Value, Variety and Viability: New Business Models for Co-Creation in Outcome-based Contracts

Introduction

While manufacturing in the past century has been essential to wealth creation, developed economies are gradually becoming service-oriented (Ramirez, 1999). Research recommends that manufacturers should diversify into providing services to remain viable, aiming to facilitate equipment use for customer outcomes rather than just transferring the ownership of equipment (Neely, 2008; Baines et al., 2007). This means that the value proposition of the manufacturer changes from exchange value obtained from equipment provision, to value-in-use, obtained from the outcomes of equipment use. Outcome-based contracts such as Rolls-Royce’s “Power-by-the-hour®,” exemplifies such a change in value proposition, as the firm is paid not according to its service activities such as material and repairs, but based on the outcome of such activities in continual use situations i.e., the number of hours of engine in the air. This change in business model requires firm-customer relationships to be embedded in the processes and interactions of collaborative value-creating activities, i.e., value co-creation. Therefore, cooperation between the firm and its customer is a partnership that requires a “mutual and synergistic pooling of resources and capabilities and a substantial degree of co-mingling between partners in terms of people, systems, skills etc. in order to attain their objectives” (Madhok & Tallman, 1998).

Given the challenge of having to design a manufacturer’s value propositions for more effective collaboration with their customers, we suggest that this can be best understood through the conceptualisation of service proposed by the Service-Dominant (S-D) logic (Vargo & Lusch, 2004, 2008), where assets (goods) are seen to be indirect service provision. Through an S-D logic approach, we propose three key issues for the understanding of outcome-based contracts as a new business model.

First, manufacturers must understand the interactions between asset and human activities provision when combined as value propositions, and what is the intended value to be co-created for customer outcomes.

Second, a comprehension of value-in-use also requires the understanding of contexts in which value creation occurs. The greater the variety of contexts, the greater could be the challenge in design, due to the increased complexity that can arise from supporting the system under contextual variety. This becomes most acute for outcome-based contracts, since continual use of equipment sits within the customer’s space and requires the customer’s resources to achieve use for their own goal, increasing the variety.

Finally, since contextual variety of use will impact upon the firm’s value propositions, achieving outcomes of use as part of contract performance can become increasingly complex, even threatening the firm’s future profitability and continued viability. Therefore, firms need to re-organise themselves to maintain viability, and manage the complexity that can emerge from such service systems. We propose a viable systems approach, which provides a model of organisation for the firm to maintain viability. We consider firms transitioning from being a manufacturer to a system of achieving value-in-use in co-creation with their customer under this approach, and analyse three longitudinal case studies of manufacturers moving to outcome-based service provision over a three-year period.