Results-based supplier relationships improve maintenance effectiveness

Matthew G. McKenna
Booz Allen & Hamilton Inc.
Houston

About this report...

This report shows ways to reduce refining maintenance costs by optimizing supplier relationships, eliminating defects, and conducting risk-based inspection. These and other topics are highlighted in this Refinery Maintenance Management report.

While more gains are possible through improving internal maintenance programs, many refiners around the world are looking to suppliers of materials and services for the next wave of maintenance cost and reliability improvements.

A focus on such results-based maintenance programs is expected to reduce costs, increase productivity, and more-accurately define expected deliverables.

Leading refiners have implemented many new maintenance approaches over the past several years. As reported in Oil & Gas Journal and elsewhere, companies are employing various techniques, including reliability-centered maintenance (RCM), total-productive maintenance (TPM), and risk-based inspection (RBI), to lower maintenance costs and improve reliability (OGJ, July 27, 1998, p. 86).

Results of maintenance-program implementations have varied, but in most cases significant improvements have been realized.

For example, one North American refiner implemented a set of new maintenance programs in the 1990s that incorporated many of the leading maintenance techniques. Its results were impressive. The refiner lowered its maintenance costs by more than 30% (as measured by Solomon's maintenance index of $/equivalent distillation capacity) and realized a two-point improvement in average mechanical availability.

Apart from these internal maintenance-management programs, several refiners are implementing results-based programs. Refiners in Asia, Europe, and North America are aggressively pursuing new approaches to managing supplier relationships.

These refiners fully realize that a significant portion (more than 20%) of the cost of running a refinery is for materials and services provided by suppliers. These costs typically exceed costs of refinery employees (Fig. 1 [39,587 bytes]).

Additionally, refiners are increasingly realizing the potential for suppliers to enable improvements in onstream time and resultant profitability. For example, one refinery decreased lost product revenue from turnarounds by $2 million through better integrating contractors into the maintenance program and reducing turnaround time.

Result management

Many refiners recognize the impact of suppliers on their costs and reliability and have addressed this impact through various initiatives. Popular phrases include "supplier management," "supply-chain optimization," and "contractor productivity."

Previously, relationships with suppliers have largely focused on managing costs rather than managing results, or outputs.

The airline industry is one industry that has changed in order to manage results. Airlines and jet-engine manufacturers traditionally negotiated detailed costs for replacement parts and services. After recognizing that the real output for the airline was having engines in operation, engine manufacturers began to offer "power by the hour" programs. In these arrangements, the airlines paid for units of output (hours of operation), rather than inputs like parts and labor.

For refiners, this concept of paying for outputs vs. costs (inputs) has broad application to procured materials and services. For example, in a results-based relationship, a pump supplier may guarantee a certain minimum mean time between failure (MTBF). A water-treatment company may commit to certain levels of performance of that subsystem-another results-based form of relationship.

Initial focus for such efforts tends to be towards service contractors as a result of their costs and the ability to make near-term gains. Most initial efforts are focused on turnarounds because of their cost intensity and large impact on refinery profitability.

The following discussion on results-based reliability programs will focus more on the refiner/contractor relationship, although the same principles apply to suppliers of materials.

Contractor costs

Current relationships between refiners and contractors are largely either based on time and materials (T&M) or lump sum (fixed price). Neither of these methods realizes the full potential from contractors.

T&M contracts, for example, are typically negotiated on base-wage rates and acceptable mark-ups rather than results achieved. Additionally, T&M contracts provide incentives for contractors to charge as many hours as possible, so extra provisions, such as completion bonuses and penalties, must be put in contracts to control costs.

This arrangement usually provides little incentive for contractors to openly share productivity-improvement ideas with refinery-maintenance management. The complexity of T&M relationships also creates high management costs for both contractors and refineries. The two companies must monitor actual hours worked and administer bonus/penalty clauses.

Lump sum relationships for routine, minor, or turnaround maintenance services do not optimize the value equation either. Lump sum contracts are seen as less risky for refineries than T&M as a result of their capped nature. The contractors must incorporate, however, a contingency in the fees for the risks they are taking, which drives up the costs.

Under both T&M and lump sum contracts, the contractor does not really have control over the key drivers of his costs. Instead these are "managed" by the refiner (either explicitly or implicitly) through timing of needs, shifting priorities, process requirements, etc.

A competent contractor with considerable capabilities often becomes a "temp agency" whose staff is directed by the refiner's people.

Refiners' practices, such as rush work and specific requirements, cause contractors costs to escalate, which must eventually be passed on to the refiners.

For example, when a contractor is unsure of the timing and amount of work required over the planning horizon, he will have to pay the cost of carrying additional labor and materials or pay premiums to quickly acquire the needed resources to respond to the customers' needs.

This refiners' control over major productivity levers can significantly drive up costs.

One refiner found that its contractors had to add in 20-30% of price premium over the real costs of getting the work done to cover for the refiners' practices.

Some contractors have assessed their "cost to serve" specific refiners/refineries, and actually have differential rate structures based on how well the refiner is able to manage its part of the process. Refiners that have understood this behavior and its real costs are working with their suppliers on results-based relationships. In this way, they are able to significantly reduce premiums that have to be charged.

These emerging forms of results-based relationships can also reduce the refiners' management and administrative costs. Reliance on lump-sum relationships often results in breaking down work into many discrete "projects" that must be bid and managed, which drives up internal management costs as well as contractor costs. Establishing basic prices and rates for materials and services enables the refiner to quickly scope and estimate work.

Additionally, the clarity of cost-for-results enables refiners to compare across sites/contractors to ensure competitive costs without continual rebidding of work.

Increased productivity

"Results-based" supplier relationships improve overall refinery productivity (cost and reliability). The unleashing of the contractors' knowledge to improve overall productivity is as important as the direct cost-reduction potential from results-based relationships.

Under traditional T&M or lump sum contracts, contractors have little incentive to share productivity improvement ideas. In practice, being treated as a "temp agency" inhibits contractor personnel from being aggressive in suggesting improvement ideas.

Although treating contractors like temps may appear to provide more control to the refiner, in many cases the contractor has more expertise than the refiner. Thus, the contractor's expertise is wasted.

One U.S. electric utility used the results-based approach with a key contractor to significantly reduce the amount of utility-company supervision required and to reduce average turnaround times.

This type of productivity is achieved by selecting the services needed to produce the desired outputs and assigning accountabilities to the party that most directly controls the outcome. Additionally, results-based relationships can reduce management costs by predetermining prices. These relationships also enable cross-unit benchmarking to ensure competitiveness and continuous improvement.

Engaging suppliers on a results basis enables them to help define what services are most appropriate to achieve the desired outputs.

In one case, a refinery had traditionally used T&M approaches to securing services for maintenance access such as scaffolding and manlifts. Local refinery maintenance and engineering people defined modes of access, and then contractors provided specified services.

After moving to a results-based relationship with a scaffolding supplier, that supplier leveraged his expertise to recommend optimal access methods. Under the old relationship the scaffolding supplier's incentive was to sell manhours of scaffolding erection/disassembly. Under the results-based approach, the supplier was selling access.

This supplier helped drive a different mix of access methods-scaffolding, manlifts, permanent platforms-that reduced total access cost and unit downtime.

Defining deliverables

This "results-based" approach to supplier relationships requires understanding meaningful units of "output," which vary by type of materials and services.

In piping services, the "output" or key result for bolted connections is the number of bolt-ups. Refineries' required output from scaffolding services is not the manhours required to erect scaffolding but rather the leg feet of scaffolding installed on time to support a maintenance need. Exchanger servicing "units of output" might include pulling and cleaning a crude preheater.

Delivering these "units of output" requires different craft skills, equipment consumables, and levels of interaction with refining maintenance and engineering. Understanding the inputs and costs of services provides the foundation for working with suppliers to understand what is really required to deliver the unit of output.

For example, the direct costs required to get the work done are often only about a third of the costs, while customer/contractor "relationship costs" can be almost as much (Fig. 2 [93,886 bytes]).

As suppliers are brought into the process to review the work processes and inputs typically used to provide services, they can help determine how to deliver the results at lower costs.

One refinery worked with a services contractor and identified several opportunities that were enabled by the results-based relationship. In the prior T&M relationship, the contractor made its profit through markup on labor dollars, so the higher the craft skill levels used and the more hours billed, the more profits the contractor made.

After structuring an output-based relationship, in which the contractor has profit by delivering "units of output," the contractor lowered the average skill level, changed the work process, and lowered overhead costs. These measures gave the contractor an adequate profit while reducing service unit costs to the refinery by over 40%.

Structuring the contract

Critical to realization of these types of improvements is structuring the incentives to differentiate the contractor's primary responsibilities, the refinery's responsibilities, and the joint responsibilities.

Fig. 3 [145,028 bytes] lists the primary and shared areas of responsibility for both the contractor and the refiner.

For example, once an output-based price is established the contractor has incentives to actually complete the work faster and reduce the wage rates. At this time, the refinery has incentives to plan better to avoid pricing premiums for contractors to lay off or hire people.

Establishing key performance indicators (KPI) that are part of the incentive structure enable areas of joint responsibility to be translated in bottom line profitability for the contractor and net costs for the refiner. Initial introduction of this type of balanced performance metrics can be very uncomfortable for both a contractor and a refiner.

In a traditional relationship, the contractor is "successful" if the immediate "customer" (for example, the foreman) is happy and the costs are close to the estimate. In the results-based relationship, the contractor may have to push the "customer" to make changes to improve overall productivity. The transparency of these metrics may concern refinery personnel because there is more focus on their ability to plan and execute the work.

Contractors and refiners also have to agree on how to set "competitive" unit rates to ensure low costs for services. Converting to output-based relationships actually facilitates benchmarking comparisons across units or sites.

For example, one European refiner found wide differences in service costs across sites and contractors when it initially converted from T&M to unit-output contracts (Fig. 4 [65,637 bytes]). This led to more-competitive bidding for services and provided the baseline for continuous improvement activities.

Many refiners around the globe are using aspects of output-based contractor relationships. Specific approaches vary, but generally there are three major steps that refiners go through when converting to unit-output relationships: developing unit cost baselines, redesigning how services are delivered, and defining pricing and performance measures (Fig. 5 [93,630 bytes]).

Choosing results-based maintenance may result in changing contractors, in using fewer suppliers, and/or in requiring restructuring relationships with existing contractors.

Structuring performance indicators is also important. These might include percentage rush work, percentage break-in work, and delays. "Report card" measures of "customer satisfaction" (for example, refinery operations and maintenance) may also be included, as well as safety and other important objectives. Making these indicators few, clear, and transparent appears to provide the proper incentives for contractors and refinery personnel to work together towards common objectives.

Challenges

The major challenges for refineries in adopting results-based contractor approaches are developing a shared understanding of costs, involving contractors and refinery people closely in joint activities, and ensuring commitment by refinery and contractor management.

Refineries may have difficulty collecting data from current systems to understand the true "unit costs" of activities. For example, what is the cost of a "unit" of crude preheat clean?

Contractors generally have reasonable estimating tools and approaches but are often reluctant to share cost information with customers for fear of having those numbers used against them in negotiations.

Refinery-maintenance people may initially resist having contractors who are more involved in planning work. In a results-based program, contractors suggest ways to improve productivity rather than just "doing what they are told because we're paying them." Similarly, contractor personnel may be hesitant to be proactive about identifying opportunities for fear of offending the customer.

Successful transitions to these relationships seem to depend on strong leadership from both refinery and contractor management. In cases where the company's people were heavily involved in the transition, results appear to be much better than in other cases.

Regardless of the specific level of people involved, there must be joint commitment to at least exploring the potential of results-based approaches. Initial results of these contractor relationships look promising, although the concepts are still somewhat early in their lifecycle in the refinery industry and will require further refinement.

The Author