Contract Management: Avoiding Common Pitfalls of Service Maintenance Agreements

Multi-year agreements (MYAs) essentially require an original equipment manufacturer (OEM) to provide maintenance, as defined contractually, for a turbine or other equipment for a predefined duration.

As EY reports, MYAs offer advantages to both OEMs and operators. However, when dealing with any kind of contract management, agreeing on the details can be complex, and—if not done properly—can lead to future problems.

Pricing for MYAs is usually based on a clear understanding of a defined, preplanned maintenance schedule outlined in the contract. However, when this schedule changes unexpectedly or differs from assumptions made in the contract, as invariably happens, disagreements can arise between OEMs and operators about liability. Here are some tips on how to avoid common pitfalls associated with contract management plans.

Understanding the Scope of the MYA

It may sound obvious, but the first and most important challenge for both parties is to clearly lay out, define, and mutually understand the scope of the contract management plan. This is especially important in regard to the termination points: When is the termination point? Does the scope cover anything outside of the turbine? Does it include all the auxiliaries? Does it include periodic maintenance on the auxiliaries or not?

It is critical that the basic scope of the service contract agreement is laid out clearly before the price is mutually agreed upon.

Sudden Outages: Guaranteeing a Timely Response

MYAs will typically include availability guarantees that require the service provider—the OEM—to be available for remedial work in the event of an unexpected outage or breakdown.

It's important to note that an availability guarantee is not intended to offset an operator's loss, but guarantee the OEM's responsiveness.

To decide on a level of responsiveness that's agreeable to both parties, a few things need to be considered. For example, are materials available to support a high guarantee of availability from the service provider?

The plant manager bears some of the responsibility of ensuring that spare parts are available, so the service provider can respond in a timely fashion. Based on the amount of support materials that both parties expect to have available, the OEM and plant manager can define a guarantee level.

Therefore, if a plant manager commits to having enough spare parts available, then they can reasonably expect a high level of availability from the OEM. However, if a plant manager is unable to supply those spare parts, then OEMs may push back and want a lower availability guarantee. This trade-off is often required for practical responsiveness.

Plant managers should ask for a big guarantee and plan to supply parts for that guarantee. Spare parts are often covered in the agreement, and the plant operator should make sure payments are regular enough—or negotiate a suitable enough payment plan—that spare parts are on site. In return, the OEM will provide those parts and should accept a larger availability guarantee.

Defining What Is Considered Extra Work

When conducting unplanned work outside of scheduled maintenance, it is often difficult to establish who is liable—the OEM or the operator?

Before liability can be determined, an investigation by the service provider is necessary. After which, the service provider can decide whether the job is considered extra work, and therefore the liability of the plant manager, or equipment failure, and therefore the liability of the OEM.

Both parties want the equipment fixed promptly, but can be nervous about who is liable. Often, the OEM is concerned about paying investigation costs and then needing to recuperate them later if liability falls to the operator.

To avoid delay, a process for this scenario should be clearly defined in the contract. For example, the operator could agree to provide the purchase order for the OEM immediately under the assumption that the repair is extra work, and, if it turns out to be the OEM's responsibility, no bill will be issued.

Deciding on the Right Length of Contract

How long should an MYA be, so the service provider can invest in the equipment and the plant manager gets enough value for their money?

It is fair to say that, from both perspectives, it's preferable the contract is long enough to drive investment from the service provider.

A contract length of a minimum of two major inspection intervals gives the OEM time to learn the equipment, invest, advance, and make sure the customers' desired outcomes are being met.

It's also helpful to have a risk-reward scenario in place for meeting those outcomes. It's reasonable for the operator to outline major goals they want met over the duration of the contract. If the service provider fails to meet these goals, a contract review could take place. For example, the operator can routinely test the service provider, expecting them to meet clearly defined key performance indicators. If met, the contract can continue.

Agreeing on a Payment Schedule

As part of the service contract agreement, the plant operator will need to make scheduled payments to the OEM. There is typically a major upfront investment from the service provider to supply parts and capital equipment costs in the contract. However, cash flows from the operator to the OEM can be customized to make the project work for the equipment owner, if a balance is struck. For example, service providers will say they need payments to reflect the reality of what they can reasonably manage in terms of their own cash flow.

To arrive at the best arrangement for both parties, it's critical to know what drives cash flow and price changes based on other contractual elements. Charges are based on the hours the equipment operates, but there are modifiers. It's critical to understand how these and general assumptions drive price and cash flow, so the OEM and operator can reach a mutually workable agreement.

Recognizing Shared Goals

For operators and OEMs to maintain a good relationship, it's important that they align their outcomes from the beginning. If the OEM knows what the operator wants to make happen, then the OEM can show the operator how it can achieve those goals.

The OEM will most likely recognize that their customer's outcomes and key performance indicators will change over time, and be willing to be flexible when this happens. In turn, the operator should recognize that the OEM needs to recover its upfront investments.

Overall, it's important to maintain an open dialogue around desired outcomes, as well as realistic expectations on both sides. If communication is constant, there will usually be a way to modify a contract during its term, so both parties are fulfilled.