Trends and Issues

TAKING SUPPLIER RELATIONSHIPS TO THE NEXT INNOVATION LEVEL THROUGH SHARED RISKS AND REWARDS

Staying competitive depends on having a process in place to generate and capture innovation. The supply chain is an excellent source of suppliers who can be a primary source of continuous innovation with contracts that share risks and rewards.
- BY Valerie Gomez

Historically, corporate buyers have negotiated supplier contracts focused on price, delivery reliability, and type of products and services. Innovation is a one-off consideration, meaning the buyer chooses a product or service because it meets the buyer’s pre-determined innovation requirements, and the supplier does not speculate on innovation. The financial risks are too great.

Yet, in researching it, Wagner and Bode point out that most buying firms pull innovation from suppliers. Suppliers may offer an innovative product or service, but in a traditional procurement contract, suppliers are not motivated to push innovations because of the investment risks. Factors like strong buyer-supplier collaboration, contract length, and the length of the relationship influence the willingness of suppliers to push innovation. As a result, innovation contracts are emerging where designated suppliers have an ongoing opportunity to develop innovation for customers collaboratively.

Beyond the One-Time Joint Venture to the Ongoing Collaborative Innovation Venture
To change the nature of the buyer-supplier relationship so that suppliers push innovation requires buyers to be willing to share the risks and rewards of innovation. Joint ventures, which make a formal business arrangement to collaborate on a set project, are not particularly applicable to encouraging ongoing supplier innovation. Instead, a joint investment makes more sense.

Unlimited opportunities for ongoing innovation collaboration exist. For instance, the technology industry, which is constantly in flux, can benefit from collaboration between a technology company and a component manufacturer to develop new microchips with advanced features. Similarly, a medical device company can work with a materials science supplier to create innovative implant designs that evolve with materials and technology. A clothing company can partner with a textile supplier to produce sustainable fabrics. These ongoing collaborations foster innovation and strengthen long-term partnerships.

Integrating Suppliers into the Innovation Process
Developing a collaboration contract is the key to successfully integrating a designated supplier in the innovation process. The corporation and the supplier commit to developing new products, improving existing ones, and driving innovation within the supply chain. The supplier actively contributes innovative ideas, technologies, or processes to improve the corporation’s products or services. There are incentives for the supplier to encourage the development and delivery of innovations. Incentives can vary. One example is a defined payment structure based on the value of the innovation delivered. Perhaps there is a profit-sharing agreement or milestone payment. This approach shares the risks and rewards.

The contract should deliver mutual benefits, like access to new technologies, improved product quality, and broader market access. It should clearly outline specific innovation targets and objectives that maintain alignment between the corporation and the supplier concerning corporate strategic goals. In an ongoing joint development process, the corporation and supplier leverage each other’s expertise while designing, developing, and testing innovative products and services or improving existing ones.

In this collaborative arrangement, there are clearly defined risks and rewards. For example, how are innovation ownership rights and intellectual property rights defined? How are required investments determined? These are crucial questions that must be addressed upfront to ensure a smooth and transparent innovation process.

Kevin Smeets, Partner, Transportation & Services at Oliver Wyman, highlights the findings of a company study that revealed more than 80 percent of companies struggle with integrating their supplier base. The consequences of not integrating suppliers can lead to various challenges, from fear about IP issues to lack of transparency about real needs and supplier capabilities to poor execution. Smeets suggests three guidelines to address these challenges: prioritize development capabilities for supplier innovation, focus on profit improvement instead of cost reduction, and simplify collaboration with suppliers during innovation processes. One of the key success factors is clearly defining supplier innovation objectives and aiming for long-term win-win partnerships.

According to the law firm Cirio, a good innovation contract with a supplier will address three areas. One is that it answers the question, “Innovation for what?” The reasons for developing innovation include more than cost-cutting today. For example, innovations may be needed to improve sustainability or expand markets. Also, the supplier incentives must ensure the rewards or incentives are fair. A typical innovation clause may say the supplier will earn 50% of savings attributed to innovation if the corporation implements the innovation. However, what if the innovation improves efficiency and leads to fewer activities? The supplier finds it has less business with the customer and loses more money than gained from the 50% savings. The third area says there must be appropriate mechanisms regarding innovation governance. Many innovation activities will occur at the supplier’s and corporate offices, so clear roles and responsibilities should be established.

Organizational Cultural Shift
Sharing the innovation process with designated suppliers necessitates a supportive culture. Both parties need a willingness to experiment and take calculated risks. The standard contract will no longer be adequate. Tamer Assem, Contracts & Procurement Manager at Energean, explains the corporation must allow for agile contracting, in which iterative contracts can be issued as innovation advances, and does not focus on what supplier contracts usually focus on, which is deliverables at a particular cost and within a preset timeframe. Procurement professionals need skills in developing contracts that incentivize achieving goals while recognizing risks and rewards. Innovation should be part of procurement planning and supplier management.

In today’s business environment, standard supply chain management practices are insufficient to meet the challenges. Companies must innovate to remain competitive, and the supply chain is one of the best sources of innovation. Sharing the risks and rewards in supplier relationships makes sense in a business environment that thrives on change. Being able to embrace change productively and profitably is at the heart of win-win contracts that incentivize supplier innovation.

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