Product Support Financial Value Drivers. 7/10 – Regulatory Requirements

Nov 27
2012

This post is the seventh of ten entries that will discuss product support financial value 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

As nations become wealthier, there is a drive to mitigate the risks of occurrence of the events that unfavorably impact society – think auto safety, hazardous materials disposition, and many others. As a result, many regulatory actions have been employed by nations and local legislatures. These regulations have had a significant impact upon Product Support financial value driver results.

Product support financial value drivers – regulatory requirements

Let’s start with safety concerns. All industries have regulations that require certain Product Support processes to be employed that either protects the users of equipment, or the outputs of the equipment. Transportation equipment has as extensive amount of time/use/condition based preventive maintenance tasks to avoid any unplanned failure. From brake overhauls for trains, to flight control actuator overhauls for aircraft, very specific maintenance tasks must be performed throughout the life of the equipment; in most cases the ability to operate a piece of equipment requires that the OEM has obtained approval by a regulatory body for a detailed preventive maintenance schedule. These requirements can often drive 20-40% of the Product Support life cycle costs.

Another area of regulation driving costs is one that continues to expand every year; maintenance activities that avoid unfavorable environmental events. For example, the preventive overhaul of a valve in order to avoid failure resulting in a hazardous material spill, or the inspection of a structure for corrosion that could result in equipment releasing toxic fumes into the atmosphere. This area is specifically costly in the process industries of chemicals, oil and power generation.

In certain cases, regulatory requirements have a strange impact on Product Support costs. A case in point is in Japan and the insurance of automobiles where in order to generate demand for new cars, the Japanese government has mandated that insurance rates increase based upon the age of a vehicle. Upon a car approaching 10 years old, the insurance rates are so high that it “pays”  to get rid of the car (they leave Japan for  less developed countries) and purchase a new car. This regulation has a major impact upon the Product Support financial value driver solutions for older vehicles; there is none!

Recent changes to the fuels employed to operate equipment has created unintended impacts upon Product Support maintenance; some have decreased the frequency of unplanned failures, but others have significantly changed the frequency of preventive maintenance tasks; think bio-fuels for commercial truck engines.

The disposition of Product Support parts that are deemed hazardous materials can also increase costs; sometimes the cost of disposition is more expensive than the acquisition of the part. This is often true of certain consumables such of filters, lubricants, and others.

Product support financial value drivers – regulatory requirements

One of the Product Support financial value cost challenges is that there are many different regulations throughout the globe requiring different Product Support processes to be employed. For many global organizations, where equipment is transported to many sites, think oil drilling equipment, Product Support processes are often employed that meet the most demanding regulations of any nation that the equipment can be employed. This is done in order to be flexible in aligning demand and supply of equipment on a global basis. For example if ExxonMobil has to move equipment from Nigeria to the USA, even though Nigeria may have less demanding Product Support regulations, the Nigerian equipment is maintained to USA standards so that if demand shifts to the USA, the equipment doesn’t have to be reset to use in the USA.

All the above cases of regulatory requirements are always driven by optimizing equipment cost and minimizing its unfavorable impacts on society. Product Support costs, which constitute the plurality of Total Ownership Costs for most equipment types, will remain a primary “victim” of many of these regulations.

Product Support life cycle financial planning must include scenario-based tools that can analyze the impact of different regulatory changes upon the short-term and long-term TOC.

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. Hypatia is also a proven, trusted and highly effective tool for assisting in the development of product support business case analysis.

Product Support Financial Value Drivers. 3/10 – Product Failure

Oct 11
2012

This post is the third of ten entries that will discuss product support financial value 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

Product Support Value Drivers – Product Failure Physics Envy

This area is one of the most “abused” areas in Product Support life cycle financial planning. Operation Research [OR] analysts, design engineers and logistics professionals have what is affectionately called “physics envy” when it comes to estimating the product failure rates of end-items and their components. The elite group of professionals in the business of predicting product failures tend to have a universally low success rate…

The marketplace has defined the acceptable average level of unplanned failures for a capital good/end-item at about once every 5-7 years. This product failure rate is applicable primarily for Commercial Off The Shelf [COTS] items, with Developmental/Design-To-Order items incurring product failure rates anywhere from 50-100% higher than that of COTS items.

The source of the aforementioned failure data is the Security Exchange Commission [SEC] mandatory filings by OEMs detailing their actual expenses incurred to support their warranty programs. There is over 10 years of reliability/failure rate data sets. Note that product failure rates have dropped by almost 50% over this 10+ year period. Why the “failure analysis” community does not employ this treasure trove of data in all their cost calculations is always amazing to me.

Product Support Value Drivers – Product Failure

Recently Giuntini & Co. developed a scenario-based Product Support life cycle financial plan that included the target cost for the correct-failure process throughout the twenty life of a product. We employed a series of SEC filing data sets and estimated $10 million per year in costs associated with the correct-failure process for an installed base of $200 million end-items. We also employed another method to calculate the cost and it still resulted in approximately the same number.

Product Support Value Drivers – Product Failure

While we had been calculating the correct-failure process costs, a team of OR brains were also calculating the same cost; we were both aware that we were working to the same goal. We both agreed to compare our estimated costs and there was a 4-fold difference in our costs; the OR guys were the higher number. After I examined their methodology, which was quite eloquent, I must say (disclosure; I once was an OR geek myself), I found their results to be totally bogus.

If the higher product failure rates were to have occurred, the product would never have been acquired by any end-user. Our common client accepted the Giuntini & Co. cost estimate as the one to be included in his Total Ownership Cost [TOC] calculation. To this day the OR brains have remained convinced that their methodology was the right way to go, even after being proven decidedly inaccurate.

Lesson learned – be extremely careful of ”physics envy” professionals providing you with product failure rate estimates. There is a high probably that they are materially off from the real world and if you accept their costs without an alternative opinion, you have only yourself to blame when an estimated TOC is way, way off.

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.

Product Support Business Case Analysis [BCA]: Fast, Accurate, Proven Results Employing The Hypatia© Scenario-Based Product Support Life Cycle Financial Planning Software Tool

Oct 01
2012

Product Support Business Case Analysis for MRAP

A Product Support Business Case Analysis [BCA] study is employed by the Program Manager [PM] Office of a Program Executive Office [PEO] of a Life Cycle Management Command [LCMC] in their Milestone Weapon System Acquisition review. The Product Support BCA study applies a disciplined methodology for recommending the best solutions for efficiently and effectively managing the processes employed by a Product Support Enterprise [PSE] during the in-service life and End-Of-Life [EOL] of a weapon system. The Product Support BCA output is a major input to the Life Cycle Sustainment Plan [LCSP] that is delivered by the Product Support Manager/Integrated Logistics Support Manager of the Program Office. Giuntini & Company, Inc. [GCI] has successfully performed five Product Support BCAs for the CECOM LCMC and the TACOM LCMC.

As a result of the experience above, GCI has developed a listing below of the varied elements required as inputs to the BCA.

Item #

BCA elements

1

# of end-items to be fielded

2

# of end-users

3

Deployability status of end-users

4

Global location of end-users

5

Product Support processes employed during life cycle

6

Product Support process frequency

7

Product Support process duration

8

Business model of each Product Support solution delivered by the PSE

9

Volatility of product technology/DMSMS issues

10

Regulatory requirements

11

Aging of the fielded end-items

12

Life of the product in DoD inventory

13

Manufacturer’s warranty coverage

14

Item design source/IP ownership/TDP

15

Materiel Availability [Am] requirements of end-user

16

“Jointness” of solution with multiple end-users

17

Business model elements for each Product Support solution

18

BOM levels employed

19

BOM variations

20

BOM level capabilities

21

End-item on-site maintenance strategy

22

End-item off-site maintenance strategy

23

BOM item costs

24

LRU renewal cost

25

Current/constant $$

26

Continuous Process Improvement [CPI] initiatives

27

Level of BOM in which Government owns IP

28

Employment of PSM/PSI PSE construct

29

Employment of ARFORGEN reset/reconstitute Product Support process

30

Funding sources included in analysis

31

Reparable parts Beyond Economic Repair [BER]/washout rate

32

Others

Product Support Business Case Analysis using Hypatia Tool

With over 35 years of data collection and development, GCI has created a software tool that encompasses all the above elements to create the outputs of a BCA study; it is called “Hypatia: A Scenario-Based, Product Support Life Cycle Financial Planning Software Tool.” Hypatia has enabled GCI to reduce the time to complete a Product Support BCA by 30%, and in turn has been able to reduce the cost of the study by the same amount. Another benefit of Hypatia has been its ability to deliver target life cycle Product Support costs that have been considered reasonably accurate by the recipients of the study. Traditional Product Support cost estimating tools such as COMPASS  are often inadequate to be employed in a BCA.

If you are interested in discussing how our proven Hypatia tool can be employed in your Product Support BCA study initiative, both for new programs and legacy programs, call a Giuntini & Co. SME at 570-713-4795 or visit us at www.giuntinicompany.com.

Fake COTS Products

Aug 16
2010

An area that has experienced greater scrutiny since the advent of global terrorism has been the infiltration of fake and stolen COTS products into the supply chain. This initiative by terrorists has had three primary drivers:

  1. An “easy” way to generate large profits from an illicit enterprise in order to fund terrorist activities against US Warfighters and others
  2. The deployment of sub-quality products into the supply plain in order to cause business disruptions and economic harm to US firms
  3. The erosion of the value of brands and in turn the value of Intellectual Property (IP) rights; this can undermine the foundation of Western capitalism…but that is for another blog

The Organization for Economic Cooperation and Development estimates that 5-10% of world trade employs fake or stolen products. This is a serious problem that provides almost a limitless source of funds to terrorists, besides that of illegal drugs.

The Government and/or its contractors pay the following price for the need to secure the COTS product supply chain:

  • Higher insurance costs to mitigate the risks of “being stuck” with fake products or experience the thief of their product
  • Higher costs for the security of goods while in storage
  • Liabilities for branded products that fail and cause harm
  • Higher warranty expenditures for fakes
  • Overhead costs for providing surveillance of employee: espionage, bribery and theft
  • Authentication efforts to be able to validate the source of goods
  • Legal expenses to pursue wrongdoers

As COTS products continue to increase their presence in weapon systems, the above issues will have to be addressed by the Government and its contractors.

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.

The “Miracle” of COTS Products

Jul 09
2010

The Department Of Defense and its research organizations have always been touted as working on the “bleeding edge” of a multiple array of technologies. This is often true, leading to more effective (i.e. lethal) mission capabilities, but rarely are these initiatives more efficient (i.e. cost per outcome) in completing a mission.  See Undersecretary Carter’s comments regarding this issue here.

When we move to the COTS product world, the employment of COTS products in the processes of everyday life has resulted in both improvements in effectiveness and efficiency. In a recent article in the Journal of the American Enterprise Institute,  a striking comparison of what could be purchased in 1964 and today with the same purchasing power (price as a % of average salary) was illustrated below based upon an average one month salary.

1964:
 A moderately priced Radio Shack stereo system.

2010:
Panasonic Home Theater System, Insignia 50″ Plasma HDTV, Apple 8GB iPod Touch, Sony 3D Blu-ray Disc Player, Sony 300-CD Changer, Garmin Portable GPS, Sony 14.1-Megapixel Digital Camera, Dell Inspiron Laptop Computer, TiVo High-Definition Digital Video Recorder.

Also note that a personal computer in 1978, the Radio Shack Model 1, with 4K of RAM, a tape recorder as a data storage device, a green screen and little application software cost $600, or equivalent to about $3,000 today.

The above are stunning testimonials as to the value of COTS products and the inevitable greater and greater employment by DoD. Though our enemies have the same access to COTS products, it is the Acquisition corps that has to use their prowess at COTS product integration in developing solutions for the Warfighter. The US is second to none when it comes to integration and our enemies will never be able to duplicate our COTS products integration efforts resulting in our remaining the most efficient and effective military force of all time .

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

The COTS Wagon Keeps On Rolling…But Is Anyone Watching?

Jul 02
2010

It is inevitable that the Services Acquisition Commands continue to focus on employing COTS products in the design of their new weapons systems and key infrastructure; this is aligned with the focus of Secretary Gates and Undersecretary Carter to reduce costs, but retain the military’s effectiveness.

Below are two recent acquisition initiatives at employing COTS products. I know of no DoD study that annually measuring the COTS content of new weapon systems…if there is none, one should be started.

1. The U.S. Navy’s Space and Naval Warfare Systems Command (SPAWAR) is placing orders under the Common Afloat Local Area Network Infrastructure (CALI). Under the CALI contracts, contractors will provide ships and submarines with Common Computing Environment (CCE) Components, Integrated Logistics Support (ILS), Configuration Management (CM), Test and Evaluation (T&E), Quality Assurance (QA), and Installation Support. Each contractor will deliver a secure, commercial-off-the-shelf (COTS) hardware, software and networking equipment. Each CALI contract has a total potential value of $502 million if all options are exercised. 

2. The Air Force is working on the Common Large Area Display Set (CLADS) acquisition program to replace aging CRTs in the Airborne Warning   And Control System (AWACS) aircraft with one of three flat-screen technologies: active matrix LCD (AMLCD), gas plasma, or a digital micro-mirror device. “The heart and soul of this is COTS, with some heavy ruggedization to operate under depressurization. The prices we`re seeing coming in the door are a third of what the old technology stuff now costs,” Bill Sirmon, a civilian contract negotiator at the Warner Robins Air Logistics Center at Robins Air Force Base, Ga. Aboard the AWACS now are CRTs that operate for about 300 hours between failures; the new products are planned to increase that operating time to 3,000 to 5,000 hours between failures.

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