Planning Report 04-2

Economic Impact of

Inadequate Infrastructure

for Supply Chain

Integration

Prepared by:

RTI International

for

National Institute of

Standards & Technology

Program Office

Manufacturing Engineering Laboratory

Electronics and Electrical Engineering Laboratory

June 2004

U.S Department of Commerce

Technology Administration
May 2004 

Economic Impact of 

Inadequate Infrastructure for 

Supply Chain Integration

Final Report

Prepared for 

National Institute of Standards and Technology 

Program Office 

Manufacturing Engineering Laboratory 

Electronics and Electrical Engineering Laboratory

Prepared by 

William J. White, Ph.D. 

Alan C. O’Connor 

Brent R. Rowe 

RTI International 

Health, Social, and Economics Research 

Research Triangle Park, NC 27709 

RTI Project Number 07007.013 


iii 

Contents 

 Acronym List x 

 Executive Summary ES-1

 1 Introduction and Scope of Study 1-1

1.1 Scope of the Study.......................................................................1-2

1.2 Definition of a Supply Chain.........................................................1-2

1.3 Conceptual Discussion of Supply-Chain Information Flows ........1-3

1.3.1 Electronic Data Interchange (EDI) ..................................1-5

1.3.2 Extensible Markup Language (XML)...............................1-6

1.4 A Description of Ideal and Suboptimal Supply-Chain 

Integration (SCI)...........................................................................1-6

1.4.1 Perfectly Efficient Supply-Chain Integration....................1-7

1.4.2 Inefficient and Incomplete Integration.............................1-8

1.4.3 Example—Invoice Payment Authorization......................1-8

1.5 Role of Standards and Need for Effective Standards 

Infrastructure ..............................................................................1-10

1.5.1 Conceptual Description of SCI and Standards 

Development Process...................................................1-10

1.5.2 Industry Approaches to Standards Development .........1-12

1.6 Market Failures in the Provision of Standards 

Infrastructures ............................................................................1-13

1.6.1 Underinvestment Due to Public Goods Externality.......1-13

1.6.2 Coordination Failures in Development of 

Standards......................................................................1-14

1.6.3 Government's Role in Correcting for Market 

Failures in Standards Provision ....................................1-15

 2 Overview of Manufacturing Supply Chains 2-1

2.1 Structure of Manufacturing Supply Chains ..................................2-1
iv 

2.2 Evolution of Organizational Structures and Supply Chains .........2-4

2.3 Information Technology’s Impact on Current Supply Chain 

Integration ....................................................................................2-6

2.3.1 Inventory and Information as Ways to Manage 

Uncertainty with Customers ............................................2-6

2.3.2 Local versus System-Wide Optimization ......................2-10

2.3.3 Interoperability as an Approach to Optimizing 

Supply Chains ...............................................................2-12

 3 Supply Chain Optimization in Practice 3-1

3.1 Conceptual Descriptions of Current Supply Chain Models..........3-1

3.2 Supply Chain Integration Developments......................................3-5

3.3 Increased Globalization of Supply Chains ...................................3-7

3.3.1 Motivators to Internationalizing Trade.............................3-8

3.3.2 Inhibitors to Internationalizing Trade...............................3-9

3.4 Supply Chain Innovators ............................................................3-11

3.4.1 Business on Demand—The Evolution of IBM...............3-11

3.4.2 Understanding Demand—The Li & Fung Virtual 

Enterprise......................................................................3-12

3.4.3 Build to Demand—The Dell Model................................3-13

 4. The Automotive Supply Chain 4-1

4.1 The Anatomy of an Automobile....................................................4-1

4.1.1 Automobile Platforms and Models ..................................4-2

4.1.2 Production by Platform....................................................4-3

4.2 The Automobile Production Process............................................4-3

4.2.1 Engineering and Manufacturing Philosophies.................4-4

4.2.2 Process and Factory Design...........................................4-5

4.2.3 Assembly.........................................................................4-6

4.3 The U.S. Automotive Supply Chain .............................................4-7

4.3.1 OEMs ..............................................................................4-9

4.3.2 Tier 1 Suppliers .............................................................4-10

4.3.3 Subtier Suppliers...........................................................4-11

4.4 Trends in U.S. Automotive Supply Chain Integration ................4-11

4.5 Interoperability Issues in the Automotive Industry .....................4-15

4.5.1 Customer–Supplier Interoperability...............................4-15

4.5.2 Interoperability with Third-Party Logistics 

Companies ....................................................................4-16

4.5.3 Emerging E-business Trends in the Automotive 

Industry: Implications for Interoperability .....................4-17

4.5.4 Engineering Changes....................................................4-19
v 

 5. The Electronics Supply Chain 5-1

5.1 Overview of the Electronics Supply Chain Industry .....................5-1

5.1.1 Brief History of the Electronics Industry..........................5-3

5.1.2 Electronics Manufacturers...............................................5-4

5.2 Computer and Peripheral Equipment...........................................5-4

5.2.1 The Anatomy of a Microcomputer...................................5-4

5.2.2 Computer and Peripheral Products Supply Chain ..........5-6

5.2.3 Computer and Peripheral Products Trends ....................5-7

5.2.4 Computer and Peripheral OEMs...................................5-11

5.3 Communication Equipment Industry ..........................................5-16

5.3.1 Definition of a Computer Network .................................5-17

5.3.2 Computer Networking Current Trends..........................5-18

5.3.3 Computer Network Hardware Supply Chain.................5-20

5.4 Interoperability Issues in Electronics..........................................5-21

5.4.1 Inventory Management .................................................5-22

5.4.2 Time-to-Market..............................................................5-25

5.4.3 Efficiency.......................................................................5-27

5.4.4 BTO/CTO Support.........................................................5-28

5.4.5 Partnering vs. Standards...............................................5-28

5.4.6 Opportunities Summary ................................................5-30

 6. Conceptual Approach for Measuring Costs 6-1

6.1 Scope of Supply-Chain Activities .................................................6-3

6.2 Categories of Excessive Costs ....................................................6-6

6.3 Technical and Economic Impact Metrics .....................................6-8

6.4 Informing the Metrics through Data Collection—Case 

Studies .........................................................................................6-8

6.5 Extending the Cost Data to the Industry Level—LargeScale (Internet) Surveys.............................................................6-12

6.6 Refining the Methodology ..........................................................6-14

6.6.1 Difficulties with Understanding “Excessive Costs”........6-14

6.6.2 Lack of Unified Information ...........................................6-15

6.6.3 Sensitivity of Information...............................................6-15

6.6.4 Many Metrics with Low or Unobtainable Costs.............6-15

6.6.5 Resulting Changes to Execution of Data Collection 

Activities ........................................................................6-17

 7. Analysis of Data and Development of Cost Estimates 7-1

7.1 In-Depth Interviews ......................................................................7-1

7.1.1 Profile—An Ideally Integrated Firm.................................7-2
vi 

7.1.2 Profile—A Firm in the Early Stages of Integration ..........7-4

7.1.3 Cost Estimation for Different Degrees of 

Integration .......................................................................7-6

7.2 Quantitative and Qualitative Survey Results................................7-9

7.2.1 Results from Internet Survey of Automotive Firms .......7-10

7.2.2 Results from RosettaNet Survey of Electronics 

Firms .............................................................................7-12

7.3 Aggregating Costs up to Industry Level.....................................7-15

7.3.1 Industry Sales Revenues ..............................................7-15

7.3.2 Industry Wage Estimates ..............................................7-16

7.3.3 Costs of Inadequate SCI Infrastructure.........................7-17

7.3.4 Cautions in Interpretation..............................................7-19

 8. Implications and Potential Applications of Results 8-1

8.1 Implications for industry ...............................................................8-2

8.2 Implication for the growth of global supply chains .......................8-4

8.2.1 More Small Firm Players.................................................8-5

8.2.2 Increased Delays ............................................................8-6

8.2.3 Necessary Infrastructure Investments ............................8-7

8.3 Implications for NIST....................................................................8-7

 References R-1

Appendix A: Site-Visit Guide A-1 

Appendix B: Automotive and Electronics Industries Survey B-1 
vii 

Figures 

 1-1 SCI and Standards Development Process ..........................................1-11 

 2-1 Supply Chain Process Flows: Discrete Parts Manufacturing ...............2-3

 2-2 Managing Uncertainty with Inventory and Information ..........................2-7

 2-3 Costs of Uncertainty and Coordination................................................2-10

 3-1 Conceptual Supply Chain Models: Changing Control ..........................3-2

 3-2 Li & Fung Supply Chain Model ............................................................3-14 

 3-3 Dell Model vs. Traditional Model of Distribution...................................3-15 

 4-1 Automobile Systems and Components..................................................4-2

 4-2 U.S. Automotive Supply Chain...............................................................4-9

 5-1 Computer Components..........................................................................5-6

 5-2 U.S. Computer Manufacturing Supply Chain.........................................5-7

 5-3 Outsourcing Models within the PC Industry...........................................5-8

 5-4 Network with Router.............................................................................5-19

 5-5 Simplified Network Hardware Industry Supply Chain ..........................5-20

 5-6 Inventory Uniqueness ..........................................................................5-23

 5-7 Typical System Information Flows .......................................................5-24

 5-8 Sample Consumer PC Demand Profile ...............................................5-27

 5-9 Pressure to Standardize ......................................................................5-30 

 6-1 SCI Estimation Methodology..................................................................6-2 
viii 

Tables 

 2-1 Pros and Cons of Local and System-Wide Supply Chain 

Optimization .........................................................................................2-11

 4-1 “Big Three” Production, Sales, and Employees.....................................4-9

 4-2 Characteristics of Prominent Tier 1 Suppliers .....................................4-12

 4-3 Characteristics of Prominent Subtier Suppliers ...................................4-13

 5-1 U.S. Electronics Sales by Industry Group..............................................5-2

 5-2 Largest Electronics Firms ......................................................................5-5

 5-3 Major Microcomputer and Peripherals OEMs......................................5-12

 5-4 Largest EMS Providers........................................................................5-13

 5-5 Characteristics of Prominent Subtier Suppliers ...................................5-15

 5-6 Shipment Values for Communications Equipment Industry ................5-17

 5-7 Hardware Used in Computer Networking Industry ..............................5-19

 5-8 Large Computer Network OEMs..........................................................5-21

 5-9 Specific Opportunities for Standardization...........................................5-31

 6-1 Supply-Chain Information Processes and Relative Importance ............6-4

 6-2 Impact Metrics for Inefficient SCI...........................................................6-9

 6-3 Supply-Chain Task/Cost Metrics Matrix...............................................6-11

 6-4 Overview of Weighting Approach ........................................................6-14

 7-1 Plant-Level Effort Requirements and Identified Costs (per $100 

million in annual sales)...........................................................................7-9

 7-2 Percentage of Automotive Firms Using Each Communication 

Method for SCI Interactions .................................................................7-12

 7-3 Business Processes and Degree of Integration of Electronics 

Firms ....................................................................................................7-14

 7-4 Value of Shipments and Employment Data for Electronics and 

Automotive Sectors..............................................................................7-16
ix 

 7-5 Industry-Specific Wage Estimates for Electronics and Automotive 

Sectors.................................................................................................7-16

 7-6 Estimated Costs of Inadequate Supply Chain Infrastructure: 

Automotive Industry .............................................................................7-18

 7-7 Estimated Costs of Inadequate Supply Chain Infrastructure: 

Electronics Industry..............................................................................7-19
x 

 Acronym List 

AIAG Automotive Industry Action Group 

ASIC application-specific integrated circuit 

AVL approved vendor list 

B2B business-to-business 

BTO “build to order” 

CAD computer-aided design 

CAE computer-aided engineering 

CAM computer-aided manufacturing 

CD compact disk 

CPUs central processing units 

CRM Customer Relationship Management 

CRP continuous replenishment 

CTO “configure to order” 

DFM design for manufacturing 

DRAM dynamic random access memory 

DSL digital subscriber line 

EC engineering changes 

ECN engineering change notice 

EDI electronic data interchange 

EMS electronics manufacturing service 

ERP enterprise resource planning 

GM General Motors Corporation 

IBM International Business Machines Corporation 

ICs integrated circuits 

IM inventory management 
xi 

IT information technology 

JIT just-in-time [delivery] 

LANs local-area networks 

MAC media access control 

MOSFETs metal oxide semiconductor field-effect transistors 

MRP Materials Requirements Planning 

NAICS North American Industry Classification System 

NEMI National Electronics Manufacturing Initiative, Inc. 

NIST National Institute of Standards and Technology 

ODM original design manufacturer 

OEMs original equipment manufacturers 

PC personal computer 

PCA printed circuit assemblies 

PCBs printed circuit boards 

PDEs partial differential equations 

PIPs Partner Interface Processes 

R&D research and development 

RFID radio frequency identification 

ROI return on investment 

SCI supply chain integration 

SCM supply chain management 

SIC standard industrial classification [code] 

SKUs stock keeping units 

SMT Surface Mount Technology 

SOC system on a chip 

VI vertically integrated 

VLSI very-large-scale integration 

VMI vendor-managed inventory 

WANs wide-area networks 

WSJ Wall Street Journal

WTO World Trade Organization 
xii 

XML extensive markup language 

XTS Li & Fung’s Electronic Trading System 
ES-1 

 

 Executive Summary 

The emergence of low-cost communications and information processing 

has made it possible for firms to revolutionize the way they operate 

internally, especially in distributing information throughout their 

organizations. Through the use of Manufacturing and Enterprise 

Requirements Planning (MRP and ERP) systems, they can operate with 

lower levels of inventory, can respond more quickly to changes in 

customer requirements, and can eliminate or outsource costly 

accounting functions. 

However, companies have made much less progress in improving the 

efficiency of communications between their facilities and those of their 

suppliers and customers, along what is known as their supply chain. A 

lack of universally accepted and implemented standards for the format 

and content of messages that flow between supply chain partners 

reduces the potential for inventory and expense savings, as well as 

leading to duplication of effort, maintenance of redundant systems, and 

investment in non-ideal information processes. 

In this study, we examine the current state of supply chain integration 

(SCI), estimate the economic impact of inadequate integration, and 

identify opportunities for governmental organizations to provide critical 

standards infrastructures that will improve the efficiency of supply 

chain communications. We estimate the total annual costs of 

inadequacies in supply chain infrastructures to be in excess of $5 billion 

for the automotive industry, and almost $3.9 billion for the electronics 

industry. These figures represent about 1.2% of the value of shipments 

in each industry. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

ES-2 

 1 HOW WORK GETS DONE IN SUPPLY CHAINS 

Firms engaged in supply-chain relationships, as customers, suppliers, or 

providers of services, need to share a great deal of information in the 

course of their interactions. Over the years, companies have managed 

these information flows in a number of ways, including telephone calls, 

letters, telex, faxes, and electronic data interchange (EDI). More 

recently, firms have begun using the power of the Internet to create more 

effective and open transmission protocols for machine-to-machine 

communication of the same high-frequency data now handled by 

traditional EDI.1 

 2 EFFICIENCY OF INFORMATION EXCHANGE 

Supply chain information systems require a great deal of data input, both 

from automated sources (software applications, control systems, bar 

code readers, sensors, analytical instruments) and manual interactions. 

In an ideal system, each piece of data would be entered only once and 

be available to any system in the information network that needs it. 

High-frequency, routine data input tasks should be fully automated, with 

oversight on a periodic basis by skilled systems optimizers, such as 

planning or logistics personnel. In a similar manner, high-frequency 

information flows should be fully automated and transmitted in standard 

formats with common protocols. 

Much evidence is available that this ideal information system integration 

is not evolving within industry supply chains: 

• Manual data entry is widespread, even when machine sources 

are available; critical information is often manually reentered at 

many points in the chain. 

• Interventions from purchasing clerks, order processors, and 

expediters are required to maintain supply-chain information 

flows. 

• The use of translators to convert data from one format to another 

is almost universal, even between systems that are nominally 

compliant with established protocols. 

• Organizations of all sizes and across industry tiers use “informed” 

estimates rather than actual or production plan data in 

scheduling, materials management, and expediting. 

 

1 It is the implementation of these Internet-based information systems that is most often 

referred to as SCI, even though EDI and telephone/fax are also ways of integrating 

supply chains. 
Executive Summary 

ES-3 

• Large numbers of firms, especially in the lower tiers, simply 

operate without essential data. 

The business case for better integration has been evident in the 

automotive industry for several years and for more than a decade in the 

electronics sector. As a result, a number of companies in these 

industries have made efforts to provide partial or total solutions, almost 

all resulting in either inefficient or incomplete integration. Under 

inefficient integration, systems are put in place to automate information 

inputs and flows, but the unavailability of a suitable standards 

infrastructure leads to excessive capital investment, duplication of effort, 

higher than optimal staffing and support levels, and inadequate 

organizational flexibility. In the case of incomplete integration, key 

elements of a comprehensive system are missing, or improved systems 

are only implemented for a subset of supply-chain partners. In the latter 

case, the supply chain as a whole still experiences costs well above 

optimal levels, and many of the gains from integration remain unrealized. 

 3 MARKET FAILURES IN THE PROVISION OF 

INFRASTRUCTURE 

From the standpoint of public economics theory, the efforts of private 

businesses are likely to lead to inadequate standards infrastructures for 

at least two reasons. The first arises from the public goods nature of 

these standards, which inevitably leads to a free-rider problem2 and 

resultant under-investment in provision of these infrastructures. The 

second reason is coordination failure, in which asymmetric incentives 

lead participants to pursue investments that are suboptimal for the 

industry as a whole. 

Resolving these public-goods and coordination failures requires 

intervention from an organization outside of industry. Underinvestment 

can be partly corrected by government provision of research funding, by 

subsidies for private R&D efforts, and by agency participation in 

standards and infrastructure development efforts. Direct participation by 

a government agency can also help eliminate coordination failure, as 

long as industry participants are willing to accept its leadership. 

 

2 A free rider problem arises when firms can benefit from the actions of others in producing 

a public good, without themselves contributing, i.e., they may free ride. This gives 

every firm an incentive to under-invest in production of the public good. In the present 

case, the public good is an adequate standards infrastructure for SCI. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

ES-4 

This study was initiated by the National Institute of Standards & 

Technology (NIST), an agency of the Department of Commerce whose 

mission includes supporting industry by helping to improve our country's 

technology infrastructure. The public good content of the 

infratechnologies underlying most industry standards often causes 

under-funding of needed research in the private sector. One of NIST's 

roles is to provide industry's standards-setting processes with these 

infratechnologies. Furthermore, NIST's expertise and unique research 

facilities can result in greater efficiency, and hence, cost savings in the 

development of the technical basis for standards. 

Secondly, NIST’s role as a third party independent of the supply chain 

and its competitive constraints allows it to serve several vital coordination 

roles as well. NIST's status as a competitively-neutral third party permits 

its technical experts to seek timely solutions that are optimal for the 

entire sector, as opposed to the technically inferior or incomplete 

standardization that often results when competing private entities cannot 

agree on the public goods content that results in optimal standards. The 

collaborative process used by NIST ensures that all parties have the 

opportunity to be represented and involved, which is not always the case 

with trade associations or voluntary standards groups. A NIST-led 

process can reduce transactions costs through its competitively-neutral 

leadership role in coordinating consensus building. 

 4 SUPPLY CHAINS IN INDUSTRY 

The U.S. manufacturing sector is the largest in the world; its 15.9 million 

workers produced $1.85 trillion in value-added in 2001, according to the 

most recent government data (U.S. Census Bureau, 2001). The success 

of the United States in efficiently producing consumption and investment 

goods has relied on the optimal management of the logistics of 

manufacturing (i.e., forecasting demand, scheduling production, and 

ordering and receiving raw materials). To that end, businesses have at 

various times 

• vertically integrated to control as many materials and interfaces 

as possible, 

• maintained large inventory buffers to protect their operations from 

risk, and 

• installed sophisticated planning systems to speed key information 

to decision-makers. 
Executive Summary 

ES-5 

 4.1 The Automotive Supply Chain 

The U.S. automotive supply chain is not easy to characterize. It consists 

of thousands of establishments ranging in size from 50 to many 

thousands of employees. In addition, many of the lower-tier suppliers 

also supply the aerospace and other transportation industries. The 

sheer size of the industry is overwhelming. Manufacturing employment 

in the motor vehicle and motor vehicle parts industry was 949,984, or 

about 6.5 percent of all manufacturing employment, in 2001. Shipments 

of motor vehicles and motor vehicle equipment amounted to almost 

$403 billion in 2001, or approximately 10 percent of the value of all 

manufactured goods (Census Bureau, 2003). 

Further complicating an analysis of the automotive supply chain is the 

complexity of the relationships between customers and suppliers. OEMs 

design and produce only some of the 15,000 parts and accessories that 

make up an automobile; they procure others from first-tier suppliers. The 

first-tier suppliers can in turn outsource to subtier suppliers. A 

company’s position in the supply chain may differ depending on the part 

and the customer. Thus, a company that is a first-tier supplier of 

transmissions to one OEM may be a subtier supplier of other parts to the 

same or other OEMs. 

At the production stage of the product life cycle, most of the information 

exchanged between an OEM and its vendors concerns ordering and 

schedule requests, acknowledgements of messages received, ship 

notices, and order tracking. To assure on-time delivery, there is also 

information exchange with logistics functions (i.e., warehousing and 

shipping). Communication with logistics often means communication 

between the OEM and the supplier, but it could also mean 

communication with a third party to whom logistics has been outsourced. 

 4.2 The Electronics Industry 

The electronics industry is an aggregation of several widely disparate 

product segments, from radar equipment to biomedical devices. A 

combination of factors, including mass customization, rapidly shrinking 

product life cycles, lean inventory practices, complex multisource supply 

chains, and rising global competition, have created a highly competitive 

industry. Electronics products are brought together by commonality in 

components, manufacturing technologies, or consumption patterns. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

ES-6 

With almost $430 billion in sales in 2001, or approximately 10 percent of 

the value of all manufactured goods, and 1.6 million employees, 

electronics is the third-largest manufacturing industry, behind chemicals 

and transportation equipment (U.S. Census Bureau, 2003). Of total 

electronics sales, semiconductors and electronic components made up 

the majority of sales followed by computers and peripherals and 

telecommunications equipment. 

 5 METHODOLOGY FOR MEASURING COSTS 

In this study, we modeled our analytical approach on ones used 

successfully by RTI in several previous economic studies for NIST, 

including an Interoperability Cost Analysis of the U.S. Automotive Supply 

Chain, an Economic Impact Assessment of the International Standard for 

the Exchange of Product Model Data (STEP), and The Economic Impact 

of Inadequate Infrastructure for Software Testing (Brunnermeier and 

Martin, 1999; Gallaher and O’Connor, 2002; and RTI, 2002, 

respectively). We began by developing a task/cost matrix for the 

industry sectors being studied. This matrix identified the most important 

information flows for which excessive costs were likely being incurred. 

Representative case studies or in-depth interviews were then used to 

estimate excessive costs for each cell of the task/cost matrix. A largescale survey was conducted to provide data that will allow us to estimate 

the incidence of these costs across the heterogeneous population of the 

entire industry. Finally, secondary data on industry sales and 

employment and wage rates allowed aggregation to industry-level 

impacts. 

Primary data collection was necessary to inform the impact metrics 

developed during the conceptual phase of the study. As it would be 

difficult or impossible to design a single instrument to collect information 

from a cross-section of the industry’s firms, much of the data needed 

was obtained from a small number of in-depth interviews. These 

structured conversations were similar to the case studies done in many 

qualitative analyses, although in this case the intent was to gather 

components of excessive costs borne by firms due to a lack of adequate 

information infrastructure. By summing these components of cost, we 

developed an estimate of the cost of inadequate standards for SCI. 

 
Executive Summary 

ES-7 

 6 RESULTS AND COST CALCULATIONS 

The initial thrust our data collection for this study was the series of nine 

in-depth interviews we conducted during the summer and fall of 2003. 

Several of these firms have traditional relationships with their suppliers, 

indicating that they communicate primarily over the telephone and by 

faxing machine-generated documents. These firms required the highest 

levels of effort to accomplish their supply chain information tasks. 

Firms with incomplete integration most often used EDI for their customer 

communications, and several reported using EDI with their larger, more 

sophisticated suppliers. In addition, the first-tier firms in this category 

were obligated to support one or more proprietary logistics systems by 

their customers. As a result, their costs were a combination of planning 

and coordination effort and information systems charges, including 

license fees, in-house software development, contract software costs, 

and charges for EDI translators. 

Finally, we estimated these types of costs for firms we would 

characterize as having an ideally integrated supply chain information 

system. Despite their high degree of automation, they still experienced 

some costs of inefficient integration, mostly in dealing with suppliers with 

a low degree of e-capability and customers that required use of 

proprietary systems. 

 6.2 Large-Scale Survey Results 

With the results of the in-depth interviews in hand, we proceeded with 

large-scale surveys of the two industry sectors. The automotive portion 

of the survey was fielded with an AIAG working group through an email 

list-serve announcement and was completed by logistics or information 

systems professionals actively working on supply chain integration 

issues. The survey posed questions about the degree of integration and 

labor effort required in each of the major supply chain processes, the 

number of software systems supported and their annual costs, and effort 

expended in several avoidance and mitigation areas. Results from the 

survey used in quantifying the cost of inadequate integration are 

summarized in Table ES-1. 

In electronics, we were fortunate to be granted access to results from a 

RosettaNet survey conducted in the fall of 2003 by San Jose State 

University. Although we did not have influence on the questions posed 

in the survey, they were quite similar to the core questions in our survey 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

ES-8 

and yielded a reasonable profile of the degree of integration of 

electronics firms in the process areas we had identified in the in-depth 

interviews. The results from this survey used in quantifying costs are 

summarized in Table ES-2. 

Table ES-1. Relative Use of Different Communication Methods by 

Representative Automotive Firms 

With Suppliers 

(%) 

With Customers 

(%) 

XML/Internet 22.6 22.5 

EDI 45.2 45.1 

Paper/Fax 32.2 32.4 

Table ES-2. Relative Use of Logistics and Accounting Process 

Integration by Electronics Firms 

Traditional

(%) 

Incompletely 

Integrated 

(%) 

Ideally 

Integrated 

(%) 

Customer Logistics 46 32 22 

Customer Accounting 43 34 23 

Supplier Logistics 51 14 35 

Supplier Accounting 52 20 28 

Note: Logistics refers to communications about and coordination of production 

schedules, inventory levels, shipment information, etc. 

 6.3 Aggregating Costs to Industry Level 

With complete information on estimated effort levels, degree of 

integration by process, and industry data on sales and wage rates, it was 

possible to estimate the total annual costs to U.S. firms of inadequacies 

in their supply chain infrastructures. Using the methodology described 

above, we estimated total costs for the automotive industry slightly in 

excess of $5 billion per year, which equates to about 1.25 percent of total 

value of shipments. In electronics, the figures equate to almost $3.9 

billion per year, or an almost identical 1.22 percent of the value of 

shipments. In both industries, roughly 50 percent of the total costs were 

in dealings with suppliers, while nearly 40 percent arose from 

interactions with customers, figures which were roughly constant along 

the supply chain. 
Executive Summary 

ES-9 

In order to put these figures into perspective, it may be helpful to 

consider the costs of operating under each of the integration scenarios to 

a typical firm in the automotive and electronics industries. Using data 

from the most recent Economic Census reports, we calculate that the 

value of shipments for the average automotive parts establishment was 

$30 million in 1997. Had such a facility operated with traditional supply 

chain systems, its managers could expect to incur almost $500,000 in 

annual costs for the logistics and accounting functions described above. 

Investing in incomplete integration would lower that figure to about 

$400,000 per year, while implementing an ideal integration strategy 

would result in a total of $150,000 in annual costs. 

In the electronics industry, the average value of shipments for a 

semiconductor facility is $71 million per year, while a typical computer 

maker produces about $55 million in annual shipment value. Using the 

summary data from Table 7-7, we can estimate that a semiconductor 

facility operating traditionally would incur annual expenses of $1.15 

million, while a computer maker would see logistics and accounting costs 

of about $900,000. Once again, incomplete supply chain integration 

would lower costs only slightly. Implementation of an ideal system, 

however, would reduce these expenses substantially – to slightly more 

than $350,000 for a semiconductor establishment, and to $280,000 for 

the slightly smaller computer facility. 

 7 IMPLICATIONS OF THE STUDY 

In this study, we have described how the emergence of low cost 

communications and information processing has made it possible for 

manufacturing firms to fundamentally change the way they manage their 

supply chains. Our quantitative analysis suggests that the total cost of 

managing supplier-customer inventory and schedule information 

exceeds $5 billion per year in the automotive industry, and almost $4 

billion in the electronics sector. Almost all of this cost could be 

eliminated if firms implemented true interoperability, which we have 

termed 'ideal supply chain integration'. 

A handful of firms in both automotive and electronics industries have 

come close to achieving this ideal state with some or most of their supply 

chain partners. Industry-wide adoption of interoperability will require 

significant investments in standards and other critical infrastructures that 

are not in place today. The evidence from our study strongly suggests 

that businesses in these two key sectors have not made sufficient 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

ES-10 

infrastructure investments to capture the benefits from interoperability. 

The public goods nature of these infrastructures, along with possible 

coordination failures, suggests that government involvement is needed to 

support the optimal level of investment. 

NIST's expressed purpose in commissioning this study was to determine 

if there was evidence of market failures in the creation of the critical 

infrastructures required to create effective integration. A secondary 

objective was to gather data that would enlighten potential roles taken by 

NIST's Manufacturing Engineering Laboratory (MEL) and Electronics and 

Electrical Engineering Laboratory (EEEL) in industry-wide consortia 

working on improving supply chain information systems. In the judgment 

of the present authors, the study's results provide support for both of 

these aims. 
1-1 

 

 Introduction and 1 Scope of Study 

The emergence of low-cost communications and information processing 

has made it possible for firms to revolutionize the way they operate 

internally, especially in distributing information throughout their 

organization on new and existing products, production and shipping 

schedules, engineering and technical requirements, and costs of 

manufacturing and distribution. Through the use of Manufacturing and 

Enterprise Requirements Planning (MRP and ERP) systems, they can 

operate with lower levels of inventory, can respond more quickly to 

changes in customer requirements, and can eliminate or outsource 

costly accounting functions. 

However, companies have made much less progress in improving the 

efficiency of routine and exceptional communications between their 

facilities and those of their suppliers and customers, along what is known 

as their supply chain. A lack of universally accepted and implemented 

standards for the format and syntax of messages that flow between 

supply chain partners reduces the potential for inventory and expense 

savings, as well as leading to duplication of effort, maintenance of 

redundant systems, and investment in non-ideal information processes. 

In this study, we examine the current state of supply chain integration

and identify opportunities for governmental organizations, such as the 

National Institute of Standards and Technology (NIST), to provide 

infrastructures that will improve the efficiency of supply chain 

communications. First, we will describe conceptual issues related to 

communications within and across supply chains, detail the types of 

market failures that may lead to suboptimal levels of private investment 

in information technologies, and explore the changing nature of global 

supply chain operations. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

1-2 

Next, we present detailed information about supply chain integration in 

two key manufacturing sectors in the United States: the automotive and 

electronics industries. We use a methodology that we have developed in 

previous studies to estimate the cost to the nation’s economy of the 

current inefficiencies in supply chain structures in these industries. 

Finally, we describe the results of a major data collection effort that 

attempts to inform the metrics identified in the methodology. The report 

concludes with some implications of our results for firms in the two 

targeted industries and for the future actions of NIST, both for the 

continued support of U.S. supply chains and for helping domestic firms 

deal with emerging global organizational structures. 

 1.1 SCOPE OF THE STUDY 

In this study, RTI International has estimated the costs associated with 

an inadequate standards infrastructure for supply-chain integration (SCI) 

in the automotive and electronics sectors, including the portion of those 

expenditures due to incomplete or inefficient integration. Although our 

study restricts the focus of these costs to two industry sectors, the 

implications could be extended much further. The magnitude of these 

socially wasteful expenditures across all industries represents the size of 

government's opportunity to contribute to the nation’s economic growth 

by helping U.S. industry create and use improved standards 

infrastructures. 

Our work has included performing extensive literature reviews, 

conducting in-depth interviews with industry stakeholders, and surveying 

several groups to help determine the average costs incurred as a result 

of inefficient and incomplete supply chains. The final results are a 

combination of qualitative examples and quantitative impact data 

because both types of data are necessary to inform those making policy 

decisions related to government involvement in supply change 

integration. 

 1.2 DEFINITION OF A SUPPLY CHAIN 

According to Ganeshan and Harrison (1995), a supply chain is “a 

network of facilities and distribution options that performs the functions of 

procurement of materials, transformation of these materials into 

intermediate and finished products, and the distribution of these finished 

products to customers.” Many supply chains have been significantly 

altered over the past decade, but this core definition remains unchanged. 
Section 1 — Definition and Scope of Study 

1-3 

Made up of a group of firms linked together in a series of customersupplier relationships, every supply chain eventually results in the 

delivery of finished products and/or services. Over time, firms have 

increasingly looked to improve the efficiency of their supply chains by 

reevaluating two key types of transactions: 

• Physical flows of material connect members of a supply chain, 

moving “forward” from suppliers to customers in each link of the 

chain. 

• Data flows move “backward” from customers to suppliers, as 

orders are placed and payments are made for materials, services, 

parts, and supplies. 

To facilitate these goods/services and financial transactions, information 

flows throughout the supply chain, with the highest volume and 

frequency of data moving between adjacent links in the chain. Firms 

continue to look for ways to improve each piece of this web of 

relationships. 

 1.3 CONCEPTUAL DISCUSSION OF SUPPLYCHAIN INFORMATION FLOWS 

In this section, we describe an ideally integrated supply chain and 

compare it to less efficient types of integration. Firms engaged in a 

supply-chain relationship, as customers, suppliers, or providers of 

services, need to share a great deal of information in the course of their 

interactions. These diverse data include descriptive information such as 

quantities, prices, dates, technical specifications, and quality attributes, 

and significant contractual and legal transactions, such as purchase 

orders, shipment authorizations, receipt acknowledgment, and payment 

processing. To understand the types of information flows, it is most 

convenient to break them down into functional categories. Many 

different types of information must be exchanged for the supply chain to 

function efficiently, including 

• product descriptions, specifications, and prices; 

• purchase order information such as quantities, required shipment 

dates, and addresses; 

• planned and actual production, shipment, and delivery 

dates/times and status against such schedules; 

• technical and engineering data on products, components, and 

equipment; 

• accounting information such as prices, discounts, allowances, 

and account numbers; and 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

1-4 

• product quality data, such as test results, performance 

measurements, and warranties. 

Over the years, companies have managed these information flows in a 

number of ways, including telephone calls, letters, telex, faxes, and 

electronics data interchange, known as EDI.3 Often firms will have 

several systems in place simultaneously, perhaps more sophisticated 

ones for normal, high-volume exchanges and manual systems for 

communicating schedule changes, quality problems, needs for 

expediting deliveries, canceled orders, or other emergencies. 

Redundancy is often built in to stop a system failure from leading to a 

business disaster, such as a plant shutdown or shipment of poor-quality 

product. 

Most large first- and second-tier suppliers and original equipment 

manufacturers (OEMs), along with a smaller fraction of firms in the lower 

tiers, have installed EDI between each customer-supplier pair for 

handling high-volume, routine communications such as transactions 

processing, accounting entries, and billing activities. EDI is also at the 

heart of most automated inventory control systems, including continuous 

replenishment (CRP) and vendor-managed inventory (VMI). With 

effective EDI, human intervention is not required to initiate or operate the 

periodic communication of information, leading to a low marginal cost of 

data transmission. Significant fixed-cost investment in high-cost 

expertise is typically needed to develop and install the systems, to 

upgrade or troubleshoot each script, and often to translate the EDI data 

streams into alternate formats required by other information systems 

within each firm. 

Finally, firms are increasingly using the power of the Internet to create 

XML-based transmission protocols for machine-to-machine 

communication of the same high-frequency data now handled by EDI. 

These flexible XML implementations have the potential for lower up-front 

engineering costs more than can EDI and require lower levels of support 

in use. They also can be modified much more easily for use with other 

customers or suppliers by the target firm. Most importantly, the nature of 

Web-based architecture and protocols offers the potential for better 

scalability—the degree of effort and cost required to expand coverage to 

an entire supply chain. Here, scalability is proportional to the number of 

firms involved, rather than to the much higher number of customer–

supplier pairs, as is the case with EDI. 

 

3 EDI is described in greater detail in the next section. 
Section 1 — Definition and Scope of Study 

1-5 

 1.3.1 Electronic Data Interchange (EDI) 

If machines are going to communicate, they need a common vocabulary 

that can be universally understood, and messages must be structured in 

a standardized way so that they can be properly interpreted and acted 

on. In the case of EDI, most companies in the United States have 

adopted ANSI X12 as a common language, whereas, in Europe, Edifact 

is the accepted standard. With one of these systems, computers at each 

end of a message can be programmed to understand the letters (bits) of 

the data stream. Furthermore, computers need to know how the 

message will be formatted (i.e., the exact order of elements, how bits of 

information will be separated, and what real piece of information each 

letter or word represents). For example, if the message is a purchase 

order, the pieces must be properly arranged and coded to ensure that a 

part number is not misinterpreted as a quantity or a delivery date as a 

shipment address. 

Because of the requirements for exactness in each EDI transmission, the 

diversity of business relationships and communications needs has led to 

a large number of similar but distinct EDI protocols and formats in the 

industry sectors we are studying. Each newly established link between a 

customer–supplier pair is a custom installation; the particular business 

and technical needs at the time mean that each link may be slightly 

different, using nonstandard syntax, unique variables, or reordered 

transmission. So invoicing and billing systems, vendor-managed 

inventories, and production schedules shared between an OEM and an 

important Tier 1 supplier may all use different EDI formats. 

The complexity of the automobile and electronics sectors’ supply chains 

increases this confusion. Firms with an extended network of customers 

and suppliers may be forced to support a large number of mutually 

incompatible EDI implementations. The resources needed for support 

and the risk of errors from mix-ups increase with the complexity and 

diversity of EDI protocols installed. 

As an example, if an OEM like Ford inadvertently sent a high-priority 

purchase order to Johnson Controls (JCI) in the EDI format used for 

communications with Visteon,4 JCI's information systems might not be 

able to correctly interpret the order. A great deal of additional effort 

would be required by both parties to make sure the proper products were 

 

4JCI and Visteon are tier-one automotive suppliers. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

1-6 

made and delivered on the timing required. In the absence of this 

additional manual effort, it is likely that Ford's needs would not be met. 

 1.3.2 Extensible Markup Language (XML) 

A standardized XML implementation offers the opportunity to address 

many of these issues. One extremely flexible feature of XML is that it is 

self-referencing: the label attached to the bit of data describes the type 

of information contained within. For instance, in an EDI purchase order, 

the receiving computer may be programmed to interpret the third bit 

string in the message to be a part number and the fourth an order 

quantity for that part. If these strings are sent out of order, or if an 

extraneous word is added, the recipient will not be able to interpret it 

correctly. An XML-based purchase order could have a piece of data 

labeled “1stpart#” and a second one labeled “1stpartqty.” The instruction 

that contained the label and associated numerical data could be located 

anywhere within the XML data stream, and the computer would interpret 

the instruction correctly. As a result, XML messages can be easily 

expanded or modified to meet specific needs. 

Although the emergence of XML offers opportunities for flexible, 

adaptable implementations, it does not reduce or eliminate the need for 

standardization. Vocabularies must be established and adopted, labels 

need to be assigned agreed-upon meanings, and change-control 

procedures must be established. As we describe in the next several 

sections, the most likely outcome of pure private-sector SCI is the 

creation of a number of competing, incompatible systems, each one 

adopted incompletely within industry sectors. NIST and RTI have 

identified the excess costs of this type of outcome in the communication 

of engineering design information in the automotive and other industries, 

in both a prospective study (Brunnermeier and Martin, 1999) and a 

recently completed analysis of the STEP initiative (Gallaher and 

O’Connor, 2002). 

 1.4 A DESCRIPTION OF IDEAL AND SUBOPTIMAL 

SUPPLY-CHAIN INTEGRATION (SCI) 

A perfectly efficient supply chain information structure does not exist in 

most industries today, and it is extremely unlikely that a fully optimized 

system could be implemented in any industry in the future. Nonetheless, 

it is useful to describe such a system to estimate the excess costs 

experienced in current operations, if for no other reasons than to quantify 
Section 1 — Definition and Scope of Study 

1-7 

the size of the opportunity and allow more informed decisions about 

public and private investment in this area. In the following sections, we 

describe conceptually what forms ideal integration should take and then 

discuss how the current state of affairs is both inefficient and incomplete. 

 1.4.1 Perfectly Efficient Supply-Chain Integration 

Supply chain information systems require a great deal of data input, both 

from automated sources (numerically controlled machines, scanned bar 

codes, sensors, analytical instruments) and manual interactions. In an 

ideal system, each piece of data would be entered only once and 

subsequently made available to any system in the information network 

that needs it. High-frequency, routine data input tasks should be made 

fully automated, with oversight on a periodic basis by skilled systems 

optimizers, such as planning or logistics personnel. In a similar manner, 

high-frequency information flows should be fully automated and 

transmitted in standard formats with common protocols. 

Ideally, each firm would expend resources primarily on its own data, as 

well as on contributing to the maintenance and improvement of the 

standardized backbone. Information from supply-chain partners should 

“arrive” as needed (or be made available for query), without additional 

cost to the receiving firm. A set of agreements should exist to identify 

and empower the system optimizer, often the OEM, who would initiate 

the major changes to which other members must adjust.5 These 

unusual events include the launch of new products or services, product 

termination decisions, production acceleration or slow-down, and 

sourcing changes. 

In today’s competitive environment, many medium and large firms set 

internal goals to approach this ideal state; integrated enterprise resource 

planning (ERP) and internal networks can come close to this state within 

the boundaries of a multidivisional firm. Extended to the entire supply 

chain, however, this level of sophistication rarely occurs. A proper goal 

of supply chain integration, then, would be to extend these concepts to 

inter-firm interactions across the entire chain of industries. A piece of 

information is entered at the source and is instantly available to all 

members of the supply chain who need it, information flows to points of 

use without manual intervention, and standard protocols obviate the 

need for translation. 

 

5 It is not necessarily the case that the OEM acts as the system optimizer. As we 

described later in this report, firms at a number of different places within a supply chain 

can play the key optimizing role. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

1-8 

 1.4.2 Inefficient and Incomplete Integration 

Much evidence is available that this ideal information system integration 

is not occurring within industry supply chains: 

• Manual data entry is widespread, even when machine sources 

are available; critical information is often manually reentered at 

many points in the chain. 

• Purchasing clerks, order processors, and expediters are 

widespread within the automotive and electronics sectors, and 

their manual interventions are critical links in supply-chain 

information flows. 

• The use of translators to convert data from one format to another 

is almost universal, even between systems that are nominally 

ANSI X12 or Edifact compliant. 

• Organizations of all sizes and across industry tiers use “informed” 

estimates rather than actual or production plan data in 

scheduling, materials management, and expediting. 

• A lack of system integrity creates a continuing need for verbal or 

written authorizations to protect against costly errors or even 

catastrophic failures. 

• Large numbers of firms, especially in the lower tiers, simply 

operate without needed data. 

As an example, the business need for better integration has been 

evident in the automotive industry for several years and for more than a 

decade in the electronics sector. As a result, a number of companies in 

these industries have made efforts to provide partial or total solutions, 

almost all resulting in either inefficient or incomplete integration. Under 

inefficient integration, systems are put in place to automate information 

inputs and flows, but a lack of a suitable standards infrastructure leads to 

excessive capital investment, duplication of effort, higher than optimal 

staffing and support levels, and a lack of organizational flexibility. In the 

case of incomplete integration, key elements of a comprehensive system 

are missing, or improved systems are only implemented for a subset of 

supply-chain partners. In the latter case, the supply chain as a whole still 

experiences costs well above optimal levels, and many of the gains from 

integration remain unrealized. 

 1.4.3 Example—Invoice Payment Authorization 

A simple example involving authorization and payment of a supplier 

invoice will help illustrate the contrast between optimal, inefficient, and 

incomplete integration. After a product has been shipped to a customer 

from one of its suppliers, the supplier will submit an invoice for payment, 

which must be approved and subsequently paid. This transaction is one 
Section 1 — Definition and Scope of Study 

1-9 

of the last steps in the order management process and feeds directly to 

both firms’ accounting systems. As such, the information flows here 

involve both informational and contractual issues between the firms. 

In an optimal information system, record of a shipment by the supplier 

(perhaps generated by optical scanning of a bar code in a warehouse 

vehicle loading system) would trigger a request for an automatic 

payment of the amount described in the purchase order requisition. The 

requisition may have been generated automatically through a CRP or 

vendor-managed inventory process. Receipt of the shipped items, 

perhaps also recorded via an optical scanner, would generate invoice 

approval, and subsequently the seller’s account would be credited and 

buyer’s account debited. Aside from the supervision of the loading and 

unloading process and the physical transportation of the products 

themselves, no manual intervention is required for the steps outlined 

above. 

Inefficient integration would require additional effort and use costly 

resources. Suppose that the supplier and customer use EDI systems for 

such transactions, but their formats differ slightly. In this case, recording 

the shipment triggers the generation of an invoice, which is immediately 

translated from the seller’s format to the buyer’s format, using a piece of 

customized software. The EDI system then transmits the invoice, which 

is subsequently processed in the customer’s payments system and 

approved when the receipt is recorded. The customer’s accounts are 

then updated, and a record of the automated payment is transmitted 

back to the seller. Finally, the record of payment is translated back into 

the seller’s format, and the supplier’s accounts are updated. 

With incomplete integration, lower tiers in the supply chain may be using 

almost completely manual systems for this process. To handle this 

same event, a shipment notification (with information transcribed from a 

bill of lading, perhaps) is faxed to the supplier’s own invoice processing 

department, where an invoice is prepared and authorized manually. This 

invoice is then mailed or faxed to the customer’s purchasing agent, who 

confirms delivery through its internal information system. The invoice is 

approved for payment, at which point an accounts-payable clerk updates 

the customer’s accounting system and wires (or even mails) payment to 

the seller’s accounts-receivable department. The accounts-receivable 

clerk, in turn, verifies payment and updates the supplier’s accounting 

system. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

1-10 

 1.5 ROLE OF STANDARDS AND NEED FOR 

EFFECTIVE STANDARDS INFRASTRUCTURE 

The discussion and example in the previous section clearly suggest that 

various standards are needed to support ideal implementation of SCI in 

the automotive and electronics sectors. At the lowest levels of 

communication, semantic and syntactic standards are needed so that 

data elements can be understood without the need for translation or 

interpretation. The content and format of high-frequency transactions 

also must be standardized so that modifications by one supply-chain 

partner do not require manual intervention at the other end. The wide 

variety of information flows and the diversity of customer–supplier 

interactions make the standards infrastructure very complex, resulting in 

a large absolute number of standards. For example, the RosettaNet 

consortium has identified more than 100 separate business processes 

for which standard protocols, called Partner Interface Processes (PIPs), 

are necessary within the electronics sector. 

 1.5.1 Conceptual Description of SCI and Standards 

Development Process 

Although the detailed process for integrating supply-chain information 

systems is likely to depend on particular technologies and business 

conditions within each industry sector, the overall flow of events should 

have many similarities. Figure 1-1 shows a conceptual diagram that 

attempts to illustrate the development process. Although this figure 

depicts the improvements being led by a single firm, other approaches 

are also feasible, as the next section discusses. 

Initially, firms that will participate in the process must establish a 

business need for the systems change and determine whether sufficient 

support is available within the supply chain. At the same time, an 

assessment of the current state of the standards infrastructure will 

typically lead to efforts to produce needed standards and protocols for 

the information system improvement. The quality of effort at this point 

will have a major impact on whether the new standards will be effective 

and efficient. After a decision to proceed, the firms involved will identify 

the business processes for replacement and initiate development work. 

 
Section 1 — Definition and Scope of Study 

1-11 

Figure 1-1. SCI and Standards Development Process 

Lead Firm Supplier 1 Supplier 2 Customer 1

Lead Firm

Establish business need for

change to supply chain

information system

"Poll" customers and suppliers

to determine level of support

Are

standards

adequate?

Evaluate current standards and

protocols

Critical

mass to

proceed?

Work with selected customers

and suppliers to choose

business processes for

replacement

Establish or join standards

making consortium

Produce standards adequate to

support business needs

Yes

No

Develop software

for chosen

processes

Start up and test

new software

Develop software

for chosen

processes

Start up and test

new software

Develop software

for chosen

processes

Start up and test

new software

Develop software

for chosen

processes

Start up and test

new software

Success

criteria

achieved?

Operate new information system

in parallel with old

Shut down old

system

Optimized new software and

systems

Yes

No

Yes

No
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

1-12 

Next, the lead firm, along with key suppliers and customers, will develop 

software and operational procedures for the improved process, typically 

with the help of third-party vendors or consultants. When development is 

complete, each firm will start up and test the new software and make a 

decision to proceed with the conversion. After running old and new 

systems in parallel, if the project’s success criteria have been achieved, 

the new system will be accepted and old systems will be shut down. If a 

subset of the supply chain has been involved in developing the new 

information process, the final step is to roll it out to remaining members 

of the supply chain. 

It is important to note that the involvement of a lead firm and key 

business partners is not sufficient to create efficient integration. 

Companies not participating in the initial process may choose to adopt 

different standards or protocols or to implement totally incompatible 

improvements. Firms may be unable or unwilling to convert to the new 

process or may lack critical skills in adopting the new technology. A 

mismatch between the incidence of costs and financial benefits may 

distort the incentives of supply-chain participants. These issues are 

covered as a part of the market failure discussion in Section 1.6. 

 1.5.2 Industry Approaches to Standards Development 

Firms within an industry can put needed standards infrastructures in 

place to support integration efforts in several ways, and each approach 

has implications for the efficiency and completeness of the resulting 

systems. If the industry is dominated by a single firm (usually an OEM) 

or if a statutory monopoly exists, that firm can create standards and 

impose them on the rest of the industry. AT&T took this role in 

telecommunications during the era of regulation and developed and 

implemented most of the standards used within that sector. In the case 

of personal computer operating systems, Microsoft’s dominance has 

allowed it to set standards that hardware and software firms alike are 

obligated to support. The U.S. Department of Defense has forced all 

military contractors to use its procurement specifications and procedures 

since shortly after its creation in the 1940s. 

In an alternative scenario in imperfectly competitive markets, each large 

OEM can develop its own standards and insist that its suppliers comply 

to enjoy continued business. This has long been the practice in the 

automotive sector, in which General Motors, Ford, and DaimlerChrysler 

have routinely imposed their unique standards on direct suppliers. Many 
Section 1 — Definition and Scope of Study 

1-13 

of the Tier 1 firms in turn require the lower tiers to comply as well. 

Because many of these Tier 1 firms supply products to all three OEMs, 

as well as to many Japanese-owned domestic facilities, there are 

inevitably excessive costs under this regime from duplication of effort 

and lack of interoperability. 

Potentially, many or all of the firms in an industry can work together to 

create a mutually beneficial infrastructure for integration, either by 

forming a consortium through an industry trade or technical association, 

or with the help of one or more standards development organizations. 

Antitrust concerns have receded sufficiently over the past 20 years so 

that firms in an industry can meet to develop standards without risk of 

adverse governmental attention. Still, it is difficult to manage power and 

influence issues within consortia and other voluntary organizations, and 

success in creating efficient standards is not assured. In addition, 

incomplete representation of entire industry supply chains within these 

groups means that important suppliers and customers may be left out of 

the process. 

 1.6 MARKET FAILURES IN THE PROVISION OF 

STANDARDS INFRASTRUCTURES 

From the standpoint of public economics theory, all of these approaches 

are likely to lead to inadequate standards infrastructures for at least two 

reasons. The first arises from the public goods nature of these 

standards, which inevitably leads to a free-rider problem and resultant 

under-provision of the good. The second reason is one of coordination 

failure, in which asymmetric incentives lead participants to pursue 

investments that are suboptimal for the industry as a whole. Each of 

these market failures is discussed briefly below. 

 1.6.1 Underinvestment Due to Public Goods Externality 

According to standard microeconomic principles, goods and services can 

be classified as rival if one buyer’s consumption reduces the amount 

available for purchase by others. Goods and services are considered 

excludable if the owner(s) can prevent consumption by others. Public 

goods are defined as those that are neither rival nor excludable, and 

economic theory tells us that the market, left to its own devices, will not 

provide the optimal level without outside intervention. This is because 

each participant can obtain much of the benefit from the public good 

based on the prior investment of others (i.e., to act as a free rider). 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

1-14 

Because many or all market participants have similar incentives, an 

insufficient level of investment will result. 

Scientific and technical knowledge, along with other forms of human 

capital, have long been considered at least quasi-public goods. 

Knowledge is clearly not rival, in that its use does not diminish the 

amount of it available to others. In fact, learning by doing and network 

externalities make the opposite more likely. With the exception of trade 

secrets and the limited exclusivity granted by patents and copyrights, 

knowledge is also largely non-excludable. Tassey (1997) has 

demonstrated that investments in standards, along with other generic 

technologies and infratechnologies, have this quasi-public goods nature 

and are therefore underprovided by private markets. 

 1.6.2 Coordination Failures in Development of Standards 

Coordination failures arise from asymmetries in incentives between 

market participants, either among competitors or among levels in a 

supply chain. In the competitive case, firms acting in their self-interest 

may invest in standards or other forms of human capital that are not 

optimal for the industry as a whole. This is especially critical in 

imperfectly competitive markets, where strategic interaction is important. 

As an example, the separate and incompatible systems created by the 

automotive OEMs for the exchange of technical data (e.g., computeraided design [CAD], computer-aided manufacturing [CAM], computeraided engineering [CAE]) are a direct result of the focus on private 

optimum among the oligopolistic Big Three. 

A second type of failure may occur between customers and suppliers 

along the supply chain, especially if the size and technical capabilities of 

the partners are quite different. Small firms in the lower tiers may have 

an interest in improving their information infrastructure but may lack the 

financial resources or technical capability to make it happen. Their 

incentives to invest are further reduced if they believe that any cost 

advantages they obtain from increased efficiency will be quickly 

competed away through lower prices. The larger upper-tier firms might 

more easily take on the burden of developing improved information 

systems. If, however, most of the initial benefits will accrue to their 

suppliers, these Tier 1 and OEM corporations may conclude that their 

investment might not pay out over their required time horizon. 
Section 1 — Definition and Scope of Study 

1-15 

 1.6.3 Government's Role in Correcting for Market Failures 

in Standards Provision 

If private markets are unlikely to provide the optimal level of these critical 

standards infrastructures, then there is the potential for government to 

intervene in economically beneficial ways. This involvement could take 

the form of increasing the overall level of investment in standards 

development, providing financial and logistical support for standards 

organizations or consortia, and helping industry participants coordinate 

their activities in producing flexible, interoperable systems. In the case of 

the present study, NIST requested that we estimate the magnitude of the 

potential market failures in automotive and electronics supply chain 

integration, and identify potential roles NIST could play in alleviating 

these failures. 

In our judgment, the NIST Laboratories are ideally suited to help correct 

both the public goods and coordination failures outlined above. The 

provision of government funding for the highly complex and timeconsuming tasks involved in creating the new information systems 

software and processes raises the overall level of investment, alleviating 

the potential public goods failure. The expertise of NIST personnel 

ensures that the critical human capital applied to standardization efforts 

is effective in supporting and/or leading the private-sector efforts. NIST’s 

efforts can lower overall costs of development and adoption because of 

the expertise of its personnel. 

Secondly, NIST’s role as a party independent of the supply chain and its 

competitive constraints allows it to serve several vital coordination roles 

as well. Its status as an uninvolved third party permits its technical 

experts to seek solutions that are optimal for the entire sector, rather 

than those that would favor one or more powerful OEMs. The 

collaborative process used by NIST ensures that all parties have the 

opportunity to be represented and involved, unlike the situation of a trade 

association or voluntary standards group. Finally, if NIST takes a 

leadership role in the development process, it can coordinate mutually 

beneficial outcomes both vertically and horizontally, without concerns of 

collusion or anticompetitive practices. 

2-1 

 Overview of 

 Manufacturing 2 Supply Chains 

The U.S. manufacturing sector is the largest in the world; its 15.9 million 

workers produced $1.85 trillion in value added in 2001, according to the 

most recent government data (U.S. Census Bureau, 2001). The success 

of the United States in efficiently producing consumption and investment 

goods has relied on the optimal management of the logistics of 

manufacturing (i.e., forecasting demand, scheduling production, and 

ordering and receiving raw materials). To that end, businesses have at 

various times 

• vertically integrated to control as many materials and interfaces 

as possible, 

• maintained large inventory buffers to protect their operations from 

risk, and 

• installed sophisticated planning systems to speed key information 

to decision-makers. 

The following section presents an overview of the structure of 

manufacturing supply chains, traces the evolution of organizational 

structures and optimization strategies, and discusses the complex 

interrelationships between organizations and their supply chain activities. 

 2.1 STRUCTURE OF MANUFACTURING SUPPLY 

CHAINS 

To make and deliver products that meet consumers’ needs, 

manufacturing firms must manage relationships with complex supply 

systems that involve movement, transformation, and legal transfer of 

physical materials and information. These systems have been 

envisioned as supply chains, virtual supplier-customer links that connect 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

2-2 

upstream suppliers of basic materials, intermediate products, and 

associated information to the final consumer. In reality, the system will 

likely be more complicated than the chain analogy suggests, with crosslinkages and reverse flows being common occurrences. 

Nonetheless, for description and analysis, it is helpful to present a 

simplified model of the most significant components that illustrates the 

vital physical and information flows. Figure 2-1 presents a simplified 

supply chain schematic for a discrete parts product. (Note that the term 

“discrete parts” indicates that the products are made and sold in 

individual units. By contrast, homogeneous, or “bulk products” such as 

agricultural goods, chemicals, and primary metals, are most often sold in 

pounds or tons.) 

As Figure 2-1 indicates, the physical flows in a supply chain move from 

raw materials to intermediate components and assemblies to finished 

products, with value added at each step of the process. Finished 

products most often enter a distribution system, which may include 

wholesalers, jobbers, retailers, and other services before reaching the 

final consumer. In a supply chain, information flows in several directions, 

with a great deal of it being controlled at the location where the finished 

product is made. In many of the most important manufacturing sectors, 

the organization that controls this last step is known as an original 

equipment manufacturer, or OEM. The term OEM is used whether or not 

the firm in question actually owns and operates the facilities where final 

production or assembly takes place. 

Each link in the supply chain has its own information and logistics needs, 

although some information (e.g., long-range sales and production 

forecasts) is needed by all links for capacity planning and procurement. 

Each supplier in the chain must know its next-in-line customer’s 

materials requirements, including quantities needed, delivery dates, and 

shipping instructions. Each customer needs to factor its suppliers’ 

shipment schedules into its own planning, and must receive shipment 

notification, quality specifications, and invoices as products are 

delivered. 

Most forms of supply chain organization and information transmission 

work adequately if forecasts and schedules seldom change and 

production dynamics are predictable and stable. However, events such 

as production problems, shipment delays, order cancellations, and 

forecast revisions at any step in a supply chain may interrupt physical 
Section 2 — Overview of Manufacturing Supply Chains 

2-3 

Figure 2-1. Supply Chain Process Flows: Discrete Parts Manufacturing 

Primary Materials

Fabrication

Primary Materials

Supply

Components

and Systems

Production/Assembly

Final Product

Production/Assembly

and Testing

Warehousing and

Distribution Final Consumer

Demand Forecasts

Legend

 Physical Flow

 Information Flow

Production

Schedules /

Materials

 Requirements

Production

Schedules /

Materials

Requirements

Production

Schedules /

 Materials

Requirements

Shipment Notification

& Invoices

Shipment Notification

& Invoices

Shipment Notification

& Invoices

Shipment Notification

& Invoices

and information flows. These interruptions pressure suppliers to adjust 

their business plans. For example, a small problem at one of the primary 

materials suppliers may propagate through the chain and shut down final 

assembly for weeks. A reduction in a sales forecast may result in idling 

facilities all the way up the chain. A quality defect may cause costly 

rework at several plants. 

OEMs and various firms in the supply chain have a number of options to 

protect themselves from these types of risks. A vertically integrated firm 

(described in more detail in Section 2.2) may be able to coordinate 

logistics activities over the entire supply chain and rapidly respond to any 

unexpected situations. Stocks of intermediate or finished goods, usually 

called inventory buffers, can protect both suppliers and customers from 

small interruptions or system failures; however, the cost of holding this 

inventory must be set against the benefit of risk reduction. Finally, the 

firms in the supply chain, led by OEMs, can integrate their operations 

through real-time sharing of vital information, thus minimizing the cost of 

changes and errors. This last option requires significant investment in 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

2-4 

information technology, and realizes its major impact through reducing 

the need for large inventory buffers or vertical integration. 

 2.2 EVOLUTION OF ORGANIZATIONAL 

STRUCTURES AND SUPPLY CHAINS 

Firms that emerged in the first few decades of the 20th century, including 

those in the emerging automotive and electrical products industries, were 

very concerned about the performance of their supply chains. One of the 

most common organizational strategies was vertical integration, in which 

the entire supply chain was brought within the firm’s ownership structure. 

Henry Ford built such an integrated company in the 1920s and 1930s, 

owning not only automobile parts production and assembly, but also car 

dealerships, steel mills, iron ore mines, and even rubber plantations 

(Nevins and Hill, 1957). 

The advantages of vertical integration in centralizing decision-making 

and maintaining coordination across the supply chain were sufficient to 

make it an organizing strategy of choice throughout much of the 20th 

century. There were disadvantages as well, however. Firms often found 

themselves running operations in which they had little expertise, such as 

Ford’s rubber plantations. These noncore businesses were likely to have 

inferior technology and thus higher costs than more focused competitors. 

Vertical integration often raised antitrust concerns, especially if the 

industries in which the firm operated were highly concentrated. In 

addition, the divisional structures adopted by most firms after World 

War II tended to defeat the close coordination that vertical integration 

was intended to foster—two divisions of the same corporation might 

have as much difficulty communicating and managing logistics as 

separate firms in a similar supplier-customer relationship. 

During the 1960s and 1970s, corporations invested heavily in information 

technologies to manage intrafirm planning and logistics. Given sufficient 

vision and adequate investment, information systems could be 

developed to control and optimize the entire production chain, from raw 

materials to customers. The development of Materials Requirements 

Planning (MRP) and its successor models, along with dramatic 

decreases in the cost of computing and internal networking capacity, 

helped firms retain the benefits of vertical integration. 

Over the past 20 years, U.S. firms have undergone a radical change in 

their approach to integration. During the last period of corporate 
Section 2 — Overview of Manufacturing Supply Chains 

2-5 

consolidation in the late 1970s and early 1980s, firms integrated both 

horizontally and vertically and combined into multimarket conglomerates. 

The rationale behind these mergers was that larger firms may benefit 

from economies of scope and scale in financing, production, distribution, 

and marketing. 

The trend toward integration began to reverse by the mid-1980s. Faced 

with rapid technological change, increasing global competition, and 

accelerating quality improvement expectations, many large enterprises 

found their agility in the marketplace hampered by the rigidity of their 

corporate structure. To concentrate on leveraging “core competencies,” 

firms began to spin off subsidiary operations. This process began with a 

slow reversal of many conglomerate mergers, and the benefits noted 

above were overwhelmed by issues of communication, coordination, and 

corporate focus. 

The necessity of developing core competencies, along with the arrival of 

low-cost computing and communication via the Internet, catalyzed the 

beginnings of vertical disintegration. With external communication and 

data transfer costs decreasing, much of the rationale for vertical 

integration began to erode. The potential emerged for a chain of firms, 

each focused on its own areas of expertise, to cooperate to provide 

products and services for final consumers. These factors have altered 

the strategic choices available to firms regarding the set of activities they 

choose to perform and the inputs they purchase in the market. The 

result of these and other developments has been to encourage new 

forms of organization that leverage modern information/production 

technologies (see Besanko, Dranove, and Shanley, 1996). A critical 

need for ensuring success in these organizations is the creation of 

interfirm information systems, embodied in ERP software or SCI 

systems. 

These systems look at the entire supply chain as a virtual enterprise that 

may include a global network of suppliers, factories, warehouses, 

distribution centers, retailers, and service centers. The virtual enterprise 

acquires raw materials, transforms them into products, markets and 

delivers products to customers, and services products over their lifetime. 

Supply chain functions must operate in a coordinated manner to optimize 

performance. In a dynamic marketplace and a changing economic 

environment, the supply chain management system must coordinate the 

revision of plans/schedules across supply chain functions. The efficiency 

of the production system is ultimately determined by the agility with 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

2-6 

which the supply chain is managed at the tactical and operational levels 

to enable timely dissemination of information, accurate coordination of 

decisions, and management of actions among people. 

 2.3 INFORMATION TECHNOLOGY’S IMPACT ON 

CURRENT SUPPLY CHAIN INTEGRATION 

This section provides a more in-depth look at the current state of affairs 

in supply chain integration and, in particular, firms’ options for 

coordinating activities across supply chains and minimizing risks.6 The 

three major benefits of supply chain optimization are improved customer 

service, improved internal operating efficiency, and reduced inventory 

costs. The key objectives of supply chain optimization are to manage 

uncertainty and dependency. The tighter and more complex the 

dependencies, the greater the criticality of suffusing supply chains with 

dependable coordinating mechanisms. 

We begin by articulating the trade-off between two ways to manage 

uncertainty—using inventory as a buffer or relying on information to 

predict requirements. We then extend the information/inventory 

perspective to explain coordination between trading partners. Then, we 

present the pros and cons of two approaches to supply chain 

optimization—local optimization in the form of improving the interfaces 

between companies in adjacent tiers and overall optimization of the 

supply chain as a whole. Finally, we argue that improved communication 

is the most promising tactic for improving supply chains, and that 

improved interoperability is the most promising way to improve 

communication. 

 2.3.1 Inventory and Information as Ways to Manage 

Uncertainty with Customers 

One way to look at supply chain management is to see it as a set of 

interorganizational arrangements whose purpose is to manage 

uncertainty. Uncertainty is defined in terms of the probability of an event 

either occurring or not occurring. Each member of a supply chain has a 

core commitment to deliver particular goods to a particular place at a 

particular time, and these fundamental commitments become ever more 

difficult to meet as uncertainty increases in suppliers’ capacity or 

customers’ needs. One way to manage uncertainty is with inventory as a 

 

6 Jenny Morell and Tom Phelps, of Altarum, developed much of the material for this section 

of the report. Portions of their contributions also appear in Morell and Phelps, 2001. 
Section 2 — Overview of Manufacturing Supply Chains 

2-7 

hedge against the vagaries of supply sources and fluctuations in 

demands from customers. 

A second tactic for managing uncertainty is to keep inventory low, while 

maintaining good information on what suppliers can deliver and what 

customers will demand. Both approaches have costs. The critical 

question is what the inventory/information combination should be, given 

specified targets for internal efficiency and customer service. Real-world 

decisions about inventory levels are more complex than portrayed here 

because hedging against uncertainty is only one of several factors used 

to make decisions about inventory. 

Also important is the overall cost structure of production, because it may 

be cheaper to run a plant at full capacity and maintain inventory than to 

keep inventory low. (For instance, in screw machine production, set-up 

costs are high relative to the cost of material and operation.) Also, 

inventory may support a business model, as would be the case if a 

company’s reputation depended on fast response to low-probability 

changes in customer needs. Figure 2-2 illustrates the trade-off between 

information and inventory. 

Figure 2-2. Managing Uncertainty with Inventory and Information 

Amount of Uncertainty

Cost of

Managing

Uncertainty

Low

High

Low High

Information

Inventory
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

2-8 

Assuming that a choice can be made to rely exclusively on either 

information or inventory, two lines can be drawn that show how the cost

of managing uncertainty changes with the degree of uncertainty. The 

actual shapes of curves that define the relationship are highly dependent 

on the specific supply chain context. With respect to inventory, we 

believe that the line is straight through most of its length, with an upward 

swing when uncertainty is very high. 

For the most part, as the goods increase, so does the investment, in 

direct proportion to the size of the inventory. At very high levels of 

uncertainty, we believe that a series of factors may combine to result in a 

nonlinear increase. For example, at some point in time, a new 

warehouse may be needed, with all its attendant building, maintenance, 

and personnel costs. Also, as inventory increases, it becomes 

progressively more likely that larger amounts of goods would spoil or 

age. As these factors come into play, expected costs increase at a 

faster rate. While these dynamics are present in any industry, they are 

more acute in some than in others. For instance, desktop computer 

manufacturing is subject to product life cycles measured in months. In 

this time context, both raw and finished goods can become obsolete very 

quickly. 

Information technology (IT) investment behaves in the opposite way. An 

IT infrastructure must be built early in the supply chain implementation 

process. For example, it may be necessary to establish workable 

systems for accounting, production control, inventory management, and 

forecasting. However, once this investment is made, costs rise at a 

decreasing rate as more functionality is added. 

In the real world, uncertainty is managed through a combination of 

inventory and information. For any given setting, an acceptable solution 

may involve a greater investment in one method and a corresponding 

decrease in the other. In a particular business context, the shape of the 

trade-off is determined by several relevant factors, including 

• the degree of uncertainty for the business, 

• how critical are accurate projections, 

• how tight the time deadlines are on production and delivery, and 

• the cost of material needed for an adequate hedge. 
Section 2 — Overview of Manufacturing Supply Chains 

2-9 

On-Time Delivery Requirements 

So far, we have dealt with supply chain management as a tool for 

improving a company’s internal efficiency. However, supply chain 

management is also a tool for achieving on-time delivery, which is critical 

to maintaining customer satisfaction. Obviously, cost and quality are 

major factors with respect to customer satisfaction, but timing is the 

critical factor in the context of optimizing the functioning of a supply 

chain. After all, on-time delivery is what the customer needs to minimize 

uncertainty and associated costs. On the other hand, on-time delivery 

requires coordination across the supply chain, and this coordination has 

a cost. These costs can be calculated in terms of the labor and 

technology investment needed to assure that a supplier can deliver to a 

customer within an agreed-upon time frame. 

Requirements for coordination may shift supply chain choices away from 

the most cost-effective balance of inventory and information; this 

situation is depicted in Figure 2-3. Just as managing uncertainty can be 

plotted against cost, so too can coordination. Two sets of “Information x 

Inventory” curves are shown. One set (solid lines, using the bottom 

horizontal axis) shows the relationship depicted in Figure 2-2, 

“uncertainty against cost.” The second set (dashed lines, using the top 

horizontal axis) shows the “coordination against cost” relationship. As in 

Figure 2-2, these are hypothetical plots drawn to illustrate general 

relationships. 

The vertical gray lines describe the dilemma faced by a manufacturer. 

Given the uncertainty that the firm faces, a relatively low-cost, inventorybased solution is the most promising option. However, a higher-cost, 

information-based solution is needed to meet customer expectations.7 

Depending on how the manufacturer can manage relations with its 

customers, the company must find a solution somewhere between the 

lower-cost choice sufficient for uncertainty reduction, and the higher-cost 

solution required for customer satisfaction. 

 

7In this context, “customer satisfaction” refers to customer needs such as product quality, 

on-time delivery and personal relationships. The latter two can be solved with more 

information but not higher inventory. In our example, such requirements have 

interfered with what might otherwise be the most efficient activities for the company. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

2-10 

Figure 2-3. Costs of Uncertainty and Coordination 

Amount of Uncertainty

Low

Low

High

Low High

High

Cost

Inventory

Inventory

Information

Information

Degree of Coordination

Environmental Uncertainty

Faced by Firm

Coordination

Required in Firm

 2.3.2 Local versus System-Wide Optimization 

Almost all supply chain management involves information flow and 

coordination between a company and its customers and direct suppliers, 

and these relationships are bound together by contractual obligations. 

Thus, “supply chain optimization” usually means a series of local 

optimizations. Because many trading partner relationships are far from 

optimal, improving one-to-one coordination would result in much 

improved supply chain functioning. 

However, a collection of local optimizations may not result in optimization 

at the system level. Dynamics along the supply chain may create 

perverse system-level distortions even in cases where each of the 

customer-supplier relationships in the supply chain is functioning well. 

These distortions can include: 

• amplification of variance in the order stream as purchase orders 

move further away from the end-use customer, a phenomenon 

known as 'cracking-the-whip'; 

• spurious correlations in the order stream that can lead to unstable 

amplification of order signals; and 

• persistence of demand disturbances long after a change has 

been made in the system. 
Section 2 — Overview of Manufacturing Supply Chains 

2-11 

Agent-based simulations of these phenomena and detailed descriptions 

of their operation can be found in Parunak (1998) and Parunak, Savit, 

and Riolo (1988). The authors of these studies conclude that because 

these problems are so sensitive to timely and accurate information, a 

multi-tier communication system is highly desirable. 

The desirability of system-wide optimization calls for supply chains that 

are characterized by groups of companies across multiple tiers who 

interact as a group, rather than as a collection of individual trading 

partner relationships. Table 2-1 summarizes the pros and cons of local 

and system-wide optimization. However, making collective business 

models work is extremely difficult; this difficulty is both business-related 

and technological. 

Table 2-1. Pros and Cons of Local and System-Wide Supply Chain Optimization 

System Level Direct Relationships Only 

Pros • Fast transmission to people with a need to 

know. 

• Promotes multi-company collaboration. 

• Opportunity to deal with system-level 

phenomena. 

• No radical change in traditional business 

processes. 

• The familiar traditional business case can be 

used. 

• Amendable to implementation support 

through existing organizations (e.g., AIAG). 

Cons • Messy. Difficult to know who gets what 

information, or what the information can 

be used for (e.g., information only, 

instructions to act). 

• Difficult to implement—requires major 

changes in how business is traditionally 

done. 

• No existing industry force is up to 

facilitating the change. 

• Communication is relatively slow up and 

down the chain. 

• Does not promote multi-company 

collaboration. 

Under present conditions, there is a very well-defined sequencing of 

parts flow through a supply chain. Further, responsibility and authority in 

that flow are very well defined. Companies know who can make 

demands on them and the allowable limits of those demands. When 

data flow between companies, the meaning of those data is clear. All 

parties know if the data are to be used for information and planning, or 

interpreted as a command to act, or taken as a query that demands a 

response. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

2-12 

However, when many companies interact as a group, authority, 

responsibility, and the interpretation of messages become much more 

difficult to negotiate and track. Argyres (1999) shows that information 

technology and agreement over technical standards can play a vital role 

in helping multi-company collaborations function, and his research 

highlights how organizational dynamics and business forces make tight 

multi-company cooperation extremely difficult to establish and maintain. 

The most difficult technological issue is the multiplicity of 

communications methods, protocols, and formats that exist among 

trading partners. Consider all of the elements of communication that 

might move within an extended enterprise—part descriptions, 

manufacturing specifications, requests for bids, purchase orders, ship 

notices, price and availability of information, sequencing instructions, and 

order status, to name a few. Even with our existing methods of 

interoperability—EDI, XML, IGES, STEP, and specially negotiated 

trading partner agreements—there is a low probability that any pair of 

companies in the enterprise could communicate with each other in an 

unambiguous fashion without considerable groundwork and oversight. 

 2.3.3 Interoperability as an Approach to Optimizing Supply 

Chains 

Morell and Phelps (2001) define interoperability as “the flow of 

information from one system to another without the need for human 

intervention.” Interoperability is one of the most important factors to 

improving supply chain functioning because communication in supply 

chains must be limited and precise to be efficient. Small improvements 

in interoperability can produce disproportionately large improvements in 

supply chain function. 

Business process change might make the greatest contribution to 

improving supply chains. Unfortunately, new forms of business 

relationships can be extremely difficult to design and implement. When 

one-to-one relationships are to be developed, the difficulties center on 

the tighter relationships (see Figure 2-3) that require extended 

negotiation, complex dependencies supported by contract and trust, 

long-term commitments, mutual interdependence, and shared assets. 

When multilateral relationships are involved, difficulties are even greater 

because business models have to be developed that proliferate 

communication pathways; provide the benefits of greater certainty and 

coordination; and continue to assure unambiguous authority, 
Section 2 — Overview of Manufacturing Supply Chains 

2-13 

responsibility, interpretation, and security of messages. Because these 

changes are so difficult, we see them as rare events. 

Communication alone will not rationalize supply chains because 

communication has no value without a business context. Still, lowering 

the cost of communication can provide business with expanded choices 

in designing a business process. One way to see this expansion is to 

consider the “information” curves in Figures 2-2 and 2-3. Because of the 

lack of interoperability discussed above, effective communication can be 

a large component in the information costs. Thus, more facile 

communication would lower the information curves, thereby increasing 

the amount of certainty and coordination that trading partners could 

afford. 

While interoperability can help with both one-to-one and multilateral 

approaches to supply chain optimization, its greatest potential 

contribution is in multilateral situations. This is true even though 

multilateral change is extremely difficult, because even small 

improvements in a complex supply chain can lead to major 

improvements in the chain’s overall performance. Parunak, Savit, and 

Riolo (1988) and Parunak (1998) show how this “butterfly effect” 

emerges in supply chains. Communication delays and inaccurate 

information lead to inventory fluctuations, which in turn lead to higher 

costs. Because of this leverage, interoperability improvement should be 

one of the highest priorities when it comes to pursuing supply chain 

optimization. 

4-1 

 Supply Chain 

 Optimization in 3 Practice 

Although the focus of this report is on the automotive and electronics 

industries, this section provides a summary of current supply chain 

activities throughout the world economy, with a focus on U.S. activities. 

We first introduce several conceptual supply chain models. Next we give 

an overview of supply chain activities over the past several years and 

provide an analysis of the recent trend toward globalization. Finally, we 

use three companies as examples of supply chains that have excelled in 

specific areas. 

 3.1 CONCEPTUAL DESCRIPTIONS OF CURRENT 

SUPPLY CHAIN MODELS 

In today’s economy, we see a number of different approaches to supply 

chain management, which leads to a wide variety of organizational 

structures. Several of these structures can be thought of as existing 

along a continuum characterized by the degree of control by the OEM. 

At one extreme lies the traditional vertically integrated firm, in which a 

single corporation directs and operates facilities at every step of the 

supply chain, and at the other is the “virtual enterprise,” in which the 

OEM plays no part in the supply chain aside from product design and 

sales and marketing functions. Figure 3-1 presents a visual comparison 

of the distribution of control in each extreme supply chain structure. 

Each of these models is described below. 

The vertically integrated (VI) firm manages all supply chain activities, 

from raw materials to final customers. This type of firm manufactures 

most or all key component parts, assemblies, and finished products inhouse, purchasing only less critical parts and commodity items from 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-2 

outside vendors. In some industries, historical practice or legal 

restrictions may separate distribution and final sale from VI 

manufacturers; for example, in the automotive industry, franchise laws in 

many states prevent OEMs from selling their vehicles at retail. 

Nevertheless, these firms manage all of the information needed to 

support the supply chain, although vertical integration does not 

guarantee efficient management. The use of multiple incompatible 

information systems is common among the vertically integrated OEMs in 

the automotive industry. One large, vertically integrated Tier 1 

automotive business reported having more than 20 home-grown 

planning systems in their plants, none of which could interoperate with 

the others. 

 

Figure 3-1. Conceptual Supply Chain Models: Changing Control 

Direct Control

over Design and

Manufacturing

Decreases

Contract Manufacturing Led

by OEM

Virtual

Enterprise

EMS Provider

Operated

Decentralized Manufacturing

Led by OEM

Vertically Integrated
Section 3 — Supply Chain Optimization in Practice 

3-3 

In decentralized manufacturing led by the OEM, the OEM owns and 

operates the final assembly and processing steps, but most steps in the 

supply chain are in the hands of independent suppliers. Operationally, 

this may have cost and/or quality advantages, as each firm is able to 

focus on its core competencies. However, information sharing must now 

cross corporate boundaries, so contractual and legal complexities are 

added. The OEM has less control than in a VI organization and must 

rely on information or inventory to protect itself. The OEM may keep 

control of product performance and quality by providing component 

design, process engineering, and facility tooling. All of these functions 

can be transferred to another supplier if necessary, but effective control 

resides with the OEM. Most of the automotive industry operates in this 

way today; for example, Arnaldo Camuffo (2002) writes, “In Ramos 

Arizpe, Mexico, General Motors has recently used modular assembly for 

the new Pontiac Aztek. Modules—preassembled groups of parts—

account for about 30 percent of the vehicle and are shipped to the plant 

and bolted together.” 

Another model is contract manufacturing led by the OEM. In this 

structure, the OEM turns over operation of all production, including final 

assembly, to other firms; this allows the OEM to focus on product design 

and sales and marketing functions, which it may consider to be its core 

competencies. The OEM turns over production to a firm that specializes 

in the necessary skills to be successful in this arena; these skills might 

include shop floor supervision, employee (and perhaps union) relations, 

risk management, maintenance, and repair. Outsourcing can permit 

OEMs to be more flexible because they no longer have responsibility for 

employees or production management, and if the product fails to meet 

specs, they merely cancel the contract. In 2002, Asyst Technologies 

developed a relationship with Solectron Corp. to manufacturer many of 

its electronic products so that they could use the expertise of Solectron 

and presumably reduce overhead costs for labor and facilities (Chappell, 

2002). 

OEMs initiating contract manufacturing may achieve better business 

results through the resulting management focus. However, OEMs cede 

more control than in previous structures and can no longer directly 

control the quality and performance of the finished products. In most 

cases, OEMs still maintain control over design, engineering, and tooling; 

in electronics contract manufacturing, OEMs often purchase all capital 

equipment. Information flows are critical in this structure to avoid costly 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-4 

errors. In one well-publicized case, Cisco was forced to write off $2.25 

billion in unsaleable products made by contract manufacturers in 2001 

(Barrett, 2001). 

Electronics manufacturing services (EMS) providers enable another 

supply chain structure. If OEMs are willing to cede control over design 

and engineering as well as manufacturing, they may contract with EMS 

providers to manage the entire process. In this case, the OEM’s name 

will still appear on the product, and the OEM will still handle marketing 

and sales functions, but most of the supply chain will be controlled by the 

EMS provider. From the latter’s perspective, the resulting supply chain 

will look like one of the structures above; all of the complexity, 

information needs, and risk have now shifted to the EMS firm, although 

quality defects, supply disruptions, and perhaps cost overruns may injure 

the OEM as well. For these reasons, the OEM remains in nominal 

control (specifies designs) and must be able to manage all of the supply 

chain information generated by the EMS provider and other firms in the 

chain. 

In the virtual enterprise supply chain, a service provider controls and 

manages the entire supply chain, while the firm that will put its name on 

the product and contribute sales and marketing effort is entirely 

disconnected. In this last step in the continuum, the service provider 

actually functions as the OEM and has the same information needs as 

an EMS provider or traditional OEM. The “brand name” firm becomes a 

spectator in the production process and exerts no control at all; its role is 

limited to marketing. Li & Fung represent the quintessential example of a 

virtual enterprise; they manufacture products for companies such as 

Coca-Cola and Levi & Straus; however, these firms have no control over 

operations. 

In distinguishing among the five manufacturing models, the tradeoff 

between process control and the advantages of distributing responsibility 

among levels of a supply chain (degree of specialization) is value added. 

Although specialization may increase the total value added for the supply 

chain as a whole due to production efficiency gains, the OEM in the 

virtual enterprise model relinquishes significant control. 

Thus, for any degree of vertical disintegration, choices must be made 

among alternative supply chain management techniques. In weighing the 

respective costs and benefits of alternative techniques, each firm must 

decide which is best. Several factors could impact this decision: 
Section 3 — Supply Chain Optimization in Practice 

3-5 

• Production Type—Whether a company produces small or large 

components can drastically affect supply chain management 

possibilities, such as transportation costs, and if products are 

commonly specialized or customized, timing becomes more of an 

issue. 

• Target Markets—The geographical and societal characteristics 

of a company’s market can drastically affect SCM choices; for 

example, international markets might necessitate manufacturing 

goods in another country to expedite time-to-delivery. 

• Technology Infrastructure—Firms will be affected in their plans 

by their current IT infrastructure and how they are able to use IT 

to solve SCM problems; they could additionally be affected by the 

level of IT used by their customers and suppliers. 

Based on these factors and others, firms must decide what type of 

supply chain model will enable them to perform most efficiently. In the 

next section, recent supply chain integration activities are discussed. 

 3.2 SUPPLY CHAIN INTEGRATION 

DEVELOPMENTS 

At the end of the last decade, software makers touted the efficiency and 

cost savings that companies could expect from buying and implementing 

new supply chain software. Venture capitalists invested millions and 

U.S. companies spent billions purchasing new software expected to 

increase efficiency, but most reported very few benefits. In November 

2003, a Wall Street Journal (WSJ) article on the status of B2B electronic 

commerce suggested that only one-third of the B2B Internet startups 

operating in 2000 were still in business by the end of 2001; 

approximately 1,350 companies went under during this period. The WSJ

piece went on to say that as start-ups were trying to profit by charging 

transaction fees on billions of dollars in trading, many companies initiated 

their own B2B programs, often with great success. The market for 

supply chain management software is alive and well; last year, U.S. 

companies conducted approximately $482 billion in business using 

online transactions, an increase of 242 percent from 2 years prior 

(Angwin, 2003). 

As companies make efforts to increase supply chain efficiency, they are 

taking few risks in purchasing software after the overspending that 

typified the late 1990s. Software makers are more aware of what 

companies are looking for and thus products are less expensive, easier 

to integrate into their internal software, and simpler to use; additionally, 

customers are seeing a return on their investment (ROI) more quickly. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-6 

Many companies continue to use EDI systems and SCM products are 

still selling; however, and total solutions are becoming increasingly 

popular.8 

New individual and “total solution” products are being developed and 

sold by software titans such as Oracle, PeopleSoft, and SAP, but other 

companies are entering the market as well. IBM has been developing its 

On Demand service offering, and HP and Microsoft are working on 

supply chain solutions. Some companies, such as Dell and Intel, are 

integrating software programs such as i2’s TradeMatrix and supply chain 

standards such as RosettaNet, which can be individualized for each 

company but enable interoperability with other firms. Additionally, as 

companies need more customization to allow SCM programs to 

interoperate with internal software, smaller companies can gain some 

market share. Some companies even outsource the management of 

these systems to companies such as Li & Fung (see Section 3.4.2). 

As these supply chain software packages for companies become more 

sophisticated, companies are looking for ways to use this new-found 

power. One way to improve efficiency is to perform more statistical 

analysis of their internal operations using software packages such as Six 

Sigma or SAS. Radiofrequency identification, or RFID, chips are a more 

recent example of a technology that can help SCM. Beginning in 

January 2005, Wal-Mart will require that its 100 top suppliers use RFID 

tags, which will allow Wal-Mart to track information such as the origin of 

each product, a perishability date if applicable, and the movement of 

items both within a store and as they move out the door. Subsequently, 

Wal-Mart could save between $1.3 to 1.5 billion (Shim, 2003). As WalMart pushes the demand for RFID chips, more retailers could be forced 

to begin using the tags to be competitive. 

Additionally, firms are looking for ways to cut costs. Today, popular 

supply chain models being adopted by companies relinquish more 

control to contract manufacturers, such as Solectron, and electronics 

manufacturing services, which specialize in locating and using the most 

efficient supply chain components to make the lowest-cost products (see 

Section 3.1). From manufacturing plants to service centers, companies 

are hiring process management firms and consulting groups with 

 

8Supply Chain Management (SCM) software includes program types such as Enterprise 

Resource Planning (ERP), Customer Resource Management (CRM), and Product 

Lifecycle Management (PLM). These programs are both supplier-side and customerside applications. 
Section 3 — Supply Chain Optimization in Practice 

3-7 

expertise managing and operating complex activities. Although many 

companies are using supply chain software and Internet-enabled 

solutions, others have benefited by redefining the roles of the players in 

their supply chain as well as by leveraging the knowledge of supply chain 

experts. Some companies have found that moving certain processes 

abroad has enabled them to cut costs and become more competitive; the 

following section addresses motivations and inhibitors to globalize supply 

chains. 

 3.3 INCREASED GLOBALIZATION OF SUPPLY 

CHAINS 

The proliferation of free trade agreements, increased membership in the 

World Trade Organization (WTO), and historic increases in the volume of 

cross-border trade all indicate that the trend towards internationalizing 

business will continue.9 David Ricardo’s law of comparative advantage 

has proven that it is more efficient for countries to specialize in a few 

products rather than produce many goods at a high opportunity cost. As 

companies around the world continue to learn of the cost savings 

involved in moving certain job functions and process facilities to the most 

cost-effective location, outsourcing will increase. 

The growth in the globalization of business will inevitably be 

accompanied by growth in the internationalization of supply chains. The 

implications of this growth transcend scaling problems that attend normal 

supply chain expansion. Rather, particular sets of problems become 

salient in the international context. The question is not whether supply 

chains will continue to internationalize but how to manage the process to 

the best advantage of domestic industries. To succeed, it is necessary 

to first define potential globalization practices. 

First, a distinction needs to be made between moving an entire level or 

industry (e.g., manufacturing) in a supply chain offshore and moving one 

phase of an industry’s activity (e.g., R&D, service, or production). The 

majority of outsourcing being implemented today concerns specific 

activities within an industry. For example, over the past several years, 

numerous U.S. companies have built customer service call centers and 

“programming plants” in Asia, most often in India. Recently, some 

 

9A December 17, 2003, Star-Telegram article entitled “U.S. Reaches Central America 

Trade Deal” discusses the progress of several free-trade agreements currently being 

debated by the U.S. administration. To view the article, go to 

<http://www.dfw.com/mld/dfw/ 

7513520.htm>. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-8 

companies have moved R&D activities overseas as a way to combine 

manufacturing and R&D activities or reduce costs in some cases. 

The next sections discuss motivations and inhibitors that drive decisions 

about the internationalization of supply chains. 

 3.3.1 Motivators to Internationalizing Trade 

For an individual company, many factors might lead to the globalization 

of its supply chain. However, four main factors consistently motivate 

companies to move operations overseas: 

• access to complementary assets, 

• cost savings, 

• marketing necessity, and 

• trade regulations. 

By access to complementary assets, we mean that if a certain resource 

(e.g., raw materials) is located in a particular country, then a company 

would be more likely to perform other activities (e.g., manufacture 

products) in that country if other circumstances are not prohibitive. As an 

alternative example, a company might decide to move R&D activities 

overseas because they want to ensure that employees working on 

manufacturing and R&D are located in the same geographic vicinity; if 

manufacturing is less costly in a certain country, R&D personnel could 

follow for strategic and/or coordination-related reasons. 

The most common reason for sourcing overseas is the cost of 

components. In many cases, decreased production costs outweigh any 

added cost due to longer, more elaborate, or more unpredictable 

logistics. In general, the greater the contribution of labor to product cost, 

the greater the appeal of sourcing in low wage-rate countries. Prime 

examples of such industries are apparel, textiles, and electronics. 

Anther reason for sourcing in multiple countries is the sales and 

marketing advantage that can accrue to having a presence in, and 

making a contribution to, local economies. This consideration is likely to 

be important in industries characterized by low volumes and high product 

prices, a set of conditions that requires global sales for business 

success. Aerospace is a good example of such an industry.10

 

10A GE Aircraft Engines Press Release in February 2002 discusses a new plant in 

Thailand that was opening to support GE aircraft in Japan, Korea, China, Taiwan, 

Australia, and New Zealand. To view the article, go to 
Section 3 — Supply Chain Optimization in Practice 

3-9 

Local trade restrictions may also cause firms to expand their supply base 

to additional countries. In recent conversations with several 

manufacturers of measurement equipment, we learned that unique 

country and/or trade-bloc approval systems created the need to maintain 

separate supply chains in Europe and the Americas. 

 3.3.2 Inhibitors to Internationalizing Trade 

Mitigating the advantages of global sourcing is a set of factors that 

increase risk and cost. While few of these factors are solely a function of 

international sourcing, the greater the international dimension of a supply 

chain, the greater the likelihood that these factors will be important. 

Increasingly global supply chains will bring 

• increased system heterogeneity, 

• increased political complexity, 

• decreased legal security, 

• more transportation modality changes, 

• greater delivery times and higher volumes, and 

• new geopolitical concerns. 

As uniformity decreases, there is a corresponding increase in the cost of 

maintaining and coordinating multiple systems. Systems are affected by 

laws, regulations, business culture, currency, and data and 

communication standards. Each of these can be unique to individual 

countries (or trading blocs). Thus, one consequence of international 

sourcing is that each new location carries the burden of accommodating 

several new systems. The multisystem coordination problem may 

compound in a nonlinear fashion because each new locale results in 

many new interfaces among multiple systems. 

Political boundaries bring requirements that touch on how business can 

be conducted in a locale and on the activities needed to transport goods 

across borders. With respect to conducting business in a particular 

country, examples of relevant issues include laws requiring the use of 

local supplies for manufacturing in a particular country, labor and 

environmental regulations, or export/import laws. Dell provides a perfect 

example for us; before China joined the WTO in 2002, Dell decided not 

to build a plant there because government leaders indicated that they 

would maintain control over Dell’s operations (Frahm, 2004). 

 <http://www.geae.com/aboutgeae/presscenter/ 

services/services_20020228.html>. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-10 

As firms enter new territory, they are often faced with legal systems that 

do not adequately support the security needs of many business 

activities. For example, the laws in some countries do not enable firms 

to apply for patents or protect previously developed intellectual property. 

One Industry Week article on the effects of globalization on 

manufacturing noted that despite China’s membership in the WTO, 

“manufacturing executives say China still does not offer the kinds of 

protection for know-how, patents and other sorts of intellectual property 

that are common in the U.S., Canada, and Europe” (McClenahen, 2003). 

With respect to transportation across borders, critical factors are customs 

requirements, documentation of export/import regulation compliance, 

and advance notification of shipment content. The data management 

burden resulting from these requirements can be very high, particularly in 

this age of increased security vigilance. As international sourcing 

increases, the need for overseas transportation will follow, thus requiring 

goods to move from a ship or an airplane to a truck or train. Each 

transition increases cost, time, and the possibility of loss or damage. TT 

Club, the mutual-insurance provider for the international cargo container 

industry, estimates that as many as 5 percent of container movements in 

the world develop problems during transit (Machalaba and Pasztor, 

2004). 

Additionally, international sourcing usually involves increased delivery 

times and high numbers of units per shipment. Both are attributable to 

reliance on sea transportation, a mode of transport that is slow and most 

economical with large volumes. These requirements are not conducive 

to business tactics such as vendor-managed inventory, just-in-time 

delivery, or mass customization. 

Global sourcing requires dealing with the vicissitudes of political, social, 

and economic conditions. In the short term, these conditions may affect 

delivery and production schedules. In the longer term, they may 

undermine business plans based on assumptions about assured supply 

and predictable costs. Oil is a primary example of these kinds of 

uncertainties, as evidenced by recent interruption in supplies from 

Venezuela; a protest against President Hugo Chavez in Venezuela in 

December 2002 brought oil production in the country to a stand-still and 

marked the 2-year high of world oil market prices, as the uncertainty 

inherent in the oil supply chain increased dramatically (Banerjee, 2003). 

Another example is the problem of critical materials whose sale is caught 

up in regional conflict, as is the case of coltan, a dull metallic ore that is a 
Section 3 — Supply Chain Optimization in Practice 

3-11 

critical component in the electronics industry that is found in plentiful 

supply in the Democratic Republic of Congo. 

A second dimension to geopolitical concerns in sourcing is the need for 

government-to-government agreements as part of sourcing decisions. 

For instance, weapons systems are often developed by international 

consortia and require not only agreements among the many companies 

involved but also negotiated agreements among the countries in which 

those companies reside. In cases like these, the transaction costs of 

establishing business relationships can be extremely high. One reason 

the expense may be justifiable is the need to sell globally. Another 

reason, though, is that governments may see these agreements as 

instruments of foreign policy. 

Building on the understanding that today’s business climate is driving 

companies towards more efficient supply chains and often more global 

supply chains, next we will identify several case studies. 

 3.4 SUPPLY CHAIN INNOVATORS 

This section describes the operations of three companies that are 

leaders in supply chain management innovation. Through focusing on 

internal optimization, external relationships, and inventory management, 

each was able to improve their supply chain role. 

 3.4.1 Business on Demand—The Evolution of IBM 

Over the past 10 years, International Business Machines (IBM) has 

gradually transformed its business practices to improve supply chain 

efficiency, and today the company exemplifies a combination of many of 

the features described in Section 2.2. In the early 1990s, IBM started 

consolidating its business hierarchy and used advances in technology 

after company data processing costs reached three times the industry 

average. Largely based on a more efficient and widely adopted supply 

chain infrastructure, IBM cut IT spending by 31 percent even after 

incurring large investment and growth costs. 

With a self-reported $14.5 billion in benefits achieved from a $4.7 billion 

investment over 9 years, IBM exemplifies the benefits of IT-based 

integration of a supply chain. More specifically, IBM has deployed 

extensive middleware to reduce repetition in data entry and ease access 

to the company’s vast information resources (IBM, 2003). The company 

has leveraged the use of many third-party solutions, such as SAP for 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-12 

Enterprise Resource Planning (ERP), Siebel for Customer Relationship 

Management (CRM), i2 for Supply Chain Management (SCM), and Ariba 

for procurement. However, IBM believes that its value chain ideology 

has allowed a symbiotic relationship to form with many of its suppliers. 

This value network is defined by an IBM white paper as “a group of 

trading partners, focused on core competencies and connected via webenabled technology, collaborating to provide total solutions to customers” 

(IBM, 2001). 

Today, IBM’s supply chain R&D efforts are exemplified by its OnDemand Supply Chain Research Laboratory at Penn State. In 

collaboration with faculty and students at Michigan State, Arizona State, 

and University College Dublin, IBM’s supply chain projects will enable 

the company to continue to work toward a value network with maximized 

efficiency. The work at these labs is intended to help IBM build more 

dynamic supply chains that can automatically anticipate and respond to 

customer demands and changes in the market (Penn State, 2003). 

 3.4.2 Understanding Demand—The Li & Fung Virtual 

Enterprise 

According to their Web site, Li & Fung is “one of the premier global 

consumer products export trading companies managing the supply chain 

for high-volume, time-sensitive consumer goods, including garments, 

fashion accessories, toys, sporting goods, promotional merchandise, 

handicrafts, shoes, travel goods, and household items.” In the United 

States, Li & Fung subsidiaries have regularly stocked the shelves of WalMart, JC Penny, Kohl’s, and Meijer. In 2002, Coca-Cola partnered with 

the Asian company, and Levi Strauss proposed a licensing agreement 

with them in August 2003 (Li & Fung, 2002; 2003). Amazingly, Li & 

Fung’s success has been achieved without either manufacturing or 

supplying any real product; they rely totally on selling their expertise in 

managing supply chains. 

By 1997, the Internet had begun to transform the American economy and 

Li & Fung was forced to reevaluate its operations. In response, they 

decided to focus on new technology as a primary means of maintaining 

competitive advantage. Li & Fung used new Internet capabilities to 

develop a CRM system in which information could flow quickly and 

seamlessly. 

Dedicated Internet sites are developed for Li & Fung’s 10 largest 

customers. From these sites, customers are able to 
Section 3 — Supply Chain Optimization in Practice 

3-13 

• access past orders and billing information, 

• track current orders, 

• initiate a new order, and 

• identify products being manufactured for other clients (and 

“piggyback” if desired).11

Li & Fung’s Electronic Trading System, known as XTS, is linked to 

customers’ internal networks, enabling very quick transfer of order and 

production information. Depending on the technology available, some Li 

& Fung offices can access central databases and share design and 

production images in seconds. For example, Microsoft’s Biztalk software 

enables seamless data transfers, which increase the efficiency of 

supplier-side interactions and thereby decrease the time from receipt of 

an order to initiation of the processing stage. 

Despite the continuing evolution of Li & Fung’s order management 

capabilities, many interactions still occur in traditional ways, through 

phones, faxes, and personal visits. Li & Fung has excelled at finding 

extremely low-cost labor and raw or processed materials and then 

identifying the most efficient manufacturers. Figure 3-2 displays the 

complex nature of Li & Fung’s business model. Although their supplier 

relationship mechanisms are not as sophisticated as their customer-side 

interactions, Li & Fung is able to coordinate the production of highquantity, low-complexity products at extremely low prices. According to 

William Fung,12 “We’re actually the bridge between low-cost, laborintensive manufacturing of consumer goods in the developing world and 

the consumers of those products, who are primarily in large, developed 

economies” (Hostein, 2002). 

 3.4.3 Build to Demand—The Dell Model 

In 1994, Dell was a company struggling to keep afloat in the intensively 

competitive PC market, but one decision set Dell on a course to 

eventually become the number-one computer systems company in the 

world in 2001. The management team at Dell decided to adopt a new 

supply chain operations model based on a “build-to-order” procedure. 

By eliminating the costs associated with holding inventory, Dell was a 

pioneer in just-in-time delivery. 

 

11Although Li & Fung does not actually manufacture any products, they coordinate the 

manufacturing of products for companies. If Li & Fung has contracted a product to be 

manufactured for one company, another company can see these products through their 

customized Web site and order more of, or “piggyback” on, the same product. 

12William Fung is the current group managing director and CEO of Li & Fung. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-14 

Figure 3-2. Li & Fung Supply Chain Model 

Customer

#1

Customer

#2

Customer

#3

Shipping

Companies

Raw and

Processed

Materials

Manufacturers Labor

Li &

Fung

Physical Flow

Information Flow

Supplier and customer relationships were the key to the success of the 

“Dell Model.” By finding stable companies interested in consistently 

high-quantity supplies and large IT-based customers interested in routine 

PC upgrades, Dell was able to successfully implement its business 

model. In addition, the company started a Web site, Dell.com, which 

allowed PC buyers to purchase computers designed to their personal 

specifications (Copacino and Byrnes, 2001). 

Unlike competitors such as Apple, IBM, and Compaq, Dell sold directly to 

customers and thus eliminated the need for distributors and retailers or 

resellers, who completed the supply chain in the more traditional model 

(see Figure 3-3). Dell was able to have a direct relationship with its 

customers, enabling more targeted service and the ability to promote 

repeat or additional sales. As a result of good management and a well-
Section 3 — Supply Chain Optimization in Practice 

3-15 

defined business model, Dell’s stock price appreciated over 40 times 

from 1994 to 1999 (Dedrick, Kraemer, and Yamashiro, 1999). 

Traditional

Model

Dell

Model

Dell

Final

Customer

Final

Customer

Retailers/

Resellers

PC Maker

Suppliers

Distributors

Suppliers

For Dell to keep a manageable balance between supplier deliveries and 

customer orders, it has relied heavily on the use of software programs 

and other IT processes that enable very efficient transfers of information. 

As Dell grew its global supply chain model, the use of IT continued to 

expand as new technology was developed. In the mid-1990s, the most 

important component of Dell’s IT was its Information to Run the 

Business, or IRB system, which enabled the optimization of production, 

quality, and distribution both globally and locally (Dedrick, Kraemer, and 

Yamashiro, 1999). Dell continues to update its IT capabilities; in 2001, 

Dell deployed i2’s TradeMatrix Supply Chain tools to gain a “costFigure 3-3. Dell Model vs. 

Traditional Model of 

Distribution 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

3-16 

effective, flexible solution... to sustain a global, 24x7 manufacturing 

operation” (Dell, 2001).
4-1 

 The Automotive 4 Supply Chain 

The production of an automobile requires interaction and coordination 

among many functions and industry participants. An automobile consists 

of a large number of components, parts, and accessories that must 

function together as an integrated unit. Consequently, the development 

and manufacturing process is also complex, requiring a number of 

iterations among the steps for different vehicle components. Because 

these components are typically designed and manufactured by many 

companies that are part of a complex supply chain, these companies 

must coordinate their activities to ensure that the components they 

manufacture are compatible with other components. 

This section is divided into five parts. The first discusses the anatomy of 

an automobile and the basic theory behind automobile assembly. 

Building on the concepts described therein, we then present the actual 

process through which components and parts are assembled into a 

motor vehicle. Next we describe the corporate and industry structure of 

the U.S. automotive supply chain, followed by a discussion of current 

trends in supply chain integration and interoperability issues faced by the 

industry. 

 4.1 THE ANATOMY OF AN AUTOMOBILE 

The structure of an automobile is extremely complex. A typical motor 

vehicle consists of approximately 15,000 parts and accessories that must 

be designed to be compatible. As shown in Figure 4-1, an automobile 

comprises several major systems, each of which contains many 

subsystems, components, and interfacing parts (e.g., bearings, 

crankshafts, filters, gears, pistons, pumps, and valve trains make up the 

engine, and their design must be compatible). Similarly, other systems, 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-2 

Figure 4-1. Automobile Systems and Components 

Automobile

Electronic

Systems and

Components

Engine and

Components

Exterior Fasteners and

Adhesives

Hydraulic and

Pneumatic

Systems

Steering and

Components

Suspension and

Components

Transmission

and

Components

Axles and

Components

Brakes and

Components

Cooling

Systems and

Components

Electrical

Systems and

Components

Interior

Source: Research Triangle Institute. March 1999. Interoperability Cost Analysis of the U.S. Automotive Supply 

Chain. Prepared for the National Institute of Standards and Technology. Research Triangle Park, NC: Research 

Triangle Institute. 

such as axles, suspensions, transmissions, bodies, seats, and 

instrument panels, consist of many parts that must work together. 

Manufacturers must coordinate these systems to enable the successful 

final assembly of the vehicle. 

 4.1.1 Automobile Platforms and Models 

Most motor vehicles are built under the platform concept. A platform is 

typically defined as the vehicle’s basic mechanical structure. Different 

vehicles based on the same platform commonly share several structural 

elements, such as the floor plan and door pillar (Automotive News, 

1997). Automakers typically offer several car models per platform. For 

example, the soon-to-be discontinued Chevrolet Lumina, Chevrolet 

Monte Carlo, Pontiac Grand Prix, Buick Regal, and Buick Century all 

share the same platform. In addition, these cars may be offered in 

several body styles, such as a two-door coupe, four-door sedan, and 

four-door hatchback. 

The platform concept is becoming increasingly important as automakers 

seek to reduce costs by designing and producing more vehicles from 

common platforms. The number of platforms is an important measure of 

the annual design and engineering effort of each company. Models built 
Section 4 — The Automotive Supply Chain 

4-3 

on common platforms carry over a large percentage of parts and 

production processes, and the engineering and tooling for the vehicle’s 

basic structure account for the majority of total product development and 

launch costs (Womack, 1989). Thus, the potential savings from using an 

existing platform for a new model are considerable. Ford estimated that 

when they develop a new model on an existing platform, development 

and engineering costs fall by 15 to 20 percent (Automotive News Europe, 

1997). In addition, components and subassemblies may be 

interchangeable within groups of platforms, thereby reducing the total 

number of parts that OEMs must procure. 

 4.1.2 Production by Platform 

Maximizing unit production and sales per platform is an important 

industry strategy for decreasing design and development costs over the 

next decade (Auto and Auto Parts, 1997). In 1997, the most popular 

platform grouping, Chevy S/K pickups and utilities, produced over 

1 million, while some of the less popular platform groupings produced 

only 100,000 or less. 

Industry’s current strategy of consolidating on fewer, more flexible 

platforms is a response to an opposite longer-term trend. Over the past 

20 years, the unit sales per platform have declined for the U.S. OEMs. In 

addition, more frequent model renewals are required to keep pace with 

faster changes in style and taste. An analysis of the OEM plans for major 

and minor redesigns shows that 12 platforms undergo major redesigns 

and 8 undergo minor revisions in an average model year (IRN, 1997). 

Each revision may affect the engineering and geometry of automotive 

components; this information must be transmitted throughout the supply 

chain to ensure proper physical and electrical compatibility between the 

platform and automotive components. 

 4.2 THE AUTOMOBILE PRODUCTION PROCESS 

Automotive production in the United States has changed significantly over 

the last few decades. These changes have contributed to development 

and production complexity while simultaneously shortening automobile 

development and production timelines and improving product quality. 

Prior to these changes, U.S. automakers considered new automobile 

development a linear process that took 5 or more years to complete. 

Automakers proceeded sequentially from concept design through product 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-4 

design, product engineering, and component sourcing to final assembly 

(Womack, 1989). 

 4.2.1 Engineering and Manufacturing Philosophies 

U.S. automakers were compelled to rethink their linear approach to the 

vehicle development and production process in the face of stiff 

competition from Japanese automakers. In the 1980s, Japanese auto 

companies completed the automotive design process, from initial 

conception to delivery to consumers, in 43 months, on average; their 

U.S. counterparts took 63 months (Womack, 1989). Thus, Japanese 

automakers were able to introduce novel design changes that met 

customer demand more quickly and at less expense, which accounted, 

at least in part, for their rising market share. 

Concurrent engineering, which integrates design, manufacturing, and 

support processes to provide early manufacturing input into the design 

process, is a fairly recent phenomenon in the U.S. automotive industry. 

The design of the GMC CK pickup in the early 1970s marked the first 

time in the U.S. auto industry that manufacturing engineers formally 

worked with design engineers. This early effort at concurrent 

engineering was very successful and eventually led to its further 

acceptance in the auto industry. 

Concurrent engineering has enabled lean manufacturing, a 

manufacturing philosophy that “focuses on delivering the highest quality 

product at the lowest cost” (Liker and Wu, 2000). The system focuses 

on value streams, where all steps in the production process include only 

those steps needed to convert raw materials into end products. 

According to Liker and Wu, any steps that fail to do this are considered 

wasteful. Included in their assessment of wasteful activities is the 

transportation of parts from suppliers to OEMs located at significant 

geographical distances. To mitigate this waste, OEMs and suppliers 

have adopted the Japanese concept of just-in-time (JIT) delivery—

getting the right part to the right place at the right time. Under JIT, 

manufacturing operations are coordinated so that the quantity of parts 

produced and shipped by suppliers to OEMs meets their demand 

requirements at that particular time. The goal was primarily to reduce 

inventories and ancillary expenses, and the process has had the dual 

effect of deepening supplier-OEM relations. 

As a result of these efforts, lead times for U.S. automakers have been 

falling since the mid-1980s and continue to fall. Buchholz (1996) reports 
Section 4 — The Automotive Supply Chain 

4-5 

that Chrysler’s average lead time was 54 months in 1987 and about 

29 months in 1996. The Dodge Durango, first sold in 1998, was 

developed in 23 months; the shorter lead time was attributable to heavy 

borrowing from the Dakota pickup (Brooke, 1998). The late 1990s 

Concorde and Intrepid redesigns took about 31 months (Jost, 1998). 

GM has recently reported that its cycle time has fallen from 36 months in 

1995 to about 24 months in 1998 (Martin, 1998). It now takes the auto 

industry 9 months to convert raw materials into a vehicle in the driveway 

(Piszczalski, 1998). 

The remainder of this section discusses the process through which the 

automobile supply chain takes design information and brings a final 

product to market. The discussion is divided into two components: 

process and factory design and assembly. 

 4.2.2 Process and Factory Design 

Once an OEM has identified a need in the marketplace and designed a 

vehicle to that end, it proceeds with production procurement and design 

decisions for the body, power train parts, and other components. In 

parallel, a factory and process are designed for the parts that will be 

produced in-house. The plant floor layout is determined, and tooling and 

fixtures are designed or procured. These activities are mimicked by the 

suppliers that will produce the design’s constituent pieces. 

The degree of design activity conducted by suppliers varies along a 

continuum. At one extreme, suppliers simply manufacture parts based 

on the specifications and designs provided by the OEM. At the other 

extreme, the supplier is responsible for the component or system design, 

responding only to high-level specifications from the OEM. In the 

intermediate case, detailed design may be a collaborative process 

involving engineers from both supplier and OEM. 

In any event, the OEM contracts with suppliers to procure the parts and 

subassemblies that will comprise the final product. Suppliers themselves 

may contract with subtier suppliers for the components needed to fulfill 

their contracts. In this way, the entire supply chain coordinates the 

process through which the final product is brought to market. This 

process requires the efficient exchange of information within and 

between processes among OEMs, suppliers, and subcontractors. 

Information exchanges include design and engineering data, financial 

data, and scheduling information. Interoperability problems can interrupt 

this process causing delays and increasing costs. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-6 

 4.2.3 Assembly 

The process through which raw materials are converted to the 

constituent pieces of a motor vehicle is a complex one. The intricacies of 

automotive design and production call for an array of materials and 

systems, very few of which are low value-added products. Even the 

simplest of components may be composed of engineered materials 

produced through a complex process. What is more, these materials 

and components are sourced from a diverse variety of industries. These 

two factors combine to inhibit a concise description of the production 

process. With this limitation in mind, what follows is a general 

description of the automotive assembly process. It also important to 

keep in mind that the transition from one activity to another may also 

entail a shift in geographic locale and a change in production agent as 

components move through the supply chain. 

As mentioned earlier, motor vehicle parts include thousands of both 

finished and semifinished parts that are later assembled into 100 major 

components (e.g., suspension systems, transmissions, and radiators). 

These components and systems are eventually transported to a plant for 

assembly. In the past, these parts were traditionally composed of iron 

and steel. Demand for more fuel-efficient vehicles in recent decades has 

altered the overall material composition to include plastics and 

aluminum. On average, 70 percent of the materials in a car are ferrous 

metals, 9 percent are nonferrous metals, and 21 percent are nonmetals, 

such as plastic, rubber, glass, and textiles (EPA, 1995). 

The manufacturing processes used to produce the thousands of discrete 

parts and accessories vary depending on the part design and the 

material used. Different processes may be employed for the production 

of metal components versus the production of plastic components (EPA, 

1995). Most processes, however, include casting, forging, molding, 

extrusion, stamping, and welding. Once a part has been produced it is 

either incorporated into a subassembly, a larger component, or directly 

incorporated into the final product (see Figure 3-1). 

Although components and systems assembly occur at many points along 

the supply chain, final assembly occurs solely at the OEM’s plant. Here, 

all the parts produced by suppliers are combined into the final product. 

Body parts are assembled on platforms and move through various 

painting operations. Afterwards, the body moves along production belts 

during which time the remaining systems are installed, including power 
Section 4 — The Automotive Supply Chain 

4-7 

train, engines, interior components, and electrical systems. Next, the 

assembled vehicle is checked over for defects and flaws. If none are 

detected, it is tested and readied for shipment. Otherwise, the 

automobile is returned to the production area to have its faults corrected 

and then joins other vehicles being readied for shipment. 

 4.3 THE U.S. AUTOMOTIVE SUPPLY CHAIN 

The U.S. automotive supply chain is not easy to characterize. It consists 

of thousands of establishments ranging in size from 50 to many 

thousands of employees. In addition, many of the lower-tier suppliers 

also supply the aerospace and other transportation industries. The 

sheer size of the industry is overwhelming. Manufacturing employment 

in the motor vehicle and motor vehicle parts industry was 949,984, or 

about 6.5 percent of all manufacturing employment, in 2001. Shipments 

of motor vehicles and motor vehicle equipment amounted to almost 

$403 billion in 2001, or approximately 10 percent of the value of all 

manufactured goods (Census Bureau, 2003). 

Further complicating an analysis of the automotive supply chain is the 

complexity of the relationships between customers and suppliers. OEMs 

design and produce only some of the 15,000 parts and accessories that 

make up an automobile; they procure others from Tier 1 suppliers. The 

Tier 1 suppliers can in turn outsource to subtier suppliers. A company’s 

position in the supply chain may differ depending on the part and the 

customer. Thus, a company that is a Tier 1 supplier of transmissions to 

one OEM may be a subtier supplier of other parts to the same or other 

OEMs. Furthermore, these companies, especially the subtier suppliers, 

often supply parts to customers outside the auto industry. 

Production infrastructure, such as hardware, tooling, robots, and 

software, is also an important part of the supply chain (Fine and Whitney, 

1996). The supply chain in the automobile market, therefore, comprises 

a long, dynamic, and complex network that involves the OEMs, Tier 1 

suppliers, subtier suppliers, and companies that provide infrastructure. 

Finally, the relationships between the customers and suppliers are 

changing over time as competitive pressures force changes on the 

industry. In response to Japanese competition, U.S. automakers are 

reducing the time it takes to develop a concept into a final product by 

adopting the philosophies of core competence, concurrent design, and 

JIT delivery. The adoption of these philosophies is forcing significant 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-8 

changes in the relationships between the OEMs and their suppliers 

(Flynn et al., 1996). 

All of these factors complicate the task of clearly identifying and 

describing the different components of the automotive supply chain. 

Analysts have proposed two competing characterizations of the supply 

chain. The first identifies a company’s position in the supply chain based 

on its customers. If a company directly supplies the OEMs, it is a Tier 1 

supplier; a subtier company supplies the Tier 1, and so on. However, 

this definition is difficult to operationalize in today’s business scenario 

because a supplier can simultaneously serve multiple customers. As 

noted earlier, the same company can act as a Tier 1 supplier on one 

project and a subtier supplier on another project. 

An alternative characterization identifies a company’s position in the 

supply chain based on its products and its role in production. The Tier 1 

suppliers are responsible for integrating systems, while the subtier 

supplies modules or subsets of systems, and the next subtier contributes 

components and basic material (Phelan, 1997; Flynn et al., 1996). 

Despite the limitations of both characterizations, it is useful to choose 

one to facilitate a discussion of the industry’s structure. We use the first 

method for characterizing the industry. Figure 4-2 provides a simplified 

view of the overall industry structure. The OEM market is highly 

concentrated: a few large firms dominate the market. The Tier 1 market 

is more competitive. There are hundreds of Tier 1 suppliers, some of 

which are very large with sales of billions of dollars. The subtier market 

is even more competitive and consists of thousands of smaller 

companies in addition to a few large companies. Some Tier 1 suppliers 

also operate on the subtier by either vertically integrating or by supplying 

parts to their rivals on the Tier 1. Infrastructure suppliers often supply 

software, hardware, tooling, and robots to all levels of the supply chain. 

Some of the major players at each level of the automobile supply chain 

are characterized below. Information on the current trends in integration 

among these companies and tiers follows. 
Section 4 — The Automotive Supply Chain 

4-9 

Figure 4-2. U.S. Automotive Supply Chain 

The U.S. automotive industry is less concentrated and more competitive in downstream segments of the supply 

chain. 

Original Equipment Manufacturers

• highly concentrated

• “Big Three” (Chrysler, Ford, and GM)

First Tier

• hundreds of companies

• some large and some small

Subtier

• thousands of companies

• mostly small

Infrastructure

Suppliers

 4.3.1 OEMs 

The “Big Three”—DaimlerChrysler, Ford Motor Company, and General 

Motors Corporation (GM)—are the major U.S. auto OEMs. As illustrated 

in Table 4-1, the three OEMs produced over 11 million cars and light 

trucks in 2002 in North America. They generated over $503 billion in 

total revenue and employed over 1 million people in 2002. 

Table 4-1. “Big Three” Production, Sales, and Employees 

GM is the largest U.S. OEM in terms of production and sales.a 

OEM 

2002 North American 

Production (Cars and Light 

Trucks) (thousand) 

2002 Global Total 

Revenue 

($million)b

2002 Global Number 

of Employees 

(persons) 

DaimlerChrysler 4,999 156,839 365,571 

Ford Motor Company 3,928 162,586 350,321 

General Motors Corporation 2,288 184,214 350,000 

aThe Production and Revenue numbers come from “Standard and Poor’s Auto and Auto Parts Industry Survey” dated December 

25, 2003, by Efraim Levy. The employees numbers for Ford and General Motors are from Hoovers Online, 2004, and 

DaimlerChrysler’s figure is from their annual report. 

bIncludes revenue from financial services, insurance, and other revenue. 

In an attempt to become more globally competitive, the OEMs are 

restructuring to cut costs and speed vehicle development. They are 

increasingly focusing on parts and services in which they possess a clear 

competitive advantage and are outsourcing other work. In 1997, GM, 

Ford, and DaimlerChrysler were already outsourcing 30, 50, and 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-10 

70 percent of their vehicle content, respectively (Auto and Auto Parts, 

1997). With GM’s recent spin-off of Delphi Automotive Systems, GM’s 

percentage of outsourced work will climb to levels more comparable to 

those of Ford and DaimlerChrysler. Successfully transferring the design 

and manufacturing of many components to their supplier base requires 

concurrent design processes that demand effective EDI and interaction 

between the OEMs and their many tiers of suppliers. 

 4.3.2 Tier 1 Suppliers 

The Tier 1 of the supply chain consists of several hundred companies. 

Each supplier, depending on its size and diversity, can produce anything 

as minor as a part for a major system (fasteners for the brake system) or 

as integral as the entire axle assembly. Many of the larger companies 

have several divisions and sites and are responsible for producing 

several parts, systems, components, and accessories. Many suppliers 

are also increasing their input into designing and manufacturing 

complete modules or systems rather than just building simple component 

parts based on OEM specifications. Therefore, sharing data throughout 

the product life cycle has become an important feature of a Tier 1 

supplier’s operations. 

While OEMs are becoming less vertically integrated, many Tier 1 

suppliers are purchasing subtier suppliers to become more vertically 

integrated. Suppliers are becoming system integrators by combining 

related components into a single product to provide increased value to 

the OEM. Many suppliers, eager to deliver a larger share of the content 

of a vehicle, have become large system integrators by acquiring 

competitors and related-parts assemblers and operations, giving them 

the resources, financial strength, and the capacity to serve several 

manufacturers globally. For example, Lear Corporation purchased 

Automotive Industries in 1995 and acquired Masland, a maker of carpet 

and trim, in 1996. Similarly, Johnson Controls, Inc., recently acquired 

interior components manufacturer Prince in 1996, and Magna 

International purchased Douglas and Lomason, a seat manufacturer, in 

the same year (Flynn et al., 1996). Companies pursuing a niche in the 

system integration market know that they must communicate efficiently 

to compete effectively. 

Tier 1 suppliers often work for multiple OEMs. For example, TRW 

conducts 23 percent of its business with Ford and 10 percent with GM. 

Johnson Controls earns 11 percent of its revenues from Chrysler and 
Section 4 — The Automotive Supply Chain 

4-11 

10 percent from Ford (NIST, 1997). Table 4-2 lists a few of the largest 

members of the Tier 1 of the automotive supply chain, their auto industry 

revenue, and their primary products. The total sales of the top 150 U.S. 

OEM parts suppliers to North American OEMs in 2000 were $85.5 billion 

(Automotive News, 2001). 

 4.3.3 Subtier Suppliers 

The subtiers of suppliers consist of thousands of smaller companies that 

work with OEMs only indirectly via other suppliers. An exception would 

be some of the Tier 1 suppliers that also operate on the subtier by 

supplying parts to their rivals on the Tier 1. An example is Dana 

Corporation, which directly supplies Ford (18 percent of its revenue) and 

Chrysler (11 percent of its revenue). Dana also acts as a subtier supplier 

to Eaton, which, in turn, supplies Ford. The subtier companies that have 

no direct OEM business are relatively smaller companies that supply 

integral components or modules to the Tier 1 without having much 

interaction with the OEMs. Table 4-3 lists a few of the larger subtier 

suppliers and their total sales (including nonauto sales). 

 4.4 TRENDS IN U.S. AUTOMOTIVE SUPPLY 

CHAIN INTEGRATION 

As discussed earlier, the predominant manufacturing and engineering 

philosophies adhered to by the automobile industry, such as Lean 

Manufacturing, necessitate efficient communication across entities that 

produce automotive parts. Supply chain management (SCM) activities 

are now as integral to operations as manufacturing; efficient 

management of the chain can reduce costs and delays that may add 

thousands of dollars to end product prices and eat away at corporate 

profits. Three basic categories of SCM activities are currently being 

pursued by OEMs and suppliers: business-to-business (B2B) 

exchanges and markets, long-term relationships and alliances, and realtime communications links. 

Business-to-Business Exchanges and Markets. The Internet plays 

an essential part in current SCM activities, improving time-to-market 

cycles, lowering inventories, and reducing costs (LaLonde, 2000). It has 

done so in two ways: B2B exchanges and real-time communications. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-12 

Table 4-2. Characteristics of Prominent Tier 1 Suppliers 

Tier 1 suppliers vary in terms of their size and the range of parts and components they produce. 

Company 

North American 

OEM Auto Sales 

2002 

($millions) 

Worldwide 

OEM Auto Sales 

2002 

($millions) Primary Products 

Delphi Automotive Systems 19,656 25,527 Brakes, steering, suspension, cockpit 

components, wire harness 

Visteon Automotive 

Systems 

12,168 16,900 Steering, chassis, electrical, energy and 

engine management, interior, electronic 

components 

Lear Corporation 9,504 14,400 Interior systems, seats, instrument/door 

trim panels, overhead, flooring and 

acoustic systems, electronic/electrical 

systems 

Johnson Controls, Inc. 7,687 13,653 Seats, interior trim, batteries 

Magna International, Inc. 

(NOTE: Acquired Donnelly 

Corp. in October 2002) 

7,650 12,172 Interiors, exteriors, body and chassis 

systems, seats, mirrors, closures, 

electronics, engines, transmissions 

Dana Corporation 5,340 7,315 Structural, engine, chassis, sealing, brake 

and fluid system products 

TRW, Inc. 4,950 9,900 Steering suspension, braking, engine 

components, fasteners, occupant restraint 

systems, electronic safety and security 

Robert Bosch Corporation 4,390 19,085 Safety systems, break systems, fuel 

injection systems, electrical and electronic 

equipment 

Denso International 

America, Inc. 

3,769 15,348 HVAC, electrical and electronic 

components, filters, fuel management 

systems 

American Axle & 

Manufacturing Holding, Inc. 

3,341 3,480 Chassis and driveline systems, forged 

products 

ThyssenKrupp Automotive 

AG 

3,171 6,218 Body systems, chassis modules, 

powertrains, suspensions, steering 

systems, drivetrains 

Collins & Aikman Corp. 3,147 3,886 Cockpit modules, instrument panels, 

flooring and acoustic systems, fabrics, 

trim, convertible top systems and 

accessory mats 

DuPont Automotive 2,700 5,400 Engineering polymers, fibers, refrigerants 

and finishes 

Valeo, Inc. 2,372 8,787 Electronic/electronics, thermal systems, 

transmissions 

GKN Automotive, Inc. 2,348 4,733 Constant velocity products, powdered 

metal components, traction systems 

Source: Automotive News. “Top 150 OEM Parts Suppliers to North America.” Detroit: Marketing Services Inc. As 

obtained on January 19, 2004. <http://www.autonews.com/images/dataCenter/1448.pdf>. 
Section 4 — The Automotive Supply Chain 

4-13 

Table 4-3. Characteristics of Prominent Subtier Suppliers 

Subtier suppliers tend to be smaller and supply various parts to Tier 1 suppliers. 

Company Name 

1999 Worldwide Sales

($millions) Primary Products 

Textron Automotive, Inc. 463.1 Plastic products and custom injection 

moldings; ABS components, sensors and 

actuators, solenoids, valves, and controls 

Intermet, Inc. 956.8 Aluminum and magnesium die-cast parts 

Lectra Systems, Inc. 250 to 500 CAM systems, CAD systems, design 

hardware, design software 

Illinois Tool Works, Inc. 9,333.0 Batteries and parts, door systems and trim, 

molded components, filtration products 

Amtec Precision Products 90.5 Wire splices, assembly material, ignition 

components 

Auburn Gear, Inc. Axles, differentials, transfer cases, gears, 

and linkages 

Veridian Engineering 225.0 Design hardware, engineering design, and 

prototyping 

Cascade Die Casting Group, 

Inc. 

60.0 Dies, molds, tools and equipment, filters (air, 

oil, fuel, pumps, tubings, hoses, and fittings) 

Breed Technologies, Inc. 1,395.3 ABS components, airbag components, 

antitheft systems, sensors and actuators 

aEstimated by Gale Research Inc. (1997) based on prior year data. 

Sources: Gale Research Inc. 1997. Ward’s Business Directory of U.S. Private and Public Companies. Detroit: 

Gale Research Inc. 

Information Access Corporation. 1998. Business Index [computer file]. Foster City, CA: Information Access 

Corporation. 

Chilton Company. 1997. Automotive Industries Annual Source Guide. <http://ai.chilton.com>. 

B2B electronic commerce market exchanges in automotive parts have 

been in rapid development since the late 1990s. Several are currently 

functioning, including Free Markets and Covisint, the latter having the 

backing of North American OEMs and a handful of Japanese and 

European automakers. These online marketplaces are not just bazaars 

for parts and products, but also are portals through which companies can 

see a clear picture of the supply chain’s needs at any time (Memishi, 

2000). By participating in these marketplaces, companies hope to 

reduce inventories and speed up the process through which parts and 

vehicles are designed. The benefits are perceived to lie not in the 

contracting of parts, but rather in the development of new products and 

better management of manufacturing and distribution. Analysts at 

Morgan Stanley estimate that the cost savings could reach as high as 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-14 

$2,750 per vehicle for companies that participate fully in these 

exchanges (Memishi, 2000). 

The goal of these B2B initiatives is for the industry to create efficient 

supply chains that can produce a car in 20 days. It is still unclear, 

however, if the industry will be able to reach that goal and if so, how 

(Kiesel, 2000; Sedgewick, 2001). Although these initiatives, particularly 

Covisint, have both policy and financial backing from the major 

automakers, suppliers are wary of participating. For example, Covisint 

was developed and will likely remain controlled by large automakers, a 

fact that does not sit well with some suppliers. These suppliers have two 

additional concerns: first, they fear that these markets, which employ 

reverse auction techniques, will eat into their profits. Second, many have 

already invested heavily in establishing EDI and PDM links with longterm customers; they are wary of investing in another system that may 

not contribute significantly to their profits. 

There is no question that B2B exchanges will be employed by the 

industry to facilitate supply chain collaboration, but there are questions 

about their short-term penetration and adoption, particularly in an 

environment of preexisting real-time communications links and emphasis 

on alliances and long-term relationships. 

Long-term Relationships and Alliances. Long-term relationships and 

alliances are becoming increasingly common in this industry as 

manufacturers see the benefits of close, long-term ties with their 

suppliers. By forging stronger ties, companies work together to refine 

parts and components, and can more easily and quickly respond to shifts 

in demand and unclog bottlenecks (Landry, 1998). Companies 

participating in alliances deepen their ties beyond the contractual level, 

developing common interests and business goals and becoming more 

comfortable with information sharing. Companies within alliances are 

more likely to share business and production information through 

integrated systems than companies that work together on a contract-bycontract basis. An example of this would be DaimlerChrysler’s Extended 

Enterprise policy through which the automaker works closely with parts 

makers on future vehicle programs and establishes long-term supply 

relationships (Automotive News, 1998). 

Real-Time Communications Links. Many OEMs and suppliers have 

invested in automated supply chain technologies that make important 

business data visible to suppliers, distributors, and customers. These 
Section 4 — The Automotive Supply Chain 

4-15 

systems are viewed as being essential to maintaining a firms’ 

competitiveness in the industry. Examples of the communications tools 

include EDI systems, PDM systems, electronic mail, and direct links 

between corporate information systems. 

 4.5 INTEROPERABILITY ISSUES IN THE 

AUTOMOTIVE INDUSTRY 

This section provides an overview of interoperability issues affecting 

manufacturing systems in the American automotive industry. For this 

study, we focus on interoperability associated with the production phase 

of a vehicle's life cycle, a time when engineering design has been 

completed, vendors have been chosen, and contracts put in place. 

At the production stage of the product life cycle, most of the information 

exchanged between an OEM and its suppliers concerns ordering and 

schedule requests, acknowledgements of messages received, ship 

notices, and order tracking. To assure on-time delivery there is also 

information exchange with external logistics functions (i.e., warehousing 

and shipping). Parallel to all this product-oriented data is a flow of 

financial information that drives accounts payable and receivable, which 

in turn drives payments and clearing transactions with banks. 

The supply chain network in the automotive industry is quite complicated, 

with significant differences in business practices above and below the 

first tier. First tier suppliers do almost all their business within the 

automotive sector, which means they have a relatively small number of 

OEM customers. Suppliers to the first tier, however, deal with a large 

number of customers, who operate both inside and outside the 

automotive industry. Thus, as you move further away from the customer 

in the automotive supply chain, dependence on automotive business 

decreases while the complexity of information flow increases. Supply 

chains in other industries that produce complex discrete products, such 

as aerospace and major appliances, are generally similar. 

 4.5.1 Customer–Supplier Interoperability 

From the point of view of understanding automotive interoperability, two 

different scenarios are important. In the first scenario, the customer and 

supplier exchange high volumes of information, a situation found 

between OEMs and their most important first tier suppliers, as well as 

between first tier firms and their larger second-tier suppliers. In the 

second scenario, the volume of information exchange is low. This 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-16 

situation occurs often in customer-supplier interactions in the lower tiers 

as well as between OEMs and minor suppliers. 

The OEMs have insisted on the use of EDI by all of their suppliers, 

regardless of the transactions volume, and will likely continue to do so in 

the foreseeable future, for three main reasons. First, OEMs have large 

legacy systems that are integrated into EDI applications. Switching costs 

would be very high. Second, the OEM’s IT personnel have much 

experience with optimizing EDI systems. This human capital is valuable. 

Third, for high-volume communication, EDI requires less bandwidth for 

the OEMs than XML. 

First- and second-tier firms have been much less insistent on pushing 

EDI into their supply base, especially for suppliers that produce a low 

volume of information exchange transactions. In these instances, EDI's 

high installation costs may make it uneconomical to deploy, and some 

other means is found to communicate between customer and supplier. 

One solution is for the first- or second-tier customer to translate its data 

streams into plain English and send the information via e-mail or fax. A 

second solution is for the customer to direct the data stream (in EDI 

format, perhaps) to a third-party that does such translations. A third 

possibility is for the supplier to purchase a low-end EDI system that can 

receive messages and output them in plain text. 

Another option is developing that within a few years may improve 

interoperability in low-volume situations. In this scenario, EDI- and XMLformatted messages are translated into one another during transmission 

over a secure internet link or through a web portal. This option would 

allow customers to send and receive information in EDI format and 

suppliers to send and receive messages in XML format. 

To affect interoperability under these conditions, the cost/benefit ratio for 

interoperability must be lowered to a point where individual companies 

can make a business case for implementing whatever changes would be 

required to achieve system interoperability with their trading partners. 

XML represents such a solution. In terms of cost, XML does not require 

large investments in new hardware, software, or human capital. 

 4.5.2 Interoperability with Third-Party Logistics Companies 

It is common in the automotive industry for warehousing and shipping to 

be handled by third parties who specialize in logistics. One reason for 

this trend is cost. It is often more cost-effective to outsource services to 
Section 4 — The Automotive Supply Chain 

4-17 

specialists. A second reason is that third-party logistics firms can 

provide value-added services that cannot exist with direct shipping 

between suppliers and customers. One common service is “cross 

docking.” In this case, a logistics firm picks up parts from multiple 

suppliers and reorganizes the loads so that the right mix of parts goes to 

the OEM. One advantage of this technique is cost reduction resulting 

from more fully loaded trucks. Another advantage is that the right mix of 

parts arrives, at the right time, at the OEM’s loading docks. Taking cross 

docking one step further, logistics companies also provide “sequencing” 

services. Here, different parts are arranged so that a particular 

combination of components can move together, from a truck into the 

assembly process. This frees the OEM from the effort of reorganizing 

parts that come off a truck as those parts move through vehicle 

assembly. 

While the inclusion of third parties and value-added services complicates 

data flow, the basic issues of interoperability mirror that of direct 

communication between supplier and customer. Logistics companies 

working between Tier 1 suppliers and OEMs have sophisticated systems 

that are compatible with the “local” standards their customers use. EDI 

communication is used to coordinate all the necessary activity. 

However, logistics below the Tier 1 level usually do not justify EDI-based 

communication. While some Tier 2 companies are EDI-capable, most 

are not. Fewer and fewer EDI-capable companies appear below the Tier 

2 level. As with direct suppliers to customer communication, system 

interoperability in this domain will require the development of XML-based 

communication standards. 

 4.5.3 Emerging E-business Trends in the Automotive 

Industry: Implications for Interoperability 

Two developments in e-business may have consequences for 

interoperability. The first is electronic catalogues (e-catalogues). This 

development is important because the move from paper to bytes can 

change how business is done. Customers can check prices and 

availability from a larger pool of potential suppliers. Because publishing 

lags are eliminated, information on price and availability will be current. 

A greater variety of complex information can also be provided and 

accessed. For instance, companies are now including AutoCAD files as 

a part of their e-catalogues, thus allowing customers to easily incorporate 

a part into a design. As with EDI and XML, the impact of e-catalogues 

differs from the Tier 1 up and from the Tier 1 down. Above the Tier 1, 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

4-18 

contracts tend to be long term. It is uncommon for an OEM, in the 

middle of a production run, to shop for a new supplier. In any case, the 

industry’s emphasis on buying complex components limits the number of 

potential Tier 1 suppliers available to an OEM. As a result, the impact of 

digitizing catalogues is, and will likely remain, small. 

Below the Tier 1, however, contracts are likely to be shorter term, and 

any potential customer will have a relatively wide choice of suppliers. As 

a result, e-catalogues may very well affect who gets automotive business 

and on what terms. However, the power of e-catalogues can only be 

realized if customers can query a wide variety of catalogues. 

Complicating the problem is that the best value for a buyer may come 

from outside of its traditional industrial buying base. As a result, either 

standards or trustworthy translation systems are needed to allow 

catalogue searching across a very wide range of companies and 

industrial sectors. In essence, to capitalize on the potential of 

e-catalogues, a high level of interoperability is needed for e-catalogues 

and e-catalogue searching systems. 

The second important development is the rise of industry portals. These 

are becoming commonplace in many industries, and efforts to develop 

portals that can serve the automotive industry are well under way; 

however, the much hyped Covisint was recently bought by Compuware 

after marginal success. From the point of view of interoperability during 

the production phase of the life cycle, portals are interesting because of 

their potential to consolidate data flow and, thereby, perhaps change 

demand for interoperable systems; however, demand must be used as a 

barometer for startups. 

Without a unified portal, communication between trading partners is 

negotiated by those partners. Whether EDI, XML, or a proprietary 

format, each trading partner pair decides on its own how to 

communicate. True, partners will probably use an industry standard, but 

no matter how good the standard, variation will always creep in to each 

individual decision. And each company involved has to make that 

decision with each of its trading partners. With a portal, however, the 

situation changes. Now each company makes an information format 

decision with only one entity, the portal. The greater the number of tiers 

at which the portal operates, the greater the degree of data uniformity 

within the industry. The greater the uniformity, the lower the cost of 

interoperability. We do not know if automotive industry portals will 

succeed or to what degree. We know, however, that the cost of 
Section 4 — The Automotive Supply Chain 

4-19 

interoperability is inversely related to the success of a uniform portal. 

We believe that lower costs for interoperability may change business 

practices, but we cannot predict how. In any event, the success of 

portals and their impact on interoperability should be watched carefully. 

 4.5.4 Engineering Changes 

An inevitable part of production is dealing with engineering changes 

(ECs). These are the formal product changes that are instituted in 

response to some officially recognized need for a change in the product. 

An EC may be initiated because of a request from the end user, the 

manufacturing floor, marketing, or any other interested party. The 

common element is that each EC must be at least approved by the 

engineering staff overseeing the product. Then the EC must be 

approved by others and distributed to all affected parties, which, 

depending on the affected product, will include such groups as 

customers, suppliers, tooling design and manufacture, the manufacturing 

floor, inspection (quality control), and so on. 

Interoperability is an issue for ECs because they now nearly always 

include electronic data, especially CAD data defining the geometry of the 

part. Other controlling data may also be provided electronically, such as 

effective dates, approvals, and existing completed parts disposition. ECs 

are relatively rare compared to the business data described above. They 

are usually generated at unpredictable intervals, although the rate is 

normally much higher in the time surrounding a product’s early 

production. The data they contain also tend to be much more complex 

and unstructured than business data. Hence exchange methods are 

substantially different from the EDI or XML approaches. 

5-1 

 The Electronics 5 Supply Chain 

 5.1 OVERVIEW OF THE ELECTRONICS SUPPLY 

CHAIN INDUSTRY 

The electronics industry is an aggregation of several widely disparate 

product segments, from radar equipment to biomedical devices. A 

combination of factors, including mass customization, rapidly shrinking 

products and product life cycles, rapid inventory depreciation, complex 

multi-source supply chains, and rising demand, have created a highly 

competitive industry. Electronics products are brought together by 

commonality in components, manufacturing technologies, or 

consumption patterns. Because of this diversity, the report will focus on 

two product segments—personal computers and communications 

equipment (i.e., routers)—that have made a more pronounced effort to 

develop integrated supply chains throughout their manufacturing cycle. 

The interoperability section focuses only on computer production; 

however, the issues in the computer industry are similar to the problems 

found in integrating the networking equipment supply chain. 

With almost $430 billion in sales in 2001, or approximately 10 percent of 

the value of all manufactured goods, and 1.6 million employees, 

electronics is the third-largest manufacturing industry (behind chemical 

and transportation equipment) (U.S. Census Bureau, 2003). Table 5-1 

lists 1997 computer and electronics product sales and employment by 

industry groups. Of total electronics sales, semiconductors and 

electronic components made up the majority of sales followed by 

computers and peripherals and telecommunications equipment. The 

NAICS codes separate the electronics market into six different product 

sectors. The following is a brief description of each category and the 

products included in each sector. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-2 

Table 5-1. U.S. Electronics Sales by Industry Group 

NAICS 

Code Industry Group 

2001 Sales 

($106) 

2001 Number 

of Employees 

3341 Computer & Peripheral Equipment 89,528 193,109 

3342 Communications Equipment 102,004 301,732 

3343 Audio & Video Equipment 8,942 27,142 

3344 Semiconductor & Other Electronic Components 124,215 566,864 

3345 Navigational, Measuring, Medical & Control 

Instruments 

97,169 468,114 

3346 Manufacture & Reproducing Magnetic & Optical Media 7,612 41,805 

334 Total Computer and Electronic Products 429,471 1,598,766 

Source: U.S. Census Bureau. January 2003. 2001 Annual Survey of Manufacturers. Washington, DC: 

Government Printing Office. Available at < http://www.census.gov/prod/2003pubs/m01as-1.pdf>. 

Computer and peripheral equipment manufacture is the third-largest 

sector of the computer and electronics industry, consisting of over 20 

percent of the total value of shipments. This grouping includes personal 

computers, servers, workstations, and other peripheral equipment, such 

as monitors and scanners. This industry sector is further discussed in 

Section 5-2. 

Similar in size to computer and peripheral equipment, communications 

equipment manufacturing consists of such industries as telephone unit 

manufacturing, equipment for radio and television broadcast, and both 

wireless and non-wireless networking. This sector claims almost 24 

percent of total computer and electronics product sales and is discussed 

in Section 5-3. 

The audio and video equipment sector includes firms manufacturing 

audio and video products such as televisions, camcorders, VCRs, and 

DVD players. Most production of audio and video equipment takes place 

overseas, reducing production of domestic audio and video equipment to 

roughly 2 percent of total computer and electronics products sales. This 

report does not focus on audio and video equipment because of the 

predominance of overseas manufacture and the relatively small size of 

the market. 

The semiconductor and other electronic components sector contains 

firms engaged in the production of printed circuit boards (PCBs), 

transistors, transformers, integrated circuits, and other electronic 

components. At over 28 percent of total shipped value, the 
Section 5 — The Electronics Supply Chain 

5-3 

semiconductor and other electronic components sector makes up the 

largest percentage of electronics sales. Semiconductors and electronic 

components are used across the electronics sector, and a significant 

portion of components go into telecommunications and computers and 

peripherals. For this reason, this sector will be included in the supply 

chain analysis as well. 

The navigational, measuring, medical, and control instruments sector is a 

grouping of various products including biomedical products, automatic 

environmental control, watch/clocks and components, measuring and 

controlling devices, and industrial process and control instruments. The 

wide diversity and lack of commonality with other segments has led us to 

exclude these products from our study, despite its significant share of 22 

percent of the computer and electronics products sales. 

The manufacture and reproducing magnetic and optical media sector 

includes firms engaged in record, tape, compact disk (CD), and software 

reproduction, as well as magnetic and optical recording. Manufacturing 

and reproduction of magnetic and optical media account for only about 

two percent of total electronics sales. 

Because of the diversity of the computer and electronics products 

industry, a coherent analysis requires focusing on one or two specific 

sectors. In addition, the computer and peripheral and communications 

categories have made significant strides in integrating their supply chain 

in an attempt to create a virtual “company.” For these reasons, this 

report focuses on the computer and peripheral and communications 

businesses in the computer and electronics products sectors, as well as 

the semiconductor industry that acts as a key supplier to both 

businesses. 

 5.1.1 Brief History of the Electronics Industry 

Until the invention of the microprocessor in 1971, computers were 

discrete pieces of equipment used primarily for data processing and 

scientific calculations. They ranged in size from minicomputers to 

mainframe systems. The microprocessor enabled computer engineers 

to develop smaller microcomputers that had enough computing power to 

perform many kinds of business, industrial, and scientific tasks. The 

large demand for microprocessors led to high-volume production and a 

dramatic reduction in cost, which promoted their use in many other 

applications (including household appliances and automobiles). 

Continued advances in integrated circuit technology gave rise to very-
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-4 

large-scale integration (VLSI), which substantially increased the circuit 

density of microprocessors. This technological advance, coupled with 

cost reductions from improved manufacturing methods, made feasible 

the mass production of personal computers (Britanica, 2001). 

By the 1980s, microprocessors had stimulated computerization of a 

variety of consumer products, including programmable microwave ovens 

and thermostats, clothes washers and dryers, self-tuning television sets 

and self-focusing cameras, videocassette recorders and video games, 

telephones and answering machines, musical instruments, watches, and 

security systems. Since the 1980s, microprocessor-based equipment 

has also proliferated, ranging from automatic teller machines and pointof-sale terminals in retail stores to automated factory assembly systems, 

communications equipment, and office workstations (Britanica, 2001). 

 5.1.2 Electronics Manufacturers 

Table 5-2 lists the largest electronics manufacturers. These firms 

generated almost $664 billion in total revenue and employed over 2.5 

million people in 2003. The top five electronics manufacturers alone 

produced over $380 billion in total revenue and employed nearly 1.4 

million people. 

 5.2 COMPUTER AND PERIPHERAL EQUIPMENT

The production of a personal computer (PC) requires interaction and 

coordination among industry participants throughout the manufacturing 

cycle. Computers consist of thousands of discrete components, 

systems, and accessories that must function together as an integrated 

unit. These components and subsystems are typically designed and 

manufactured by numerous companies that are members of a complex 

supply chain. The supply chain companies must coordinate their 

activities to ensure that the finished product functions according to 

design goals. 

 5.2.1 The Anatomy of a Microcomputer 

A computer performs high-speed mathematical or logical calculations 

and assembles, stores, correlates, or otherwise processes coded 

information in accordance with predetermined software programs 

(Petska-Juliussen and Juliussen, 1996). The structure of a PC is 

complex. A typical PC consists of thousands of parts and peripherals 

(both interacting and external) that must be designed to be compatible 
Section 5 — The Electronics Supply Chain 

5-5 

Table 5-2. Largest Electronics Firms 

Company Name 

2003 Total Revenue 

($million)a

2003 Number of 

Employees 

International Business Machines Corporation (IBM) 89,131.0 255,157 

Siemens 86,467.0 417,000 

Hewlett-Packard Company 73,061.0 141,000b

Hitachi 69,343.0 320,528 

Sony 63,264.0 161,100 

Matsushita Electric Industrial 61,681.0 288,324 

Toshiba 47,191.8 165,776 

NEC 39,788.4 145,807 

Fujitsu 38,529.1 157,044 

Koninklijke Philips Electronics N.V. 36,505.0 164,438 

Intel 36,141.0 79,700 

Motorola 37,068.0 97,000b

Lucent Technologies 8,470.0 34,500 

aIncludes revenue from software sales and services. 

bRevenue and number of employees in 2002 values. 

Source: Hoovers Online. 2004. Available at <http://www.hoovers.com. 

with other hardware and software drivers. There are three major types of 

computer peripherals: mass storage devices, output devices, and input 

devices. Mass storage devices store data, both temporarily and 

permanently, as well as software programs. Output devices display the 

results of computer calculations. Finally, input devices are used to enter 

data into a computer system. As shown in Figure 5-1, a PC comprises 

several major systems, each of which contains many subsystems, 

components, and interfacing parts (e.g., microprocessor ICs, memory 

ICs, discrete devices, and wires). Similarly, external peripheral devices, 

such as a mouse and monitor, consist of multiple parts and subsystems 

that must work together. Consequently, we view production of 

peripherals and their incorporation into a finished computer system as 

integral parts of the computer supply chain.
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-6 

Figure 5-1. Computer Components 

Bus

Memory

(RAM)

Cache

Data

Cache

Processor

Input/

Output

(Port)

DIMMS (Direct Inline Memory Modules)

Video Card

Sound Card

Hard Drive

Interacting CPU Peripherals:

• Keyboard • Communication Interface (modem) • Floppy Disk

Mouse

Speakers,

Printers

Monitor

Magnetic Tapes

BIOS-ROM

Clock

Plastic Casing

Power Unit

2 Types (IDE offers more peripheral ports):

• IDE (Integrated Drive Electronics) • SCSI (Small Computer Systems Interface)

Motherboard

(CPU, central processing unit)

Fan CD-ROM

Source: Englander, Irv. 1996. The Architecture of Computer Hardware and Systems Software. New York: John 

Wiley & Sons, Inc. pp. 12, 170, 305. 

 5.2.2 Computer and Peripheral Products Supply Chain 

The computer and peripheral supply chain maintains a complex network 

of relationships between customers and suppliers. OEMs design and 

produce only a few of the hundreds of parts and accessories that make 

up a finished product. Many OEMs contract out manufacturing and other 

functions to electronics manufacturing service (EMS) firms. Both OEMs 

and EMS firms procure most parts and accessories from Tier 1 suppliers. 

Tier 1 suppliers can in turn outsource to subtier suppliers. A company’s 

position in the supply chain may differ depending on the part and the 

customer. A Tier 1 supplier of integrated circuits to one OEM may be a 

subtier supplier of other parts to the same or other OEMs or EMS firms. 

Figure 5-2 demonstrates a simplified representation of the computer 

industry supply chain. 
Section 5 — The Electronics Supply Chain 

5-7 

Figure 5-2. U.S. Computer Manufacturing Supply Chain 

A rapidly evolving supply chain leads from raw materials to the final consumer. 

Infrastructure

Suppliers

• Hardware

• Software

• Manufacturing

Equipment

• Logistics

Original Equipment

Manufacturers

Electronics

Manufacturing

Services Providers

Semiconductor

Manufacturers

Other Component

Makers

Dealers Final

Consumers

Components

Chips

Systems

Complete Units

Computers Dealer

Sales

Direct Sales

(Web, Telephone)

 5.2.3 Computer and Peripheral Products Trends 

The PC industry has been characterized for some time as a leader in 

very short product life cycles, rapid time-to-market, high material cost 

content, low margins, and increasing functionality. Widespread 

competition and widely available core technology means that no 

company can maintain a price advantage for long. In fact, sales prices 

for new PC models have typically dropped 1 to 2 percent per week after 

market introduction. The recent slowdown in the PC market implies that 

price erosion behavior is expected to continue for some time. 

As a result of these characteristics, PC manufacturers have adopted one 

or more of the following manufacturing strategies: 

• outsourcing to EMS firms, for manufacturing of printed circuit 

assemblies (PCA), assembly of finished systems (“box build”), or 

both; 

• outsourcing to Original Design Manufacturer (ODM) companies 

that provide turnkey final assemblies (this outsourcing method is 

very common with notebook PCs, primarily through Asian ODM 

companies); 

• build to order and mass customization; 

• configure to order; 

• global sourcing and supply; and 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-8 

• inventory reduction (especially important in a business with high 

material content and significant price erosion). 

Outsourcing. “PC companies” are increasingly focusing on services, 

such as advertising and product development, in which they possess a 

clear competitive advantage. There are essentially four outsourcing 

models in use today within the PC industry (see Figure 5-3). First, some 

of the large OEMs still maintain at least part of their PCA manufacturing 

internally (lower left corner of the diagram). Second, there is an 

increasing move to EMS outsourcing (lower right). Third, some firms 

prefer to keep manufacturing in-house while contracting design and/or 

sales operations. Finally, there have been many successful examples of 

outsourcing entire products to ODM companies (upper right). The supply 

chain implications for these three models are very different. 

Figure 5-3. Outsourcing Models within the PC Industry 

• Contracted design, or sales

of complete designs (e.g.,

Intel PC motherboards)

• Traditional OEM

manufacturing business

model

• Traditional EMS model

• ODM model for custom

components or assemblies

• Purchase of standard, offthe-shelf parts

External

Internal

Internal External

Design

Manufacturing

Outsourcing to EMS Providers. Many PC companies began operation 

with no internal PCA manufacturing (e.g., Dell, Gateway, and Micron 

Electronics) and have consistently used EMS firms for the supply of 

printed circuit assemblies PCAs. Recently, most of the other PC 

companies (e.g., Compaq, IBM, HP) have decided to follow the same 

strategy for at least part of their business. Cellular phone manufacturers 

(e.g., Motorola, Ericcson, Nokia) appear to be following the same path. 

In 2000, Bear Stearns projected that 70 percent of total value added 

would be outsourced by 2005 (Bear, Stearns & Co. Inc., 2004). A few of 
Section 5 — The Electronics Supply Chain 

5-9 

the important characteristics of this business model from a supply chain 

standpoint are as follows: 

• The OEM usually maintains control of the design of the board, 

including the approvals for changes to the approved vendor list 

(AVL) for all components used in the manufacture of the board. 

Infrequently, the EMS provider is given approval to make 

changes to certain classes of components on the board without 

approval, but this has been generally limited to less expensive 

commodity components. 

• The selection of the EMS manufacturer of the board is frequently 

made late in the design process, providing limited opportunities 

for the EMS provider to give recommendations on design for 

manufacturing (DFM) or design-for-supply-chain changes. 

• Supplier management responsibilities are frequently split between 

the OEM and the EMS (they sometimes overlap). 

• The manufacturing and test process is frequently designed, 

controlled, and maintained by the OEM, and then provided to the 

EMS company for execution. Production test hardware and 

software are routinely provided by the OEM. In fact, it is not 

uncommon to see fully dedicated lines within the EMS factories 

(i.e., these lines are only intended to build boards for one OEM 

customer). 

• Ownership of defective products is not always clear, because it is 

not always easy to separate a design-related failure from a 

manufacturing execution-related one. Consequently, the OEM 

has much more interest in monitoring daily production defect 

rates than it would with another type of supplier. 

These characteristics, as well as the fact that few standards exist, 

combine to create a supply chain environment that is exponentially more 

difficult to manage than the traditional internal manufacturing structures. 

Outsourcing to ODM Companies. ODM outsourcing means that the 

ODM provider owns the product design, sourcing, assembly, and testing. 

These are custom products that are designed to match an OEM 

customer’s overall product specification. The specification usually 

remains at a form, fit, and function level, and decisions regarding how to 

achieve these results (either in product design, procurement, or in 

manufacturing) nearly always rest with the ODM. 

The ODM outsourcing model has been used within the electronics 

industry for years, and is also common in other industries, such as 

automotive and defense. Within the PC industry, a few early examples 

of this outsourcing were in the areas of power supplies, option cards, 

keyboards, and displays. In the last 8 years, this outsourcing model has 

become increasingly common for entire PCs, especially notebook PCs. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-10 

All of the major PC manufacturers in the United States have adopted this 

practice for some or all of their notebook production. 

The important characteristics of outsourcing to ODMs from a supply 

chain standpoint are the following: 

• The ODM has virtually complete autonomy in decisions around 

the design of the product, the sourcing of raw material, the 

manufacturing, and the product testing. In fact, it is not unusual 

for the ODM to follow design or manufacturing practices that 

would not be allowed within the OEM customer’s own design or 

manufacturing operations (or in their EMS outsourcing). 

• The ODM is involved from the beginning of the development 

process, and owns all aspects of the product design and the 

manufacturing process. The ODM also owns most of the 

component supply chain, although certain components are 

occasionally selected and controlled by the OEM customer. 

• The ODM exclusively handles supplier responsibilities. 

• The ODM nearly always has complete control of the 

manufacturing and test process. 

• Ownership of defective products nearly always belongs to the 

ODM. In terms of supplier quality management, the OEM 

generally treats the ODM as they would any other supplier. 

Obviously, the ODM outsourcing model has a much simpler supply chain 

structure than the EMS outsourcing model. There are some indications 

that OEM companies are moving more toward the ODM model for 

products that had previously been built by EMS providers. 

Build to Order, Configure to Order, and Mass Customization. To 

reduce levels of finished goods in the supply chain, PC companies have 

been implementing production systems in various versions of configure 

to order. Common terms for these systems are “build to order” (BTO), 

“configure to order” (CTO), “mass customization,” and “postponement 

manufacturing.” While these terms are frequently defined differently 

across the industry, the goal is the same—to reduce the inventory 

between the manufacturer and the end customer. In building standard 

Stock Keeping Units (SKUs) for the retail market, this would likely imply a 

strategy of building those standard units in small batches in a highly 

responsive manner (short lead times and dependable supply times). In 

building for a specific customer (e.g., in direct sales), this probably 

means building the final unit after the customer orders it, including 

customizing it to that specific customer’s needs. The issues and 

opportunities associated with these strategies will be discussed in more 

detail in a later section. 
Section 5 — The Electronics Supply Chain 

5-11 

Inventory Reduction. Given the combined pressures of short product 

life cycles, rapid time-to-market, and significant price erosion, effective 

inventory management is a critical success factor for the industry. Dell 

has set the standard in this area for years, and has recently dropped 

their total inventory to a low of 5 days.13 In addition to improving the 

management of material within the manufacturing supply chain, 

companies are also focused on reductions in raw material through 

strategies such as supplier hubs and vendor-managed inventory (VMI). 

Companies are also focused on reductions in the distribution channel 

through strategies such as BTO, CTO, and direct sales to customers. 

For example, an OEM selling computers through traditional channels has 

an added burden of inventory obsolescence and price erosion in the 

channel (another 4 to 8 weeks of inventory)—a penalty that is not a 

factor for direct OEM sales to the end customer. 

Global Sourcing and Supply. Given the characteristics already 

discussed, global sourcing and supply is a natural requirement. The 

general philosophy in the PC industry is to build as much of the product 

as possible in or near the target market. Additionally, developing regions 

of the world frequently offer much lower labor rates, as well as other 

financial investment incentives. Consequently, the large EMS 

companies have all undergone significant global expansion, and this 

trend is likely to continue. One implication of this global expansion is that 

applicable operating standards must be worldwide in scope. 

 5.2.4 Computer and Peripheral OEMs 

The producers of finished products in computer and peripherals 

manufacturing, also called “boxmakers,” include IBM, Hewlett-Packard, 

Dell, Compaq, Sun Microsystems, Apple, and many others. As noted 

earlier, OEMs typically contract out manufacturing so that they can focus 

on product development and marketing. Table 5-3 illustrates the total 

revenue, revenue generated from hardware sales, and employment 

figures for several major U.S. computer and peripheral manufacturers in 

2003. 

 

13Dell Earnings Announcement, February 15, 2001. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-12 

Table 5-3. Major Microcomputer and Peripherals OEMs 

OEM 

2003 Sales 

($million)a

2003 Hardware 

Sales ($millions) 2003 Number of Employees 

IBM Corporation $89,131 $27,456a 355,421a 

Hewlett-Packard $73,061 $59,230 142,000 

Dell Computer $41,444b N/A 39,100 

Cisco Systems, Inc. $18,878 N/A 34,000 

Xerox $14,704 N/A 61,100 

Apple Computer, Inc. $6,207 N/A 10,912 

Sun Microsystem $11,434 36,100 

3Com Corporation $932.9 3,300 

a2002 information used. 

b2004 information used. 

Source: Hoovers Online, 2004. Available at <http://www.hoovers.com>. 

Tier 1 Suppliers. The Tier 1 of the supply chain consists of several 

hundred companies. Each supplier, depending on its size and diversity, 

produces a variety of products, including casing for electronics products, 

subassemblies, and peripheral equipment. Many of the larger 

companies have several divisions and sites and are responsible for 

producing several parts, systems, components, and accessories. Many 

suppliers are also increasingly manufacturing complete modules to OEM 

specification. Therefore, sharing data throughout the product life cycle 

has become an important feature of a Tier 1 supplier’s operations. 

The firms that provide electronics manufacturing services within the 

electronics industry have exploded in importance within the past 4 or 5 

years. These largely unknown firms, including Solectron and Flextronics, 

consider their core competency to be management of high-volume, lowcost fabrication and assembly operations. Expanding out of an initial 

niche producing assembled, or “stuffed,” printed circuit boards for OEMs, 

they have gained enough expertise and credibility to begin taking over 

the entire assembly process. In 1999, EMS firms sold services worth an 

estimated $28.1 billion (Lee, 2000); in 2003, the combined revenue of 

Flextronics, Solectron, and Sanmina-SCI was over $34 billion (Hoovers 

Online, 2004). 

While OEMs are disaggregating many manufacturing processes, many 

contract electronics manufacturers are becoming more vertically 
Section 5 — The Electronics Supply Chain 

5-13 

integrated. For example, Sanmina acquired Hadco Corporation, 

Interworks, and Nortel Networks Enterprise Design Services Operations 

(Sanmina, 2001). Researchers have estimated that there were more 

than 100 mergers, acquisitions, and strategic alliances between contract 

electronics manufacturers and other companies in 1999 (Advanced 

Manufacturing, 2000). Many EMS providers have also begun to contract 

out portions or all of their manufacturing process, allowing them to focus 

on core competencies. Many EMS providers have also outsourced 

inventory management and flow to electronics distributors and other 

infrastructure contractors. These supply chain management programs 

are often employed by start-up manufacturers because they do not have 

the resources to manage components and inventory (Carbone, 2000). 

Table 5-4 provides a list of the largest EMS providers. 

Table 5-4. Largest EMS Providers 

EMS 

2003 Total 

Revenue 

($million)a

2003 Number 

of Employees Primary Manufacturing Services 

Flextronics International 

Ltd. 

$ 13,378.7 95,000 Design, manufacturing, and distribution 

services 

Solectron Corporation $ 11,014.0 66,000 Product design and prototyping, printed 

circuit board and systems assembly, and 

repair services 

Sanmina-SCI Corporation $10,361.4 45,008 Multilayered printed circuit boards, 

backplanes, cables, and complete systems 

Celestica Inc. $ 8,271.6b 40,000b Complex printed circuit assemblies and 

systems 

Benchmark Electronics, 

Inc. 

$ 1,630.0b 6,380b Complex PCBs and other electronic 

subsystems 

Plexus Corp. $ 807.8 4,800 Product design and engineering, circuit 

board assembles, integrated circuits, 

memory chips, and other electronic 

components 

IEC Electronics Corp. $ 48.2 182 PCBs and electronic assemblies 

Jabil Circuit, Inc. $ 43.0 26,000 PCBs and other electronic components 

and systems 

aIncludes revenue from software sales and services. 

bIn 2002 values. 

Source: Hoovers Online. 2004. Available at <http://www.hoovers.com>. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-14 

Subtier Suppliers. The subtiers of suppliers consist of thousands of 

smaller companies that work with OEMs indirectly via other suppliers. 

The subtier companies that have no direct OEM business are relatively 

small companies that supply integral components or modules to the 

Tier 1 without having many interactions with the OEMs. Table 5-5 lists a 

few of the larger subtier suppliers and their total sales, including 

nonhardware sales. 

Subtier suppliers often work for multiple OEMs. For example, Intel 

supplies CPUs to virtually every microcomputer manufacturer, including 

Dell Computer Corporation, Gateway Inc., NEC Corp., IBM Corp., and 

Hewlett-Packard Company. 

Semiconductor Suppliers. The integrated circuits that control 

computation (i.e., CPUs), display, memory, input/output, and other 

functions are the most expensive components. Further, their proper 

operation is the most critical for the performance of the finished computer 

system. The major suppliers of these semiconductor chips are large, 

economically powerful firms such as Intel, Motorola, and Texas 

Instruments. Maintenance of logistics and communications linkages 

between the semiconductor suppliers and EMS suppliers and/or OEMs is 

one of the key requirements of the computer industry’s supply chain 

integration. Intel is the largest of the semiconductor suppliers, with about 

$30 billion in 2003 sales, but hundreds of smaller chips suppliers 

interface with the supply chain in the same way as the giants. 

Other Component Suppliers. A computer is not nearly as complex a 

machine as an automobile; computers contain hundreds of unique parts 

versus thousands in the case of autos. Nonetheless, suppliers of 

internal drives, modems, transistors, diodes, power supplies, housings, 

and even knobs and lights are an important part of the supply chain. An 

unexpected shortage in production of any of these components could 

easily shut down production of finished computers, resulting in customer 

dissatisfaction and lost sales. Some component suppliers, such as data 

storage makers Seagate Technology and Quantum, are Fortune 500 

companies, while many others are quite small in terms of sales and 

employment. 

Infrastructure Suppliers. As is the case in the automotive sector, a 

number of infrastructure suppliers provide manufacturing equipment, 

hardware, and software to the various segments of the computer industry 

supply chain. The infrastructure suppliers may be focused on a single 
Section 5 — The Electronics Supply Chain 

5-15 

Table 5-5. Characteristics of Prominent Subtier Suppliers 

Subtier suppliers tend to be smaller and supply various parts to Tier 1 suppliers. 

Company Name 

2003 Worldwide 

Sales 

($millions) Primary Products 

Intel $26,764.0a PC microprocessors, flash memories, 

embedded chips 

Texas Instruments, Inc. $ 8,383.0a Digital signal processors, analog ICs, digital 

ICs, logic chips, microprocessors, 

microcontrollers 

Micron Technology, Inc. $ 3,091.3 DRAMs, flash memory, Rambus DRAM, 

Synchronous DRAM products 

Advanced Micro Devices, Inc. $ 2,697.0a PC microprocessors, embedded chips, 

nonvolatile memories 

Molex Incorporated $ 1,843.1 Plugs and other connectors 

Vishay Intertechnology, Inc. $ 1,822.8a Capacitors and resistors, diodes, 

optoelectronics, transistors 

National Semiconductor Corp. $ 1,672.5 Analog chips, SOC components 

Amkor Technology, Inc. $ 1,639.7a Packaging and test services 

AVX Corporation $ 1,134.1 Passive electronic components 

Winbond Electronics Corp. $ 917.8a Data communication, memory, 

microcontrollers, multimedia, PCs, speech, 

telephony, visual communication ICs 

International Rectifier Corp. $ 864.4 MOSFETs (metal oxide semiconductor fieldeffect transistors), diodes, and rectifiers 

Creative Technology, Ltd. $ 701.8 PC sound cards, graphics accelerator cards, 

MP3 players, PC multimedia upgrade kits 

MEMC Electronic Materials, Inc. $ 687.2a Silicon wafers 

KEMET Corporation $ 447.3 Tantalum and multilayer ceramic capacitors 

Technitrol, Inc. $ 406.4a Electrical contacts and assemblies 

Methode Electronics, Inc. $363.1 Connectors, current carrying distribution 

systems, and automotive electronic controls 

DuPont Photomasks, Inc. $ 323.1 Photomasks 

Entegris, Inc. $ 248.8 Wafer carriers, storage boxes, fluid 

management components, and transport 

systems 

BMC Industries, Inc. $ 248.1a Aperture masks, photo-etched and 

electroformed products 

Advanced Energy Industries, Inc. $ 238.9a Conversion and control products 

FSI International, Inc. $ 88.8 Microlithography systems 

Kopin Corporation $76.8a Gallium arsenide wafers 

aIn 2002 values. 

Source: Hoovers Online. 2004. Available at <http://www.hoovers.com>. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-16 

level in the chain, as is the case with semiconductor equipment 

manufacturers, or they may support components makers, EMS 

providers, and OEMs. With the rapid pace of technological change and 

short product life cycles that define the electronics industry in general, 

these firms must maintain close working relationships with both R&D and 

manufacturing functions in the firms they support. A great deal of 

commonality in technology across the electronics sector ensures that 

infrastructure suppliers work within many of the subsectors, as well as in 

less closely related industries. 

 5.3 COMMUNICATION EQUIPMENT INDUSTRY 

The communication equipment industry comprises companies 

manufacturing wire telephone and data communications equipment, 

radio and television broadcast devices, wireless communications 

equipment, and other manufacturing communications equipment. An 

important focus of this study is the supply chain for the development and 

integration of routers and other computer network hardware, which are 

key components in communications equipment. 

Communication equipment products may be stand-alone or board-level 

components of a larger system. In 2003, the value of shipments for 

communication equipment totaled $125 billion. Table 5-6 lists total value 

of shipments for the different sectors within the communication 

equipment industry. The two largest segments of this industry, 

communication systems and equipment and other telephone and 

telegraph equipment and components, constitute over 70 percent of the 

communications industry. 

The largest segment of the industry is communication systems and 

equipment, accounting for 50 percent of total communication equipment 

sales. This sector includes equipment for amateur, meteorological, fixed, 

telecommand, telemetry, radionavigational and locational, and 

aeronautical communications; and mobile radio and microwave signals. 

Communication systems and equipment also includes antenna systems, 

fiber optics, and other carrier equipment. However, this industry tends to 

be more monolithic and less dynamic than other sectors in the 

communications equipment industry. 
Section 5 — The Electronics Supply Chain 

5-17 

Table 5-6. Shipment Values for Communications Equipment Industry 

NAICS 

Code Description 

2002 

Shipments 

($106) 

1997 

Number of 

Employees 

3342101 Telephone switching and switchboard equipment 7,368 26,268 

3342104 Carrier line equipment and modems 4,730 22,334 

3342107 Other telephone and telegraph equipment and components 17,648 52,961 

3342201 Communication systems and equipment (except broadcast) 25,600 122,654 

3342203 Broadcast, studio, and related electronic equipment 3,300 21,187 

3342903 Intercommunications systems, including inductive paging 

systems (selective calling) 

367 1,519 

3342901 Alarm systems 2,993 13,790 

3342902 Vehicular and pedestrian traffic control equipment and 

electrical railway signals and attachments 

808 6,901 

3342 Communication Equipment Manufacturing 62,813 267,614 

Sources: U.S. Department of Commerce. 1999b. 1997 Economic Census. EC97M-3342A through EC97M-3342C. 

Washington, DC: U.S. Government Printing Office. 

U.S. Department of Commerce. 2003. Current Industrial Reports. Communication Equipment. MA334P(02)-1. 

Washington, DC: U.S. Government Printing Office. 

Accounting for over 20 percent of total sales, the second-largest 

segment in the communication equipment industry is other telephone 

and telegraph equipment and components. Other telephone and 

telegraph equipment and components includes telephones, data 

communications, voice frequency and voice call message processing, 

facsimile communication, and other telephone and telegraph equipment. 

In 1999, data communications equipment14 made up over 69 percent of 

total other telephone and telegraph equipment and components, and in 

the same year networking equipment sales grew 17 percent to $37 billion 

(U.S. Business Reporter, 2000). However, communication network 

manufacturers’ shipments dropped approximately 23 percent between 

1999 and 2002. 

 5.3.1 Definition of a Computer Network 

A computer network is a group of two or more computer systems linked 

together. There are several different types of computer networks, 

including local-area networks (LANs) and wide-area networks (WANs). 

Computers in a LAN are geographically close together, whereas 

 

14Data communications equipment consists of routers, gateways, bridges, terminal 

servers, concentrators, and other networking equipment. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-18 

computer systems in a WAN are farther apart and connected by 

telephone lines or radio waves. Computers connected to a WAN are 

often linked through public networks, such as the telephone system. 

They can also be connected through leased lines or satellites. The 

largest WAN in existence is the Internet. There are three types of 

networks: converged, wireless, and broadband. A converged network 

transmits voice, data, and video over a single network. Wireless 

networks transmit voice and data traffic over wireless networks. 

Broadband networks are primarily used to transmit data traffic through 

the Internet. Equipment for broadband includes cable modems, digital 

subscriber lines (DSL), satellites, and fiber optics (U.S. Business 

Reporter, 2000). Figure 5-4 illustrates a simplified network and some of 

the computer networking hardware involved. 

Table 5-7 defines some of the hardware used in the computer 

networking industry. Routers, the largest segment of the industry, are 

specialized computers that determine the best route for data packets 

over a network and offer enhanced security for the data. Cisco Systems 

maintains 75 percent of the router market. Switches offer a faster 

alternative but lack the security features of a router. With the 

development of low-cost switching devices, the importance of routers in 

networking is waning (U.S. Business Reporter, 2000). 

 5.3.2 Computer Networking Current Trends15

From 1999 to early 2001, most major telecommunications hardware 

producers divested manufacturing to EMS providers. In 2000, Nortel 

Networks divested PCB assembly and repair services to Solectron. The 

4-year supply agreement, valued at over $10 billion, is the largest 

outsourcing relationship to date (Nortel, 2000). At the same time, Nortel 

Networks switched from their traditional, in-house distribution process to 

third-party logistics and transportation contractors (Zuckerman, 2000). 

Other telecommunications hardware producers that have recently 

outsourced production include Lucent Technologies, CISCO Systems, 

and Nortel Networks. 

 

15 The information in the next few subsections was provided by Rodney Walker of Altus 

Consulting, a subcontractor to RTI on this project. 
Section 5 — The Electronics Supply Chain 

5-19 

Figure 5-4. Network with Router 

Hub Router Hub

Internet

Table 5-7. Hardware Used in Computer Networking Industry 

Hardware Type Definition 

Hubs • Concentrate network signals from many devices 

• Track MAC addresses and route packets to destinations (intelligent hubs only) 

Repeaters • Connect similar types of networks together 

• Perform simple signal amplification takes place 

Bridges • Connect different types of networks together 

• Translate network packets from one network type to another 

Routers • Direct traffic to its destination 

• Implement delivery policies 

Switches • Filter and forward packets between LAN segments 

• Support any packet protocol 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-20 

 5.3.3 Computer Network Hardware Supply Chain 

Most companies in the computer network supply chain divest most or all 

of manufacturing and logistics to EMS firms. The OEM’s role is to define 

products and fulfillment processes, marketing, customer interfaces, 

research and development, and management of information flow across 

the supply chain. Figure 5-5 illustrates a simplified network hardware 

industry supply chain. In some cases, the OEM takes on the role of the 

installer. 

Figure 5-5. Simplified Network Hardware Industry Supply Chain 

Supplier A

Suppliers

B, C, D

Supplier E

Supplier F

Distributor

Contract

Manufacturer

Installer

"OEM"

Customer

Key

Product

Order

Computer Network OEMs. Many of the computer networking 

equipment OEMs are the same as the computer and peripheral 

equipment OEMs. These OEMs generated over $45 billion in total 

revenue and employed 131,948 people in 2003; however, since 1999, 

sales figures have dropped by almost 35 percent and employment has 

decreased by 38 percent. Table 5-8 lists employment and sales figures 

for the largest computer network OEMs. The top five networking 
Section 5 — The Electronics Supply Chain 

5-21 

Table 5-8. Large Computer Network OEMs 

Company 2003 Sales ($106) 

2003 Number of 

Employees 

Cisco Systems, Inc. $ 18,878 34,000 

Nortel Networks Corporation $10,560a 36,960a

Lucent Technologies, Inc. $ 8,470 34,500 

Avaya Inc. $4,338 16,900 

3Com Corporation $933 3,300 

Brocade Communications Systems, Inc. $ 562a 1,332a

Juniper Networks, Inc. $ 547a 1,542a

Adaptec, Inc. $ 408 1,527 

MRV Communications, Inc. $ 253a 1,400a

Terayon Communication Systems, Inc. $129a 487a

Total $45,078 131,948 

aIn 2002 values. 

Source: Hoovers Online, 2004. Available at <http://www.hoovers.com>. 

hardware manufacturers produced $43 billion in total revenue and 

employed 125,660 people. Similar to the computer and peripheral 

industry, competitive pressures have led networking hardware 

manufacturers to outsource most of their subassembly and final product 

assembly to EMS providers. This outsourcing leaves computer 

networking hardware firms with R&D, market development, and sales 

functions, in addition to overall control of the supply chain. 

Computer Networking Subtier Suppliers. Because of the similarities 

of the input parts and components of the PC and computer networking 

equipment, subtier suppliers are largely the same for both industries. 

Similarly, computer-networking equipment shares other subtier suppliers 

with the computer industry. For example, IBM produces ASIC chips 

used to produce Junipers routers. Table 5-5 provides a more complete 

listing of subtier suppliers for both industries. 

 5.4 INTEROPERABILITY ISSUES IN 

ELECTRONICS 

The trends and challenges described earlier indicate a set of important 

interoperability issues within the PC industry’s manufacturing supply 

chain. A few of the more important issues are 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-22 

• inventory management in a distributed supply chain, 

• time-to-market, 

• efficiency, 

• BTO/CTO support, and 

• partnering vs. standards. 

 5.4.1 Inventory Management 

The essential challenge of inventory management is having just enough 

material at the right time. The penalties of not having enough material 

are missed customer commitments, lost revenue opportunities, lastminute revisions to production plans, and overall reductions in factory 

performance. The penalties of having too much material are increased 

working capital requirements, write-downs in inventory value, and the 

increased potential for ultimate material obsolescence. Obviously, 

neither state is desirable, but companies generally operate under the 

belief that too much material is better than not enough. At the same 

time, OEMs have been trying for years to reduce their inventory levels. 

In the PC industry, the material cost is 60 to 80 percent of the purchase 

price of the unit. Small improvements in inventory management can 

create positive results at the bottom line. 

As more OEMs have outsourced manufacturing to EMS companies, 

inventory management has become increasingly difficult, but no less 

important. A few of the key factors in this new environment are 

• unique material, 

• reduced visibility of the demand, and 

• less capable information systems across the supply chain. 

Many of these are well-known issues in inventory management, but the 

trends in the industry have increased their importance. 

Inventory Management—Unique Material. At a board level within the 

PC industry, a large number of components (resistors, capacitors, 

connectors, etc.) are standard within the industry and among customers 

(see lower left quadrant of Figure 5-6). Standard inputs allow the EMS 

supplier to share inventory across multiple products. Unfortunately, 

although the majority of components on the board are fairly standard, the 

highest-cost components tend to be unique to either the customer or the 

customer’s specific product (top half of Figure 5-6). If the unique 

component is inexpensive, the logical strategy is to always over-buy. 
Section 5 — The Electronics Supply Chain 

5-23 

Figure 5-6. Inventory Uniqueness 

Industry “Special”— 

Custom and/or 

Proprietary 

Examples: Some ASICs; some PC 

motherboards; many option boards 

Risky for a supplier to hold, since it is 

unique to a customer. Risk mitigated 

some by the fact that other products 

could use the material. 

Information management important, 

especially for high-dollar parts. 

Examples: LCD panel on a notebook 

PC; some ASICs; raw PC board 

Extremely risky for a supplier to hold, 

since there are no other customers for 

the material. Good candidate for a 

BTO/CTO strategy at the suppliers. 

Critical information management 

requirements. 

Industry Standard— 

One that Other 

Customers Are 

Likely to Use 

Examples: Many components, 

including commodity passive 

components; Intel processors and 

chipsets early in the cycle 

Low inventory risk—surpluses can be 

sold to other customers. Best candidate 

for vendor-managed inventory 

programs. 

Lowest IM criticality. 

Examples: Components that are 

near the end of their production life, 

such as last-generation processors 

and memory 

High inventory risk. Frequently 

managed through one-time “lifetime 

buys.” 

Information management important, 

especially for high-dollar parts. 

 Customer Standard—One They Are 

Likely to Use on Another Product 

Customer “Special”—One They Are Not

Likely to Use on Another Product 

However, these components tend to be expensive, and they can become 

a significant liability for the manufacturer. Unused material at the end of 

the production life can sometimes be allocated for field service 

requirements, but the rest is scrap. Effectively managing this type of 

material has always been a challenge for the OEM, and it is worse in the 

EMS outsourcing environment, where the visibility is much lower. 

Inventory Management—Reduced Demand Visibility. Sales forecasts 

in the PC business are never accurate. There are examples of products 

that were never profitable just because the forecast was too high, and 

there are numerous examples of successful products that gave up a 

potentially dominant market position because the forecast was too low. 

For years, OEMs have worked to improve the accuracy of their forecasts, 

but it is still considered by most to be a significant issue. 

Outsourcing has aggravated an already challenging situation. Within an 

OEM, improvement teams have focused on tactics such as shortening 

the forecast-to-execution loop (to reduce delays as well as to minimize 

the multiple levels of management judgment of the forecast), improving 

the information systems, and implementing VMI and BTO systems. One 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-24 

of the keys to making all of this work is an effective and well-connected 

information management system. 

These systems have been challenging enough to implement within the 

large OEMs, and are more difficult to achieve with multiple EMS 

companies that are running on different systems. 

Inventory Management—Less Capable Information Systems. Within 

the last 6 or 7 years, most large OEMs began projects to rebuild their 

internal planning systems using software from SAP, Baan, i2, 

Manugistics, and many others. The scope of these planning systems 

can be enormous, as shown by the diagram (Figure 5-7) of typical 

information flows. For the information flows that are within an enterprise, 

it can be a difficult but achievable project to define the desired business 

processes, system transactions, and reporting. It can be much more 

difficult for flows that go outside of the enterprise, as in the case of 

outsourcing PCA manufacturing to multiple EMS companies. 

Fortunately, much work has already been done in the areas of EDI 

among suppliers, manufacturing, and distribution. 

Figure 5-7. Typical System Information Flows 

Sales

Planning and

Procurement Suppliers

Final

Assembly

Distribution

PCA

Manufacturing

Process

Engineering

Product Design

and Sust Marketing
Section 5 — The Electronics Supply Chain 

5-25 

It is unclear how successful these internal projects have been. Several 

large OEMs have announced that they have abandoned or restructured 

their projects. The outsourcing that has occurred in parallel within many 

of these companies has clearly aggravated the situation. 

One of the larger challenges in implementation within a company is the 

“change management” aspect of getting an entire company to define and 

adopt a new set of processes. By outsourcing a key part of the overall 

operation, this issue becomes much larger in scope. Interfaces to 

different systems can be developed, but each one adds a new layer of 

complexity to an already complex system. There must be a core set of 

interoperability standards across the supply chain, and organizations 

such as NEMI, IPC, RosettaNet, and others are working to put them in 

place. Given the difficulties that OEMs have had within their own 

companies in developing and implementing standards of this type, the 

challenge in implementing them across an entire industry is enormous. 

However, these standards are absolutely essential to having the right 

type of information systems. 

 5.4.2 Time-to-Market 

As noted earlier, time-to-market is especially critical in the PC industry. 

Product life cycles have shortened to a few months, with at least one 

example of a product that had a life cycle of 2 weeks. Given weekly 

price erosion in the range of 1 to 2 percent, a large percentage of the life 

cycle profit is made within the first few weeks after product introduction. 

The manufacturer must get the new product to market as quickly as 

possible, and then ramp production volumes up rapidly to meet market 

demand. 

OEMs have focused on time-to-market improvements for years. A 

primary area of focus has been to improve the participation of 

manufacturing in the design process to avoid issues that might delay or 

limit production at introduction. Over 10 years ago, the problem was 

frequently described within the industry as design “throwing the product 

over the wall” to manufacturing. Within the last 10 years, OEMs have 

made significant progress in removing the old barriers between design 

and manufacturing. These improvements have resulted in product 

designs that were much more likely to be ready for manufacturing, and 

vice-versa. 

Unfortunately, the move to EMS outsourcing has created new barriers 

between manufacturing and design. These organizations are now parts 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-26 

of two different companies, the manufacturing standards are unknown, 

and the EMS selection decision is frequently not made until late in the 

design cycle. In addition, there are new problems regarding simple 

communications between the OEM’s design organization and the EMS 

company. There are few standards for communication of design data 

between the companies, and different design organizations within an 

OEM frequently have different standards. 

This inconsistency creates delays while the EMS provider translates the 

data for use in its systems, limits the amount of automated errorchecking that it can do, and generally transforms what should be an 

automated process into a manual one. All of this means that 

manufacturing is less prepared to build the product, the product is not 

necessarily ready for production, and engineering changes take much 

longer to implement. NEMI is in the process of putting together an 

industry forum on the topic, titled “The Perfect BOM.” This forum will be 

a good step in focusing industry attention on the issues, and hopefully it 

will lead to projects to define and adopt standards for communication of 

design data across the supply chain. 

A related issue is the management of ECNs and AVLs. In the normal 

model of EMS outsourcing, the OEM design organizations maintain 

control of the design (i.e., they are the originators for all ECNs and 

supplier changes). This plan adds to delays in responding to issues that 

might arise during production and creates communication issues due to 

incompatible systems between the companies. 

Interestingly, the ODM outsourcing model is much more likely to provide 

better performance in overall time-to-market and time-to-ramp. The key 

reasons are as follows: 

• The ODM company generally already has a base product design 

completed when it is selected by the OEM, and may already have 

some experience in building the product. 

• The ODM fully owns the design and can quickly detect and 

correct any design errors that arise during manufacturing start-up. 

• The critical information flows between design and manufacturing 

are all within ODM, eliminating the issue of incompatible systems. 

• The ODM has the opportunity to have manufacturing involved 

with engineering from the beginning. 

Given the lack of standards and partnering in the EMS outsourcing 

model, the ODM model has a structural advantage in the area of time-tomarket and time-to-ramp. 
Section 5 — The Electronics Supply Chain 

5-27 

 5.4.3 Efficiency 

One argument in support of EMS outsourcing is that the EMS company 

can bring more manufacturing assets to bear during peak demand 

periods, and can put those assets to use elsewhere during the periods of 

low demand. Within the PC industry, demand swings on individual 

products can be severe, as shown in Figure 5-8. 

Figure 5-8. Sample Consumer PC Demand Profile Daily Volume

Production Life Cycle

Immediately after a design’s release to production, the desire is to 

quickly ramp production up to a peak level to capture the early market 

opportunity. Following this initial surge, the demand tends to be much 

more constant throughout the remainder of the product life cycle. Near 

the end of the product’s production life cycle, production is quickly scaled 

down to clear out inventory in advance of the next product introduction 

(the dotted line in Figure 5-8). Production swings of this magnitude can 

be challenging for a manufacturer. 

At the peak of production, a manufacturer might need 10 lines of 

production, going down to 3 lines for the ongoing production period, and 

less than 1 line at the tail-end prior to the next product’s introduction. 

This effect seems to be the most pronounced on consumer retail PCs, 

but exists to some extent in the other products. Additionally, production 

is sometimes shut down due to parts shortages or product issues. In 

these cases, there is a production lull resulting in excess manufacturing 

capacity, followed by a volume spike requiring extra capacity to catch up 

after the problem has been resolved. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-28 

The EMS outsourcing model can theoretically provide more 

manufacturing flexibility than an OEM during such production swings. 

Unfortunately, this statement assumes that the production is standard 

enough that a line can smoothly switch from building products for one 

OEM to another. As noted earlier, these standards do not exist, and it is 

not uncommon for an EMS company to dedicate lines to production for 

one OEM. In this case, these potential flexibility advantages are limited 

by the amount of commonality across the production lines. It seems that 

there are only two acceptable end-states to this issue: either partnering 

between OEMs and EMS companies, or a comprehensive set of 

manufacturing standards that are used at least within an industry 

segment. 

 5.4.4 BTO/CTO Support 

BTO, CTO, engineer-to-order, and similar terms all refer to strategies 

aimed at improving responsiveness and removing inventory from the 

supply chain. Dell’s 5 days of inventory demonstrates how important 

these processes can be. Effective implementation of these systems 

requires real-time information on the availability of all subassemblies, 

including PCA boards that are being assembled by an EMS. This 

communication should ideally happen automatically to ensure timeliness 

and accuracy. 

An effective BTO/CTO system as part of a direct sales operation will 

eliminate channel inventory (which is a liability given the industry’s price 

erosion profiles), and can allow the OEM to more tightly match demand 

and supply. This need has been recognized in the industry for some 

time, but it is not clear how far companies have progressed in 

implementing solutions. Dell is probably the leader in this area, although 

it appears that the system connections with their suppliers are still more 

manual than automated. The need for BTO/CTO is likely to become 

more important during the current softening in the PC market. 

 5.4.5 Partnering vs. Standards 

Electronic OEM manufacturing organizations have historically been slow 

to see the value of standards. In the early days of Surface Mount 

Technology (SMT) manufacturing, each manufacturer believed that it 

had a competitive advantage in this area. Manufacturers tended to be 

unwilling to share information, and they had little interest in industry 

standards. For example, at one time, most large OEMs had their own 

custom formulation for solder paste. They believed that it gave superior 
Section 5 — The Electronics Supply Chain 

5-29 

results, that it gave them an edge over their competition, and did not care 

that the custom formulation was expensive and had a long procurement 

lead-time. The product also had a relatively short shelf-life, and 

companies frequently faced the decision of either shutting down 

production to wait for the next batch to arrive, or to take a risk on one of 

the standard formulations of paste. 

In the last 6 or 7 years, OEM manufacturers have become more 

interested in collaboration with their peers through organizations such as 

NEMI. This collaboration has been assisted by stabilization, in-process 

technology, and by OEMs challenging their manufacturing organizations 

to become more efficient. 

In some ways, the outsourcing trend is threatening to slow down the rate 

of collaboration. Whereas many of the OEMs eventually decided that 

manufacturing technology was no longer a competitive advantage and 

became more willing to collaborate, some companies became more 

protective. 

However, significant pressures within the industry are likely to result 

eventually in either OEM/EMS partnerships or widespread industry 

standards. The intersection points in Figure 5-9 are individual EMS sites 

and lines. As noted earlier, OEM customers generally require these 

individual sites and lines to meet their specific requirements in 

processes, systems, reporting, and so forth. At the same time, the EMS 

corporate group usually likes to have each site operate in the same way 

as other lines and sites within the company to gain flexibility and 

efficiency. (As noted earlier, it is common today for EMS companies to 

dedicate specific lines to individual OEMs in order to provide the 

“common look” desired by the OEM. This solves the problem from the 

OEM’s view, but it severely restricts the flexibility that the EMS provider 

has in shifting products across lines to match peaks and valleys in a 

product’s demand.) The current slowdown in the industry is likely to 

increase the pressure for standardization within the EMS. The squeeze 

point between the OEM customer and the EMS corporate requirement is 

the individual line, and it seems likely to result eventually in either 

partnering or some amount of industry standardization. 

Partnering can create an OEM with “virtual” manufacturing. This 

partnership between the OEM and the EMS company would allow the 

use of customer-specific processes and procedures with little penalty. 

So far, there seems to have been little willingness for OEM companies to 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

5-30 

Figure 5-9. Pressure to Standardize 

EMS Corporate View: Standardize where possible to

provide flexibility and efficiency.

OEM View:

Do it my way

my processes,

my systems,

my EDI methods,

my reports,

etc.

Individual

Lines/Sites

Nortel

Dell

Others

SolectronCelesticaSCIFlextronicsJabilOthers

partner with their EMS providers. A significant exception to this rule was 

Motorola’s decision in June 2000 to outsource manufacturing to 

Flextronics, while purchasing an equity position in Flextronics. However, 

most OEMs still appear to believe that it is beneficial to have multiple 

EMS suppliers and generally want them to follow the OEM’s rules. 

 5.4.6 Opportunities Summary 

The trend toward EMS outsourcing of PCAs has been accelerating over 

the last 6 or 7 years, and it is spreading to include other manufacturingrelated services, such as procurement and engineering. However, 

today’s structure implicitly assumes that the EMS operation would 

become a virtual part of the OEM’s operation, whereas the OEMs appear 

to have little interest in forming long-term partnerships with EMS 

companies. Without the right set of standard definitions and processes 

to allow these operations to link seamlessly, the OEMs and/or the EMS 

companies are at a competitive disadvantage to companies with internal 

manufacturing—or to OEMs that use ODM outsourcing. Figure 5-9 
Section 5 — The Electronics Supply Chain 

5-31 

Table 5-9. Specific Opportunities for Standardization 

Opportunity Benefit Area 

Design data Time-to-market 

Manufacturing processes Time-to-market/ramp, DFM, manufacturing cost, flexibility 

ECN communication Manufacturing cost, predictability, quality 

AVL communication Supplier cost, predictability, flexibility, quality 

Process quality reporting Manufacturing cost, time-to-ramp, predictability, quality 

provides a good picture of the necessary standards. Any information 

flows that cross company boundaries should ideally be covered by a 

consistent set of standards. A few specific opportunities for 

standardization are listed in Table 5-9. 

6-1 

 Conceptual 

 Approach for 6 Measuring Costs 

In this section, we discuss RTI’s methodology for measuring the costs of 

inadequate standards for supply chain integration. We modeled our 

approach on others used successfully by RTI in several previous 

economic studies for NIST, including an Interoperability Cost Analysis of 

the U.S. Automotive Supply Chain, an Economic Impact Assessment of 

the International Standard for the Exchange of Product Model Data 

(STEP), and The Economic Impact of Inadequate Infrastructure for 

Software Testing (Brunnermeier and Martin, 1999; Gallaher and 

O’Connor, 2002; and RTI, 2002, respectively). 

Figure 6-1 provides an overview of this methodology for estimating 

industry-level impacts using a bottom-up, cost component approach. We 

began by developing a task/cost matrix for the industry sectors being 

studied. These matrices identify the most important information flows for 

which excessive costs are likely being incurred. We then used 

representative case studies or in-depth interviews to estimate excessive 

costs for each cell of the task/cost matrix. We conducted a large-scale 

survey to provide data that allowed us to estimate the incidence of these 

costs across various elements of the industry sectors studied. Finally, 

secondary data on industry sales and employment and wage rates 

allowed aggregation to industry-level impacts. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-2 

Figure 6-1. SCI Estimation Methodology 

Informal Interviews Case

Studies

Telephone/Internet

Interviews

Secondary

Data

Excessive Costs

for SCI

Cell Level

Impact

Estimates

Firm Level Input

Estimates

Industry Impact

Estimates

Population Data

• Number of Firms

by Tier

• Size Distribution

(Sales)

Firm Level Information

• Number of Supplier

Relationships

• Avoidance Activities

• Level of Information Flows

• Number of Interoperability

Problems

• Cost of Interoperability

Problems

• Cost of Avoidance Problems

Cell Level Cost Analysis

• Avoidance Costs

(Firm Level)

• Mitigation Costs

(Exchange Level)

Task/Cost Matrix

Matrix

Tasks

Cost Elements

For this SCI study, we first identified the scope of activities affected by 

the lack of an adequate standards infrastructure, striving to understand 

the basic sources of costs and benefits that may be affected. Following 

this step, we created an implicit counterfactual to compare the current 

state with one in which an ideal infrastructure is in use. In each of the 

cost categories identified, we developed technical and economic metrics 

that allowed quantitative estimation of costs and benefits for the firms 

involved, relative to the lower-cost ideal state. We used these metrics to 

develop the task/cost matrix for the methodology. Data were then 

collected to inform the metrics, first through a series of structured 

interviews with representatives from several firms in the industry, and 

then through wide-scale placement of a more structured survey. As the 

project was a prospective study, we looked at potential benefits from 

creation and adoption of an ideal standards infrastructure, but not at the 

public and private costs required to develop such a system. 

Due to the scope and complexity of supply chain activities in our chosen 

sectors, we refined our proposed methodology before its execution. 

Details of the methodology, as originally developed and including 
Section 6 — Conceptual Approach for Measuring Costs 

6-3 

subsequent revisions, are described in Sections 6.1 through 6.5. We 

executed the scoping and metrics development steps and created data 

collection instruments to gather the desired information. 

When we began the actual data collection, however, it became evident 

that our methodology needed modification. Several of the motivating 

factors for revising our procedure are discussed in Section 6.6, along 

with a brief description of the revised methodology. A more detailed 

discussion of the industry data and interview feedback that informed our 

revisions is presented along with the data collection results in Section 7, 

which also contains the calculations and explanations for the cost 

estimates. 

 6.1 SCOPE OF SUPPLY-CHAIN ACTIVITIES 

Based on input from the project team and preliminary discussions with 

knowledgeable industry experts, we identified the key characteristics of 

the information flows involved in supply-chain activities in the automotive 

and electronics sectors. Despite their obvious technological differences, 

the two sectors have a great deal in common from a supply-chain 

perspective. Automobiles, personal computers, and communications 

devices are all assembled products, each containing hundreds or 

thousands of component parts, supplied by a large number of 

independent firms. Information on inventory and production quantities, 

shipment dates, prices, and quality attributes must be passed from one 

partner to another; the speed and accuracy of the communication is 

critically important to the sales of the ultimate consumer products, and in 

turn, to the success of each firm. 

As the earlier sections of this report detail, the electronics industry has 

progressed much faster than the automotive sector toward SCI using 

Internet-based, XML-enabled information systems. The NEMI initiative 

and RosettaNet consortium have achieved considerable progress in 

enumerating and understanding the basic information processes 

involved in complex, assembled-parts supply chains. The first column of 

Table 6-1, which was adapted from RosettaNet’s directory of PIPs, 

details many of the important supply-chain activities that are relevant for 

this study. In the second and third columns of Table 6-1, we include our 

project team’s subjective assessment of the frequency and complexity of 

these information flows, an important factor in their likely overall cost 

impact. As the length and detail of the table demonstrates, a 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-4 

Table 6-1. Supply-Chain Information Processes and Relative Importance 

Supply-Chain Tasks Frequency Complexity 

1. Managing Partner Information 

Request Account Setup—New Partner Low Medium 

Maintain Account—Existing Partner Medium Low 

Manage Product Information Subscriptions Low Medium 

2. Managing Product Information 

Distribute New Product Information Medium Medium 

Distribute Design Engineering Information Low High 

Query Product Information High Low 

Query Marketing Information Medium Low 

Query Technical Information High Medium 

Query Product Discontinuation Information Low Low 

Change Basic Product Information Medium Medium 

Change Marketing Information Low Medium 

Change Technical Information Low High 

Change Product Lifecycle Information Low Medium 

Notify of Product Change Medium Low 

Distribute Engineering Change Status Low Low 

Request Engineering Change Low Medium 

Request Engineering Change Approval Low Medium 

Notify of Engineering Change Low Low 

Request Bill of Material Medium Low 

Notify of Bill of Material Low High 

Notify of Approved Manufacturer List Medium Medium 

Request Approved Manufacturer List Low Low 

3. Order Management 

Request Quotation High Medium 

Request of Price and Availability High Medium 

Request Purchase Order Medium Low 

Notify of Authorization to Produce Medium Low 

Query Order Status High Low 

Distribute Order Status High Medium 

Notify of Purchase Order Update Low Medium 

Request Purchase Order Change Medium Medium 

Request Purchase Order Cancellation Low Low 

Notify of Shipping Order Medium Low 

Source: Adapted from RosettaNete Partner Interface Processes PIP Directory. (continued) 
Section 6 — Conceptual Approach for Measuring Costs 

6-5 

Table 6-1. Supply-Chain Information Processes and Relative Importance (continued) 

Supply-Chain Tasks Frequency Complexity 

Request Shipping Order Low Low 

Notify of Shipment Confirmation Medium Low 

Notify of Authorization to Ship Medium Low 

Notify of Shipment Documentation Medium High 

Distribute Shipment Status High Medium 

Query Shipment Status High Low 

Request Shipment Change Medium Medium 

Return Product Low High 

Request Financing Approval Medium Medium 

Notify of Invoice High Medium 

Notify of Invoice Reject Low Medium 

Notify of Remittance Advice High Low 

4. Inventory Management 

Notify of Strategic Forecast Low High 

Notify of Release Forecast Medium High 

Notify of Forecast Reply Medium Medium 

Notify of Shipment Receipt High Low 

Distribute Inventory Report High High 

5. Manufacturing Information Management 

Distribute Work In Process Medium Medium 

Query Work In Process Medium Low 

Notify of Manufacturing Work Order High Medium 

Work Order Change Notification Medium High 

Notify of Quality Goals Low Medium 

Notify of Manufacturing Quality Medium High 

Query Manufacturing Quality Medium Low 

Distribute Product Quality Event Data Low High 

6. Marketing Information Management 

Distribute Product List High High 

Request Design Registration Low Low 

Distribute Registration Status Medium Medium 

Query Registration Status Low Low 

7. Service and Support Management 

Query Service Entitlement Low Low 

Request Warranty Claim Medium Medium 

Source: Adapted from RosettaNet Partner Interface Processes (PIP) Directory. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-6 

large number of critical business functions fall under the purview of 

supply chain management. This complexity makes it very challenging to 

attempt to analyze the entire supply chain process. 

Table 6-1 shows that the major categories important in integrating supply 

chains relate to information about partners, products, orders, inventories, 

manufacturing, marketing, and service and support. Of these, the 

product and orders categories have by far the most elements, although 

the order and inventory sections have the largest number of items with 

high frequency and/or complexity. 

Our preliminary hypothesis was that a significant amount of the total cost 

of the inadequate infrastructure would be found in order management

and inventory information. Our methodology and data collection 

instruments were designed to focus on these phases of supply chain 

information flows, especially in the automotive sector where most recent 

integration activity has been in inventory visibility, with secondary focus 

on order change management. In the electronics sector, the explosion in 

Internet-based business-to-business software products during the 1999-

2001period led to a large amount of spending on product and marketing 

databases, but the past year has seen a dramatic reduction in this 

activity. As our data collection results show, most excess cost and 

improvement efforts in electronics are focused on order and inventory 

areas, just as in the automotive sector. 

 6.2 CATEGORIES OF EXCESSIVE COSTS 

Tasks in a well-integrated supply-chain information system will place 

relatively low burden on suppliers and customers, along the lines of the 

ideal system described in Section 1.4 and illustrated with an invoice 

approval example. Most of the “notify” and “distribute” tasks listed in 

Table 6-2 can be generated automatically by physical activity at the 

supplier site (scanning a bar code, for instance); many customer 

“queries” and “requests” will also arise without manual intervention. The 

“maintain” and “change” activities, along with unusual events such as 

cancellations or quality event distributions, are manually driven at least at 

the initiating end, but standard formats and protocols should reduce the 

complexity in these cases as well. 

If multiple systems are being used to manage different portions of the 

supply chain, however, several types of additional costs will be incurred, 

unless the systems have been designed to interoperate. Likewise, if 
Section 6 — Conceptual Approach for Measuring Costs 

6-7 

systems are only partially integrated, translation or data reentry are 

required for flows to and from all supply-chain partners that do not share 

the improved information systems. Finally, if the lower tiers of the supply 

chain do not have the financial resources or technical capability to 

support integration, their internal work processes and communications 

are likely to be significantly less efficient than in an optimal system. 

These situations give rise to excessive costs within the supply network, 

which serve to raise prices of intermediate goods and finally of the 

OEM’s consumer products. These costs have been usefully categorized 

in previous RTI work as avoidance, mitigation, and delay costs 

(Brunnermeier and Martin, 1999). Manufacturers incur avoidance costs 

to prevent technical interoperability problems before they occur and 

mitigating costs to address interoperability problems after they have 

occurred. 

Examples of avoidance costs in the present context include 

• the cost of purchasing, maintenance, and training for duplicate 

systems required by one or more suppliers or customers; 

• the cost of purchasing, maintenance, and training for translator 

programs that link noninteroperable systems; 

• the cost of manually entering data generated by a production 

process or other system not interoperable with the SCI system; 

and 

• costs associated with sending and receiving faxes, telephone 

calls, and letters to communicate supply chain–related 

information, such as production or ship dates, quantities, or 

product queries. 

Mitigation costs that are experienced across the supply-chain tasks 

detailed above include those associated with 

• routine reentry of data from one information system into another 

within the supply chain; 

• correcting errors in manually generated, reentered, faxed, or 

telephoned data; 

• correcting errors generated by translation software and from 

troubleshooting translation systems; 

• tentative or delayed approvals of orders, schedules, shipment 

notifications, and invoices due to a lack of confidence in the 

systems in use; 

• expediting orders or shipments to meet unanticipated or changed 

due dates; 

• product losses stemming from inappropriate decisions made 

without the proper information; 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-8 

• premium costs, such as overtime pay and higher freight charges, 

incurred as a result of communications errors and/or delays; 

• fines or penalties imposed by customers because of informationrelated missed deadlines; and 

• lost business from incompatibility-induced delays or delivery 

failures. 

 6.3 TECHNICAL AND ECONOMIC IMPACT 

METRICS 

Quantifying the economic impacts of these cost-related factors requires 

appropriate metrics that capture the most important tangible costs. For 

each of the factors listed above, we developed two kinds of impact 

metrics: 

• Technical impacts describe the impact of ineffective integration 

on the accuracy and usability of information flows and the 

resources required to avoid or mitigate interoperability problems. 

• Economic impacts describe how technical impacts translate into 

changes in cost and economic activity. These measures can be 

either quantitative or qualitative. 

We used the technical and economic metrics to inform planning activities 

for the in-depth interviews (case studies), the large-scale survey 

instruments, and other data collection activities. Table 6-2 shows the 

two sets of metrics developed for the cost factors from the previous 

section. 

 6.4 INFORMING THE METRICS THROUGH DATA 

COLLECTION—CASE STUDIES 

Primary data collection is necessary to inform the impact metrics 

developed during the conceptual phase of the study. As it would be 

difficult or impossible to design a single instrument to collect information 

from a cross-section of the industry’s firms, it was necessary to acquire 

much of the data needed from a small number of in-depth interviews. 

These structured conversations are similar to the case studies done in 

many qualitative analyses, although in this case the intent was to gather 

components of excessive costs borne by firms due to the lack of 

adequate information infrastructure. Then, by summing these 

components of cost, we developed an estimate of the cost of inadequate 

standards for SCI. The cost component approach has the advantage of 

building an impact estimate from information provided by industry and 

other sources. Interviewees provide only pieces of the total estimate. 
Section 6 — Conceptual Approach for Measuring Costs 

6-9 

This approach puts a smaller burden on industry sources to process the 

information and provide an overall estimate. 

Table 6-2. Impact Metrics for Inefficient SCI 

Source of Cost Components Technical Metric Economic Metric 

Avoidance Costs 

Multiple 

information 

systems 

Purchase or license 

of SCI software 

Number of SCI software 

products required within the 

organization 

Investment in purchased 

SCI software or license 

fees 

 System maintenance Labor required to maintain 

all SCI software systems 

Cost of labor required to 

maintain SCI systems 

 System training Labor hours devoted to 

training and certification on 

all SCI software systems 

Cost of labor time 

required for training on all 

SCI systems 

Multiple 

translators 

Translation software 

licenses 

Number of translation 

software licenses required 

by type 

Investment in translation 

software licenses 

 Software training Labor hours devoted to 

training on the use of 

different translators 

Cost of training labor to 

use different translators 

Interfacing with 

noninteroperable 

systems 

Manual data entry 

from order, 

production, shipping 

processes 

Labor hours consumed by 

manual data entry in sales 

support, materials 

management, production 

Cost of labor expended in 

manual data entry across 

functional areas 

Telephone, fax, 

communication of 

supply-chain 

information 

Labor hours devoted to fax, 

and phone communication 

to suppliers and customers 

Cost of labor expended in 

telephone, fax, 

communication 

Investments in 

interoperability 

solutions 

In-house 

interoperability 

research 

Capital, labor, and materials 

devoted to in-house 

interoperability research 

Cost of in-house 

interoperability research 

Activities in industry 

consortia 

Time and materials devoted 

to participation in industry 

consortia 

Cost of membership, labor 

effort, and materials 

devoted to consortia 

activities 

Mitigation Costs 

Routine data reentry Manual re-entry of 

data from one system 

into another 

Labor hours expended in 

routine re-entry 

Cost of labor expended in 

re-entry of data 

Preventing and 

correcting errors 

Correcting errors 

from fax, telephone, 

manual data entry 

Labor hours consumed by 

error correction of low-tech 

date entry 

Cost of labor expended in 

error correction 

Correcting errors 

introduced by 

translation software 

Labor hours devoted to 

troubleshooting translation 

software, correcting errors 

Cost of labor expended in 

translation software 

troubleshooting 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-10 

Cautionary approvals 

due to lack of 

confidence in system 

Supervisory hours required 

for additional oversight, 

manual approvals 

Cost of supervisory effort 

for secondary approvals 

of orders, schedule, 

shipments 

(continued) 

Table 6-2. Impact Metrics for Inefficient SCI (continued) 

Source of Cost Components Technical Metric Economic Metric 

Mitigation Costs 

(continued) 

 

Expediting to 

make up for late 

or inadequate 

information 

Re-ordering 

production, shipment 

schedules to meet 

emergency needs 

Labor hours devoted to 

expediting plus forced 

changes in schedules 

Labor cost for expediters 

plus loss of efficiency in 

production, shipment 

Product losses 

from unneeded or 

unshippable 

production 

Operating without 

forecast or order data 

leading to unneeded 

production 

Quantity of unshippable 

product made due to 

production ahead of orders, 

poor information flow 

Total produced cost of 

unshippable product 

Premium costs Overtime pay and/or 

premium freight due 

to delays caused by 

poor information 

Hours and materials used 

by overtime operation or 

use of airfreight or 

expedited truck delivery 

Total plant cost of 

overtime operation or 

charges for air freight or 

expedited truck delivery 

Fines or penalties Penalties imposed by 

customer for failure to 

meet delivery dates 

Number of penalties or fines 

imposed by customers 

Cost of penalties or fines 

imposed by customer 

Lost business Sacrificed sales and 

profits as result of 

delays or missed 

shipments

Order cancellations or loss 

of parts contracts for future 

products 

Value of lost profits from 

cancelled orders or lost 

future business 

We developed interview guides for the electronic and automotive 

industries to provide a structure for the conversations. Copies of these 

guides are included with this report in Appendix A. Members of our 

project team shared these interview guides with prospective interviewees 

along with a brief description of the entire project to solicit their 

participation. Although we expressed a preference for on-site visits with 

the selected firms, past experience has shown us that we can achieve 

meaningful results in a telephone conversation with proper preparation. 

Our goal was to have conversations with up to nine firms, with 

representation from the automotive and electronics sectors. Early in the 

project, we believed that it might be useful to interview supplier/customer 

pairs from each of the supply chains. Upon discovering that firms in 

these two industry sectors were not actually cooperating in developing 

supply chain information processes (except through consortia like 
Section 6 — Conceptual Approach for Measuring Costs 

6-11 

RosettaNet and the Automotive Industry Action Group), we elected to 

convert our case study plan into profiles of individual firms. 

The end product of the case study interviews was to be a task/cost 

matrix for each firm that could be aggregated with the other in-depth 

responses to create the primary cost metrics for the economic 

estimation. The one we designed for this study appears here as 

Table 6-3. In this table, we selected the information processes with the 

highest frequency and complexity scores from Table 6-1, combined with 

the major cost metrics outlined in Table 6-3. This matrix was intended to 

be somewhat fluid, with additional processes or cost elements to be 

added if the in-depth interviews made that necessary. 

Table 6-3. Supply-Chain Task/Cost Metrics Matrix 

Avoidance Costs Mitigation Costs 

Detailed Task 

Description 

Multiple 

Systems 

Multiple 

X-lators 

Manual 

Entry 

Data 

Re-entry 

Error 

Correction 

Order 

Expediting 

Product 

Losses 

Distribute New 

Product 

 

Query Product 

Query Technical 

Information 

 

Request Quotation 

Request Price and 

Delivery 

 

Distribute Order 

Status 

Request Purchase 

Order Change 

Distribute 

Shipment Status 

Notify of Invoice 

Notify of 

Remittance 

 

Distribute 

Inventory Report 

Distribute Work in 

Process 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-12 

 6.5 EXTENDING THE COST DATA TO THE 

INDUSTRY LEVEL—LARGE-SCALE 

(INTERNET) SURVEYS 

After the differential costs per transaction were estimated through the 

case studies, our methodology called for using telephone or Internetenabled surveys to characterize the Tier 1 and Tier 3 supply-chain 

populations for the automotive and electronics industries. We designed 

a survey suitable for both industries and obtained OMB approval for the 

instrument. The instrument was designed to be fielded primarily over the 

Internet, although electronic and hard-copy documents were also 

prepared for potential telephone placement. The survey was closedended and not burdensome for the respondents; OMB estimated 30 

minutes’ preparation and 30 minutes’ completion time for the instrument. 

The survey instrument was designed to collect data on each company’s 

supply-chain information activities and to determine the distribution of 

companies by size and by position in the supply chain (OEM, Tier 1, Tier 

2, or lower Tiers, for example) in terms of their 

• number of supplier relationships, 

• type of information flows and level of complexity, 

• frequency of information flows, and 

• avoidance activities. 

The survey also asked direct questions about interoperability problems 

and costs during the Internet surveys. However, experience from past 

projects led us to believe that it would be difficult to obtain usable cost 

details from companies through a standardized electronic survey 

instruments. Thus, our approach was designed to provide defensible 

estimates of industry-level impacts even if little or no quantitative cost 

data were obtained through the telephone/Internet survey. For 

companies that did provide usable cost data on their interoperability 

problems, we planned to integrate this information directly into the study. 

However, for companies not able to provide these data, we were to 

estimate costs using the matrix developed from the case studies and 

companies’ data exchange characteristics obtained through the 

telephone/Internet surveys. 

Once the task/cost matrix for each industry sector was complete and 

information was obtained through the large-scale survey, total 

interoperability costs for a surveyed company could be expressed as 
Section 6 — Conceptual Approach for Measuring Costs 

6-13 

 Ci

 = Σj avoidance costsij + Σj mitigation costsij , 

where 

i = company identifier 

j = type of information flows. 

For surveyed firms able to provide quantitative estimates of their actual 

costs, these estimates were entered directly into the costs database. For 

those that provided only activity, tier, and scale information, an 

appropriate set of activity-specific costs from the in-depth interviews 

were included. Once interoperability costs were calculated for all the 

companies included in the telephone/Internet interviews, secondary data 

were used to weight the survey population impact to obtain industry cost 

estimates. 

Our background research and discussions with industry experts 

suggested that we might find significant differences between firms of 

different sizes or supply chain tiers. If our actual data supported such a 

possibility, the respondent firms would be stratified and results 

aggregated separately. 

Two weighting procedures were planned for the estimation: 

1. Mitigation costs were to be weighted by sales. The value of 

annual sales by the firms that were surveyed would be found 

from the most recent Economic Census (EC), or Annual Survey 

of Manufactures (ASM). We believe sales is the appropriate 

weighting metric because mitigation costs are a function of the 

level of production activity (quantity of information flows), and 

this is best represented by sales. 

2. Avoidance costs were weighted by the number of U.S. 

establishments involved in the industry supply chain, also 

obtainable from EC or ASM data. The number of entities is the 

appropriate weighting metric because avoidance costs are 

mostly firm-level annual costs such as licensees and staff 

training and do not necessarily vary by intensity of use. 

We used this hybrid weighting approach to scale up avoidance and 

mitigation costs for surveyed companies to obtain industry-level impact 

estimates: 

Industry cost estimates = Mitigation costs x (Industry 

sales/surveyed sales) + Avoidance 

costs x (National entities/surveyed 

entities). 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-14 

Table 6-4 provides an overview of the proposed weighting process, 

which was to be implemented separately for the two industry sectors 

being studied. 

Table 6-4. Overview of Weighting Approach 

 Industry Subsectors 

Cost and Weighting 

Categories OEMs 

Tier 1 

Suppliers and 

Integrators 

Tier 2 

Suppliers 

Tier 3 and 

Lower Tier 

Suppliers 

(A) Avoidance costs $ $ $ $ 

(B) Mitigation costs $ $ $ $ 

(C) Number of entities in 

surveyed population 

# # # # 

(D) Total number of entities # # # # 

(E) Sales of entities in 

surveyed population 

$ $ $ $ 

(F) Industry sales $ $ $ $ 

Total end-user industry 

costs 

= A x (C/D) +B 

x (F/E) 

= A x (C/D) +B 

x (F/E) 

= A x (C/D) +B 

x (F/E) 

= A x (C/D) +B 

x (F/E) 

 6.6 REFINING THE METHODOLOGY 

As we began to conduct the structured interviews, we found that 

respondents either did not understand our counterfactual approach or 

had access to only a fraction of the information needed for us to 

complete the data collection effort. The most important of the concerns 

are discussed below. 

 6.6.1 Difficulties with Understanding “Excessive Costs” 

The complexity of supply chains and the multidisciplinary nature of SC 

activities make it very difficult to isolate costs related to inefficient or 

incomplete integration. Most firms have invested considerable effort in 

using information to manage inventories, for reasons that are discussed 

in the early sections of this report. As a result, managers in logistics or 

IT roles were often quite aware of their firm’s savings from inventory 

reduction, and even cost/benefit ratios or rates of return from 

investments in integration. 

However, managers had difficulty understanding the rationale for and 

potential benefits to their firms from shifting the focus to potential benefits 
Section 6 — Conceptual Approach for Measuring Costs 

6-15 

from an improved information infrastructure, except in a few well-defined 

cases such as inventory visibility. Almost all of the managers we spoke 

with who understood the excessive costs their firms were experiencing in 

other supply chain areas reported that their management hierarchy was 

not prepared to take the steps needed to quantify such costs. Implicit in 

this rationale is an assumption on the part of management that other 

active corporate initiatives had far greater potential for reducing costs 

and/or raising profitability. 

 6.6.2 Lack of Unified Information 

Information on materials, subassemblies, work-in-process, and finished 

product is increasingly spread across manufacturing organizations within 

a supply chain. As such, a large number of people are involved in 

operating and optimizing information flows. Only in a very few firms is 

there one person or functional group that has sufficient knowledge to 

estimate the costs we sought for our study. As an example, one large 

firm we contacted in the electronics industry has had more than 1,000 

employees involved in optimization of supply chain information flows. By 

contrast, engineering product and process design, which was addressed 

in our recent STEP analysis (RTI, 2002), are well-defined and focused 

activities within a manufacturing organization. It is a fairly straightforward 

task to identify the organization and individuals who are knowledgeable 

about costs and systems used for engineering design. 

 6.6.3 Sensitivity of Information 

Much of the information we requested from firms in the automotive and 

electronics industries is closely guarded, as it is critically important for 

their financial success. Not only are these firms intensely competitive, 

but the financial strength and negotiating leverage of many of their key 

OEM customers makes data on staffing levels, software development 

and licensing costs, and accounting practices very sensitive. This is 

especially true in the automotive sector, where OEMs and the largest 

Tier 1 firms demand and analyze detailed cost and profit data from their 

suppliers as a part of the negotiations for new sourcing decisions. 

 6.6.4 Many Metrics with Low or Unobtainable Costs 

Finally, it became apparent from our discussions that inefficiencies in 

many of the supply chain information processes listed in Tables 7-1 and 

7-4 do not contribute significantly to bottom-line product costs (inventory 

communications and order management being clear exceptions). In all 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-16 

of the in-depth interviews, the contacts we spoke with stated that little 

attention was being paid to optimizing processes such as sharing 

product information, marketing communications, and after-sale warranty 

work. This is not to say that these activities are not costly, just that 

inefficiencies in communicating information do not add significantly to 

costs. 

During the height of the dot-com boom of 2000-2002, hundreds of startup firms were selling B-to-B software products that claimed to solve 

costly information and communications problems for industrial firms. 

Among the offerings relevant to the present study were proprietary 

portals (often called marketplaces) where buyers and sellers could be 

matched electronically, Web-based product catalogs, enterprise resource 

planning systems, and both open source and proprietary supply chain 

integration software. On-line catalogs were especially popular in the 

electronics industry, while many firms in the automotive industry chose to 

or were forced to support Web portals such as Covisint, a start-up 

funded by most of the major U.S. OEMs. 

The bursting of the dot-com bubble carried away many of the small 

B-to-B firms, and left the electronics and automotive supply chain 

participants in a quandary as to how to proceed. More sober reflection 

on the potential of these solution providers to reduce costs led to a sharp 

reduction in software usage and incremental investments. In electronics, 

most of the XML-based online product catalogs were retained, although 

competition drastically reduced the prices of the software required to 

operate them. Most of the electronic marketplaces were abandoned as 

firms realized that the reverse-auction mechanism did not necessarily 

produce savings sufficient to replace the supplier-customer cooperation 

that was lost in the process. As a result of these changes in electronics, 

we did not find that firms are experiencing costly inefficiencies in their 

communications of product marketing information. 

In the automotive sector, we learned through our in-depth interviews that 

the historical nature of contracting is strongly at odds with the reverseauction marketplace approach, despite the presence of the OEMsponsored B2B electronic marketplace, Covisint. When a new car or 

truck model is being developed, suppliers compete aggressively for their 

parts or subsystems to be specified. A great deal of technical 

information is exchanged, face-to-face marketing and sales 

communications are common, and price and delivery terms are 

negotiated. Once the supplier has been chosen for a particular part, 
Section 6 — Conceptual Approach for Measuring Costs 

6-17 

however, the competition ceases; most parts are sole-sourced for the 3- 

to 5-year duration of the model’s production run, as long as the supplier 

meets cost, quality, and delivery expectations. Repeated contracting is 

not experienced for most of the expensive and critical parts of an 

automobile, and thus, product feature and marketing information is rarely 

exchanged and costs of these information flows are low. The belated 

realization of these common industry norms appears to be one of the 

elements behind Covisint’s recent abandonment of reverse auctions, and 

its reshaping into a SCI firm focusing on inventory visibility solutions. 

 6.6.5 Resulting Changes to Execution of Data Collection 

Activities 

As a result of the feedback we received from our initial in-depth 

interviews, we elected to significantly simplify the analysis and estimation 

procedures in both the remaining case studies and in the survey 

execution. First, we placed a greater degree of emphasis on those 

activities we knew were leading to large costs for electronics and 

automotive firms, especially sharing of inventory levels and 

communication of order and shipment information. In our onsite and 

telephone interviews, we restricted the quantitative discussions to 

metrics related to these activities: inbound logistics staffing; outbound 

logistics staffing; in-house or contract costs for EDI systems; license fees 

for customer-required proprietary information systems; handling of 

payment to suppliers through an accounts-payables function; and billing 

and recording of payments from customers through an accountsreceivables organization. Although the already-approved survey was not 

modified, we altered our instructions for its completion. 

Resolving the issues around respondents’ breadth of knowledge and 

sensitivity of information required a more creative approach to recruiting 

and enrolling survey respondents. With supply chain information 

affecting purchasing, production operations, materials management, 

logistics, accounting, and information systems functions, managers in 

any of those organizations might have some or all of the information we 

required. Organizations that had chosen information integration as a key 

priority might have cross-functional teams leading their efforts. On the 

other hand, highly focused firms might have outsourced optimization 

efforts to a consultant or logistics supplier. Smaller companies might not 

have even one person who could estimate these costs. We could not 

envision a way to decide a priori who was most likely to be able to 

respond in each sector and for each target firm. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

6-18 

Rather than engaging in an expensive and uncertain search process 

across the universe of automotive and electronics firms, we elected to 

sacrifice some randomness in the selection of survey firms by working 

through an industry association that we knew was already involved in 

supply chain integration. For the auto sector, we contacted a technical 

group within AIAG that was involved in an inventory visibility test using a 

set of XML-based transaction messages. Other partners in the venture 

include the Original Equipment Suppliers Association (OESA) and 

ODETTE, a European consortium of automotive suppliers. They offered 

to introduce our survey through an email listserve and to encourage their 

members to participate, in the hopes that our data and analysis would 

prove interesting and valuable to their membership. 

In the electronics industry, the logical choice for a similar effort was 

RosettaNet, the consortium that has been working on interoperability in 

supply chain communications for a number of years. Upon reviewing a 

copy of our survey, the person we contacted let us know that our 

questions were very similar to a survey that had been placed in 

September 2003 with members of several of their working groups, 

including Semiconductors and Information Technology. Although 

RosettaNet was not interested in supporting a second survey of very 

similar nature to their internal effort, they agreed to share the results of 

that survey with us for our use in this study. In taking this approach to 

the large-scale data collection, we were confident that we would receive 

responses from a broad spectrum of industry participants, that the 

respondents would understand the details of the information we needed, 

and that RosettaNet would have already forged contacts within these 

firms necessary to gather information across the spectrum of functional 

areas. 
7-1 

 Analysis of Data and 

 Development of Cost 7 Estimates 

In this section, we describe how the methodology developed in the 

previous section was applied to the challenge of estimating costs related 

to inefficient and incomplete integration within automotive and electronics 

supply chains. We first describe the in-depth interviews we conducted to 

gather detailed cost data for a few large firms. A couple of these firms 

are profiled in greater depth, to highlight the complexity of the problems 

and various approaches taken to create truly interoperable structures. 

We then move to the industry-wide surveys conducted to gather data 

that allow aggregation of costs across the entire industrial sectors that 

formed the heart of this study. The actual calculations and resulting 

estimates are presented next, along with a qualitative assessment of 

those cost elements we were unable to quantify. The section concludes 

with an extended discussion of the difficulties encountered in data 

collection and interpretation, along with several cautions and limitations 

of the results. Broad conclusions and recommendations are left for the 

concluding section of this report. 

 7.1 IN-DEPTH INTERVIEWS 

The heart of our data collection for this study is in the series of nine indepth interviews we conducted during the summer and fall of 2003. Five 

of the discussions were held onsite at the firm’s corporate or divisional 

offices, and four were conducted over the telephone. In each case, we 

sent an interview guide to our contact several days before the visit or 

telephone call and asked the recipients to gather as much information as 

possible prior to the contact. The conversations averaged about 60 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-2 

minutes and relied extensively on the interview guides to structure the 

questions asked. In most cases, we spoke with only one person, 

although for two of the interviews a small group was assembled to 

provide information. 

All of the corporations we contacted reported more than $1 billion in 

sales for the most recent fiscal year, making these firms larger than 

average in both industry sectors. The majority of the respondents were 

from firms that operate primarily as Tier 1s, although we did speak with 

two companies that have product lines in which they are OEMs. 

Especially in the automotive industry, it is common for the large, 

multidivisional firms to have products in several tiers of the overall supply 

chain—one of the firms we interviewed has operations at Tiers 1, 2, and 

3. This focus of in-depth contacts on Tier 1, although not representative, 

makes a great deal of sense given the realities of both automotive and 

electronics industries. In background research and the in-depth 

interviews, we found that Tier 1-OEM interfaces are mostly automated 

(either via XML or EDI transactions processes), while the Tier 2-Tier 1 

and lower tier linkages tend to be less integrated. As a result, the Tier 1 

firms end up incurring most of the inefficiency costs, including 

management of multiple systems, manual reentry of data, and 

duplication of effort. 

Two of the interviews were especially illuminating, as one of the firms is 

very close to the “ideally integrated firm” described in this report, while 

the other has only begun the process of information integration. They 

provided useful reference cases for effort levels and costs. These firms 

are profiled in greater detail below, along with the specific costs and 

activities reported by their representatives. Although the data shared 

during the interviews were not obtained as Confidential Business 

Information (CBI), we did assure the firms that we would not disclose 

their identities in our final report. For this reason, the profiles and 

ensuing discussion have been somewhat generalized to avoid accidental 

disclosure. 

 7.1.1 Profile—An Ideally Integrated Firm 

Our interview with the architect of the “ideally integrated firm” provided us 

with much of the quantitative information we used to anchor the baseline 

of our industry estimates. In the following paragraphs, we discuss some 

of the salient features of this firm’s supply chain information systems. 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-3 

As background, this corporation is a multibillion dollar, global Tier 1 firm 

with more than 30 plants in North America. These facilities are located in 

close proximity to their major customers to insure on-time delivery. An 

average plant for this firm has about $30 million in sales. Most of their 

products are shipped directly to OEMs or systems integrators, although 

some parts are produced for aftermarket sales. New acquisitions are 

being integrated into this firm’s information systems as a part of the initial 

assimilation process. 

Outbound Logistics 

Approximately 30 million transactions come into this firm's information 

systems from its customers, almost all via EDI. Currently, these are 

structured as ANSI X.12 data streams. Although our contact believes 

that EDI will continue to be used into the indefinite future, the format of 

these messages is in the process of being converted over to XML, which 

will lower the cost and make them more flexible. Messages 

automatically pass into the firm's planning systems, where they are used 

to generate production and shipping schedules for the facility in question. 

Each new customer publishes its EDI standards to the firm, which are 

sent along to a third-party software house for development of new 

program code to link the new customer to the firm's information systems. 

Currently, the cost of adding a new customer is around $5000. 

It is the responsibility of the firm to plan production and shipments so that 

its products land on its customers' docks at the specified time window. In 

addition, each plant is required to manage its customers' in-plant 

inventory levels of the parts it supplies, and is authorized to self-generate 

releases to correct any shortages. Penalties for shutting down a 

customer are prohibitively high, but this firm has never shut down a 

customer's facility due to logistics or information systems-related failures. 

(Some shutdowns have occurred due to quality or part performance 

problems, but this is extremely rare.) Each plant has one or more fulltime-equivalent workers (FTEs) to handle exceptions to the automated 

processes and to manage emergency situations. 

Inbound Logistics 

Once the production schedule has been set, the planning system 

automatically generates production and shipment authorizations for 

materials and other parts provided by outside suppliers. These 

authorizations are 'published' on a secure Web site accessible to all 

suppliers, using XML-based data elements. Supplier firms also have 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-4 

restricted access to downstream schedules and inventory levels that 

affect their products. As shipments are received at the facility or as 

inventory is pulled into production, parts are scanned into the data 

system. This receipt and usage data is also published on the supplier 

Web site. 

All suppliers are required to use the Web-based system, to take 

information from it, and to plan their production and shipments 

accordingly. Depending on their capabilities and information systems, 

suppliers can download information in structured electronic format, dump 

it into a planning system or Excel spreadsheets, or make hard copies. 

They are required to acknowledge the information published and to enter 

planned production and ship dates into the Web site. Reports of actual 

shipments are also required to be entered. Although the firm has a 

couple of suppliers that cannot yet meet these requirements, in the long 

run, suppliers that refuse to support the Web site will be disqualified. 

Accounts Payable and Receivable 

All inbound and outbound accounting transactions are handled 

automatically by the firm’s information systems. Payments for all 

shipments come into the accounting system via EDI transaction streams, 

and there is little or no need for manual intervention. On the outbound 

side, this company has achieved 98 percent automatic application of 

cash from customers for product shipments. On the inbound side, 

remittance advices are generated automatically and sent to the Web site, 

where the supplier can download them to their systems or record the 

payment manually. Actual payment is made electronically through 

automated financial networks. As a result of this integration, two people 

oversee accounting information flows for all of North America, one for 

receivables and one for payables. 

 7.1.2 Profile—A Firm in the Early Stages of Integration 

The second firm to be profiled operates more than 100 plants worldwide, 

has annual sales of several billion dollars per year, and deals with about 

75 major customers. This firm makes products in several distinct lines, 

each of which has its own production locations, supply networks, and 

distribution systems. The firm’s involvement in several recent 

acquisitions, along with a history of independence at the plant level, has 

produced a highly decentralized supply chain system. Across the 

domestic manufacturing operation, more than 25 unique, noninteroperable planning and logistics information systems are in use. 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-5 

Although the firm is committed to supply chain integration as one of its 

key strategic priorities, management recognizes that this effort will be 

costly and time consuming. 

The individual we interviewed has responsibility for a great deal of the 

integration tasks for the worldwide organization. His efforts have been 

focused on standardization and simplification, and he is actively 

supporting industry-wide efforts to create true interoperability. As 

resources and time allow, he plans to bring the plants toward a single 

planning system, and to incorporate XML-based solutions wherever 

financially feasible. 

Outbound Logistics 

As a result of our in-depth interview, we were able to quantify information 

about costs, both at the plant level and across the corporation. An 

average plant for this firm has about $45 million in sales revenue each 

year, approximately 300 suppliers, and 25 to 30 customers (as defined 

by unique ship-to points). Throughout the firm’s network, most 

scheduling and shipping functions are handled through EDI transactions 

with customers, whereas purchase order releases and other in-bound 

logistics are handled more traditionally, i.e., through fax, phone, or paper 

communications. 

A staff of 5 to 8 people in corporate headquarters manages the EDI 

systems, which are well established and reasonably efficient. Most 

software development costs are sunk at this point, but about $100,000 

per year is spent for license fees for translator programs. Because 

several of this company’s most important customers insist on using 

custom or proprietary logistics systems, each facility has two full-time 

people who handle routine reporting and tracking functions for these 

systems. Additional people at the plant level are needed to handle 

exceptions and emergencies. 

Inbound Logistics 

On the inbound side, the corporation is beginning to institute common 

practices across plants, including a requirement that suppliers be 

capable of supporting electronic transmission of data. Currently, the 

planning systems at most of this firm's plants generate advanced 

shipment notices (ASNs) that are faxed to suppliers. This manual data 

process not only requires significant effort, it also introduces errors into 

the process that must be corrected after the fact. More importantly, there 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-6 

is currently no standard format for the ASNs, making electronic 

(software-based) processing of these notices impossible. 

Accounts Payable and Receivable 

For all plants in the country, shipping notices for outbound transfers and 

receiving reports for purchases are handled by a staff of 30 accounting 

personnel at a central location. Approximately 40,000 invoices per 

month are processed manually by this staff. Although billing to most 

customers is handled automatically via the EDI system, payments to 

suppliers are still initiated by the accounting organization. Our contact 

estimated that if systems were well integrated, even without a change in 

supplier or customer capability, as few as 5 to 10 people would be 

needed for these tasks. 

As the result of significant assistance from the executive we spoke with, 

we were able to get a fairly complete estimate of the costs this firm is 

incurring due to its incomplete supply chain integration. Once again, it is 

interesting how closely this firm resembles the hypothetical situation we 

outlined in our methodology. As will become clear in the next section, a 

large number of firms in the electronic and automotive industries find 

themselves at this point in their evolution toward supply chain integration. 

 7.1.3 Cost Estimation for Different Degrees of Integration 

In addition to the two profiles included above, representatives we 

interviewed in depth from other firms provided useful quantitative 

estimates of their size and complexity (annual sales, number of plants, 

customer and supplier networks), staffing levels, and one-time and 

annual software charges. We were also able to get substantive 

information concerning their degree of integration, current efficiency of 

information flows, and integration-related activities. From the 

quantitative information shared, we were able to construct a matrix of 

effort requirements and costs representative of three distinct degrees of 

integration: traditional, incompletely integrated, and ideally integrated 

operations. 

Several firms we interviewed had traditional relationships with their 

suppliers, similar in nature to that described in the second case study 

profile. Based on two of the interviews for which we received detailed 

information on staffing and effort, we estimate that managing purchase 

order releases and coordinating inbound logistics would require 4 fulltime equivalent (FTE) employees for an average-sized plant of $30 to 35 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-7 

million in annual sales. Outbound logistics coordination includes 

customer management, coordination of routine scheduling and shipping 

information, and handling exceptions and emergencies. Traditional 

handling of accounts receivables and payables involves effort at the 

facility to generate and distribute receiving reports, shipment 

notifications, and freight bills. The accounting for these transactions is 

most often done at the corporate level, along with distribution of invoices 

and processing of payments. Firms may maintain in-house accounting 

organizations or may outsource accounts payable and accounts 

receivable activities. Estimated FTEs for logistics and accounting efforts, 

standardized to $100 million in annual sales, are as follows: 

• Inbound (supplier) logistics coordination 

 12 FTEs per $100 million in sales 

• Outbound (customer) logistics coordination 

 7.5 FTEs per $100 million 

• Inbound financial (payables) accounting 

 1 FTE per $100 million 

• Outbound financial (receivables) accounting 

 1 FTE per $100 million 

Firms with incomplete integration most often used EDI for their customer 

communications, and several reported using EDI with their larger, more 

sophisticated suppliers. In addition, the Tier 1 firms were almost all 

obligated to support one or more proprietary logistics systems by their 

customers. As a result, their costs were a combination of planning and 

coordination effort and information systems charges (license fees, inhouse software development, contract software costs, and charges for 

EDI translators). Based again on our in-depth interviews, we estimated 

the following FTEs for logistics and accounting: 

• Inbound (supplier) logistics coordination 

 10 FTEs per $100 million in sales 

• Outbound (customer) logistics coordination 

 6 FTEs per $100 million 

• Inbound financial (payables) accounting 

 0.6 FTE per $100 million 

• Outbound financial (receivables) accounting 

 0.6 FTE per $100 million 

In addition, these firms spent, on average, a little more than $10,000 for 

an average sized ($30 million annual sales) plant to support third-party 

development of in-house information systems. This equates to 

approximately $32,000 per $100 million in sales. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-8 

We spoke with one firm that we would characterize as having an ideally 

integrated supply chain information system, the company that is profiled 

at the beginning of this section. Despite their high degree of automation, 

they still experienced some costs of inefficient integration, mostly in 

dealing with suppliers with a low degree of e-capability and customers 

that required use of proprietary systems. We estimated the following 

costs for logistics and accounting for nearly ideally integrated firms: 

• Inbound (supplier) logistics coordination 

 4 FTEs per $100 million in sales 

• Outbound (customer) logistics coordination 

 2.4 FTEs per $100 million 

• Inbound financial (payables) accounting 

 0.1 FTE per $100 million 

• Outbound financial (receivables) accounting 

 0.1 FTE per $100 million 

Although some of the staffing and logistical effort expended by these 

firms is employed to support 'non-ideal' transactions required by their 

customers or suppliers, it was not possible to estimate the costs for a 

truly interoperable system, i.e., one in which every supply chain partner 

is operating with open-source, interoperable information processes. 

Nonetheless, the staffing levels described here are likely a practical 

minimum for automotive and electronics firms, even as the overall level 

of integration increases. Finally, in the ideal type of system that we 

describe, ongoing software development costs would be very low, and 

license fees and charges for EDI translators would not exist. 

The information on facility and firm-specific costs that we were able to 

quantify are summarized in Table 7-1. 

Costs from inefficient integration for a number of process areas could not 

be quantified, either because these costs were low or because 

information was not available. None of the respondents in the in-depth 

interviews reported significant staffing or out-of-pocket costs associated 

with distributing or querying product information, nor were any other 

types of routine queries noted. There was actually significant interest in 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-9 

Table 7-1. Plant-Level Effort Requirements and Identified Costs (per $100 million in annual sales) 

 Traditional 

Incompletely 

Integrated Ideally Integrated 

Inbound Logistics 12 FTE 10 FTE 4.0 FTE 

Outbound Logistics 7.5 FTE 6.0 FTE 2.4 FTE 

Inbound Accounting 1.0 FTE 0.6 FTE 0.1 FTE 

Outbound Accounting 1.0 FTE 0.6 FTE 0.2 FTE 

Information Systems Costs $0 $32,000 $0 

Source: In-depth interviews with automotive and electronics firms. 

visibility of work-in-process to next-in-line customers, but our contacts 

were unable to estimate costs from the lack of this information in current 

operations. Sharing product quality data and communications regarding 

warranty claims are other areas where significant expenditures are being 

incurred, but it proved impossible to estimate the portion of those costs 

related to incomplete or inefficient supply chain integration. 

During our in-depth interviews, we were unsuccessful in obtaining 

quantitative estimates for several of the mitigation cost metrics. These 

also proved elusive in the large-scale survey, as is detailed below. Aside 

from the data we obtained about staff for handling exceptions and 

emergencies (commonly called expediting), we did not obtain data on 

information-related costs for error correction, product losses, premium 

freight, or shutdown penalties. The last of these items was interesting in 

that most of our contacts reported huge potential costs from shutting 

down key customers, on the order of $100,000 to $500,000 per hour. 

However, none of these people recalled a situation in which information 

systems problems had led to this type of failure. 

 7.2 QUANTITATIVE AND QUALITATIVE SURVEY 

RESULTS 

With the results of the in-depth interviews in hand, we proceeded with 

large-scale surveys of the two industry sectors. The automotive portion 

of the survey was fielded with an AIAG working group through an email 

listserve announcement, and was completed by logistics or information 

systems professionals actively working on supply chain integration 

issues. The survey posed questions about the degree of integration and 

labor effort required in each of the major supply chain processes, the 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-10 

number of software systems supported and their annual costs, and effort 

expended in several avoidance and mitigation areas. In electronics, we 

were fortunate to be granted access to results from a RosettaNet survey 

conducted in the fall of 2003 by academics from San Jose State 

University. Although we did not have influence on the questions posed 

in the survey, they were quite similar to the core questions in our survey, 

and yielded us a reasonable profile of the degree of integration of 

electronics firms in the process areas we had identified in the in-depth 

interviews. 

 7.2.1 Results from Internet Survey of Automotive Firms 

We placed our OMB-approved survey on an RTI internal web site during 

late fall of 2003 and collected responses from participants over a 5- week 

period. In the survey, we requested contact information (e.g., name, 

address, telephone number, and e-mail address) and asked for 

permission to follow up in case their responses were unclear or 

incomplete. We contacted several participants to obtain additional data 

during the survey period, although many of the respondents asked not to 

be contacted. 

In all, we received completed surveys from 55 individuals representing 

46 separate firms. Approximately half of the responses were for a single 

division of a larger entity, while the other half were for an entire 

company. We were pleased with the coverage achieved by this data 

collection effort, especially in light of the placement of the survey and the 

difficulties we anticipated in reaching knowledgeable managers in this 

industry. The firms represented in the survey account for about $220 

billion in annual sales in North America, which is over half of the $400 

billion reported for the automotive industry in 2001. 

Almost two-thirds of the responses came from Tier 1 companies, with the 

remainder from OEMs and lower tier firms. This was an expected result, 

as AIAG membership is weighted toward Tier 1 firms. Although this 

weighting will force some caution in the use of cost estimates derived 

from this study, our background research suggested that Tier 1 firms 

have been bearing a large share of supply chain inefficiency costs. 

Our overriding finding from the automotive firm survey was the 

tremendous diversity of process involvement, degree of integration, 

reported effort levels, and usage and costs of software systems. The 

range and calculated standard deviations of quantitative responses were 

so large that systematic analysis of means or medians would not be 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-11 

meaningful. As a result of this diversity, we used a relatively limited 

number of survey responses in quantifying costs for the study. 

Nonetheless, we found a great deal of useful qualitative information in 

the responses; the most notable of these are detailed here: 

• As we suspected from the in-depth interviews, order and 

inventory management were the business processes with the 

greatest degree of automation, with more than 70 percent of 

respondents reporting use of automated systems. No difference 

was found between OEMs, Tier 1, and lower tier firms in the 

degree of integration for these key business processes. 

• In contrast, only about one-third of the firms reported use of 

automated information systems in managing partner information, 

product and marketing communications, and service and support 

functions. Once again, this finding was robust across tiers of the 

supply chain. About half of the firms across the supply chain had 

automated their internal manufacturing management information 

flows. 

• Respondent firms in the automotive industry were linked to 

almost 10 times as many suppliers as customers, although there 

was a great deal of spread in these data. The median firm had 

300 suppliers in our database, with responses ranging from 10 to 

7000. On the customer side, the median firm supported 40 

customers, with a range of 1 to 2,000. This suggests that firms 

in the automotive supply chain, especially Tier 1 firms, may be 

able to achieve more benefits from working to establish 

integration with their suppliers than with customers. 

• About 70 percent of the firms responding to the survey used EDI 

in their supply chain communications, and about one-fourth 

reported at least some use of XML-based information exchange. 

No companies were using XML systems for all of their 

customer/supplier interactions. At the other extreme, several 

lower tier firms reported only manual (paper/fax) communications 

with their customers. All of the remaining companies used more 

than one method of interacting with customers. Half of the firms 

in the overall survey used multiple approaches with suppliers. 

Table 7-2 summarizes the percentage of firms using various 

communications methods with suppliers and customers. 

• Although not all of the participants shared information about the 

software packages used by their company or division, we did 

receive responses from 12 individuals. On average, their firms 

supported two to three separate packages, most of which were 

installed within the past 3 to 4 years. Some of the largest firms 

did not report a number of separate software systems, but 

commented that the number was almost too large to count. 

Installation costs were highly variable, ranging from $20,000 to 

$300,000, with license fees from $0 to $15,000 per user. The 

spread of these data was too broad to provide a meaningful 

estimate of average or median annual software costs. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-12 

Table 7-2. Percentage of Automotive Firms Using Each Communication Method for SCI 

Interactions 

With Suppliers 

(%) 

With Customers 

(%) 

XML/Internet 22.6 22.5 

EDI 45.2 45.1 

Paper/Fax 32.2 32.4 

Source: RTI calculations based on automotive industry survey. 

• Several comments about use of redundant systems were added 

to the section on software costs. By and large, these managers 

accepted the excessive costs and inefficiencies created by this 

duplication as a necessary cost of doing business. 

• The final questions related to premium freight, material losses, 

penalties, and lost product sales were not answered by enough 

respondents to support qualitative or quantitative analysis. This 

does not indicate that the costs were low, just that the people 

responding to the survey did not have the data or chose not to 

share it. 

In summary, the automotive survey was useful in supporting some of the 

conclusions we reached during the in-depth interviews, especially the 

rather narrow focus of integration investments on order and inventory 

management. Although this may have resulted partly from the process 

by which these respondents were identified, i.e., through an AIAG group 

working on inventory visibility, there was little information in the survey to 

indicate that other costs or concerns were of critical importance. Most 

importantly, we were able to obtain quantitative information on the 

fraction of firms at each stage of supply chain integration, data that feeds 

into the primary cost calculations detailed below. 

 7.2.2 Results from RosettaNet Survey of Electronics Firms 

The electronics industry has moved much further along the path toward 

efficient supply chain integration than the automotive sector, most 

notably through the efforts of industry-wide consortia like NEMI and 

RosettaNet (RN). Since its founding, RN in particular, has been 

committed to interoperable e-business process standards, which align 

very closely with NIST's expectations for interoperability. In view of the 

complexities of our data collection task, made especially difficult in the 

case of a truly global electronics sector, we had hoped to link up with RN 

for execution of our survey. When our project team found out that RN 

had recently sponsored a survey of its members that asked questions 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-13 

similar to the ones we had posed, we requested access to their results 

and publications. 

Thus, the primary source of our electronics industry supply chain data 

was a preliminary report entitled "Pilot Survey Project—RosettaNet 

Implementation Penetration Road Map" (Ongoiba and Saini, 2003), 

prepared by two researchers at San Jose State University (SJSU). 

Because data were collected under promise of confidentiality, we did not 

have access to the primary data, but we did obtain a list of the firms who 

responded. This did not provide us with the same amount of information 

we would have obtained from our own survey, but served to protect the 

identity of the respondents, as desired by SJSU and RN. 

The survey form, the text of which is included in Appendix B, requested 

information about firms' use of several different methods of information 

exchange in the business process areas of interest to RN. The survey 

asked respondents to estimate the percentage of their transactions, 

currently and 2 years in the future, using traditional methods 

(fax/phone/e-mail), a Web site browser interface, EDI, RN, or a custom 

server-to-server connection. For our purposes, both RN and a Web site 

interface would be classified as ideal integration, while EDI or custom 

connection would be considered inefficient integration. 

In the preliminary report, information was shared about the coverage of 

the survey, stratified both by sector and tier. Data were collected from 

September 22 through October 13, 2003, which corresponds closely to 

the timing of our automotive survey. A total of 29 responses were 

obtained, representing 22 separate companies. All were members of the 

RN Board, which consisted of 78 leading electronics firms at the time of 

the survey. After obtaining the names of the firms who responded to the 

survey, we determined that they accounted for $260 billion in U.S. sales 

annually, accounting for about 75 percent of the industry's domestic 

revenues. 

The cross-sectional data revealed that four responses were received 

from companies in RN's IT grouping, 12 from electronics components 

firms, 12 from semiconductor manufacturers, and one from a 

telecommunications equipment maker. When divided out by tier, three 

responses were from component materials suppliers (equivalent to Tier 2 

in the automotive industry), 15 from components manufacturers (like Tier 

1 suppliers), four from OEMs, and 2 from contract manufacturers (similar 

to systems integrators or 'Tier 0.5's). The remaining participants were 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-14 

from other supply chain participants, including distributors and logistics 

services providers. 

In the survey design, the participants' responses allowed percentages of 

firms using each technology to be stratified by electronics sector and tier. 

Unfortunately, we were limited to the information presented in the report, 

which did not contain all of the possible permutations. Nonetheless, we 

were able to extract sufficient data to inform not only our quantitative 

estimation, but to provide useful qualitative results as well. The only 

significant assumptions that the aggregate data forced us to make were 

that there were no significant size or tier effects (i.e., that large firms in 

the survey behaved like small firms), and that the firms surveyed were 

representative of the electronics industry as a whole. 

Table 7-3 contains the quantitative information for the business 

processes of interest for our overall estimation, and provides some 

surprising results. In contrast with the automotive results in Table 7-2, 

many more of the electronic firms were still using manual processes for 

both planning/logistics and for accounting. On the other hand, far fewer 

were using EDI or other custom systems, which we have defined as 

incomplete integration. Perhaps due to the influence of RosettaNet on 

the respondents, compared to the automotive industry, a larger fraction 

of firms had implemented ideal integration, especially in the case of 

inbound (supplier) logistics. 

Table 7-3. Business Processes and Degree of Integration of Electronics Firms 

Traditional 

(%) 

Incompletely 

Integrated 

(%) 

Ideally Integrated 

(%) 

Outbound Logistics 46 32 22 

Outbound Accounting 43 34 23 

Inbound Logistics 51 14 35 

Inbound Accounting 52 20 28 

Note: Table entries are the percent of firms whose business processes are traditional, incompletely integrated, or 

completely integrated. 

Source: RosettaNet survey and RTI calculations. 

The most significant finding from the sector and tier information 

presented was the relative unimportance of product information among 

those firms that had implemented RN processes. Firms in the 

components sector reported that only 1 percent of their RN transactions 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-15 

related to design, and 6 percent to product marketing, the latter of which 

includes the formerly trendy area of online product catalogs. This pales 

in comparison to the forecast, order management, and manufacturing 

processes, each of which account for about 30 percent of the 

transactions volume. Semiconductor firms reported even smaller 

numbers, with 2 percent of their RN volume related to product marketing 

and none to design. We conclude from this information that electronics 

companies, like their peers in the automotive industry, are focusing their 

efforts on order and inventory management. 

 7.3 AGGREGATING COSTS UP TO INDUSTRY 

LEVEL 

The data collected through the in-depth interviews and two survey 

efforts, which have been presented in Tables 7-1, 7-2, and 7-3, are 

nearly sufficient to calculate industry-level costs resulting from an 

inadequate infrastructure for supply chain integration. Two secondary 

data elements were needed to complete the picture: a total value of 

industry sales and estimates of labor rates to convert full-time 

equivalents into dollars. As with RTI's standard practice, we relied on the 

Census Bureau's latest Annual Survey of Manufactures (ASM) for the 

former and the Bureau of Labor Statistics' (BLS) Occupational 

Employment Statistics (OES) for the latter. 

 7.3.1 Industry Sales Revenues 

Table 7-4 lists relevant information on both of the industries included in 

this study, taken from the 2001 ASM. To be consistent with the scope of 

the study as outlined in other sections of this report, we included only 

those portions of the industry connected in supply chain customersupplier relationships. For this reason, we excluded navigational 

equipment, audio and video equipment, and magnetic and optical media 

(from electronics firms) and motor vehicle bodies and trailers (from the 

automotive industry). Therefore, the bottom-line sales revenue numbers 

used for quantitative estimates were $316 billion in electronics and $403 

billion in autos. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-16 

Table 7-4. Value of Shipments and Employment Data for Electronics and Automotive Sectors 

NAICS 

Code Industry Group 

Value of 

Shipments 

(millions of dollars) 

Total Employees 

(thousands) 

3341 Computer & Peripheral Equipment 89,528 193 

3342 Communications Equipment 102,004 302 

3344 Semiconductor & Other 

Components 

124,215 567 

 Total Electronics Industry 315,747 1,062 

3361 Motor Vehicle Manufacturing 216,128 214 

3363 Motor Vehicle Parts Manufacturing 186,839 736 

 Total Automotive Industry 402,967 950 

Source: “Statistics for Industry Groups and Industries: 2001.” U.S. Census Bureau Annual Survey of Manufacturers. 

M01(AS)-1. January, 2003. 

 7.3.2 Industry Wage Estimates 

Table 7-5 lists a variety of employment classifications and annual wage 

estimates from the OES data for 2002. Although all of the occupations 

listed here are relevant to our study, a review of the detailed role 

descriptions compared with the activities discussed in our in-depth 

interviews suggests that the category “Production Planning Clerks” is 

most appropriate for the logistics functions and “Accounting & Auditing 

Clerks” for the payables and receivables operations. To convert these 

direct wages into employer costs, including benefits and social security 

taxes, we multiply the wage numbers listed in Table 7-5 by 2.0 in our 

estimates. 

Table 7-5. Industry-Specific Wage Estimates for Electronics and Automotive Sectors 

SOC Code Occupational Description 

Annual Wages in 

Electronics 

Annual Wages in 

Auto Industry 

13-1023 Purchasing Agents $58,560 $53,230 

13-2011 Accountants & Auditors $55,120 $54,610 

43-3031 Accounting & Auditing Clerks $32,510 $30,080 

43-5061 Production & Planning Clerks $38,160 $38,890 

43-5071 Shipping & Receiving Clerks $26,840 $28,720 

Note: Loaded wage rates are estimated at 2.0 time wages listed in this table. 

Source: “2002 National Industry-Specific Occupational Employment and Wage Estimates.” U.S. Department of 

Labor, Bureau of Labor Statistics. January, 2004. 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-17 

 7.3.3 Costs of Inadequate SCI Infrastructure 

With complete information on estimated effort levels, degree of 

integration by process, and industry data on sales and wage rates, it is 

possible to estimate the total annual costs to U.S. firms of inadequacies 

in their supply chain infrastructures. We performed the calculations as 

specified in the methodology and generated the results listed in 

Tables 7-6 and 7-7. Total estimated costs for the automotive industry 

were slightly in excess of $5 billion per year, which equals about 

1.25 percent of the total value of shipments. In electronics, the figures 

were almost $3.9 billion per year, or an almost identical 1.22 percent of 

the value of shipments. In both industries, roughly 50 percent of the total 

costs were in dealings with suppliers, while nearly 40 percent arose from 

interactions with customers. Less than 1 percent of the total inefficiency 

resulted from purchase costs and annual expenses from software 

programs. 

In order to put these figures into perspective, it may be helpful to 

consider the costs of operating under each of the integration scenarios to 

a typical firm in the automotive and electronics industries. Using data 

from the most recent Economic Census reports, we calculate that the 

value of shipments for the average automotive parts establishment was 

$30 million in 1997. Had such a facility operated with traditional supply 

chain systems, its managers could expect to incur almost $500,000 in 

annual costs for the logistics and accounting functions described above. 

Investing in incomplete integration would lower that figure to about 

$400,000 per year, while implementing an ideal integration strategy 

would result in a total of $150,000 in annual costs. 

In the electronics industry, the average value of shipments for a 

semiconductor facility is $71 million per year, while a typical computer 

maker produces about $55 million in annual shipment value. Using the 

summary data from Table 7-7, we can estimate that a semiconductor 

facility operating traditionally would incur annual expenses of $1.15 

million, while a computer maker would see logistics and accounting costs 

of about $900,000. Once again, incomplete supply chain integration 

would lower costs only slightly. Implementation of an ideal system, 

however, would reduce these expenses substantially – to slightly more 

than $350,000 for a semiconductor establishment, and to $280,000 for 

the slightly smaller computer facility. 

 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-18 

 

 

Table 7-6. Estimated Costs of Inadequate Supply Chain Infrastructure: Automotive Industry 

Process Operation FTEs 

Loaded Wage

Rates ($/year) 

Cost per 

$100M 

in Sales 

($thousands) 

Fraction of 

Firms 

Total Industry 

Cost 

($millions) 

Traditional Processes: 

 Inbound Logistics 12 $77,780 $933 0.322 $1,211 

 Inbound Accounting 1.0 $60,160 $60 0.322 $78 

 Outbound Logistics 7.5 $77,780 $583 0.324 $782 

 Outbound Accounting 1.0 $60,160 $60 0.324 $79 

Incomplete Integration: 

 Inbound Logistics 10 $77,780 $778 0.452 $1,417 

 Inbound Accounting 0.6 $60,160 $36 0.452 $66 

 Outbound Logistics 6.0 $77,780 $467 0.451 $848 

 Outbound Accounting 0.6 $60,160 $36 0.451 $66 

Ideal Integration: 

 Inbound Logistics 4.0 $77,780 $311 0.226 $283 

 Inbound Accounting 0.1 $60,160 $6 0.226 $5 

 Outbound Logistics 2.4 $77,780 $187 0.225 $169 

 Outbound Accounting 0.1 $60,160 $6 0.225 $5 

Subtotal−Labor Effort $4,989 

Subtotal−Software 0.452 $58 

Total $5,047 

Source: RTI calculations. For details, see text. 
Section 7 — Analysis of Data and Development of Cost Estimates 

7-19 

Table 7-7. Estimated Costs of Inadequate Supply Chain Infrastructure: Electronics Industry 

Process Operation FTEs 

Loaded Wage

Rates ($/year) 

Cost per 

$100M 

in sales 

($thousands) 

Fraction of 

Firms 

Total Industry 

Cost 

($millions) 

Traditional Processes: 

 Inbound Logistics 12 $76,320 $916 0.51 $1,475 

 Inbound Accounting 1.0 $65,020 $65 0.52 $107 

 Outbound Logistics 7.5 $76,320 $572 0.46 $831 

 Outbound Accounting 1.0 $65,020 $65 0.43 $88 

Incomplete Integration: 

 Inbound Logistics 10 $76,320 $763 0.14 $337 

 Inbound Accounting 0.6 $65,020 $39 0.20 $25 

 Outbound Logistics 6.0 $76,320 $458 0.32 $463 

 Outbound Accounting 0.6 $65,020 $39 0.34 $42 

Ideal Integration: 

 Inbound Logistics 4.0 $76,320 $305 0.35 $337 

 Inbound Accounting 0.1 $65,020 $7 0.28 $6 

 Outbound Logistics 2.4 $76,320 $183 0.22 $127 

 Outbound Accounting 0.1 $65,020 $7 0.23 $5 

Subtotal−Labor Effort $3,843 

Subtotal−Software 0.32 $14 

Total $3,857 

Source: RTI calculations. For details, see text. 

 7.3.4 Cautions in Interpretation 

As with any study of this type, potential biases are inherent in the data 

collection effort and the assumptions used to generate a national-scale 

estimate. Because of the selective nature of the in-depth interviews and 

the two survey efforts, the aggregate numbers calculated should be used 

with some caution. The following items deserve mention (for a more 

comprehensive study they would be part of a sensitivity analysis): 

• The costs calculated arose from a fraction of total supply 

chain activities, i.e., the order and inventory management 

processes. Although we believe that these two areas contain 

much of the inefficiency-related costs now being borne by 

electronics and automotive industry firms, it is possible that other 

parts of the supply chain also make significant contributions. 

This factor in isolation would tend to suggest that our estimates 

may be conservative. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

7-20 

• The subsets of each industry from which we gathered data 

may experience different levels of supply chain information 

inefficiencies compared with other, un-surveyed segments 

of our two selected industries. In particular, we did not have 

strong representation from the lower tiers of either manufacturing 

sector, which tends to house smaller, less e-capable firms. 

Large firms that supply basic materials to autos and electronics, 

including primary metals producers and chemical firms, also 

likely experience costs of supporting multiple systems and 

standards; they were also excluded from our study. It is not 

clear whether a more representative mix would have raised or 

lowered the resulting estimates, but the possibility exists that 

future work could explore this potential further. 

• The geographic limitations of the study were somewhat 

difficult to nail down, as many of the firms operate globally 

and their basis for reporting was not always clear. We 

attempted to obtain quantitative data from our in-depth interviews 

from a consistent geographic region—North America for the 

automotive industry and the United States for electronics. 

Although facility-specific labor effort and software cost data 

should not have been affected by any such uncertainty, some of 

the sales data used to create the aggregate estimates could 

have been from a wider geographic area. To the extent that the 

Census value of shipments data may under-represent the 

production output of firms in our interviews and surveys, the 

aggregate costs of an inadequate U.S. infrastructure could be 

much larger than we estimated (although the value as a 

percentage of sales would remain unchanged). 
8-1 

 Implications and 

 Potential 

 Applications 8 of Results 

In this study, we have described how the emergence of low cost 

communications and information processing has made it possible for 

manufacturing firms to fundamentally change the way they manage their 

supply chains. The use of XML-based specifications over the internet or 

proprietary networks can replace costly EDI implementations as well as 

paper and fax-based communications systems, resulting in considerable 

savings for the firms involved. The analysis in the previous section 

suggests that the total cost of managing supplier-customer inventory and 

schedule information exceeds $5 billion per year in the automotive 

industry, and almost $4 billion in the electronics sector. Almost all of this 

cost could be eliminated if firms implemented true interoperability, which 

we have termed 'ideal supply chain integration'. 

In such an ideal integration, each piece of information needed by a 

supply chain participant is entered only once, preferably through an 

automated process such as bar code scanning. Subsequent use and 

dissemination of that information is managed through software programs, 

without the need of manual intervention or translation. Communication 

of this information across geography, among facilities within a firm, and 

between firms is accomplished seamlessly. 

This type of interoperability does not yet exist, but firms in both 

automotive and electronics industries have come close to achieving this 

ideal state with some or most of their supply chain partners. Full 

implementation and widespread adoption of interoperability will require 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

8-2 

significant investments in standards and other critical infrastructures that 

are not in place today. The evidence from our study strongly suggests 

that businesses in these two key sectors have not made sufficient 

infrastructure investments to capture the benefits from interoperability. 

As we have discussed earlier in this report, the public goods nature of 

these infrastructures, along with possible coordination failures, suggests 

that government involvement is needed to support the optimal level of 

investment. 

NIST's expressed purpose in commissioning this study was to determine 

if there was evidence of market failures in the creation of the critical 

infrastructures required to create effective integration. A secondary 

objective was to gather data that would enlighten potential roles taken by 

NIST's Manufacturing Engineering Laboratory (MEL) and Electronics and 

Electrical Engineering Laboratory (EEEL) in industry-wide consortia 

working on improving supply chain information systems. In the judgment 

of the present authors, the study's results provide support for both of 

these aims. 

 8.1 IMPLICATIONS FOR INDUSTRY 

The automotive and electronics industries are the two largest 

manufacturing sectors in the U.S. economy, both in terms of the value of 

production and number of employees. They contribute significantly to 

our nation's GDP and have seen substantial growth over the past ten 

years. In addition, they exert a strong influence on other manufacturing 

sectors. Strategic directions set by automotive and electronics firms are 

frequently adopted across other manufacturing sectors; trends in these 

industries often mirror those in the U.S. economy as a whole. 

As estimated in this study, the total costs of inadequate integration are 

significant—in excess of 1 percent of sales in both sectors. This 

represents a loss to the owners of manufacturing firms in these 

industries, including large numbers of shareholders and proprietors, as 

well as welfare losses to final consumers of products produced by these 

companies. Moreover, the lower profits resulting from these 

infrastructure inadequacies reduce investment incentives at the affected 

levels in the supply chain and thereby indirectly reduce domestic 

employment growth. 

Although no evidence was collected on the level of expenditures that 

would be required to create the infrastructures needed to eliminate these 
Section 8 — Implications and Potential Applications of Results 

8-3 

excessive costs, it seems unlikely that they would compare with the $3 to 

$5 billion dollars per year being lost. Current initiatives in supply chain 

working groups at AIAG, OESA, and ODETTE in the automotive 

industry, as well as the more well-established electronics efforts at NEMI 

and RosettaNet, provide evidence that firms in these sectors believe that 

investments in integration infrastructures are justified. Nonetheless, the 

relatively slow pace of progress and the magnitude of unrealized benefits 

give evidence that private efforts are unlikely to produce the desired 

results without assistance from the public sector. 

Second, the mismatch between those who would benefit greatly from an 

improved infrastructure, namely the first-tier firms, and those who would 

need to make additional investments, the lower-tier companies and many 

of the OEMs, supports the contention made in this study that a 

coordination failure may be preventing optimal levels of investment. This 

is especially relevant for historical and current behaviors in the 

automotive industry. The OEMs' continued efforts to drive down prices 

through automatic cuts and threats of loss of business have made 

coordination of infrastructure investments even more difficult. 

As evidence of this difficulty, our contact at one of the firms we profiled in 

the last section observed that Tier 1 firms have been very reluctant to 

share information on logistics issues and systems efficiencies with their 

OEM customers. Many in top management positions in these 

companies are convinced that if they turn over proprietary information on 

product specifications, details of production operations, line 

configurations, and information flows, this will provide more opportunities 

for OEMs to extract price concessions. 

Recent announcements that OEMs and first-tier firms may move 

production overseas provide more evidence of a lack of coordination. 

Aside from the strategic threat contained in these announcements, it is 

difficult to believe that moving a portion of the supply chain to East Asia 

would be a profitable option. In the first place, it is still the case that 

automobile parts have low value-to-weight ratios; as a result, they are 

difficult to ship long distances without losing money. Second, the entire 

automotive supply chain is built around just-in-time deliveries, with most 

factories located within 30 minutes’ to 2 hours’ transport time from their 

next-in-line customers. It certainly does not seem logical to move one or 

more operations 4,000 miles away, adding several days’ or weeks’ 

transit time to the inventory pipeline. Although complete manufacture of 

automobiles in China certainly is possible (or shipment of castings or 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

8-4 

chassis units from China to Korea or Japan for final assembly), it is very 

unlikely that substantial components business can profitably move 

overseas in the lower tiers. The Far East, North America, and Europe 

will very likely remain as distinct manufacturing centers for a long time to 

come. 

However, this does not mean that suppliers are not threatened. All of the 

major OEMs have announced intentions to reduce their supplier base by 

a factor of at least 2 or 3 over the next major product cycle. This 

relentless pressure, along with the OEM’s active oversight of profits from 

their suppliers, makes it likely that the recent spate of bankruptcies and 

mergers will continue. Only by making themselves more efficient, 

perhaps through more efficient supply chain integration, can first-tier and 

lower-tier suppliers hope to assure their future. 

In electronics, the movement toward contract manufacturing, use of EMS 

providers, and wholesale relocation of the manufacturing supply chain 

will continue. The information improvements over the past 2 decades 

have made it possible, albeit risky, to supply the entire U.S. market from 

East Asia. Unlike automobiles, computers and their major components 

have a high value-to-weight ratio, so they can be shipped long distances 

at low unit cost. The largest risk within the supply chain is that the 1- to 

2-month pipeline includes a lot of expensive inventory that may become 

obsolete prior to final sale. The next section focuses more on trends 

concerning globalization and associated risks. 

 8.2 IMPLICATION FOR THE GROWTH OF GLOBAL 

SUPPLY CHAINS 

For many firms, the motivations to globalize trade are substantial, 

particularly in industries such as electronics, where efficiency and just-intime delivery are necessary to keep up with market demand and new 

technology turnover. However, greatly increased complexity will 

accompany the transition to more global supply chains, and often the 

risks will be very uncertain. As an example, Li & Fung (previously 

discussed in Section 3.4.2) has succeeded because they are experts at 

understanding supply chain intricacies and potential problems, and they 

are able to react quickly and ensure timely and cheap manufacturing and 

shipping operations. However, when SARS became widespread in 

China and Hong Kong, Li & Fung, like many other companies, was 

caught unprepared. According to Dr. William Fung of Li & Fung Trading, 
Section 8 — Implications and Potential Applications of Results 

8-5 

“It shows you can’t have all your eggs in one basket as far as sourcing 

product is concerned. So the idea of having a diversified base of 

production and sourcing is very important” (Louie, 2003). 

As the time between transactions decreases, the need for a more 

complete understanding of the inhibitors to more global trade (see 

Section 3.3.2) increases. Unfortunately, as supply chains become more 

global, the players in a supply chain lose more and more control over 

these potential problems. As such, investments by companies and 

government agencies, such as NIST, could reduce risk as well as 

leverage efficiency. 

In comparison with other companies around the world, U.S. firms have 

not been consistent leaders of global supply chain efforts. U.S. 

automobile manufacturers have only recently reorganized on a North 

American basis to take advantage of post-NAFTA strategic realities, and 

are just now beginning to consider possible cost benefits from the use of 

truly global supply chains. In fact, the importance of transportation costs 

and need for just-in-time deliveries have induced many first-and secondtier automotive suppliers to move even closer to OEM facilities. This is 

certainly true of suppliers to the 'New American' automotive firms like 

Toyota and Honda; many of these suppliers have opened up facilities in 

the U.S. in place of their far-away East Asian operations. It remains to 

be seen if the extremely low labor costs in China will reverse this trend. 

 8.2.1 More Small Firm Players 

As globalization continues to become more pervasive, firms that have 

never attempted to export any products and/or have relatively small 

customer bases are considering developing more global supply and 

distribution networks, and those that are not, should be. To compete in 

today’s marketplace, companies large and small are being forced to 

outsource operations in which they do not have expertise, or face the 

possibility of going out of business. Small businesses often take the 

brunt of this trend, as large companies such as Wal-Mart, which operate 

fully global, efficient supply chains, use global resources and their 

expansive buying power to undersell their competition in most cases. 

However, the Department of Commerce has said that the number of 

companies with fewer than 100 employees that export merchandise 

increased from 96,000 in 1992 to almost 213,000 in 2001, accounting for 

almost $130 billion in exported goods. Donna Sharp, executive director 

of the World Trade Institute of Pace University in New York, was quoted 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

8-6 

as saying, “There is a new culture and openness in international 

business today. With a little know-how, creativity and confidence, even 

the smallest business can find opportunities around the globe” (Levere, 

2004). As an example, in a matter of 5 or 6 years, Gayle Warwick 

started a global business that makes handmade bed and table linens; 

today, she uses labor in both Europe and Vietnam and sells to the United 

States and Britain, and she only just recently decided to hire a second 

employee (Levere, 2004). 

As the availability of information has increased, smaller businesses are 

easily able to access global contacts and resources. In a BusinessWorld

article, Hannah Ira V. Alcoseba writes that smaller businesses actually 

have an advantage because they have more flexibility. She encourages 

small organizations to focus on a small number of products that they can 

produce efficiently and outsource other activities. Similarly, she advises 

larger companies to rely more on smaller companies because of their 

flexibility, speed, and specialized nature (2003). 

 8.2.2 Increased Delays 

The relentless movement toward global supply chains, based on a set of 

labor and market factors, will raise the importance and hence the cost of 

failures dramatically, whether these failures are caused by poor 

information on physical flows, quality defects, multiple data format and 

other institutional-based infrastructure issues, or cultural/political factors 

such as overt acts of sabotage or terrorism. U.S. automotive suppliers 

face fines upwards of $500,000 per hour if they cause the shut down of 

an automobile assembly line, a figure that reflects the economic loss 

from idling people and equipment due to lack of parts. Extended, 

complex supply chains may raise the probability that a system failure 

occurs, as well as reduce options for ameliorating the situation. 

As an example, last September, the 10-day shutdown of West Coast 

shipping ports prevented many retailers from ordering adequate holiday 

merchandise. According to Peter Gatti, vice president for international 

policy at the National Industrial Transportation League (a group of cargo 

shippers), such a problem mainly affected “retailers that source a lot of 

their materials through Southeast Asia and Central Asia. . . when the 

spigot closes, you’re going to get shortages and retailers have been 

particularly affected by that.” As a result, many retailers found 

themselves unable to replenish toy store shelves before the holiday 

season came to a close (Chartier, 2002). 
Section 8 — Implications and Potential Applications of Results 

8-7 

The reality is that increased globalization in the past has led to less 

expensive goods and increased profits for many companies, U.S. and 

foreign. However, as globalization has increased, new political, 

economic, and cultural issues have complicated supply chains, and 

increased collaboration between governments and industries is 

necessary to protect the U.S. economy while continuing to enable more 

efficient business practices to reduce prices for consumers. 

 8.2.3 Necessary Infrastructure Investments 

Investments in infrastructures to support global supply chains, including 

hardware and software standards, information languages and protocols, 

and financial accounting and clearing systems, must increasingly be 

made across national boundaries. In the past, the focus of NIST’s efforts 

has broadened from the United States to North America (due to NAFTA) 

to industrialized nations generally (through ISO and other international 

efforts). Today, however, as the market becomes more global, there is 

growing need for leadership in both international trading and 

standardization arenas. 

 8.3 IMPLICATIONS FOR NIST 

The aggregated estimates produced by the case studies and industry 

surveys should prove useful in identifying the rough magnitude of NIST’s 

opportunity in supporting the creation of a better standards infrastructure. 

As with any prospective study, the estimates generated are most useful 

in helping government agencies such as NIST prioritize their available 

resources and justify why additional resources are needed in areas such 

as interoperability, where the costs of inadequate infrastructure are high. 

The results of this study support implementation of the Enterprise 

Integration Act passed by Congress in 2003 that authorized NIST to 

provide leadership in supply chain integration. 

Eliminating all of the inefficiencies in supply-chain information systems 

will likely prove impossible because of their high level of complexity and 

rapid pace of change. New supply-chain partners will enter the system, 

some with a low level of capability, others with incompatible legacy 

systems that must be integrated or adapted. Business and technical 

conditions will change, and today’s optimal infrastructure will likely 

become inefficient. Realities of business rivalry among competitors and 

customer–supplier pairs may prevent close cooperation, even with 

neutral party leadership and coordination. Thus, an effective 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

8-8 

infrastructure support program is required that is of sufficient size and 

also flexible enough to respond over time to the dynamics of complex 

supply chains. 

Second, there will be a significant resource cost to government 

organizations and all involved supply-chain members in developing and 

implementing new standards regimes. Firms must invest in time, human 

capital, and information systems software and hardware and incur 

startup costs to make the improvements that will lower their costs. Any 

subsequent analysis of the benefits generated by such a program will 

need to consider these costs, as well as evaluate the participation of 

supply-chain software firms and solutions providers, a now struggling 

business sector that will undoubtedly be thriving once a (nearly) optimal 

standards structure has been established. 

In summary, the analyses conducted in this study indicate that 

government laboratories such as NIST can help address the need for 

infrastructure investment, a public good that otherwise would fail to 

receive sufficient private investment. 
R-1 

 

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Appendix A: 

Site-Visit Guide 

A-1 

 A.1 INTRODUCTION 

Firms across the country have invested heavily in Supply Chain 

Integration (SCI) over the past several years, in an attempt to improve 

operating efficiency, reduce inventory cost and risk, and increase their 

responsiveness to new business opportunities. RTI and Altarum have 

been asked by the National Institute of Standards and Technology 

(NIST) to conduct a study that will estimate costs from inadequate 

standards that support SCI, in both the Automotive and Electronics 

Industry supply chains. The size and complexity of these supply chains 

make this a daunting task for any researchers, and our organizations 

greatly appreciate any help you can give us in completing our study. If 

the potential savings are found to be significant, NIST may be able to 

invest in leading a process similar to the one that developed STEP for 

the interchange of product data. We believe that the introspection 

provided by your support of this research can bring added benefits to 

your firm, and that the completed study may raise the level of interest 

within the automotive industry about the need for additional 

standardization in SCI. 

 A.2 SCOPE 

In order to make this project manageable, we need to carefully define the 

scope of analysis, and would value your guidance in this effort. The 

breadth of supply chain information exchange is too large for any single 

study of this type—more than 150 separate businesses processes make 

up the supply chain, each of which offers some opportunity for 

improvement. We can divide these information processes into several 

major areas: accounts, products, orders, inventories, manufacturing 

data, marketing data, and service and support. In which of these major 

areas: 

• are you actively involved in supply chain integration activities; 

• have you spent significant amounts of money in supporting; 

• do you see the greatest potential for savings from integration? 

Are there specific activities within each of the areas you indicated that 

have occupied most of your efforts, expenditures, and future plans? For 

instance, is providing inventory visibility the primary focus of your 

integration efforts? What about XML-based online product catalog 

information? For the remainder of this interview guide, we would like you 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

A-2 

to focus on providing information related to those areas you have 

identified in this scope section. 

 A.3 YOUR DEGREE OF INTEGRATION 

Our background research and preliminary discussions with automotive 

industry experts has convinced us that there is a broad spectrum of 

integration activity and capability across the industry, including what 

Altarum has called 'e-readiness'. Could you identify for us where you 

believe your company or division would fit in to the following integration 

taxonomy? (If different parts of your firm are at different stages, we 

would be interested in exploring each one.) 

• Total integration—most or all critical and costly activities are 

linked through interoperable systems, approaching the ideal – 

each piece of data is entered once, and becomes instantly 

available to all other users of the system, both human and 

electronic. 

• Inefficient integration—most or all critical and costly activities are 

automated, but different, non-interoperable systems are used, 

requiring high levels of support, custom translators, manual data 

re-entry 

• Incomplete integration—many or most critical activities are not 

automated, requiring a great deal of human intervention - manual 

data entry and re-entry, routine expediting of production and 

shipments, extensive use of telephone and fax 

 A.4 COSTS OF INEFFICIENT INTEGRATION 

In evaluating STEP and several other NIST initiatives, RTI and Altarum 

have successfully used an engineering-cost approach to estimate costs 

related to inefficient and incomplete integration. We would be interested 

in obtaining quantitative estimates from you (in the areas outlined in the 

scope section) about activities and costs for the following measures 

related to inefficient integration: 

1. Support of multiple information systems, including capital cost or 

annual license fees, upgrade and maintenance contracts, labor 

costs for operating and supporting systems, training costs 

including out-of-pocket fees and effort hours for trainees 

2. Capital and operating costs for custom translation programs 

used to link incompatible information systems, whether 

developed in-house or purchased 

3. Number of people whose primary function is manual re-entry of 

data, and estimated annual labor costs for these positions 
Appendix A — Site-Visit Guide 

A-3 

 A.5 COSTS OF INCOMPLETE INTEGRATION 

If there are areas within your firm where integration is less-developed, 

and would be best described as incomplete, we would like to obtain 

information from you on the following activities and costs: 

1. Number of people whose primary function is original entry of 

data, including product, price, marketing, order, production, 

schedule, shipment, and billing information, and estimated labor 

costs for these positions 

2. Number of people whose primary function is expediting or 

managing exceptional supply-chain events, such as emergency 

orders, cancellations, quality problems, and estimated labor 

costs for each 

 A.6 ORGANIZATION-WIDE DELAY COSTS 

A final aspect of the costs related to and inadequate standards 

infrastructure (and therefore a lack of widely-available interoperable 

software products) relate to delays caused by incomplete or inefficient 

integration. As an example, in the electronics industry, rapid demand 

changes lead to frequent delivery schedule modifications, yet a batch 

EDI order-update job is run only once per day. This delay leads to 

frequent missed expectations, as well as a high level of product 

scrapping. Have you studied or can you estimate, at the level of the 

entire organization (division, company), annual economic or financial 

losses from these types of delays caused by lack of integration: 

• Costs of scrapping products made but not sold due to 

order/shipment changes not communicated in a timely manner 

• Penalties paid or discounts lost due to late shipments caused by 

information delays 

• Premium costs, including overtime labor and rush shipment 

charges, incurred in attempting to meet customer-imposed 

shipment schedules 

• Lost business from failure to meet customer expectations on 

delivery or responsiveness 

 A.7 CONCLUSION AND THANKS 

We appreciate your time and efforts in helping RTI and Altarum with this 

important study for NIST. We would like to be able to follow-up with you 

at a later date if we have additional questions. In addition, RTI would be 

happy to send you a copy of the final report once it has been approved 

by NIST. Thanks again for your assistance! 

Appendix B: 

Automotive and 

Electronics Industries 

Survey 

B-1 

Questionnaire: Automotive and 

Electronics Industries 

Introduction 

On behalf of the National Institute of Standards and Technology (NIST), RTI International is 

evaluating the cost associated with an inadequate standards infrastructure for supply chain 

integration (SCI) in the automotive and electronics industry sectors. Costs can arise in the form 

of investments in purchasing and supporting multiple information systems, excess effort 

required to interface with incompletely integrated systems, labor hours consumed in resolving 

problems with supply chain software interoperability, and costs stemming from informationrelated production delays. These costs are determined through assessing current adoption of 

SCI software by members of a supply chain and gauging relative inefficiencies within uninvested 

companies. 

As a member of an industry that is actively involved in supply chain interaction, you have unique 

insight into the nature of supply chain management issues. The information you provide will 

help NIST better assess the benefits of supply chain integration projects and the needs of your 

industry in particular. Consequently, NIST will be better prepared to channel future investments 

toward projects that best meet those needs. 

Questionnaire 

Please answer the questions in the attached questionnaire with reference to your work in supply 

chain management and feel free to collaborate with colleagues when answering these 

questions. The data you provide will be considered confidential and will only be used in 

aggregate with other companies; no third parties will have access to this information. 

If you have any questions about the purpose of the survey or how to answer the any of the 

items therein, please feel free to contact Brent Rowe via email at browe@rti.org or by phone at 

(919) 485-2626. 

Thank you for participating in this survey. 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

B-2 

1. Company Background Identification 

This section requests background information on your company and your role within your 

company. As indicated earlier, your individual response to this questionnaire is confidential and 

will not be shared with any third parties, including NIST. Any information you choose to provide 

will be aggregated with other responses for analysis and results-reporting purposes. 

Company Name: 

Mailing Address: 

Contact Name: 

Title: 

Phone Number: 

E-mail: 

Are you providing responses to this questionnaire for your division or your entire company? 

(Hereafter, your company or division will be referred to as “organization.”) 

 Division Company 

At what tier of the industry supply chain would you characterize your organization? 

 OEM Tier One Tier Two Subtier 

What is your organization’s approximate annual sales revenue for which your response is 

relevant? 

$ Dollars per year 

 percent of total company sales associated with your division, if applicable. 

2. Methods for Coordinating Supply Chain Management 

Activities 

This section asks you to reflect generally on how your organization manages the exchange of 

supply chain information, such as purchase orders, schedules, and inventory levels. 

How do you accomplish the exchange of supply chain information with your suppliers? 

 

 

 
Appendix B — Automotive and Electronics Industries Survey 

B-3 

How do you accomplish the exchange of this information with your customers? 

 

 

 

How does your organization manage the following seven supply chain management processes? 

Please indicate whether you use an automated or manual process for these activities. 

Additionally, please estimate the labor effort required (in full-time equivalent workers, or FTEs) 

to support each process. 

Process Automated Manual Effort (FTEs)

Managing Partner Information (e.g., account 

maintenance, credit approval) 

 

Managing Product Information (e.g., distribution of 

new product data, notification of product change) 

 

Order Management (e.g., checking order status, 

requesting price and availability, sending shipment 

notification) 

 

Inventory Management (e.g., distributing inventory 

reports) 

 

Managing Manufacturing Information (e.g., work 

order change notification, checking status of work in 

progress) 

 

Managing Marketing Information (e.g., distributing 

product list) 

 

Service and Support Management (e.g., requesting 

a warranty claim) 

 

If you would like to comment on your organization’s method of coordination for each activity, 

please use the space provided below. 

 

 

 

Has your organization encountered technical complications in managing the exchange of these 

supply chain information processes? 

 

 

 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

B-4 

Approximately how many suppliers did your organization work with in its manufacturing 

operations in 2002? 

 Suppliers 

Approximately how many customers did your organization supply in 2002? 

 Customers 

3. Supply Chain Information Technology Investment 

This section asks you to reflect on your organization’s information technology investment in the 

management of supply chain information. Where percentages are requested, please provide 

approximate values based on your working knowledge. 

3.1 Electronic Exchange of Supply Chain Information 

Does your organization use EDI? EDI (electronic data interchange) is defined as the electronic 

interchange of processable data between computers. 

 No 

 Yes, for approximately percent of business transactions 

 With your customers 

 With your suppliers 

 Internally, i.e., between your firm's manufacturing locations 

Does your organization use XML-based systems? XML (extensible markup language) based 

software systems are defined as programs that allow standardized, automated information flows 

within and between organizations via the Internet, enabling the definition, transmission, 

validation, and interpretation of data between applications and between organizations. 

 No 

 Yes, for approximately percent of business transactions 

 With your customers 

 With your suppliers 

 Internally 
Appendix B — Automotive and Electronics Industries Survey 

B-5 

If applicable, please list supply chain integration and EDI or XML-based software systems your 

organization uses, including ERP (enterprise resource planning), PDM (product data 

management), and translator systems that manage supply chain information. Examples of 

commonly used software include iSupply, Powerway, BRAIN, BPCS, , and EDIFACT EDI. 

Please also include the year the software was installed, approximate installation and startup 

costs, and information on licensing. 

Software 

First Year 

Used 

Installation/startup 

cost (one-time fee) 

Approximate Licensing 

Fee (annual) 

Number of 

Licenses 

 

If you would like to comment further on your software systems, please use the space provided 

below. 

 

 

 

3.2 Software Users and Information Technology Staffing 

How many employees in your organization use one or more of your aforementioned software 

programs for supply chain activities? 

 Employees 

Of this number, what is the average number of systems supported by each employee? 

 Systems 

On the average, how many hours of software training per user does your organization sponsor 

in a typical year? 

 training hours per employee 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

B-6 

What is the total level of IT staffing and support your organization employs for operating and 

maintaining your supply chain information technology investment? 

 number of network systems administrators 

 number of software support specialists 

3.3 Supply Chain Integration Activities 

Has electronic supply chain integration increased productivity (reduced the number of working 

hours needed) to fulfill business interactions with customers and suppliers? Please provide a 

percentage estimate based on your working knowledge. 

 Yes, supplier interactions productivity increased by percent 

 customer interactions productivity increased by percent 

 No, 

 productivity did not change 

 productivity decreased by percent 

 Don’t know 

Did your organization contract with an outside consulting firm to facilitate supply chain 

integration? 

 Yes; approximate fees paid: $ 

 No 

4. Manual Labor Effort Required to Manage Supply Chain 

Information 

Does your organization use any of the following manual processes for customer/supplier 

interactions? Please estimate the number of employees involved in these activities, and the 

approximate hours each employee may spend on those activities in a typical month. If you 

would like to comment on the software system, please use the space provided in the comments 

field. 

Activity 

Total Number Employees 

Engaged in Activity 

Typical Number of Hours per 

Month, per Employee for 

This Activity 

Manual data reentry 

Faxing or phoning supply 

chain information 

 

Expediting delayed or 

overdue inbound or 

 
Appendix B — Automotive and Electronics Industries Survey 

B-7 

outbound shipments 

Resending information 

electronically 

 

Other 

If you would like to comment further on these activities, please use the space provided below. 

 

 

5. Added Costs from Incomplete or Inefficient Exchange of 

Supply Chain Information 

Have supply chain data exchange problems caused delays that have led to incurrence of 

premium operating or freight costs, payment of late charges or penalties, the need to rework or 

scrap finished product, or lost product sales in the last two years? 

Cost Incurrence Category Check Box if Yes 

Approximate 

Average Cost per 

Occurrence? 

Number of 

Occurrences in 

Last Two Years 

Premium operating or freight 

costs 

 $ 

Payment of late charges or 

penalties 

 $ 

Rework or scrap finished 

product 

 $ 

Lost product sales $ 

Other $ 

If you would like to comment further on these activities, please use the space provided below. 

 

 
Economic Impact of Inadequate Infrastructure for Supply Chain Integration 

B-8 

6. Thank You Very Much for Your Participation in this Survey. 

Are you available for further comments about supply chain management? 

 Yes No