Outsourcing E&M: the tricky issue of the contract April 2000

This article, the last in a series of three*, addresses perhaps the most difficult issue in outsourcing E&M — the contract. How should the contract be written to protect and encourage performance and service standards? What service levels should be included? Do incentives and penalties work?

These questions are not just valid in a real outsourcing arrangement. They also arise as airlines move their E&M functions to the profit centre and subsidiary organisation models. In these cases, the challenge of controlling, protecting and encouraging cost and service levels becomes even more difficult because the "walk–away" threat does not exist in reality (as compared to a real arms–length supplier contract). Additional thorny issues include: managing changes in fleet and the associated cost of divesting and/or building capability; the allocation of costs and responsibility for ramp damage, and the management of new aircraft during the warranty period.

Service levels

The prime rationale used not to outsource is "we can’t control service levels and look at the potential impact on operations". This raises two key issues. First, "Service Levels", the critical service level/performance standards that must be covered in an agreement. Second, "Contract Management", how the contract and supplier relationship should be managed in order to ensure that these service levels are delivered. "High–level" service levels are relatively obvious. For engine and component repair and overhaul, the critical measures are turn time, turn time reliability, and post–overhaul reliability. For engines, EGT margin is a well–established indicator of build standard, and of course, all airlines seek maximum (safe) "time–on–wing".

For buyers of component/inventory management services, the right measures include consignment stock performance, number of AOGs, number and duration of spares–driven defects, and "within time promise" delivery rates.

For airframe heavy maintenance, important measures include turn time, turn time reliability, completeness of work package, defects in/defects out, and the completeness of pre–check (plannable) spares stock. Some airlines use annual maintenance man–hours (or conversely, aircraft availability for revenue generation).

Line maintenance has the greatest potential to impact an airline’s sensitive spots, schedule integrity and customer service. Competitive technical dispatch reliability is obviously critical and is a measure used by every airline. Genuine accountability for technical dispatch reliability is often blurred, and only in reality only exists in those airlines where all maintenance is done either in–house or on a total turnkey, outsourced basis.

This is because many other factors impact line maintenance performance such as spares flow to the stations, spares stock, maintenance control effectiveness, and technical services support to name but a few. For smaller line maintenance contracts at non–base outstations, then other measures such as completion rate of requested work packs and time–on–stand performance should be used.

Defect levels have a significant impact on technical dispatch reliability so they are monitored in a multitude of different ways: number carried, number of repetitive defects, average length of defect, fleet "defect days", analyses by defect category and clearance rates.

Contract management

Are these "high–level" service levels enough? Many of the services being delivered and measured are outputs of a set of underlying processes. Well–managed suppliers should have in place measures to monitor the key drivers of their own business and the services they deliver. So, for example, a component management supplier should be actively monitoring items such as delivery times and fulfilment rates. Or a line maintenance supplier should be monitoring spares stock completeness and availability of technical cover. Since such measures in effect are the real underlying drivers of service performance, then perhaps these should become vital additions to service level agreement. A contract is likely to become unmanageable if it is set up wrongly in the first place. For longer–term relationships, interviews with managers who have experienced life under such contracts pointed towards some common themes and pitfalls:

• "The biggest mistake is for the buyer to adopt an adversarial role, to police the contract and to try to second guess or outsmart the E&M provider"
• "The trick is to negotiate a contract that encourages the right behaviour and attitude between the parties"
• "The contract will be a failure if the buyer duplicates functions"
• "Keep it simple. A contract that legislates for every eventuality will be unworkable"
• "Make the invoicing transparent and easy to manage"

It is clear that a contract established on the basis of win–win and where a clear set of principles are set out provides the context for developing a successful relationship. It appears vital that the contracting process lays the basis for building trust and respect, which is easier where time and the environment allow (e.g., where the contract is internal between a parent airline and E&M). This takes a serious time investment by management — estimates of elapsed time varied from two to nine months.

The mutual dependency of the airline and its E&M organisation extends into how the relationship is structured, contracted and managed on a day–to–day basis. In a turnkey environment, the complexity and unpredictability of the services needed, particularly in line maintenance, requires significant flexibility. A detailed contract could try to anticipate each of the specific services needed for each aircraft and then price them. But this would create a wasteful bureaucracy.

Instead, the contracts should be kept simple. Establish specific prices and performance parameters to provide control and manage exceptions and unusual events through separate negotiation. For example, more and more contracts cover over basic maintenance services -- line, base checks up to and including C checks, component overhaul and engine overhaul -- on a flying hour basis. This cost driver has an obvious benefit. Airlines want aircraft in the air flying and the E&M provider focuses attention on doing the same — to earn more revenue out of the same input.

Invoicing clarity is very often a difficult problem to handle, and can cause frustration to the airline. One UK airline developed a simple two–page invoice pro–forma within the initial contract. For each type of maintenance input, there is an agreed price and volume driver, and the monthly check is straightforward. The 20–20 hindsight lesson learnt by this carrier was to minimise exclusions. Cabin interior parts and repair are often excluded from component management contracts. "We spend so much time looking at the individual invoices for these items and at the end of the day, when you see the bottom line it’s just a few dollars on the flying hour rate".

Contracts are generally reviewed annually in order to allow for re–negotiation of prices and performance standards where one or other party may be hurting and to allow for flexibility and updating as each party gains more experience in how best to manage the contract. The length of contract (assuming this is not a spot market deal) will rarely be less than three years and many reach up to ten.

Do penalties and incentives work? The major criticism often levelled at such approaches is the disconnect between the corporate penalty/incentive and the individuals actually delivering the service. For example, the supplier may receive significant benefits if technical dispatch reliability averages higher than a certain rate. The supplier’s management has to motivate a large number of different people to achieve this target — the AOG desk, the inventory planners, the line engineers, the goods in/out team. But do the individuals feel motivated by the contracted incentive? Accountability, benefit and ability to impact become too watered down. That’s why more detailed service levels — as discussed above — must be a better solution. At this level, accountabilities can be much more direct.

Contracts are the framework for a long–term relationship and provide the goals and objectives that support success. Real success will only be achieved when the two parties trust and respect each other, when the supplier aligns its objectives and motivation with those of its airline clients and when it succeeds in delivering and exceeding the targets desired. And that comes down to team and people management, not just a good contract.