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--> Panel 6 Emerging Challenges and Diverging Interests Kirk Bozdogan Massachusetts Institute of Technology Dr. Bozdogan presented findings from a recent study by the Massachusetts Institute of Technology (MIT) Lean Aerospace Initiative. He emphasized the complexity of the issues and the difficulty of measurement and interpretation. Although some believe that there is no need for a specific policy on offsets, the offsets issue relates to a number of larger issues that do need to be addressed. In attempting to take up these issues, he noted that his presentation would take both a historical perspective and a look at the future. He proposed to raise questions and move toward answers, noting that, at some point, we must stop talking about the issues and provide solutions. Current Trends The aerospace industry has undergone a process of consolidation, restructuring, and downsizing over the past decade. This process was driven by a downturn in the commercial aircraft industry and by deep cuts in the defense sector. Although important, the impact of offsets has been dwarfed by these larger factors. At the same time, there has been a clear shift in the innovation model in the aerospace industry. Government's role has progressively diminished. R&D support for the industry has declined, as has infrastructure such as wind tunnels. However, the change in the structure of the innovation process is a consequence, and not a cause, of the larger changes in the industry, as will be discussed later. Dr. Bozdogan agreed with previous speakers as to the trends in the industry. Growth in overseas demand has outpaced domestic demand. Although U.S. markets have dominated, the main growth is now occurring overseas, especially in the Pacific Rim. U.S. dominance in commercial aircraft production has been chal-
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--> lenged, but not overturned. International collaboration and subcontracting has increased the globalization of the industry. On the defense side, concerns over affordability have dominated. The industry has focused on the reduction of cycle times and costs. In fact, these were the reasons for establishing the Lean Aerospace Initiative at MIT. The Initiative is a consortium bringing together industry, government, and unions to achieve significant fundamental improvements in the way in which weapons systems are designed and built. The Initiative collects and analyzes best practices from around the world, together with a research agenda directed by consortium members. The results are disseminated straight down the supplier chain. The defense sector is also the focus of a drive toward greater utilization of commercial technologies and practices, as previous speakers mentioned. This includes utilizing the commercial industrial base to meet military requirements. Fewer Suppliers Dr. Bozdogan then presented the results of a survey of the aerospace supplier base, broken down into three sectors: airframes, electronics and avionics, and engines and other. The survey found a dramatic decrease of over 50 percent in the number of direct production suppliers between 1991 and 1995 in all three sectors of the industry. The story is the same in both the commercial and the defense sides of the industry. Higher Certification Although companies are decreasing the number of suppliers, they are increasing the certification requirements of the suppliers who remain. Certification is being used to ensure that suppliers are fully qualified in terms of process technology. This is part of the larger issue of how companies synchronize their production technology with that of their suppliers. The result is that companies are able to devolve more responsibility to their suppliers, including design, development, inspection, and testing. In response, suppliers are taking a larger responsibility for more complex subassemblies. This requires a carefully forged long-term relationship between companies and their suppliers. More Information Sharing A key part of these long-term relationships is the sharing of information. Within the aerospace industry, there has been a significant increase in communication and information sharing between companies and their suppliers. Included is information as to production costs, the supplier's statistical process control processes, and their performance improvements. This represents a sea-change in the relationship between companies and their suppliers.
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--> More Outsourcing The survey shows that prime contractors are undertaking outsourcing for a variety of reasons. Chief among these is lower costs. Ninety percent of the companies responded by saying that lower cost was the reason for the outsourcing of the largest dollar-value products that were previously built in-house. The second major reason given for outsourcing was the strategic realignment of production. This reflects the structural shifts within the industry, the slowdown in commercial markets, the cutbacks in defense spending, and the streamlining of production operations. In essence, companies have reassessed their core competencies as to what they should build in-house and what they should devolve to suppliers in order to make large efficiency gains. Higher quality was also given as a reason for outsourcing, although this was less significant than other factors. Production Partnerships Two types of long-term partnerships have evolved in the industry. One of these Dr. Bozdogan referred to as ''production-focused supplier partnerships." These involve support given to suppliers for ongoing production operations. Eighty-five percent of firms in the industry have established this type of long-term purchase agreement with their key suppliers. The major reason given was to reduce costs, followed closely by a desire to minimize future price fluctuations and to realize mutual performance improvements. It is important to note that these are truly mutual improvements, not simply companies demanding improvements from their suppliers. These long-term agreements have taken a number of forms, including partnerships focused on one or more products for more than three years, multiyear design/build teams, and ongoing partnerships. Development Partnerships The second form of long-term partnership Dr. Bozdogan referred to was "development-focused supplier partnerships." These partnerships focus on product development, technology development, and process development. Over half of the firms in the industry have established these development-focused supplier partnerships. One of the main reasons given by companies is to win new business—in essence, market access. Another reason was to enhance supplier performance capabilities—companies helping to improve the suppliers. Also important was achieving material cost reductions. Eighty-six percent of the respondents believe that these partnerships are either "very important" or "absolutely critical" to their long-term competitiveness. At the same time, there is evidence of a shift in the industry from partnerships to knowledge integration. In a way, the aerospace industry is replicating the experience of the electronics industry, where companies are engaging their sup-
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--> pliers in the front end of the R&D process, rather than only at the back end of procurement. The old model featured top-down control with the interfaces between prime contractors and suppliers totally defined and well controlled. Product requirements were passed straight down the supplier chain. The current lean model features more collaboration and partnerships, but still retains existing organizational boundaries. There is collaborative information exchange and some risk sharing, but these activities are constrained by pre-established contractual arrangements. Virtual Teams The emerging model is one of "virtual teams." These teams of prime contractors, key suppliers, and sub-tier suppliers operating without boundaries have fostered architectural innovation that has resulted in significant benefits in cost reductions, cycle-time reduction, and quality improvements. Under this new model, best practice is when the interfaces are allowed to freely change to optimize the system. The enablers of this new system include long-term commitment, open communications, and maintaining trade secrets to allow such communications to occur. The emergence of these closely linked partnerships and networks has changed the industry, to the industry's benefit. The industry now has one common and highly integrated domestic supplier base supporting commercial and defense activities. It is crucial to maintain and strengthen that supplier base to support production and maintain the existing aircraft fleet. Risks Ahead Looking ahead, opportunities and demand for offsets will accelerate. One potential risk to the U.S. supplier base is excess capacity in defense production. To the extent that offsets create new foreign competitors, cost and competitive pressures on the U.S. supplier base are exacerbated. Displacement of U.S. suppliers in specific areas is a real possibility. Dr. Bozdogan reminded participants that other governments are actively attempting to boost their own nations' aerospace capabilities. Another risk to the industry concerns the nature of the new production model. This new model of collaborative partnerships is more conducive to technology transfer. As the United States moves toward this new model, there is the potential for an exodus of U.S. technology overseas. Dr. Bozdogan referred to the questions raised in his paper. In particular, he remains concerned as to what are the long-run national security implications of greater military reliance on the commercial industrial and technological base as that industrial base becomes increasingly internationalized. The situation can be characterized as a prisoners' dilemma, requiring negotiations with our allies. But
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--> we cannot count on the "invisible hand." We may not know where our suppliers are when we need to engage the system's surge capability. The risks facing the industry are very real. Discussants William Reinsch U.S. Department of Commerce Undersecretary Reinsch began by commenting that he found Dr. Bozdogan's analysis very useful. He noted that he would confine his comments to the questions and issues raised in the presentation. Specifically, he commented on a similar situation concerning the national security implications of the military moving to the commercial technological base as pointed out in the presentation. The technology involved was high-performance computing. In the high-performance computing sector, the normal government procurement process takes longer than the normal product life cycle of the computer. If the government uses normal procedures, it will always be technologically behind. Thus, the Pentagon is moving to commercial technology and commercial procurement in computers. The military has discovered that it relies on high-performance computing for a variety of applications, ranging from those involved in direct conflict activities to applications such as real-time battlefield weather prediction. They have also discovered that they do not buy enough to keep any of the small companies that make high-performance computers in business. The military sector simply is not a significant enough buyer of a civilian technology to make much difference to the health of a sector. The DoD needs the companies to be healthy in order to "run faster" to maintain a lead in the technology. Exports contribute significantly to the health of the industry, but exports mean the globalization of the industry. This raises a number of national security problems because globalization means the handing over to others of an important military capability, either in the form of the export of a product or in the form of technology transfer. Exports, therefore, end up defeating the purpose of the U.S. military in maintaining dominance in this key technology. The dilemma facing the DoD is that if you do not allow exports, you endanger the viability of some of the companies who produce directly for defense use. After grappling with the issue, the DoD decided that it was in their greater interest to maintain the health of the industry and deal with the technology risks in some other way, rather than try to keep the technology within the United States. This illustrates the problem facing other sectors as they go global. In response to the question raised in the paper as to whether trade policy and technology policy know what each other is doing, Undersecretary Reinsch stated that in his experience, the answer is no. This is a chronic problem both between
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--> agencies and within agencies, as it is within Congress. There are trade people and there are technology people. They each have their own portfolios and mind-sets and tend not to talk to one another. Thus, policy tends to end up disjointed. Undersecretary Reinsch went on to point out that, clearly, corporate business interests and national strategic interests can and often do diverge—collectively and individually. Companies enter into business arrangements that may be in their interest, but raise significant questions as to whether the activity is in the national interest. This raises questions about the process. A related question concerns how to look at the health of an entire sector, such as aerospace. Are the activities in a sector convergent with both business and national interests? Specifically, are the developments in the aerospace industry, which might be very much in the interests of members of the industry in terms of profits and jobs, in the national interest and the national security interest? The answer is not necessarily yes. This poses a difficult question. The companies are doing exactly what they are supposed to—they are making money to presumably invest in the next generation of technology. That activity, however, may run up against national security goals. There is no process in the government to address these questions, except in isolated circumstances. There is a process concerning the review of foreign acquisitions of U.S. companies. But that is not a process where these issues are frequently addressed. There is no process to regularly address these questions that are raised in the process of U.S. companies globalizing, other than through ad hoc arrangements. There is an attempt to address some of these issues in the intergovernmental Committee on National Security as part of the National Science and Technology Committee, which is chaired by the President's science adviser. The original purpose of this committee was to look at gaps and redundancies in government R&D. The committee has taken on as an additional task the process of trying to identify a way in which government can more systematically address these globalization issues on an interagency basis. There is no desire, nor is there legal authority, to intrude into private business transactions. But there should be someone who speaks for the national security interest—even if that role is only to publicly point out that interest. The appropriate government role may be simply to point out how these events impact on national interests. There is no governmental authority to go further. There is authority to control technology transfers for national security purposes, but not for competitiveness consequences. National security is not defined in a broad manner so as to encompass the issues being discussed at this symposium. This interagency committee is looking at ways to address these issues, and if it succeeds in developing a process it will surely consult with industries such as those represented at this meeting.
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--> Albert Kelley Massachusetts Institute of Technology Dr. Kelley noted that offsets evolved from a decision years ago at the White House to promote foreign arms trade as a reaction to what other countries were doing. Offsets were devised as a mechanism to provide financial inducements to other countries that were legal under U.S. "corrupt practices" standards. This mechanism was not devised as a complete set of activities known as offsets. Rather, it grew out of a series of unique individual deals. Dr. Kelley noted that he was always worried that these mechanisms left U.S. companies naked to face off against foreign governments. The policy of the U.S. government has always been "we do not like offsets as a government, but, on a private basis, go ahead on your own." Companies have done a good job in handling the issue in a mature and ethical way. Dr. Kelley went on to raise a number of "yellow flags"—issues to worry about. Buyers want an economic return from offsets, more than simply the product. This means that various ministries, such as the finance ministry, get involved. The result is a greatly complicated process. It is no longer a straight defense-to-defense airplane deal. The process becomes one of barter—trying to determine what type of offsets will be involved. He used the analogy of leasing an automobile, where there is a whole series of mini-offset agreements concerning interest rates and dealer discounts. Defense buyers often want to add capability to the products they are purchasing. They want to have better technology and capabilities more than anyone else—even if it is just for show. Sometimes they are encouraged to do this by the contractor. This leads to a general escalation of military requirements, because no one, including the United States, wants to be number two. A case in point was the F-20. It is important to stick to the purpose of the weapons system—the core military requirements. It is also important to avoid having countries buy the wrong plane because of the offset. There have been deals in which the country was more interested in the offset package than the airplane. Dr. Kelley stated that it is a myth that foreign sales reduce the cost of airplanes by increasing production. As was pointed out earlier, requirement for the recoupment of R&D costs is often waived. In addition, orders from foreign governments are different enough so as to essentially require the building of custom planes. Unlike the automotive industry, every plane in the production line is a different airplane. Thus, foreign sales do not result in significant savings due to greater economies of scale. The key concern, including that of the U.S. government, is jobs. Dr. Kelley noted that the Apollo space program was undertaken, in part, to create jobs in the aerospace industrial base that was declining after the Korean War. He closed by noting that coalition warfare and the U.S. ability to ramp up defense production very quickly are important keys to national security. Reform
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--> of the acquisition and procurement system will be required to accomplish this, including more sole-sourced contracts. Developing ties with foreign countries, including the use of offsets, can help strengthen the U.S. defense industrial base. Offsets are not bad per se, but there are bad offsets. A solution to the issues raised by offsets will undoubtedly develop, so we should not kill off offsets before we understand their consequences.
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