Performance Based Logistics, Rolls Royce and Power by The Hour

Table of Contents: Select a Link to be Taken to That Section

Executive Summary

What is Performance Based Logistics?
We cover why Performance Based Logistics is unlikely to happen based on the entities involved’ institutional incentives and orientations.

Introduction

Performance Based Logistics (PBL) is a much-discussed concept in the military and among defense contractors. We will discuss a range of issues with PBL, from its trend to an example of it in the Rolls-Royce Power by the hour program. However, this post questions whether it is an authentic pattern based upon the military’s incentive structures and their suppliers.

However, this post questions whether it is an authentic trend based upon the military’s incentive structures and their suppliers.

Performance-Based Logistics as a Trend

PBL has become a strong trend among companies’ management classes in the A&D Environment Performance Based Logistics. Performance-based logistics builds upon a kernel of truth that may or may not spread from management conferences. This article discusses PBL and makes some educated guesses about where Performance Based Logistics might be in 5 years from now.

Performance Based Logistics is often introduced to improve service levels and increase the responsibilities of supplier service parts management and, in some cases, service part service operations. In this way, it may be viewed as a form of outsourcing where the part planning and management are moved from the client to the suppliers. In cases where the military is the customer, it can be seen as a light form of military privatization.

Supporting Case Studies

The excellent case study for Performance Based Logistics in the A&D environment is Rolls Royce. While not called “PBL,” Rolls’ TotalCare engine service program is a long-term service contract where Rolls controls the engine service parts inventory. And, in a way, goes beyond Performance Based Logistics by offering direct guidance and instruction when certain parts are due for maintenance. Rolls actively monitor over 3000 engines aggregating a healthy level of service intelligence about engine maintenance. Rolls have, by most accounts, leveraged this capability to grow its market share, take business from larger competitors, and reinforce the premium reputation of its industry-leading engines.

Deviations Between the Strong Case Study and Other Projects Performance Based Logistics Clients and Environments

It would be a mistake to assume that Rolls’ success can be duplicated to every A&D supplier or can be generalized to other areas outside of engines. However, this is a common oversimplification and mistake made by the business press. By comparison, there were distinct organizational differences between Toyota and US manufacturing firms. The geographic differences between the suppliers that make up the supply base in Japan vs. the US prevented other companies from ever duplicating Toyota’s success with JIT, regardless of decades of attempts across thousands of factories. (Secondly, many of the concepts of Japanese manufacturing were not explained to US executives as they would have been unappealing to them, which is described in this post)

This means that the case for PBL with Rolls must be observed regarding how Rolls as a company and Rolls business is different from other companies that want to implement PBL type programs.

Some of the differences are listed below:

Rolls are only managing a small proportion of the overall service parts of an airplane. They are providing 100% of the parts for the  engines under the TotalCare program. This means that a 95% availability does mean a 95% availability for the engine as  there are no other suppliers. However, this is not true with companies  that provide the entire airplane. Therefore it must be considered that Rolls is solving a much simpler problem than a supplier that  supplies the whole aircraft would be.
Rolls appear to be on the outer edge of competence within the  industry. Secondly, this is not a new philosophy for Rolls. Their  “Power by the Hour” program, which is substantially similar to the  TotalCare program, dates back to the 1930s. This means that  Rolls has been organizationally oriented towards service for  generations. (This has also been known about in the industry for ages, so attempts to present it as something new are missing the historical facts.) The competence in this are is not necessarily distributed across other A&D suppliers.

The Cultural and Business Model Changes Required

We have found several articles on how well this new concept fits into the existing culture of A&D suppliers. The consensus is that a great deal of cultural change will be required to move A&D providers to a PBL environment. However, less discussed is how PBL fits into A&D, and particularly defense contractor’s business models. There is probably a good reason for this. The reality of the security service parts business model would not be popular if it were known. Enough documentation is available to demonstrate an intense and lengthy line of continuity in service parts pricing.

How The Government is Price Gouged

Service parts are priced at the beginning of the program, and in subsequent years the service parts rise terrifically. This applies to so-called unique elements but is also true of what appear to be commodity items. Many of the oversight bodies for regulating component increases were removed in the past six years in particular but have been even before then as the public furor over military contracting overcharging died down from a decade and a half ago. Therefore, the part price escalation continues. This is how the industry has worked for many decades.

If this is a strategy of defense contractors and real evidence, it’s hard to see how they would want to move towards a performance-based logistics environment. The performance-based logistics contract would undoubtedly be for several years. If defense contractors intend to continue their price increases, the PBL would need to reflect that year-to-year increase. This would raise flags, so again it’s not something a defense contractor would want to do. The entire scenario is illogical.

The Actual Power Dynamic

There is a hidden assumption in the discussion of performance-based logistics about defense. It presumes the DLA (Defense Logistics Agency, which negotiates with suppliers) is very powerful vis-à-vis its suppliers. Indeed, as a monopsony (one buyer, many sellers), the DLA could be a powerful actor if it wanted to be. However, there is a good deal of evidence that it does not want to be. There are strong relationships between the DLA and the defense contractors. At the decision-making level, many of the DLA and, more broadly, the procurement decision-making apparatus in the armed forces look to defense contractors for their next job.

This results in the military being less willing to press their claims and hold defense contractors accountable. The evidence for this is the big year-to-year increases in service parts costs the military accepts, combined with the significant cost overruns in weapons systems they take. And the public policy they have for not going back to defense contractors and asking for refunds when parts break far before their stated expected lifetimes. If the military will not confront defense contractors on these more fundamental issues, it’s hard to see how they intend to punish the contractors for missing service level targets that are part of enforcing a PBL contract. However, this is the central thesis of PBL.

Coming Trends Limiting Performance Based Logistics’s Adoption for Defense

The US is at the high-end of a cyclical spending upswing due to a highly pro-military administration and a war with two countries. However, some bills are coming due for these wars that have not been fully funded.

There is significant evidence that veterans’ health care and long-term care have been substantially under-funded. Secondly, a large amount of equipment that is neither serviceable nor economically repairable has not been written off of the books. When these costs become apparent, the US military may move from strategy to having contractors provide “PBL” to continuing to do it themselves (to save money). An extended service contract is a luxury product; Rolls is considered an excellent provider of “PBL” type service, and however, it is also widely recognized as expensive. This is to say that the US military may move away from PBL when it has less money to spend.

For the reasons given above, PBL does not appear to be a trend with any staying power. The many articles on this topic are mainly a waste of time. Much of it has to do with consultants and executives publicly strutting and making self-importance statements about how they subscribe to this or that leading edge concept.

PBL and Alternatives

“Performance Based Logistics is a strategy for system support. Instead of goods and services a supplier is paid for a guaranteed level of performance and system capability. The supplier often has to guaranty the performance at lesser costs but has more control over all logistics elements. The performance is declared in Performance Based Agreements.”- Wikipedia

Performance-Based Logistics can be in the commercial area of A and D or the government/military. A quote from the 2006 Quadrennial Defense Review Report indicates the Department of Defense’s orientation regarding PBL.

“There is a growing and deep concern in the Department of Defense’s senior leadership and in the Congress about the acquisition processes. This lack of confidence results from an inability to determine accurately the true state of major acquisition programs when measured by cost, schedule and performance. The unpredictable nature of Defense programs can be traced to instabilities in the broader acquisition system. Fundamentally reshaping that system should make the state of the Department’s major acquisition programs more predictable and result in better stewardship of the U.S. tax dollar.”

PBL has become a strong trend among the management class of companies in the aerospace and defense environment. This paper discusses PBL and makes some educated guesses about where PBL might be in 5 years from now.

The Basis for Performance Based Logistics

PBL is introduced to improve service levels and increase the responsibilities of supplier service parts management and, in some cases, service part service operations. In this way, it may be viewed as a form of outsourcing where the part planning and management are moved from the client to the suppliers. In cases where the military is the customer, it can be seen as a light form of military privatization.

Supporting Case Studies

The excellent case study for PBL in the aerospace and defense environment is Rolls Royce and their Power by the Hour program. While not called “PBL,” Rolls’ TotalCare engine service program is a long-term service contract where Rolls controls the engine service parts inventory. And, in a way, goes beyond PBL by offering direct guidance and instruction when certain parts are due for maintenance. Rolls Royce actively monitors over 3000 engines aggregating a healthy level of service intelligence about engine maintenance. Rolls have, by most accounts, leveraged this capability to grow its market share, take business from larger competitors, and reinforce the premium reputation of its industry-leading engines. This is the basis for Rolls Royce’s power by the hour program.

Deviations Between the Strong Case Study and Other Projects PBL Clients and Environments

It would be a mistake to assume that Rolls’ success can be duplicated to every aerospace and defense supplier or can be generalized to other areas outside of engines.

By comparison, there were specific organizational differences between Toyota and US manufacturing firms and geographic differences between the location of supplier base in Japan vs. the US that prevented other companies from ever duplicating Toyota’s success with JIT, regardless of decades of attempts across probably thousands of factories. This means that the case for PBL with Rolls must be observed regarding how Rolls as a company and Rolls-Royce business is different from other companies that want to implement PBL type programs. Some of the differences are listed below:

Rolls Royce is only managing a small proportion of the overall service parts of an airplane. They are providing 100% of the parts for the engines under the TotalCare program. This means that a 95% availability does mean a 95% availability for the engine as there are no other suppliers. However, this is not true with companies that provide the entire airplane. Therefore it must be considered that Rolls is solving a much more straightforward problem than a supplier that supplies the whole plane would be.
Rolls appear to be on the outer edge of competence within the industry. Secondly, this is not a new philosophy for Rolls. Their “Power by the Hour” program, which is substantially similar to the TotalCare program, dates back to the 1930s. This means that Rolls has been organizationally oriented towards service for generations. This is not necessarily the case for other A&D suppliers.

Power by the Hour

Rolls Royce’s Power by the Hour program is where those that purchase Rolls Royce engines are said to pay only per hour of usage.

This Power by the Hour program puts the burden of service on the producer rather than the customer.
The Power by the Hour is one of the ways a manufacturer can show its faith in its product.
Power by the Hour is somewhat unique in that while there is much discussion about Power by the Hour, Power by the Hour does not have many other adopters of this strategy.

The Expertise Required

Developing a PBL contract requires more than the capability to run an advanced service parts planning system like MCA or Servigistics. It also requires a way to cost the PBL contract. This is so the firm can determine each contract’s profitability and can use this information to adjust future contracts. SAP Project Systems is SAP’s software solution to cost the transactions associated with a contract. The difficulty comes in trying the specific operation to the particular contract in question. To understand SAP Project Systems more, see this post.

References

On the lack of funding for the war

https://www.cfr.org/publication/13418/cq.html

On the need for procurement reform

https://www.pogo.org/p/defense/do-990920-reform.htm