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.

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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.

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 .

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.

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”.

The Frugal Engineering Paradigm Shift For Product Support

Jun 18
2010

Strategy + Business recently published an article on frugal engineering, discussing how providing new goods and services to “bottom of the pyramid” customers requires a radical rethinking of product development.

As the domestic economic growth of industrial nations remains at 0% to 3% over the long term due to demographic issues, OEMs will be more aggressive in seeking revenue growth opportunities in Developing Nations. The Developing Nations buyers of products cannot afford the sophisticated products that the Industrial Nations currently acquire, but they are beginning to be able to purchase “stripped down” products that cost 10-25% and perform 85% of the capabilities of that of a product sold by OEMs based in Industrial Nations. In order to develop products to meet this new demand, OEMs will have to focus upon “frugal engineering,” a design concept that develops a product that is simple, low-cost and delivers a highly focused solution that appeals to Developing Nation buyers.

A product that is frugally engineered will have a huge impact upon an OEM’s Product Support business strategy. Many of these products will be platforms in which as the end-users increase their economic prosperity, they will demand additional capabilities delivered as upgrades throughout the life of the product. Understanding Product Support lifecycle management will be critical for successfully deriving the profit margins required for the risk exposure in entering these markets.

US Second-To-None For Product Support Prowess

Jun 14
2010

Americans have been bombarded by the Main Stream Media (MSM) touting the demise of US manufacturing base, and in turn the demise of the demand for the resources (parts, maintainers, tech support, and others) employed during the processes of the Product Support stage of the lifecycle of a capital good….but the MSM is a foolish bunch that is clueless regarding our true manufacturing might, and in turn our true Product Support prowess which is second-to-none in the world and will remain so for the foreseeable future.

Here are some facts about the US manufacturing sector from a recent article from Barrons:

“The U.S. economy is the largest and most productive on the planet. With just 4.6% of the global population, the U.S. accounts for roughly one-quarter of global output, generating more output in a year than the next three largest economies (Japan, China and Germany) combined. America’s economy is three times the size of China’s; the per capita income of China is only about 10% of that of the U.S.

The United States is a manufacturing superpower; we’re still in the business of making stuff, despite incessant reports to the contrary. We shouldn’t equate the demise of Detroit with the death of U.S. manufacturing. The U.S. makes more goods in a year than any other country, although America’s share of global manufacturing output was roughly 17.5% in 2008, down from 22.4% in 1990 and about 20.5% in 1980.

Many U.S. manufacturers have held their own the past few decades, even in the face of stiff competition from Japan, Germany and China. China’s share of global manufacturing has increased sharply over the past decades, hitting 17.2% in 2008, close to the U.S. number. However, the Chinese figure includes mining and quarrying, and electricity, gas, and water supply, in addition to manufacturing, and most of China’s gains came at the expense of Japan, South Korea, Mexico and others — not the U.S.

The largest exporter in the world is neither Germany nor China. It’s the U.S., despite annual trade deficits and all the chatter about U.S. companies not making anything the world wants to buy.”

Product Support Supplier Buys An OEM

Jun 10
2010

In a twist to the normal M&A activity of the capital goods sector, a Product Support organization, Progress Rail Services (a Caterpillar subsidiary) is to acquire Electro-Motive Diesel (EMD), a locomotive OEM (formally owned by GM). This is a case where an independent Product Support organization became larger than the primary OEM in which its offerings were employed. This is a cautionary tale for OEMs who “don’t get” the importance of revenues and profits that can be generated from Product Support offerings; over time the OEM may end up missing out on where the “real” profits are found in Product Support.

The announcement can be found here.

Counterfeit COTS Parts

Jun 07
2010

With the advent of the increased employment of COTS parts in weapon systems, counterfeit commercial parts infiltrating its supply chain has become a concern for the US military community of Defense contractors, LCMCs, DLA and others. OEMs have historically struggled with the counterfeit issue due to IP concerns and its impact upon losing market share to the suppliers of counterfeit parts. For the military, the primary concern is its impact upon warfighter safety during a mission due to quality issues of the counterfeit part, as well as reliability issues resulting in decreased system availability due to higher failure rates of the counterfeit part. 

DoD is attempting to address the above issues through its Industrial Base Office. Thoughts?

http://www.bis.doc.gov/defenseindustrialbaseprograms/osies/defmarketresearchrpts/final_counterfeit_electronics_report.pdf

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