Advanced services - contracts and modelling

Service Innovation | Dr Shaun West

Advanced services – contracts and modelling

Aston MBA Programme

1 March 2016

Dr Shaun West


ObjectivesBy the end of the class you will understand the importance of contracts and models

What do you know about service contracts?

Critical aspects of service contracts

How do you know the outcome from a service contract?

By the end of the class you will understand the importance of good contracts and why you should model their outcomes

Revenue and cost models for advanced services


WHAT DO YOU KNOW ABOUT SERVICE CONTRACTS?


What do you know about service contracts?Group work

Please work in groups for 20 minutes on the following-‐ Left side of the class work on the MAN Trucks advanced services case

-‐ Right side work on the Hitachi trains advanced services case

Be ready to share your thoughts with the rest of the class.

-‐ What are your top 10 issues you need the contract to control and why?

-‐ Describe the top 5 differences between service contracts and equipment contracts. It might help if you think of a car:-‐ when you buy a car-‐ when lease a car-‐ when you hire a care-‐ when it is repaired-‐ when it is serviced-‐ when you rent a car-‐ when you hire a taxi-‐ …

What did we find out?


What forms of service contact exist?Group work

Please work in groups for 10 minutes on the following-‐ Please build up a mind map showing what forms of service contact could exist?


What forms of service contact exist?Mind map of service contract forms

-‐ Who do we sell to?-‐ Why do they they buy?

Equipment

-‐ Assume services are for equipment

Site Services

O&M Services

Spare parts

AssetMgt

ConstructionInstallation

Craft labour

Service shop

CommissioningTech advice

Consulting

m-‐support

m-‐planned

O-‐support

O-‐optimisation

Trouble shooting

m-‐unplanned

Big ”M”Process integration

Big ”O”Full

"O&M”

Remote M&D

Strategic spares

Fleet mgt

Fleet optimisation

CMUs Consulting

Capital spares

Consumables

-‐ What are their outcomes?-‐ What options do we have to support them?


What forms of service contract exist?From one-‐time product sales to advanced service contracts

Where would you place:-‐ Transactional product sales-‐ Product sales with discounts and volumes-‐ Installation services-‐ Construction contracts-‐ IT service contracts-‐ O&M contracts-‐ Outsourced logistics-‐ Tolling agreements

Transactional Relationship

Nature of interaction

Product-orientation

Use-orientation

Outcome-orientation

Prod

uct

Cust

omer

Proc

esse

s

Prod

uct s

ervic

e sy

stems

Serv

ices

Not all advanced services require a long-‐term relationship


CRITICAL ASPECTS OF SERVICE CONTRACTS


Critical aspects of service contracts What are contracts for?

Group work-‐ In your groups create in 15 minutes why we need contract and what they help.

-‐ We will then spend time to share what we think the contracts are actually for before moving on.



Critical aspects of service contracts The contract is the written form of the customer value proposition

Important facts-‐ The contract is not the small print nor should it be left in the drawer to be forgotten

-‐ The contract describes the obligations of all parties-‐ The optional assumptions-‐ Communications and contract governance-‐ The contract is an organic document that evolves



Critical aspects of service contracts Buyer-‐Supplier risks, responsibilities and obligations

This model will be used to visualize where the risks lie

SupplierBuyer

Issue

The Buyer has responsibility and assumes the risks

There is some risk transfer to the supplier

The Supplier takes full responsibility and risk


Critical aspects of service contracts Scope, Covered Units and Terminal Points

The greater the scope provided and the greater the integration the higher the supplier risk

Issue

Parts

SupplierBuyer

ServciesLittle ”m”

Condition monitoring

Upgrades

Operational support

Big”M”

Little ”m” plus upgrades

O&M


Critical aspects of service contracts Owner’s Support Obligations

The obligations are part required and in part to facilitate getting the work done

Issue

Free issue parts

SupplierBuyer

All parts supplier issued

Supplier inventory

managementSupplier: to provide all

local supportBuyer: provide site support to

facilitate working

Buyer: to provide all

local support


Critical aspects of service contracts Operating Assumptions

Important as the cost model is based on specific operational assumptions

Issue

No change in assumptions allowed

Clear operational assumptions and process

to allow them to be updated

No operational assumptions given and fixed price

SupplierBuyer


Critical aspects of service contracts Monitoring of Performance and System Conditions

How can you use monitoring and diagnostics systems (iPhone 6 and lockout…)

Issue

System used only for checking on assumption breaches

Data is shared openly, no advice

Advice provided on O&M based on

monitoring system

SupplierBuyer

Joint root cause analysis

System used for billings


Critical aspects of service contracts Price, Payment and Performance Commitment

There are many, many ways to get paid…

Issue

Cost plus Fixed price/ fixed scope

Tariff based (pay per x)

SupplierBuyer

Consignment

Price list

Target price

Liquidated damages/ bonuses

Liquidated damages

Fixed escalation

Pay per outcome

Governance of performanceSupplier

currency Buyercurrency


Critical aspects of service contracts Term, Termination and Suspension

What is important for your customer and for you? You cannot force a relationship

Issue

TransactionalLong-‐term (>12 years)

Undefined

SupplierBuyer

Multi-‐year (<12 years)

Termination at buyer’s will

Termination for material default

Termination with fee

Termination at supplier's will

Suspension of 3-‐6 months


Critical aspects of service contracts Liabilities and Warranties

The project should never risk the sustainability of your business

Issue

12 months from delivery

SupplierBuyer

Fix first breaking part

In/out costs

Evergreen

Consequential material damage

Consequential business damage

12 months from use

Post service performance

PO value Contract value

Annual contract value

Parent Company guarantee


Critical aspects of service contracts Choice of Governing Law and Dispute Resolution

Will English Common Law work in the country you are working in?

Issue

Supplier Law English Law Buyer Law

SupplierBuyer

Independent arbitration

Court

Code Law

German (Code) Law


Critical aspects of service contracts Delivery, Title Transfer, Repair Services Logistics and Inventory Utilization

How would you define delivery of an inspection or a repair service?

Issue

EXW

SupplierBuyer

DDP DDU EXW + logistics support

May use buyer’s inventory

Must use buyer’s inventory

Right to reject buyer’s inventory

Logistics support

Title of scrap is with supplier


Critical aspects of service contracts Site Conditions, Hazardous Materials, Health and Safety

The supplier must be able to walk off site when site conditions are dangerous

Issue

Must work in site conditions given

by buyer

SupplierBuyer

Supplier has right to declare site

conditions/materials as dangerous

Country risk


Critical aspects of service contracts Taxes and Duties

Even with EXW-‐basis there are taxes/duties that the supplier cannot ignore

Issue

EXW-‐basis

Permanent site establishment

DDP-‐basis

SupplierBuyer

Import/export of temporary tools

Withholding taxes


Critical aspects of service contracts Insurance Coverage

The Supplier should not act as an insurance for the Buyer

Issue

Names on the Buyer’s insurance

policy

Damage to Buyer’s property via Gross

Negligence

3rd Party Liability

SupplierBuyer

No waiver of Subrogation

Accidental damage to Buyer’s property

Supplier accepts care and custody

Deductible with cap for accidental damage of Buyer’s

property


Critical aspects of service contracts Indemnification

Indemnification is very technical and important for business sustainability

Issue

The Buyer has responsibility and assumes the risks

– Supplier is indemnified

Note: It is not possible to indemnification for ”Willful Misconduct or Gross Negligence” but it is possible to carve out what is ”Gross Negligence”. Cap on indemnity, period limit for claims.

The Supplier takes full responsibility and risk –Buyer is indemnified

SupplierBuyer

The Buyer indemnifies the Suppler for damage away from the equipment being worked on

The Buyer indemnifies the Supplier for accidental damage

on the equipment being worked on (or provides a cap)


Critical aspects of service contracts Force Majeure, Excluded Events, Unforeseeable Events and Compensation

Core Article in a multi-‐year contract must be included in some form

Issue

Both clearly defined Not included

SupplierBuyer

Not included


Critical aspects of service contracts Laws, Codes and Standards

It is impossible to understand what will happen in the future with governments!

Issue

Costs associated with changes in Laws, Codes or Standards to

Buyer’s account

SupplierBuyer

Costs associated with changes in Laws, Codes or Standards to

Supplier’s account

Costs associated with changes in Laws, Codes or Standards in suppliers

operational countries to

Supplier’s account

Costs associated with changes in Laws, Codes or Standards in suppliers

operational countries to

Buyer's account


Critical aspects of service contracts Critical aspects of Service Contracts vs EPC Contract “musts”

-‐ Buyer-‐Supplier risks, responsibilities and obligations

-‐ Scope, Covered Units and Terminal Points

-‐ Owner’s Support Obligations-‐ Operating Assumptions-‐ Monitoring of Performance and

System Conditions -‐ Price, Payment and

Performance Commitment-‐ Term, Termination and

Suspension-‐ Liabilities and Warranties-‐ Choice of Governing Law and

Dispute Resolution-‐ Delivery, Title Transfer, Repair

Services Logistics and Inventory Utilization

-‐ Site Conditions, Hazardous Materials, Health and Safety

-‐ Taxes and Duties-‐ Insurance Coverage-‐ Indemnification -‐ Force Majeure and Excluded

Events-‐ Laws, Codes and Standards

-‐ Coming into force – no work before

-‐ Warranties & Performance Guarantees – definition, period, exclusive remedy

-‐ Indemnification – exposure to negligence, capped, limit claim period

-‐ Limitation of Liability -‐ on all types of damages, NO Consequential Damages

-‐ Force Majeure – unforeseeable events, grant time and costs

-‐ Change Order provisions – must be compensated (time & cost)

-‐ Exclude responsibility for Client responsibilities

-‐ Intellectual Property protection-‐ Arbitration Clause-‐ Deemed Acceptance of work /

documents after specific review period

-‐ Rejection – remedy defined

Services EPC

“Law is not common sense – No oral commitments; No unlimited commitments (time or scope)”


HOW DO YOU KNOW THE OUTCOME FROM A SERVICE CONTRACT?


How do you measure the outcome from a service contract?Group work

Please work in groups for 20 minutes on the following-‐ Left side of the class work on the MAN Trucks advanced services

-‐ Right side work on the Hitachi trains advanced services

Be ready to share your thoughts with the rest of the class.

-‐ Describe how you would measure the effectiveness (client’s view) of an advanced service contract

-‐ Describe how you would measure the efficiency (supplier view) of an advanced service contract



How do you measure the outcome from a service contract?Measuring outcomes

Effectiveness (in the view of the Buyer) and Efficiency (in the view of the Supplier) must be measured -‐ Did it deliver the outcome the buyer was expecting

-‐ NPS (or other)-‐ Sales, costs, margins, on time etc-‐ What could be improved?

Closing)projects)with)impact))

40!!

!

Figure!54!The!project!closeout!canvas!!

!Measure service contract outcomes regularly and share lessons


REVENUE AND COST MODELS FOR ADVANCED SERVICES


Revenue and cost models for advanced servicesLet’s look at the business model canvas

Important facts-‐ Costs should be less than revenues in the long run-‐ Both must be modelled-‐ Accounting rules have important impact

-‐ sales recognition and POC-‐ Often risks can be embedded

-‐ exchange rates, escalation and are not well understood

What are the most important costs inherent in our business model? Which Key Resources are most expensive? Which Key Activities are most expensive?

Through which Channels do our Customer Segments want to be reached? How are we reaching them now?How are our Channels integrated? Which ones work best?Which ones are most cost-efficient? How are we integrating them with customer routines?

For what value are our customers really willing to pay?For what do they currently pay? How are they currently paying? How would they prefer to pay? How much does each Revenue Stream contribute to overall revenues?

For whom are we creating value?Who are our most important customers?

What type of relationship does each of our CustomerSegments expect us to establish and maintain with them?Which ones have we established? How are they integrated with the rest of our business model?How costly are they?

What value do we deliver to the customer?Which one of our customer’s problems are we helping to solve? What bundles of products and services are we offering to each Customer Segment?Which customer needs are we satisfying?

What Key Activities do our Value Propositions require?Our Distribution Channels? Customer Relationships?Revenue streams?

Who are our Key Partners? Who are our key suppliers?Which Key Resources are we acquiring from partners?Which Key Activities do partners perform?

What Key Resources do our Value Propositions require?Our Distribution Channels? Customer Relationships?Revenue Streams?

Day Month Year

No.

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Revenue and cost models for advanced servicesGroup work

In your groups and using the business model canvas list the cost structures/revenue streams you need to understand. -‐ How could you model the costs and the revenues? -‐ What is the difference between the costs and

revenues?-‐ What happens when costs are driven differently to the revenues?











Day Month Year

No.




Revenue and cost models for advanced servicesRevenue streams

The revenues streams are fees in the contact, some fixed, some variable some performance based










Day Month Year

No.



Fixed• Mobilisation• Annual fees• Lump-‐sum fees• Upgrades• Monitoring

Variable• Per x usage

Performance• Bonuses• Liquidated

damages

Out of scope• List prices• Lump sum• Time and

materials• Waiting time


Revenue and cost models for advanced servicesCost drivers

Costs are fixed, variable, not all costs are controllable










Day Month Year

No.



Fixed• Condition

monitoring• Project

management• Site

management• Mobilisation

Variable• Parts• Planned

inspections• Warranty

Performance• Productivity

improvements• Escalation• Bonuses• Liquidated

damages• Management

effort

Out of scope• List prices• Lump sum• Time and

materials


Revenue and cost models for advanced servicesWhat is between the revenues and costs

-‐ Accounting rules, sales recognition vs cash-‐ Deferred cash flows-‐ Value at risk calculations for performance issues-‐ Cost escalations (inflation adjustments)-‐ Project Gross Margin vs NPV

Accounting rules are important for the back office, for the front office good project management










Day Month Year

No.



Fixed• Mobilisation• Annual0 fees• Lump5sum0fees• Upgrades• Monitoring

Variable• Per0x0usage

Performance• Bonuses• Liquidated0

damages

Out0of0scope• List0prices• Lump0sum• Time0and0

materials• Waiting0time

Fixed• Condition*

monitoring• Project*

management• Site*

management• Mobilisation

Variable• Parts• Planned*

inspections• Warranty

Performance• Productivity*

improvements• Escalation• Bonuses• Liquidated*

damages• Management*

effort

Out*of*scope• List*prices• Lump*sum• Time*and*

materials

Risk…


CLOSING


ClosingIt is important to always model the service contract

You have an understanding of what is in a service contract

You understand the critical aspects of service contracts

You have ways to assess the outcome of the service contract

You now understand the importance of good contracts for advanced services and why you should model them

You understand the modelling of advanced service contacts


Thanks for your time!

Advanced services - contracts and modelling

Engineering

Transcript of Advanced services - contracts and modelling