How popular performance based supply chain contracts are?

Filed in archive Point of view on April 9, 2009

During the last month I had to work on a cost reduction engagement in a client and had to go to client's main factory everyday. I tried to enjoy having a lot of time in the train and used my iPod to listen to a Wharton podcast series on logistics.

One of them which I liked the most was an interview with Serguei Netessine, professor of operations and information management at Wharton. Serguei and another colleague at Wharton. They have introduced a new concept in supply chain contract management (well, for supply chain people in certain sectors it's not that new...) called performance based logistics.

The new term has its roots in Serguei's with supply chain at Department of Defense. In the recent years, what the Department of Defense wants from Lockheed Martin is a performance-based contract. What does it mean?

Previously, the Department of Defense would ask their suppliers to open their books and basically report to the Department of Defense how much money they spent on maintenance of military equipment. And then the Department of Defense would reimburse those suppliers and maybe give them a little something to make a small profit margin. That is how it used to work.

But now, under the new scheme, Lockheed Martin doesn't get paid if an airplane doesn't fly. And this is a very radical transformation, a very radical departure from the way the Department of Defense used to operate let's say 40, 50 and even 10 years ago.

Serguei believes that this new form of working together is a win-win situation as services normally have more margin for the suppliers and allow them to have more flexibility on the spare parts and buyers benefit from reduced costs and higher quality of service.

What do you think? Other other sectors, beside automotive, which use performance based contracts?