21 September 2006
Unique challenges face procurement in the military supply chain over the coming years. Changes in the global demand for weaponry and the demand for capability have influenced a trend towards through life development of machinery, with buyers demanding upgrades, maintenance, and repairs as part of a package. The question is: Is it possible to achieve the ultimate contract for capability, specifying capability without constraining supply as far as possible? How can organisations such as the MOD get the best out of potential suppliers? How can you write a contract for capability without also constraining innovation?
Changing defence of logistics
Such challenges have been at the heart of the work of Dr Derek Wright, Consultant to defence companies, the DLO on logistics and Former Head of the Acquisition and Logistics Unit for the Royal Military College. For Wright, the structure of logistics is changing rapidly for the defence sector and various circumstances are changing the way in which the military supply chain is formulated: "Military equipment has often led science and technological developments in the past, but it is perhaps not doing so in the future," Wright explains. "Innovation in the Military is likely to come from other fields because now the total spend by governments on military technology is not enough to generate and sustain industries of their own in the same way as it did in the past." Such a problem poses a significant strategic question because innovation is influenced by the ways in which contracts are drawn between the public and private sector, and manufacturers. Wright interprets that: "The whole value chain that supports the supply chain is becoming radically different now to previous years."
The problems are also compounded in that the reducing market for defence is further shrinking, due to individual equipments having greater military capability and wider demands exist for a greater variety in defence capabilities as a result of asymmetric warfare, consequently diluting the demand for specifics. Such pressures have resulted in manufacturers looking to diversify by developing repair, support and upgrade services for equipment and training rather than merely selling the stock. "It is important to consider where the future sources of revenue lie for tomorrows defence businesses," Wright argues. "It is critically important to make a return on investment, so we have to look at the characteristics of the revenue stream over the long term."
Through long-term contracts, the role of business changes from manufacturing to more integrated solutions. "What we have seen worldwide is that the whole defence sector has rationalised. There are very few large global manufacturers of defence equipment," considers Wright. There is now pressure on firms to pool resources in order to manufacture and maintain the equipment bought on the market. "This of course causes tensions," says Wright. "Something which I think sums up the inevitability is a phrase which used to be banded about by private sector supply chains called 'co-ompetition – co-operating with your competitor'." So with the potential for such tensions, what benefits might outweigh these?
Such a long-term procurement approach is attractive to organisations such as the MOD for a number of reasons. For example, with a long-term contract, the MOD is isolated from unexpected cost increases which might arise from unreliability or rising component costs, because the contract is fixed leasing or selling equipment in terms of its output. "In return for paying an all inclusive premium, you can insure yourself downstream," Wright explains. So there is now a wide spectrum of procurement developing, where on the one hand, for consumables and other regular, easily specified requirements, there is the traditional method of setting competitors against each other and buying at the lowest price. Whilst on the other hand, because the manufacturing base has shrunk and support services are in greater demand, there is a complex, fully integrated agreement with suppliers, where capability is bought at the other end of the scale – from competitor firms with shared strategic goals and management targets developing holistic 'output-driven' solutions.
Changing this procurement environment leads to some fundamental considerations. It becomes very important to consider what is meant by capability – smaller buyers might not be able to exhort the same influence on suppliers as larger firms in a worldwide market. This leads to the question of how does one specify this capability? "I do not just want to buy a BMW M-Series so that I can thrash it around a track like a lunatic," Wright argues, "I just want four wheels and a seat that will get me from A to B. This means that if I were to supply you with transport capability, you may not have the same car two days in a row, but you still have the ability to travel." Capability is difficult to specify because the more that is specified in a contract, the more the supplier is constrained and unable to innovate. "If I were to say I want the capability to undertake a certain incursion within a period of time, I have almost outsourced complete military activity, which clearly I don't want to do – because Military Forces are the only feasible element of the fighting arm."
However, there is a problem where contracting methods and procedures conflict with strategic aims. Strategic requirements can be undermined by standardisation of contracting conduct which can stifle innovation by requiring tenders to follow strict guidelines. "This raises all sorts of constraining issues, for example, as to who owns the Intellectual Property Rights, which is exactly the problem of 'co-ompetition'" argues Wright.
Contracting for capability
When procuring equipment, it is important to contract for capability thereby managing the risks of the future. When contracting for specific capability, it is becoming more critical to develop these requirements with someone with a wide range of skills, most likely developing equipment from a number of manufacturers. An integrator or an OEM acting as an integrator, is often in the best position to meet this requirement because they have project management skills and the levels of capital needed in order to contract with various manufacturers, supporters or repair organisations. "Now you have a situation where supplying to the Military is a far bigger spread of potential bidders than it was in the past," Wright explains. "If I want capability from a mixed fleet of aircraft, I may have a variety of aircraft made by Lockheed Martin, another by BA, a helicopter made by AgustaWestlands and it is the OEM or stand-alone integrator who must place individual contracts with all of those companies, in order to deliver you the output that you require."
The growth of interest from companies that, in the past, would not be associated with the defence sector, is something that must now be considered when sending out invitations to tender. There are some new key considerations for selecting companies for the shortlist in the bidding process and perhaps deciding between a very large and wealthy venture capital organisation with little association to building equipment or a conventional aircraft manufacturer or maintenance and repair organisation:
• Have they worked with the organisation before?
• Does the company have enough capital to do this business?
• Does the company have a track record of building equipment on time?
But in more recent times, it has been important for both the Defence Procurement Agency (DPA) and Defence Logistics Organisation's (DLO) supplier assessment methodologies to include and consider what Wright refers to as 'soft' issues. "Issues such as culture, cultural fit, whether they are in it for the long term and whether they are making the decision process much more complex. This is why it is increasingly important to have robust and transparent multi-criteria decision-making tools."
Wright has been involved with the use and development of a number of such tools, including the Business Alliance and Supplier Assessment Tool (BASAT) which endeavours to measure 'soft' issues alongside 'hard' issues, such as output reliability. Another project, financed by the MOD, is Critical Enterprise Supply Path Analysis (CESPAN) which looks to research and identify risks in the organisations along the supply chain. The project considers the risks associated with subcontractors, by mapping out the enterprises involved in the contract and considering their stages of development.
In January, the Defence Industrial Strategy urged caution due to the shrinking UK manufacturing base. Additionally, more small and medium size companies are trading or buying from overseas, creating difficulties that previously did not have to be addressed. "We are introducing commercial risks that we didn't know about before," Wright states. "We have a wonderful challenge where the MOD and DLO are rightly wanting to buy capability because this places risk where it is best managed." While there is a significant loss of budget flexibility year on year, there is considerable benefit from financial planning security that such an approach brings into fruition.
The challenge of selecting suppliers best capable of providing output, and maintaining and upgrading it over the next 25 years, is a formidable task. It is of considerable importance that the output is specified correctly, the boundaries involved in delivery of the outputs of a number of organisations are specified and crucially that it is recognised that the output of the first person in line is entirely dependant on the complete supply chain that he/she stands in front of. In addition, it is also important to be fully aware of how, with organisations further down the supply chain that might be vulnerable to a variety of commercial pressures, such a take over may impact the ability to sustain the output.
Intrinsic to the future success of logistical development in defence supply chains is the retention of skilled professionals in the public sector. "Perhaps we have a bigger problem in terms of intellectual continuity than perhaps we realise – how we bring people in and maintain the intellectual base of the organisation against this complex procurement environment," Wright considers. "I think this is a real challenge. People who want to move forward and change things often find they don't fit and they become frustrated and move out." Such a contention is exacerbated by public sector reforms urging a downsizing of staff in what Wright sees as a "blanket, headcount downsizing leading to some of the intellect of the organisation leaking out."
In light of downsizing and scarce promotion opportunities in the MOD, Wright describes a number of issues that are affecting innovation in procurement. "We often find that it is only those people who are politically astute tend to rise and it is not necessarily a meritocracy – it means the way in which you get on is possibly by not upsetting people resulting in an environment non-conducive to innovation. While there are some very clever people within the MOD, I have seen a lot of bright people very quickly get frustrated and move on and I think that this is an absolute pity for the organisation."
While some of the talent flows into the supplier base, some of it does not, resulting in a drain of intellect. "The catchphrase is 'if only the MOD knew what the MOD knows'," Wright bemoans. "We are not briefing our people, we are not retaining the knowledge and we need to find a way of better managing continuity so that when people move into jobs, they do not make the same mistakes that have been made in the past. We have a complex situation in the Military because of the high technology involved and because of the high unit costs and also because of things like military imperatives, the need to search, often the need to do things in response to an urgent operational requirement, which means you may need to work outside contractual issues. You then add to that the fact that the industrial base is changing – the nature of the suppliers are changing, creating a complex picture indeed."
Wright's concerns go deeper into training issues, with the changing situation leading to new training requirements. "On the one hand, they need to have the skills of an investment banker to understand and analyse contractual issues and, on the other hand, they need to be well learned in chapter and verse in the particular financial manual." Because of the complexity of the situation there are fears that misunderstandings are making the changes impracticable. "For anyone working in the MOD as a civil servant, there is an immense set of challenges around procurement," says Wright. "It is at the top that these guys have to drive changes and I cannot say that I have confidence that the nature of problem is fully understood."
Contracting for capability is a strategic liaison between the supplier and the suppliers back up the supply chain. Requirements are evolving and Wright believes the ultimate aim is to be confident that when a certain output is required, the capability to provide that output will be available within a specified timeframe; an achievement that will require understanding of the challenges in order to fulfil it. It is important that those responsible for procurement become comfortable assessing disparate bidders and assessing the 'soft' areas, together with empirical 'hard' areas, which is a key priority for Wright: "It is important to give people the tools and the knowledge in order to use them – this is the greatest challenge I think."