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. ***