Pricing Product Support Parts for Clueless OEMs

Sep 14
2012

Pricing Product Support parts continues to be an area in which many OEMs struggle.

A 2011 Defense Department’s Inspector General  report accused Sikorsky Aircraft Corp. a unit of Hartford, Connecticut-based United Technologies Corp. (UTX) of overcharging the U.S. Army Aviation and Missile Life Cycle Management Command’s Corpus Christi, Texas Depot  for 28 UH-60 Black Hawk helicopter Product Support parts, including $2,393.41 for a plastic wiring box cover worth $181.70.

Most OEMs continue to employ the following, dated method to pricing Product Support parts:

1. This is my cost.

2. This is the profit I have to make.

3. Therefore, this is the price I charge the customer.

Overly simplistic, and frankly, quite archaic.

Archaic Pricing Product Support models…

Earlier in my career, I ran an OEM’s (Falcon Jet) Product Support parts business unit for 10 years and my predecessor employed the cost-plus approach above. Customers were always screaming about $10 bolts, which met demanding aerospace specifications and were produced in small lots, but which a mechanic would perceive should only cost $1…because that is what you would pay at Sears.

Here is the funny part - a proprietary flight control actuator priced at $13,451 would have no pushback on price; the mechanic had no reference point to compare prices.

One day I decided to be very “clever” about pricing. I identified about 2,000 parts that “appeared” overpriced by our customers. Regardless of their cost, I brought them all down to $1. I then calculated my “loss” and increased the price of my proprietary items by the “loss” incurred, keeping my bottom line the same. Our customers were very happy that their concerns were acted upon…and there was no reaction to the higher prices on the proprietary parts.

Lesson learned: When an OEM stays with an illogical and rote Product Support parts pricing policy of cost-plus, their customers will be vocal about their disatisfaction. However, if you are clever, you can make your customers happy and still make the same profit. Voila!

Learn more about dynamic Product Support parts pricing models at www.giuntinicompany.com.

 

 

 

 

 

 

 

 

 

Capital Goods OEM Warranty Costs Have Fallen By 20% Over The Last 8 Years

Sep 11
2012

 

Capital Goods OEM Warranty Costs Have Fallen By 20% Over The Last 8 Years

 

Overall annual warranty costs, as a % of sales revenue has been steadily declining. In 2003 warranty costs comprised about 1.8% of revenues for OEMs and last year it dropped to 1.4% or a 20% decline. This trend is positively impacting the end-users Total Ownership Cost [TOC] as products become more reliable and require less failure-driven maintenance.

Visit www.giuntinicompany.com for product support best practices.

DoD Has No Idea How Much It Has Invested In Product Support Parts

Sep 09
2012

The DoD’s auditor has reported material financial management weaknesses in the following areas:  Financial Management Systems, for Inventory, Equipment, Government-Furnished parts and Contractor-Acquired parts. In other words, the DoD doesn’t really know what and how much it has in its possession.

In 2005, the DoD issued its Financial Improvement and Audit Readiness (FIAR) Plan  to define the Department’s strategy and methodology for improving financial management operations and controls, and reporting its progress to Congress…and Congress still awaits auditors to sign-off that the DoD is currently compliant.

Not the most effective strategy, eh?

A few years back we performed an extensive analysis of the inventory investment for an ACAT I Army weapon system that had been continually fielded over a 15 year period. We were told repeatedly by Army leadership that Class IX parts were balanced with demand…were they ever wrong!! Upon the conclusion of our study, 90% of the parts supply was classified as obsolete or excess…and I can tell you this poor Supply Chain Management of Product Support parts is common across all Services today. DoD has an estimated $90B of Class IX parts in inventory and my guess is that 30% is obsolete or excess…

Product Support Gone Bad

Sep 06
2012

Giuntini & Co. will be starting an ongoing series of posts about some of the big ‘uh ohs’ in the product support world. Take these as lessons folks – proper product support can be the difference between disaster and success…

Can you imagine if 15% of your fleet has been down for over 2 years because of the lack of Product Support parts. Take a look at what has happened with a bus fleet in India.

Spare Parts Product Support Gone Bad - Broken Down Bus

Spares rage can make the acquisition process for Product Support parts a stressful event. Take a look when someone gets really, really upset when they believe that someone has ripped them off.

Visit www.giuntinicompany.com for product support best practices.

Changes Are A Comin’ to DoD Contractor Product Support

Aug 10
2010

The U.S. Department of Defense is the biggest purchaser of Product Support expenditures in the world; it annually buys an estimated $50 billion dollars worth of such goods and services.

The last ten years has proven to be an especially favorable period for military contractors; overall DoD spending has increased from $300 billion per year to $700 billion, or 130%, and America now employs nearly half of all global military resources.  It is estimated that Contractor Product Support expenditures rose at a 150% to 200% rate during the ten year period.

As a result of the large build-up in DoD expenditures, the US currently generates 50% of the global military expenditures, but the US economy only generates 25% of the global economic output…this imbalance will most likely be realigned back to a historical ratio of 1:1 between the US economic output and defense spending.  

When many contractors have only one customer that matters financially, options are limited as to generating additional sources of revenues to compensate for lost Product Support revenues.

Even the biggest military contractors claim less than five percent of the Pentagon’s budget, so a contractor’s fortunes is influenced more by how defense dollars are spent than by the size of the budget. For example, contractor revenues can decrease, even when military spending remains high, if money migrates out of weapon system acquisition and into uniformed and civilian manpower.

Below are some of the primary trends driving down Contractor Product Support expenditures:

  1. Reduction in overall weapon system OPTEMPO due to the scaling back the size of the US military deployment in SW Asia. With an estimated 25% of all weapon systems in theatre and their OPTEMPO an estimated 100% higher than those systems not in theatre, it is estimated that overall Product Support expenditures will decrease by 15%-20%, with contractors experiencing an estimated 20%-30% drop in Product Support revenues
  2. The current fiscal challenges of the Federal Government to finance all their budgeted programs will most likely result in the military being a “victim” of fiscal austerity. It is quite feasible that 15-20% of DoD weapon system inventories will be stored long-term in order to reduce Product Support expenditures. Given the US Congress and the power of the depot-lobby, many of the systems stored will be those currently primarily supported by contractors
  3. The emphasis that Secretary Gates has put on “rebalancing” the defense strategy. Rebalancing means putting less emphasis on conventional, industrial-age warfare, and more emphasis on non-traditional skills like counter-insurgency warfare; this strategy will reduce complex weapon systems that require a complex Product Support Enterprise. There will be more an emphasis upon COTS items being integrated into a solution for the warfighter. COTS Product Support expenditures are often materially less than that of Developmental Items, thus resulting in overall lower Product Support expenditures
  4. The move to “in-source” Product Support management jobs previously contracted out to industry by the Program Offices and Life Cycle Management Commands. The Government is actively recruiting “seasoned” professional from contractors; either the professionals join the Government or they lose their job.

Each of the major weapon system contractors will be encountering different Product Support issues:

  • Northrop Grumman (NG) has decided to remain primarily focused upon new weapon system deliveries. It recently sold its services unit, TASC, due to conflicts between its OEM business and its Product Support business. This was a major policy change for NG
  • General Dynamics (GD) has generated material Product Support revenues from Interim Contractor Support (ICS) programs for the communication communities, especially for weapon systems in theatre; a GD Contractor Field Service Representative (CFSR) in theatre generates almost $500,000 per year of revenue. Supplemental funds have been an engine of growth for GD Product Support programs; this will be going away sooner, rather than later
  • Raytheon is less exposed than other primary OEMs due to the nature of their products being electronics; Product Support expenditures, at least at the organizational maintenance level, is much smaller than that of weapon systems that have more mechanical parts
  • Lockheed Martin (LM) will encounter many challenges in the Product Support area. The company needs to generate $130 million in new sales every day just to stay where it is, and that won’t be easy in a down market for Product Support.

There will be many challenges in the area of DoD Product Support over the next few years. Adding value to DoD, rather than filling positions to perform routine Product Support tasks, will differentiate winners from losers. And let us not forget that Outcome Based Product Support programs will be the rule rather than the exception for all future Product Support contractor offerings; that will be the only way that DoD will be able to manage Product Support processes more effectively for less costs.

For a more detailed discussion on the above topic, review the recent conference discussions at the Lexington Institute.

Don’t Always Trust Product Support Enterprise Financial Data

Jul 23
2010

Recently General Motors (GM) reported their 2009 new-condition light vehicle sales warranty expenditures. In calculating the warranty expense per vehicle sold, the results were $357. Utilizing this per vehicle cost in calculating the average price per vehicle sold to the dealer network, this would indicate that GM sold each of their vehicles at an average price of $14,300…appears to be a very low number relative to all its major competitors…and common sense.

With US sales about 35% of GM’s overall unit sales and the average US vehicle sold to dealers at around $23,000, GM is implicitly indicating that the average price of the remaining light vehicles sold in the EU and Asia would be about $9,000 each…not likely. The warranty expenditures have a material impact on overall earnings for GM, thus this “cost conflict” is important.

It may be that GM, currently controlled by the Federal Government is applying “creative” financial accounting, similar to that of the Federal Government has been employing for decades…but that is another story.

Lesson Learned: When performing financial analysis of a Product Support Enterprise (PSE), warranty is an OEM’s cost incurred by the PSE, always validate the results by employing a secondary calculation for at least a selected group of costs that are material….a bit more work, but important in delivering accurate results.

Saving on COTS Parts – The Airline Industry’s Secret

Jul 14
2010

There are many ways to reduce the unit cost of parts employed in the Product Support Enterprise (PSE). Each industry sector end-users take a different approach at parts cost control, based upon the materiality of parts relative to overall costs. The airline industry is one sector that has identified parts as a major cost, specifically for jet engine Product Support; from parts employed in the organizational/line maintenance level process, to the overhaul process to the modification process.

An airline’s jet engine PSE can take the following steps at controlling the cost of parts:

  1. Acquire surplus new-condition parts directly from other airlines; bundled package of parts at large discount from list price
  2. Acquire not-new-condition parts from distributors: overhauled/ remanufactured, repaired and certified/as-is
  3. Acquire reversed engineered manufactured parts that are like-kind to that of original manufacturers; the FAA provides the manufacturers of these parts a Parts Manufacturer Authorization (PMA) in order to sell these parts
  4. Acquire and disassemble not-new-condition products for parts, also known as cannibalization
  5. Acquire new and not-new condition piece parts that are employed in a LRU and assemble LRU
  6. Develop multi-user LRU exchange pool with several user of same product; decrease depreciation of reparable LRUs

Aggressively finding ways to reduce parts cost can pay large dividends in reducing the Total Ownership Cost (TOC) of a product. Check out this Aviation Week story that touches on many of the points above.

OEM PSE Profits -The Secret The Industry Doesn’t Know About

Jul 06
2010

Commercial OEMs create from 15% to 40% of their profits as a result of the revenues generated from each Product Support Enterprise (PSE) that employs their product. A PSE engages all the processes employed by a product end-user to: meet materiel availability levels, increase maintainability, assure capability, grow reliability, improve deployability and decrease costs. The remainder of an OEM’s profits is primarily derived from the sale of new-condition products, with the exception being those OEMs that have a financial arm.

When I have had nothing to do at 0400 on a Sunday morning, I have used that time “wisely” to dig into the Quarterly (10Q) or Annual (10K) Security and Exchange Commission (SEC) financial reports of capital goods OEMs in order to better understand the financial impact of PSEs upon their balance sheet….but I have been highly “disappointed” when virtually no information could be found to satisfy this longing of mine! I have reviewed close to 200 OEMs and I have developed a list below of only 13 OEMs who are willing to acknowledge, in even a minor detail, the existence of investments employed in PSEs.

When an OEM truly believes that being proactively engaged in PSEs is material to their financial health they often segment their balance sheet investments employed for PSEs. Note that for some OEMs, creating opaqueness in being engaged with PSEs is by design; they often do not want to indicate to their competitors that their business model is more like the razor-and-razorblade then one that focuses on the sale of the razor…but that is another story.

# OEM or Key Supplier Sector Financial Statement Description
1 AGCO Farm Balance Sheet: Current Assets Repair and Replacement Parts
2 NCR Office Balance Sheet: Current Assets Service Parts
3 Pitney Bowes Office Balance Sheet: Current Assets Supplies and Service Parts
4 Cognex Mfg. Automation Balance sheet: Long-term Assets Service Inventory
5 Ciena Data/Voice/Network Balance sheet: Long-term Assets Maintenance Spares Inventories
6 Diebold Specialty Balance Sheet: Current Assets Service Parts
Balance sheet: Long-term Assets Rotable Parts
7 KLA-Telcor Mfg. Semiconductor Balance Sheet: Current Assets Customer Service Parts
8 Rofin-Sinar Technologies Mfg. Automation Balance Sheet: Current Assets Service Parts
9 Faro Technologies Mfg. Automation Balance sheet: Long-term Assets Service Inventory
10 PAR Technologies Transactions Balance Sheet: Current Assets Service Parts
11 Terex Construction Balance Sheet: Current Assets Replacement Parts
12 Applied Materials Mfg. Semiconductor Balance Sheet: Current Assets Customer Service Spares
13 Wabash National Transportation: Trucks/Engines Balance Sheet: Current Assets Aftermarket Parts

Will the DoD Ever Manage Parts More Efficiently?

Jun 27
2010

The estimated current inventory investment by DoD for the organizational level parts employed during the Product Support processes of correct/prevent unplanned weapon system failure is $40 billion. An estimated 35%-50% of this investment is materially excess or obsolete (will never be used). Another issue is that the financial accounting accuracy of these parts would never meet the “smell test” by any private sector auditing firm; people would go to jail for this type of accounting…but that is another story.

GAO has had many studies dealing with the efficiency and effectiveness of the management of parts by the Services; none have been very flattering: Study 1, Study 2, Study 3

DoD accountants are not “bad people;” they do the best with the procedures provided to them. The real issue is that DoD, nor the Federal Government, develops a balance sheet that has any merit; politicians like it that way because accountability for “mistakes” can often be hidden from view…nothing better for a politician than to be opaque!

As more and more parts are COTS, and CLS, coupled with PBL/Outcome-Based Product Support constructs become more common, some of these inventory investment issues will become less glaring.

The Dark Side of Remanufacturing

Jun 23
2010

The Product Support process of remanufacturing can be employed for good…or for evil. Remanufacturing is a process that extends the economic life of a used-condition system by: growing its reliability, evolving its technology, assuring its design capability and improving the efficiency of Product Support processes employed.

Many firms acquire used systems and induct them into a remanufacturing process that delivers a product that has many of the attributes of a new system, but at 50% to 70% of the price; the customer wins and the entrepreneur wins by taking an “ugly duckling” and making an attractive profit from the make-over.

But there is one organization that can view remanufacturing unfavorably; OEMs who believe that the remanufactured product has “stolen” sales from their new-condition products. One approach an OEM could take is to begin a remanufacturing business and at least grab some of the used product market…but an “evil” approach would be to purchase as much used products as possible and then destroy the products so they could never be remanufactured…forcing customers to buy the OEM’s new-condition products.

One of America’s business leader icons, Thomas Watson, Sr., founder of IBM, used exactly this “evil” practice and was found guilty of anticompetitive practices. In 1903 Watson, working for National Cash Register (NCR) created a bogus firm to monopolize the used cash register business and systemically destroyed the machines, thus driving increased demand for new-condition cash registers.   

The above event and much more about Thomas Watson can be found in the book, “The Maverick and His Machine: Thomas Watson Sr., and the Making of IBM”.

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