The U.S. Department of Defense (DoD) is already doing 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 was 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. Their interests are more closely aligned with their customer's interests.
Improving uptime provides a more reliable service at a lower cost. This reduces the number of planes the DoD has to buy, lowers inventory levels, and decreases the number of service personnel needed, as well as cutting 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 agree with the definition of the level of performance you need, 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. Focus on the results and leave the "how" up to your supplier.
· 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 multi-billion dollar, highly diversified conglomerate (retail, construction, food, transportation, forest products). In the past, they specified exactly the type of equipment they wanted in their plants. Now, instead, they are specifying the outcomes they want and the process improvements and performance gains they expect from their suppliers. For example, they have packaging machines that apply plastic film to their lumber products. Instead of specifying the characteristics of the machine (e.g. horsepower, features, etc.), they specify to the suppliers the results that they want (e.g. rate of application, look and feel and performance of the finished, wrapped product, etc.) 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 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 rewarding or penalizing the entire group based on the outcomes achieved.
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.
Outcome sourcing, in its purest form, may not be right for every category of goods and services, but the general principles can be applied across a very broad range of needs. Progressive companies are figuring out how to use this approach across more and more categories, and are reaping the benefits.
Outcome Sourcing is covered in our report series on the Next Generation Best Practices in Managing Suppliers.
See also: Outcome Sourcing Part 2: Expressive BiddingTechnology for Specifying Outcomes
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