Do Contracts & Catalogs Deliver on the Promise of OTP & Cost Savings?

By Erkki Brakmann & Nauman Saeed, SkySelect

A version of this article is also featured on MRO Business Today

Summary:

Long-term exclusive and non-exclusive agreements (LTAs), price sheets and catalogs requests from customers are on the rise with hopes of improving part service levels first and pricing second. However, the data suggests, procurement departments are spending ample resources negotiating contracts that may yield less desirable results in terms of on-time performance and cost savings metrics compared to buying transactionally and competitively. 

In our research, aggressive (and automated) sourcing across broad market supplier participants (top tier and long-tail) yields better on-time performance and savings metrics. And given the human capital bandwidth constraints across procurement departments, this strategy is not overly employed today. 

Trail blazing industry participants are recognizing that a new generation of technology is available today, and getting better daily,  to help accelerate the sourcing effort to effectively realize the metrics they desire. 

Transactional vs. Contracted Parts 

To ensure a comprehensive understanding, let’s first talk about the different contracts and the incentives behind contracts (see the graph below). According to our customers, there are two primary reasons for signing these contracts:

1. Achieve lead-time stability: through definitive agreements involving exclusive regional/centralized supplier stocking commitments or on-site consignments.
2. Achieve price savings and/or stability:  exclusive price contracts and non-exclusive price sheets (or catalogs) to maximize savings.

If the buyer's goal is to achieve lead time stability or optimize for working capital by stocking less, they have to pay a premium as the supplier will be carrying a higher risk and costs. Depending on the agreement type and services provided, the premium may range from 5-20%.

Secondly, we can divide contracts into:

1. Exclusive contracts - supplier agreements that include service level commitments including customer on-site consignments or exclusive stocking plans; alternatively, this can include pricing agreements with deep bundled discounts in return for exclusivity to contracted suppliers.
2. Non-exclusive contracts - represents the customer specific price sheets and catalogs, whereby the customer has the option but not the obligation to purchase from a particular said supplier of the contract/catalog.

Exclusive contracts are bound to clear pricing commitments, sometimes service-level agreements and penalties. Suppliers are typically only willing to give commitments to 10-20% of the addressable parts, because the demand of such parts is predictable and the supply chain is plannable.

Non-exclusive price sheets and contracts are loose agreements where the buyer is not bound to buy the parts from a particular vendor nor is the supplier bound to stock them. Out of stock part numbers result in longer lead times or having to source the parts from a different supplier. 

While it’s possible that up to 80% of parts can be covered with non-exclusive price sheets and contracts (and we have seen some customers reach 80% coverage through a combination of contracts and catalogs), only 10-20% typically are covered.

What also should be taken into consideration is that aircraft parts requirements change often and it can take months or up to a year to negotiate contracts with top OEMs and distributors. Therefore, by the time an agreement is reached, the contractual terms may already be outdated or not applicable to current needs or market dynamics. 

While traditional thinking suggests these contracts are a convenient and efficient route to purchasing, especially with North American major airlines, there is data to prove otherwise.

How Do Contracts Actually Perform?

SkySelect recently ran data on LTAs or contracts to measure two things: operational and commercial performance. Here’s what we discovered: 

Operational Performance: The OTP of Transactional purchases is on average 15% higher

Note: OTS represents on-time shipment to suppliers’ commitment date while OTP is based on customers’ need by date requirement

1. Transactional or Non-Contracted parts performed the best when sourced competitively across the broader supply base. This is contrary to the current-state at many airlines, where sourcing is performed with limited suppliers, many of which are repeat suppliers, because of bandwidth constraints of the buyer. With the use of AI technology, there are no bandwidth constraints and this outcome can be accelerated across the board.
2. Non-Exclusive Contracted and Catalog parts performed better than exclusive contracts in terms of on-time performance to customer need-by-date. However, they performed worse compared to competitive transactional purchases with true market lead times compared to static lead times in the catalogs and non-exclusive contracts. 
3. Exclusive Contracted parts performed the worst in terms of on-time performance to customer need-by-date requirement. The lack of competitive sourcing prioritized better cost savings to on-time performance.   

Let’s now look at how the same parts performed from a commercial standpoint: 

Commercial Performance: Transactional Purchases Have the Highest Savings Contribution

1. Transactional or Non-Contracted: Represents the most amount of cost savings potential. We see suppliers not taking the risk of holding pricing over longer periods of time as required under exclusive and non-exclusive price catalogs. Therefore, to yield the highest absolute savings, automating sourcing across hundreds of suppliers yields the highest cost saving potential.   
2. Non-Exclusive Contracted and Catalog: Savings contribution from non-exclusive contracts or catalogs have been limited as the part scope is limited. Nonetheless, the average percentage of cost savings at a part number level is higher than that of transactional. But as mentioned before, suppliers continue to limit the number of parts with a fixed price commitment due to uncertain cost basis and evolving supply chain constraints. Hence, absolute cost savings remains low compared to transactional.   
3. Exclusive Contracted: Represents by far the lowest opportunity to save money in absolute terms. However, the cost savings percentages are the highest at part number level. Similarly to the argument above, limited part scope in this segment results in the lowest cost savings contribution.

In addition to the above, as the aircraft parts market rapidly changes, the contracted pricing may not always be the best. According to SkySelect’s data, buying on non-exclusive contracts could result in missing out on 5-6% in tangible price savings. Considering an annual budget of $50 million for parts, this could translate to a significant $3 million in savings.

Contracts Can Both Improve Automatic Ordering & Lead to Delays

Now let’s examine how contracts perform from an efficiency and reliability standpoint. Contracts, as static agreements stored in the airline or MRO's ERP (enterprise resource planning) systems, do not accurately represent current market availability. Despite facilitating quick and easy purchasing, data indicates that 20-30% of these orders bounce and need manual intervention from a buyer.

Ideally, you'd want to know whether or not a part is available when placing the order. However, in most cases, the buyer typically learns about delays when the part was already supposed to be shipped. In worse case scenarios, it can turn into an AOG (aircraft on ground) order.

From the on-time shipping (OTS) perspective while companies like Amazon expect its suppliers to have 99% OTS, the aviation industry's performance is much lower. An OTS of 70+% is considered satisfactory. However, SkySelect data shows that OTS of contract items is ~60%. This is because most of the contracts are non-exclusive price sheets and catalogs without any commitments by either party.

Real-time Market Visibility Helps Overcome Contracting Bottlenecks

While 90-95% of the purchasing volume is made up of parts that cost less than $5,000, contracts are thought to require less human effort to fulfill these part requests since the terms and conditions are already set. But the data above shows that this is not the case.

Thanks to advancements in technology, airlines and MROs can easily overcome these bottlenecks. SkySelect Procurement AI can process hundreds of parts at the same time, checking the real-time market availability and finding the best options without adding any extra workload.

This mechanism not only allows you to check availability before placing orders but also compares the contract with the market and creates a PO with the best option. The result is higher-quality purchase orders, leading to improved on-time performance.

Procurement AI can automate up to 90% of purchases in real-time based on specific business rules, reducing the need for manual effort and dispelling false expectations from contracts. This saves a significant amount of time, reduces cognitive load on human resources, and leads to better overall performance.

In conclusion:

1. On-time performance (OTP) is on average 15% higher with transactional purchasing.
2. Cost savings at part level is good with contracting, however transactional purchases have the highest cost savings contribution potential.
3. With the modern technology available today, one can maximize both on-time performance and cost savings potential through transactional purchasing.