Service Matters from MCA Solutions

There is significant anecdotal evidence that Performance-Based Logistics (PBL) contracts are effective; however, studies from the GAO and others highlight the pressing need to improve the management of existing PBL programs and to develop more realistic business cases to assess the costs, benefits, and risks.  A recent report from the Lexington Institute and a quantitative study from the Wharton School are helping to answer the question: Do PBL contracts provide value to both suppliers and customers?

The report from the Lexington Institute titled "Performance-Based Logistics:  A Primer for the New Administration," describes the challenge that the Obama administration faces in decreasing defense spending while maintaining a strong military. 

The Institute, who "strives to find non-governmental, market-based solutions to public policy programs," states that "the administration can have a significant, early impact on national security by directing the Department of Defense to move forward aggressively on PBL."

Since the Department of Defense began implementing PBL in 2001 through Performance-Based Agreements (PBA's), the services have seen a marked increase in the availability of equipment and systems to our military in combat, and a study of 23 PBA's showed an average savings of $21 million.

PBL programs from Boeing IDS and Lockheed Martin Aeronautics, who have implemented MCA's PBL solution across several platforms, are noted as dramatic success stories, but PBL contracts have been implemented across only a small percentage of the hundreds of major weapon systems managed by DOD.  The report makes an argument that the DOD needs to redouble its effort to institutionalize PBL in its logistics and sustainment activities by clearing up lingering uncertainties about PBL effectiveness and defining and documenting the business case.

To better understand the case for PBL, MCA founder Morris Cohen, and his colleagues at the Wharton School have been doing extensive research on PBL to determine effectiveness and quantify its benefits.  In a recent study performed with a major aerospace manufacturer the team looked at 5 years of reliability data based on MTBR (Mean Time Between Removal) in contracts that were executed as either Time & Material (T&M) contracts or Performance-Based Contracts (PBC).  After isolating the impact of contract type from other factors such as contract choice and type of product, the results showed with high confidence that there is a significant correlation between choice of a PBC contract and an increase of product reliability of 10% to 25% in comparison to T&M contracts.  Analysis of the data shows that, all else being equal, PBC increases the MTBR of a product by 790 flying hours in the five-year observation period.

The study is significant in that it's the first to test and validate the reliability improvement hypothesis for performance-based contracting based on transactional data, and it makes a step in closing the gap between theoretical modeling and empirical evidence.  

MCA remains committed to continuing to provide tools to improve the effectiveness of PBL contracts, and we look forward to hearing from our readers on their experiences with PBL contracts and what could make them more effective.

To learn more from Dr. Cohen on the details and implications of the Wharton study, you can contact him at cohen@wharton.upenn.edu.

MCA's recent survey of more than 30 executives at leading companies across several core manufacturing industries revealed some interesting findings around the recession's impact, and how companies are leveraging aftermarket customer service support to mitigate the effects of the downturn.   While the impact varies by industry, a universal observation is that service revenue and profitability are holding steady and in some cases growing and effective management of the service business is becoming a critical capability for the survival of manufacturing companies.  Below are some observations by industry:

Aerospace & Defense

A&D organizations have seen a reduction in the number of flying hours generated by their customers.   This has led to a reduction in aftermarket service parts consumption, which is an important revenue source for companies in this industry. 

The current situation also has created opportunities to bring new service offerings to the market.  These changes are especially important for customers adopting performance-based logistics (PBL) or "power by the hour" aftermarket support programs in order to transfer costs and financial risks to their suppliers while providing their customers with increased product availability and a reduced cost-of-ownership.

Medical Equipment

Medical equipment companies are seeing a relatively smaller drop in demand for sales of their end equipment than some other capital equipment industries, although there is some delay in spending.  The changes that they have seen are primarily driven by customers extending the lifecycle of products, leading to readjustments in lifecycle product buying.  As a result, aftermarket service to support the existing installed base is becoming more important, both as a means to retain customers and to drive revenue as new product purchase revenues are reduced.

Semiconductor Equipment

Semiconductor equipment companies seem to be struggling the most, as demand for new products continues to drop (so far by more than 50% compared to last year).  As a result, semiconductor companies are relying more heavily on aftermarket services, which are driving a much higher percentage of total revenue. 

Even as service becomes a more important source of revenue, semiconductor companies have seen the demand for (service) parts drop as customers scale back on equipment usage.  They're also finding that customers have an increased interest in a broader range of service offerings for aftermarket support.

Automotive

The recession has had a visible and substantial negative impact on new product sales in the automotive industry.   The only bright spot is that as noted above, consumers are extending the usage of the products, generating increased revenue in service and parts.  In the automotive industry, the auto OEM's challenge is to hold on to market share against independent repair services as well as retail auto parts distributors, some of whom have seen significant growth during the recession.   The OEMs must retain customers through high levels of customer service (including parts availability) while managing cost through advanced inventory management.  Some OEM's are turning to service parts optimization as a means of doing this.

While the new economy is a challenge for us all, there is a significant opportunity for service businesses to demonstrate increased value to both their internal provider organization as well as to their customers.  For those companies that seize this opportunity, the impact of doing so will last well beyond the current downturn.  A responsive, cost-effective and optimized service support function will continue to provide competitive advantages as the economy improves.   In a follow-up article, I will discuss specific service parts planning requirements that help companies perform better in this business environment.