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AEROSPACE—Net Exchange to Boost Contractors, Hurt Subcontractors

The aerospace/defense industry has been very slow to adapt to the world of e-commerce, but that is about to change and L.A.’s community of aerospace subcontractors isn’t very happy about it. That’s because, while a new Internet exchange being developed by some of the biggest aerospace companies is expected to save those giants billions of dollars, the savings will come at the expense of smaller subcontractors and suppliers. By the end of September, a consortium of major aerospace/defense contractors Boeing Co., Lockheed Martin Corp., Raytheon Co. and BAE Systems will launch a global online trading exchange called Exostar SM. The four companies have hired e-commerce specialist Commerce One to supply the core technology for the site. The exchange, in essence, will be used to award to the lowest qualified bidder the contracts for parts, supplies, and services needed by these giants. Although the Internet exchange initially will be used to purchase non-aircraft commodities and services (such as office supplies or cafeteria services), it will ultimately also be used for the procurement of highly customized aircraft parts and supplies. The volume of e-business to be conducted is gargantuan. The four partners combined spend $71 billion annually on goods and services, and expect to save between 10 percent and 15 percent on these outlays by procuring them through the exchange. That would amount to between $7 billion and $10 billion in savings. But their gain will come out of the pockets of the subcontractors. “There’s no question about it,” said King Lum, director of progress with Ace Clearwater Enterprises, a Torrance-based aerospace manufacturer. “The small companies are going to get squeezed by the big ones that’s the name of the game. This type of exchange benefits the buyers, and the only thing we can do is to become more efficient in order to stay competitive.” Lum acknowledged that Internet exchanges can also benefit smaller companies Ace Clearwater, for example, can get better deals on so-called “exotic raw materials” it uses in its manufacturing process. But those savings don’t make up for the degree to which Ace and other subcontractors will have to lower their prices to win contracts from the giants in online bidding. “Many second-tier contractors are concerned about being forced to do business in a way that is disadvantageous to them,” said Jim Schwendinger, global leader for aerospace and defense at Deloitte Consulting LLC. “The concern is that they will need to go through an exchange that is owned by their customers.” Buyers win, sellers lose That means the balance of power will shift heavily toward the buyers of parts and services. The Internet exchange will make it easier for more suppliers to bid for contracts, ultimately making the process more competitive and thus less lucrative for subcontractors. It will also give the buyer direct access to the prices that their competitors are paying for similar goods and services so if a subcontractor is selling parts to Lockheed for a very low price, it has no chance of negotiating a better deal with Boeing, because Boeing will know all about Lockheed’s deal. “It will be an open exchange,” said Hugh Burns, a spokesman for Lockheed Martin. “Vendors and buyers will have access to the same information and it will create new opportunities for both.” Exostar SM is not the first Internet-based procurement exchange for the aerospace/defense industry. Boeing already has its own proprietary exchange, as does General Electric Co. for its commercial and military aircraft engines division, and United Technologies Corp. and Honeywell International Inc. are launching MyAircraft.com this summer. But those exchanges are private. Exostar is the first effort by so many big players to share information with each other. “Unlike in the Internet industry, where change is generated from the bottom by new startups, in the aerospace and defense industry change is generated from the top down by the big players,” said Jon Kutler, president of Quarterdeck Investment Partners Inc. “They are looking to take costs out of the supply chain through these exchanges, and the local businesses have no choice but to go along with it.” According to Kutler, the wave of consolidation among big defense contractors in the 1990s has resulted in huge savings for the industry, but those savings accrued mostly to the U.S. government. This time around, the prime contractors are looking to shore up their own bottom lines by straightening out their often-convoluted procurement systems. Further, the exchanges may be just the first step in a more thorough integration of the e-business model into the industry. To further streamline communications between contractors and suppliers, many companies may in the near future undergo costly overhauls of their data systems. Currently, because so many different incompatible systems are used, it is often impossible for companies to communicate directly with each other. A unified system would allow contractors and subcontractors to enter each other’s databases for making and tracking orders, and completing other transactions. While it remains unclear how the changes are going to be made, industry observers expect the aerospace/defense industry in the coming years to adapt to the business-to-business e-commerce model. The challenge for the smaller companies will be to prepare for the looming change. “The big guys are going to determine which interface will be used, and the smaller guys will have to be cautious,” Schwendinger said. “They will want to be proactive and be prepared, but at the same time they will not want to commit too many resources to a system that could get redefined again.”

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