Product Support Financial Value Drivers. 2/10 – End User Product Utilization Rate.

Sep 24
2012

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.

 

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 .

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.

Outcome-Based Pricing Offerings, Industry Leaders Agree

Jun 03
2010

Traditional pricing models of cost-plus and transaction-based for system/equipment product support offerings are changing today. This is being driven by end-users wanting to materially shift their risk of unfavorable availability, reliability and Total Ownership Cost (TOC) to their suppliers. This new pricing model is referred to as outcome-based. It can be quite profitable for a supplier, if the operational aspects are managed well, as well as be highly advantageous to maintenance organization…or it can generate significant levels of red ink if the supplier doesn’t do its homework, and the maintenance organization’s operations may become less effective. These pricing programs can be offered in the following packages:

  • Fixed price per unit of system/equipment output (i.e. Power By The Hour; customer doesn’t pay for reliability problems)
  • Fixed price for a period (i.e. extended warranty; customer doesn’t pay for reliability problems)
  • Fixed price for performance (i.e. pay for uptime; customer doesn’t pay for reliability, nor for materiel availability problems)

The above presents revenue recognition issues and cost accrual challenges for the finance organization of the supplier providing the above offering; the financial analysis should be done by a managerial accountant and not a financial accountant; from my experience financial accountants will often destroy an outcome-based pricing program due to their lack of the knowledge of the operational drivers for such a program.

Giuntini & Co. isn’t the only one to agree that these pricing models are the way of the future. Read further on the general subject matter related to pricing models from TATA Consulting’s website: http://www.tcs.com/offerings/platform_BPO/resources/Documents/Platform_BPO_White_Paper_Transaction_Based_Pricing_in_BPO_05_2010.pdf

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