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Managing Complexity in Performance-based Defence Logistics Contracts

As the scope of logistics-focused performance-based contracts increases, so does the level of the associated management complexity which can lead to increased costs and performance degradation.

Over the last few years, many militaries around the world have outsourced their logistics and support activities to industry suppliers using Performance-Based Contracting (PBC). PBCs (also known as Contracting for Availability) focus on the required outcomes of military capability, specifying availability targets for equipment, platforms and systems, and with the aim of incentivizing improved performance or penalizing poor performance, through gain-share arrangements.

There are many reasons for this trend. A key driver has been the transition to Through-Life Management of systems, both in the commercial world and in defence. This has moved the focus from maintenance and repair activities, and the associated provision of spares, to the goal of providing availability within a single overarching contract. This should deliver a range of benefits. The military customer will expect to get more reliable equipment and greater availability which, in turn, will reduce operating costs in the longer term. As these benefits can only be achieved through longer-term investment and learning from experience than, for suppliers, there is the attraction of extended duration contracts delivering a stable source of revenue.

However, these benefits come with increased complexity and risk. A traditional maintenance and support contract could be easily costed on the basis of resources consumed and time expended. Although difficult to incentivize, these types of contracts are relatively easy to specify and manage, with the outputs clearly visible. Risk is also readily allocated between the customer and supplier. With a PBC, availability targets must be set. For a new system, for which there is little operational data, this can be difficult. If too high an availability target is set, then the contractor is likely to factor in a significant risk premium, negating any potential cost savings. If too low a target is set then operational availability is unlikely to improve. Flexibility must, therefore, be built into the contract to allow targets to evolve as operational experience is gained – with the associated data recorded and shared amongst relevant stakeholders.

Setting targets at the right 'system level' is also difficult. Setting a single availability target for the complete system or capability may seem desirable, but it is often difficult to fully define and identify the system, and it can result in a ‘one size fits all approach,’ where critical elements of the system are given the same targets as component equipment, which only has a marginal impact on the capability if they fail. The result is over-specifying in some areas, at additional cost, and under-specifying in others, leading to performance shortfalls.

If performance targets are allocated to each constituent element of the capability then this adds significantly to the complexity and the cost of managing the contract. Performance must be monitored for each element but the performance improvement is difficult to incentivise, especially when the contribution of each element to overall system availability is difficult to define. It will also likely result in performance targets being cascaded down from the system prime to a multitude of sub-contractors who may be reluctant to take on the additional risk of a performance-based contract when they have little influence as to how the system is operated and maintained.

A solution is, therefore, to identify which system elements drive overall system availability and, in turn, support the key capability requirements – these are the critical elements. The performance management activities then focus on these critical areas, identifying potential conflicting requirements and gathering performance data and learning which leads to the setting of appropriate targets, availability improvements and shared efficiency benefits.