One of the most important developments in supplier relationships is outcome sourcing—moving from buying things to buying results or outcomes. This concept is expressed in the quote attributed to the President of Stanley Tools, “Our customers want holes, not drills.” What is new is the actual practical application and methods for achieving it.
The U.S. Department of Defense (DoD) is moving toward a form of outcome sourcing. They refer to it as Performance Based Logistics programs (PBL) or Power By the Hour. In aircraft maintenance, for example, their traditional approach is to specify the parts needed and the required service levels (parts availability). However, what the DoD really wants is not parts, but planes that are ready and able to fly when needed. Their PBL contracts specify aircraft uptime requirements, rather than spare parts availability levels—and make the manufacturer responsible for that uptime. As a result, aircraft manufacturers have a much more direct financial incentive to make their airplanes and parts more reliable and easier to maintain.
Improving uptime provides a more reliable service at a lower cost. This reduces the number of planes the DoD has to buy, inventory levels, service personnel, and a host of other costs. The following are some of the lessons learned in these PBL contracts:
- PBL contracts can take more time and effort to write than traditional contracts. As the buyer, you need to ensure that you are in agreement on the definition of what performance you want and how specifically it will be measured during the life of the contract. You need to thoroughly think through all the scenarios and how you want to be served.
- Resist the ingrained approaches and people’s tendency to dictate how the job will be done.
- Create long-term business arrangements that will stand the test of time….be flexible in creating mutually beneficial outcomes.
- To make it work for both parties, you may need to share some risk with suppliers.
- Specifying outcomes in no way decreases your (the buyer’s) responsibility for managing the relationship. It can actually increase your responsibility.
Specifying Desired Outcomes
Specifying desired outcomes provides more flexibility to suppliers. It allows suppliers to bid on a specified outcome, rather than a buyer-specified solution, resulting in better solutions for the buyer. For example, take the case of a multibillion dollar, highly diversified conglomerate (retail, construction, food, transportation, forest products) moving past specifying the equipment for their plants, and instead specifying the outcomes they want and process improvements they expect from their suppliers. They have packaging machines that apply plastic film to their lumber products. Instead of specifying the characteristics of the machine, they specify to the suppliers the rate of application and performance of the wrapped product. To enable their suppliers to serve them better, this company also allows suppliers to come in and look at the way their machines are running. By allowing suppliers to bid on providing that specified outcome, rather than a buyer-specified solution, the supplier has a lot more freedom in finding the best way to meet those needs. This also represents a major change in how the buyer’s engineers think about and specify the problem.
Taking it one step further, this conglomerate is also experimenting with letting three or four suppliers bid together to meet requirements. For example, a particular paper production process has a machine supplier, chemicals supplier, belting supplier, and fabric supplier. These suppliers are specifying the desired outcome of the whole system—multiple companies create a combined bid. The buyer’s firm is just learning how to make these more complex, multiple-supplier arrangements work—making sure that roles are well-defined, tying their compensation as a group into the performance, and penalizing all three if there are significant problems.
Outcome Sourcing Changes the Equations
Outcome Sourcing dramatically changes the dynamics of the sourcing process:
- Dramatic increase in innovation – Giving suppliers freedom to come up with the solution unleashes supplier creativity and opens up all sorts of new options for solving the problem—solutions that the buyer never would have come up with themselves.
- Discovery of hidden opportunities – Because suppliers have so many more degrees of freedom in responding, they uncover and discover many more opportunities for improvement.
- Better alignment of suppliers’ incentives with customer needs – In the old paradigm, more spare parts and repairs meant more money for the supplier (except under warranty programs). In the new paradigm, fewer required repairs and more reliable equipment mean more profit for the supplier.
A Whole New Way of Thinking for Buyers and Sellers
The move to an outcome economy encompasses radical changes in the core elements of commerce. It requires a whole new way of thinking on the part of both buyer and seller – from buying and selling things to buying and selling outcomes. This rewrites the rules on what the product offerings actually are, the requirements specification process, contractual agreements, sales models, cash flow models, and the meaning of service and support. It fundamentally changes the relationship between buyer and seller.
|Buy/sell things & services
|Buy/sell outcomes & experiences
|Supplier as automaton order-taker
|Supplier as creative innovator
|Constrained to buyer’s way of seeing the problem. Opportunities remain hidden.
|Freedom to find a different way. Opportunities revealed.
|Seller maximizes consumption
|Seller minimizes consumption
|Walls and silos constrain organizations
|Focus on material/service cost
|Focus on total cost
Interestingly, it also could help to save the environment! In the traditional economy, the seller is incented to maximize the customer’s consumption of products (upgrade/replace often) and parts, supplies, and services, which are often the biggest source of revenue. In the outcome economy, the buyer is no longer paying for consumption, but is paying for outcomes. The seller is incented to deliver the best possible outcome at the lowest cost, which equals the lowest consumption of materials and energy. That translates into making products and parts last as long as possible, minimizing the consumption of raw materials and energy for a given outcome, and making products so reliable that they almost never break or require service. With those direct financial incentives, it’s amazing how creative suppliers can become, reducing energy and material consumption by 10 times or even 50 times.
Progressive companies are moving not just to outcome sourcing, but also to outcome selling. They recognize that this whole new way of thinking on both the buying and selling side can be a key component of sustained competitive advantage.
[This is an excerpt from Part 1 of a four part report, “Next Generation Best Practices in Managing Suppliers”.
For more information on this report, contact Bill.McBeath@clresearch.com