Capital equipment OEMs need to take a fresh look at their supply chains and rethink which capabilities they need to own. Failing to do so, and quickly, means missing multiple generations of technology development—a prescription for disaster in long-cycle businesses such as capital equipment manufacturing.
Some of today’s problems are specific to capital equipment, while others are more general. The most critical are strategic as well as financial, and are very damaging to OEMs’ long-term competitive position and performance. Here are the chief challenges:
Continually Shrinking Margins. For most OEMs, aftermarket profits come from parts, not service, and parts are linked to systems and subsystems. As OEMs have transferred responsibility for designing and producing systems to their suppliers, they have relinquished control of the aftermarket and the associated profit streams. This transition became apparent as older parts, which were owned by the OEMs, wore out and were replaced by new parts now being sold by suppliers.
There is a very strong logic for OEMs to pull back some of their critical systems—but which ones? An OEM can counter shrinking margins by determining which systems and components generate substantial aftermarket profit streams.
Technical Atrophying. Following the transfer of a system from the OEM to a supplier, the first integration is a relatively straightforward matter because the OEM continues to have a deep understanding of the system. Over time, however, the OEM’s knowledge erodes, and system integration costs and the related risks increase—costs and risks that are borne completely by the OEM. This problem can be magnified when the technology that was the basis for the system’s competitive advantage advances.
In deciding which systems and capabilities to bring back in-house, OEMs should understand which systems and components encompass technologies that are critical to the competitive position of the product.
Loss of Control over the Experience Curve. As companies produce units, they get smarter and more efficient at producing more units. In letting suppliers produce the complex systems, OEMs have effectively transferred the total experience benefit to the suppliers, which makes it difficult for the OEMs to share in the cost improvements that the suppliers’ experience brings.
In businesses such as airplane, ship, or satellite manufacturing, it can be crippling to an OEM’s competitive position to lose control of experience curve benefits. The suppliers end up making more profits than the OEM that took on the responsibility and risk of developing the program in the first place. OEMs need to identify which systems and components have steep experience curves, and bring those back in.
Operational Complexity. With the shift toward the integration of complex supplied systems, supply chains have become much more difficult to manage. Complexity adds cost directly, and also indirectly, in the form of increased inventories and the expense of delays and fixes. The impact is borne almost completely by the system integrator, since in all cases, the OEM maintains program risk. So when things go wrong with a supplier, the OEM steps in and incurs the cost of fixing it.
To reverse the damage, OEMs must take a fresh look at their supply chains and properly weigh the risks that it bears against the operational cost of the complexity of supply chains.