Industry Today: The World of Manufacturing

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 Date:4/21/2009

 

Dollars & Sense
Flight Ready
Performance based logistics can transform aerospace & defense support and maintenance.

Aerospace and defense industry output represents some of the most expensive industrial products ever produced. List price on a new Airbus A380 double-decker is between $317 and $338 Million and a new Virginia class submarine will set you back a cool $2.5 Billion. If that is not in your budget range, you might consider your own very lightweight jet for $3 million. However expensive these products are, what is not so well known is how expensive these products are to maintain and keep operational. Contrasted with automobiles or consumer products, aerospace products operate in extreme conditions with quality and safety requirements that are significantly higher, resulting in much more frequent and costly maintenance, repair, and overhaul.

That was then and this is now
In past decades, these products were maintained just like your car – scheduled maintenance, or if something breaks, you get it fixed. Airlines and military forces around the world had built up infrastructure for product support, with trained technicians, spare parts inventories, and capability to support ready product availability for their mission – to carry airline passengers, or be ready at a moment’s notice to defend freedom in far corners of the world.

Particularly since the commercial airline industry has been deregulated, these businesses have been on a never-ending quest for efficiencies. Maintenance has been a prime target, where scale economies were pursued, investment in parts inventory were pared back, or outright outsourcing of the maintenance repair and overhaul function was accomplished. In weapons systems, defense contractors have been increasingly involved in support contracts, supplying spare parts and skilled technicians to supplement the armed services materiel command depots, but in many cases on a cost plus basis.

More recently for both the commercial as well as defense sectors, there has been a transition to performance based contracts, where instead of buying equipment, the customer is buying delivered performance. For example, airlines might buy “power by the hour”, instead of a $10 million jet engine and spare parts. Another example is where the Air Force might buy “strategic lift with 99.9 percent dispatch reliability”, rather than purchasing a $200 million military transport and its spare parts. In this way, the providers of the equipment assume performance risk, while the customer obtains a predictable cost arrangement for guaranteed performance.

Performance based logistics, otherwise known as “PBL,” is increasingly seen as a transformational business model, which promises to provide more value for less money, while managing risk better for both producer and customer.

How PBL works
Although PBL contracts take on many forms, the basic model for PBL is relatively simple: The asset owner (e.g., military service) essentially outsources nearly all of the major support processes in return for guaranteed availability of the asset to perform its task. Ultimately the business model is changing from one of purchasing the asset and related support services, on an event and cost-plus basis, to paying for guaranteed results for its usable life for a flat fee per unit of use.

Contracts based on performance, represents a fundamental change in the business model for aftermarket support. PBL addresses the need for incentives to improve efficiency in production and service delivery since in the old business model, the customer would reap virtually all of the benefits. Performance based contracts turn the business model upside down. Service providers agree to deliver a specific level of support at a fixed price – thereby taking on virtually all of the risk. Under this type of outcome based scheme, cost avoidance measures such as reliability enhancements directly contribute to service provider profitability.

This new environment for asset sustainment presents unique challenges and requires a new business model with a greatly enhanced set of capabilities. Challenges in this new environment lie on both the customer and the provider side and require a strong commitment to collaboration and trust amongst both parties.

Customer responsibilities
Customers need to develop a set of policies to manage PBL across the board; making sure that it is implemented consistently across all organizations. In addition, they need to make sure there is adequate accountability for delivering results and that those results are measured equally across the board. Thirdly, they need to provide the necessary oversight to resolve issues and ensure an environment of collaboration and trust. Lastly, customers need to work to balance the work-share equation to ensure adequate capabilities remain in core areas while outsourcing non-core capability.

Provider responsibilities
For providers, there is a need to shift culture from cost-plus to profit accountability, where every dollar of savings counts and changing the image of the aftermarket from a “necessary evil” to a key driver of revenue growth and profitability is accomplished.
Secondly, pricing PBL contracts to reflect increased risk and determining what a fair and equitable risk sharing proportion is necessary. In addition, providers need to effectively communicate the company’s various services and capabilities to different types of customers. Most importantly, providers need to accurately forecast and optimize the spare parts network to have the right parts at the right place at the right time. Determining how to accurately track transaction costs and measure performance while significantly improving performance in all parts of the business to achieve a high degree of profitability on each PBL contract is required.

Providers need to treat PBL as a “business within a business”, identify and empower a respected business leader to develop and execute a long-term PBL strategy and undertake a comprehensive evaluation of the capabilities required to deliver.

Summary
The idea of PBL is a radical change from the past and holds the potential to yield significant benefits to both parties. Current experience shows that significant savings can be achieved through lower life-cycle costs while at the same time increasing asset availability and effectiveness. It can increase revenue and margin potential to the provider while helping to balance risk for both parties. However, because collaboration, mutual trust, new capabilities and increased risk take center stage, PBL is not without its challenges. If designed and executed poorly there is significant risk to both the customer and the provider. With this dramatic change comes the need for wholesale evaluation on both sides of the equation; from policy, accountability and oversight on the customer side to new capabilities, new culture and greater risk management on the provider side. A holistic approach is required to evaluate customer and provider readiness to take steps to implement the necessary changes.

Tom Captain is Vice Chairman and Global and U.S. Aerospace & Defense Leader for Deloitte LLO.

Tristan Whitehead is a Principal for Deloitte Consulting LLP who serves the A&D Customer Support & Sustainment leadership team.

This publication contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this publication, rendering business, financial, investment, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication.

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