Performance contracting: Gaining competitive advantage

Editor's note: This is the second of a two-part series. Clearly, there is no universal best approach for performance contracting. The specifics of your strategy, situation, and goals ultimately must dictate your approach. However, my experience with performance contracts in numerous industries serving companies large and small, with diverse visions, strategies, and operating philosophies sugges...


Clearly, there is no universal best approach for performance contracting. The specifics of your strategy, situation, and goals ultimately must dictate your approach. However, my experience with performance contracts in numerous industries serving companies large and small, with diverse visions, strategies, and operating philosophies suggests that the more successful users of performance contracting have similarities.

The Focus process for outsourcing services assures achievement of long-term strategic objectives while producing quick business results. Maximum impact is achieved by minimizing departmental barriers and constraints to real competitive advantage. Although capital improvements are not excluded, the primary objective is to enhance long-term competitive advantage by renewing or replacing suboptimal work processes and systems, and by aligning the skills, knowledge, attitudes, and behaviors of the plant workforce with the required changes.

Another major objective of the Focus process is quick, quantifiable successes. Eliminating plant bottlenecks and cost drivers optimizes the discounted rate of return from improvement expenditures while generating enthusiasm for the improved processes and systems. As opposed to downsizing, labor issues are minimized with the theme of skills enhancement, safety improvement, and throughput increases. Initially placing high priority on activities that generate value quickly with high workforce receptivity usually makes the Focus process self-funding.

Focus process for outsourcing services


The first step in the process is visioning . During visioning, the owner's executive management team creates a vivid working description of the desired business operations in the future. Facilitated by external resources, executive management meets to create vision for performance-based partnering. Deliverables include:

  • Future state description

  • Outsourcing approach to gain/maintain competitive advantage

  • Goals and target metrics for improved operating performance.

    • Alignment

      Often with external support, the management team then determines what competencies their company must have to achieve their vision. The team will also identify the company's existing and missing core competencies, as well as activities to consider for outsourcing. Relative to future state, management team agrees on:

      • Required competencies that should not be outsourced

      • Existing competencies that could be outsourced

      • Missing competencies that should be outsourced

      • New competencies that must be developed.

        • Strategies

          During the third step of the Focus process, the management team (or focus groups established by the management team) develops strategies for the activities to be outsourced. The strategies address sourcing, sequencing of outsourcing activities, and partnering philosophies. Operations and maintenance leadership establish implementation strategies:

          • Work packaging

          • Partnering vs. conventional contracting decisions

          • Timing

          • Priorities

          • Impacts on key metrics

          • Trade-off and sensitivity analysis.

            • Assessment

              Focus groups next evaluate the business case for the outsourcing options being considered. Savings opportunities, resource requirements, and transition schedules are quantified to create what becomes the performance contract basis.

              The objective of the assessment is to quickly identify the value drivers and the estimated value of outsourcing maintenance and other services. The outline of a plan to assemble the needed resources, programs, and procedures also results from the assessment step.

              The assessment team may be composed of both owner and contractor personnel. An ideal team includes the following personnel for two to four weeks:

              • An experienced assessment team leader who has completed similar assessments

              • Owner's prospective contract representative

              • Specialists from the contractor's industrial relations, maintenance echnology, training, operations technology, and legal departments

              • Management or specialists from the owner's engineering, human relations, and operating departments.

                • The assessment team's first task is to evaluate operations, maintenance, and plant support improvement opportunities achievable through an outsourcing partnership. This evaluation includes:

                  • Performance objectives and metrics

                  • Organizational structure, staffing, roles and responsibilities, skills of current resources, and internal customer interfaces

                  • Costs, budgets, and capital spending

                  • Planning and management methods for the work to be performed

                  • Daily planning and scheduling processes

                  • Shutdown planning, scheduling, and management procedures and systems

                  • Contracting strategies

                  • Logistics planning and management

                  • Preventive and predictive maintenance programs

                  • Safety programs and practices

                  • Wage and salary structures

                  • Labor relations and personnel policies and procedures

                  • Plant quality assurance, control, and management processes

                  • Equipment-related downtime, delay, product reject, or defect causes and consequences

                  • Downtime, equipment failure, and plant reliability improvement processes

                  • Training programs and practices.

                    • To complete the evaluation, the team performs the following:

                      • Assess the facility's culture and change constraints, including attitudes, morale, value systems, paradigms, and organizational alignment

                      • Benchmark costs and other performance measurements

                      • Identify potential improvements achievable through a performance-based plant services partnership and the activities and resources necessary to realize those improvements

                      • Evaluate the liabilities, risks, and value to the owner in achieving potential improvements

                      • Identify organizational and technical impediments and risks associated with prospective improvements.

                        • Risk/reward assessment of outsourcing options includes:

                          • Labor relations impacts

                          • Preliminary cash flow analysis

                          • Selection of outsourcing partner(s)

                          • Savings opportunities

                          • Resource requirements

                          • Transition strategies

                          • Decisions to proceed.

                            • Commitment

                              Development of a working relationship and commercial basis for partnering, good definition of roles and responsibilities, work process changes, and win/win terms are crucial outcomes of this step.

                              Commitment usually starts with a memorandum of understanding that outlines intended terms, contingencies, and schedules for the outsourcing contract. The plant owner then announces to the workforce his intent to outsource selected services. Following that announcement, the partner begins discussions with candidates for transitioning employment. The contractor's site management team is assembled as the due diligence process begins.

                              During the due diligence effort, the conceptual business case, prepared as part of the assessment, is detailed and validated. Contingencies in the memorandum of understanding are researched to eliminate them or to plan how to address them. The transition plan for outsourcing is detailed and performance baselines are finalized.

                              The commitment activity ends with final negotiations of the performance-based outsourcing contract. Contract metrics often include cost control, safety, plant reliability, customer satisfaction, first-pass yields, and production rate. Financial incentives for contractor employees are usually based on these same metrics. Depending upon the situation, labor agreements and arrangements for asset transfers may be finalized.

                              Development of a performance-based contract involves outsourcing partners and includes:

                              • Memorandum of understanding

                              • As-is vs. future-state metrics

                              • Work process design/redesign

                              • Roles and responsibilities

                              • Refined business case

                              • Win/win commercial terms

                              • Transition planning

                              • Establishment of new management team

                              • Final contract negotiation.

                                • Transition

                                  The outsourcing transition starts with a detailed mobilization plan. Other early activities include implementation of work process changes and a significant amount of communications and training.

                                  Some of the other activities include:

                                  • Mobilization of site management team

                                  • Relocation of personnel

                                  • Site/plan orientation

                                  • Client team building

                                  • Establishment of site policies/procedures

                                  • Establishment of contractor offices and work areas

                                  • Site-specific training and education

                                  • Contracting plan

                                  • Selection of preferred suppliers

                                  • Safety orientations

                                  • Enhancement of the predictive maintenance effort and/or development of failure analysis and removal programs, if appropriate

                                  • Upgrades to planning, stores, or training programs

                                  • Customization of the maintenance value awareness approach

                                  • Establishment or refinement of asset management system

                                  • Establishment of tracking and metrics required under the performance-based contract and contractor standard practices.

                                    • As these activities progress, the contractor completes interviews of members of the hourly workforce who are candidates for transfer. New or additional employees are recruited. The process includes structured interviews and skills and validated socio-technical tests. Sometimes, it is necessary to work with leaders of the plant bargaining unit to establish or transfer a labor agreement. Next, the contractor takes responsibility for executing the outsourced services. Normally, the following begin:

                                      • Work by all new and transitioned employees on contractor's payroll

                                      • Use of the contractor's work management system, practices, and procedures

                                      • Certification and on-the-job training of technicians and craft personnel

                                      • Tracking of the performance metrics specified in the outsourcing contract and contractor's standard practices.

                                        • Transition to work includes:

                                          • Contractor consolidation

                                          • Establishment/modification of management systems

                                          • Alignment and training of owner and partner personnel

                                          • Work process changes implemented

                                          • Transfer/redeployment of owner or contractor employees.

                                            • Improvement

                                              During and after the transition phase, the contractor's quality process relies on formal and structured use of the plan-do-check-act (PDCA) cycle that includes performance monitoring, routine management reviews, aggressive implementation of incident and action item reporting, and a simultaneous focus on results and work processes.

                                              In concert with the owner's planning cycle, an annual value creation plan is established to help steer the contractor's work force toward cost reduction and throughput improvement. Systematic failure elimination (see PLANT ENGINEERING, October 2002), audits, and benchmarking are tools to identify and capitalize on improvement opportunities.

                                              The PDCA cycle is a program of:

                                              • Routine steering and executive team reviews

                                              • Discipline in incident and action item reporting

                                              • Key results and key process indicator reporting

                                              • Value creation program implementation.

                                                • Summary

                                                  Properly applied performance contracts increase a manufacturing company's competitive advantage by leveraging the capabilities of its service suppliers, improving the cost effectiveness of purchased services, and reducing the risks of outsourcing. Improperly applied performance contracts are administrative nightmares. The difference between success and a failed experiment lies in the strategy, skill, and discipline of those applying the tool.

                                                  <table ID = 'id3007750-0-table' CELLSPACING = '0' CELLPADDING = '2' WIDTH = '100%' BORDER = '0'><tbody ID = 'id3008664-0-tbody'><tr ID = 'id3008401-0-tr'><td ID = 'id3008534-0-td' CLASS = 'table' STYLE = 'background-color: #EEEEEE'> Author Information </td></tr><tr ID = 'id3001630-3-tr'><td ID = 'id3008395-3-td' CLASS = 'table'>Jim Humphries, vice president of performance technology for Fluor, has spent over 25 years in operations and maintenance, inspiring step-change improvements in manufacturing, purchasing, materials management, quality, maintenance, engineering, human relations, training, and marketing. He can be reached at .</td></tr></tbody></table>

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