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Trends in MRO Agreements

In a letter written in 1796 by the famous British Admiral Horatio Nelson, he makes an appeal to the ruling politicians to reconsider an order given for the Navy to evacuate the Mediterranean; the reconsideration based on a change of affaires in the region. In fact, rather than withdrawing, he recommends making a vigorous and desperate attempt to defend the area, led by Naval Officers exhibiting “more than common resolution”. It is in this letter that he utters his famous quote “desperate affaires require desperate remedies.” A more commonly cited proverb today is “Desperate times require desperate measures.” That we are in desperate times today does not require a vigorous defense. On the other hand, current remedies and measures being taken require a degree of contemplation. And so it is with some emerging trends in MRO RFP’s (Maintenance Repair and Overhaul, Request For Proposals), Agreements, and Contracts.

TREND: Your ability to get the MRO contract may be greatly influenced by your ability to buy the inventory and lease it back.

Airlines often have a mixture of aircraft that are outright purchases, and aircraft that are leased. This actually provides a degree of financial flexibility. For example, in bad times the airline can return leased aircraft to the leasers. The airline can also sell their purchased aircraft to a leaser and ask that they lease it back to them. Result? The airline just raised some cash and still maintained their capability to operate. In the Aircraft and Engine world this is not news, but this ability to raise cash has crept into other aircraft subsystems, and is increasingly coupled to MRO contracts. For example, an airline puts out an RFP for repair and overhaul of a family of parts. Conspicuously within the RFP is a Damocles-sword statement that, among other factors, “The selection of the successful Supplier may be influenced by the Supplier’s ability to purchase the entire inventory of affected parts, both spares and installed parts…” This reminds me of the military, when a ranking person comes up to you and says “I need you to volunteer to do this;” it’s a veiled order. There are several issues to be carefully considered before entering into this arrangement:

• MRO: An operator seeking to raise cash this way may be cause for concern. Is it because of financial distress? If so, how carefully have you evaluated their ability to pay their bills and to stay in business?
• MRO: How confident are you that the operator does not already have plans to retire the aircraft fleet using the parts you’ve purchased?
• MRO: How will you accurately assess the market value of the parts you are about to purchase? What type of leasing arrangement will you offer?
• MRO: If the operator has altered the fleet of parts with modifications or PMA’s for example, and you buy them, you’ll have to consider that if you ever need to sell these parts on the market, you’ll have to pay to have them de-modified or to have another operator go through the expense of approving them for their fleet.
• AIRLINE: Consider the enhanced negotiating position the Supplier now has; they own the parts that you need to operate. You can expect them to leverage this in future mediations

TREND: Pressure to buy extra spares for the use of the operator

For any airline, the level of spares is constantly being evaluated. If the operator is under-spared, what actions can it take? If a new MRO contract is out on RFP, the operator can ask for leaner turn-around-times. This would certainly alleviate the pressure to purchase more spares. The operator can also infer that the Supplier buy the necessary amount of additional spares to keep its maintenance stations adequately stocked. This trend too, requires careful consideration in these areas:

• MRO: How are you going to fund the purchase of additional spares? Do you have enough margins in the MRO contract to pay for this?
• MRO: In case the operator’s aircraft fleet is growing, how will you know if the operator is making the expected investment in the spares? What is to keep the operator from concluding that the MRO will make the investment instead?
• MRO: If you agree to inject additional spares in order to keep the operator’s stations properly stocked, does the agreement or contract contain penalties for not meeting stated turn-around-times? Imagine that you are meeting the stocking levels for the stations, but you miss some turn-around-times and are penalized for it, why? The point is that if you are going to invest in spares, insist that the Key Performance Indicator be the stocking of the stations, not your turn-around-time.
• AIRLINE: Consider the enhanced negotiating position the Supplier now has; they own the parts that you need to operate. Here too you can expect them to leverage this in future mediations

TREND: Multiple rounds of RFP competition

In an effort to get the very lowest quotes on proposals, some operators have instituted multiple rounds of competition. Here is a likely scenario: An RFP is issued to 12 MRO’s resulting in 8 respondents. The RFP asks the participants to give their very best response. After all have submitted their responses, the operator informs 4 of the respondents that they are in the final 4 and establishes a new deadline for those 4 MRO’s to amend their quotes to remain competitive. This may even extend to a third round with the final 2. Here’s some counsel:

• MRO: Unless conspicuously stated, always ask if the RFP is going to be a multiple round competition as just described. Reason: If you sincerely do your finest to offer your best and final offer on the first round of a multiple round competition, the next round may force you to erode returns below acceptable profit margins. If you have an established boundary for margins which you can’t cross, consider resubmitting the same numbers in the next round, after all, you may have been the price leader to begin with, and your competitors are the ones who have to amend their quotes.

TREND: Pricing concessions embedded in the Terms and Conditions

It used to be that the T&C section was boiler-plate legal lingo quickly reviewed and approved. The trend is to embed language that further chips away at the thin margin an MRO Supplier is exhibiting. Such language may include:

• Unusually generous discounts for early payments
• Annual price discounts for the MRO Supplier’s efforts to implement Lean initiatives, or Learning Curve Efficiencies regarding the contract. The idea being that the savings the Supplier will experience by implementing these initiatives should be shared with the operator.
• Restrictions on price escalations. For MRO’s, escalations on pricing are caused by two influences: Prices for parts, freight, and raises in labor prices. Any economist can easily demonstrate that all these rise over time, and incidentally these are not able to be directly controlled by most MRO’s. Imagine if Government stipulated that airline ticket price increases be capped at 3% annually even if fuel prices raised 100%.

TREND: Increased use of penalties

On the way into work recently I heard a radio station news story which revealed that certain cities, in an effort to gain more revenue, had placed new emphasis on issuing tickets for speeding, parking, and driving violations. It seems that certain operators have tapped into this phenomenon in a new effort to raise revenue. It comes in the use of language in contracts or agreements for penalties. These ‘speeding tickets’ typically address:

• Not meeting stated turn-around-times
• Not meeting stocking levels at the maintenance stations
• Penalties for delays
• Penalties for cancellations

In the darkened corridors of airline maintenance operations centers, fewer topics arouse more passion than discussion of delays and cancellations charged to maintenance. For example, a delay or cancellation due to lack of parts, or a part was replaced that failed upon installation and testing (AKA Defective from Stock). If the MRO contract has provisions for penalties, these will certainly be triggered.

• AIRLINE: If you charge a fixed amount per event (delay or cancellation), share the logic used to determine that amount with the MRO. These amounts vary considerably from operator to operator, and if the language in an agreement has these amounts, you can expect the MRO to negotiate the amount or language
• MRO: If you are going to be assessed a penalty for an event, you have every right to be presented the facts and reasonable access to the applicable airline documents. For example, what if you are being assessed a penalty for your part that failed on the aircraft, but on the next flight the crew writes up the same problem, and subsequently maintenance technicians replace a different part which apparently was the root cause. Do you think the airline system is sufficiently robust to get back to you to withdraw the penalty? Don’t bet on it. If the operator insists on the agreement having such penalty clauses, you should counter with the following or similar language: “Both parties acknowledge that in the event a penalty is being assessed, Supplier has the expectation to be provided, or have reasonable access to the Customer’s documentation so as to positively establish the basis of the penalty. This includes but is not limited to aircraft logbooks, electronic logbooks, Maintenance tracking, Maintenance Messages, and System Operations Messages.”
• MRO: It is not uncommon that the initial cancellation or delay cascades to subsequent delays until sometime in the day the aircraft’s schedule goes back to being on-time. If you are being assessed for the subsequent delays, make sure you have a way to positively determine that the delays were indisputably tied to the original event. Were the other delays due to common factors such as weather, ATC delays, or crew-time delays? This is why reasonable access to the aforementioned documents is vital.

TREND: The RFQ requesting the MRO provide sensitive financial information on how the pricing was determined.

One of the policies I generally support is that of ‘transparency’; sharing previously un-shared information with employees, suppliers, and customers. Generally, this transparency fosters better relationships and increased open dialog. In this trend however, the operator leverages the information in an attempt to manipulate the pricing. As I learned in Business School, the pricing of your product is one of the most difficult of exercises. In fact, your pricing may represent years of modeling and refinement, and you consider it to be sensitive, confidential, and even proprietary. Do you share it?

If these are desperate times, do these trends represent desperate measures? Your answer likely depends on which side of the negotiating table you are sitting on. If you are an operator fighting for the life of your firm, these measures won’t seem desperate at all, rather the logical actions of a determined business to survive the current malaise at all costs. If you are an MRO, these measures may seem a throwback to the ‘us versus them’ days; a digression from the era where the MRO was courted as a partner, a part of the team, and real awards were given to top performers. Regardless, we are all adjusting to the new environment and relearning through clenched teeth that we should not take it personally, it’s just business. Sign up for that charity golf event with your customer/operator and have some fun.

8/11/09

Roy Resto - VP Technical Operations, FAA-DAR
Phone: 414 875-2191   Fax: 414 875-0200
royboy@mbtrepair.com

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