Defense Industry Buyers Face Multiple Challenges

jim-1A shrinking component supply base, counterfeit parts and working with suppliers to reduce supply chain risks are some of the issues defense OEM buyers must deal with.

Component obsolescence, counterfeit parts and semiconductor industry consolidation are some of the major supply chain challenges that buyers in the defense industry face.

While electronics buyers in other industries face similar challenges, the issues are more acute in the defense industry because defense OEMs frequently must purchase small volumes of older semiconductors and other components for systems that may be used for decades. For instance, the B-52 bomber was originally built in the 1950s and is still in service today, In fact, the Air Force says it plans to keep the plane in service until 2045.

There are many other warplanes, radar systems, vehicles, missile systems and systems for fighting ships defense systems that were designed years ago and are still in service or newer versions of the systems still being built. The challenge for defense industry buyers is to make sure there is a reliable supply base to support such older defense systems still in production or for maintenance and repair of those systems.

Unfortunately, defense systems often have longer life cycles than the components and other parts that are used in the equipment. Chipmakers often cease production of older parts that have diminishing demand in favor of higher margin semiconductors needed for products and systems that have high demand such as smart phones, consumer electronics equipment and computers.

As a result, managing component obsolescence is a front burner issue for many buyers at defense OEMs. They must have obsolescence management plans to demonstrate how they would handle diminishing resources for the systems over time.

Such plans often include strategies such as having multiple sources for parts and using alternate or standard parts whenever possible. Buyers must also monitor end-of-life (EOL) notices very closely, arrange for lifetime buys when necessary, or arrange to have an EOL part built by another manufacturer if possible.

Dealing with obsolescence

Key to managing obsolescence is getting advanced notice of when a semiconductor or other component manufacturer is about to halt production of a part needed in a defense system.

Buyers at BAE Systems closely monitor EOL notices from suppliers, “but we also go out and query our supply base about which parts the supplier will soon stop producing,” said Roger Ogilvie, vice president and general manager of BAE’s Mission Support business. BAE Systems builds missile launchers, artillery systems, military ordnance, night vision, cockpit controls, surveillance and reconnaissance and other systems for the U.S. military.

Monitoring EOL/PDN notices is important because about 4,000 notices will be sent out in 2016 and each notice could have dozens of parts listed, according to researcher IHS Market Technology. The good news is that the number of EOL parts being issued will be less in 2016 than the number in 2013 when 5,732 were issued, according to IHS Markit Technology.

The number of EOL notices tends to increase when semiconductor suppliers suffer annual sales declines and decreases when chip sales are strong, the researcher said.

Ogilvie says the company learns about “a lot of new EOL notices by picking up the phone and calling suppliers,” rather than waiting for them to send notification. “Some manufacturers are very good about end-of-life notices,” said Ogilvie. “Some provide them to their top customers, but don’t know how to provide the information to the other folks,” in the supply chain, he said.

Component manufacturers “recognize the importance of EOL notices, but don’t have the processes in place to make sure everyone knows about them when they are issued,” said Ogilvie.

Greg Wood, director parts content for IHS Markit Technology in Englewood, Colo., said another challenge for defense industry buyers concerning obsolescence is that defense OEMs must factor in the lifecycle of the system and forecast the expected lifecycle of components that will be used in a system when selecting parts and suppliers.

“A lot of contracts today stipulate that you need to have a good extended lifecycle prediction on the components you are buying,” said Wood. Selecting parts that have good drop-in replacement across manufacturers “is also important.”

He added there is a lot more information these days to make intelligent design selections. Wood said there are component manufacturers that will “guarantee product longevity of the component and will closely work with customers” to manage it.

Dealing with consolidation 

While managing component obsolescence is a major issue for defense buyers, so is supply base consolidation, especially among semiconductor companies. IHS Markit Technology said from 2014 through 2016 there was “record consolidation” in the chip industry. In 2015 there were more than 20 chip industry acquisitions with a total value of more than $100 billion. Through the third quarter of 2015, there has been more than $55 billion of M&A activity, according to the researcher.

Such consolidation means fewer sources for parts and, in some cases, “you may end up with sole-sourced parts” said Ogilvie.

As a result, it’s important to monitor the semiconductor industry for possible future mergers and acquisitions because when chipmakers merge they often consolidate their product portfolios to eliminate redundant products, which mean there could be dozens of products that have one less source.   In addition when semiconductor companies merge, defense industry buyers may have to re-qualify parts purchased from the company that bought the other.

“It depends on the branding,” said Wood. If a part is rebranded with a new logo and a different part number, the chip will likely be rejected at inspection. That means the rebranded part needs to be re-qualified, which is a costly and time-consuming process. However, if the part keeps the same brand and part number of the acquired company, “it’s much less of a challenge,” said Wood.

Defense contractors typically have two or more sources for a part which could be a problem for buyers who purchase parts from two merged suppliers. Noting that ON Semiconductor and Fairchild announced plans to merge, “if a buyer was getting the same device from ON Semiconductor and Fairchild, that would be challenging,” said Wood. The buyer would have to secure a second source for the chip” if ON and Fairchild were the only two suppliers that the buyer had used for the part, he said.

Counterfeiting: A big problem

Another key issue for defense industry buyers is counterfeiting. “It is a big problem because of the risk, but it’s not a big problem because of the frequency of occurrence,” said Michael Burkett, vice president and distinguished analyst for researcher Gartner “There aren’t a lot of incidents of counterfeiting, but one incident is too many,” he said. “It’s a real challenge.”

Old or obsolete parts that are no longer produced are often targeted by counterfeiters. As a result, buyers sometimes purchase parts from independent distributors or brokers on the open market. While there are many legitimate independent distributors, some are unscrupulous and sell bogus parts.

There’s greater vigilance about counterfeit parts in the defense industry and legislation designed to stop the proliferation of bogus parts in the supply chain has been enacted. Buyers at defense contractors must be able to trace back parts they purchase to the original component manufacturer.

Ogilvie said BAE buys most parts from component manufacturers and not so much from distributors. “It is a requirement now that we need to be able to track the part to its manufacturing source. The best way to do that is the buy from the component manufacturers,” he said. If a part can’t be purchased directly from a manufacturer, BAE will purchase it from authorized distributors. Buying from non-authorized distributors is a last resort.

Wood said counterfeiting is “certainly an ongoing issue and there’s a lot of emphasis on it,” but security of parts is also an issue. “As components themselves become more of an integrated system, there is potential for those integrated systems to be hacked,” said Wood. The chips may have communications capabilities “which could be vulnerable to hacking.

More innovation needed

Besides consolidation, obsolescence and supply chain risk, there are other issues for purchasers including getting suppliers to take on more “innovation risk,” said Burkett. “They want their suppliers to not just respond to a drawing or fulfill against an existing contract,” said Burkett. “They’re asking their suppliers to be more innovative, whether it is product related or whether it is process related,” he said.

For instance, buyers may want the supplier to develop a product based on a certain technology that can be used in a defense system or find a new way to manufacture a product to reduce cost.

Defense OEMs also want to gain a deeper visibility into their tier 1 supplier supply chain in order to manage risk and “better predict disruptions in the supply base,” said Burkett.

“They want suppliers to be able to identify any variables that are going to introduce risk and disrupt their supply chains and they want suppliers to put processes in place to reduce that risk,” he said. OEMs need tier 1 suppliers to take responsibility to identify the “risk variables” and find ways to reduce risk and “ figure out how to get visibility” into the tier 1’s supply chain, Burkett said.

Another issue is cost. “At the end of the day defense OEM buyers want everything for less,” Burkett said. However, it’s not just about price. Increasingly buyers are working with suppliers on identifying the attributes of cost beyond price and eliminate waste and overhead in doing business with suppliers, according to Burkett.

Buyers are asking suppliers, “is there a way that we are engaging you that is adding overhead? For instance, is the way we share demand with you making it hard for you to do business with us?” said Burkett. “Are we creating cost with the way we work with you?”

He said defense OEMs are “trying to get better at “should cost analysis” and analyzing designs, estimating what they think a product should cost and then going to the suppliers” with the data.

Gartner added defense contractors often do value engineering/analysis to evaluate a design and see where there’s an opportunity to reduce costs.”

To help costs, defense OEMs are looking to reduce “product complexity,” said Burkett. ”There’s a lot of work on collaborative design with suppliers to try to see if there is a way to simplify product and simplify cost,” he said.

“There’s a huge initiative to deal with complexity management and to move towards platforms and more modular designs and have suppliers provide input on how they can help achieve that goal,” said Burkett. The idea is by having a less complex design, fewer components may be needed and cost can be reduced.