrot, the probability of the company working through the
    entire production was low because the program could be downsized,
    canceled, or the prime contractor might award later production to
    another supplier.

    One second-tier supplier did have a long-term agreement with a
    first-tier customer that had not worked out well.  According to one
    supplier official, the firm established a fixed-unit price for its
    component based on the volume forecast.  They noted that while the
    supplier made good on its prices, the customer had only met 30
    percent of the forecast volume, and had been inaccurate from the
    start.  One supplier manager said that they typically invested their
    own funds in engineering efforts because with most customers, the
    return from large volume production covered the investment.  On BAT,
    they lost money with this approach.  The official said that they will
    not renew their long-term agreement with the first-tier customer and
    that any new agreements for research and development will be on a
    customer-funded basis.

    Some suppliers had more positive experiences on the program.
    Supplier E officials said that they helped formulate the requirements
    in the development contract and that they had worked with another
    supplier to compromise on space utilization.  Supplier F also
    believed the prime contractor was open to suggestions.  Supplier C
    believed that many of the suppliers' recommendations to use
    commercial rather than military standards would be incorporated,
    although the supplier thought some changes would be too costly at
    this phase of the program.

          BAT PRIME CONTRACTOR
          BELIEVED DOD REQUIREMENTS
          PROVIDED LITTLE FLEXIBILITY
    -------------------------------------------------------- Chapter 4:2.3

    BAT prime contractor officials said their ability to treat
    established suppliers differently from new suppliers, such as with
    streamlined inspections and paperwork, was constrained by program
    requirements.  The officials stated that the development contract
    with DOD was very clearly defined and they were compelled to pass
    explicit requirements down to their suppliers, regardless of prior
    dealings with those suppliers.  The officials said one difficulty in
    obtaining supplier input was that the program started with a
    "build-to-print" development package based on specifications.  Every
    drawing referred to military specifications we were told.  As a
    result, the prime contractor prepared and sent technical documents to
    potential suppliers requesting that they bid on the component as
    designed.  They said they did not solicit input from suppliers even
    in low-rate initial production because the design was set and it
    would be too expensive to make substantial design changes.  DOD
    disagreed that it has exerted such control over the BAT design.
    According to DOD, the Army did not have control of design when the
    Engineering and Manufacturing Development phase started, but only
    established a functional baseline.  DOD stated that the contractor
    was responsible for developing the specifications and passing on
    requirements to subcontractors.

    Prime contractor officials believed the low-rate production phase of
    the program would have more latitude in the requirements passed down
    to suppliers, but that many customer-imposed requirements would
    persist.  They stated they have tried to use the miliary
    specifications only as guidelines wherever possible, but the customer
    still wanted the same product.  Consequently, many of their direct
    suppliers incorporated the original military specifications in their
    low-rate production contract proposals.

    Prime contractor officials stated that they have forwarded any
    business forecast information they received from their customer to
    the suppliers.  They noted that one of the reasons the firm invited
    the DOD customer to a supplier conference was so that suppliers could
    get the information directly.  They said they wanted their suppliers
    to stay interested in the product because they wanted their suppliers
    to invest in equipment and tooling for BAT.  However, the officials
    said that for some suppliers, the BAT contract amount was a "drop in
    the bucket," and thus not a great spur for investment.

          JDAM PROVIDED A
          COMMERCIAL-LIKE ENVIRONMENT
          IN A DEFENSE SETTING
    -------------------------------------------------------- Chapter 4:2.4

    On JDAM, the prime contractor said they formed
    alliances--sophisticated relationships--with key suppliers.  The DOD
    program manager played an active role in creating the conditions
    conducive to such relationships, according to prime contractor
    officials.  The ultimate success of this approach in producing a
    weapon that will perform as required remains to be seen.  However,
    the approach did receive praise from key suppliers for the types of
    relationships it fostered.

    The prime contractor and all four key first-tier suppliers informed
    us that the strong alliance between participants was based on trust
    and mutually shared goals.  The parties agreed to long-term
    relationships that, according to the prime contractor, was the
    optimal way to achieve program target costs, high quality, and
    schedule performance.  This approach was strongly supported by the
    Army customer.  Vice presidents from the key first-tier suppliers
    were members of an executive IPT, which made them strategic partners
    in the program's development and design process.  Participants had to
    focus on how to make the best product as a whole because of the top
    priority DOD placed on decreasing the cost.  To achieve cost
    reductions, the program manager at the time said the prime contractor
    had to turn to their suppliers.  These characteristics encouraged
    suppliers at different tiers to invest more of their own resources in
    design and performance improvements.

    Suppliers echoed the importance of developing a strong alliance
    between the parties.  In highlighting differences between JDAM and
    other projects, supplier M said the "seamless" teams on JDAM stood
    out.  The supplier said the prime contractor did not take a
    strong-armed role but asked its subcontractors to participate as
    partners.  Supplier N said the prime contractor held clear authority
    over the program, but the development of new solutions to win the
    contract was the result of great teamwork.  A second-tier supplier
    said the teaming arrangement was a lot closer than with other weapon
    systems.  These arrangements also offered the second-tier suppliers
    the opportunity to add value because they were involved early in the
    design phase.

    The JDAM environment was the byproduct of actions taken by DOD, the
    prime contractor, and the suppliers.  Suppliers participated in the
    weapon's design and had open communications with the prime
    contractor.  Unlike the detailed specifications for BAT, DOD had
    stated the JDAM requirements in terms of key performance parameters,
    which allowed the contractor teams room to make design trade-offs.
    Instead of passing down specific design requirements to the
    suppliers, the prime contractor delegated design authority and
    configuration control where possible, according to DOD program
    officials.  This added responsibility gave the suppliers a stake in
    the product design and ultimate success.  The suppliers retained
    ownership of their design responsibilities as long as they met the
    cost and performance specifications.  According to the DOD program
    manager at the time, the lifetime warranty DOD demanded of JDAM also
    had the consequence of increasing supplier involvement.  He said the
    suppliers were willing to accept the liability as long as they had a
    voice in the design.

    Second-tier suppliers reported similar team participation
    experiences.  For example:

      -- Supplier U said they were attracted to the program because their
         early involvement allowed them the opportunity to be innovative
         and make suggestions rather than work from a blueprint.

      -- Supplier S said they worked extensively with its first-tier
         customer to reduce the cost of its part.

      -- Supplier Q characterized its role in JDAM decision-making as a
         dynamic exchange of information.  The supplier was asked how it
         would meet requirements and also to pose alternatives.  At no
         time was the first-tier contractor dictatorial.  The supplier
         was treated as an expert and its opinions were respected.

    The planned stability and high procurement volume of the program
    facilitated the building of long-term relationships on the JDAM
    program by allowing the prime contractor to guarantee suppliers a
    certain amount of work and obtain their commitment, according to DOD
    program officials.  One of the major steps that DOD took to
    facilitate this was to state in the contract that the government
    would neither compete the production nor ask the prime contractor to
    compete the suppliers for the duration of the commitment, as long as
    the program's performance specifications and cost goals were met.
    Prime contractor officials agreed that the long-term aspect of the
    program was very important and believed that suppliers were attracted
    to the high volume and long-term mutually beneficial relationships
    that resulted.

    The suppliers agreed that the JDAM program was attractive from a
    business standpoint and they did not believe they were contending
    with a low volume, annually funded program.  It represented a
    long-term commitment and a high volume of parts and millions of
    dollars in business potential on the domestic market, plus the
    potential for foreign sales.  Suppliers could fit JDAM into their own
    strategic plans because the program offered long-term stability--they
    would be together for 5 or 6 years if they won the contract.
    Supplier U said they signed a general memorandum of understanding for
    5 years with its first-tier customer.  Most suppliers also reported
    that there was extensive sharing of business information.  According
    to supplier A, the prime contractor shared project information,
    scope, scale, and business forecasts with them, which they shared
    with their second-tier suppliers.  Lower-tier suppliers found the
    information important in planning and in staying fully informed on
    the program's status.  Equally as important, the suppliers found the
    information to be valid and accurate.

    CONCLUSIONS AND RECOMMENDATIONS
    ============================================================ Chapter 5

       CONCLUSIONS
    ---------------------------------------------------------- Chapter 5:1

    In both the commercial and defense sectors, suppliers play a key role
    in the development and manufacture of major products.  Suppliers are
    critical in terms of both the amount of the finished product they
    make, as well as the technological innovation included in the final
    product.  The leading commercial firms have found that developing
    sophisticated relationships with key suppliers gives them a
    competitive edge in the cost, features, quality, and development time
    of their products.  If such relationships were not beneficial from a
    business standpoint, they would not be cultivated because they take
    commitment, effort, and resources.  DOD and its prime contractors
    realize the criticality of suppliers to the success of weapon system
    programs and DOD has emphasized the selection of capable suppliers.
    Nonetheless, a gap can be seen between how supplier relationships
    have traditionally operated on weapon system programs and how they
    operate in the leading commercial firms.  DOD's experience with JDAM
    may show how to narrow that gap.  Clearly, the need exists.  The
    persistence of problems on weapon system programs, coupled with DOD's
    desire to modernize more quickly, spotlight the need to get better
    outcomes from new weapon programs, particularly in terms of
    development cycle time and cost.

    Best commercial supplier practices, when analyzed in the aggregate,
    can be seen as four traits that operate in a system that is
    self-sustaining because it provides mutual benefits to both suppliers
    and the product developer.  When this construct is applied to a
    traditional DOD program, gaps can be seen in two traits:  (1)
    providing central support for optimum supplier relationships and (2)
    creating an environment whereby key suppliers see their extra
    commitment and effort as worthwhile.  Experience on the BAT program
    shows that weaknesses in these two areas can diminish the effect of
    other best practices, such as the use of a rigorous supplier
    selection process, teams, and rating procedures.

          CENTRAL SUPPORT
    -------------------------------------------------------- Chapter 5:1.1

    In the commercial sector, the product developer can unilaterally
    commit to centrally supporting better supplier relationships and can
    institute the requisite organizational changes that make a company a
    preferred customer.  In the defense sector, DOD and prime contractors
    share this responsibility.  It is difficult for the prime contractors
    to translate the desire for better supplier relations into tangible
    differences in the actual relationships without the active support of
    DOD.  To some extent, the prime contractors have their own history to
    overcome; the Aerospace Industries Association, for example, noted
    that until recently, the Association itself had not adequately
    considered supplier firms.  Similarly, DOD has traditionally focused
    its attention on the prime contractors; it has encouraged the
    selection of capable suppliers but adopted a hands-off approach
    regarding supplier relationships.

    DOD's involvement is important in influencing the prime contractors'
    commitment to better supplier relations and the extent to which such
    commitment permeates the different tiers of suppliers.  DOD shares
    this responsibility because on any given weapon systems program, it
    is the customer, financier, requirements setter, and co-manager.  One
    reason for the distance DOD has kept between itself and suppliers is
    the concern over violating the privity of contract that exists
    between the prime and its suppliers.  However, the role played by the
    program office on JDAM shows how critical DOD's support can be to the
    value placed on supplier relationships at the outset of a program,
    without crossing the line on privity.  Essential to DOD's influence
    on that program was the program office's weighing the choice of
    suppliers heavily in selecting a prime, supported by clear
    action--such as substantive visits to the suppliers during the
    competition.

          A REWARDING ENVIRONMENT
    -------------------------------------------------------- Chapter 5:1.2

    DOD and the prime contractors share in fostering an environment in
    which suppliers believe that there are true incentives for doing more
    than complying with the contract's terms.  It is true that the BAT
    program did not enjoy all of the advantages of the JDAM program for
    improving supplier relations.  Nonetheless, the best practices that
    were attempted on BAT were not perceived by some key suppliers as
    much more than procedural changes.  Several suppliers believed their
    design and other ideas were not welcomed or acted upon.  In their
    view, despite their years of experience, they were treated like
    newcomers when they bid on subsequent BAT contracts.  They also
    expressed reservations regarding the business projections that
    upper-tier customers shared with them.  In short, they believe little
    trust or mutual benefit existed.  They viewed their role as
    restricted to delivering a product that complied with the design
    requirements given them--they saw no value in doing more.

    Several defense prime contractors stated that they were attempting to
    build long-term, more rewarding relationships with their suppliers,
    but believed that aspects of government business inhibited such
    relationships.  They noted that government requirements, though
    reduced, were still complicated and that competition for lowest price
    was still emphasized by DOD contract officials.  Another noted that
    instability of DOD programs, such as from funding uncertainty,
    weakened business projections.  We do not disagree that these may
    inhibit developing long-term relationships.  Nonetheless, ways were
    found on the JDAM program to overcome these obstacles and create a
    commercial-like environment for suppliers.

    While it remains to be seen if JDAM can deliver as promised, the
    lessons learned may help other programs to fully realize the
    potential of involving lower-tier suppliers to get better outcomes.
    Acquisition reform initiatives may provide vehicles for facilitating
    supplier relationships.  On the other hand, the suppliers' full
    participation may be essential to the effectiveness of such reforms.

    In establishing good supplier relationships, commercial firms have
    had to become better customers.  By implementing the lessons learned
    from those firms--creating a system of incentives that rewards
    productive supplier relations--DOD can become a better customer for
    weapon systems.  In so doing, DOD can also help its prime contractors
    forge better relationships with their suppliers.

       RECOMMENDATIONS
    ---------------------------------------------------------- Chapter 5:2

    We believe that actions to improve supplier relations are needed at
    both the Department level and the individual program level in DOD.
    Accordingly, we recommend that the Secretary of Defense:

      -- Develop a policy that promotes productive supplier relationships
         and emphasizes the importance of suppliers in improving program
         outcomes.  In its absence, concerns about privity may dominate
         and minimize the contribution of suppliers.

      -- Communicate this policy throughout the acquisition workforce and
         the defense industry through training and other means.  Training
         could include tools that effectively promote best supplier
         practices for both new and ongoing programs.  Practices used in
         the JDAM program would be one good source of identifying such
         tools.

    We also recommend that the Secretary of Defense ensure that weapon
    system program managers provide leadership and incentives for
    optimizing supplier relations on their programs by taking the
    following actions:

      -- Establishing acquisition strategies that support good supplier
         relationships.  The conduciveness to supplier relations may be
         affected by (1) how program priorities, such as performance
         requirements, are set; (2) how enabling practices, such as
         design flexibility, cost-performance tradeoffs, and teaming
         responsibilities will be used; and (3) what tools for
         recognizing and incentivizing prime contractor performance, such
         as source selection factors and contracting arrangements, are
         made available.

      -- Supporting the strategies with action.  This can involve active
         interfaces with suppliers, through teaming or other vehicles,
         providing technical assistance, evaluating the prime
         contractors' success in fostering best supplier practices, and
         following through on promised rewards and corrective measures.

       AGENCY COMMENTS AND OUR
       EVALUATION
    ---------------------------------------------------------- Chapter 5:3

    DOD concurred with a draft of this report and all of its
    recommendations (see app.  I).  In agreeing that a policy, which
    emphasizes consideration of the prime subcontractor relationship and
    its outcome on programs is needed, DOD noted that this policy must
    also reflect consideration of privity concerns.  DOD envisioned that
    this policy would also include the actions called for by our
    recommendation to ensure that leadership and incentives be provided
    by program managers in their acquisition strategies.  DOD believes
    that current policies and efforts address some of the concerns raised
    in the report.  These initiatives include (1) reducing the use of
    detailed specifications; (2) placing decision-making authority with
    the prime contractor; and (3) using IPTs, cost as an independent
    variable, past performance information, and integrated program team
    contractor reviews.  DOD stated that, in addition to the extensive
    acquisition reform training currently offered, a JDAM case study was
    being prepared for release this year.  Finally, DOD noted that (1)
    the biggest impediment to acquisition strategies that support good
    supplier relationships is the financial stability of the program and
    (2) stability is considerably beyond the control of any program
    manager or service.  Nonetheless, DOD stated that long-term
    relationships can be established that are contingent upon the
    program's continuation under commercially acceptable terms and
    conditions.

    We believe that some of DOD's current policies--such as less detailed
    specifications and cost as an independent variable--can give a
    program manager the latitude needed to create an environment that
    fosters greater supplier involvement.  Others, such as IPTs,
    represent tools program managers can use to build and maintain
    relationships.  Although these policies and tools are not directed at
    supplier relationships, they can facilitate stronger relationships
    and are at the same time dependent on the relationships.  A supplier
    policy could thus clarify the role expected of program managers in
    cultivating supplier relationships to increase the chances for
    program success.  We believe that the JDAM case study DOD plans to
    incorporate into its training curriculum could help communicate a
    supplier policy by sharing not only the specific experiences of the
    JDAM program, but also by making the broader points that program
    managers (1) recognize their responsibility to be fully aware of the
    activities and progress being made by key suppliers, regardless of
    tier; (2) be made aware that, with appropriate regard for privity
    concerns, they may be more directly involved with suppliers; and (3)
    be encouraged to do so for the benefit of the program.

    As DOD points out, there are factors that create instability beyond
    the control of a program manager or service.  These could include
    reductions necessitated by an unexpected military operation or
    congressional direction.  On the other hand, other factors are
    controllable by the services, such as decisions to reduce the funding
    of some programs to accommodate changes in other programs or to start
    new programs.  Nonetheless, stability is but one of several factors
    that can affect a program manager's ability to build trust and
    commitment among suppliers.\1 Other factors, which are more
    controllable, include setting reasonable expectations about
    production quantities and schedules; setting a cost, schedule, and
    performance baseline that has a practical probability of being
    executed within available funding; and taking steps to ensure that
    prime contractors reward high-performing suppliers, such as with
    simplified business arrangements and increased business.

    (See figure in printed edition.)Appendix I

    --------------------
    \1 For more information on these issues see Weapons Acquisition:
    Better Use of Limited DOD Acquisition Funding Would Reduce Costs
    (GAO/NSIAD-97-23, Feb.  13, 1997) and Weapons Acquisition:  A Rare
    Opportunity for Lasting Change (GAO/NSIAD-93-15, Dec.  31, 1992).

    COMMENTS FROM THE DEPARTMENT OF
    DEFENSE
    ============================================================ Chapter 5

    (See figure in printed edition.)

    (See figure in printed edition.)

    MAJOR CONTRIBUTORS TO THIS REPORT
    ========================================================== Appendix II

       NATIONAL SECURITY AND
       INTERNATIONAL AFFAIRS DIVISION,
       WASHINGTON, D.C.
    -------------------------------------------------------- Appendix II:1

    Louis J.  Rodrigues
    Paul L.  Francis
    Gordon W.  Lusby
    Maria J.  Santos

       LOS ANGELES FIELD OFFICE
    -------------------------------------------------------- Appendix II:2

    Sharon L.  Caudle
    Monica L.  Kelly
    Marguerite P.  Mulhall

       OFFICE OF THE GENERAL COUNSEL
    -------------------------------------------------------- Appendix II:3

    John A.  Carter

    *** End of document. ***