Supply Partnerships as Illustrated by the CN/GM Locomotive Power-by-the-Mile Agreement
John K. Edwards
John K. Edwards, Senior Director - Supply Management, CN Rail, Montreal, Canada H3B 2M9, 514/399-5868.
Danielle Dansereau, Agreement Manager, CN Rail, Montreal, Canada H3B 2M9, 514/399-5868.
83rd Annual International Conference Proceedings - 1998
Abstract. Long-term partnerships are built on a few key elements that link customers and suppliers. Strategic fit, trust, open communications, flexibility, quality, on-time delivery along with performance measures are elements that must be present for a successful partnership. This presentation outlines how a supply partnership can be a win-win situation for both parties involved.
Purpose of the Presentation: This presentation will outline how partnerships can lead the partners to achieve cost reductions. It describes how reliability and availability of equipment can be improved and how outsourcing of non-core activities is necessary and can be better achieved by another party. The presentation illustrates how CN and GM have put partnership theory into practice. The purpose of this presentation is to provide an understanding of the specifics of a partnership, of what makes a partnership successful for the long term, and of the obligations of both parties. The topic also applies to broader applications of machine or equipment maintenance and in fact, supply partnerships in general.
What is a Supply Partnership? A partnership is a long-term relationship process that focuses on mutual strategic goals. It has continuous improvement as an objective and it places a high priority on the quality of the relationship. A partnership includes shared strategies and shared risks and rewards. To help ensure the success of the agreement, there must be commitment and support from top management and close collaboration from both parties' key functional players.
The CN/GM Power-by-the-Mile Agreement. The CN/GM PBM agreement is an 18-year locomotive maintenance contract that started in July 1996. The agreement, valued at hundreds of millions, consists of full-service maintenance beginning with a base of approximately 500 locomotives. It will allow CN to achieve organizational and operational savings. In addition to being an opportunity to reduce costs, the partnership allows CN to improve the availability and reliability of its locomotives.
Why a Partnership for Locomotive Maintenance? CN is continually examining ways of increasing revenues by improving what it does best that is providing freight transportation services. In parallel, CN has also continued reducing costs. One of the ways to achieve both these goals has been to involve third-party specialists in non-core activities such as locomotive maintenance. Maintenance has evolved with technology and getting the equipment supplier directly involved in maintenance is the best way to guarantee reliability. In turn, the supplier uses the knowledge he has gained to improve the product.
Specifics of the PBM Service. The maintenance management program comprises three parts. The first, Scheduled "running" maintenance, is performed every 92 days. It consists of specific component inspection, replacement and repairs. The second, unscheduled maintenance, consists of all unscheduled repairs required to make the locomotives fit for intended operations. The third, reliability-centered maintenance, consists of periodic overhauls and repair and replacement of key components based on component wear.
The deal involved 511 locomotives initially, but any new locomotives from GM will be included in the agreement based on cost-effective PBM rates. The locomotives represent in excess of 50% of CN's high horsepower fleet. CN pays for the maintenance agreement on the basis of a set fee per mile for each class of locomotive. Maintenance is performed by GM at two CN facilities: one in Toronto and one in Edmonton.
What Does Each Party Bring to the Deal. Specifically, GM brings to the partnership the following elements: technical expertise, similar experience with other railroads, management/supervision capabilities; materials; performance guarantees; and continuous improvement commitment.
CN provides: its facilities; skilled craft personnel; some locomotive components; incentive payment commitment; and continuous improvement commitment.
The Business Case. At the beginning, CN evaluated with the assistance of a locomotive maintenance specialist its internal cost to repair locomotives by class of locomotives. The conclusion of the study revealed that it could cost less for CN to have the maintenance done externally.
The agreement allowed CN to achieve total cost reductions in many ways. Fixed costs were reduced because facilities where locomotive maintenance was performed were consolidated to two locations. The increased availability and reliability of locomotives would also mean optimum use of the fleet and a reduced need for additional equipment. GM bought from CN critical inventory pool items. This generated savings to CN on inventory carrying costs. GM was also committing to improving employee productivity.
Doing the Deal. Preparing the partnership meant high involvement on the part of people from both organizations for approximately a six-month period. A memorandum of agreement was first prepared then, during two months, there were "heavy" brainstorming, discussions and negotiations about each aspect of the agreement. The CN team was composed of representatives of Supply Management, Mechanical, Law and field management. The GM team included top "Service" managers, field experts and lawyers. Experts from both organization were brought in to discuss taxation, labour, safety, environmental and financial matters. The final document produced was an 80-page agreement with 22 annexes.
Benefits for Both Partners. CN benefits because the PBM agreement lowers its total cost and it provides guaranteed availability and reliability. GM benefits from a long-term supply agreement because it enables them to provide a service that is a core activity for them.
An additional benefit to CN is that it pays a fixed cost per mile and that the onus is on the supplier to provide parts without failure. Previously, CN had to pay for the failure of a part due to design. Now, GM assesses failure modes and improves the product or the repair process accordingly. CN wins because there is increased availability and reliability at lower total cost of locomotives and GM wins because it reduces their cost. There is an incentive for the supplier to make a product that has the least failures possible as opposed to having a product that generates after-market sales.
The PBM rate also accounts for an expected material cost. There is an incentive for GM to maintain the locomotives with fewer parts. They have control over the engineering of parts.
CN obtains locomotive maintenance at predetermined costs, that are variable in proportion to revenue gained. GM gets a long term, defined business that establishes a high volume production plan and provides opportunity for gain through improved processes and efficiency.
Combining GM's technical and management people with CN's craft personnel ensured that both parties' specific expertise and skills would be used. This meant making some changes in culture and maintenance practices. This provided a practical solution to the delicate issue of contracting out within a unionized environment.
Performance Measures: Incentives and Penalties. Performance measures have been inserted in the agreement at the start. One of the major measures is the availability of the locomotives, measured as a percentage of days of the performance period during which the locomotives are available for use. The other important measure is locomotive reliability, measured in failures per million miles traveled by the locomotives during the performance period. Other important measures related to fleet performance are total scheduled maintenance time, total unscheduled maintenance time and total unscheduled repairs.
GM is responsible for maintaining the locomotives to a high standard, giving better availability and reliability than the railway was previously achieving. If GM misses on availability or reliability, it pays a penalty. If GM exceeds on those measures, it receives rewards.
The same applies in the case of the employee productivity ratio where it was presupposed that GM supervision, more than CN supervision, would help increase productivity. If GM doesn't achieve the target ratio, it must pay a penalty for the productivity gap.
Continuous Improvement. As cost reduction is one of the most important benefits sought from continuous improvement initiatives, CN and GM have agreed to work towards reductions in total cost through continuous improvement processes and technological improvements.
The agreement allows both parties to share benefits according to a predetermined formula. It also provides for shared labour and material cost escalation.
The GM/CN continuous improvement team's mandate involves finding alternatives to improve the program. For example, by improving shop operations or methods of scheduling locomotives for maintenance. The team also determines the method of continuous improvement benefit sharing which may be in the form of parts credits, rebates, rate adjustments or other methods.
Conclusion. Buyer/supplier partnerships are complex, long-term alliances that must meet a number of criteria in order to be successful. But the key to forming a mutually beneficial alliance is strategic fit, communications and trust, with a commitment to openness, particularly on pricing, target costs, future business plans and investment. The CN/GM locomotive maintenance agreement satisfies the key criteria of a partnership. It is aiming to achieve the best performance and cost results and a win-win situation for both partners.