Performance Based Contracting – an innovative contract and business model for the defence industry

By Dr. Mike Körner //

“Performance-based contracting” (PBC) is gaining significance in the context of maintenance and spare parts procurement for the main weapon systems of the German Armed Forces. Where flying platforms such as Eurofighter Typhoon and NH90 are concerned, it is the key element to increase material readiness.

In a PBC agreement, industry commits to achieving performance and availability targets which are then followed up by metrics. Industry is, to a large extent, fully responsible for the supply of spare parts or maintenance or logistic services to ensure availability.  Depending on achieved availability and performance the incentive share for industry increases or decreases, and with it the profitability of the services provided.

Countries like the US, UK or Australia are actively using PBC agreements for managing supplies of spare and replacement parts of their flying systems since the 1990s. Their positive experience in terms of cost savings and increase in operational readiness has been examined and confirmed for each of the affected programmes. By implementing PBC, cost savings of more than 20% and an increase in operational readiness between 20% and 40% on average could be achieved (source: BAAINBw L6.3., 2017).

But what exactly changes when shifting from traditional service business to performance-based contracting?

Traditional service contracts are based on the input factors “man hours and material”, with framework conditions fixing technical and process execution in detail. The old cost-plus contracts incentivise industry to increase the profitability of services by using more man hours and material. By applying the result-oriented incentive system PBC, this logic is reversed. Profitability can be increased by saving cost and increasing efficiency, i.e. less man hours and less material. To realise these effects, industry is granted a higher degree of freedom in organising and implementing the services.

The monetary incentive mechanism is the key element to ensure alignment of interest between the Armed Forces (system availability) and industry (profitability targets). It is the core of performance-based contracting.

A typical incentive model for a material supply contract works in two steps: in the first step, cost savings compared to a target price determine the level of the incentive amount to be shared in absolute terms. In the second step, the relative distribution between industry and Armed Forces is determined based on the achievement of contractually agreed metrics. The higher the target achievement with regards to the metric (e.g. on-time availability of spare parts), the higher the industry share. For a PBC incentive model, the combined consideration of both “savings” and “achieved performance” is important. If there was, for example, only a savings target in a material supply contract, industry would save on procurement and availability would be adversely impacted. If only availability was measured, industry would be interested in putting as much material as possible on stock to ensure availability. Only a combination of savings and availability targets allows for a suitable alignment of interest between Armed Forces and industry.

From our experience, there are five typical action areas that companies need to address when shifting to PBC.

(1) Improve quality of master data

The existing material management database is usually not in good shape. Without proper master data it is impossible to derive demands or order material correctly. This point may appear trivial, but usually involves extensive preparatory work.

(2) Refine predictive models

The second action area deals with the planning of material consumption. The forecasted demand is often based on historical data only. Demand planning can be enhanced by approaches such as predictive maintenance or the use of “big data”. Automating replenishments via modern ERP systems leads to further efficiency gains.

(3) Introduce a differentiated material management

The procurement and inventory strategy should be based both on the quality of the material and on the predictability of demand. An ABC / XYZ analysis is helpful in this context. For example, for high-value material with high predictability a just-in-time delivery by the supplier is preferred, whilst high-value material with low predictability of demand should be addressed by a supplier reserve. For the large number of C materials (small parts, standard parts, replacement parts, low-priced materials, etc.) it is often more cost-effective to outsource the management to external service providers. It is crucial to ensure lean ordering, storing and booking processes so that the process cost does not exceed the actual value of the items.

(4) Manage supply chain risks

There are often surprises when it comes to lead times and one-off costs. Due to budgetary constraints of the Armed Forces, in many cases in the past there has been insufficient procurement of spare parts and obsolescence management has been neglected. Often, a gradual amendment of framework contracts along the entire supply chain is necessary to secure the required performance.

(5) Measure and improve logistic processes 

To achieve long-term cost savings, process efficiency in the areas of procurement, warehousing and logistics must be measured and continually improved. In this context, the new discipline of process mining creates full transparency of process cycle times and process deviations and helps identifying comprehensive approaches for process optimisation.

As a conclusion, it can be stated that PBC agreements provide an opportunity to expand the services business. To achieve cost savings and efficiency gains, it is necessary in our experience to implement a change management to develop a service and performance culture, besides introducing extensive changes to the organisation and processes.

Project crises and crisis projects – mechanisms and ways out

By Dr.-Ing. Martin Kraus //

Even under perfect conditions, projects and programmes run into difficulties. Initial problems – which may be understandable and quite typical for projects – can be overcome. As work progresses, however, they turn into project crises. Project crises develop into crisis projects.

A project crisis emerges if either the “what” (e.g. aim of the project, product requirements, targeted/confirmed properties) or the “how” (e.g. methods, technologies, resources) are not (or no longer) clear. Furthermore, uncertainties about the “what” can ultimately lead to questioning the “how”.

Often the mechanisms preventing early discovery of an emerging project crisis are due to a lack of implementation of generally accepted project management principles. They can, however, also result from the project environment, e.g. company culture. Or the crisis was almost unavoidable because the prerequisites were misconceived at project release.

The more severe the crisis – in the worst case, the project is already in chaos mode -, the tougher the measures required to manage a turnaround. If the project is no longer profitable or the customer has fully lost his trust, a project cancellation needs to be considered. But even such a cancellation should follow a structured approach.

In-depth project reviews, a project audit or a project supervision can lead to an early discovery and understanding of the real situation and point to a crisis. Calling in external experts with experience in project management and complex programmes can be a valuable support. The further the crisis has already progressed, the more important it is to support the project manager and the project team with an outside view.

The “Project Status Indicator Check” (ProSIC) enables you to get a first understanding of the situation without external support and/or detailed knowledge about the project or product.

In his article, ACTRANS partner Dr Martin Kraus discusses various aspects around the emergence and solution of problems in complex projects and product developments. He refers to his almost three decades of experience in the Aerospace & Defence world and the successful delivery of several crisis projects.

At ACTRANS, we provide our customers with project reviews and audits, project supervisions and even operational project support including takeover of project management responsibilities on a temporary basis during turnaround phases.

Learn more (Access full article als PDF via link below)

Projektkrisen_Krisenprojekte_Mechanismen_und_Lösungen_ACTRANS

Leverage Process Mining for more process efficiency

By Susanne Steinbicker and Dr. Mike Körner //

Process Mining – What’s new?

Process Mining is an innovative technique supporting process optimization. Executing process steps in modern IT systems generates a series of digital footprints. Process Mining utilizes these footprints, e.g. event logs, to re-build and analyze complex processes. Thus, Process Mining makes use of actual, usually unutilized and hidden data in IT systems and combines it to build a transparent process which can be visualized and even quantified (e.g. frequency, throughput time) both in its entirety and all its variants.

Figure: Comparison Process Mining with traditional means

Source: ACTRANS

What are the trends, and how about the practical experience?

Over the last few years, the very positive practical experience with Process Mining has led to a very dynamic development regarding tools, use cases and end user community. Even with very experienced process owners, we witness eye opening moments as soon as they see the visualization of their process via Process Mining, based on actual data.

Especially the quality of discussion regarding a process and its interfaces between different departments is entirely different: it is no longer about hypothetical processes, individual assessments or blaming others, but about the objective display of throughput times, process variants and their optimization.

Moreover, we observe the following trends:

From simple support processes to complex core processes

Most companies start Process Mining with relatively standard and simple processes like accounting processes or purchase to pay. After an initial positive experience, they roll out to more complex processes like production.

From one-off process optimization to process monitoring

From our observations, experienced Process Mining clients request new consulting services. It is no longer about a short optimization project, but about continuous monitoring and optimization of complex processes.

From process documentation to implementation

According to the claims of some Process Mining tool providers, Process Mining replaces the role of external consultants in process optimization. This is not the case. Whilst the process mapping itself requires significantly less effort, the support by experienced Process Mining experts and Data Scientists during analysis, definition of measures and implementation of optimization actions is still useful and in demand. Overall, the consulting focus is shifting from process mapping and documentation to optimization and implementation.

Summary:

Data based Process Mining is more than just a hype. It will substantially change both the optimization of business processes and the involvement of consulting firms during process optimization. The effort for process mapping can be reduced whilst increasing the quality of the analysis. At ACTRANS, we support our clients in leveraging the new possibilities and potentials of Process Mining.