Increasing Innovation Using Outcome-Based Contracts

The capability to innovate, both independently and through collaboration, is an essential requirement in any organisation. On large projects where many companies and stakeholders must work together, innovating with impact can be hard, especially given the strong link between culture and innovation. A shared purpose and collaborative culture that reflects each participant’s own cultures needs to be established and aligned to promote, facilitate, and embed a sustainable ‘system of innovation’.

However, traditional ways of team-working and arms-length contracting often disincentivise collaboration and shared innovation. Different parties might take distinct positions based on misaligned cultures, contract constructs and incentives. 

But there is an alternative. Adopting outcomes-based contracts can create more space to innovate, turning ideas into sustainable value. 

Culture And Innovation

Cultures and culture-clashes affect the nature of collaboration both between and within organisations. With the link between innovation and culture so strong – what people choose to do on a day-to-day basis and the way they do it has a significant impact on how they create ideas and, through user collaboration, how the generate demand. If cultures are out of step, innovation will be constrained and the opportunity to create irreversible change lost.

At an organisational level, culture is linked to the organisation’s capability to innovate. If there is a culture of high trust, employees can be given the freedom to take greater risks and fail without fear – which leads to the creation of more ideas. But since innovation rarely works in a siloed or isolated environment, the challenge is to facilitate and promote collective innovation with freedom to fail – this can fuel game-changing ideas that create sustainable value.

Partners and stakeholders can share innovation risks and opportunities based on their collective competency and risk appetite. Agreeing the split of opportunity and risk between partners is an important reality check when different organisations must work together to deliver a set of shared outcomes. 

Outcome-Based Contracts

The relationships between companies and the way that they work together are governed by contracts. If there is a culture of trust between the companies, these contracts can sometimes be truly collaborative, irrespective of their form – but specifying outcomes rather than specifying solutions or requirements is the only way of consistently unleashing creativity. This creates the space and freedom to innovate. 

Outcomes-based contracts offer greater flexibility than other forms of contracts. which tend to be more prescriptive with greater constraints. Payments can be linked to outcomes that matter, but with the freedom for suppliers to innovate about how outcomes can be achieved. Activity micromanagement can be eliminated in favour of letting suppliers work openly with users to identify what works best in practice. 

Outcome based contracts have been prevalent in the pharmaceutical industry for some time – a sector known for its innovation and agility. Patients and healthcare providers are less concerned with how medicines are made than they are with the outcome, namely that they must treat health conditions and disease. Payment for the drug is based on its effectiveness – with outcomes-based contracts encouraging companies to innovate to achieve better patient outcomes. It drives innovation in the product development process since suppliers are not paid for their time or effort, but the end-product impact and outcomes. The faster the product development process, the earlier the outcome delivery. There is a significant incentive for process innovation to make the drug treatments more effective and reduce the time to market. 

The use of outcomes-based contracts also promotes innovation in other sectors meaning that large and complex projects can be completed ahead of time and under budget. Suppliers are incentivised by payments linked to outcomes. With user-supplier collaboration creating innovation-supply and user-demand, there will also be innovation spillovers with other users and suppliers that benefits the wider industry.. 

So What?

Culture is a key enabler for innovation. In a culture that is tolerant of failure, ideas that create sustainable value and accelerate the delivery of outcomes can be surfaced and demand created. User-supplier collaboration is easier and outcomes-based contracts promote a relationship where there are shared and aligned values between organisations. 

Outcomes-based contracts can eliminate adversarial commercial behaviours and the costs and collateral damage of a “blame and claim culture”. Instead, trust creates a virtuous cycle of user-supplier innovation with spillovers meaning innovation becomes contagious and the best ideas spread like wildfire.

Outcomes-based contracts that are enhanced by user-supplier collaboration are the most effective way of ensuring that innovation becomes business as usual.

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