By Michael Biorn
This information is based on my personal experience as well as extensive work from a multitude of senior subject matter experts within the global aerospace defense community. This discussion focuses on the structure of Performance-Based Logistics (PBL) contracts as well as best practices garnered from both government and commercial sources.
Given limited budget constraints, cost saving measures for defense systems are critical to ensure the best value for money over the entire 30-plus year life cycle of today’s major defense systems. For military aircraft, about 30% of Life Cycle Costs (LCC) are attributed to acquisition. The remaining 70% is dedicated to Operation and Support costs to operate, maintain, and manage the system. For years, military services (referred to as Services) focused on acquisition, leaving logistic through life sustenance as an ancillary issue causing negative trickle-down effects on the resulting LCC. PBLs have since emerged, with strong empirical evidence and analytical support, as a relevant product support strategy to achieve high levels of combat readiness at significantly reduced cost.
As noted across PBL literature, PBLs fundamentally are intended to change the behavior of participating entities—both government and contractor. Adjusting the figurative rheostat of risk and reward, along with aligning desired outcomes, leads to a partnership rather than a purely transactional relationship. In practice, this results in proactive problem prevention rather than reactive problem solving. The PBL structure provides the framework, latitude and incentive for such improvement.
A typical example would be an Original Equipment Manufacturer (OEM) entering a PBL with sufficient length to allow analysis to show that redesigning a part will result in some combination of benefits to reliability, maintainability, cost, etc. Instead of approaching the Service for an unexpected, transactional request for additional funding to redesign the part, the OEM simply makes the investment and implements the change, then both begin reaping benefits. Normally, the warfighter recognizes a performance benefit while the OEM seeks to recoup the initial investment via a sufficiently long contract period of performance to garner anticipated savings. The Service is left to focus on mission accomplishment while the OEM focuses on areas where their expertise provides the greatest benefit.
Writing for the U.S. Defense Logistics Agency, researchers at the U.S. think tank the Center for Strategic and International Studies (CSIS) described five areas where PBLs are best suited. Those areas include poor performing programs, sole-source environments, commercially sourced programs, highly complex systems, and small fleets. It is noteworthy that in a sole-source sustainment arena, where a Service might find itself after a down-select, PBLs can artificially create the benefits of competition. Competitions are designed to “reduce costs and improve performance… PBLs not only provide powerful incentives, but also powerful tools… towards reducing cost and improving performance.”
PBL Contract Structures
There is no one-size-fits-all PBL approach, each must be tailored to the specific sovereign requirements of the Service. As shown in Figure 1, there are several general types of PBL contract structures available, each of which will include more or less scope as determined by the Service. Ultimately, each Service must select its own balance of sovereign expertise aligned with some reliance on contractor support.
Distribution Performance
This structure is normally used by a Service when sovereign management or repair of most weapon system components and processes are performed within their respective defense department. While the arrangement may also include augmented contractor repair and return capabilities of selected parts, the focus is on-time delivery of parts. Product Support Provider (PSP) responsibility normally consists of ensuring that parts are delivered from repair sources to the point of need.
Logistics Performance
In a Logistics Performance PBL construct, PSPs have delegated responsibilities focused on providing a specified level of spare parts availability. Typical metrics could include Gross Issue Effectiveness (GIE) and/or Supply Response Time (SRT). GIE measures the effectiveness of the local warehouse stock to fill local demands and reflects the PSPs ability to forecast demands and manage available stock. SRT measures the PSPs ability to provide, transport and deliver parts to an agreed upon location within the specified timeframe. This structure may also contain additional PSP support for logistics planning, sustaining engineering, and/or reliability improvements for selected components.
Weapon System Performance
This type of contract structure places additional risk and responsibilities on the contractor. As such, this PBL construct is best for supporting mature systems with significant technical performance, reliability, and maintainability data. This enables the contractor to make informed decisions with high degrees of confidence that the proposed actions will produce the desired results. Also, this structure is most effective when the PSP was the primary Original Equipment Manufacturer (OEM) charged with the initial design, production, and fielding of the aircraft. While the delivery of logistics products and services is provided by the contractor, the Service still retains overall sovereignty of the system.
Air System Performance
Similar to a Weapon System PBL, this structure simply adds more contractor-delivered support services. Not only will contractors deliver aircraft product support, but this structure expands it to include up to the full air system: aircraft, training, support equipment, computer systems, etc. As in the Weapon System construct, the Service determines the specific PSP responsibilities and retains overall sovereignty of the system; however, in order to achieve desired metrics, the Service may need to share more operational information than is normally provided. When properly constructed, this approach can provide Services with a guaranteed level of support and more opportunities to reduce LCC over the term of the contract.
PBL Contract Types
PBL contracts typically use one of two major contract fee structures: Fixed Price Incentive Fee (FPIF) or Firm Fixed Price (FFP).
- FPIF provides a fixed fee for the contract products/services along with incentives which enable PSPs to collect additional income if specific milestones (cost, schedule, or performance) are achieved in a given award period. The better they perform, the greater their opportunity for increased income/profit. This approach can allow the government to share in the benefit but also reduces latitude for PSPs to invest in change.
- FFP is normally used for PBL support, especially when system parameters are well understood. Available empirical data enables PSPs to forecast requirements and outcomes with a high degree of confidence. Services typically prefer FFP contracts; this structure provides for a specific level of product support at a known price for the duration of the contract period.
While incentives are discussed below, it is also important to note that contract type is often an incentive as well. As an OEM enters an FFP PBL contract, performance risk associated with an agreed warfighter outcome metric(s) is transferred relative to the level of performance discussed above. If OEM estimates or analysis are incorrect, the higher costs drive down predicted profit. However, if the OEM program management team can, through innovation, investment and procedural improvement, exceed estimates, the OEM can realize higher than predicted profit.
Thus, an FFP PBL arrangement becomes a macro approach to create microcosms of innovation to identify where the return on investment in individual and aggregate improvements create better outcomes for the warfighter and the contractor. A PBL creates a harmonious partnership, rather than just a transactional relationship.
PBL Incentives
When considering strategies for the effective use of PBL, it is important to consider the range of incentives that these contracts provide and how they can be used to align the interests of both the Service and the contractor. Incentive discussions often include at least three main categories: time, cost and scope.
Addressing scope first, CSIS further noted, “in a PBL arrangement, contract scope acts as an incentive to the contractor … a greater scope provides the contractor with increased revenue … but it also determines how much opportunity the contractor has to achieve profit. The greater the contractor’s scope of activity, the more profit-generating efficiencies the contractor can” ultimately achieve. Essentially, the opportunities to implement improvements are finite for a given scope. However, positive PBL performance often allows a contractor to earn added scope over time, thus increasing the base over which to derive additional improvement opportunities resulting in a repetitive cycle of change benefitting both the Service and the contractor.
Improvements (reliability, performance, or cost) to complex defense systems require time to fully implement and become effective for the end users. A PBL construct requires a contract long enough to enable contractors to make investments and process changes, as well as the time to realize results from those initiatives. Without a contract term long enough to realize the benefits of various changes, the contractor has no incentive to invest in them. Establishing the right contract length for achieving a Service’s performance improvement objectives is a key element of an effective PBL strategy.
Thus, relative to time, contractors are incentivized by having “an appropriate length of the contract and opportunities to eventually extend the PBL arrangement.” In fact, further research has indicated the length of the contract may be the most powerful incentive and that PBLs generally result in satisfaction for both the Service and the contractor such that renewals and extensions are mutually desirable. Typically, 10 years is viewed as optimal for a PBL with 5 years being considered the minimum. Several countries have adopted PBL structures where a base period is awarded and extension intervals are subsequently awarded over time to ensure the Service has coverage for an appropriate, sovereign time horizon, while the OEM retains sufficient future certainty to retain the incentive to invest and improve. Various iterations are available with the objective of always creating Service and contractor assurances for the next five consecutive years at any given time.
PBL Best Practices
- Engage the OEM/Selected PSP Early – If engaged early enough in the process, OEM PSPs can influence design for reliability, maintainability, and supportability. The OEM is in a position to affect obsolescence or Diminishing Manufacturing Sources mitigation efforts. They also provide expertise to improve repair or maintenance processes based on product knowledge and experience.
- Clearly Defined Service Outcomes – Use measurable and manageable metrics which accurately represent Service needs.
- Incentives – Select incentives that promote behaviors and outcomes that benefit both the Service and PSP. Incentives should be directly tied to the achievement of outcomes within their scope of control.
- Contract Length – Sufficient time for the PSP to recoup investments required to improve performance or reduce LCC.
- Trust & Collaboration – Establish a collaborative business arrangement with trust between the Service and the PSP. Close and frequent communications between the Service and the PSP are imperative. The PSP should have verifiable experience and success with similar systems as well as significant existing global relationships with a proven history of successful product support.
- Senior Leadership As Champions – It is particularly important for Service leadership to create an environment that facilitates broadly implementing PBL solutions. This philosophy must flow down through the organization such that the Service and PSP are enabled to develop and execute performance-based solutions without undue oversight or review.
- Risk Management – Robust PBL solutions include a focus on total program risk reduction along with appropriate off-ramp exit criteria that are captured at the beginning. These programs balance risk with mitigation strategies accounting for all parties involved. PBL is about realigning incentives and reducing total program risk.
Summary
PBL contracts define the “what” outcomes a Service requires to meet their operational commitment and not a prescriptive “how to” used in traditional product support contracts. PBL contracts achieve outcomes through contract arrangements that deliver Service-defined requirements while incentivizing PSPs to reduce costs through innovation. PBL arrangements integrate the various product support activities (e.g., supply support, sustaining engineering, maintenance, etc.) of the supply chain with appropriate incentives and metrics.
Under a PBL contract, OEMs are responsible for performance well beyond a transactional environment and the structure of metrics and incentives, along with the associated negative results of unrealized incentives, provides the Service potent tools to hold OEMs accountable. In addition, PBLs focus on combining best practices of both the respective Service and the global aerospace defense industry and ultimately creating a truly symbiotic sustainment experience. When properly structured and managed, PBL product support contracts have proven successful in both reducing LCC while also improving system performance, reliability, and ultimately successful mission accomplishment.
About the author: Following 21 years of service in the US Air Force, Mike joined Lockheed Martin Aeronautics Company in 2014. He is the Director of Sustainment Campaigns for the Americas, Africa, Middle East and Indo-Pacific. Prior to his current role, he led the team executing Lockheed Martin’s long-term foundational F-16 sustainment contract, Falcon 2020, serving 20+ nations.
About The Author
Michael Biorn, Business Development Director – Sustainment, Lockheed Martin
