Forward Commitment Procurement
Know How Programme Part 1
Introduction to Innovation and Forward Commitment Procurement
KHP 1A : Innovation and FCP: Introduction, concepts and background
These materials remain the property of BIS. They constitute part of a ‘learning by doing’ programme and are unsuitable for stand alone use. They must not be used or passed to other individuals or organisations without
the express and written permission of BIS
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BIS and innovation: “We want to make sure that Britain is the best place in the world to run an
innovative business or service - this is critical to the UK's future prosperity, our quality of life and future job prospects”
BIS and procurement: “Developing a public procurement culture that stimulates innovation in the
economy and delivers improved value for money to the taxpayer”
BIS Innovation for Sustainability Programme Developed to support these objectives and to meet the Government’s
commitment to scale up and replicate to use of Forward Commitment Procurement across the public sector
BIS, Innovation and Procurement
“The challenge is to use public procurement and public services to lead the way, shape the market for innovative solutions and equip society to meet the challenges of the future”. Innovation White Paper 2008: “Innovation Nation”
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Forward Commitment Procurement Know How Programme Part 1
Part 1: Introduction to Innovation and Forward Commitment ProcurementBy the end of this section you will be able to explain the rationale of FCP and outline the FCP process
Overview• KHP 1A : Innovation and FCP: Introduction, concepts and background • KHP 1B : FCP principles into practice• KHP 1C : FCP process: overview
Activities and resources• Work through the key points• Complete the activities• Complete and submit the worksheets• Review and coaching session• Optional reading and activities
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Know How Programme Part 1Part 1A Contents
This section is longer and more theoretical than subsequent sections.It is divided into two parts which you can treat as two separate sections if you wish:
• Innovation and the public sector.• Forward Commitment Procurement: introduction and origins.
The section will cover:• Why innovation?• The role of the public sector in innovation• Definitions: Innovation, Forward Commitment Procurement• Concepts: Market Failure, Information Failure, Demand Pull• Why FCP?
By the end of this section you will be able to define innovation and explain the role of publicsector and FCP in addressing the market failures the impede innovation for the social good.
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About InnovationDefining Innovation
Innovation is often confused with research.
They are in fact very different processes.
• Research is a way of turning money into knowledge.• Innovation turns knowledge into money.
• Research is about doing things for the first time.• Innovation is about using known things for a new
purpose.
• You don’t know the results of research in advance.• Innovation is always targeted on known outcomes.
• A key success factor for innovation is an accurate understanding of the unmet need it is targeting.
“Research is the conversion of money into knowledge; you don’t know what the outcomes will be when you begin, but it can’t fail – you always end up knowing more than when you started. Research is a low risk activity.
Innovation is the conversion of knowledge into money: you know what new outcomes you want to achieve before you start but you can fail to achieve them. Innovation is risky. “
Jack Frost, Chairman EIAG
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About InnovationInnovation: why bother?
• Change happens because a previously unrecognised, unmet need becomes apparent.
• These unmet needs drive innovation.• Necessity is a key driver for innovation.
Innovation is hard• It takes time to come to fruition.• It requires us to think ahead.• It is inherently risky.
Innovation for innovations sake is not a good idea• don’t innovate unless it is really necessary• but it is necessary more often than we admit, for example:
– escalating costs = service reductions or higher charges – unable to deliver policy targets or ambitions = unacceptable political or
economic cost– pressing societal problems needing new approaches, etc.
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About InnovationDefining Innovation
Definition: Innovation
Innovation is the process of translating technology and knowledge, into new usable
products and services
“Innovation is the process of translating technology and knowledge into new usable products and services. It has been said that we have all the technology we need to convert to a low carbon economy. Arguably this is true but we still need innovation to translate this technology into the new products and services that we can buy”.
Jack Frost, Chairman EIAG
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About InnovationHarnessing innovation for the public good
• Without new goods and services we will be unable to bring about the transformational change of society to a low carbon economy and a sustainable future.
• The difference between these new goods and services and current goods and services is the extra social benefits (e.g. low carbon, sustainability) they provide.
• These are new unmet needs that require innovation to be delivered.
• But very often the process of innovation for the social good fails, and these new goods and services face significant barriers to market.
• Many fall by the wayside, others remain too expensive or get stuck as impractical prototypes, while even the successes make only slow progress into the market place.
• This means companies fail and society doesn’t get the products and services it needs to bring about transformational change, a lose–lose situation.
“Innovation will be the key to some of the biggest challenges facing our society, like global warming and sustainable development. We need use all the tools at our
disposal to unlock solutions”.
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ConceptMarket Failure
• This failure of innovation for the social good happens when ‘the market’ doesn’t operate efficiently in the interests of the social or common good.
• When the market doesn’t take account of the full costs or value of an economic activity, or doesn’t deliver what society as a whole needs,
economists call this ‘market failure’.
Definition: Market FailureMarket failure occurs when market prices are not equal to the
social opportunity cost of resources. External effects or ‘externalities’ are evidence of market failure.
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ConceptMarket Failure
• Market failure, occurs because individuals are reluctant to pay for, or do not value, social (as opposed to individual) benefits.
• Market failures provide a rationale for government intervention to influence and/or adjust the market for the benefit of the social good.
“Market failure is a broad, catch all term that economists use to explain why the free market is failing to deliver what society needs and explain why the market needs to be managed and regulated in some way to protect the social good – market failures are all too common……..”.
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ConceptTypes of Market Failure
• Market failures are quite common, and there are many types of ‘market failure’.
• Externalities – Where the market does not take into account the social costs of production (e.g.
pollution).– The environment is often undervalued, as is public health, good governance of
countries and companies etc.
• Information failures – Where information is not freely available markets will be inefficient.
• ‘Free rider’ problems– It is rational to let someone else do new things and take the risk and copy them. – It is rational for procurers to wait until someone else has bought a new product and
taken the risk this entails before adopting them. – If everyone does this new products only arrive in the market slowly or fail to
penetrate the market with sufficient depth or pace to justify investment and often fail to reach the market.
– In the case of environmentally beneficial goods and services this is to the detriment of society as a whole.
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ConceptExamples of Market Failure
• Negative externalities (effects) occur when the consumption or production of a good causes a harmful effect to a third party.
– In the past we regarded clean air and water as free and consequently this created problems such as the London smog or polluted rivers.
– If a company produces chemicals, but cause pollution, then local fishermen will not be able to catch fish. This loss of income will be the negative externality.
– Government intervened to regulate the “free” market with measures such as the Clean Air Act and the problem was largely solved.
– Today emitting carbon dioxide is free, despite the problems it is now known to cause, and there are attempts to correct this by putting a price on carbon dioxide emissions.
– Can you think of any others?
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ConceptMeasures to correct market failures
• As we have seen markets often undervalue social benefits and the common good.
• Government and the public sector in general are society’s agents and can intervene in the market to protect the common good.
• Government intervention to correct so called market failures can take different forms:– Policy and regulation (e.g. the Clean Air Act). – Fiscal incentives / disincentives (e.g. lower road tax for low carbon cars). – Grants and subsidies (e.g. the Renewables Obligation).– Procurement.
• A combination of these measures works best.
Britain is home to a large number of companies involved in low carbon innovation. However, there is a number of areas where strategic action from government is required to further strengthen Britain’s potential. Targeted policy measures will be essential to tackle market failures preventing innovation and growth.
UK Low Carbon Industrial Strategy
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Forward Commitment ProcurementUsing public procurement to correct market failure
• Public Procurement is gaining ground as a form of intervention through which government can intervene to address market failures and support societal objectives, for example to stimulate innovation for the public good.
• The Forward Commitment Procurement approach is a way that procurement can be used to help overcome market failures that inhibit the commercialisation of innovative goods and services. It does this by:– providing information on its unmet needs and the scale and nature of the
market opportunity; – providing a credible demand for innovative goods and services; – transferring the risk to the party best able to manage it;– placing a value on delivering societal objectives, such as reducing carbon
emissions.
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About InnovationInnovation: why us?
• As already discussed, the Public Sector has a special role in stimulating and enabling innovation where the resulting outcomes are for the public good.
• But if innovation is hard and risky, why not wait until someone else takes the risk, or prices come down?
• This is an example of the type of market failure discussed earlier, the ‘free rider’ problem – i.e. it would be more rational for procurers to wait to buy products and services, when the
costs of new products have come down, risks are ironed out and they are readily available.
• But if everyone waits new products will fail to reach the market or will only do so very slowly – (e.g. in the case of LED traffic lights).
• It can therefore be justifiable for government to intervene to help overcome this market failure by helping public sector purchasers mitigate the risks associated with innovation or early adoption
– e.g. through grants to cover the additional costs of buying innovation for lead market procurers.
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Forward Commitment Procurement Harnessing innovation for the public good
• As custodians of the public good it is the responsibility of the government through it’s agents in the public sector to hasten the arrival of socially beneficial new products and services into the market.
• Therefore the public sector has an important role to play in supporting innovation and helping to overcoming the market failures that hinder the entry of new goods and services into the market.
Government action must complement the dynamics of the market to address market failures around innovation and company growth such as those identified in the Stern Review. These include providing support to drive consumer demand for new, lower carbon solutions.
UK Low Carbon Industrial Strategy
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Forward Commitment Procurement Harnessing innovation for the public good
• Forward Commitment Procurement (FCP) was originally conceived as a tool to address the barriers to market faced by environmental innovations, but is now also used to address market failures in other sectors of societal concern, such as sustainability and health care.
• FCP provides a process by which public sector organisations can intervene to overcome market failures, and deliver benefits both for the contracting authority and society as a whole, simply by changing the way it goes about procuring goods and services.
“The challenge is to use public procurement and public services to lead the way, shape the market for innovative solutions and equip society to meet the challenges of the future”.
Innovation White Paper 2008: “Innovation Nation”
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Forward Commitment ProcurementIntroduction and Origins
• Why FCP?• The role of the public sector in creating market
pull for innovation • Definitions: FCP • Concepts: Information Failure, Demand Pull
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Forward Commitment Procurement Background
• In 2005 the industry led Environmental Innovations Advisory Group (EIAG) (a joint BERR and DEFRA advisory group) was established by Lord Sainsbury to look at why the UK environmental goods and services sector was failing to grow and develop at the rate expected, and to advise Government what to do about it.
• EIAG research showed that the lack of a credible articulated demand for environmental goods and services was at the heart of the problem.
• This is a fundamental market failure - an information failure – without information about nature of the demand the free market cannot allocate resources to deliver what is needed efficiently.
• FCP was conceived and developed by EIAG as one of the ways Government could intervene to correct this market failure by providing the missing ‘demand pull’ for new environmental products and services.
“It is the lack of credible articulated demand that is at the root of the relative failure of innovation in the environmental goods and services sector”.
Jack Frost, Chairman EIAG
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ConceptWhat do we mean by Demand Pull?
• In order to invest in innovation companies need to be reasonably certain of the size and nature of their future market i.e.
– what do people want or need, if I make the product or supply this service will people buy it, what value do they place on what it can provide etc.
• If there is no visible demand for a new product or service, companies cannot build the case for investment to deliver them to the market, as the market risk is too high.
• So the new goods and services are not developed or brought to commercial production– i.e. there is no demand to pull new products and services into the market.
• Government can intervene to overcome this market failure by helping to create the missing demand pull and by placing a value on innovation can create the market conditions that will support investment in innovation.
“The key driver of growth for companies producing low carbon goods and services is market demand. Increasing this demand will create a powerful incentive for low carbon innovation and the creation of specialist low carbon businesses. However, there are often market failures associated with innovation investment…. Government needs to adopt a pragmatic approach to identifying solutions to these problems”. UK Low Carbon Industrial Strategy
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ConceptWhat do we mean by demand pull?
• Public Sector bodies, as the agents of Government, can use public procurement processes to provide this missing demand pull.
• It does this by providing the supply chain with a ‘credible articulated demand’ for new goods and services.
– How? by providing the market with critical information about the nature and scale of a credible market opportunity.
• The great advantage of public sector requirements is that there is an implicit scaling up of demand, i.e.
– if one public sector body has this requirement it is highly likely that others will too.
• As we have discussed, it is particularly appropriate for the public sector to do this for environmentally and socially beneficial goods and services.
• This goes a long way to overcome the barriers to market that innovative goods face, manage the risks involved, and unlock investment and bring new products and services into the market.
“A large element of the perceived risk of investment in low carbon innovation is tied to uncertainty over the scale of demand and price of the end-products. Used wisely, the purchasing power of the public sector can help to reduce this risk”. UK Low Carbon Industrial Strategy
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Forward Commitment ProcurementInnovation and Procurers
• Innovation for the public good is a laudable aim, but as we have discussed, innovation is risky.
• Sensible procurers worry when they hear the word “new”.
• New products and services have risks; they might:– not work as expected; – not be delivered on time;– cost more ….. and anyway have no track record.
• But in some cases there is no choice e.g. existing products and services cannot deliver the transformation to a low carbon economy that we are aiming for.
• If we keep buying them we will fail.
• Business as usual is no longer an option – new approaches are needed.
• Forward Commitment Procurement helps procurers buy the new products and services they need, sensibly.
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Forward Commitment ProcurementInnovation and Suppliers
• Think about innovation from a suppliers point of view.
• Developing new products is risky and costs money– it inevitably incurs technical risk and requires a sound business justification to invest the
time and money it needs.
• Rational suppliers therefore develop new products only if they have to, e.g. – to protect margins;– to win business; – to retain customers.
• The various technical and resource risks are under the control of the supplier and can be managed.
• The risk that the supplier can’t control is, having developed the product will someone buy it, i.e. the market risk.
• Forward Commitment Procurement helps the public sector procurer to create the market conditions that support investment in innovation to deliver new products and services.
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Why FCP?Innovation from the suppliers side
• It is all about investment risk - not investment costs. • Many products and companies fail at the demonstration and scale up stage.• The gap between development and commercial sales is often referred to as the ‘valley of death’ - in fact it is more a
mountain of risk………….
Risk to company
Government grant support
Development
Demonstration
Commercial sales
Scale up
Revenues
Decreases as the product approaches market and
risks increase
Risk is at its highest when a
supplier needs to commercialise - the risk is high
because demand is not visible
Information that a real market exists reduces the risk and enables a
supplier to invest in anticipation of future revenues
Stages in bringing a product to market
more
less
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Forward Commitment ProcurementManaging risk and correcting market failures
• A critical factor for suppliers of new products is the confidence that there will be a market for the new product once it is proven.
• The amount of investment made by developers and by their suppliers depends on this confidence.
• The future users of the new products can significantly affect investments by suppliers by making the future market as certain as possible (while retaining competition).
• Forward Commitment Procurement is a way for public procurers to make this future market visible and credible without either procurer or supplier incurring unmanageable risks.– For example by making a ‘commitment’ to procure at a certain scale,
within a timeframe, if specification, price and performance parameters are met.
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Forward Commitment ProcurementProviding the missing market pull
• The good thing from a suppliers point of view is that in the public sector market more often than not buyers have similar needs, and hence indicate a wider market.
• This market information is highly valuable to a supplier, and if done in the right way it goes a long way to manage and reduce the supply chains market risk, and unlock the investment needed to develop innovate and develop new products and services that society needs.
• Providing the supply chain with the missing ‘demand pull’ is a corner stone of the Forward Commitment Procurement process.
“Consumers, or regulators, demanding the seemingly impossible from companies, i.e. providing high and credible demand pull, can lead to the development of radically new products. Take for example the Californian Zero Emission Mandate’s effect on the development of Zero Emission cars”. Jack Frost, Chairman EIAG.
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Forward Commitment Procurement Definitions
• FCP harnesses the power of public procurement to transform the market, creating the conditions for investment in the goods and services necessary in the shift towards the low carbon economy.
• Public procurement because of the special role of the public sector in being agents for the social good by being a lead market for innovation that society needs.
• Conceptually Forward Commitment Procurement is simple:– a public sector body has an unmet need that current products and services cannot
deliver;– rather than compromise the public sector body offers to buy, in the future, a product
or service that can deliver what it needs, when it needs it, at a price it can afford.
• It addresses directly the key issues of information, investment and contractual risks and stimulating investment in innovative goods and services.
Definition: Forward Commitment Procurement
FCP can be defined as a commitment to purchase at a point in the future, a product that may not yet exist commercially, against a specification that current products do not meet, on a scale sufficient to make it worthwhile for suppliers to tool up and manufacture.
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Forward Commitment Procurement A practical supply chain management tool
• Private sector companies actively manage their supply chains to promote investment in innovation and new or improved products.
• They do this by engaging with their suppliers and providing credible information about their future requirements and purchases.
• This provides the incentive and security for the supply chain to invest to deliver what is needed, when it is needed, at a price that is affordable.
• FCP mirrors this supply chain management approach.
• The public sector becomes the supply chain manager for the products and services required to deliver the social or common good.
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Managing the supply chain for innovation
Example - the motor industry • The motor industry and their electronics suppliers share plans and ambitions
many years ahead of products reaching the market.
• The electronics suppliers align themselves behind the goals of their customers and invest in the development of products to meet their customers future needs.
• To fail to do so would exclude them from the future market.
• This leads to unprecedented innovation in vehicle electronics, in a cost effective way.
• Every year cars can do more, perform better and cost less, in no small part due to the motor industries effective management of their supply chain.
• FCP provides an endorsed process to enable the public sector to effectively manage their supply chain.
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Forward Commitment Procurement Summary
• A critical factor for suppliers of new products is the confidence that there will be a market for the new product once it is proven.
• The amount of investment made by developers and by their suppliers depends on this confidence.
• The future users of the new products can significantly affect investments by suppliers by making the future market as certain as possible (while retaining competition).
• Forward Commitment Procurement is a way for public procurers to make this future market visible and credible without either procurer or supplier incurring unmanageable risks.– For example by making a ‘commitment’ to procure at a certain scale,
within a timeframe, if specification, price and performance parameters are met.
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Forward Commitment Procurement Summary
• This ‘commitment’ can appear daunting to a procurer; but provided a genuine need and credible intention is clear, the ‘commitment’ can take different forms and may not need to be formalised in a contract.
• FCP works best in conjunction with policy, fiscal incentives, and regulation that requires, and places a value on the outcomes being sought, or a cost on not delivering them e.g.
– Carbon reduction targets;– SOGE targets;– Building regulations;– Landfill tax.
• The FCP process:– makes unmet needs and future needs visible to today’s investment decisions;– manages risk to the supplier and the contracting authority;– creates a win-win:
• the public sector and society gets the products and services it needs; • the supplier gets a visible, credible, and scalable, market.
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KHP Part 1 ASummary
• The public sector needs to harness innovation to meet societal challenges such as climate change, sustainable development, social sustainability.
• By providing a ‘credible articulated demand’ for new goods and services to meet unmet needs, the public sector acts as a responsible supply chain manager for the ‘public good’.
• This demand pull helps companies overcome the (significant) barriers to market for innovative solutions, and unlocks private sector investment to innovate to meet the public sector’s (and society’s) needs.
• The FCP model provides a step by step process for the public sector to deliver the innovative goods and services it needs, when they are needed, at an affordable price.
• However, FCP does require changes in the way the public sector operates.
We will explore this in KHP1B: FCP principles into practice.
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KHP Part 1 A ReadingFCP Background and Principles
• EIAG Report
• Bridging the gap between environmental necessity and economic opportunity, EIAG, November 2006
http://webarchive.nationalarchives.gov.uk/+/http://www.bis.gov.uk/files/file34987.pdf
• Read pages 1 – 24
• Make a note of any questions or comments
• Copy and keep pages 20-21
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OverviewInnovation for sustainability
Listen to or watch the presentation by Dr Jonathan (Jack)Frost at the Tyndall Centre workshop:
‘Beyond Stern: Financing International Investment in LowCarbon Technologies’ (approx 40 minutes long)
The presentation can be listened to as a podcast, www.tyndall-podcasts.com/beyond_stern/jack_frost.m4a
or you can watch the movie version:
http://www.tyndall-podcasts.com/beyond_stern/jack_frost_2.mov
Make a note of any questions and comments.
A static version of the graphic referred to in the presentation relating
to the example of the North America Emission Standards can befound on the next slide.
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……Food for thoughtIs climate change a market failure?
• In the report ‘Economics of Climate Change’ Lord Stern said “Climate change is a result of the greatest market failure the world has seen”.
– Is this really true? • Failure certainly – clearly something has gone wrong - but was it the market?• Perhaps in some respects:
– “those who damage others by emitting greenhouse gases generally do not pay”.• On the other hand, billions of people worked very hard over a long period of time to
create the problem of climate change (albeit unknowingly).• The markets did give us what we asked for e.g. cheap energy.• That’s what markets do; they respond to demand, to what the customer asks for, or
indeed fails to ask for.
• Is climate change a market failure? Or was it the failure of the customer?• And perhaps that was understandable when customers didn’t know about climate
change. • But we do now – we need to start asking for different things, and enable to market to
respond.• FCP provides a process for the public sector to ask for something different, and create
the market conditions that enables the market to respond.
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KHP 1A Review and Feedback Sheet• Write down any questions or points of clarification you would like to
cover in your next review session.• Submit your completed worksheet and arrange a review session.
Optional reading and research:• UK Low Carbon Industrial Strategy
• you will find a copy of the in the KHP1A resources section• read the executive summary, highlighting key points.
• BBC Reith lectures• Listen to 1 of 4 and 4 of 4• http://www.bbc.co.uk/programmes/b00729d9• link also in the resources section of the JERA KHP website
