Picture the board room at our biannual business meeting: our senior management team faced costly problems involving the Major Surface Ships Branch within the Australian Department of Defence.
Our team were responsible for maintaining the materiel seaworthiness of 11 frigates, two tankers, three amphibious ships and six heavy landing craft. Our acquisition budget in Australian currency for new equipment was $306.0M and our budget for repairing and maintaining existing equipment was $252.6M. But underlying obstacles presented deeper challenges relating to our contract relationships.
Our contractors were:
- deliberately under-bidding their price to capture work and then expanding the emergent work volume (project growth) to attract inflated labor rates (30% penalty margins);
- offering artificially shortened and unachievable schedules knowing that they were usually safeguarded somewhere by Defence-induced excusable delay; and
- playing down risk because they weren’t expected to account for the outcome.
These behaviors -- plus the the adversarial relevance of imposing a fixed-price contract onto a variable scope -- ensured unproductive liaisons and win-lose values. We were hard pressed to find trust and respect. Management wanted a bigger ‘stick’ and the hearty determination to use it. They never got their stick!
We searched for an alternative approach through collaboration. Harnessing the power of the relationship is a tough journey, but our effort transformed and then cultivated an ethos that continues today. Here’s how we did it.
We integrated our contracts to be the enablers of our relationships.
Our approach centered on providing industry with greater predictability, certainty and stability in the scope of work and timeframes for repairing and maintaining the Navy's major fleet units; we did the following:
- We moved away from throughput-based profit making towards efficiency-based profit making. Specifically, we created the learning organization and increased our focus on innovation, creativity, conditioned-based maintenance, and pre-refit assessment; and we challenged the traditional norms of how business was done.
- We provided greater predictability of work-effort, refit location, and overall ship availability. This meant challenging the current usage upkeep paradigms and practices, without compromising safety or overall platform availability.
- We presented Navy with greater certainty of maintenance duration and completion date by incorporating programming flexibility while taking advantage of windows-of-opportunities outside normal maintenance ‘down time’.
- We offered greater stability by encouraging industry to invest in their strategic skill sets, equipment and facilities; and we incentivized industry to be our partner secure in the belief that reward results from performance and efficiency.
To keep this focus alive, we realized we had to get our own organization’s culture, business framework and contractual motivations right, with the aim that cost efficiency would then arrive by itself. So, our driving imperative became more about the relationship and behaviors that we wanted to encourage.
… but what about the strong arm of resistance?
Articulating this approach was always going to be difficult within a government environment that demands cost savings. Then we had to implement it through the business units where corporate-imposed change is usually viewed with distrust and treated as unwelcomed interference.
Our key objective was to develop a culture of greater cooperation between the Department of Defence (referred to as ‘Defence’ in this article) and industry by aligning contract rewards to capability outcomes and to drive best practices through incentives for service delivery specific to performance, time and cost parameters.
Our further objective was to establish equitable sharing arrangements of risk and reward; to achieve mutual benefit from gain-sharing opportunities; and to establish a fair balance between the different motivational drivers present, specifically, value for money spent by Defence and reasonable returns to industry.
To be successful, we needed to introduce performance-based, relational contracting methods vice the more transactional, fixed-price ship-repair contracts that existed. Performance based contracts are designed to emphasize results related to output, quality, and outcomes rather than how the work is performed. They use clearly defined objectives and timeframes, measurable performance standards, quality assurance plans and provide performance incentives that tie payment directly to these outcomes.
We realized that our existing contracts needed restructuring. We developed what became known as Group Maintenance Contracts (GMCs) (production maintenance and supply support contracts) which by nature were:
- grouped-asset (the entire class of a particular ship type under one contract);
- long-term (5 years – single year target cost estimate within a rolling 3 year planning forecast);
- ‘rolling-wave’ award term (where efficiency is rewarded by contract extensions after year 2, ensuring a rolling planning envelope in excess of 3 years);
- incentivized payment (through a Weighted-Payment Regime and an Incentive Profit Regime); and
- performance-based with all profit at risk through Key Performance Indicators (KPIs).
The GMC’s Statement of Work includes:
- engineering change production and implementation;
- maintenance support, production and implementation, defect rectification, work package determination, planning and scheduling; and
- supply support (material supply management, material list development and management, and progressively phasing in procurement and management of consumables and repairables).
In developing our proposals we engaged heavily with our industry counterparts and searched for innovative practices in the Oil & Gas and manufacturing industries. Through a balance of ‘payment’ and ‘non-payment’ incentives and remedies, we eventually settled on motivating the GMC’s ‘prime’ sustainment contractor, via a Target Cost Incentive Contract model, to:
- operate continually at an efficiency level near or at 10% greater than historical data (via a Weighted Payment Regime);
- seek realizable production cost reductions actively through innovation (via an Incentive Profit Regime);
- verify costs with Objective Quality Evidence, ensuring that closed-out tasks in Navy’s IT tool (Asset Management Planning System) were the only basis for paying the contractor’s Direct Variable Costs;
- operate safely (as an actual measure via Lost Time Injury Frequency Ratio KPI) and to have an effective Safety Assurance program;
- complete tasks on the Annual Approved Work List (The subject of the Target Cost Estimate (TCE)) at the designated certification standards (via KPIs);
- manage the maintenance program to maintain the ship’s materiel certification and data integrity (via KPIs);
- deliver the ship out-of-maintenance, with its materiel certification, on time (via KPIs);
- build the relationship through mutual trust, openness in communication and recognition of mutual aims (guiding rolling-wave extensions);
- build Value-for-Money through performance effectiveness, efficiency, economy; and
- invest in the Sector’s work-force skill development and infrastructure (through contractual stability and longevity).
The relational bed
That was the structure, but it needed the ‘relational bed’ to sit upon and a ‘change-management’ imperative to get there … we needed to melt our iceberg.
Critical to this ‘relational bed’ were the nine tenets of Relational Contracting posed by IACCM1. Briefly these are:
- mutual objectives
- performance measurement
- problem solving
- no blame culture
- joint working
- continuous improvement
- gain and pain sharing
- risk allocation and mitigation
These nine tenets formed the Relational Charter between all the stakeholders that had a materiel interest in the broader enterprise of getting our ships to sea, safely, in a materielly seaworthy condition, on time, every time. They include various organizations within Navy and Defence, the GMC contractor, the Combat System contractor and the other commercial entitities involved in Integrated Materiel Support.
Most importantly, we felt that the behavioral-based Enterprise Charter2 that supported this relational initiative had to be dynamic, owned, and self-assessed against the commitments that the owners of the charter had made.
The self-assessment alone, undertaken at the Relational Workshops, enabled us to evaluate business-to-business interactions and raise issues in a safe environment which, in practice, is less confrontational and more resolution-focused than other evaluation or assessment methods. Our self-evaluation and the open and free discussion that it generated seemed to break down commerciality-based barriers.
Moving from antagonism to high-performance relationships
Within the first three months of signing the first of our GMCs (for the ANZAC Class frigates) we achieved three objective and tangible outcomes:
- We reduced hidden waste in scope of work and repair. We found that emergant growth was as much a cultural issue (we have always done it this way) as it was a hidden determinant in ship repair and maintenance practice.
Specifically, we needed to define the outcome objectives and level-of-work effort of the TCE as the baseline for determining efficiency. This allowed us to develop our Task List (our Standard Products and our Standard Activity specifications that make up the Statement of Work) to more accurately define the work scope as specified by the contract.
- We saved 20% cost at outset through open competitive competition. We now have tangible evidence that we achieved a 20% cost saving for a given scope of work (based on a representative TCE) compared with exactly the same scope of work using historical data.
- We rewarded innovation. The tender responses alone generated many innovative ideas, new products and business approaches that made sense. We still needed to further evaluate these ideas and products and understand the risk(s) associated with them but we had immediately changed our culture. We had moved from measuring the ‘cents’, to becoming a learning and an adapting organization. It was no longer good enough to answer ‘we have always done it this way’.
Over the following 18 months, the outcomes saw:
- improvements in Defence’s understanding of their maintenance and repair liability through the cleansing of technical and maintenance data;
- the on time delivery of ships back to Navy at the end of maintenance periods with all maintenance and repairs acquitted;
- ongoing enhancement of technical work instructions (data structure improvements);
- better management of safety critical ‘certified’ items;
- the clearing of legacy defect reports;
- early identification and staging of required inventory (spare parts and stores);
- better integration of planned, emerging and external work packages into the master schedule; and
- the direct application of lessons learned into the next dedicated maintenance activity. This, in turn, has substantially improved the materiel availability and sustainment efficiency of the ships themselves.
From an overview perspective, we have seen a 60% reduction in overall project management and corporate overhead costs due to the longer term nature of the relationship and the consistency of project management functions over time. This improvement has also allowed specifications and task descriptions to be developed that more accurately define the work scope being contracted — which means that the contractor had a much better idea of Defence’s needs and expectations, and of his own work flow, volume, scheduling and workforce requirements.
By 2017, the Adelaide Class frigates were reporting:
- an increase in material availability, from 82% of days available (from their Usage Upkeep Cycle) in 2012 to 106% of days available throughout 2016 and 2017; and
- tangible cost savings exceeding Aust$28M per year arising from a 45% savings on like-for-like scope of work, 46% reduction in cost per task, 43% reduction in labor hours per task, and a 44% reduction in labor costs per hour. As a measure of reliability, Material Ready Days (ship being available for operations) rose from 206 days per annum per ship in 2014 to 298 days in 2017.
The relational journey had, by that time, aligned the leadership to to encourage inter-company Lean Six Sigma transaction business processes improvements; engage more closely on recruiting to ensure better cultural fit; increase communications, and recognize the empowerment of junior managers — trust.
We had progressively achieved consistent and predictable outcomes for all work undertaken. This included establishing, executing and improving approved planning and management processes, safety and environmental practices and maintenance routines with a long-term view to their application.
The Power of the Relationship
In conclusion this journey is far from over. Those involved are a little wiser, and certainly wise enough not to profess to know all the answers. But for those in similar circumstances trying to introduce a relational paradigm to a traditional contracting environment, we have tried to articulate some lessons that may be helpful:
- Create the motivation and you will create the behavior. Commercial operatives generally work to achieve a commercial advantage or their best commercial outcome to any given situation.
- Commercial behaviors follow commercial incentives. Too many professional relationships are thwarted, despite their best efforts, by the commercial motivations of the contract framework they have entered into. To stand any chance of success, you have to align the motivations generated by the contractual framework and the requirements of the business relationship.
- Culture trumps policy every day. Too many senior managers think they can change culture through policy … it doesn’t happen.
- Perception is fact … manage perception. Arguments are not won by being factually correct, or by insisting your version of the truth is the correct one. If perceptions differ, manage that difference.
- The most difficult and most important aspect of change management is stakeholder management. Your stakeholders need to be on the same journey that you are on.
- Never underestimate the power of storytelling. People relate to stories. People remember stories.
- Cost efficiency is the byproduct. Concentrate on the inputs, constraints and culture. Get the inputs, constraints and culture right and the cost efficiency will arrive by itself.
- True competition realizes (at least) a 20% plus cost saving. But competition not a ‘blanket’ to be thrown over everything. Competition needs considered diligence and environmental relevance as to applicability.
- In today’s outsourcing environment, Government entities (Defence being one) do not appear to realize direct savings through economies of scale (Industry does). But it does benefit by creating the environment where resource levelling and mitigating risk can occur.
- Key Performance Indicators are “nudge” metrics to focus on a behavior or an outcome; if they become “sticks”, they will change behaviors to that which mitigates against the “stick”.
- We need both the supplier and the customer to collaborate to tackle the constraints that oppose efficiency optimization (standard Constraint Theory does actually work).
- Asset management is not a plan, it is a philosophy and a methodology which needs to be embedded as standard practice within all plans. Contracts and relationships should also be seen as assets, and the high yield assets (i.e., contracts and relationships) require segmentation, prioritization and suitable investment.
- Collaborative enterprises can be efficiency linked through communally accepted and incentivized enterprise outcomes. It is all about strategic alignment and inclusiveness across the breath of the enterprise.
- We, in Government, must provide our industry partners with the stability, security of tenure, a commonality of contract expectation, and a manageable and predictable level of effort that they can grow efficiencies from.
The relational contracting model works — it’s about the deliberate pursuit and systematic management of post-signature contract value; it’s about the relational investment in the long-term opportunity.
- Case study shows the Relational Contracting Model may be changing the contracting process, Contracting Excellence Magazine, 15 June 2013.
- See presentation titled, Leading Collaboration and Culture to Achieve Transformation – AUSTRALASIA CONFERENCE 2016 – Captain Greg Laxton Director FFGSPO, Chair Enterprise Governance Board