The current Knowledge @ Wharton has an article on an emerging trend to pay for equipment only when it is performing to expectations. This type of contractual arrangement has seen some use with the maintenance side of high-end defense and industrial contracts, but it is now being talked about at the general consumer level.
Imagine paying for your car only when it works. Or your television. Or even your high-end toaster. That might sound far-fetched, but it could be the future model for purchases requiring service over time.
The level of contractual and tracking complexity required for such arrangements boggles my mind a bit, but if it does come about it could represent a significant change to how we do business as consumers, and perhaps even more significantly how businesses interact with consumers.
The essence of Performance Based Logistics is buying performance outcomes, not the individual parts and repair actions…. Instead of buying set levels of spares, repairs, tools, and data, the new focus is on buying a predetermined level of availability to meet the [buyer’s] objectives. According to Netessine, "With performance-based contracting or power by the hour, basically you pay for the equipment when it works. And you don’t pay for it when it doesn’t. I’m not paying for the repairs or the spare parts. I am buying a working product, and when it works, I pay you. When it doesn’t, I don’t."
Not to mention the financial reporting dilemmas… what is a "sale?" How much is that "sale" worth if there’s an undetermined final value? You would have to figure out rather exactly what repair rates and costs are, when they are likely to happen, and accrue appropriately. I could see a whole new industry for bored life insurance actuaries.
"It raises the question of why do customers need to own products? When I talk about [Performance Based Logistics], I [Wharton’s Cohen] always ask the question, ‘Why do we acquire products?’ If you are buying a food product that you consume, you have to own it to consume it. But if you talking about an automobile or a television or a hair dryer, do you need to own the product to use it? Not necessarily. Why not contract for use, and pay on the basis of the value of that use? It goes beyond leasing a car — it’s more like a taxi ride, and you pay on the basis of that ride. As we move more and more to a service economy, I may not always have to own."
In other forms the concept has been around for decades.
Cohen acknowledged that the concept of performance-based contracting "has been around, and some would argue that the commercial application is ahead of the military." He pointed out the term "power by the hour" was coined by Rolls-Royce over 20 years ago to describe their performance-based contracts for engines and other avionics products that were sold to commercial airlines. Operators are assured of an accurate cost projection and avoid the costs associated with unscheduled maintenance actions.
Performance- or availability-based contracts create interesting supplier-side incentives that dovetail nicely with some lean manufacturing and six sigma concepts. Simplicity of design becomes critical to ensure long-term reliability, simplicity of process becomes critical to ensure assembly consistency and quality. Process capability and robustness itself becomes similarly critical.
The Wharton researchers are also working on an economic analysis of the incentives to invest in reliability improvement for products through product re-design and engineering change. The ultimate improvement of product reliability is often included with increased up-time and a lower cost of ownership as predicted benefits of PBL contracting arrangements. Their initial results indicate that inclusion of performance-based payment is linked to investment in reliability improvement and can lead to efficient supply chain performance.
So if this somehow came to pass, what would be the value of a Toyota versus a GM vehicle? Actually Toyota has had some problems recently due to design flaws and lengthening supply chains, so how would this type of contract affect strategic decisions that could affect quality? Perhaps there would be an advantage for smaller manufacturers?
It’s obviously a ways off, if it ever arrives, but a world where you pay for a hair dryer only when it is working would create interesting ramifications for manufacturing and supply chain operations.