The P is for performance: Rethinking the opportunity of PBL in defense aircraft sustainment

Sustain the gain: Budgeting for tomorrow's defense readiness

Following the release of the US FY25 defense budget request, a recent publication noted that the US defense discretionary spending hit the ceiling of what is likely possible in today’s congressional budgeting environment. Despite the recent passage of a $95B supplemental funding bill through Congress providing aid to Ukraine, Israel, and Taiwan, and some analysts predicting flat defense budgets in the future, the US Department of Defense (DoD) remains steadfast on certain non-negotiables. One of these is Operations and Maintenance (O&M) spend, which is projected to increase by 6% in the FY25 request and increase 9% from FY25 to the projected FY29 levels (including supplementals). To maximize the effect of this forecasted increase, the US DoD is looking at both novel and established levers like performance-based logistics (PBL) to successfully lower costs for defense aircraft sustainment.

The 9% projected growth in O&M through FY29 signals a growing opportunity for companies performing sustainment activities in the defense industrial base to capture significant contract opportunities. 

Historically, defense programs and contractors were focused primarily on original equipment (OE) production ramps to meet delivery targets and offset requirements, with sustainment as an afterthought.  However, today’s heightened geopolitical tensions are turning the services’ eyes towards the possibility of having to sustain aircraft for much longer than originally planned, and often in complex, contested environments. This highlights the importance of service contracts and how OEMs need to ensure their services offerings are robust enough to meet increased demand.

This will require a higher investment in supply chain and logistics operations to ensure availability of the right workforce, systems, supporting tools, and parts.

Sustainment evolution: Tracing the trajectory

The above chart depicts a significant market opportunity for contractors to capture MRO demand, which is just one aspect of sustainment costs. 

Even though sustainment extends far beyond MRO, maintenance and original equipment spend signals help contextualize the size of the opportunity. Considering global MRO demand for major U.S. military aircraft programs, a 10-year outlook projects total MRO demand to outpace spend on platform acquisition during that same period by 1.5x (by 2.2x if not including spend on F-35 OE or MRO). The Government Accountability Office (GAO) recently revised the lifetime cost estimate for the F-35 to $2T, of which roughly $1.6T is sustainment costs – a drastic 44% increase from the $1.1T sustainment price tag estimated in 2018. In this case, the $165B in F-35 MRO costs represents only <10% of the evolving sustainment costs. 

Still, while defense platform procurement is often concerned with stabilizing unit costs, the ultimate value of operations & maintenance dollars spent on MRO/sustainment is primarily measured in mission capability rates, an area in which industry and the customer have historically found themselves disconnected. 

A now well-known study by the GAO showed that these dollars may not necessarily translate into the ability of a service to meet mission capability rates—the percentage of total time when the aircraft can fly and perform at least one mission—in the event of a conflict. The GAO performed an in-depth analysis of 46 types of aircraft varied by type, age, fleet size, and number of flying hours across 11 years of sustainment activity and found that pre-pandemic sustainment operations consistently led to underperformance on mission readiness rates. 

Some highlights from the study:

• Compared to the start of the study in 2011, mission capability rates for the selected aircraft fell to varying degrees for the Air Force, Navy, and Marine Corps

• Only 3 aircraft types met their goals during a majority of the years

• 26/49 aircraft types did not meet their mission capability goals a single time over the 11-year survey period

• No fighter type met their goals more than three years in total over the survey period

• In FY21, only 2/49 aircraft met mission capability goals, whereas 30 aircraft were more than 10% below the mission capability threshold 

When speaking to the GAO, program officials highlighted three categories of challenges responsible for the sustainment issues, which resulted in the mission capability rates: 

• Aging Aircraft: Delays in acquiring replacement aircraft, Service life extension, Unexpected replacement of parts and repairs**

• Maintenance: Access to technical data, Delays in depot maintenance, Shortage of trained maintenance personnel, Unscheduled maintenance**

• Supply Support: Diminishing manufacturing sources, Part obsolescence, Parts shortages and delays**

**most frequently cited in category

As the defense sector continues to emerge from the pandemic these challenges to mission readiness have gotten worse. In the past year, defense contractor earnings calls have continued to cite supply chain challenges, labor shortages, and raw material inflation as headwinds to operations; these are certain to filter through into sustainment operations. It’s clear that improvements to mission capability rates will require a rethink of how the Pentagon evaluates sustainment outcomes, as well as the role contractors ought to play. 

Performance-based logistics: Gear up for the comeback

For contractors to capture a greater share of the defense MRO market, sustainment activities will need to be more closely tied to mission readiness rates. In the past, we have seen successful execution of Performance Based Logistics (PBL) contracts in achieving acceptable mission readiness rates. 

PBL contracts can drive contractors to improve product support by incentivizing them based on their ability to meet mission requirements, rather than on units of output. It also incentivizes OEMs to quickly address equipment reliability issues and design-in upgradeability, and incentivizes suppliers to participate in these efforts. This drives affordability, as the services can reduce transaction costs, but also provides an upside, should contractors be successful in meeting requirements. 

Between 2009-2016, the top 5 DoD PBL vendors accounted for 64% of overall DoD PBL obligations (with 93% being captured by the top 15 vendors). Even though PBL contract obligations as a share of DOD contracts have declined since a peak in 2012-2013, several high profile PBL announcements have been announced since then, including:

• (Feb ’24) Pratt & Whitney wins PBL Award to sustain F100s

• (Dec ’23) Lockheed Martin negotiates with USG over F-35 PBL 

• (Jul ’22) Parker Aerospace signs hydraulics support PBL w/DLA for 5 platforms

• (Feb ‘22) Boeing wins PBL contracts for F-15, CH-47, and AEW&C

• (Aug ’21) BAE Systems signs PBL with Lockheed Martin to sustain F-35 EW

• (Feb ’20) Bell Flight awarded PBL to support UH-1Y and AH-1Z

Still, PBL isn’t a silver bullet as seen with the ongoing F-35 PBL negotiation. Since 2023, Lockheed Martin and the government have been in prolonged negotiations over instituting a performance-based logistics (PBL) contract for F-35 sustainment. However, both sides continue to struggle over finding common ground due a lack of agreement on ownership of data rights and fidelity of execution.   

To successfully execute a PBL contract, contractors need to evaluate their present operations to baseline their current ability to meet mission rates. Do they have the talent tools and capacity to adequately support their end customers’ needs, or do they find themselves with capability shortages and operational bottlenecks? It is essential to drive this evaluation back up through their supply chain to identify vulnerabilities. This is important, as PBL drives greater accountability on the contractor to meet readiness, and OEMs will be held accountable by their customers, even if the shortage is due to an issue with one of their subcontractors. Effective supplier management will be a key differentiator between companies that benefit from PBL vs. companies that are unable to be competitive in this new landscape.

How can defense contractors prepare? Four strategic plays for performance-based contracting success 

An example of a successfully implemented PBL is the M-TADS/PNVS system on the Apache 64 helicopter where Lockheed Martin leveraged data on maintenance indicators to improve forecasting and drive optimal locations of supply, which resulted in sustainment contract cost reduction and improvement in parts availability. In this instance, LM and the USG had multiple years of contracts ranging from 2007-2016. By the third contract, LM was able to sign on at a 10% lower price than the previous contract as they were able to reduce their overall sustainment costs while surpassing the minimum availability requirement of 85% because of supply chain improvements and their ability to effectively manage obsolescence. 

This one case is a potential illustration of the win-win opportunity of PBL-style contracting if companies have the proper levers in place to drive execution. Here are some ways in which contractors can better prepare themselves to capture the opportunity from PBL:

Demand forecasting and supply planning are foundational

Historically, sustainment execution meant reactive ordering and stocking to support outdated demand forecasts. This approach creates waste, as customer requirements and engineering changes can quickly make spares excess and obsolete. As these signals reach deeper down in the supply chain, negative impacts quickly multiply which can erode the margins. Better analytical capabilities and closer relationships with suppliers and customers can help produce and deliver the optimal quantity of parts to support agile sustainment, unlocking PBL benefits.

Connectivity matters: systems integration is a priority

Historically, data-driven decision making has not been the strong suit of large, multi-site industrial organizations. However, to capture the greatest profit opportunity with PBLs, contractors and customers need to seamlessly operate as a coordinated entity, integrating data from multiple systems, sites, ERPs, etc. In the event of an unscheduled maintenance event on a program, suppliers may be looking to purchase parts on the open market to deliver against lead time KPIs, but they may already have the part at a factory or warehouse. Connecting disparate systems is key to remaining competitive in a new sustainment environment. Those contractors that have true supply chain visibility and can act with greater certainty of outcomes will be able to quickly respond to evolving sustainment needs.

Inflation defense

During the pandemic and its aftermath, many suppliers passed on price increases associated with longer lead times and raw materials constraints to their customers. However, those price increases haven’t abated, and many procurement teams may be surprised to see the cost of parts continue to rise, despite price decreases in the associated inputs. Structured negotiations and inflation defense initiatives are key to stemming those price increases and locking in win-win arrangements with your supply base to set the stage for sustainable, high-margin growth.

Can’t throw boxes at the enemy

Even as defense R&D continues to push the limits with novel weapons systems, there will be a limit to hardware as a capability differentiator. Software and expendable/attritable platforms are the newest frontier, so there are key unanswered questions around what performance-based sustainment looks like. As an example, one of the biggest unanswered questions in the F-35 PBL negotiation process is around the question of who owns the rights to the underlying software. Both prime contractors and suppliers must be proactive in articulating their strategy for elements of their sustainment responsibilities that don’t fit the traditional model of industrial contracting, as this can cause significant delays and erode margins.

If you’ve ever spent time working within the sustainment organizations of defense contractors, or throughout the tiered supply chain that supports them, you’ve undoubtedly heard how sustainment is only given full attention when it’s too late. Priority has historically been given to shiny new aircraft with next generation features and capabilities, and budgets have traditionally skewed towards buying as many as possible as quickly as feasible. As contractors find themselves operating in an environment with a growing O&M budget, sustainment’s opportunity to shine is increasingly becoming more critical for DoD.  PBLs offer a compelling opportunity for contractors to exceed current margins when properly planned and executed. Those contractors that can deliver new assets and sustain them effectively are likely positioned to thrive in the years to come.

Contact the authors: Ben Brooks, Brian Jones, Olivia A. White, and Rodion Kaplounov

Originally published as "The A&D Minute" on May 9, 2024: The P is for performance: Rethinking the opportunity of PBL in defense aircraft sustainment | AlixPartners