Pentagon Supply Chain Improving Distribution Process

Picking Apart the Pentagon's Part Pricing

May 24, 2019
$4,361 for a $46 pin: That's mighty creative math.

TransDigm Group Inc. could be paid about 9,400% in excess profit for a half-inch metal pin, prompting the Pentagon to weigh legislation that would give contracting officers the power to demand backup data on spare parts costs.

All told, the Pentagon found it was overcharged for 98 of 100 TransDigm parts sampled, adding $91 million to the parts’ $28 million value.

The fact that this is going on shouldn’t surprise anyone. It has been going on in industry, it seems, forever, and is possible when a manufacturer --- usually an OEM --- has a captive customer, i.e. one where there is no alternative source. Transdigm has said that it is the sole supplier for 80% of its parts.

There are multiple reasons that sourcing is restricted to a single supplier. Among them are:

  • The limited market for these parts doesn’t justify the cost of the capital equipment for other manufacturers to produce the part.
  • Patents, and patent protection.
  • No-bid contracts.

I have recent first-hand experience in this area. For a large part of my career, I was employed by a lawn-mower manufacturer. Since retiring from that company, I have remained loyal to that former employer. A few weeks ago, I was mowing under a fir tree when a large “widow-maker”—i.e., a broken branch that is typically hanging far above the ground—fell and severely damaged the plastic hood assembly on my riding lawn mower.

In one sense, I was lucky the branch didn’t hit me. On another, when I went to check on the price of a replacement hood, I found out that it would cost about 1/7th the original $5,000 dollar price of the tractor! And due to the factors listed above and others like them, no one else manufactures an off-the-shelf product that can substitute for it. Talk about captured.

You may wonder what is going on here. About 15 years ago, I was, in fact, materials manager at the factory that produces these mower,  and at that time a similar hood assembly cost in the area of $100. Assuming that over the years the company’s purchase price increased to $200—something I highly doubt, since most OEM suppliers are expected to deliver annual price reductions—the manufacturer is selling this service part at a price of three to four times what it cost. Hmmm. Going forward, I guess I’ll be mowing without a hood.

I had recently heard from a retiree of a large aerospace company that her former employer had significant government contracts and routinely charged 1500 times their own purchase price for many service parts they sold through those contracts, especially on parts needed for product maintenance. I had a hard time believing this level of governmental gouging was possible until having read this article.

The relationship this practice has to supply-chain management is that the companies selling these service parts are, in fact, suppliers to their customers. And—for the most part—they buy these same parts from their own suppliers. And when they deal with them, these OEMs negotiate every penny out of the prices they have to pay. Because many of their own customers are essentially “captured,” they can basically charge them anything they want. What a racket! Go figure.

I guess when buying a personal product this may be OK if you look at it from the point-of-view that the customer is making their own buying decision.  For instance, I’m not going to buy a new hood. But when it applies to governmental purchases—where American taxpayers have no choice as to whether a purchase is going to be made—it rankles me quite a bit. 

Ex-Im No Longer in Limbo

The U.S. Export-Import Bank can finally start approving deals over $10 million again, with a new president and three new board members approved.

Bloomberg reports that Ex-Im, the independent federal credit agency that helps large companies with export financing, has almost $40 billion in transactions pending.

These confirmations will provide the quorum the agency needs to approve deals, for the first time since 2015. According to Bloomberg, the nominees were confirmed "despite objections from conservative Republicans who say the Ex-Im bank provides corporate welfare for wealthy manufacturing and aerospace companies such as Boeing Co. and General Electric Co., and big banks, like JPMorgan Chase & Co., that help finance deals.”

If you read the on-line comments after the article, you will see that many small- to middle-sized manufacturers feel left out because they do not generally have access to this financial benefit; since it is available only on foreign orders of $10 million and over. 

I tend to agree that smaller manufacturers should be included. Small- and medium-sized manufacturers are a significant contributor—some say the most important contributor—to the health of our country’s economy. Rarely, however, do they have a foreign sale above the current financial threshold figure.

Read more Supply Chain Initiative columns by Paul Ericksen

In addition, I think it is just plain wrong that the Export-Import Bank is essentially providing subsidies for foreign purchases allowing them to buy U.S. goods at a lower overall cost than domestic buyers! 

On the other hand, I support the existence and function of the Export-Import bank. This support is not one of principle. Rather, it is one of practicality. Just about every major manufacturing country in the world provides this sort of support to their own exporting manufacturers. If the U.S. doesn’t, its exporters will be at a competitive disadvantage.

Tariffs and More Tariffs …

IndustryWeek published several articles on tariffs last week. They express competing views, as do the readers in the Comments section following the articles. And in my weekly updates I’ve offered my view on the tariffs. It seems, however, that the discussion is becoming a bit polarized and even emotional.

Because of that I think it is expedient to lay out what I believe is the common ground between the two extremes of the discussion:

  • Over the last 30 or so years, China has operated outside of the normal parameters of international trade. Many of their practices are considered illegal. As a result, they have an overwhelming advantage in their balances-of-trade with most countries world-wide.
  • China is not to be trusted in commitments they may make to review their practices.  Over the last 15 years, they have pledged multiple times to make changes--such as allowing the Yuan to float in value relative other world currencies—that have either not be acted on or done over extended periods of time.
  • After World War II, U.S. policy was to help countries recover economically as part of the strategy to fight the spread of communism. Over time—and as these countries recovered from the war—this assistance was expanded, not reduced. In fact, since then, the trade policies and financial support that our country has given are positioning other countries as stronger competitors to our own countries manufacturers.
  • Our government needs to be involved to mediate the above three points.  Why? Although we are generally a patriotic people, consumers in the U.S. are not likely to stop pursuing the lowest price.
  • Tariffs have proven to be generally effective in getting the attention of targeted countries or providing a limited respite for domestic industries that are under competitive pressures.  History, though, shows that over the longer-term, tariffs tend to reduce a country’s competitiveness in those targeted areas, and to stifle international trade; i.e., a bad thing.
  • If the expectation is that the current negotiations will delivery step-function type results, we’re probably setting ourselves up for a disappointment. We don’t have all of the leverage here, and any changes that are agreed on will likely only have significant impact over time.

Regardless of how you think the current administration operates or their approach to trade negotiations, they should be given kudos on at least stepping up to the challenge of addressing the issues outlined above. And, although we may disagree on tactics, strategies and goals, we should all support their trying to remedy the current situation.

Hopefully the above creates some common ground upon we can conduct current discussions on tariffs. That doesn’t mean everyone will agree, but if 80% of us do, I consider that a great success.

Paul Ericksen is IndustryWeek’s supply chain advisor. He has 38 years of experience in industry, primarily in supply management at two large original equipment manufacturers. 

About the Author

Paul Ericksen | Executive Level Consultant; IndustryWeek Supply Chain Advisor

Paul D. Ericksen has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers. At the second he was chief procurement officer. He then went on to head up a large multi-year supply chain flexibility initiative funded by the U.S. Department of Defense. He presently is an executive level consultant in both manufacturing and supply chain, counting Fortune 100 companies among his clientele. His articles on supply management issues have been published in Industrial Engineering, APICS, Purchasing Today, Target and other periodicals. 

Read Paul's articles

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