14 April 2016

Supplying Innovation: unlocking innovation in the supply chain

Leading companies invest a lot on innovation and constantly ask themselves 'am I innovative enough to secure my leading position?' They have loads of internal innovation programs, covering a wide range of subjects from technology innovation to business model innovation. But these programs, in many cases, fail to generate expected value. Some of them start to think about the possibility of innovating together with other players in the supply chain. One obvious benefit of doing so would be the integration of capabilities and skills. But the contractual approaches make it almost impossible for large scales of integration. Just think, as a client, how can I share my knowledge, capabilities, data and information with my direct suppliers without any concerns?

Apart from limited innovation, the consequences of locking innovation internally in the companies are obvious. Knowledge and information are not integrated from companies in the supply chain, so that the services and solutions delivered to end customers may not be the best ones. Also, traditionally in the supply chain, it is output-focused instead of outcome-focused. Suppliers are only incentivised to deliver outputs based on service level agreements. They seldom focus on the value delivered to end customers. On the other hand, if innovation can’t be unlocked in the supply chain, the supply chain is not efficient. The stakeholders such as suppliers, contractors and clients, have to discuss back and forth several times before the final decisions.

In some industries in the UK, such as the utility industry, the regulator has triggered the change to unlock innovation in the supply chain. The regulator starts to direct the industry to be outcome focused and customer focused. Customer satisfaction and customer experience have been paid unprecedented emphasis. Companies are incentivised to explore new models to engage suppliers for innovation. One innovative trial is to form a strategic alliance, where suppliers / contractors, and the client companies can work together within one organization, and to jointly deliver services and solutions to end customers. Suppliers are contracted on outcomes instead of on outputs, so that they are incentivised to include end customers as key stakeholders.

The shift from output based model to outcome based model and the formation of a strategic alliance to engage suppliers and clients can bring benefits for key stakeholders. For customers, when suppliers are contracted on outcomes and get rewards when customer experience is improved, they will pay attention to end customers, so that customers are expected to get better services. For client companies, in outcome-based contracts, they can transfer some of the responsibilities and related risks to suppliers, and risks and rewards are shared with suppliers. And for suppliers, since they are contracted on outcomes, they will have certain flexibility to choose among possible solutions. In this situation, they are incentivised to innovate and to come up with more efficient and effective solutions.

However, the challenges and barriers are enormous. Partners in the alliance have different business models, and conflicts can arise when they are brought in under the same outcome-based model. Also, partner companies have very diversified backgrounds. Some of them may be competitors outside the strategic alliance, and some of them may not have smooth relationships previously. If trust and collaboration in the alliance are limited, failure can come very soon. When the whole industry is still output focused, extended suppliers may not have capabilities nor confidence to be contracted on outcomes. And if the atmosphere in the whole industry is not collaborative, it is challenging to form collaborative and trusting relationships.

I observed this new model closely and worked together with people from industry, aiming to unveil key points that can ensure the success of an outcome-based model with a strategic alliance approach where suppliers and clients partner with each other to deliver services and solutions to end customers.

What comes out of the research is that there are three areas that partners in the strategic alliance should work on. These three areas are commercial solutions, collaboration and operational design. A commercial solution that is accepted by all partners lays the foundations of working together. Collaboration ensures that partners start to integrate their skills and capabilities, and design and deliver solutions collaboratively. Process design aims to ensure the smooth operations of the strategic alliance.

Commercial Solutions
Since partners are measured against outcomes, an applicable commercial solution should address the risk and reward sharing mechanism and the benefit realization framework. The risk and reward sharing mechanism needs to solve these problems: how benefits and rewards are shared among partners based on contributions, how risks are shared among partners based on accountability, and to what extent the alliance should be measured against end customers’ outcomes. The benefit realization framework needs to solve the following problems: How to decide on the final solutions among many possible capital solutions and operational solutions; How to solve conflicts between return on investments and customer outcomes; and How to solve conflicts among partners regarding their preferences on solutions, etc.

Collaboration should be built from four aspects: strategic objectives, organizational culture, trust and communications. With shared strategic objectives, partners can work towards the same direction. A collaborative and innovative organization culture needs to be formed within the strategic alliance, collecting the best parts of partners’ organizational cultures. Trust can ensure that partners are willing to share data, knowledge and information, and trust other partners’ decisions. Consistent and efficient communication rules need to be followed, and educational communications will be helpful to deliver the concepts of outcomes and collaboration to every employee.

Operational Design
Operational design includes continuing education, information platforms, process design and metrics and measurements. Continuing education is important to ensure that employees understand the strategic objectives of the alliance and that everyone talks on the same tune. Information platforms help to integrate knowledge and capabilities from partners, and that data and information can flow efficiently. Also, data security needs to be addressed. Process design such as decision-making process, risk management process, culture change process, etc. can facilitate the smooth operations of the alliance. Metrics and measurements that measure the contributions of partners, behaviours of individuals, financial status and the achievements of outcomes also needs paying attention to in everyday operations.

The following figure summarises the key elements for successful alliance delivery of outcome-based projects. Firms that would like to engage suppliers for innovation can consider forming a strategic alliance, combining suppliers and client companies, while focusing on delivering outcomes to end customers. However, they should be fully aware of the challenges and barriers in this model, and carefully make decisions to ensure the success.