Ideas and Insights

This post is the second of ten entries that will discuss product support financial drivers for solutions supplied by a commercial or military focused capital good Product Support Enterprise [PSE]. The 10 topics that will be discussed are the following:

1. # of products employed by end-users
2. End-user product utilization rate
3. Product failure
4. Environment in which end users engage the product
5. Preventive maintenance processes employed
6. Volatility of product technology
7. Regulatory requirements
8. Chronological age of the product installed base
9. Life cycle stage of the product
10. Manufacturer’s warranty coverage

The utilization rate of a product materially drives the financial impact of Product Support upon Total Ownership Cost [TOC]; an aircraft end-user that flies 500 hours/year will spend less on Product Support solutions than that of an aircraft end-user that flies 3,000 hours/year. The Product Support processes most impacted are correct/prevent unplanned failures and conformance to safety/regulatory requirements.

There are three primary ways in which a product’s utilization can be measured:

Period of use (i.e. 3 hours), frequency of use (i.e. 8 trips, 20 cycles), and output from use (i.e. 500 miles travelled, 1,000 pieces produced).

End user utilization rate for aircraft. Product support financial value drivers.

Choosing the appropriate utilization measurement can significantly impact the understanding of this key Product Support financial value driver. For example, if mileage is the only utilization measurement for a truck, and if the truck spends many hours idling, Product Support estimated costs based upon only mileage utilization may result in inaccurate forecasts; utilization measurement may sometimes require a blend of several factors.

The following four deployability types that can be employed to segment the planned utilization of a product, as well as be compared to a baseline utilization level:

1. Preparing for deployment (i.e. garrison training); 1.00=baseline
2. Non-deployable (i.e. schoolhouse training); ~1.25 of baseline
3. Deployed (i.e. combat, humanitarian); ~2.00 of baseline
4. Stored for future deployment (i.e. advanced deployed); ~.05 of baseline

Recently I delivered a weapons system Product Support Business Case Analysis [BCA] to a TACOM lifecycle management command program office in which the products were to be employed in all of the four above deployability types. The product studied was to be fielded over a 6 year period, but the distribution of the product’s deployability types had yet to be decided, but regardless, I had to estimate the impact of Product Support upon TOC in order to deliver my Business Case Analysis.

EOD team and product support

Given several known and unknown factors, I applied the following distribution of the products to be fielded for each period that a product was in-service: 70% preparing for deployment, 10% non-deployable, 15% deployed and 5% stored for future deployment. Using the variance factors from the baseline, the utilization of all the fielded products from the baseline was calculated as 1.15= [(70%*1.00) + (10%*1.25) + (15%*2.00) + (5%*.05)]. This weighted cost factor was applied to all processes that were driven by product utilization. For example, if the utilization baseline was 1,000 hours year, then a 1.15 weight factor would drive the annual utilization rate for each fielded product to be 1,150 hours.

Knowing that the Mean Time Between Failure [MTBF] was 2,000 hours and the weighted utilization was 1,150 hours/year and that the average cost of a repair was $2,000, I could estimate that the annual Product Support cost for the correct-failure Product Support process per fielded product was $2,875= [(1,150hrs/2,000hrs)*$5,000]. This was a simplified calculation, but it provides an overview of how utilization impacts Product Support costs.

Hypatia©, a Giuntini & Company financial software tool, provides a highly automated means of calculating the above and other product support financial value drivers, as well as an effortless way of being able to change any utilization assumption and immediately understand its impact upon total ownership costs.

This post is the first of ten entries that will discuss product support financial drivers for solutions supplied by a commercial or military focused capital good Product Support Enterprise [PSE]. The 10 topics that will be discussed are the following:

1. # of products employed by end-users
2. End-user product utilization rate
3. Product failure
4. Environment in which end users engage the product
5. Preventive maintenance processes employed
6. Volatility of product technology
7. Regulatory requirements
8. Chronological age of the product installed base
9. Life cycle stage of the product
10. Manufacturer’s warranty coverage

The first financial value driver – the number of products that are in the hands of the end-user – is THE biggest driver of all. Put simply, the more products delivered to end-users, the more Product Support required. It is always surprising to me that OEMs often do not know the quantity of their products that are in the hands of end-users. Almost all OEMs are focused upon production, but few are focused upon Product Support solutions.

number of products employed is the most important part of a product support enterprise

Working recently with one construction equipment OEM, I sat down with their leadership to discuss areas of revenue/profit opportunities in Product Support. Leadership was gloating that Product Support revenue had been increasing at 15%/year for the last 4 years. I asked them how much was their installed base changing for their products, but they couldn’t answer my question. So, I asked them to give me their warranty files and I did a quick and dirty analysis and I found that their installed base was growing at a 25%/year rate. When I plotted the results and told them that they had foregone 40% of the potential Product Support revenue, they were crushed…but I got them to be angry at themselves for not seeing all the money that were leaving on the table, and the OEM became much more proactive in assuring that they got “their fair share” of revenues generated from solutions delivered by a PSE.

To give some OEMs slack, they often employ authorized distributors to sell their products directly or indirectly to end-user; the OEMs don’t know when their products are actually sold and to whom.

Lesson learned: OEMs must know the current and future size of their installed base in order to develop a Product Support life cycle financial plan…and as a result of not knowing the size of their installed product based, especially for out-of-production product lines, the typical OEM captures only an estimated 15% of the value of all the solutions supplied by a PSE.

The next product support financial value driver entry coming in a few days.

Learn how to maximize your profits using Hypatia financial cost analysis forecasting software from Giuntini & Co. 

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

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.

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…

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.