Edward's Great Expectations

Edward fumed.  “Why can’t these guys be more innovative?  I told them when we outsourced to them, I needed them to be innovative.  But it’s just same old same old.”  Edward (not his real name) was a procurement manager for a large consumer products company.  He was visibly frustrated but hopeful that applying Vested Outsourcing practices would help.

“Tell me how your agreement is structured,” I said.

“It’s simple. We had three homegrown facilities, legacies of acquisitions.  They consolidated everything into one of their facilities.  They receive all our inbound products and components, inventory them, then fulfill orders, picking, packing and kitting.”

Edward wasn’t through venting.  “At every quarterly business review, they go through the scorecard, and everything looks great, and then I ask them about innovative practices, and they talk about some arcane improvement in materials handling systems, or something like that, but it’s nothing to write home about. And these are the people who came to me and said ‘We can revolutionize your operations, drive huge efficiencies.’  But it just looks exactly like what we were doing, only centralized.”

“Are they performing well?”

“Absolutely.  They’re very good, always hitting their metrics.”

“But you’re not getting something you want.”

“Exactly.”

“Edward,” I said, “I bet the problem lies in your contract.  I bet the reason you’re not getting innovation is that it’s not in the contract.”

“Yes it is!  Here, I’ll show you.”  And there it was, a single sentence buried dozens of pages into his MSA:  Supplier shall innovate.

“Edward, what’s your pricing model?”

“We pay them to receive.  We pay them to inventory, by the pallet.  We pay them to pick, pack and ship by the touch.”

“Do you pay them for innovation?”

Edward became flustered.  “What do you mean, do we pay them?  Of course we pay them.  The whole purpose of the contract was to get innovation!”

“Edward, I hear your frustration.  I’m going to tell you something you may not want to hear. The reason you’re not getting innovation is that you didn’t buy innovation.  You bought activities, and thereby set up a pricing structure that actually inhibits innovation.  We call it the Activity Trap.  Your supplier has no financial incentive to innovate.  In fact, it’s just the opposite.  If they innovate, it will only hurt them.”

“How will it hurt them?  It’ll hurt them if I don’t renew the contract!”

“Any innovation will mean reducing touches, or reducing inventories, or reducing some activity they’re getting paid for.  Which means they lose revenue.  When you’re asking them to innovate, you’re asking them to give up revenue.  Why would they do that?  Just like you, they’re in the business to make money.  You have great expectations, Edward, but until you revise your pricing structure based on the Vested Outsourcing principles we’ve been talking about, to make innovation financially rewarding to them, you’re going to get the same old same old.”

With that, Edward launched a contract amendment process that eventually got him what he really wanted:  continuous transformation of his distribution system.

What are your expectations?  And where are the gaps in your outsourcing agreement that cause you frustration?