The invisible bottleneck: Why the future of arms is decided in the supply chains

If the bottleneck is not at the top but in the foundation

The German defense industry is facing a historic turning point. While billions are flowing into new production lines and order books are bulging, the true success of this turning point will not be decided at the workbenches of the major systems integrators. Rather, it will be decided in the small, specialized companies at the lower levels of supply – where precision parts, seals, and brackets are manufactured. Anyone talking about production increases today must understand that speed is not achieved by more machines, but by the way companies collaborate along the entire value chain.

From prototype to production: How the industry is reaching its structural limits

The roots of the current challenge go back a long way. For decades, the German arms industry was focused on small series, prototypes, and highly specialized individual solutions. After the end of the Cold War, defense budgets shrank continuously, manufacturing capacities were reduced, and an industrial base for mass production was deemed unnecessary. The result was a specialization geared toward low volumes and long development cycles.

With the turning point in 2022, the situation changed fundamentally. The Russian war of aggression against Ukraine made it clear that Europe urgently needed to expand its defense capabilities. Germany announced a €100 billion special fund, and NATO called for an increase in defense spending to at least two percent of gross domestic product. For 2026, Germany plans a defense budget of over €108 billion—a historic figure corresponding to approximately 2.2 to 2.3 percent of GDP.

This sudden surge in demand hit an industry that was structurally unprepared for it. While large companies like Rheinmetall, KNDS, and Hensoldt possess sufficient resources, stable processes, and the necessary expertise, the real bottleneck lies deeper in the supply chain. It is the highly specialized Tier 2 and Tier 3 companies – those often family-run medium-sized businesses that manufacture add-on parts, fasteners, or high-precision optical components.

These companies possess specialized knowledge and customized manufacturing processes that have evolved over decades and cannot be replicated quickly. Establishing a second source, i.e., an alternative supplier, is often neither technically nor economically feasible in the short term. The combination of dependency, a monopoly on expertise, and a lack of scalability makes these companies critical but difficult-to-replace links in the industrial chain. If a single one of these companies cannot expand its capacity or reaches its quality limits, the entire production process comes to a standstill.

Added to this are structural bottlenecks in raw materials. Armor steel must be ordered at least a year in advance. Delivery times for stainless steel and specialty alloys have increased dramatically in recent years, and prices have risen to record highs. China has also tightened its export regulations for rare earths, posing additional challenges for the German defense industry.

The anatomy of modern defense supply chains: Complexity as a systemic risk

Modern defense supply chains follow a hierarchical structure divided into several levels. At the top are the OEMs (Original Equipment Manufacturers) – the large systems integrators such as Rheinmetall, KNDS, Thyssenkrupp Marine Systems, and Hensoldt. These companies develop and integrate complete weapon systems and supply them directly to the Bundeswehr or other armed forces.

Directly below them are the Tier 1 suppliers, who deliver complex modules and systems to the OEMs—such as drive systems, electronic modules, or weapon control systems. These companies often have close development and production partnerships with the system houses.

Tier 2 suppliers are component suppliers who deliver individual assemblies to Tier 1 suppliers—for example, electronic components, hydraulic components, or steel components. At the lowest level, Tier 3 suppliers are parts suppliers who provide raw materials or standard components such as screws, seals, or fasteners.

This structure is highly interconnected and interdependent. A failure at the lowest level can have cascading effects throughout the entire chain. The complexity is exacerbated by the fact that many Tier 2 and Tier 3 suppliers serve not only the defense industry but also the automotive, mechanical engineering, and aerospace sectors. This leads to competition for limited capacity, especially during periods when several industries are experiencing simultaneous ramp-up.

The defense industry also has specific requirements for quality, documentation, and traceability that go beyond civilian standards. Every component must be fully documented, and supply chains must be transparent for security reasons and originate from NATO member states. This significantly increases the demands on suppliers and makes it difficult for smaller companies to enter the defense industry without support.

A turning point under pressure: The current situation between boom and bottleneck

The German defense industry is currently experiencing an unprecedented boom. Rheinmetall's sales increased by ten percent in 2023, and the company's share price has multiplied since the Russian attack on Ukraine. Hensoldt, the Ulm-based radar specialist, plans to increase its radar systems production capacity fivefold to approximately 1,000 units per year by 2027, creating up to 200 new jobs.

Satellite images across Europe show a similar picture: Since the beginning of the war in Ukraine, over seven million square meters of new industrial space for defense production have been created. This expansion is being supported by public subsidies, particularly the EU's Act in Support of Ammunition Production (ASAP) program, which provides €500 million in funding. The new European Defence Industry Programme (EDIP) will provide an additional €1.5 billion by 2027.

But behind the impressive figures lie structural challenges. Production capacities cannot be ramped up as quickly as politicians demand. Rheinmetall plans to increase artillery ammunition production twentyfold by 2026 – from 70,000 rounds in 2022 to 1.1 million rounds annually by 2027. But even this massive increase would not even cover half of Ukraine's estimated annual demand of two to 2.4 million rounds.

The problem doesn't primarily lie with the large system houses, but with the suppliers. Sebastian Schaubeck, Managing Director at ACS Armoured Car Systems, explains: If you can rely on existing supply chains and employ shift work models, expansion can happen relatively quickly – in less than twelve months. However, if new halls have to be built, permits obtained, and machinery procured, such an expansion can easily take over 24 months.

Added to this is the shortage of skilled workers. Rheinmetall is seeking more than 3,500 new employees, and the German Armed Forces are competing with industry for qualified personnel. While the simultaneous crisis in the automotive industry offers opportunities for the defense sector – Hensoldt CEO Oliver Dörre reports talks with Continental and Bosch about taking on employees – the transferability of skills is limited and requires training measures.

Supply chain resilience is another critical issue. Many suppliers rely on components from China, which poses a significant risk given geopolitical tensions. Peter Wambsganß of etatronix emphasizes the importance of resilient supply chains: Recent crises have shown how important it is for the value chain to be as closed as possible within NATO member states. His company develops and manufactures military products entirely in Germany and consistently relies on components from NATO member states.

From practice: successful models and learning areas

A look at practice shows that successful approaches already exist, but have not yet been implemented across the board. The automotive industry offers valuable experience in this area, particularly in the transition to electromobility. Systematic supplier development programs have been launched there to prepare Tier 2 and Tier 3 suppliers for new requirements. Technical training, maturity models, co-investments, and long-term development agreements have helped to raise highly specialized micro-enterprises to the necessary quality and process levels.

Rheinmetall has introduced a digital procurement portal that systematizes collaboration with suppliers. The platform provides suppliers with access to relevant documents, creates transparency regarding business processes, and offers a direct communication channel. From onboarding to sourcing to contract management, all processes are consolidated in one place, increasing efficiency and effectiveness.

In its corporate strategy, KNDS emphasizes the importance of a stable supplier network of renowned component and subsystem manufacturers. Consistent demand guarantees long-term supply and creates planning security for suppliers. This is a crucial factor, as many companies are hesitant to invest in capacity expansions until it is clear whether demand will be sustained.

Another example is the ZEBEL (Central Bundeswehr Spare Parts Logistics) project, one of the Bundeswehr's most successful public-private partnerships. ESG, together with DB Schenker, manages a 17,000-square-meter central warehouse, thus providing a positive example of effective cooperation between public clients and industry to increase effectiveness and efficiency.

But there are also challenges. Ukraine demonstrates that even massive investments do not automatically lead to full capacity utilization. Despite a tenfold increase in production value from 2021 to 2024, to over ten billion euros, capacity utilization is only around 40 percent. Reasons include inadequate protection of production facilities, a lack of financing, and shortages of raw materials such as gunpowder.

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System failure or system change? The critical debate

Despite the boom and political commitment, there are considerable criticisms of the German defense industry's supply chain management. One of the central allegations is that supplier management is still often viewed as a mere purchasing discipline and not as a strategic task of corporate management.

A study commissioned by the Federal Ministry of Defense uncovered numerous risks in centralized procurement processes. Criticism is directed primarily at a lack of transparency, excessive bureaucracy, and a lack of planning security. Klaus-Heiner Röhl of the German Economic Institute emphasizes: "Industry needs long-term prospects backed by orders. Manufacturers aren't benefiting much from discussions about increased defense spending."

A structural problem is the lack of systematic development of supplier structures, especially at the lower levels of the value chain. While large Tier 1 suppliers are generally well-positioned, smaller Tier 2 and Tier 3 companies often lack the necessary resources for training, certification, and capacity expansion.

The automotive industry demonstrates that Tier 3 suppliers are often smaller and less diversified—both in terms of customers and production sites. Their biggest challenge is rapidly rising energy and material prices. In addition, they are bound to annual price agreements with their customers and lack a unique selling proposition. This limits their ability to pass on cost increases in the short term.

Another point of criticism concerns the lack of transparency along the supply chain. A study by Forrester Consulting found that only 13 percent of surveyed companies rate their supplier management as leading—with formal programs consistently applied across the entire supply base. Without robust supplier management programs, companies risk disrupted supply chains, compliance issues, and missed savings or innovation opportunities.

The arms industry also faces ethical questions. The sudden shift of industrial capacity from civilian to military production raises questions about Germany's long-term economic strategy. Critics warn that an excessive focus on arms production could lead to a structural dependence on conflict demand.

Finally, there are concerns about the timeline. Leading generals cite the time frame for further Russian escalation as 2027 to 2030 at the latest. The Bundeswehr would have to be capable of fighting by then. The question is whether the arms industry and its supply chains can be ramped up quickly enough to meet this deadline. Experience shows that building capacity at suppliers takes at least 12 to 24 months – and that's assuming that permits, financing, and skilled workers are available.

Digitalization, AI and autonomous systems: The next stage of evolution

The future of defense supply chains will be significantly shaped by technological innovations. Artificial intelligence, digital platforms, and autonomous systems offer enormous potential for increasing efficiency and minimizing risk. China has established a lead in this area with its strategy of intelligentization, forcing Europe to rethink its approach.

The integration of AI into all facets of military operations, including logistics, is a central element of Chinese modernization. AI is used for predictive logistics, autonomous replenishment, and optimized resource allocation in dynamic environments. Studies indicate efficiency gains of 20 percent or more.

Europe and Germany need to catch up here. With its Battlesuite software solution, Rheinmetall has taken a first step toward networked, digitalized combat management. The platform is designed to improve military communications and data analysis by connecting all relevant information and networking all relevant users on the battlefield.

Digital platforms offer significant advantages in supply chain management. Establishing systems for recording and monitoring delivery status, risks, quality indicators, and capacities along the entire value chain creates the necessary transparency for effective management. Cloud technologies, collaborative platforms, and common standards for data exchange promote transparent, real-time communication.

Blockchain technology could provide decentralized, transparent, and tamper-proof documentation of transactions. This offers significant potential, especially in the defense sector, where traceability and compliance are key.

The adoption of AI for predictive maintenance is another important trend. By predicting component failure before it occurs, unplanned downtime can be reduced, costs saved, and operational safety increased.

Autonomous replenishment systems – UAVs for critical air support and robots for warehousing and transport in hazardous environments – are already under development. Rheinmetall already has systems in this area in its portfolio with the HERO series of loitering munitions and the LUNA NG reconnaissance drone.

The challenge lies in implementation. Europe needs a committed, well-resourced smart logistics strategy, not just isolated projects. This requires the initial availability of standardized, accessible, and secure data—a fundamental prerequisite for the effective deployment of AI at the coalition level.

The European Defence Agency and NATO are working on common standards and interoperability. The European Defence Industry Programme (EDIP) explicitly provides funding for digital transformation and technological innovation.

But there are also risks. The excessive dependence on a few global providers in the field of software and AI technologies is a warning sign. Technological sovereignty—the ability to develop and manufacture key technologies in Europe—is increasingly becoming a strategic imperative.

Digital transformation is not an end in itself, but a necessity for surviving in global competition. Those who invest in digital supply chain technologies today are laying the foundation for tomorrow – both in defense and the civilian economy.

The Foundation of Defence: Why Supply Chains Decide on Security

The analysis clearly shows: The German and European defense industry is at a turning point. This turning point is not just a political phrase, but an industrial reality. The challenge lies less in technological expertise or financial resources than in the systematic development and management of supplier structures.

The bottleneck isn't with the large system integrators, but with the highly specialized companies at the lower supply levels. These Tier 2 and Tier 3 suppliers are the backbone of the industry—irreplaceable, yet often invisible. Their ability to scale determines whether political announcements actually translate into deliveries.

The solution lies in a fundamental paradigm shift. Supplier management can no longer be viewed as a mere purchasing discipline, but must be anchored as a strategic task of corporate and government leadership. This encompasses five key areas of action:

First, capacity building and redundancy management. The expansion of additional production capacity must be carried out jointly with key suppliers across all levels. At the same time, redundancies must be created to reduce dependence on individual suppliers.

Second, qualification and development programs. The lower delivery levels require targeted support through technical training, maturity models, co-investments, and long-term development agreements. The automotive industry has achieved decisive success with similar programs in the transition to electromobility.

Third, transparency and real-time control. The development of digital platforms for recording and monitoring delivery status, risks, quality indicators, and capacities along the entire value chain is essential. Only those who have a data-based understanding of their supplier landscape can manage it effectively.

Fourth, collaborative value creation and incentive systems. The development of long-term partnerships through joint development initiatives, technology partnerships, and performance-based incentive systems replaces short-term purchasing thinking.

Fifth, institutionalized governance. Embedding supplier management not only in the purchasing strategy but also in strategic corporate management—with clear roles, competencies, and responsibilities, regular audits, and reporting obligations across all hierarchies.

The greatest potential lies not in new technologies, but in new connections. Those who understand cooperation as a strategic capability will ensure speed, quality, and reliability in the long term. Competitiveness is determined not at the top of the supply chain, but at its foundation.

Delivery capability is no coincidence. It is the result of transparency, systematic development, and a shared will to shape things. The European defense industry can continue to remain in the mode of individual optimization – or it can use this changing era to jointly redesign its industrial base. The decision is being made today. The consequences will shape Europe's security for decades to come.

Markus Becker

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Chairman SME Connect Defense Working Group

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Konrad Wolfenstein

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contact me under Wolfenstein ∂ Xpert.digital

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The global economy is currently experiencing a fundamental change, a broken epoch that shakes the cornerstones of global logistics. The era of hyper-globalization, which was characterized by the unshakable striving for maximum efficiency and the “just-in-time” principle, gives way to a new reality. This is characterized by profound structural breaks, geopolitical shifts and progressive economic political fragmentation. The planning of international markets and supply chains, which was once assumed as a matter of course, dissolves and is replaced by a phase of growing uncertainty.

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