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Wednesday, 10 March 2010

outcomes, competitive advantage and sustainability

I thought I'll share some of my thoughts about the work I'm doing in outcome-based contracts.

Outcome-based contracting (OBC) is a contracting mechanism where the firm is tasked to deliver outcomes rather than merely assets or activities. This is the case for Rolls Royce “Power-by-the-hour®” contracting for their aerospace engines, where the continuous maintenance and servicing of the engine is not paid according to the spares, repairs or activities rendered to the customer, but by how many hours the customer gets power from the engine.

It's not really easy, if you think about it. Imagine buying a power drill but only paying for holes in walls. Imagine English lessons being paid by how many English words come out of the student's mouth. There is the determination challenge (which outcomes?). There are measurement challenges (how do I measure the outcomes?), there is the revenue challenge (how do I pay for these outcomes?), there are skill challenges (the teacher needs skills in psychology, or counselling to get the student to be motivated to learn, rather than just teach). But overall, it's a nice idea. I've written an exec briefing on it so you can check it out here.

They are many types of outcomes of course, and it really depends on how far up to endstates you want to go. But its important to start from the ultimate end state. Customers won't tell you of course, because they probably are not sensitized about their endstates. It took us half a day (using a particular method we developed) of triangulating information of various employees before the National Library Board (Singapore) endstate was finally revealed - Literacy of the Nation. It might sound so obvious now but believe me it isn't obvious when you start to think about contracting and procurement of books on the basis of achieving literacy. Remember, a system endstate comes from both customer and firm and when a customer contracts, they are often not sensitized to their roles and their resources to achieve the endstate. Did you ever realise, when you drink coffee at the cafe, that you have the resource of being able to smell and taste to realise the endstate of 'good coffee'? you probably just think the cafe's good right? Now you see the problem when you talk to customers about endstates.

Well, that's where we always have to start from - the ground zero of endstates. Probably not measurable but its the axis on which proxies and measurements further down the endstate ladder are developed and the axis is crucial because all proxies and measurements have to consider the incentives, alignments and mechanism design of the parties involved in achieving outcomes. But then I get too technical so lets move on.

To me, the pursuit of outcomes and the capability to derive the right outcomes and how to achieve them is the pursuit of capability for value co-creation. Can you guarantee the 99% of IT systems even if a user could stick a virus infected usb stick into his computer? can you guarantee a clean washing load even if the user abuses the machine? The challenge of value co-creation is the challenge of managing/changing behaviors and integrating resources of the customer. Not many companies are up to the task. In fact, most firms would usually say 'well, we cant help it if they killed the system/dont know how to use it/dont know when to use it/abuse it'? They draw a strong boundary of what is us and them. It then gets relegated to 'high risk'. end of story. Well, imagine if your competitor can.

Here's a picture for you. If a firm can't achieve end states, they are basically saying they dont have the capability to manage a crucial system resource - the customer. To achieve desired endstates (see pic), the resources to achieve them is less dependent on the firm's resources and more dependent on customer resource (size of arrow depicts the level of resource to achieve which stage). Solve that, and you'll be dancing to outcome-land. Solve that, and you'll become a better English teacher, a better organization.

If you can't, this means that you have failed to understand what resources are contributed by both customers and the firm in order to achieve the benefits realized within the customer experience. Only by understanding the resources contributed by both parties in value co-creation can we achieve the best outcomes for customers in the target market, at the lowest costs. The substitutability of resources contributed by the firm, by the customer, and by technology must therefore be evaluated not merely from the cost perspectives, but with the possibility that it could also lead to better outcomes, resulting in the firm being able to either increase price or demand for the service. How's that for competitive advantage.

Why are outcomes important? Remember the English teacher and the change in skill set so that she can be more effective for student learning rather than teaching? Outcomes changes the boundaries of the firm. It shifts the boundaries of what is service, as that rendered not only by people but also by assets (see service dominant logic). It shifts the skills sets and capability of the firm (and therefore increases risk) and to get the firm to focus on effects of what they make/do and the effects of what customers do in combination for achieving endstates. It redraws a system to focus on joint system capability of customer and firm – rather than drawing a boundary and sub-optimizing. It makes all parties think of a better re-configuration of resources and substitutability of resources. For a UK economy that has lost so many jobs in manufacturing, it refocuses us to think about the future capability and skill sets that sits in our companies, indeed all companies to achieve outcomes and endstates of society, whether its living longer in our homes, or effective washing loads.

Most importantly, it shifts the focus from manufacturing/production to complex service systems – human, processes, assets – to achieve outcomes/effects/endstates call it what you will. If engines to fly longer - even if every component would have changed after 10 years, we would stop the make-buy-consume-break-buyagain model of production. If washing machines could last forever even it could change colour, component etc. along the way because the revenue models support it, we would be on a road towards a more sustainable future. If we worked hard to get our firms to develop capabilities to achieve outcomes, we make them motivated to innovate and outperform each other to achieve better outcomes and higher endstates of customers. That's a future that is surely worth working for.