Performance-based logistics aims to drive down costs while increasing efficienty. Can airlines find a way to use this military concept to save money?

Performance-based logistics (PBL), the outsourcing approach now favored by the U.S. military to reduce aircraft support costs, stresses high-level objectives, alignment of goals between the government and the service provider, analysis of current cost baseline, definition of work scope, and the use of performance metrics and incentives. It requires trust between the parties, sharing of data and a willingness to see the supplier do well if metrics are met. "Customers are not buying parts and services, but performance outcomes," explains Tristan Whitehead, a principle at Deloitte & Touche.

PBL aims to drive down costs in the supply chain, while increasing efficiency, or, as Whitehead puts it, "to get some guaranteed outcome at a predictable cost." Typically, these are long-term contracts that may require investment by the service provider to improve components and processes. How do these ideas play in the commercial aviation market?

Actually, commercial aviation — Rolls-Royce, in particular — may have invented the core of the approach 20 years ago, with "power by the hour" (PBH) programs which aim to boost availability and lower customer risk. The engine companies’ job is "to know their engines so well that they can place a bet at a fixed [maintenance] price and outperform their bet," explains Kate Vitasek, a well-known PBL expert and managing partner at Supply Chain Visions. PBH has been widely imitated and its concepts have been applied to avionics and other components.

Engines lend themselves to performance-based maintenance programs, Whitehead says, because "rotating parts by nature are much more predictable in failure modes and failure rates...than an entire airframe with parts that also interact with each other, [such as] hydraulics, pneumatics, avionics, actuators, and wheels and brakes." Moreover, engines are also used at a very constant set of performance parameters. Ninety percent of a flight is at cruise, he says, with very constant RPMs. Looking at many factors, such as temperatures and turbine inlet and exit pressures, engine manufacturers can predict failures and have parts available.

The commercial side also focuses on supplier management, says Chris Doan, president and CEO of Team SAI consultants. The big cargo operators, UPS and FedEx, pioneered that with the early strategy of outsourcing when they set up their airlines in the ‘70s, he says. "They purposefully outsourced their heavy maintenance, engines and most of the components and really worked on perfecting the supplier performance."

Vitasek predicts that hard times will speed carriers farther along the route of buying outcomes rather than counting costs. Others say the current crisis is so grave that legacy carriers have to focus on immediate costs to stay in business.

Rande Cruze, director of business development for original equipment manufacturers (OEMs) with AAR, agrees that the airlines could go further in the direction of performance-based logistics, but probably not right away. The company is a military PBL contractor, with a "couple of [contracts] where we incorporate outside repair houses, as well as depot, and for one set fee we manage that entire repair chain of components and inventory, so that it all comes together," Cruze says. The Air Force and the Navy are in effect buying "mission effectiveness ratings" from AAR, he says.

The company’s flying-hour contracts typically focus on inventory buying and parts availability, he says. He predicts that "flying by the hour" contracts eventually will evolve into more of a PBL-like system, where parts availability is bundled with inventory management and repair services, broadening the focus to system availability. This is starting to happen, but "there is still a mentality with legacy carriers of not really buying an outcome but managing the cost," he says. AAR combines maintenance, repair and overhaul (MRO), parts supply, parts management, and aircraft leasing.

A "big shift in behavior patterns" is occurring in the $9 billion aviation components business, agrees Kevin Michaels, a principal at the AeroStrategy consulting firm. Whereas in the past airlines owned and managed their own inventory and dealt with "dozens and sometimes hundreds" of suppliers, they are now "turning to suppliers to manage a broad array of component types as well as to own and maintain the inventory." He cites Lufthansa Technik (LHT), SR Technics and ST Aerospace among the leaders.

Michaels cites the concept of "total technical support," where suppliers are responsible "for pretty much all of the maintenance, asset and engineering support for an aircraft." Bundling of component supply and asset management, which comes closer to the spirit of PBL, is more common in Europe, which has developed maintenance alliances and areas of specialization.

Is Pure PBL Possible?

Pure performance-based logistics for the airlines would be when they say they want an airplane at the gate at 8 a.m. every morning for a negotiated rate — and that the contractor would be responsible for parts, fuel, repairs, whatever it takes to accomplish that outcome, Cruze contends. Moreover, the "true higher calling of PBL is actually at the airplane level, even fleet level."

The airlines "are not exactly there yet," Cruze concedes. Until five or six years ago, he says, most U.S. airlines "really wanted the same serial numbers and inventory back rather than an exchange or pooling arrangement." European airlines were more advanced in this regard, he says. Giving up control of spare parts inventories is something legacy carriers do "rather reluctantly," agrees David Sisson, CEO and president of AirLiance Materials, a parts supplier owned by LHT, Air Canada and United.

The airlines, furthermore, tend to separate what they insource from what the outsource, Cruze says. If a chunk is outsourced to a contractor, it’s not always easy to align the customer’s desired outcome with the degree of control necessary to produce it.

"Transaction-based" outsourcing agreements — anathema to PBL purists — are also commonplace in commercial aviation. In these arrangements the carrier and the provider focus on a particular job to be done at particular labor and material prices. Although these arrangements can take longer to negotiate and costs are less predictable, they are preferred by customers who have not yet established a good cost baseline for calculating a flat rate or who don’t want to enter a long-term relationship with a service provider.

Another tenet of PBL is to hand over the keys, so to speak, to the provider. Once a deal is reached, the service provider should perform the work as they know best. Some airlines with great engineering expertise find that very difficult to do, Whitehead says. One sends out repairs with its own engineering drawings and directives attached, he says. "They’ve actually made it more difficult for them to outsource."

The carriers that can afford to take an outcome-oriented approach are the "white sheet airlines like Virgin America," Michaels says. "They don’t have a maintenance and engineering department, don’t have labor union issues, so they can do what is possible in a difficult environment." Most of the low-cost carriers in Europe and Asia also contract this way, he says.

Another difficulty for pure PBL in commercial aviation is its base of independent companies. Individual components of the supply chain want to optimize their own profit, which may not equate with cutting an airline’s costs. And airlines "normally don’t and can’t collaborate," Doan says. The U.S. military, ironically enough, can’t do pure PBL either, in the area of reducing the amount of inventory and its holding costs. Under U.S. federal acquisition regulations, for example, components for different programs can’t be shared, Whitehead says.

Airlines

JetBlue, a newer airline known for outsourcing, considers "predictable costs" part of its goals, says Larry Montreuil, the carrier’s director of corporate supply chain. "We have to have predictability in our costs because 50 percent of our cost structure is fuel, which is volatile." JetBlue is held up as a model in PBL circles.

The carrier "tends to do flight hour agreements" and "fixed pricing for heavy maintenance services," outsourcing "our aircraft work except for line maintenance," in order to focus on "customers’ JetBlue experience." JetBlue has fixed-price, flight hour agreements on the engines, APUs and most of the components of its A320 fleet. These agreements typically include repair time guarantees, Montreuil says. Wheel and brakes are also managed on a cost-per-aircraft-landing basis.

Although unfamiliar with the details of the U.S. military’s PBL programs, Montreuil speaks in similar terms. He says, for example, that JetBlue’s "goal is to align the incentives of the supplier and us" and that both sides in flight hour agreements are "in it to maximize availability." Turnaround time is "big for us because it drives availability and performance on airplanes," he says. Montreuil also emphasizes the importance of a baseline. "You look at the total cost of maintaining a part and look at its reliability, what you’ve been experiencing, what the industry’s been experiencing, and once you’re comfortable with the baseline, you see what the market is offering on that part," he explains.

On the components side, JetBlue was able to calculate a cost baseline by extrapolating from time and material repair costs accrued on repairs to components that were coming out of warranty. The airline used this cost data to forecast repair costs over a 10-year period. For the V2500 engine work, JetBlue had anticipated doing a time and material contract, Montreuil says, but the "data really drove us to a flight hour agreement."

The carrier also has simplified its supply chain. A320 wheels and brakes support, for example, uses Messier Services to coordinate the efforts of multiple suppliers. Although the wheels and brakes come from Messier Bugatti, the tires from Michelin and the overhaul services from Honeywell, "for us it’s a single invoice," Montreuil says. The contract was structured this way to simplify administration. "We don’t need to worry about getting tires and wheels into the shop, carbon stacks for the brakes — it’s all done behind the scenes."

AAR has a more sweeping deal with Mesa. Under this integrated program AAR provides inventory at all the line stations for all the different aircraft models. It is responsible for the repair chain and owns a portion of the carrier’s inventory, including consumables and rotables. The relationship with Mesa has grown to include not only inventory and repair, but also parts forecasting and buying.

AirLiance also has a more narrowly defined but comprehensive arrangement with an unnamed U.S. carrier, to whom it supplies life-limited parts (LLPs), primarily engine disks, and preferably from surplus stocks identified in the aftermarket. The arrangement is such that when AirLiance can’t find enough disks to meet the customer’s technical requirements — and has to buy from manufacturers — it gets essentially "zero profit," Sisson says. This airline "has no buyers, no inventories, virtually no expertise in sourcing these things — they have given us this responsibility."

Airbus’ deal with now-defunct Skybus Airlines may be a portent of the future, as well. Airbus had signed the carrier on to "total support package," including aircraft maintenance, components management and support, engineering and technical services for the Skybus fleet.

Although Skybus collapsed, there will be more manufacturer support packages, analysts say. AeroStrategy predicts that by 2018 Boeing and Airbus will have "locked up 50 percent of single-aisle customers with integrated MRO contracts that include airframe/component maintenance, rotable, logistics and/or fleet management."

MRO Directions

The MRO providers, Delta TechOps (DTO) and LHT, reflect different approaches to supply chain and inventory management. Both offer power-by-the-hour-like arrangements among other options. The German company has established a joint venture with Rolls-Royce in Erfuhrt, where it handles repair and maintenance for Trent engines on the A340-500 and -600, the A330 and the A380. LHT engine services range from single part repair to single engine overhaul to single-type and fleet overhaul, says Walter Heerdt, LHT’s senior vice president for marketing and sales.

Both MROs use PMA parts. LHT works with HEICO to reverse engineer parts, including rotating parts, but not life-limited parts, Heerdt says. Delta, on the other hand, has launched an initiative, with partner Chromalloy Gas Turbine Corp., to break into the "last frontier in PMA" — life-limited parts, including engine disks. Chromalloy is working on parts for the CFM56 -7 and -5 engines, says Bob Currey, the MRO’s director of supply chain. Delta Air Lines flies many -7s in its fleet, so TechOps "can blend operational experience with expertise and proficiency on the maintenance side," he says.

"To date, as an airline, we’ve had no alternative for LLPs other than OEMs," Currey says. The only instance where non-OEMs provide them is Pratt & Whitney, he says. "They’ve basically PMA’d the whole CFM56-3 engine," although they STC (supplemental parts certificate) the parts, as well, he adds. Delta expects savings from the project in a percentage "north of the teens," Currey says. Its recent support contract with Alaska Airlines is the first opportunity the MRO has built based on the Chromalloy relationship.

Inventory Management

Delta TechOps is "very keen on reducing inventory levels," says Stephen Maceyko, general manager of global customer service. Maceyko cites use of Boeing’s integrated materials management (IMM) program, where Boeing owns the inventory of selected parts and sells them back to the carrier as they are used. Boeing is responsible for planning and provisioning parts on consignment in our warehouse, he explains, so this inventory is not on DTO’s books.

Delta sees programs like IMM as an essential to the supply chain solution. "There’s a general awareness in the industry that airlines are less and less willing to carry large amounts of inventory," Maceyko says, especially inventory that turns very slowly. Delta routinely identifies these items and "pushes them out through our materials sales organization." Delta also shops parts requirements to surplus providers.

Of Delta’s approximately 250,000 part numbers, about 10,000 are covered in the IMM program, and Delta has similar programs with other suppliers. On new parts, in particular, it is trying to push more and more to the suppliers, the company says. The reverse, where DTO would hold inventory of other airlines, is very rarely the case, Maceyko says.

When Delta TechOps outsources repairs, it expects to be supported with an inventory program, Currey says. Delta will set its spares level based on its repair partner’s turn times. "Rather than be at the risk of [supplier’s] nonperformance, [that company] needs to bring to the table, coupled with aggressive repair pricing, aggressive inventory support program — buying our inventory to take that risk off the table."

Delta is also streamlining its supply chain. It has a deal with AMG in Miami, for example, covering more than 100 components, some of which work AMG also outsources. The deal has allowed the MRO to reduce its supply base for certain parts from "well over 100 [suppliers] to one," Currey says.

Delta TechOps has some contracts with incentives, others with penalties. Turn time can be very important to the service provider, but (if it’s a guaranteed replacement deal), not so important to the customer. A lot of suppliers want monetary incentives, but Delta prefers "a natural progression," such as a contract extension.

Lufthansa Technik

LHT has made aggressive efforts to own and manage, as well as repair, customer components through programs such as total component services (TCS) and total material operations (TMO). Both programs include guaranteed parts availability and participation in parts pools. In more and more cases LHT buys an airline’s component/line replaceable unit (LRU) inventory and leases it back to the customer, Heerdt says.

"We see this more and more" in customer requests, Heerdt says, referring to performance-based logistics concepts. Customers want guaranteed component services and service levels all the way up to contracts guaranteeing the availability of the fleet. "More and more airlines are going to ‘total solution’ contracts," he says, "paying on a power-by-the-hour basis." But power-by-the-hour contracts can be limited to MRO performance, only, Heerdt adds, with metrics such as turnaround time.

LHT has enrolled more than 400 customers in its "aircraft component contracts," involving a range of parts and services. At the high end, the MRO not only supplies components, but does provisioning studies, allocates repair and overhaul, and provides documentation and engineering services. TCS also involves a components pool — whose inventory LHT owns and controls — equivalent to nearly all Boeing and Airbus aircraft.

More recently LHT has offered "total material operations," which "integrates all material processes and provides the complete aggregation of aircraft-related material," according to the company. The TMO organization is located at the customer’s site, is fully integrated into the maintenance operation, and interconnects with the maintenance control system. "It focuses on aircraft availability, making the requested material available right at the customer’s operation," Heerdt explains.

Growth Prospects

Several of the majors who have outsourced heavily in the last five to 10 years claim savings in airframe work of 35 percent to 45 percent, Doan says. Some 53 percent of worldwide commercial maintenance requirements are outsourced today, he says. Doan predicts that global commercial airline outsourcing will increase from 32 percent in 1990 to 65 percent in 2010.

Observers also predict that the range of items outsourced will expand. Doan thinks the next frontier will be the IT, the back office environment. Other areas include administration, technical services and materials management.

AAR’s Cruze anticipates the possibility of PBL-like deals for administrative services or hangar management. A carrier might want a hangar available at 7 a.m. every morning or for six months out of every year, he says. "There are myriad different aspects to this and all related to the outsourcing phenomenon." Administrative and office functions such as ticketing could be an outsourcing target, he says. "It’s overhead for the airlines," he says.