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The top 10 concerns when contracting services

Jan. 4, 2007
Companies are balancing regulatory and shareholder influence, while seeking the agility and speed to compete globally. Scrutiny of capital expense budgets has slowed infrastructure upgrades and allowed older equipment to fall out of warranty. To compensate, companies are placing a higher value on contractual services to offset lost manpower, supplement their technical abilities, and increase profitability.

It once was that companies were extremely protective of their strategies and tactics, and shielded their equipment, technologies and practices from view of the outside world. To sustain a competitive advantage, they took pains to protect trade secrets, conceal new designs and emerging products and strategies, and shelter their operational methodologies.

In recent years, industrial dynamics have caused this defensive barrier to break down, provoking organizations to enlist third-party assistance in critical service roles throughout the organization.

Economic, financial and technology pressures have contributed to this trend. The existing workforce is aging, the replacement labor pool is shrinking, and cost reductions have constrained hiring within maintenance and engineering organizations. Companies are balancing regulatory and shareholder influence, while seeking the agility and speed to compete globally. Scrutiny of capital expense budgets has slowed infrastructure upgrades and allowed older equipment to fall out of warranty. To compensate, companies are placing a higher value on contractual services to offset lost manpower, supplement their technical abilities and increase profitability.

Keep your eyes open

Pepsi Bottling Group-Detroit (www.pbg.com) has service agreements with a variety of vendors to conduct tasks such as electrical PMs for high-voltage systems, printer PMs, vibration analysis, part manufacturing and a component exchange program for filler parts. “Using contractors to meet our requirements for a healthy operation where we do not either possess the skill nor have the time to perform specific tasks has resulted in increased uptime and has saved us considerable costs,” says Anthony Yanora, maintenance manager.

Aladdin Temp-Rite (www.aladdintemprite.com), a division of the Ali Group, also favors the strategy. “Service contracting helps us to take better care of our customers, supplementing our internal technical staff,” says Kim Sprout, manager of technical and customer services.

[pullquote]The counterargument can also be compelling. Only when specialized knowledge or equipment isn’t in-house will Diamond Chain (www.diamondchain.com) farm out a service. “We choose to remain self sufficient for two reasons,” says Larry Edwards, manager of plant services. “First, because most of our assembly equipment and tooling were designed and built inside the plant, making it difficult to have outsiders come in to perform maintenance. Second, as a strategy to engage and retain a skilled workforce.” Diamond Chain does, however, contract outside support for non-core tasks such as janitorial services, elevator inspections, fire extinguisher service and relocating large equipment.

Providers’ perspectives

For vendors, service contracting is a growth opportunity. OEMs have leveraged their expertise to service systems related to their offerings. “Service contracting allows plants to stabilize their own end costs,” says Scott Tackett, manager of centrifugal systems at Cameron Compression Systems (www.c-a-m.com). “We are their insurance policy — if a unit goes down, the burden is on Cameron. It reduces their risk and gives them peace of mind.”

“Some of our installed base has an architecture that is 20-years-old,” says Greg Bodenhamer, general manager, Schneider Electric Solutions and Services (www.schneiderelectric.com). “They need help migrating to reduce their repair costs, improve operational efficiency and achieve world-class expense budget productivity. And, they want to leverage these outcomes at locations around the globe.”

Some OEMs offer services far beyond their own products. “We allow our customers to focus on their core competencies, which in many cases do not include reliability engineering or maintenance management,” says Stephen Rahr, vice president for services processes, ABB (www.abb.com). “Our performance services are scalable to fit the needs of the customer. We can provide short-term contracts to quickly improve the performance of a specific piece of equipment, or long-term outsourcing agreements where benefits are measured in terms of strategic impact and operational improvements made across an entire facility for multiple years.”

There also are service providers originated solely for the purpose of providing comprehensive maintenance and repair services. “There is a tremendous difference between companies that supply an on-site staffing service and a company like ATS that is held totally accountable for machine availability,” says Jeff Owens, president, Advanced Technology Services (ATS, www.advancedtech.com). “By making them responsible, they can improve production significantly — many times up to 30% by implementing a unique style of maintenance and methodologies.”

So while some are yet resisting the temptation, there has been an explosion of growth in service contracting. Once limited to non-threatening and inconsequential roles, service contracts are now encompassing a much greater scope and strategic significance within the heart of the organization, and lengthening to multi-year terms.

Relying on third parties can solve many problems, but it also introduces risks. An ill-conceived approach or a poorly written contract can generate small challenges or trigger great failures with ripple effects throughout the operation. Here are suggestions on how to prevent or prevail over the top 10 problems presented by contracted services:

1. Labor constraints are often global

A common rationale for outsourcing labor is the difficulty of maintaining a skilled workforce on site. The challenge of recruiting from a shrinking pool of qualified resources, and retaining them once they’ve been hired and trained, seems reason enough to seek outside help. But, have you considered how well your service provider is dealing with these same issues? Can you afford the loss of core competence in your organization and have your operations depend on third parties?

“At Aladdin,” Sprout says, “overall, we’ve found it is less expensive to outsource certain services than to hire and train employees with technical expertise. We look at our internal resources and the strengths of those resources, and then carve out areas of expertise that would be best handled by outside sources.”
Pepsi’s Yanora agrees, saying, “Since staffing resources are at a premium, I seek out companies to fill voids in skills and our ability to produce results in a timely fashion. I look at the value of using our personnel and their time, and compare that to the cost of the service company, before I decide which method to utilize.”

On the other hand, Diamond Chain finds the lack of internal competence a disadvantage. “We have found that some of the tradesman hired from other manufacturers who outsourced much of their skilled work were lacking in their craft knowledge,” says Edwards. “We’ve developed our own apprenticeship program to develop skills internally. And, because the interesting work stays in house, our people are less willing to give up their job even if their suitor is offering a higher rate of pay.”

Service providers also consider access to qualified labor to be a top priority. Owens has found that, “The biggest challenge for the service industry is the availability of good, skilled people. To maintain a sizable skilled labor force, we have a heavy recruiting focus. We provide a training program for candidates out of high school and junior college, we hire military personnel with desirable skills and transition them into the commercial environment, and we recruit experienced professionals.”

Furthermore, many service contractors have developed cooperative relationships with their peers and freely exchange knowledge with OEM vendors. The OEMs benefit when third parties ensure their customers’ equipment is running and well maintained.

2. Cultures may clash

Changing the way business has always been done can devastate expectations and challenge the job security of established employees. Leaving mundane work to your employees and bringing in outsiders who are expected to do a better job can put your employees on the defensive — they may refuse to work with the new-comers, and some may go so far as to sabotage the efforts of the service provider. Be sure to explore your service contractor’s success with change management.

“When a company’s maintenance direction is effective and operating costs are reduced, cuts tend to be made within maintenance to make the new budget stretch,” observes Shirley Hansen, president of Hansen Associates and an player in performance contracting, observes. “Ultimately, the reward for doing a better job is to spread resources thin until, eventually, management has to bring in outsiders to do what could have been done internally if only they had adequate resources. This paradox can breed huge resentment in the operations and maintenance people, which can be overcome only if management is sensitive to it.”

Diamond Chain believes in keeping the interesting work in-house and stimulating its employees by involving them in special projects and more cutting-edge work. “Our electricians are involved in the design of new circuitry,” says Edwards. “Our plumbers are involved in construction, hydraulics and pneumatics and designing new pieces of equipment. The goal is not so much to save jobs but to have the operation run smoother. Involving employees in design and construction work gives them an intimate knowledge of the equipment, which makes maintenance easy.”

“We have no desire to outsource functions away — instead we’re all about collaboration,” says Scott Teerlinck, director of marketing for customer support and maintenance, Rockwell Automation (www.rockwellautomation.com). “We partner with our clients, who come to depend on us to help predict, prevent and react to issues that impact the plant’s downtime and productivity.”

The people side of maintenance is very important, says Owens. “ATS promotes a culture that is focused on the customer, continuous improvement and proactive maintenance,” he says. “When we take over maintenance, we bring in new leadership and hire individuals from the client organizations who are suited to our culture.” Roughly 40% to 60% of the employees are hired from in-house so ATS can drive change, but also retain some history. “Although we don’t pay the employees less than they earned previously, we may staff fewer people who work more efficiently,” Owens adds. “Our value proposition is production improvement — not labor savings.”

3. Specialty equipment can stymie

Companies with complex, internally-designed, heavily customized, or otherwise specialty equipment may achieve less desirable results from service contracting. External technicians could do more harm than good if they don’t have a clear understanding of the machine’s purpose, design specifications and maintenance history.

“We’ve found that when we do bring outside contractors to Diamond Chain, my people often end up helping them because they are not as prepared or familiar with our specialized and customized equipment,” says Edwards.

When an equipment or process is unfamiliar, service contractors must take pains to educate themselves. ATS has a startup phase after the contract is signed and before the service starts in which it ramps up on the technologies to be supported. “We’ll send our technicians out for the necessary tools, training and documentation,” Owens says. “We’re not experts in all technologies, and it’s in the agreement that we can call in help when it’s needed.”

4. Interests sometimes conflict

If your third-party service contractor also is an OEM or has an affiliation with certain brands, will you receive impartial assistance and advice? Consider the potential for a conflict of interest when your service provider recommends replacing competitive equipment, as well as the impact that third-party services will have on your existing warranties.

Manufacturers working to raise their service revenues are increasingly branching into competitive territory. Tackett sees Cameron’s history as an asset in this regard. “With more than 50 years in the air business, our technical services people pretty much know all the nuances of all the air supply and compressor system brands in the industry. Regardless, our technicians are only part of the decision-making process. We can make recommendations, but our customers make the final decisions when it comes to repairs, replacement, shutdowns and enhancements.”

Schneider Electric’s Bodenhamer says, “We recognize we can’t survive by servicing only our own brand, so we have added the capability to repair, service and support complementary products. Warranties have not been a problem. In fact, some OEMs are leveraging companies like Schneider Electric to provide service for their products in other countries.”

Independent service providers have no apparent allegiances. “Our clients are not concerned about bias,” says Owens. “We provide proactive equipment performance information such as downtime and maintenance costs. We can share information on OEM reliability based on our own experiences. But, the customer ultimately decides when the equipment has reached the end of its useful life and specifies the replacement.

As for assets under warranty, we charge a discount rate. This way, our clients get the financial benefit while we manage the warranty. And, we sometimes partner with the OEM for training so we can provide warranty service on their behalf. This frees up the OEM, who reimburses us for the parts and time spent on the equipment.”

5. Who handles spare parts?

Service outsourcing can stumble when the responsibility for spare parts isn’t clearly specified, leading to emergency requisitions and prolonged downtime. Someone must be held contractually accountable for ensuring the right parts and quantities are on-hand when needed. And, a fine level of real-time communication must occur between you and your service provider to maintain adequate stock.

“In some of Cameron’s agreements, the customer owns the spare parts on the shelf. If we use them, we replenish them,” says Tackett. “At the end of the contract, they can be assured they will have the exact same amount of parts as when the contract began.”

Companies like ABB, Rockwell and ATS can manage an operation's entire spare parts strategy, taking responsibility for forecasting, sourcing and supplying the right parts in time for planned and unplanned maintenance. Such companies have the advantage of being able to optimize inventory across client sites to minimize inventory carry costs while accelerating access to critical parts.

6. Consider capital costs

When a service provider assumes ownership of machines that are ill-maintained, operating at less than peak efficiency, or nearing the end of their service lives, who pays the costs to refurbish or enhance the equipment? Performance can suffer and costs will rise when capital improvements are delayed.

Likewise, if the capital isn’t available, it can be very difficult, if not impossible, to perform on agreed-upon performance goals and objectives.

“Schneider Electric’s upgrade recommendations are customized to meet each client’s prioritization of needs and budget considerations,” says Bodenhamer. “For instance, if repairs have grown to a significant percentage of the operating budget, we’ll recommend adopting a new platform or more reliable equipment.” If the client chooses not to upgrade, the company will still service the equipment although the performance expectations will be lower. If the entire system is antiquated, it might suggest a phased migration approach. Incremental upgrades could start where the highest volume of repair dollars are spent, or the plant might save this equipment for last if the upgrade would infringe on the production system during a peak period or season.

Cameron’s Tackett suggests resolving potential issues upfront. “Before the contract is written, we perform a site audit. Based on the findings, our client will need to get their units tuned up to an acceptable level before the handoff occurs. Once the unit is accepted into the program, any performance issues are on Cameron’s nickel. Our commitment is to leave the equipment in better condition than when the contract started.”

7. Accepting risks

Equipment maintenance is never without risk. Depending on the type of equipment, an unexpected failure could cost millions of dollars in lost production, environmental consequences, regulatory fines and equipment replacement or repairs. Safety issues are another perpetual concern, as is the potential loss of intellectual property. Your attorneys should address how the risks will be mitigated and specify the extent to which your service provider will assume risks.

Safety is the number one priority at ATS. “During the assessment, our safety people meet with our client’s safety people. Each is accountable and they report their numbers to OSHA independently,” Owens explains. “We are responsible for our own negligence and we stand by our workmanship.”

Service providers may negotiate consequential damages on a case-by-case basis. Nondisclosure agreements and other devices should be used to protect such valuables as your intellectual property, infrastructure strategy and production schedules.

8. Scope creep

Change orders can stretch the limits of a project’s original scope and add unexpected costs to the service agreement. End users and vendors alike are developing strategies to minimize the extent of scope creep — from improving the original scoping process to refining the contractual terms.

Schneider Electric’s Bodenhamer says, “Although an occasional change order is necessary, we avoid them by doing a very thorough job of mapping out the effort upfront and tailoring the contract and budget accordingly. This diligence results in an extremely accurate and detailed scoping of work. Additionally, rather than offering piecemeal, inflexible fixed contracts that require payment whether you use the service or not, we offer tailored services, ‘pay-by-the-drink’ pricing and flexible payment schedules.”

Rockwell also has found that contract customization is necessary. “In the two or three decades that we’ve been providing contractual services, we have gotten smarter,” says Teerlinck. “No two clients are the same and, even for similar services, our offerings must be customized to maximize the impact we have on customer profitability and productivity.”

Unexpected costs aren’t always passed on. “If we commit to having three mechanics dedicated to maintenance and overhauls, and have to bring in additional support during a downtime, we absorb the added cost,” says Cameron’s Tackett. “We don’t pass it on to our customers.”

Pepsi has had positive experiences thanks to its own due diligence. “I have not experienced problems with my contractors and I believe this to be a result of creating expectations from our very first meeting,” Yanora explains. “It usually takes several meetings before I’m satisfied that this person wants to be a part of the Pepsi Bottling Group in Detroit. I also write these expectations and make them visible to my counterparts and ask them to do the same so we have no misinterpretation.”

9. Lack of accountability

Is it enough to keep your equipment running, or do you want it to run faster, smarter and more efficiently?

The best service contracting agreements establish ownership and accountability, contain unambiguous contractual terms and provide incentives for performance improvements in the form of rewards and penalties.

Cameron is among the companies that incorporates rewards for performance improvements and penalties for unmet expectations. “For example, we can earn a piece of the electricity cost savings when we apply performance enhancements to equipment during an overhaul,” says Tackett. “Alternately, we can be penalized a percentage of the contract value if we fail to meet availability or efficiency targets.”

“We help our customers through upgrades and migrations, provide industrial performance services such as correcting process bottlenecks, and facilitate ongoing process improvements through methodologies such as Lean Manufacturing and Six Sigma,” says Bondenhamer.

“We take a balanced scorecard approach that aligns service targets with the customer's business objectives,” says Rahr. “The mutually agreed KPIs are monitored closely and serve to quantify the business benefits delivered to the customer. The scorecard is designed to measure continuous improvement, share risks and rewards, and serves as a communication tool with employees.”

10. Communication gaps

Communication breakdowns that occur when selecting a service provider, specifying agreement terms, performing contracted services or reporting results can cripple the potential of the program.

“People in the business office and the boiler room typically don’t know how to communicate with each other,” says Hansen. “When a company decides to hire an outside consultant, the consultant might be selected and signed off at the business office without consulting the boiler room about what’s really needed. The opposite is true when management enters into a contract that forces specific services onto the boiler room. Finding common needs and a common language are critical to minimizing communication gaps.”

To avoid this risk, Pepsi seeks out partner relationships. “I want a partner involved in my business, one who is seeking the same results from his or her service as I am expecting,” says Yanora.

Openly sharing equipment status and performance information is essential to ensuring that problems don’t escalate. ATS accomplishes this in several ways. They present performance metrics in monthly reports and make the data available through the Internet in real time. They provide a color-coded factory map that lays out the plant equipment and dynamically indicates the current machine status, which PMs are overdue, labor utilization, parts usage, machine performance, historical information and more. They ensure their service technicians are involved in the same meetings an internal maintenance department would attend, and that problems in production are communicated within minutes.

The rapid growth of service contracting is indicative of how a palpable need within the industry is suddenly being fulfilled. If you choose to incorporate service contracting into your operational strategy, being aware of its potential traps is essential to avoiding them in the first place.

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