• Action Plans

    The current and future health of the Army industrial base, against a backdrop of reduced defense spending and continuing national budgetary pressures, was a topic of much discussion at the AUSA Annual Meeting and Exposition in Washington, DC.

    A host of stakeholders speak frankly on what the Army needs to do to preserve its industrial base


    By Army AL&T magazine staff


    Preserving the unique and often highly specialized skills and capabilities of the Army industrial base is critical to the Army and to the nation. In addition to the organic industrial base, companies both large and small in the commercial base offer critical or hard-to-make products and services that ultimately result in critical systems that help maintain the U.S. military’s superiority.

    Yet fiscal austerity is likely to constrain U.S. spending on national security even as the Army faces growing complexities and multifaceted dangers. Some of those companies may be at risk of losing their indigenous capabilities to develop and produce critical goods and services. So, too, may some of the Army’s own organic capabilities be at risk of ramping down to the point that they are no longer readily available.

    “Critical Thinking” generally offers the perspective of a single thought leader from outside DOD and the defense industry on issues faced by the Army AL&T community. Our intent is to provide fresh opinion and expertise on difficult challenges. However, for this issue, we took a slightly different approach.

    It’s clear that, just as the Army’s industrial base is broad and complex, so, too, are the interests and concerns of those who work in and around it. With that in mind, rather than reach out to a single individual with multiple questions, Army AL&T magazine reached out to multiple individuals with one question:

    In your opinion, what does the U.S. Army need to do in the very short term, in the near term and in the long term to protect the skills and capabilities of its industrial base?

    Here are the answers from 10 individuals representing a cross-section of big and small defense businesses, think tanks and interest groups. These views are the opinions solely of the individuals and do not reflect the policy or viewpoints of Army AL&T, the U.S. Army or DOD.



    Gregory Bloom
    Seal Science Inc.
    Irvine, CA

    The United States’ ability to provide for the safety and security of its citizenry is being significantly impacted by a silent killer that has received almost no attention—the loss of critical engineering talent and the inability to attract the next generation of scientists and engineers who will make up the Army industrial base.

    Misunderstood by many, the industrial base is not just six large prime contractors focused on producing equipment for the Army. The Army industrial base comprises mostly small to mid-sized companies that possess the intellectual property, specialized skill sets and unique technical capabilities necessary to develop the products used by our nation’s military. Small businesses employ most of America’s best scientists, engineers and skilled craftsmen to deliver products that make our military the best equipped, most advanced and most effective in the world.

    Fiscal austerity is permanently crippling the Army industrial base, specifically the attraction and retention of the high-tech, highly skilled workforce that is the real foundation of the industrial base. The Army will not be able to be reconstitute that workforce when times require.

    The defense industrial base has become the consummate underdog in the competition for our nation’s best and brightest young engineers entering the workforce. Top graduates who historically entered the defense industry were driven by a desire to serve, an opportunity to work on cutting-edge technology and a reasonable expectation of job security—all at a discount in salary to the private sector.

    Today’s fiscal crisis is driving an industry drawdown that is different from those in the past. Fewer public dollars means fewer contracts, but it also means less private investment. Investment is needed to hold on to the defense industrial base’s essential infrastructure—its people.

    Engineers, as very rational individuals, are deciding en masse to leave careers in the Army industrial base as further cuts in defense and reductions in workforce are forecast. Moreover, because of the already scarce supply of STEM [science, technology, engineering and math] graduates, the heavily recruited best and brightest engineers and scientists are choosing careers in social media and in nondefense-related industries.

    In order to attract and retain the technical workforce required by the Army industrial base, resources are required to conduct the research and development (R&D) that allow our scientists to deliver the cutting-edge technology as well as to innovate and deliver future solutions and capabilities that our uniformed military uses in the field. R&D funding is critical in attracting the next generation of scientists and engineers, by providing them with the opportunity to learn on the job from our nation’s elite “retiring” engineers and to work with cutting-edge technology.

    The Army industrial base, with its specialized workforce, must be treated as a national asset and insulated from furloughs, job “insecurity” and funding uncertainties. Moreover, DOD must develop a long-term industrial base strategy focused on core capabilities that are critical to maintain technological superiority.

    For the first time in modern history, U.S. security is at risk due to the weakness in the total defense industrial base. As a consequence, the nation may no longer be able to produce certain essential military systems and capabilities. Facilities and equipment can be built and replaced relatively quickly—people and skills cannot.



    Samir Mehta
    Sikorsky Military Systems
    Stratford, CT
    To protect the skills and capabilities of its industrial base, the Army needs to focus on two critical areas.

    First: Protect your multiyear commitments to the industrial base, even in this fiscally constrained environment. Multiyear contracts allow the Army to reap significant savings through quantity pricing. And they give companies the short-term financial security to continue investing in new technologies and more efficient manufacturing processes.

    Very few significant technologies can be developed in the course of a single year, so a revenue stream over more than one year raises the certainty that companies will fund technology development projects that take longer than one year to mature.

    More importantly, multiyear contracts allow prime contractors to provide a high degree of certainty to their own supply base. For many of Sikorsky’s small and medium-sized suppliers, predictable revenue maintains company viability.

    Secondly, even with the short-term fiscal challenges, the Army cannot lose sight of its longer-term needs. The Army must clearly define the capabilities needed to prevail on the 21st-century battlefield, and allow industry to compete with innovative solutions and advanced technologies.

    Without definition, the danger arises that those who work projects within a constrained budget environment will bring an unprecedented level of influence to a short-term focus.

    The long-term view will mean protecting future programs like the Army’s Armed Aerial Scout (AAS) helicopter, or the Joint Multi-Role/Future Vertical Lift (JMR/FVL) program that seeks to replace the Black Hawk and Apache helicopter fleets in the mid 2030s.

    Programs like AAS and JMR/FVL stimulate industry’s top technical minds to develop game-changing technologies.

    Currently, an entire generation of engineering and technical talent could languish without ever working on a new-start, next-generation rotary-wing program. That is dangerous and shortsighted, and could “level the playing field” as it relates to our country’s current and future combat operations.

    A clearly defined long-term view is required if companies are to continue their willingness to speculatively invest millions of dollars in R&D, without which our nation’s industrial base and long-term military superiority are at risk.



    GEN Gordon Sullivan (USA, Ret.)
    Association of the United States Army (AUSA)
    Arlington, VA

    As I reflect upon my time as chief of staff, I can remember an important message I shared with representatives of industry at AUSA’s Winter Meeting two decades ago. It still rings true today: “We must combine forces, leverage our resources and make the best decisions for the welfare of our Army and our nation.” Now, as AUSA’s president, I’m even more convinced that the Army’s partnership with the industrial base is key to success.

    Many of the unsung heroes of the wars in Iraq and Afghanistan reside within the industrial base, which includes the 23 geographically dispersed government ammunition plants, manufacturing arsenals and maintenance depots that comprise the Army organic industrial base (AOIB), as well as commercial enterprises small and large. Their significant contributions to materiel readiness ensured that members of the joint force had the tools needed to accomplish the mission.

    A healthy industrial base with the depth, breadth and diversity needed to support the joint warfighter—today and in the future—remains paramount to sustaining military operations in an uncertain, complex national security environment. Senior leaders face a difficult fiscal environment that requires hard decisions about how to prioritize spending on personnel, readiness and modernization.

    A focus on four key areas—capacity, capital investment, modernization and workload—will chart a path for the future of the AOIB. This will allow the Army to leverage best business practices; maintain an experienced, skilled and specialized workforce; make prudent investments in modern, safe and capable infrastructure and equipment; and ultimately provide the capability for the joint force. Likewise, commercial enterprises that best meet the emerging readiness and modernization requirements of the joint force and embody best business practices to maximize return on investment of taxpayer funds will have the best prospects, now and in the future.

    The secretary of the Army and the chief of staff of the Army said it best when they testified before the Senate Armed Services Committee in April 2013: “The ability to reduce the industrial base in times of peace but surge as required remains essential to equipping the Army, the Joint Force and, in many cases, our allies and coalition partners.”

    For more information, see “The Army’s Organic Industrial Base: Providing Readiness Today, Preparing for Challenges Tomorrow,” online at http://www.ausa.org/publications/ilw/DigitalPublications/Documents/tbip-aoib/index.html.



    Mark DeYoung
    President and CEO
    Arlington, VA

    A capable, responsive and resilient industrial base is essential to the national security of the United States. In order to retain the essential skills that underpin the base, there are five fundamental enablers that should be considered and incorporated into the Army’s approach, now and in the future.

    First, maintain and expand an open and active dialogue between the Army—particularly acquisition managers—and industry. With data points that include product inventories, consumption rates, potential impacts due to force size reduction, and training or doctrine requirements, industry can make informed decisions that support the preservation of industrial base capability. To assist in the open dialogue, use and improve industrial base tools developed by joint life-cycle commands. One example is the Minimum Sustaining Rate database that helps identify the production and support levels necessary to avoid placing the industrial base at serious risk.

    Second, an acquisition policy that incentivizes innovation, preserves intellectual property rights and streamlines contracting practices would improve and sustain the industrial base. Meaningful dialogue on long-term plans, ensuring a steady flow of information to inform industry planning and investment, is a necessary element of this policy. Also, it is necessary to address Army and DOD policy regarding competition and maintaining multiple sources for products. History demonstrates that repeated competitions and smaller awards to multiple suppliers present serious challenges for industry, which can swiftly erode capability and threaten the health of the supply chain.

    Third, adequately funded programs and realistic requirements are essential. With clear and concise program requirements and plans, industry not only focuses on delivering key performance parameters and controlling cost, but also can more efficiently identify and develop critical skills to meet current and emerging needs.

    Fourth, increasing the Army’s support for international sales could reduce and/or sustain current production costs. The resulting expanded market for U.S. military products would help lower procurement costs to the Army while helping sustain the domestic manufacturing base.

    And finally, the Army, along with the other services, should continue to explore new ways to work productively with industry, academia and local communities to support STEM education. Investing in STEM education initiatives will help our nation attract, train and retain the next generation of innovators and skilled workers needed to lead the industrial base of the future.



    Michelle J. Lohmeier
    Vice president, Land Warfare Systems
    Raytheon Missile Systems
    Tucson, AZ

    I believe the Army and industry face similar challenges associated with sustaining the defense industrial base, and share responsibility for putting together collaborative, forward-leaning solutions that establish the right balance of investments in technology and talent.

    In the case of technology, the Army must fully implement the recommendations put forward in its latest industrial base study. For example, the Army has made protection of the Abrams main battle tank industrial base a priority and is investing in key subsystems accordingly. The precision munition and missile industrial base is particularly reliant on technologies that exist in the sub-tier supplier base. Going forward, Army and industry must work jointly to identify critical, at-risk companies and develop roadmaps for sustaining investment in them during the downward trend in defense spending.

    In addition, industry must challenge itself to retain a tight focus on evolving core capabilities and products in a way that increases capability and reliability while reducing cost. This aligns well with our desire to further optimize operations and deliver even more value to the Army acquisition customer.

    DOD and industry must also face head-on the dual challenge of a decline in new college graduates with technical degrees and the aging of our respective workforces. Companies like Raytheon have launched STEM initiatives, ranging from middle school to university, that encourage young Americans to enter math and science fields. In addition, we need to find ways to make a career in defense more appealing to young, tech-savvy people with lots of career options. We have a compelling story to tell about developing innovative solutions that protect our warfighters and secure America and our allies in an uncertain world.

    Combined with a focus on sustaining key technologies, a joint approach to building the defense workforce of the future will be critical to protecting our industrial base.



    Dr. Ron Rosemeier
    Brimrose Corp. of America
    Sparks, MD

    The global battlefield as we know it is changing rapidly, and the American Soldier must be equipped to stay ahead of the enemy. As global technology and information become more commonplace, the ability to stay ahead is becoming more challenging. Therefore, it makes sense for the Army to look to smaller companies as it faces reduced funding allocations, because they don’t require the larger funding leads that bigger companies do.

    At Brimrose, we are focused on helping the Army stay ahead in the technology race, to keep its edge in terms of critical battlefield thinking. We place tremendous effort in moving rapidly from concept to instrumentation. If we receive $500,000 to $1 million, that goes a lot further than it would for a larger company, which might require several times that amount to do the same thing.

    For example, we are studying our leading-edge unmanned aerial vehicles and exploring innovative ways to use and control them. Further out, we have initiated tests in which drones can literally be controlled by the brain waves of Soldiers in the field. This kind of technology already is being used to help wounded warriors control artificial limbs with their thoughts. Complementary to that, we are studying how a Soldier thinks in the field, how he or she responds to stress, and what he or she can and cannot handle.

    Are these at the outer limits of conventional warfare thinking? The answer is yes. But a lot of people thought Thomas Edison was crazy because he was ahead of his time. Smaller companies can move faster and move resources more rapidly, and they are unlikely to have resources tied up by the bureaucracies that plague some larger companies.



    Michael E. O’Hanlon
    Senior Fellow, Center for 21st Century Security and Intelligence
    Director of Research, Foreign Policy Program
    Brookings Institution
    Washington, DC

    In assessing the health of the national security industrial base, we can take several approaches, each of which has its own value:

    • Try to preserve defense employment in general, especially in a time, like the present, of national economic difficulty and need for federal fiscal stimulus. In other words, try to save jobs.
    • Seek to preserve the immediate capacity of our industrial base to ramp up production fast in the event of a national security surprise.
    • Attempt to keep key manufacturers in crucial areas of industrial capability as healthy as possible.
    • Promote ongoing technological advancement by paying special heed to those parts of industry that are also pushing forward scientific and technological frontiers, with linkages to R&D and basic science activities.

    Because these industrial base goals are quite different from one another, it is important to be clear about which ones a given policy might support. As a general proposition, the latter two are of greater concern to me than the first two, in light of scarce defense dollars and downward pressure on Pentagon budgets, combined with our generally adequate inventories of advanced military gear today. This is especially true for many ground combat systems, which, while extremely important to our nation, may not always be as technologically sensitive or advanced as, say, stealth aircraft or nuclear submarines or tilt-rotor aircraft.

    As such, without disregarding the first two concerns entirely, I would submit that we focus more on advanced, avant-garde and/or endangered technologies. How to do this? In its “Annual Industrial Capabilities Report to Congress” (2012 edition), DOD lists a number of areas of military technology and manufacturing capacity that it deems to be at risk, given trends in overall defense budgets as well as specific developments within the Pentagon’s acquisition accounts. These areas of technology are rather specific in some cases and include the following:

    • Heavy forgings.
    • Heavy castings.
    • High-precision bearings.
    • High-temperature and low-temperature co-fired ceramics.
    • Rare earth elements.
    • Long-range cruise missile propulsion technologies.
    • Tri-mode seekers.
    • Solid rocket motors.
    • Thermal batteries.
    • Rayon precursor material.
    • Triaminotrinitrobenzene (TATB) explosive.
    • Advanced fuzes.
    • Ammonium perchlorate.
    • Butanetriol trinitrate propellant.

    This list is a good place to start. It is not the end of the debate, to be sure. But by mapping various Army-related manufacturing capabilities against the above list, we can perhaps construct a first draft of those technologies that most require our vigilant oversight and perhaps even our nurturing. And then, with that first draft in hand, we can move on to a second draft. But there needs to be a place where we begin.



    Lt Gen Lawrence P. Farrell Jr. (USAF, Ret.)
    National Defense Industrial Association
    Arlington, VA

    The Army, like the other services, is facing a big hill. Continuing pressure from the 2011 Budget Control Act (BCA), combined with the sequester, is squeezing needed funds as the Army faces a tough transition from continuous war to the need to reset the force. One major issue in the transition is the health of the industrial base in a downsizing environment. The latest budget deal provides some breathing room in BCA budget caps. How, then, to protect critical capabilities in the base?

    A first step is to recognize that company downsizing, defense business exits and consolidation are certain. So we need a way to assess the likely impact on critical suppliers of coming budget levels.

    A model program for this already exists in the munitions area. A few years ago, the Joint Munitions Command (JMC) and industry undertook a collaborative project to develop assessment tools for the situation we face today. One of these, the Industrial Base Assessment Tool provides the ability to identify the impact of a given budget on a specific product area. Another tool, the Minimum Sustaining Rate tool, permits the JMC and the Single Manager for Conventional Ammunition to identify the impact on key production facilities (read: businesses).

    These methods, if expanded and applied to other Army industrial base sectors, would go a long way toward ensuring the survival of critical indigenous capabilities in the Army industrial base.



    Gregory Glaros
    Arlington, VA

    In my experience as a former DOD executive and combat veteran, determining and defining an industrial base’s near-term and lasting value was critical to deciding how a requirement was established and to what extent the American industrial market could meet those requirements. There is a misperception in the defense community—both on the procurement side as well as the industrial base—that the commercial or defense market should be able to answer all requirement needs if DOD could just write a better requirement or invest in the necessary infrastructure absent a requirement.

    Unfortunately, specifying a better requirement demands that those responsible for authorship are capable of predicting a future threat, and securing infrastructure investment assumes that the need will be imminent or takes years to procure. But the time invested in guessing about the future will not produce a better force structure—nor will it matter, if the nation pays for infrastructure designed for the wrong future.

    The alternative approach to ensuring a responsive call to arms is based on investments in the practical sciences—electrical and mechanical engineering, electronic engineering and chemistry—rather than basic sciences. These skills serve to germinate a community that is available for today and is necessary to prepare a workforce for the future. Lasting employment in these science fields occurs through rapid fielding, constant experimentation and iterative designs for the creation of new products over time.

    A lasting industrial base, then, is one that can employ and train these skills. It is one that allows for failure through trying, creation through doing, and success by iterating product design—without depending on a single funding source. An industrial base solely dependent on defense funding, making payroll by delivering existing products at a slow, steady rate, will not survive a competitive market.

    In my experience as a current corporate leader, making payroll is accomplished by investing in the future through workforce education, steadily delivering new products and participating in or creating new markets. This is not done through reliance on grants by the federal government or by paying the high cost of doing business with the services, but by preserving and reinvesting profits in workforce skills and in new product development.

    The question should be: To what extent has a company invested in its own future? How much does it cost to do business with the Army? How long does it take to get on contract? How many innovative, small and agile product-oriented companies are being nurtured?

    Disproportionate payments to training serve to secure a workforce for today; service-related contracts solve current problems; and funding laboratory facilities keep bases open. But none of these fuels a future. Perpetuating a current product base made for a threat that is long past, rather than by investing in the future serves only to prolong the inevitable. The best near-term protection against an unknown future is through funding the practical science skills in engineering, and more reliance on industrial commercial standards as a guide.



    Eugene Gholz
    Associate Professor of Public Affairs
    Lyndon B. Johnson School of Public Affairs
    University of Texas at Austin

    (Editor’s note: From 2010 to 2012, Gholz served as senior adviser to the deputy assistant secretary of defense for manufacturing and industrial base policy.)
    The Army needs a political game-changer. Too many of its proposed acquisition budget adjustments have foundered in Congress. For its part, Congress has seen too many well-intentioned but overambitious investment plans end in technological failures. Representatives are inclined to go with what they know works, which also happens to prop up government spending in their districts. Meanwhile, prime contractors’ experience tells them that continuing production is the reliable way to profits. The industry’s poor working relationship with its DOD customers in recent years makes it hard to trust an alternative path forward.

    So when the Army proposes to temporarily suspend the production of tanks, infantry fighting vehicles or trucks—the warfighter has enough right now—the legislative process recoils. Rather than giving the Army authority for targeted investments to right-size facilities, improve the manufacturing process or allow workers to practice critical skills, Congress directs spending for procurement of long-lead items and otherwise ties the industrial base to current production.

    The Army and the nation would be much better off with the targeted investments. This alternative would cost less, because it would not require as much material or large-factory overhead. And each dollar spent would be much more likely to go to a critical capability, whether in engineering, facilities improvement or high-end workforce skills. The Army would still allow prime contractors to profit. Critical subcontractors would also work directly with the team.

    Everyone wants to help fragile niches in the defense industry. But instead of a three-way working relationship among industry, Congress and the Army, the Army has been the odd man out of the political coalition. The key remedy is for the Army to rebuild trust with its industry partners; if industry and the Army are on the same page, Congress will follow.

    The Army has been working on it for several years, but the job is far from done. Badgering industry for short-term overhead savings, blaming industry for program difficulties and trying to shift program risk to contractors all just reinforce industry’s embrace of traditional lobbying strategies. It is time for a new partnership.


    Read more »
  • Parallel Equations

    The Army has a lot of stuff to move. Amazon moves a lot of stuff.


    Nearly everyone knows who Amazon founder Jeff Bezos is. Less well known is the other Jeff—Jeffrey A. Wilke, senior vice president of the consumer business at Amazon.com Inc. Having joined Amazon in 1999, Wilke has been in a leadership position at the company from the time it was a small startup to the present day, when it is the top U.S. company in e-commerce and one of the world’s largest retailers, with more than $60 billion in sales per year. But Amazon also provides a host of online services, including Web hosting, cloud storage, and music and video streaming.

    Wilke’s background in chemical engineering—with a bachelor’s in the subject from Princeton University and a master’s in chemical engineering as well as an MBA from the Massachusetts Institute of Technology—might not seem the most natural fit for consumer retail, but then Amazon.com is not your ordinary retailer. Indeed, Wilke started his career writing software at what is now Accenture PLC, but came to Amazon from AlliedSignal (now Honeywell International Inc.), where he was vice president and general manager for pharmaceutical fine chemicals. He had spent the previous five years in operations and management in the chemical, polymer and electronics industries.

    “We’ve found that individuals with a military background do incredibly well in roles all over our operations’ organization. They have the right bias for action and comfort with rapidly changing environments.”

    The thing about Amazon that stands out the most, of course, is that it moves a lot of materials, from books, kitchen appliances, consumer electronics and (no kidding) a do-it-yourself casket kit, to the data it manages through Amazon Web Services (AWS). The U.S. Army is an AWS customer, along with some 300-plus government agencies. But that’s not why Army AL&T magazine contacted Wilke for an interview. We wanted to tap his logistical mind on the subject of retrograde.

    More than 750,000 major end items, worth more than $36 billion, are currently in Afghanistan, according to DOD estimates. Some two-thirds of those items are in U.S. Army hands. Dealing with these items is expected to cost close to $5.7 billion and will require intricate planning, teamwork, creativity and innovation.

    Army AL&T wanted to know how one of the greatest movers of stuff in the world does it, and Wilke did not disappoint. In an Aug. 7 interview with Army AL&T, he offered insights on planning, modeling and management of logistics that reflect both his chemical engineering and his business training. As it turns out, sometimes the solution to a problem in one area of expertise is entirely applicable to another.

    Q. You’re said to be a logistics whiz, and Amazon has an enormous logistics operation spanning the globe. The military in general, and the Army in particular, have a massive retrograde underway. If suddenly that were your job, how would you approach it, both logistically and organizationally, to make the task more manageable?

    A. This seems from the outside to be a gargantuan task. As a citizen, I’m so proud and amazed that our military will complete this mission. If presented this challenge, I suspect my approach would go something like this. Step 1: Be humbled. Whatever my teams have achieved in the past does not secure our future. Only great planning and execution of this mission matters.

    I’d start by ensuring we have the right leaders in place: Do we have great field leaders who know how to make adjustments to a good plan in the moments when local judgment counts? Do we have the best analytical minds, utilizing the most current modeling techniques and machine intelligence to build a robust plan?

    Do we have as my direct reports the very best leaders for each critical function? Once I’m confident we have the right leaders in place, I’d want our senior team to understand the situation as completely as possible. What is the definition of “mission complete”? What dates are immovable? Where do we have flexibility? What budget for talent and money is available?

    In line with its goal “to be Earth’s most customer-centric company,” Amazon reinvests continually in its operations to keep offerings fresh and customer-focused. Here, Wilke, right, meets with leaders of Amazon Prime, a premium membership program. (Photo courtesy of Amazon)

    There are many ways to build shared understanding of the situation among the senior team. I’ve found scenario analysis, including inspecting the inputs and outputs of a detailed model, to be among the most effective. My brain would first model the retrograde as a classic transportation problem, where we have source nodes (places where we have assets to move) and sink nodes (places where we want the assets to be, including destroyed.) Arcs connecting the nodes have characteristic flow times and capacities. Built the incomplete way, this model would assume that all values characterizing the system were deterministic or without randomness. But such plans are almost always too brittle. One might say, “Let’s build a plan that assumes every day, every moment will operate at the expected value of each of the inputs.” Unfortunately, things don’t operate at the expected value. They operate with a distribution of outcomes.

    I’d like to see plans that assume we are operating a stochastic system—one with variation. The best way to think about this is that there are a number of scenarios that represent the possible actual outcomes of something that is as complicated as the retrograde that the military’s planning.

    There will, of course, be a range of inputs, the things that happen every day that are part of the plan. There will be a range of possible performance each day in those inputs. And that leads to a range of outputs that are almost guaranteed to not be the average values that you would predict upfront. Of course, we should audit the model outcomes for reasonableness, which helps us learn together. Planning for variation usually produces a deeper understanding of how the team should react if the actual mission goes awry.

    Stochastic models help uncover potential bottlenecks. (Bottlenecks are choke points that determine the overall throughput of the system.) I believe you have a good operational plan when you decide where you want the bottlenecks to be. Surprise bottlenecks indicate poor planning. As my team examines the model inputs and outputs, I would direct us to decide where we will accept constraints (or capacity limits).

    As planning progresses, I would pay particular attention to the resources and leadership assigned to each bottleneck. Our team would ask: Where do we have the most flexibility in the overall plan? Where do we have the least flexibility and the fewest options for recovery? We’d perform what-if scenarios: What if we lose transportation capacity? What if a particular load area comes under bad weather? What if we have political interference in a particular country? And then what you do when you play those “what-ifs” is, you look at the outputs of the model and ask, do they seem reasonable? I have no idea what the percentage is, but suppose that 20 percent of our assets are in a particular part of Afghanistan, and in that area it will be very difficult to get the permission that we need to move things out. Well, a scenario that we would run would be, what if we can’t move 20 percent of the items for an additional month, two months? If the model predicts that this has no impact on the ultimate mission, I’m going to be very skeptical.

    Q. Of course, in the case of Afghanistan, that’s hugely complex, because shipment through Pakistan is such an on-again, off-again situation.

    “Whatever my teams have achieved in the past does not secure our future. Only great planning and execution of this mission matters.”

    A. Right. So you just described a political impediment to achieving the expected value—what time we expect it would take for an item to move from where it is to a location where we have a little bit more control over our ability to move it. This might be the item that ends up having the most impact on the variation in the plan, the place where we would need to have the most flexibility because we can’t be sure of our underlying ability to meet the plan.

    I would expect to find variation all over the place. We’ll find it in the capacity associated with the natural “batches” that we use in moving items from one point to another. Those batches are usually constrained by the size of trucks, convoys, railcars or ships. Sometimes you lose capacity because of mechanical failure, or you have to substitute one mode for another mode. Goods can arrive early, exceeding the storage capacity at the loading point. And then you have humans involved all over the place. I would suspect that there’s a standard time to load and unload each of the items that could be moved. Sometimes our human team members will perform according to those standards, and sometimes, for whatever reason (humans get sick or weather interferes), we’ll see variation in the cycle time for the loading and unloading of items.

    You put all of those sources of variation together, and you’re likely to end up with an outcome that isn’t the expected value of what you planned. And I think it’s very helpful upfront to consider some scenarios for what you would do when the plan is not met.

    Q. All of which underscores that this is a hugely complex and not entirely predictable operation. What you’ve described, the what-if planning, is something that goes on in the military all the time.

    A. Yes. The what-if planning has been going on for a long time, but we now have modeling and computing power that allows you to build more sophisticated models. The advantage of those is that you can sit with people and they don’t have to imagine it in the same way. You can do active simulations—imagine that we were in the heat of the moment and the following thing happens, what would we do? Well, you have the model in front of you, and you can, in near-real time, prepare answers with precision that in the past just wouldn’t have been possible because we didn’t have enough data in the models.

    Q. What exactly did you mean by auditing the outcomes predicted for reasonableness?

    A. I just mean that it’s an intuition test. When you have these kinds of computer models, the most valuable thing that they do, I think, is to help humans, especially in a one-off project like this. If you can run models regularly over a long period of time, eventually the model gets good enough that you don’t need that much human input.

    An example is a control system in a complicated petrochemical plant. These plants run through significant transients, or periods of variation, without a lot of human input, because the control systems have been running for a long time. They’ve been tuned, and the computers know what to do. In this one-off project, any simulation that you build is not going to be such that the machine can run the project. It’s going to be such that the humans are better prepared to lead the project.

    Q. So they’re all on the same sheet of music, so to speak.

    “Everything we do, we start with a customer, and we work backward from there,” says Wilke. That means that Amazon continually analyzes and fine-tunes every step of the process of fulfilling customer orders, particularly during high-volume periods such as the holiday season. (Photo courtesy of Amazon)

    A. Exactly. The best audits are performed by the humans who, during the execution phase, will actually be managing and leading. In advance, you can have those humans sit around with the computer models that you built and test them for reasonableness. You start with human intuition about how robust the system will be, or how long things will take, or how effective we can be. And you want to look at the outputs of the model and use that great human intuition and ask, does it make sense? If a human looks at it and says, “I’m glad that analysts have predicted that this is what’s going to happen, but I can tell you, I’ve been in the field, and I know that this particular step is going to take longer than the model’s predicting,” then we can make the plan better. In these audits of the output of the simulation, we’re trying to catch things, assumptions, that are wrong in the models, applying human experience and intuition.

    I’ve been talking about this from the perspective you asked me to think about, as if I were the leader of the whole thing. These models are incredibly useful at all levels of execution of such a mission. Since this precise military challenge has never been completed—just as no one had been through direct-to-consumer logistics challenges like we had in the early 2000s—I would not expect to have a computer model direct movement autonomously.

    Thinking about this problem reminds me of our early holiday seasons at Amazon.com. During our peak four or five weeks of ordering, which is between Thanksgiving and Christmas, we have an increase in our logistics activity of about three to four times the average rate for the rest of the year. So the challenge, of course, is to have a team ready to perform to a playbook that is very different during those four to five weeks than for all of the other weeks of the year. That is the primary leadership challenge at Amazon.

    “I believe that the field of operations matters. Too often companies, governments and other entities build great programs and products, only to have them fall short of their potential impact because the underlying operations just don’t scale.”

    So, for example, in the Amazon world, these kinds of models aren’t just used by the corporate staff; they’re used by the staff running each of the individual warehouses in our network. They’re used by departments inside of those warehouses in the network, again, to do simulation and prepare in advance of the holiday peak, which is sort of a mission for us. The great thing about these models is that you can share them very easily, or parts of them very easily, with a whole range of leaders across the organization, which makes them all better prepared.

    I would expect to have leaders on my team check in regularly with the field leaders to evaluate how closely we were delivering to plan, with our analytical team and automatic systems adjusting the models regularly for mid-course correction. During the early Amazon.com holidays, I held daily conference calls every morning where fulfillment, supply chain and transportation leaders provided key network status details. We would modify the allocation of resources in real time to balance the network, keeping our bottlenecks always front of mind.

    It boils down to examining the actual performance versus the expected value for some of the elements that measure the networks. So, for example, are the queues that we have the size that we expect them to be? The consumer really wouldn’t see it, but a queue would be orders that we’ve taken from customers that we haven’t yet moved through a particular step in our logistics. It’s an accepted but unfilled order. They might be on a truck someplace. They might be in a particular state in a warehouse. The order might occasionally be stuck in a software queue.

    Were the bottlenecks that we experienced yesterday where we expected them to be? Was productivity in each step of the process as we expected it to be, or not? When you have productivity that’s low, if it goes low enough in a particular step, that step can become the bottleneck for the day. Then, all of the steps behind the bottleneck push work faster than the bottleneck can process it, and you build up a queue. I would ask for an expected value versus actual performance. In each of these steps, you begin to build a fairly complete picture of how the network is performing.

    If we were running an operation at the same rate all year long, it would be more like the petrochemical plant scenario, where you would just tune your systems and your people to a certain way of doing things and just do it forever. But we don’t have that luxury, because our consumers order a lot more from us during the holiday peak.

    Bad weather is one of the many less predictable variables in a logistics operation that thorough what-if planning can help manage. Here, an Army convoy stops on the Terra Pass in Logar province, Afghanistan, Dec. 15, 2012, to help Afghan truckers put snow chains on their tires. (U.S. Army photo by SPC Tayler Rovere)

    When the mission was complete, I’d expect to spend quite a bit of time saying “thank you” to all the folks who made this incredible performance possible.

    Q. Speaking of the holiday shopping season, how do you manage to keep people motivated during this season and, in addition to all your other logistical tasks, make sure that people understand that their work is appreciated and that they’re doing a good job—or not doing a good job, as the case may be?

    A. That’s such a great point. Throughout the holiday, our leaders—and, in fact, many of the folks who would normally be working directly on customer orders—for the holiday season actually end up serving as ambassadors, or leaders for associates who have recently joined us. So we have a lot of presence on the shop floor. We’re visible on the shop floor so that we can offer assistance and we can pat people on the back and thank them for a hard day’s work. We try to make it fun. Break rooms get decorated and some of the folks will occasionally get quite Christmas-y with their attire. It’s very motivating to see orders that you know are going to end up as wrapped presents under a tree. It’s emotional and powerful for people.

    All Amazonians are deeply passionate about delivering a great customer experience. At Christmas, that means that the right product goes to the right address on time in a great condition. As you watch these orders go by, you know you’re basically serving as an elf in some way to help families all over the country. And that feels pretty good.

    Q. In terms of product logistics, does the handling of books differ from what Amazon does with flat-screen TVs, or groceries or automotive supplies?

    A. Yes, different product attributes require different logistics solutions. Some key attributes include: size and weight (can the item be handled by automated sorting equipment?), fragility (clothing items require different handling from most packaged automotive supplies, and some items, like food, are very temperature-sensitive), sales velocity (lower-velocity items may be located in fewer fulfillment centers, or FCs) and cost (we might not store $5,000 watches right next to $20 books.)

    Q. A major area of study for the Army logistics community, as it prepares to draw down from Afghanistan, is core competencies. Does Amazon employ logisticians per se, besides you? If so, what skills is the company looking for?

    A. I am certainly honored to be considered a “logistician,” though that is not my formal background. I have an undergrad in chemical engineering from Princeton and graduate degrees, and an M.S. Chem E and MBA, from MIT’s Leaders for Global Operations program. I started my career writing software at Accenture. I suspect I think about logistics systems as networks of nodes and arcs, or pipes, valves and tanks, because of my chemical engineering background. What matters is the ability to think analytically about such problems, using the math of optimization, process control and as much computer science and machine learning as possible.

    “I love that the words “processes” and “fixing defects” are in our highest-level leadership vocabulary. Great customer experience starts with superb attention to execution.”

    Amazon does employ logisticians—lots of them. Some have backgrounds like mine, where they’ve made a switch from a different technical field to this one. Many employees in this area are computer scientists or software development engineers encoding our algorithms in software. We’ve found that individuals with a military background do incredibly well in roles all over our operations’ organization. They have the right bias for action and comfort with rapidly changing environments.

    Q. What kinds of data does Amazon collect on its supply chain, e.g., safety stats, and how do these data reflect how Amazon likes to operate?

    A. We start every operations meeting with a safety tip. Every operations metrics deck starts with our safety performance. In fact, it is safer to work in an Amazon fulfillment center than in a retail department store. Beyond safety, we measure everything you might expect us to worry about in a complicated logistics network: customer experience, cycle times (both mean and variance), defect rates, productivity, cost and capital investment. These metrics map to our leadership principles, which include customer obsession, ownership, frugality and delivering results.

    Backups are a logistical problem common to both the Army and Amazon. Here, traffic moves slowly through Torkham Gate, which lies on the border between Afghanistan and Pakistan, on Dec. 20, 2012,. (U.S. Army photo by SGT Jon Heinrich, 1st Brigade Combat Team, 101st Airborne Division (Air Assault) Public Affairs)

    Q. Amazon aims “to be Earth’s most customer-centric company where people can find and discover anything they want to buy online.” You personally are reportedly almost fanatically committed to customer satisfaction, especially during high-pressure times such as the holiday season. The Army acquisition community’s customers are the Soldiers who use the items procured. What could the Army learn from Amazon about managing “customer” relationships?

    A. We have two leadership principles that help define Amazon’s approach to customer-centricity. First, we want leaders to display “customer obsession.” We ask leaders to start with the customer and work backward. They work vigorously to earn and keep customer trust. If you ask, “How obsessed is enough?” we answer with our leadership principle “insist on the highest standards.”

    We think leaders have relentlessly high standards; many people may think these standards are unreasonably high. Leaders continually raise the bar and drive their teams to deliver high-quality products, services and processes. Leaders ensure that defects do not get sent down the line and that problems are fixed so they stay fixed. So you will find us correcting mistakes before customers get angry about them, sometimes before they even notice. We’ll drive to stores on Dec. 24 to buy the few out of hundreds of millions of items that we just can’t find in the FC. When we build new products, we write press releases to help visualize what we would like to announce to customers about the product at a successful launch. I love that the words “processes” and “fixing defects” are in our highest-level leadership vocabulary. Great customer experience starts with superb attention to execution.

    I had the honor of visiting the Army War College at Carlisle, PA, some years ago, and I was struck by just how much consideration the Soldier-customer received by the military’s highest leaders. With respect to how we think about our employee customers, we borrowed some of our approach from the best practices of our military.

    Q. You mentioned that you found that military people have a penchant for action and are comfortable with rapidly changing environments. Can you give me a little bit of background on how much Amazon has worked with military people?

    A. For 13 years, we’ve been actively recruiting everyone from former enlisted folks and junior military officers to more senior officers because of these traits. And it’s proven to be a highly successful hiring channel for us. There are hundreds and hundreds of folks who are veterans who are at Amazon. And we expect to hire 1,200 this year.

    “Very simply, we think that thinking small is a self-fulfilling prophecy. So we ask people to envision bolder directions because they’ll lead to bold results, and it also inspires the team to think differently.”

    I mentioned my own experience with the Army War College. That experience was just prior to my joining Amazon in 1999, and so it was very fresh in my mind. The new leader for human resources for worldwide operations in 1999, Dave Niekerk, was a West Point alum.

    Q. You talked about leaders having relentlessly high standards. That’s exactly the kind of thing that DOD is trying to get at these days with better buying power. Central to that is raising the standards of leadership and independent thinking in acquisition professionals. DOD is working very hard to have top-level acquisition professionals recognized and documented as the elite that they are. What you said about high standards gets right to that point. Does Amazon ever do anything like better buying power?

    A. Not per se. We have 14 leadership principles (online at http://www.amazon.com/Values-Careers-Homepage/b?ie=UTF8&node=239365011), including the leadership principle “insist on the highest standards.” This principle of independent thinking is close to one that we have called “disagree and commit.” What we want our bright people to do, when they’re pretty sure they’re right, is to disagree when they think that somebody else’s approach is not correct or they think they can improve on an already good approach.

    And it’s interesting, because people asked for a long time, “Well, when do you stop disagreeing?” My answer is, when you’re not sure you’re right. So I tell people—I don’t know how this would work in the military—but in our world, if you’re sure you’re right and your boss tells you, “No, you’re wrong,” you have the obligation, after telling your boss that you are going to do this, to go to his boss or her boss. And if that boss says, “You know, I don’t think you’re right” and gives their reasons and you’re sure you’re right, you have the obligation to keep going up the chain until you get to our CEO. And if he tells you, “I hear you, but we’re going to do this other thing, then we want you to disagree and commit to the choice that the company’s made and move forward.”

    Logistical planning at Amazon permeates every level of management, down to individual departments at the company’s warehouses. Here, Amazon employees take customer orders from warehouse shelves. (Photo courtesy of Amazon)

    So I’ll tell people, when you’re not sure and your boss asks you to do something for us to move forward, the right thing to do is to say, I don’t agree with that, but I’m not exactly sure, so I will commit to the plan of record, and I won’t complain about it. We’ll just move forward.

    Q. Obviously the chain of command in the military means so much in terms of order and discipline and just getting things done. Once a course of action’s been decided on, you get less of that open dissent. But the principle you’re talking about is definitely a value to the military. What about the other leadership principles you mentioned?

    A. They start with customer obsession. Everything we do, we start with a customer, and we work backward from there. The second principle is ownership. We want leaders to behave like owners, and mostly that means that they think long-term, that they don’t sacrifice long-term results or long-term value for short-term results. We want people who never say, “I’m not doing that ’cause that’s not my job.” We want people to do whatever the mission requires. The next one is “invent and simplify.” We require our leaders to be innovative even when others don’t understand what they’re doing, and sometimes they won’t understand for a long time. The next one is “are right a lot,” and that basically means we want to hire smart people. We think leaders need to have a level of intelligence that makes them capable to do their work of leadership well.

    We want to hire and develop the best first. That’s completely consistent with the military. We talked about “insist on high standards.” We want our leaders to think big. Very simply, we think that thinking small is a self-fulfilling prophecy. So we ask people to envision bolder directions because they’ll lead to bold results, and it also inspires the team to think differently.

    Frugality is the next one, and that’s about not spending money on things that don’t matter to customers. We want our leaders to be vocally self-critical, and actually this is my favorite line in all of our leadership text. We say leaders do not believe that their or their team’s body odor smells of perfume. I love that one because we’re all human, and if we can’t say, “I was wrong, I don’t know” and are just full of ourselves, our teams especially will see right through it. And I’m sure that it’s that way in the military. When an officer has screwed up and doesn’t admit it, I guarantee you that they lose some respect from the members of their team.

    “Earn trust of others”—we want leaders to be able to show respect and to gain trust. We expect leaders to dive deep, really deep, because we think no task is beneath leaders, although they can’t, of course, do everything all the time.

    There are two more. The second-to-last is “have backbone.” That’s the idea of disagree and commit. And we want leaders to respectfully challenge decisions when they disagree. Finally, we expect leaders to “deliver results.”

    Q. Given that a lot of materiel that will be brought home from Afghanistan will be obsolete before long, what would your priorities be, in broad strokes, to position the Army for the future when the retrograde effort is over?

    A. First of all, sunk costs are sunk. If we’ve spent money on something that is now worthless, its value is $0, not whatever we paid for it. I would make sure we have programs to maintain the materiel that has ongoing value first. Some items provide “option value,” in case we do need to spin up again. I would plan to hold on to additional materiel beyond peacetime minimum, especially where the lead times for replacement are very long. Finally, I would dispose of what we cannot expect to use, hopefully salvaging value by selling to the private sector or using the assets in other branches of the government.

    Post-retrograde, I would make sure the Army’s processes and logistics information systems are ready for the future. I’d use our recent experiences to build sophisticated simulations to help keep our people fresh while they wait for the next crunch.

    Q. How would you characterize the corporate culture at Amazon? What are the top three defining characteristics that you want Amazon employees to appreciate fully, and why?

    A. Our culture is customer-obsessed, fast-paced, and truth-seeking. We try to hire people who are smart, possess high standards and know how to get things done. Importantly, we find that we have the best match with people who would say they feel “fortunate.” Such people are most likely to say “yes” instead of “no” and to foster an innovative, optimistic environment. We’ve found that individuals with a military background do incredibly well at Amazon in a variety of roles. Our company’s leadership principles match up closely with our nation’s military. As a result, for years, we’ve actively recruited members of the military into roles at Amazon, whether they are retired from the active military or reservists.

    Q. Tell us about CRAP—or “can’t realize any profit”—which seems almost as much about streamlining customer experience as it is about unprofitable items. What can the Army learn from the philosophy behind CRAP?

    CRAP came from observations Jeff Bezos and I made while working on the shop floor in Kentucky one Christmas. We were spending too much time (to the great pleasure of the associates watching us!) building custom boxes to hold folding chairs offered as that day’s big deal. There was no way, even with well-trained, productive employees (versus us), that we were making money on these items. We committed ourselves right there to find other similar items and either make them profitable or stop selling them. Most of the time, our vendors have been able to work with us to make such items profitable, including by changing the packaging.

    The retrograde from Afghanistan involves numerous modes of transportation working in sync with one another. Here, SPC Robert Ivey, left, and SPC Gusten Hammond, motor transport operators with 703rd Brigade Support Battalion, 4th Infantry Brigade Combat Team, 3rd Infantry Division (4/3 ID), prepare to sling-load transportation equipment on a CH-47 Chinook helicopter July 15 at Forward Operating Base Shank in Logar province, Afghanistan. (U.S. Army photo by SGT Sarah Bailey, 4/3 ID Public Affairs)

    Q. You and Amazon.com founder Jeff Bezos used to go out and spend a week each year visiting Amazon distribution facilities, even fulfilling orders. What benefit, in your view, would it be to Army brass—both military and civilian—to spend time working at the ground level a week each year the way you did?

    A. I think a significant portion of leadership is showing up, in person, to listen, say thanks, and “walk the talk.” As our jobs get bigger, it can seem harder to find the time to visit. Certainly at many times in my career, I’ve fallen prey to this mistake. But I know that face time matters. Associates notice. I suspect our Soldiers and civilian employees notice when leadership takes the time to visit.

    Recently, a longtime “Amazonian” software developer decided to leave our company. On his last day, he sent me a very personal note. He thanked me for some things, and then he offered a piece of incredibly valuable, sincere advice. He noted that in the early days, we were small enough that I communicated regularly and informally with the entire corporate staff. As we grew, they saw less and less of me, to the point where now some new engineers joked that I might not actually exist.

    He had a simple suggestion: Pick some lunch areas randomly and occasionally, and just show up with little announcement. Engage in Q&A with whoever happens to come. Though I probably haven’t done it frequently enough, I implemented his suggestion and have been pleasantly surprised with the attendance, questions and, most importantly, the opportunity to preserve our special culture by tying my answers to our leadership principles backed up by a few stories from our past.

    Q. Jeff Bezos is fairly well-known for his vision and ability, and part of that vision was hiring someone like you to rationalize and make that vision work. What’s the best part of your job in supporting that vision?

    A. I believe that the field of operations matters. Too often companies, governments and other entities build great programs and products, only to have them fall short of their potential impact because the underlying operations just don’t scale. At Amazon, we understand that process, technology and especially leadership make a huge difference in our success or failure. I love working at a company that’s proud of its operations.

    Read more »
  • The Genius of Simplicity

    Costco profits by taking great pains to keep it simple and embracing the ‘intelligent loss of sales’


    By Margaret C. Roth


    Army AL&T Magazine interviews Mr. Richard Galanti, executive vice president and chief financial officer of Costco Wholesale Corp. to offer a perspective outside of the Department of Defense on issues faced by the Army AL&T community.

    Galanti, who is also a member of Costco’s board of directors, began his retail career in 1964 at the age of 8, bagging groceries at his father’s grocery store in Canton, GA. He went on to earn a B.S. in economics from the Wharton School of the University of Pennsylvania and an M.B.A. from Stanford Graduate School of Business. Galanti joined Costco in 1984 as vice president, finance. Previously he worked on Wall Street as an investment banker with Donaldson, Lufkin & Jenrette Securities Corp., where he provided a variety of financial services to both public and private corporate clients, including Costco in its infancy.

    He is currently serving a three-year term on the board of directors of the Federal Reserve Bank of San Francisco and recently joined the advisory board of the University of Washington’s Michael G. Foster School of Business.

    Costco buys most of its merchandise directly from manufacturers, routing it to one of its depots or directly to its warehouses. Last year, Costco retained the No. 1 spot among warehouse stores with a 46.5 percent market share, compared with 38.4 percent for Sam’s Club, a unit of Wal-Mart Stores Inc.

    With 69.1 million cardholders including individuals, families and businesses, Costco is the second-largest retailer in the United States and the seventh-largest in the world. It operates 622 warehouses in eight countries, employing a total of 160,292 full- and part-time employees. Costco’s $99.1 billion in revenues for its FY12 represents more than 2 million transactions a day including 113,000 carats’ worth of diamonds, 62 million rotisserie chickens, 36 million prescriptions filled, 3 billion gallons of gas, 16,500 mortgage loans totaling $4 billion, 160,940 vacation packages, and 1.5 million pumpkin pies during Thanksgiving week.

    Q. One of the ways that the Department of Defense and the Army want to make affordability a fundamental requirement for acquisition investments is to do more market research before choosing vendors. What drives Costco’s research into the products you decide to buy? What are you looking for?

    A. In terms of the types of products that we want to sell to our members, it starts with the 80-20 rule: What are the 20 percent of items that represent 80 percent of the sales? Then, how can we choose from that limited set of items and provide the best-quality merchandise at the lowest possible price to our members? At Costco, you’ll find fewer than 4,000 active SKUs (stock keeping units). That might compare to a supermarket with 40,000 to 50,000 items and a supercenter with 100,000-plus items.

    The total number of items is a little less than 4,000, but the breadth of the items is enormous, from tires to mayonnaise, to fresh foods, to furniture, to jewelry, to certain services. So it’s a wide selection of items but not a lot of depth within each category. That is very deliberate. If you think about the fact that a supermarket generally marks up its goods 20 to 25 percent or more, and home improvement centers 30-plus percent, and the mall stores 50 to in excess of 100 percent sometimes, and we’ll mark our goods up about 11 percent on average, you’ve got to bring great efficiencies—not just buying in large volumes, but efficiencies throughout the system.

    Take something as basic as a can of peaches. If you go into a supermarket, you’d expect to find three or four brand names plus perhaps a private label. You’d then find four or five different sizes for each of those brands. Then you’d find sliced and diced and halves, and then you’d have heavy syrup and light syrup. In the end, you might have 40 different choices just of canned peaches.

    No detail of Costco’s operations is too small to be examined carefully for possible efficiencies, including the impact of packaging on the entire supply chain, from receipt of deliveries to time spent at the cash register. (Photos courtesy of Costco Wholesale Corp.)

    Part of our ability to sell at such low markups is to identify those fast-selling items that not only provide great quality but also the very lowest price—not just the purchase price but also the lowest cost in terms of logistics: shipping and handling by both the manufacturer and the employees at Costco, including stocking and ringing up the goods through the cash register. We probably underemphasize the word “research”; ultimately everything that we’re doing is research, whether it’s our buyers visiting competition and looking at what else is being sold, talking to manufacturers, going to trade shows. You’re not going to come into Costco and have a lot of selling help on the floor. You’re not going to have a lot of choices to make. Hopefully we’ve pre-chosen those items that are both great in quality and value, that our members are going to want to buy. This requires a tremendous amount of discipline, because human nature is just to want to offer a customer more: more variety, more selection, more sizes.

    At Costco, we’re going to sell what’s referred to in the business as a No. 10 can, which would be for a restaurant, commissary or day-care center, as well as a six-pack of one of the leading national brands. Maybe it’s sliced, maybe it’s diced, but it’s going to be the regular consumer-size can. Unless your 8- or 10-year-old is having a birthday party and you need the peach halves so you can put whipped cream and a cherry on top, nine times out of 10, the person buying that can of peaches is going to bring it home, open it up and put it on the table for dinner with the family. And you’re generally indifferent whether it’s one of those three leading brands or the private label, as long as you know it’s going to be high-quality.

    So what we’ve done is say, Okay, we’re not going to have 40 different choices of canned peaches. One, we don’t have to make 40 different buying decisions every week. Two, in a supermarket chain, the distribution center would have ample qualities of each of those 40 SKUs of peaches; then each store clerk orders one case of this and two cases of that, and then it’s put on a truck and delivered to each retail store and put in the back room, and then brought out, and then each case is cut open and put on the shelf.

    Getting back to the buying side, one of those leading brands probably overproduced one of those sizes last month. And so they’re giving everybody, whether it’s Costco, Walmart, Safeway, Kroger or Albertson’s, they’re giving us all a better value on that because they want to clear out that excess inventory on that one SKU.

    Part of our genius, if you will, is our simplicity. It’s a lot easier to be smarter on fewer things. We’re a very lean company.

    Well, each of those retailers is probably going to buy some extra of that item, maybe an extra two- or three-week supply. However, at Costco that’s all we’re going to buy that month, because it’s a leading national brand. And then we’re going to tell them, “You know what? Don’t put it in single cans, and 24 cans to a case, 100 cases on a pallet, where the stock clerk has to cut open each case and neatly stack every one of those 24 cans by hand so that all the peaches look pretty up front on the shelf, and then the cashier has to ring up every single can. Put them in six-packs, like you do soda, and don’t even put them in corrugated boxes; put them on a pallet and build the pallet basically in six-packs and shrink-wrap it. And let’s take 2,400 cans, or 100 cases of 24.”

    At Costco, that entire pallet of that one SKU, in order to stock those 2,400 cans, there’s a forklift operator putting it on the selling floor and cutting off the shrink wrap. And then you, the customer, are willing to buy six cans at a time instead of four, three, two or one because it’s such a great value. And then at the register, you’re only ringing up once for those six cans and not six hand strokes.

    So again, it gets back to that intelligent loss of sales: If we happen to have sliced peaches that month and you needed halves because you’re having a party with the whipped cream and the cherry on top, we’re going to lose that sale. But think about how many more cans we’re going to sell, and at such a lower price. We’re looking at selling what’s hot, and also what will save the customer money in terms of the quality and the value that we provide.

    Q. In the area of cost control, the Army is striving to eliminate redundancy within its “portfolios” of equipment: aviation, clothing, ground vehicles etc. How does Costco manage redundancy in its vendors and products?

    A. The whole mantra at Costco is limited selection, so we’ve eliminated a lot of the redundancy in the business. Redundancy, of course, means different things in different areas. Outside the product area, we have some redundancies built in. Certainly we have them in some aspects of energy management. Needless to say, we’re not going to be able to sell you goods unless our facilities, our retail warehouses, are open and running and ready for business. What we’ve chosen, and we looked at this over time, is that we’re not prepared to have full redundant energy systems in every location, with backup generators that can back up everything on location. However, on a regional basis, we do have mobile generators that can accommodate some aspect of that, unless it’s something as big as when Hurricane Sandy hit, and of course we had 18 or 20 locations closed for a few days. That’s the risk and reward of what we’re prepared to do.

    We do have redundancies within the warehouse. While we may not have full generators at every location, when the power does go out, we have the ability to run the registers to get customers out. We don’t have redundant energy systems in every location to power all the refrigerators and freezers, because unless we’re going to be out for a few days, which would be an issue, that’s something that we’re prepared to live with.

    In terms of disaster recovery, agencies like the big banks and the big credit card companies have tremendous redundancy; that’s the backbone of what they do. We have limited redundancy; we have a disaster recovery site that’s outside of the Seattle market, but not mimicking everything. We also have certain redundancies built in so we can continue to accept merchandise that’s already been ordered in the system, and receive it and deliver it. But again, if we get past a few days, then we haven’t chosen to have such full redundancies.

    Costco was founded on a philosophy of providing a good living wage and affordable health care benefits, to attract employees who want to stick with the company and work hard. On average, Costco’s 160,292 full- and part-time employees, 90 percent of whom are hourly, earn more than $21 an hour, with a starting wage of $11. By comparison, across big retail, the average hourly rate ranges from $13 to $15 an hour.

    Q. How long are you committed to that one vendor whose peaches you chose to sell?

    A. We’re committed to high-quality items with which we can save the consumer money and sell a lot. We’re still merchants; we still want to sell a lot of merchandise and services, and sometimes it might be seasonal items. So we’re committed to providing great items. Our members have learned over time that part of the requirement of these great savings is that sometimes we might even be out of an item, or we might choose not to sell an item.

    One of the things we do is to recognize that, given our purchasing power, much like the Army’s or even bigger than the Army’s perhaps, we generally don’t like to represent more than 20 percent of a given supplier’s sales, because one day we may choose not to sell that item, whether the product stopped selling well or there’s something better or hotter out there. If we choose to delete it, we don’t want to destroy that supplier. It may not be anything that they’ve done. So we have a process in place, standards to help ensure that once a supplier has been with us for a certain period of time, typically at least one or two years, a decision to terminate that relationship must be vetted at the highest level of management.

    If they’ve done something dishonest, if a vendor did something wrong, they’re out. If the proverbial manufacturer of butter cookies took a little butter out of the cookie because butter prices went up, changed the quality without telling us, that’s fatal. You have to be upfront and honest with us. At the same time, if the price of something has changed dramatically, come to us and talk to us about it, and we’ll work with you. The message throughout the organization is that we want our buyers to be tough but fair with our suppliers. We want the best quality at a great price, and they won the business based on that. But ultimately we recognize that they’ve got to make money, too. We just want us and them to make a little money, a lot of times.

    Q. There’s a lot of discussion in the military about the 80 percent solution. And that is, when you look at the portfolio, what you may want, ideally, may not be what you get because of pricing and because of affordability, availability, logistics, whatnot. From that point of view, to get back to the peach example, how does Costco choose which peaches it’s going to get, other than through oversupply and the possibility of a discount?

    A. Somebody has to prioritize all those requirements: What must you live with, and what can you live without? Generally speaking, when a consumer goes into a supermarket and looks at the top three or four leading national brands of canned fruits and vegetables, whether it’s Green Giant, S&W, Libby’s, Del Monte, in most people’s minds they’re all good and high-quality. So we’ve started with the premise that you, the customer, will generally be happy with any one of the three or four high-quality brands. And we’ve also started with the premise that most cans of peaches are not bought to present them on a party tray in a particular way, in other words sliced vs. diced vs. halves.

    Now that doesn’t carry through to every item; everything is different. We’re going to sell only the best-quality fresh meat, USDA Choice and above, even though we might be able to save you money if we sold processed, Good or Select, which is certainly healthy and fine to buy, but it’s not the cut that we’re prepared to sell our members. In the case of peaches, many of those brands are fine, but there’s probably an institutional-grade can of peaches that we’re not prepared to sell, even though we could save the customer a little more money, that’s a little lower than our quality standard that we want to provide to our customer. Not that there’s anything wrong with it; it’s our choice.

    It’s the difference between perfection and excellence. It’s going to cost you a lot more money to get to perfect, but excellent is going to cost you less. You’ve still got to put a lot of effort into it. It’s the same thing with the 80-20 rule: We’re going to sell the 20 percent of items that represent 80 percent of the sales. We’re going to spend all of our time focusing on the things that can accomplish 80 percent of what we do and recognizing that those last little incremental improvements sometimes are inefficient.

    We go the other way in terms of safety in the warehouse. We have merchandise on pallets 20 feet up in the air. We spend many millions of dollars on “floor walkers,” just making sure pallets are up there right. 80-20 doesn’t govern everything. When we talk about safety in the warehouse, we have over 2 million front-end transactions a day at our warehouses, which means nearly 4 million people, so something like 3,400 customers coming in each Costco, seven days a week. Our policy is, ideally, we never want to have a forklift out on the floor during open hours because they’re dangerous, right? Now, sometimes you have to. When you do, it requires three employees: one in front, one driving and one in back. When they have to go down one of the aisles to take a pallet of merchandise off the top, you have to cordon off two aisles.

    We don’t want to close off an aisle for even five minutes, but we have to because of safety, and we want to because of safety. We try to have enough merchandise on the floor so that it does not require us to replenish during the day. But we make the procedures safe, even if it takes three people to get that pallet out and close down some aisles for five or so minutes, because God forbid we have a pallet fall off the steel shelf.

    It’s the difference between perfection and excellence. It’s going to cost you a lot more money to get to perfect, but excellent is going to cost you less.

    I think we go to a great extreme, an appropriate extreme, on food safety. We’re never going to be perfect, but we’re going to be darn near as best we can. At our own meat processing plant in California, which serves our own needs for ground beef, hamburger and meatball items, we do an inordinate amount of extra testing for everything from E. coli to Listeria. It doesn’t say we’re going to be perfect, but it says we’re going to be as good as we can get. Then, when there is any type of issue, fortunately, because we know what every member bought, we’re able to communicate with them almost immediately, even though the items may have been purchased three to five months ago.

    Q. Getting back to the vendors, a follow-on question: How do you encourage cost efficiencies, productivity and innovation in your vendors? Do you have any sorts of incentives?

    A. There’s no incentive, like, if you save us this much more, you’ll get a piece of the action. But when you get back to the limited selection, what always amazes people when they hear from our buyers is first, the degree of knowledge that they have, not only on the quality—if it’s apparel, the thread count; or if it’s food, commodity pricing—and the cost of the tin cans and packaging, and the freight costs. When we’re trying to manage 3,800 items in a location, the buyer’s trying to buy those 3,800 items compared to buyers managing 150,000 to 250,000 different items.

    Part of our genius, if you will, is our simplicity. It’s a lot easier to be smarter on fewer things. We’re a very lean company. We don’t have any research and development department. All of our employees are the research and development department.

    Another aspect is being transparent with our vendors. If you’re a small, regional company doing $4 million in sales, we’re not going to be able to accommodate you because our appetite is so large; we never want you to double your business just for us, in case we ever decide not to use you. But by the same token, the key is coming in and understanding our quality, understanding that we’re not necessarily as interested in what’s the hottest-selling item in the department store today, but understanding the entire cost structure and the supply chain costs, and how we can work together to lower those costs, increase the quality of the merchandise and ultimately lower the price to our members.

    It’s also recognizing that we’re not looking to sell at a price point. A lot of manufacturers will say, we can sell you this item at $11, and with shipping $12.50, and you can sell it at $19.99 to make a 50 percent markup. First of all, we’re not interested in a 50 percent markup. If everybody else is selling it for $24.99, and you’re trying to get us to sell it for $19.99, we want to figure out how to do a two-pack for $14.99. And we’ll make our 10 or 12 percent, thank you very much. We want to figure out all the costs so that we’ll both be successful, Costco and the vendor, if it sells a lot. And if it sells a lot and we may end up making more money, let’s figure out how to take that item and improve it and lower the price even further and drive more business. We’re not typical retail.

    Q. What’s the primary incentive, then, for a vendor to want to sell to Costco, since you’re looking to pay them a lower price?

    A. The primary incentive is volume, and volume not in 27 different versions of the item. If you think about it, using the simple example of toilet paper, well, first of all there’s only three or four big suppliers out there that can accommodate our volume. Recognizing that if they can turn on that machine at that plant and not have to worry about the different color dyes and embossed and two-ply and one-ply and different packaging quantities, and basically come in in January and turn the machine on and just keep making it for us 24/7 for the rest of the year, it creates a lot of efficiencies for them, too. A lot of times, if we can be 5, or 10, or 20 percent of one of their facility’s production capacity, it eliminates a big hurdle for them in getting to efficient capacity utilization.

    And we talk to our vendors, I’m sure that some will say we’re a pain in the behind. But what I hear time and again, whether it’s Procter and Gamble, one of our largest suppliers across the board, to the small and medium-size suppliers, the one thing is that the message throughout Costco is consistent and straightforward. If we tell them what they need to do and we expect quality, then they know that’s what they need to do. They don’t need to try to sell us six other things.

    Q. Looking at it from an entirely different perspective, what kinds of incentives could Costco offer its employees to encourage efficiencies?

    A. We don’t have commissions anywhere in the company. Sometimes people ask in the warehouse, what about your membership desks? They’re selling upgrades to the executive membership, or getting someone to do the triple play: signing up as a member, the upgrade to the membership and the co-branded American Express card. We have contests, and basically it’s a job well done. A lot of the incentives are growing through promotion and merit, being promoted to the next-level position, whether you start off as an hourly inventory control specialist in merchandise, which is making sure the product is flowing through the system, to the assistant buyer, to the buyer, to the assistant merchandise manager, to the general merchandise manager, which is typically at the VP level.

    At Costco, it’s one message: We all work hard. I think part of it is that we start by recognizing that 90 percent of our employees are hourly. Of the 300 people employed in an average warehouse, with a warehouse manager, 20 are salaried; the rest are hourly. The philosophy of our founders was, and still is, to provide a good living wage and affordable health care benefits. So in an hourly environment where many part-time hourly employees at other retailers don’t even get health care, all of our employees do; they have to be there for three to six months to qualify, depending on whether they’re full- or part-time.

    With most employer-sponsored plans across industry, employees pay anywhere from 20 to 30 percent of their health care premium through payroll deduction. At Costco it’s about 10 percent. Our average hourly wage in the U.S., for example, is a little over $21 an hour. By comparison, across big retail, whether it’s Home Depot, Walmart, Target, Best Buy, the supermarket chains, the averages range anywhere from $13 to $15 an hour. That’s the average, whether you started yesterday or 20 years ago.

    Our starting hourly wage is $11. If you’re full-time, working 38 to 40 hours a week, in your fifth year of service you’ll get to the top of the scale. After an employee has worked for the company for about 10 years, there are some added increases every five years besides the usual annual cost-of-living increase, up to the 25-year mark. But you’ll get up to the top of the scale, which is $21.50 right now, in four to five years instead of over a lifetime.

    So if we’re paying such a higher premium, darn near 40 to 50 percent higher, we’d better be hiring better people to start with, who want to stick with us and work hard. Pay is the first priority, needless to say, a livable wage and affordable health care. Beyond that, we have our open-door policy, hopefully providing opportunities for everybody, and we have to work at that.

    We looked at our inventory shrinkage numbers, which are very low. Part of it is, nobody’s stealing toilet paper. In big-box retail, there are certain things you have to do. We don’t use electronic sensor tags. We do have only one way in and one way out, and you have to go through the cashier and then the security person; and that definitely helps. Additionally, experts suggest that one-half or more of pilferage is internal—your own employee. At Costco, many times when we catch an employee doing something wrong, it’s because a fellow employee has turned that person in, and we’ve got to believe that’s because our employees believe in us and trust us, and that’s something we work on every day of the year; that’s set up in our policy, that’s paying our people well, that’s promoting from within.

    We don’t hire M.B.A.s into guaranteed management positions. Part of that’s the philosophy of the founders; it’s kind of like the old philosophy of doctors, I worked 100 hours a week when I was doing my residency, and so will you. Seventy percent of managers in warehouses today started by pushing carts and stocking shelves. They know what it’s like to sweep the floors. As our employees grow and become supervisors and then managers, it’s the responsibility of each and every one of them to teach and develop the next generation of supervisors and managers.

    We highlight examples of what we should be doing, not just what we shouldn’t be doing: There are plenty of things, and Costco Today, which goes out monthly, highlights efficiencies, simple things in the warehouse. I think of a silly example, years ago, of kids pushing carts in the parking lot. We have the little rope that attaches to the cart, whereby you can push eight carts at a time now. You can maneuver, and it’s not like you’re going to run into a car or something. It’s those simple things: What’s somebody doing out there? Who’s going to have our best ideas? People out there. And when we promote those ideas and present them to the rest of the workforce, they look at that and they come up with ideas. So no idea’s too small.

    One of our challenges is to provide growth opportunities to all, even when our employee turnover is so low; we’re growing our workforce at 4 or 5 percent a year. So we move people around between functions, even if they’re physical functions, such as stocking shelves or folding, or working the membership desk.

    Q. What kinds of processes does Costco consider unproductive? How do you define bureaucracy in its worst sense?

    Outbound shipping is an area where Costco is making a concerted effort to find efficiencies in packaging, as well over half of its depot operating costs are for outbound freight. The company is looking to achieve full use of pallets and full use of outbound trailers by eliminating oddly sized or undersized items that make pallets harder to stack.

    A. Bureaucracy, in its worst sense, is setting up procedures, committees, inefficiencies in decision-making that take longer and make it more costly to get things done, recognizing that we’re a different company today than we were when we were 50 people in a central office 28 years ago with four locations. As Jim Sinegal, our co-founder and recently retired CEO, said, if he could do everything himself, there would be nobody else employed here. But you have to have organization.

    We pride ourselves on being efficient, and we have to constantly revisit what we’re doing and question everything we do. Let’s take a look at everything we’re doing and what we shouldn’t be doing anymore, even though we’re doing it well.

    Not everything’s printed nowadays, but management information tools and reports can take on a life of their own. Even within buying, within the 30 or so subdepartments, everyone wants to look at information differently: “We turn our inventory 13 or more times a year, not four to eight times a year, so we’ve got to look at things differently.” Maybe so, and sometimes yes. So, on a regular basis, we go back and look at every management information tool that we prepare. What’s funny is that you find, a few years later, that something that was created on behalf of a particular user group, they’re not using it anymore, perhaps because something else came about that they’re using and don’t need it anymore, which is great.

    Q. In choosing vendors, the Army is focusing more and more on “what” it wants them to produce and less on the nitty-gritty details of “how” to produce it. How does Costco ensure it gets the quality that customers want without creating overly prescriptive requirements for vendors that could prove onerous and counterproductive? How do you develop your house-brand products?

    A. It’s a two-edged sword. On the one hand, we demand whatever spec we want. Whether it’s a patio umbrella, for which we want a certain number of threads per inch and the quality of the turning mechanism and the diameter of the umbrella. Now, we’re not going to tell them where to go buy their thread necessarily, other than that there’s the vendor code of conduct that it can’t be child labor, and you now have to provide your source of work; you now have to trace your work for a lot of food items. And they’re going to determine the spec of what we want, and they’re going to bid it based on that spec.

    We have eight regional buying offices in the U.S., two in Canada and one in each other country. Needless to say, the manufacturer wants to accommodate the buyer in each region. And shame on us if we’ve got four different buyers wanting four different packaging and sizes because that buyer’s decided that something will sell better in that region. From the Costco side, we have to turn them down and say, “Guys, think of the inefficiencies that we’re creating, the efficiencies that we’re losing.”

    Q. Small businesses are a significant element in the Army’s strategy to promote effective competition, representing 26 percent of all contract dollars awarded, because they are thought to be more innovative and quicker to respond to changing needs than larger companies. What competitive value do small businesses bring to Costco’s goods and services?

    A. On the one hand, I did say that because of our appetite and our size, our quantity needs, sometimes a small vendor can’t supply us. On a regional basis, we will bring in small vendors to do things, and sometimes that will create exciting opportunities for us, new items. So we can’t lose sight of that innovation. We don’t have some of the limits that the government does—we don’t have to have X percentage for small businesses and X percentage for minority-owned small businesses. We probably can be more pragmatic on that than the Army, but we will have small business trade shows, if you will, to advise small vendors. We sometimes can turn them on to manufacturers that use small vendors, or tell them how to sell to a company like Costco. Sometimes we can turn a regional item into a national item.

    Thirteen times a year, senior managers across functions come to Issequah, WA, where we’re headquartered, for a day-and-a-half budget meeting. In those meetings, there are eight heads of regional merchandising. One of the things they do, in addition to how did we do versus our budget and how can we improve the next budget, is what’s hot in that area. And sometimes the other regions will look at that and say, I’ll give that a shot. Sometimes the CEO says, “Why haven’t you given that a shot?” I think it’s been a good forum for us to cross-fertilize ideas from one region to the next.

    One of the reasons we went from one buying office 20 years ago to two, one on the East Coast and one on the West Coast for the time difference, to eight about 10, 12 years ago was that regional flair. On a national basis, we want to be working with Procter & Gamble, or Bounty paper towels, to achieve national efficiencies. But on the food side, we’ve found some great items over the years that have become co-branded Kirkland Signature items. One of my current favorites is a peanut butter-filled pretzel, a Kirkland Signature item by H.K. Anderson. That was a strong smaller regional item. It continued to succeed, and we developed it with them.

    I think small businesses bring innovation and unique regional tastes. As much as we’re an international, cement-floor, big-box retailer, we’re also a merchandiser. And part of merchandising is offering exciting merchandise, and sometimes exciting merchandise can be found at the regional level. There may be a particular item that is unique to a particular region that we never would have found out about if we only worried about big national brands. It’s a treasure hunt.

    We get the question more than once a week about why we don’t have signage as to where merchandise is located. Well, first of all, we bring in and out a lot of seasonal items, and while the layout of the warehouse is pretty much the same—you have electronics in the front, and in the middle or lower area you have some books and CDs, seasonal items, apparel tables, for the most part, we want you to shop through the whole place. We want you to look around.

    Q. Improving the professionalism of the workforce is the newest area of focus for Army Acquisition. What sort of culture does Costco strive to instill in its workforce? If you had to describe this in three sentences to a new employee, what would you say?

    A. We’re trying to instill in them, first of all, that our mission at Costco is to provide the best-quality goods and services at the lowest possible prices to our members, and doing it in an honest way. And where there are promotional opportunities for you the individual, it’s an open-door policy. Finally, that we deal with things with a high degree of honesty and integrity, and everybody gets a fair chance.

    When we talk about quality, it’s not just quality of merchandise; it’s how often the bathrooms are cleaned; it’s the 10-foot-wide parking spaces instead of 8-foot-wide. And we get great grades for quality, even though it’s just a no-frills warehouse. We get high marks for customer service, even though in our case the best service is self-service sometimes. Our returns policy is great; we get compliments all the time. Hopefully we’ve hired the right people, and we’ve been able to hire better employees because we pay well, and if they see growth in our company and we provide opportunities, then so much the better. The message from the very beginning is that we’re about gaining the trust and loyalty of our members, and certainly gaining the trust and loyalty of our employees, and to be the best retailer out there, providing great goods and services.

    The other thing is, how do we deal with adversity? And that’s something that our CEO has talked to our managers about at the managers meeting: You deal with it head-on. Years ago, we were written up in the Northeast about a rodent problem at one of our New York City locations. Now, if you sell food, whether you’re a restaurant or a convenience store or a retail supermarket, at some point you’re going to have a rodent issue. It must have been a slow news day, but it was on one of the national programs. They asked Jim, our CEO at the time, and he said, “I’ll meet you at the warehouse and we’ll walk it.”

    I remember in the office the next day, asking him, “How did it go?” And he said, “Well, I was standing in the middle of the produce section, taking the interviewer’s questions, and I was responding to one of the questions, and he said, ‘Let’s take that again. You sounded a little defensive.’ ” And this is an investigative reporter. He saw that we weren’t trying to hide anything. We didn’t write him a letter from our lawyer saying, “If you have any questions, send them to us. And no, you can’t go near our warehouse.” So I think how someone deals with adversity, whether it’s an E. coli recall or a problem at a hotel through Costco Travel, the best way we can deal with things is to deal with them straight-on, and if we have made a mistake, we don’t throw a bunch of lawyers at it. We make it right with the customer.

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