Forward Commitment Procurement Know How Programme Part 1

1
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
2
BIS, Innovation and Procurement

• 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 Governments commitment to scale up and
  replicate to use of Forward Commitment
  Procurement across the public sector

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
3
Forward Commitment Procurement Know How
Programme Part 1

• Part 1 Introduction to Innovation and Forward
  Commitment Procurement
• By 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

4
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 public
• sector and FCP in addressing the market failures
  the impede innovation for the social good.

5
About InnovationDefining Innovation
Research is the conversion of money into
knowledge you dont know what the outcomes will
be when you begin, but it cant 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

• 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 dont 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.

6
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
• dont 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.

7
About InnovationDefining Innovation

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
Definition Innovation Innovation is the process
of translating technology and knowledge, into new
usable products and services
8
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 doesnt get
  the products and services it needs to bring about
  transformational change, a loselose 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.
9
ConceptMarket Failure

• This failure of innovation for the social good
  happens when the market doesnt operate
  efficiently in the interests of the social or
  common good.
• When the market doesnt take account of the full
  costs or value of an economic activity, or
  doesnt deliver what society as a whole needs,
  economists call this market failure.

Definition Market Failure Market failure occurs
when market prices are not equal to the social
opportunity cost of resources. External effects
or externalities are evidence of market failure.
10
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...
11
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.

12
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?

13
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
  societys 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
Britains potential. Targeted policy measures
will be essential to tackle market failures
preventing innovation and growth. UK Low Carbon
Industrial Strategy
14
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.

15
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.

16
Forward Commitment Procurement Harnessing
innovation for the public good

• As custodians of the public good it is the
  responsibility of the government through its
  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
17
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
18
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

19
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
20
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
21
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
22
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.

23
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 cant 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.

24
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
Revenues

more

Risk is at its highest when a supplier needs to
commercialise - the risk is high because demand
is not visible
Decreases as the product approaches market and
risks increase
Information that a real market exists reduces the
risk and enables a supplier to invest in
anticipation of future revenues












less


Development
Demonstration
Commercial sales
Scale up
Stages in bringing a product to market
25
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.

26
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
Mandates effect on the development of Zero
Emission cars. Jack Frost, Chairman EIAG.
27
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.
28
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.

29
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.

30
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.

31
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
  todays 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.

32
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 sectors (and
  societys) 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.

33
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

34
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 Low
• Carbon Technologies (approx 40 minutes long)
• The presentation can be listened to as a podcast,
  
• www.tyndall-podcasts.com/beyond_stern/jack_frost.m
  4a
• 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 be
• found on the next slide.

35
(No Transcript)
36
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.
• Thats 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 didnt 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.

37
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