AMR lands the medal!
John MacLean, vice president of purchasing, leads AMR's award-winning supply management team.; Responsibility for AMR's $4.5 billion annual buy lies with this team of trained professionals--front row seated: Linda Antonie, manager, strategic planning; John Rau, managing director, fuels management and energy strategies; James Fite, managing director, supply management, The SABRE Group; and David Wing, managing director, maintenance and engineering. Standing center: John MacLean, vice presiden
By Susan Avery -- Purchasing, 9/15/1998 2:00:00 AM
As chairman of AMR Corp., parent company of American Airlines, Donald J. Carty recognizes the vulnerability of his business to supplier excellence--something he says the airline truly did not understand 10 years ago.
"If we have a crisis at an airport and have to cancel a flight because of parts availability, then there is no flight for us to sell," says Carty. "The reputation of the airline is damaged, and people on that airplane have some misgiving about their next trip on American.
"In the 1980s, we were not focused on developing relationships with suppliers that we could count on. That wasn't part of our management process. We used to beat on maintenance for not having the part."
Then, as the country slipped into recession in the '90s, the U.S. airline industry began to lose billions of dollars annually. To help stop the slide--the losses eventually amounted to all of the earnings generated by all airlines since the Wright brothers flew at Kitty Hawk--Carty and his predecessor, Robert L. Crandall, borrowed a page from managers of world-class manufacturing operations. They turned to their supply management operation.
What the two executives found was an operation badly in need of an overhaul. Undaunted, they turned again to the manufacturing world and hired the former head of purchasing at Navistar International, John R. MacLean, as vice president of purchasing. They elevated the post, so that it is now just one level removed from the chairman, and asked MacLean to regularly attend executive planning meetings.
MacLean went to work, hiring and training a staff that has systematically applied supply management strategy to AMR's diverse buy--fuel, aircraft maintenance, airport & customer services, and technology. The buyers slashed costs, consolidated the supply base, and negotiated long-term agreements. They returned more than $250 million directly to the bottom line.
They developed a supplier performance measurement tool, SE-2000, that's become the envy of the service industry. They've won numerous awards for their efforts at developing a minority- and women-owned supplier base. And, by using a teaming approach to implement the operation's strategic plan, they've introduced to the airline such world-class supply management techniques as early supplier involvement, integrated supply management, global sourcing, and consortium sourcing.
"I can only underscore that MacLean and his team have certainly accomplished what we expected and, in fact, have exceeded our expectations in terms of taking manufacturing strategies and adapting them to the airline business with clearly a lot of innovation," says Carty. It is precisely for this reason--and because top management is truly committed to deploying strategic supply management to all areas of the company's operations--that American Airlines wins Purchasing Magazine's Medal of Professional Excellence for 1998.
Perusing the list of past winners finds AMR to be the first non-manufacturing company to win Purchasing's annual award, yet it is precisely because of the buying operation's successful application of supply management strategy practiced at some of these very companies--Honda, Xerox, GE--that it so deserves the honor. Still, AMR is more than a service business. The company also is involved in such diverse businesses as logistics, aircraft maintenance & repair, and the outsourcing of technology.
The service aspect of its business is, however, what generally comes to most people's minds when they think of AMR Corp. As one of the largest airlines in the world, American Airlines takes reservations; checks-in customers; provides in-flight meal service, communication, and entertainment; and offers a frequent flyer program, vacation packages, and "Admiral Club" services.
Through its logistics business, AMR owns 641 airplanes which fly to 165 cities in 40 countries in North America, Europe, Latin America, and Japan. That's 2,260 flights a day, in which schedules of pilots, flight attendants, mechanics, maintenance, fuel, meals, baggage, mail/freight, and passengers all must be coordinated.
The company's repair business mimics a manufacturer's production process: During its lifetime (30 years), each airplane AMR flies goes through an intensive series of inspections and rebuilding processes in which it is disassembled, its components repaired or replaced, re-assembled, and inspected and tested by mechanics at the airline's maintenance & engineering facilities in Dallas and Tulsa, Okla.
AMR's technology business consists of the sabre Travel Information Network and the sabre Technology Group. The former is in the electronic travel distribution business (the system that travel agents, corporations, and consumers use to make hotel, rental car, cruise, and air travel reservations); the latter provides information technology systems (telecom, data center, and desktop) to outsourcing customers. In revenue from information technology services, sabre generates more than $1.8 billion annually.
While AMR's annual purchasing budget for goods and services to support each of these businesses represents just 26% of its $17 billion annual revenue--admittedly far less than that of many manufacturers--at $4.5 billion it's still a significant figure. Annually, AMR spends $1.8 billion on fuel, $1.1 billion on airport & customer services, $1 billion on aircraft maintenance, and $500 million on technology.
MacLean has structured his operation so that a managing director of purchasing is responsible for sourcing all of the goods and services needed to support each part of the business. In many cases, purchasing is co-located physically next to its internal customers. Buyers with responsibility for purchasing aircraft maintenance parts and supplies, for instance, work at the company's aircraft maintenance center in Tulsa, Okla. Those who purchase PCs and desktop software work in the same building that houses the sabre Group located next to AMR headquarters at the company's Dallas/Ft. Worth campus.
At the same time, MacLean has stepped up his operation's recruiting and training efforts. Now on staff are commodity managers, supplier quality specialists, cost analysts, financial analysts, and systems analysts. He's recruited purchasing professionals who have worked at GE, Xerox, IBM, Motorola, AlliedSignal, and Honda as well as graduates with degrees in supply management from such educational institutions as Arizona State University, Michigan State University, and Florida A&M University.
It wasn't too long ago (1992) that a little more than half (55%) of the airline's purchasing managers had a college degree. Today, this number is 90%. What's more, 21% now have advanced degrees. This figure was just 5% in 1992. AMR now provides 40 hours of training a year to each of its purchasing professionals.
MacLean has "radically overhauled the department over the past five years," says his boss, Thomas J. Kiernan, senior vice president, corporate services. "It has moved under MacLean's leadership from a reactive support organization to one that is strategically focused and tightly integrated with our business units."
Larry Laster, vice president, maintenance & engineering, recalls when the buying operation was largely reactive. "They were not helping to manage the business. Developing relationships with suppliers fell on my shoulders, yet I didn't have the resources to do this. I knew the opportunity was there, but it was frustrating. Purchasing just wasn't interested."
Now, the operation has a strategic focus. MacLean named Linda D. Antonie as manager of strategic planning. A 13-year AMR veteran and a student of Dr. Robert Monczka, professor of strategic sourcing management at Michigan State University, Antonie is responsible for putting together the strategy that is taking purchasing into the 21st century.
Upon beginning her new tasks, Antonie, along with MacLean and the managing directors, conducted benchmarking exercises of best practices in supply management and gap analysis activities. What they learned was that the operation needed to make an investment in resources (staff as well as information systems), set goals that would demonstrate the value purchasing adds to the corporation, and develop a supplier performance measurement system.
Investing in information systems has resulted in a significant reduction in non-value-added activities that used to take up much of purchasing's time (e.g. processing POs). A National Contract Ordering System (natcos) is used by requisitioners at AMR locations worldwide to place orders electronically for office and MRO supplies. In 1997, use of the system eliminated more than 230,000 POs. Use of the American Airlines Purchasing and Inventory Control System (aapics) in 1997 also helped clear purchasing's desk--of nearly 600,000 invoices for non-fuel purchases (mainly aircraft components).
One way to demonstrate value that purchasing adds to the corporation is to hold prices in line. Each year prior to 1993, AMR had been paying prices for purchased goods and services that mirrored annual increases in the Producer Price Index.
Consolidating the supplier base helped reverse that trend. In 1995, the operation's database held 17,000 suppliers, which upon close examination revealed many duplicate listings. "We had a big data problem symptomatic of the fact that it wasn't important to the organization to manage the supplier base," says MacLean. An initial cleanup left 7200 suppliers.
As at many organizations, the first whacks were easy. The buyers reduced the supplier base by another 30% in 1996. They took 16% out in 1997, and plan to remove another 13% by the end of this year. MacLean says that while the department's vision "is not a steady number, we thought it might make sense that by the year 2000 if we'd have 2,000 suppliers. If we hit that number, then we'll be down 70% since 1995."
Now, in a lot of industries, 2,000 suppliers sounds like an enormous number, and MacLean concedes that it does appear to be unmanageable. "The reason we wind up with so many suppliers goes back to the diversity of our buy. We can't leverage a supplier that provides us with Godiva chocolates to enter into the aircraft maintenance business, and vice versa."
With the organization's current roster of suppliers, buyers negotiated long-term agreements, with most extending for at least three years. Others have lives of five, seven, eight, and 10 years. In 1994, 40% of the airline's annual buy was on long-term agreements; today, this figure is 70%. Perhaps most significant is a 20-year $6-billion agreement the company entered into with Boeing in 1996 that calls for the supplier to be its single source of jet aircraft.
As exclusive supplier to AMR, Boeing guarantees the airline that operation of its planes will meet specific cost guidelines. It has agreed to reduce leadtimes for new planes from three years to 12-18 months. It also is this agreement that provides MacLean and the directors a launching point to put into place supply management strategies for all of the goods and services the airline purchases.
Strategic sourcing
Typically, airlines customize the aircraft they purchase through the sourcing and design of interior components: seats, carpet, overhead bins, upholstery, galleys, emergency equipment, lavatories, lighting, audio systems, entertainment systems, and avionics. AMR plans to spend $325 million on the interiors of its new planes and another $400 million to refurbish the interiors of its current fleet.
To purchase these components, MacLean and the managing directors put in place a five-step strategic sourcing process that involves a core team of representatives from engineering, marketing, purchasing, and production. The team evaluates supplier capability in these areas: capacity, delivery, price, open-book costing, gain sharing, total cost guarantees, reliability guarantees, and quality processes.
"For the first time, purchasing is incorporating supply management strategy in each and every supplier-selection decision," says David R. Wing, managing director, maintenance & engineering purchasing. In the early '80s, the last time the airline furnished new planes, the only activity purchasing performed was to place a PO for whatever the marketing department decided it wanted. Even engineering at the time, other than ensuring the component would meet FAA requirements, played a minor role.
Team members now conduct industry analysis, review supplier proposals on key topics, do on-site evaluations, interview supplier executives, and make the sourcing selection. The team reports back to the executive steering committee, which is made up of vice presidents of marketing, engineering, and purchasing.
Henry Joyner, vice president marketing planning, credits purchasing with bringing discipline to the decision-making process. "We value their insight into workings of supplier relationships. We now have the data to help us understand some of the reasoning behind smart sourcing decisions."
The five-step strategic sourcing process begins with industry analysis in which the core team focuses on finding qualified suppliers. They look at supplier performance and experience, as well as market share and capacity. "Capacity is a big issue now, and results of our analysis on seating suppliers, for example, drove our decision to source from several suppliers instead of just one," says Wing.
To develop, design, and certify first-class seats for the airline's new Boeing 777s, the core team worked with the manufacturer as well as such interfacing equipment suppliers as AT&T (telephone systems) and Rockwell Collins (in-flight entertainment). The team also worked with Boeing on meeting FAA requirements. Under the long-term agreement with the seating supplier, the core team established life-cycle guarantees and extremely aggressive product reliability metrics.
For the second step, the team reviews supplier proposals. Representatives from engineering focus on technical issues, marketing reviews the esthetics of the product, and purchasing examines costs and supplier capability.
Purchasing reviews costs several different ways. Buyers evaluate price through competition, industry research, target costing, cost of bill of material, fixed cost, fixed margin, and, in one instance in which time-to-market was short, "we proposed an open-book policy to that seating supplier," says Wing. "In this case, we set a target price based on prices of past purchases. This scenario gave us the opportunity to audit the supplier. If we or the supplier find ways to lower the cost, then we will split savings."
In avionics, purchasing proposed a 'power by the hour' agreement that benefits both the airline and the supplier. This way, the two parties know annual costs up front and gain benefits by working together to develop a more reliable product. For in-flight entertainment systems, the airline negotiated reliability guarantees.
For the third step, the core team visits the supplier to perform evaluations on risk capacity as well as design. Purchasing members of the team look at process and quality. Fourth, the team interviews the supplier's executives. Here, the team determines the company's philosophy and its commitment to AMR's program. Finally, the core team makes a recommendation with alternatives to the steering committee.
Along the chain
Incorporating supply management strategy to jet fuel, a publicly traded commodity, is the responsibility of John Rau, managing director, fuels management. Evidence of his success: He's also implementing the strategy along the supply chain and adapting some of the best practices he's established to other areas within AMR purchasing.
As an airline, AMR consumes more than 2.8 billion gal. of jet fuel annually, representing 4.5% of demand in the world. To petroleum suppliers, however, jet fuel is just a small part of the business; 10%-15% of a refinery's production is devoted to jet fuel.
The fuel Rau purchases for the airline is consumed at 165 airports in 40 countries. Buying is done centrally, out of the office in Dallas. The 25 biggest airports represent 80% of total consumption.
On the other hand, the top seven jet-fuel providers represent 75% of supply. There is no one supplier capable of filling all of the airline's requirements at every airport. The largest supplier, in fact, has just 15% of the world's jet-fuel market. Rau and his team have negotiated long-term agreements that cover about 80% of the airline's jet-fuel requirements.
There are numerous pricing options upon which AMR may base its price: multiple indices, fixed price, and the New York Mercantile Exchange. As with all traded commodities, there is high price volatility--a one-cent change in price is equal to $28 million annually. "We use all of these options in varying degrees depending on where the market is at the time we make the purchase," says Rau.
In the U.S., there are four major markets for jet fuel: the Gulf Coast, New York, Chicago, and the West Coast (Los Angeles area). In each of these, the price changes daily. The price AMR purchasing pays for jet fuel is equal to what is being charged in any one of these four markets, plus costs of transporting the fuel into the airport. Logistics costs represent about 5% of the total cost of jet fuel.
"While we can't control the price of jet fuel unless we use the fixed-price option, we can control logistics costs," says Rau. "We also can manage the basis for our pricing decisions. For instance, we can buy fuel in Chicago and base it on the West Coast price or on the Chicago price."
The purchasing process for jet fuel begins at the refinery. "It is shipped on a pipeline which goes to an off-airport storage facility," says Rau. "From there, it goes on another pipeline or truck into the airport where it goes into storage again. Then, there's either a hydrant system, which consists of underground pipes that go around the airport, or the fuel is trucked to a storage facility in the aircraft."
Often a bigger player than many of its suppliers, AMR can get better cost efficiencies by moving the fuel itself than by having a refinery do it. "We have developed a multi-destination incentive transportation rate that allows us to ship fuel from Gulf Coast refineries to Chicago or Dallas," says Rau. "With volume for the two locations we can negotiate an incentive rate so that we don't have to ship all of the fuel either to Chicago or Dallas. We have flexibility that if we want to ship more fuel to Chicago than to Dallas, we still get the incentive rate."
"John is always trying to do two things," says MacLean. "One, and it's the most important, is to have 100% assurance of supply. The other is to ensure that the quality of the fuel that suppliers provide meet AMR's stringent requirements."
These pipelines are not segregated. Refineries transport multiple products through the pipelines. "So, to prevent, say, too much water in the fuel, we have numerous checks and filtration points along the system," says Rau.
The fuel management operation has developed a model that shows how much jet fuel is needed per aircraft per day. "We focus mainly on what we need per day at an airport," says Rau.
While it's important for Rau and his team to ensure that there is fuel at the airport every day, they have to try to do this with as little inventory as possible. "Since 1994, we've decreased our jet-fuel inventory by a little more than 20%," says Rau. "Basically, what we've done is eliminate some unnecessary storage facilities by working with suppliers in our non-hub and small airport locations to hold inventory for us."
To determine lowest total cost to get jet fuel into the airport, Rau and his team use a logistics model. This model analyzes such cost factors as price (for example, obtained from a supplier located on the Gulf Coast), payment TVM (time value of money), pay discount, prepay discount, prepay TVM, transportation, line loss, TVM buying FOB, and differential to low.
Once Rau and his team get jet fuel to the airport, there is the matter of determining the most cost-effective way to store it. Typically, oil companies or other players (in some cases, the airport authority itself) owned and operated multiple storage facilities at each airport. This scenario, Rau says, resulted in inefficient operations and higher costs for AMR.
In the early 1980s, the airline began looking at this and determined that it needed to get control of these facilities and make their operation more efficient. Now, at all of the big airports, AMR and other airlines jointly manage the fuel storage facility.
"As we see it, design of an airport facility is a form of early supplier involvement," says Rau. "In getting involved in the design of an airport, we hire a value engineer to work with the contractor to come up with a plan that is right for AMR. When the Dallas/Ft. Worth airport was first built, for example, it was not designed to operate as a hub with a surging flow of traffic. It was built to handle a steady flow. So we redesigned it to handle the hub operation."
All of this results in a very high dependability of fuel delivery into an aircraft. In fact, it approaches five sigma. While availability of fuel is always 100%, this measurement demonstrates the volume of fuel delivered without a delay. So, five sigma means getting the fuel into the plane without a delay.
At the same time, Rau and his team have formed supplier alliances with key providers in locations that are important to the airline. At the Dallas/Ft. Worth airport, for example, "we worked with a supplier to install a pipeline directly from the refinery to the airport, providing the airline with additional access," says Rau. "We do joint scheduling with them. This supplier is the largest at the airport, while we are the largest supplier into the airport coming in a different way. Therefore, when they need fuel, maybe we need to back off on a delivery. With joint scheduling, they know when our deliveries are coming into the airport."
As another example of an alliance with a supplier, Rau and his team have negotiated an agreement with a provider in Miami that allows AMR to bring in "foreign trade zone fuel" for flights headed to international destinations, avoiding payment of local taxes. Used to be, AMR worked with three suppliers in Miami for its international volume. "We will have logistics efficiencies as we work on a form of global sourcing," says Rau. In the agreement, Rau and the team have negotiated gain sharing. "We have a set price with them where if we can improve our supply from other sources, we can share in these gains."
Integrated supply
After jet fuel, the airline's second-biggest expenditure is airport & customer services. Here, Jim Burnett, managing director, has had the opportunity to apply such supply management strategies as integrated supply management, early supplier involvement, and consortium purchasing to this diverse buy.
One of these buys is airport ground equipment (i.e., pick-up trucks) which the airline sources from the Big Three automakers. Some of it is custom designed; the rest is purchased through auto dealers. In all, there now are 25,000 pieces of equipment throughout AMR's system, with most concentrated in the U.S. In Europe and Latin America, AMR outsources this buy.
Results of an inventory analysis conducted by Burnett and his staff in 1994 showed that the airline had on hand $35 million in parts to maintain these vehicles, while it utilized just $20 million of that annually. Purchasing of these parts at the time was decentralized. Airports in 130 cities did their own sourcing; 60% was purchased through local sources, i.e., auto part stores.
"Because that was the way it was dealt with in every city, we didn't leverage our volume and we really didn't track warranty information on the parts that we did buy," says Burnett.
In 1994, Burnett and his staff ran a pilot test with an integrated supplier at the airport in Los Angeles. (Through an on-site presence at customer locations, the integrated supplier handles all of the transactions that are conducted for the purchase of certain goods and services.) They selected this airport because it uses nearly every type of equipment that's available in AMR's system, and worked to categorize parts in terms of criticality: Some parts the supplier has to keep stocked, while others can have a 24-hour or 48-hour turnaround time.
"We ran it for a while, and conducted surveys to ensure that the process worked," says Burnett. "The supplier we selected provided service levels that reached a 97% fill rate (delivery within 8 hours), a reduction in part and material unit cost of about 19%, and a decrease of 16% in purchase volume which is based on improved inventory practices.
"Locating a supplier on site also took us out of the transaction business," says Burnett. "Although 60% of the parts were purchased locally, we still had 40% spread out over 130 people who were calling purchasing to requisition items. We also saw utilization of ground equipment increase, and had less out-of-service equipment."
Based on the results of the pilot, Burnett and his staff have located an on-site supplier in additional cities: New York, Dallas, San Juan, Chicago, and Miami, which represents about 70% of all the purchase volume for these spare parts.
Next step is to expand the concept to other cities. "We may not have the integrated supplier at each station, but perhaps the supplier will set up a distribution warehouse that will provide service to such stations as Albuquerque or Amarillo," says Burnett. Integrated supply management also is being implemented in such diverse areas as uniforms, business forms, office supplies, household moves, MRO supplies, desktop software, and computer hardware.
Early supplier involvement
One of the things that Burnett and his staff noted as AMR began to buy new aircraft in 1996 was that they were going to need new galley carts. "Probably the last time we made such a purchase was in the 1980s. Based on the fact that those carts were near the end of their useful lives, we decided to try a new approach to the cart purchase."
Burnett and his staff gathered airline employees (flight attendants, food & beverage, safety, purchasing) who use the carts and suppliers who manufacture them. With the employees, the team set out to develop specifications for the new carts. From the suppliers, they planned to learn whether what they were specifying was cost prohibitive or not. Also involved were engineering representatives from the airline's maintenance center in Tulsa, who work directly with the FAA to determine whether the carts would pass the government agency's inspection.
In selecting a supplier to manufacture the carts, Burnett and the team did not limit their sights to the U.S. In fact, of galley cart suppliers, three are based overseas (and have operations in the U.S.). The team quickly dismissed one U.S. player because it did not have capability to meet the airline's requirements.
"As we started to design these carts, we had these three manufacturers come in and tell us some of the things we needed to stay away from," says Burnett. "We showed them the carts that we use today and what we wanted to change. We also knew that there had to have been innovations in materials since the last time we bought carts."
The team also invited the airline's repair supplier to be present at the meetings.
The team selected one supplier and put together a long-term agreement under which the manufacturer would provide all of the carts the airline needs for five years, plus repair parts for the life of the cart. "The final result was that we got a cart flight attendants like because it is 8 lb lighter. Purchasing likes it because of a 21% unit-price decrease. And, because they weigh 15% less, it will take less fuel per flight to fly the planes equipped with the new carts--about $300,000 per cart per year."
The supplier benefits from the new agreement as well. Although a provider to international carriers, the manufacturer was a relatively minor player in the U.S. Now, the supplier has an entrance to the market.
Consortium buying
AMR is involved in consortium buying that involves representatives of companies in different industries. Two years ago, AMR and eight other companies representing manufacturing, services, pharmaceuticals, and consumer products businesses formed a consortium to pool their volumes and negotiate lower prices with suppliers.
To do this, the consortium hired a consultant to ensure that each of the nine companies have similar objectives. Through the consortium, of which Burnett is vice president, AMR also has the opportunity to share best practices with member companies. "Two or three times a year, we get together to discuss issues relevant not only to purchasing but to other areas of our companies as well. At the last meeting, we talked about the Y2K problem."
Each time the consortium puts together an agreement, members share their buying data with the consultant, who sifts through it all. At a "bid conference," representatives of the nine companies meet with the consultant to discuss issues raised by his findings.
Next, the consortium determines how the data should be packaged into a request for proposal (RFP). "What one consortium member wants at his or her company may be different from what another wants, we look for suppliers who provide a range of products and services that each member company can use," says Burnett.
Upon reviewing proposals from suppliers, the consultant presents to the consortium the supplier who he sees as most capable of meeting members' requirements. Each member then decides whether he or she wants to enter into an agreement with the supplier. To date, AMR has opted to enter into agreements with four suppliers the consortium has selected. These have resulted in cost savings of 15% for copier paper; 25% for copiers; 30% for office supplies; and 20% for facsimiles. Burnett currently is evaluating an agreement for computer monitors. m
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