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Keysight Technologies
Solutions for Pursuing Test Strategies
that Address the Realities of
Firm-Fixed-Price Contracts
Application Brief
Introduction
In defense contracting, firm-fixed-price (FFP) contracts are becoming more common than cost-
plus contracts. This fundamental shift in the business model begs an essential question: How can
organizations evolve to compete successfully in an FFP world?
Compared to cost-plus, FFP transfers much of the risk from the government to the prime con-
tractor. To mitigate these risks, contractors may want to reassess their assumptions and look for
opportunities to streamline or redesign their processes.
The math is simple: profit equals price minus cost. When the price is fixed, greater attention must
be paid to any and all costs that whittle away at the resulting profit. It may come as a surprise,
but test equipment is often the third-most expensive capital investment across the life cycle of a
system. To reduce the cost of test, two high-leverage action steps are available: pursue greater
reuse of test assets across multiple products and product lines, and implement new strategies for
test-asset acquisition.
This note presents context for the shift to FFP, suggests a few important implications, and offers
recommendations for effective reuse and acquisition of
test assets.
Problem: Juggling risks and costs
As noted above, FFP burdens the contractor with a greater share of the risks. The nature of
this shift is shown in Table 1.
Table 1. Cost-plus contracts versus Firm-fixed-price Cost-Plus Firm-fixed-price
contracts
Promise Best effort Delivery
Cash flow As incurred Delivery
Administration High Low
Fee limit Predetermined None
Burden of risk Greater on government Greater on contractor
When faced with an emerging set of risks, the natural response is to identify ways to mitigate
those risks. For prime contractors, existing product lifecycle (PLC) processes were created
in a world of cost-plus contracts. With new underlying assumptions, it can be worthwhile to
examine those processes and redesign them for risk reduction versus a fixed price.
One key success factor is to modify core activities such that they can dynamically change while
ensuring minimal fixed costs. For example, in the 1990s many commercial electronics compa-
nies began outsourcing the fabrication of printed-circuit boards (PCBs) to contract manufactur-
ers (CMs). As market demand changed, this gave companies greater flexibility in managing the
costs associated with labor and manufacturing assets.
Reality check #1: Operation and support dominate total
cost of ownership
As one data point, a 2003 report from the US Government Accountability Office (GAO)
broke down the total cost of designing, building and operating a ship over its lifetime. The
conclusion: nearly two-thirds of the total cost went to operation and support (Figure 1).
The report also suggested that a greater investment in development costs focused on improv-
ing operation and support requirements would yield significant reductions in overall cost. For
example, designing out common maintenance items served to reduce overall crew size and
thus reduce ongoing support needs. 1
Figure 1. For a new ship, operating and support costs
typically exceed procurement and development costs
(source: GAO).
2%
33%
65%
System lifecycle
Development cost
Procurement cost
Operating and support cost
1. GAO-03-520, Navy Actions Needed to Optimize Ship Crew Size and Reduce Total Ownership Costs, June 9, 2003
3
Reality check #2: Costs are locked in early
Another GAO report from 2003 concluded that 80 to 90 percent of the operating and
support costs of a weapon system will be determined as soon as the requirements are
set. However, at that point only 10 percent of the lifecycle costs have been spent. By
the time the system is ready for production, more than 90 percent of the operating and
support costs have been determined--but only 28 percent of the lifecycle costs have been
incurred. The distribution of these costs is shown in Figure 2. 2
Figure 2. For a new weapon system, a majority of the
operating costs are locked in during the requirements 100 Percent of lifecycle costs
phase (source: GAO). 90
80
70 80-90% of costs are locked in...
60
50
40 ...when only 10% of
30 dollars have been spent
20
10
0
Requirements sets Design final Production start
Actual dollars spent
Costs determined by decisions on requirements and design
Solution: Reducing the costs associated with
test assets
After buildings and land, test assets are often the third-most expensive capital investment
across the PLC--development, production and support. When dealing with FFP contracts, this
has two important implications. First is the need to reduce operating expenses through greater
utilization and optimized support of test assets. The starting point is a common test strategy
that enables greater reuse of test hardware and software. Ultimately, this can help maximize
your organization's return on invested capital (ROIC).
The second implication is the need to reconsider the available set of acquisition strategies
for test assets. In the past, "buy" was the default--and perhaps only--strategy deemed
acceptable by many prime contractors. Today, with FFP contracts, renting and leasing are viable
alternatives that can help reduce risks.
Step 1: Enhancing reuse of test assets
Traditionally, the incentives associated with cost-plus contracts led most aero/defense com-
panies to use a product-centric approach to design and manufacturing. In this paradigm, each
customer is treated as an individual product line with a specific set of products. What's more,
each product--in design and production--has a unique test strategy that is developed and
implemented separately from any other product or product line. Consequently, different sets of
hardware and software are developed, no matter how similar these may be across the various
products.
2. GAO-03-57, Setting Requirements Differently Could Reduce Weapon Systems' Total Ownership Costs, February 11, 2003
4
Step 1: Enhancing reuse of test assets (continued)
In the commercial world, manufacturers tend to use a process-centric point of view that spans
multiple products and product lines. Each customer is still treated in a unique way; however,
products are grouped according to common functions, features, or both. With this approach,
synergies between hardware, software and test methods provide useful leverage across many
products and product lines, independent of the end customer. This is the starting point for
greater commonality, utilization and reuse, and the beginning of reductions in engineering effort
and equipment expenditures.
This approach is also the foundation of a strategy that can help you succeed with FFP con-
tracts. The biggest benefit: it minimizes the risk and effort associated with developing, launch-
ing and manufacturing any new or enhanced product. Three key ideas help make asset reuse
a reality: mixed-product manufacturing, common measurement blocks and a common-process
test strategy.
Making the big shift: Mixed-product manufacturing
This is an important step in the shift from product-centric to process-centric manufacturing.
One of the best-known examples of mixed-product manufacturing is the model used by Toyota.
A Toyota production facility can, for example, build sedans, minivans and sports cars on the
same assembly line with no interruption to the manufacturing flow. The net effect: rather than
operating three separate lines that are partially utilized, one line runs at 100-percent utilization.
Figure 3 illustrates the difference between a set of independent production lines and one line
capable of running multiple products. This same methodology can be used for any set of similar
products once you understand how common measurement blocks and test reuse relates to
those products.
Figure 3. Compared to multiple independent product
lines, the "common process center" can significantly Multiple independent product lines One common process center
reduce infrastructure costs.
Prod C
Prod B
Prod A
Prod A Prod B Prod C
When making the shift to a common process center, the starting point is to identify the com-
mon measurements that are required across a range of similar products. One way to make
this visible is to create a matrix that includes all products and all measurements: common and
unique requirements will become readily apparent (Figure 4).
5
Making the big shift: Mixed-product manufacturing (continued)
Figure 4. Mapping measurement requirements versus
similar products will help you identify common and
unique measurement blocks--and a majority may
Measurement requirements
prove to be common. Level Digital Spectral Phase Analog
accuracy modulation purity noise modulation
Product A
Product B
Product C
Products
Product D
Product E
Product F
= Common = Unique
In many cases, you may find that a majority of the tests are common--and this means you can
use a common set of hardware and develop a common set of software modules. This approach
dovetails quite nicely with mixed-product manufacturing.
Pursuing a common-process test strategy
Combining common measurement blocks with test reuse is the next step toward a test strategy
that spans program lifecycles. This strategy also leverages previous investments in capital
equipment and engineering resources.
As with the measurement-blocks approach, a matrix is a good way illustrate the common-
process concept. As shown in Table 2, different products and their associated tests can be
integrated into common measurement blocks. When several devices-under-test (DUTs) share
Table 2. The mapping of test assets and DUTs versus common measurement needs or tests, the business unit will benefit. Whether the focus is on
measurement requirements provides the foundation for radar, EW, avionics, or another area, all have common measurement needs that may differ in
development of a common-process test strategy. terms of only a few specific details.
Measurement
Spectral purity Phase Noise figure VSWR Group delay Insertion loss
noise
Signal analyzer Y Y Y
Four-port VNA Y Y Y
Source 1 Y Y Y
Source 2 Y Y Y
Test asset
Source 3 Y Y Y
Source 4 Y
Power supplies Y Y Y Y Y Y
Digital capture Y
Test 1 Y Y Y Y
DUT A Test 2 Y Y Y Y
Test 3 Y Y Y Y Y
Test 4 Y Y Y Y Y Y
DUT B Test 5 Y Y Y
Test 6 Y Y Y Y
This is the foundation of test reuse, which includes measurement hardware and software.
Benefits include greater test-asset utilization, less reengineering for new or enhanced products,
and the potential to lower the per-unit cost-of-test for every product and program.
6
Step 2: Improving acquisition strategies for test assets
Buying, renting or leasing:
Across the lifecycle of a commercial product, a company makes an up-front investment in
A quick overview resources, people and assets during the design, validation and verification stages. When the
product is deemed ready for market, it will be launched and produced, thereby starting to
For many aero/defense organizations, generate its return on investment. Once the initial investment has been recouped, the return
buying has been the default choice becomes positive and the product moves toward profitability (depending on how ongoing sup-
when acquiring test assets. In com- port costs are tallied).
mercial circles, renting and leasing have
become essential alternatives. This is different from what happens with most aerospace or defense programs. For example,
there is no guarantee that a product-under-development will go into production. Most programs
Buying is best when capital is readily put at least two vendors in competition, basically giving each a 50-percent chance of winning
available and project risk is low. the contract.
Renting, which typically requires There is another important difference: the "zone of the unknown" between R&D and produc-
a month-to-month contract, works tion. This is the time between submission of the proposal and the awarding of a contract--and
well for short-term needs. Examples this can range from a few weeks to several months to more than a year.
include temporary projects, peak loads,
proof-of-concept work and equipment This interval can increase the risks associated with the R&D phase, especially if "buy" is the
evaluation. Renting is also good for default acquisition strategy for test assets. If your organization has an implicit or explicit policy
projects with uncertain timeframes or a of "we don't rent" or "we don't lease," periods of dramatic change are an opportunity to check
high level of risk. the assumptions behind such decisions.
Leasing is a good choice for longer-term
projects with a known, fixed duration. A Timing: Making informed decisions along the PLC
typical equipment lease lasts 12 or 24 If you purchase test equipment in the R&D phase, those assets may sit idle for an extended
months. period during the "unknown zone." If you don't win the contract, the assets could become
excess capital.
Two types of leases are common:
operating and financing ("rent to own"). For programs with moderate to high risk, renting or leasing provides greater flexibility. For
When an operating lease expires, example, you could return rented equipment after entering the "unknown zone" and then buy it
common options include returning the later--through rent-to-own or outright purchase--if you win the contract.
equipment, extending on a month-to-
month basis or buying the equipment at If you purchase test equipment in the R&D phase, those assets may sit idle for an extended
a favorable price. period during the "unknown zone." If you don't win the contract, the assets could become
excess capital.
At the end of a financing lease, you
take ownership of the asset and title is For programs with moderate to high risk, renting or leasing provides greater flexibility. For
transferred. This can be useful when example, you could return rented equipment after entering the "unknown zone" and then buy it
needs and budgets aren't aligned. It later--through rent-to-own or outright purchase--if you win the contract.
also helps maintain borrowing power
and preserve capital because it requires During the production phase, demand for test capacity changes dynamically. Figure 5 illustrates
less up-front cash. the cumulative capital outlays for test assets versus changes in test demand. Between
introduction and maturity, spending typically increases in large steps because, in most cases,
producing one or more units above existing test capacity requires a complete new test stand.
After maturity, production volume goes into a decline, which means fewer test stands are
needed and the excess assets become a drain on ROIC.
7
Step 2: Improving acquisition strategies for test assets (continued)
Figure 5. After production volume begins to decline, the
cumulative value of asset purchases remains fixed-- Phases of production volume versus time
and can become a drain on ROIC.
Introduction Growth Maturity Decline
Volume
Test demand
Asset buy
Figure 6 shows a financially attractive alternative. When test demand reaches a predetermined
level, a leasing strategy is employed. This is not an arbitrary point. Rather, by understanding the
different breakeven costs for renting, leasing and buying, the length of time under the curve can
determine the best acquisition strategy.
Figure 6. An acquisition strategy that includes leasing
can reduce costs, risks and excess assets. Phases of production volume versus time
Introduction Growth Maturity Decline
Volume
Test demand
Asset buy
Asset buy
TIME
In this case, the trigger point for the leasing of test assets occurs when the need is expected to
exist for more than one year and less than three years. Under these conditions, leasing is most
likely to minimize cost and risk, and thereby minimize the value of excess assets that remain
during the decline phase.
8
Reframing: Combining the strategies
Figure 7 shows the next logical extension of this strategy. When the concepts of common
hardware and software blocks are combined with flexible acquisition strategies, the result is an
overall test strategy that can be optimized for reuse, utilization and flexibility. As suggested in
the figure, test assets can be continually rolled forward and reused with new products that have
similar features, functionality and test needs. As in Figure 6, demand peaks can still be handled
through renting or leasing.
Figure 7. Selective use of leasing (or renting) adds a
financial advantage as common hardware and software Phases of production volume versus time
blocks are rolled forward to support new products.
Introduction Growth Maturity Decline
Volume
Test demand
Asset buy
Asset buy
Time
The interplay of these concepts is summarized in Table 3. Although none of the proposed
approaches is "one size fits all," matching each stage of the PLC with a favorable acquisition
strategy can help you reduce the total cost of ownership for your test assets.
Development Production Support
Buy Best with long development cycles Optimal for long-term production Lowest cost for long-term support
and evolutionary products (i.e., and production of evolutionary requirements
those expected to change with products
time)
Lease Effective with product development Supports the pursuit of a fixed cost- Provides flexibility when facing
programs of one to three years, of-test per unit, and production life short-term increases in support
and when using direct allocation of one to three years needs
of costs
Rent Effective for projects that last less Effective when facing short-term Provides flexibility when facing sud-
than one year upticks in production volume den increases in support needs
Table 3. The acquisition strategies offer potential For many years, commercial manufacturing companies have been combining these ideas to
advantages during each stage of the product lifecycle. reduce exposure to cyclical demand and fixed costs. In the era of FFP contracts, this approach
can be a useful alternative that aerospace and defense contractors will want to consider.
9
Conclusion
Testing is still the best way to reduce the likelihood of a product falling short of its specifica-
tions. To ensure customer satisfaction and success, many organizations spend money on test
throughout the product lifecycle--but this form of risk mitigation can be expensive.
As shown here, you can reduce the costs associated with test assets by adopting or adapting
proven strategies from the commercial world. One common thread is the power of reusing
knowledge gained from previous products and programs. This is true in the use of common
measurement blocks and in the reuse of test assets. It is also true in the analysis of test-asset
acquisition strategies versus the usual progression of production volumes and test needs.
The ultimate benefit is clear: the decision to leverage knowledge gained in commercial manu-
facturing can help aerospace and defense contractors compete more successfully in a world of
FFP contracts. It will also position your organization to more easily adjust and adapt with future
changes in the business model.
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