The Rolls-Royce Of Effective Performance-Based Collaboration
EP Editorial Staff | June 11, 2012
Continuous uptime was the destination. How a leading jet-engine manufacturer and service provider helped its valued airline customers get there has implications for any maintenance organization. Making the trip means you’ll be looking at your ‘world’ from a different perspective. So, buckle your seat belt.
When you think of Rolls-Royce, you might envision its luxury auto nameplate. But there’s also a very good chance that the airplane you recently traveled on was powered by Rolls-Royce jet engines.
A pioneering manufacturer of jet engines for civil aeronautics, Rolls-Royce was also a major ground-breaker in performance-based service and maintenance agreements for its aircraft engines.
It basically devised programs to handle vital service and maintenance functions—its core expertise—while leaving the airlines to worry about their own core business: flying safely.
Rolls-Royce PLC is generally regarded as the first company to use an outcome-based business model, and its innovative “Power by the Hour” outcome-based agreements with airlines changed the way the company and its airline customers conduct business together. The model is beneficial for each party: The airlines want planes that fly continuously, something that translates into a steady revenue stream. Any unexpected maintenance downtime disrupts the system and results in high levels of unplanned expenditures.
Within a conventional arrangement, airlines would pay Rolls-Royce a transaction fee for every single engine maintenance event and service request on a spare-parts and labor basis to restore equipment to a serviceable condition. Simple guarantees were offered for replacement parts, and these evolved into maintenance guarantees for labor as well as parts for single aircraft or entire fleets, based on the total anticipated cost per flight hour (time in flight) and flight cycle (wheels up and wheels down). The result was a perverse incentive: Under the transaction-based model, aircraft downtime for maintenance, whether it was planned or unplanned, would generate revenue for Rolls-Royce—but, obviously, no revenue for the airline.
Enter the Rolls-Royce “TotalCare” program, which flipped the conventional transaction-based approach on its head. The premise was to build a long-term relationship with customers by aligning the engine-service provider’s goals with the airlines’ goals of keeping the aircraft flying. Under this outcome-based approach, Rolls-Royce would be paid for “continuous uptime,” rather than derive revenue from turning wrenches during aircraft downtime.
Rolls-Royce now guarantees serviceable equipment availability and takes care of all maintenance in the chosen service plan. The outcome-based model gave the company an inherent incentive to drastically increase engine reliability and preventive maintenance that would increase engine on-wing life, reducing unplanned engine downtime and allowing airlines to focus on their core business.
Today Rolls-Royce calls its TotalCare program a “flexible approach to achieving an engine support service that has the correct fit and scope of services to meet the operator’s specific needs.” This is achieved through a cooperative partnership that “aligns incentives and goals,” minimizes financial and operational risk, and enables the operator to focus on its business while reducing or eliminating downtime and improving residual value.
TotalCare is a collaborative win-win approach that embodies core values on alignment, collaboration and incentives enumerated in the Vested Outsourcing business model, along with Vested’s five key rules for a successful outsourcing agreement. These rules encourage cooperation and innovation to achieve the best possible long-term results, while moving the parties away from the old transaction-based business models that can penalize one side or the other in the maintenance realm, as Rolls-Royce discovered.
Investing heavily in TCO
What increasing reliability and reducing downtime comes down to is being heavily invested in the Total Cost of Ownership (TCO) with the buyer once the engine or the part leaves the door. SKF Group, a manufacturer of bearings and a provider of seals, lubricants,
mechatronics and services, has made TCO a vital part of its business model. According to SKF, “An effective partner in achieving Total Cost of Ownership purchasing benefits must have the products, services, tools, knowledge and capabilities to take a comprehensive approach to your entire operation.”
While the initial acquisition of equipment or parts is the major focus, it is only a small part of a product’s total cost. TCO is becoming more widespread as companies and suppliers work together to reduce cost components. This includes maintenance, repair and operating supply providers, who want their customers to see the overlooked cost elements beyond the purchase price to discover the real cost drivers.
Choosing an outsource partner to handle some or all of the management and maintenance tasks—a partner that clearly understands TCO—is a delicate, yet vital decision. Many things can go wrong in an outsourcing arrangement, but poor decisions around equipment and maintenance can reduce value company-wide, hinder reliability and place the entire business model in jeopardy. It’s crucial to have a maintenance program that keeps the wheels turning, the engines running and the planes flying.
Building the right type of framework
Getting the outsourcing framework right is also crucial. That’s why the research and fieldwork of the University of Tennessee on performance-based outsourcing agreements between companies and their service providers, which led to the collaborative Vested Outsourcing business model, provides a clear path to a successful outsourcing partnership.
The Vested approach is based on collaboration between the parties on mutually desired objectives and outcomes. The focus is on aligning interests to produce results—not simply completing transactions—by leveraging outcome-based and shared-value principles. Vested is used when a company and provider want to move beyond commodity thinking and “bean-counting” to an environment where the service provider has a vested interest to achieve results and value for the buying company.
The five rules, as outlined in Vested Outsourcing: Five Rules That Will Transform Outsourcing, are:
- Rule 1: Place the focus on outcomes. The idea is to move away from buying and selling transactions to a new level of cooperation.
- Rule 2: Focus on the WHAT, not the HOW. Companies can often fall into the trap of tightly defined statements of work (SOWs) that strictly define HOW, rather than focus on objectives they want to accomplish.
- Rule 3: Early on, jointly formulate clearly defined and measurable results based on collaboration and alignment.
- Rule 4: Jointly negotiate pricing models that include incentives based on performance rather than making a sale or hiring lowest-cost labor.
- Rule 5: The partnership should have a governance framework that provides insight into the nature of the relationship and its objectives so that transition, management protocols and incentives implement continuous improvement and achieve desired results.
The five rules explained
Let’s examine the Vested concept and the five rules in more detail. As the Rolls-Royce example illustrates, the Vested approach can fit nicely with companies that want to develop effective, long-term performance partnerships where both parties have a stake in maintaining the relationship.
While no two Vested relationships are alike, the most effective ones achieve a partnership based on optimizing for innovation and improved service, reduced cost to the company outsourcing and improved profits to the supplier. The trend toward performance partnerships has evolved—companies and sup-pliers work together to develop performance-based solutions where their interests are aligned. Both parties receive tangible benefits, either through tangible or intangible incentives.
At the heart of the Vested approach is an agreement on desired outcomes. Under this dynamic, the service provider is challenged to apply “brain power” and/or investments to the relationship. It also takes on risk to do it, in essence putting “skin in the game.” The supplier or service provider looks at how it can best apply world-class processes, technologies and capabilities that will drive value to the company that is outsourcing.
Rule 1: Adopt an outcome-based versus transaction-based business model…
Traditionally, many outsource arrangements are built around a transactional model. Most often this transaction-based model is coupled with a cost-plus or a competitively bid fixed price per transaction pricing model to ensure that the buyer is getting the lowest cost per transaction. Under this method, the service provider is paid for every transaction—regardless of whether or not it is needed. Thus, the more inefficient the entire process, the more money the service provider can make.
Conventional business models achieve the lowest cost for transactions for the company outsourcing. However, it often does not help the company accomplish what it really wants or needs. That’s because the company that has outsourced gets what it contracted for; but what it really needed might fall short of an efficient and low-cost total-support solution.
The Vested model operates under an outcome-based model in which the provider aligns its interests to what the company really wants: an efficient, low-cost total solution. Aligning interests is a major element of the Rolls-Royce TotalCare program. Instead of paying a provider for unit transactions for the various services provided—such as pallets in the warehouse, miles traveled, spare parts shipped, technical and maintenance support hours, etc.—the company and its service provider agree upon desired performance outcomes. In essence, this model buys outcomes, not individual transactions.
Rule 2: Focus on the WHAT not the HOW…
Adopting a Vested Outsourcing business model does not change the nature of the work to be performed. What does change is the way in which the company purchases outsourced services.
The buyer specifies its needs; the provider is responsible for determining “how” it all gets done. The most effective Vested partnerships include minimal discussion of the processes that service providers must follow to meet the requirements. Instead, they focus on performance expectations. It’s up to the service provider to figure out how to put the supporting pieces together to achieve the company’s goals. Performance partnerships let each partner do what it does best.
Rule 3: Clearly define and measure the desired outcomes…
The parties should clearly define and measure their desired outcomes. These outcomes are usually expressed in terms of a limited set of high-level metrics. Once the desired outcomes are agreed upon, the service provider can propose a solution that will deliver the required level of performance at a pre-determined price. Under the Vested model’s purest form, the outsourcing company pays only for results, i.e., orders shipped complete, on time, not transactions such as picking, packing and shipping. In turn, the service provider is paid for the value that its overall solution delivers, not for the activity performed.
Carefully defining and measuring desired outcomes will position the relationship for success by ensuring the partners’ mutual objectives are, in fact, being correctly addressed.
Rule 4: Optimize pricing model incentives for cost/service tradeoffs…
Proper structuring of the pricing model will incentivize an optimal cost/service tradeoff. A well-structured pricing model is based on the type of contract (i.e., fixed price or cost reimbursement) that will be used to reward the outsource provider. In the establishment of a pricing model, businesses should apply two principles:
First, the model must balance risk and reward for both parties. The agreement is structured to ensure that the service provider assumes risk only for decisions within its control.
Second, a properly structured Vested model will incentivize the service provider to solve customer problems proactively. The better the service provider is at solving the problems, the more incentives or profits it will make. Thus, providers are encouraged to develop innovative and cost-effective methods of performing work.
The Vested model doesn’t guarantee higher profits: It gives service providers the authority and autonomy to make investments in their process(es) and product relia-bility that can generate greater ROI than a more conventional cost-plus or fixed-price-per-transaction approach would fuel.
Rule 5: Governance structure must emphasize insight versus oversight…
In the early days of outsourcing, many organizations made the mistake of just throwing work over the fence to their service providers without fully defining the requirements or developing performance metrics or SLAs (service-level agreements). An effective Vested part-nership outsources processes to suppliers and service pro-viders that are the real experts in those processes. These types of partnerships should be managed to create cultures of insight versus oversight.
Unfortunately, too many companies spend too much in time and resources micromanaging their service providers. A sound governance structure will establish insight—not simply provide more layers of supervision.
A commitment to deliver against projected value for the company outsourcing—such as a commitment to reduce costs or improve service or both—shifts risk to the service provider. In exchange, the company that’s outsourcing commits to allow the outsource provider to earn additional profit for achieving this incremental value. The result is a win-win Vested partnership: a true trading-partner paradigm shift.
In addition to using “win-win” without any real basis in fact, many organizations brag that they have “partnerships.” Experience and research, however, has found that most organizations focus primarily on their own self-interests—which can be characterized as the “WIIFMe” (“What’s in it for Me”) approach.
The progression toward a Vested agreement should focus on creating a culture where parties are working together to ensure mutual success. The mentality should shift from an “us versus them” to a “we” philosophy—or what can be referred to as the “WIIFWe” (“What’s in it for We”) way of thinking.
Frequently, companies that enter a Vested agreement will approach it as a symbiotic relationship. Only by working together can they succeed. The goal of a Vested partnership is to focus first on identifying and then aligning the interests of both parties. The relationship becomes more collaborative and expands beyond simply meeting requirements.
Unlearning conventional approaches
Developing a WIIFWe relationship is easier to describe than accomplish. Moving from a culture of oversight and control to mutual respect isn’t an easy transition for most companies that outsource. Adversarial relationships often persist, and getting to a true win-win relationship will likely take practice.
A win-win approach often means companies must unlearn their conventional “me-first,” win-at-all-cost approaches and ways of thinking. In a Vested relationship, organizations work together upon a foundation of trust where there’s mutual accountability for achieving mutually beneficial defined outcomes.
The five rules discussed here set the stage for a sound outsourcing partnership, which, when successfully designed, create happier clients. Because both organizations are work-ing together to achieve their goals, the Vested approach results in an authentic win-win relationship. And that’s what “partnership” is all about.
Is this model right for your operations? You be the judge. The Vested approach will work for transportation providers, manufacturers and maintenance organizations that want to reduce total costs, increase value and forge long-term collaborative, flexible and innovative partn
Kate Vitasek is a faculty member at the University of Tennessee’s Center for Executive Education and author of the popular book Vested Outsourcing: Five Rules That Will Transform Outsourcing and The Vested Outsourcing Manual, both published by Palgrave Macmillan. Email: firstname.lastname@example.org