Why Industrial Companies & Public Sectors Should Shift from Budget-Based to Value-Based Procurement
A procurement framework for industrial companies and public sectors to adopt advanced technological solutions from startups through open innovation
Procurement in both government and corporate sectors is predominantly influenced by budgetary considerations, i.e. budget-driven. Consequently, procurement decisions are often guided by the available funds rather than the potential value that a project can deliver. This budget-driven approach is particularly pronounced within the public sector, where the focus is primarily on modernization efforts. For example, in the urban sector, cities tend to prioritize projects based on budgetary constraints rather than conducting comprehensive assessments of their economic value. As a result, there is an emphasis on modernization initiatives rather than thorough evaluations of value and impact.
To provide further clarity, "value" in this context, specifically refers to the Business Value, which encompasses the financial returns that a product or project can generate after its deployment.
This approach proves effective when procuring standardized products, where the value, benefits, or returns are clearly defined. However, it has significant limitations when it comes to procuring innovative solutions, which are predominantly non-standardized. The challenge lies in the lack of clarity regarding the value or returns associated with innovative products. These solutions are constantly evolving and have not yet been proven through multiple deployments, making it difficult to assess their precise value or expected returns.
In general, administrators (in the government) and executives (in corporate) responsible for procurement, while trying to procure innovative solutions, have a sense of a project’s worth. However, it is often subjective, relying on rough estimates rather than concrete evaluations. As a result, there can be varying priorities and perspectives among different individuals and teams involved in the procurement process.
For instance, in the urban public sector, the municipal commissioner of a city might prioritize traffic management, while the smart city CEO might prioritize water bodies management. And in an industrial company i.e. a factory, the plant manager might prioritize production efficiency, while the environmental sustainability officer might prioritize waste reduction.
This issue holds significant importance at present due to organizations being in the midst of Digital Transformation and Industry 4.0—is all about adopting innovative & technologically advanced solutions. Hence it is the right time for organisations to shift from budget-based to value-based procurement.
Here is my previous blog on why traditional procurement doesn’t work while trying to source innovative solutions—this helps organisations (industrial companies and public sectors) with a process to source innovative solutions. While this blog will focus on the next step—how to successfully use a value-based procurement to successfully adopt an innovative solution from startups and why value-based procurement is critical in this process.
Organisations have to do procurement & deployment of innovative solutions in two phases:
- Paid Pilot
- Scaled-Up Deployment
Phase I - Paid Pilot
Inherent to their nature, innovative solutions are non-standardized products, and therefore, the extent of the business value they can deliver is often not well-known, at least not accurately, due to the limited number of trials and deployments it has undergone. Thus, it becomes imperative to conduct a pilot, a.k.a. Pilot-Scale deployment, before initiating a large-scale or scaled-up procurement.
This is why paid pilots are critical—to prove that an innovative solution is capable of delivering the promised value for the scaled-up deployment.
Paid Pilots are implemented to establish a “Proof of Value” for the large scale deployment
Once an innovative solution is identified to address a specific use case, the procurement manager or project owner within the organization should work with the startup to estimate the value the product will deliver, both for pilot-scale and large-scale deployment. Here is a guide to estimating value for innovative products & solutions.
At this stage, the estimated value will be theoretical to a great extent, unless the startup has done multiple deployments for similar use cases. The subsequent step involves implementing the pilot for a designated period of time. Following the successful implementation, the actual value should be compared with the estimated value and any necessary course corrections should be made to the estimated value for the large-scale deployment. Now that there is proof of value, there is a compelling case for proceeding (or not proceeding) with the large-scale procurement of the innovative solution.
Additionally, it is crucial for organizations to opt for paid pilots instead of free pilots. The rationale behind this is that in free pilots, where no cost is involved, it becomes challenging to assess the value or return on investment (ROI) accurately. While free pilots may offer some experiential benefits, they often fail to provide a clear business case for scaling up the solution. On the other hand, paid pilots provide a more comprehensive understanding of the solution’s value proposition and enable organizations to make informed decisions regarding its scalability and large scale procurement.
To illustrate this process, let’s consider the use case of replacing manual welding with machine vision-based robotic welding in a factory. Suppose a plant has 20 welding lines, and initially, a pilot is conducted for one line. Let’s assume the pilot investment (cost) is Rs. X, and the estimated value of the pilot is projected to be Rs. 10X. Similarly, for the large-scale deployment, the investment required is Rs. Y, with an estimated value of Rs. 15Y.
The same is summarised in the table below:
During the transition from pilot-scale to large-scale deployment, it is important to note that the value multiplier is expected to increase. In the given example, the value multiplier is projected to rise from 10 during the pilot-scale to 15 for the large-scale deployment. This increase can be attributed to various factors such as economies of scale, extended deployment period, and other factors.
With the estimates established, the next step is to proceed with the deployment of the pilot.
Phase II - Scaled-Up Deployment
Post the pilot implementation, if the actual value derived from the pilot is determined to be 8X, adjustments can be made to estimate the value for full-scale implementation. For instance, this could result in a revised value of 12X or 10X, depending on various factors. Based on this evaluation, the decision to proceed with the scaled-up deployment can be made. In this scenario, a value/ROI of 10X or 12X is considered favourable, and any organization would likely be inclined to move forward with the scaled-up deployment.
On the other hand, if the actual value achieved in the pilot is relatively low, such as 2X or 1.5X, the project owner can make a call on whether pursuing full-scale implementation with the solution is worth it or not. In most cases, in a scenario like this, organizations would tend to discontinue the current solution and explore alternative solutions & technologies.
It’s important to note that there is no universal standard for what is a good or bad value multiplier. Hence, organizations need to evaluate value multipliers within the specific context of their industry and the prevailing technological landscape.
Organizations should prioritize higher value or ROI because Digital Transformation is all about scaling technologies that can drive rapid growth and transformation, rather than being solely a modernization initiative.
Digital Transformation is not a modernisation initiative, it is adopting Advanced Technological Solutions to drive Transformation & Growth.
Value-based procurement, along with paid pilots, enables organizations to prioritize initiatives based on potential ROI. It facilitates the prioritization of digital transformation projects, giving preference to those with higher ROI.
In one of our corporate accelerator programs, Forge assisted its client in implementing an AI-based Predictive Maintenance solution from a startup to address boiler tube failures. Following a successful pilot, the solution yielded a value of Rs. 3 Cr with an investment of Rs. 30 L, resulting in an ROI of 10X. Furthermore, the estimated value for the scaled-up deployment was projected at Rs. 50 Cr, requiring an investment of Rs. 2 Cr, resulting in an impressive ROI of 25X. This formed a compelling case for scaling up the solution plant-wide.
SmartProcure — Innovating Procurement for Procuring Innovations
The SmartProcure Procurement Policy by the Ministry of Housing and Urban Affairs, developed in collaboration with Forge, is a groundbreaking initiative for Indian cities & towns to adopt value-based procurement while working with startups. The SmartProcure policy & the City Innovation Exchange (CiX) digital platform enables cities & towns to directly procure innovative & advanced technological solutions through a similar process described above. Thus enabling the urban public sector in the country to achieve digital transformation in an accelerated manner.
Summing it up
- Traditional budget-based procurement works well for standardised products but is not suited for innovation procurement
- Organisations trying to procure innovative solutions for Digital Transformation should shift to value-based procurement
- The first step in value-based procurement is to do a paid pilot — to establish a “proof of value” for the large-scale procurement that is to come
- Once the paid pilot has established the proof of value, organisations can decide on doing the large-scale procurement
At Forge Innovation & Ventures, we help industrial & public sectors implement Digital Transformation through Open Innovation with deep-tech startups as innovation partners. We run open innovation & accelerator programs for our clients through a structured 3-phased process — Discover, Accelerate, and Integrate. During the Accelerate Phase, we help them build a case for the pilot, estimate the business value/ROI, support in implementing the pilot, assess the pilot implementation, and help build the case for large-scale procurement.
Know more about our programs & offerings here — www.forgeforward.in
