With an entire week devoid of any kind of air travel (vacation), I was a bit behind on my magazine reading. BusinessWeek published their “50 Best Performers” issue, but what I find absolutely amazing was a terrific article on the challenges faced by Chinese factories, due to rising wages and regulation!

The nuts and bolts have to do with rising costs of raw materials, increasing demand for a fixed supply of labor, and currency changes, but the outcomes are what are really interesting. Basically, the message is that cheap labor is not enough, or even necessarily desirable. Companies are looking into increasing worker productivity through automation, and I suspect there will be growing interest in substituting “information for inventory”, which has long been a practice in higher cost economies.

This is very interesting to the B2B world, because one of the traditional challenges in driving B2B into lower cost countries is that the technology costs are not competitive with using people to solve the same problems. This is not to suggest that there is not a lot of sophisticated B2B going on, just that the goal has not been to reduce staff but to gain some kind of edge in speed or customer service.

With the current economic situation, it appears that companies may rebalance their productivity initiatives — focusing as much on using technology to drive productivity as labor arbitrage.

I just returned from a wonderful Spring Break vacation with my family, spent camping in our recently acquired pop-up trailer in the cave region of Kentucky. Mammoth Cave National Park happens to be very close to Bowling Green, so we took the opportunity to visit the National Corvette Museum, and tour GM’s Bowling Green Assembly Plant, the only factory on earth that produces the legendary Corvette…

I have had the opportunity to work with various companies in the auto industry (including GM), but I have never been to a major assembly plant before, and it was a treat. What was especially impressive is that in modern plants like Bowling Green, every car is built to order, despite the appearance of “mass production”. The plant builds both Corvettes and Cadillac XLRs, but the Corvette line fascinated me because the “outside” of the car is assembled (painted, welded, put together) separately from the “inside” (axles, tires, transmission, engine, etc). At one point in the process, the bodies descend from the ceiling and are attached to the drive train. The amazing thing is that most of the components are specific to each car — so the entire assembly operation must be kept in synch.

What impressed me was how little inventory was visible, with mobile racks of kitted parts moving around the plant. Reading the labels that happened to cross in front of me I saw no two kits coming from the same source (mostly GM plants in the midwest, though some tier one suppliers were also in evidence). With not an RFID tag in sight, I saw barcodes aplenty (one dimensional in this case), clearly linked up to a powerful production control system.

I think most of the people on the tour with me were impressed by the plant, it was hard not to be. But I doubt very many were able to appreciate that Bowling Green is so on top of its supply chain parts flow that they can start a car even though many of the kits to produce it are not even at the downstream stations yet. Since every car is built to order, parts from all over the US and some from Mexico must arrive at the station in time to be assembled — and the entire line will have to stop if anything is missing (it didn’t stop in the three plus hours I was there).

I have worked in B2B for a long time, but I still really enjoy seeing what is possible when trading partners can move at the speed of information. It was a beautiful sight…and the cars were nice too.

GXS has a terrific set of clients in the retail industry, some of whom I have worked with for many years, so stories about the industry tend to draw my eye. The other day I was reading a widely syndicated piece from AP about retail retrenchment, when something caught my eye:

“Experts also say merchants are weathering downturns better because of new systems to control inventory and costs.”

I found this very interesting because this was not an article concerned with technology, enterprise IT, or B2B — and when you find statements like that in the general media, it is a good sign that the investments in technology are paying off where it matters the most. What I find interesting is that the article references the systems, but doesn’t really explain how a system can “help control inventory and costs”.

While there are many systems that can affect inventory and costs, I like to think in general that we are attempting to affect a couple of key business capabilities, regardless of the technology:

1. How far in advance we can see what is happening
2. How quickly we can react to changes in demand or supply

These are obviously related, and interact to create “uh-ohs” or “ahas”… First to the “uh-ohs”

The above diagram is my very simplistic picture of the situation when the range of vision is shorter than the range of action, meaning by the time I realize I need to do something, it is too late. This is akin to a ship relying on the sound of scraping metal to alert it that rocks are near, rather than a lighthouse. It is tempting to do focus entirely on the red — that is, seeing farther out — through event management, forecasting, etc — but we can also change the equation by reducing the amount of time to respond to change.

In the B2B world (and not just in retail), it turns out that similar systems and technology help out with both. As a start, companies that manage their supply chain more effectively are able to sense (visibility) and respond (action) much more quickly than rivals. While it is tempting to get excited about the new possibilities of technology, many companies are not even managing the basics, like functional acknowledgements, yet (FAs are an electronic document sent back in reply to an electronic document. Basically, if you don’t get an FA from a partner, they may not have your order/ship notice/invoice/etc). Insisting on B2B integration with your supply chain, and then handling the basics well will provide more rapid information and the ability to execute more quickly. Implementing B2B gives you productivity, but doing it really well helps you see farther and act faster.

Beyond basic B2B, capabilities like logistics tracking and visibility will substantially enhance visibility, and enable members of your team to react more quickly because they have more information at hand. A system like logistics visibility is constantly “watching” the stream of logistics B2B traffic between logistics providers, and watching for exceptions or incidents.

As much as I love the software and services we build and operate for a living, the key thing is really the goal — we have to see problems (and opportunities) early enough to have time to act. Leveraging people, process and technology can get us from “uh-oh” to:

A very interesting piece from AMR Research’s John Fontanella on RFID reaching its tipping point.  This piece is free until March 14th, so click quickly!

John is a terrific analyst, and I really think he hits some great points in this, but I think the most insightful is that the attempt to drive an industry-wide standard of a nascent technology or initiative will usually not be successful (he cites ECR as another example).  RFID is a technology filled with promise, but it is still youthful, and needs the freedom to provide value in a variety of settings now that the Gen 2 standard has arrived.

To me, this is a specific instance of a wider phenomenon that I call “premature standardization”.  This occurs when a group of customers, or prospective customers, try to skip the early, difficult stages of a technology — littered with incompatibilities and proprietary solutions — and skip right to the highly desirable world of commodity technology based on industry standards.  The problem is that both of these cycles are part of a maturity cycle.  You have to go through the awkward teenage years to become a (hopefully) mature adult — there are no shortcuts.

Having said that however, the desire to standardize as rapidly as possible is completely understandable.  Standards based solutions are usually more mature, less expensive, and just plain easier to operate.  Why?  I would submit that all those characteristics are driven by the ugly, early years, when products are immature, expensive and hard to operate.  As various products mature and deliver value, which is the customers’ primary concern, people start to pay attention to all the other aspects, including costs.  Often, though not always, this drives the providers to standardize (Managed File Transfer is a case of an industry that has not standardized yet).  Generally standardization helps a market grow (because customers who were not willing to buy a proprietary solution will buy a standards based solution), and frequently the technology providers will start buying each other (consolidation).

But this is a process, and I don’t know any way to skip a step.  Everyone knows that a 1.0 product at a customer can be scary for all involved, but that first customer must happen (no amount of testing in the lab will substitute, and believe me, GXS does a ton of testing in the lab before the first customer…). 

As John states in his article: “Technologies are broadly adopted because they deliver value, not because their use is mandated.” 

A bit of an unusual topic for me, but this was too good not to share.  Fortune Magazine recently did a wonderful article on the rise of the soy industry in Brazil.  What I found so fascinating about this article is how many trends can converge in a large agricultural area with “bad roads”:

• International competition:  US agriculture (soy is a major crop) versus Brazil’s growing dominance in soy (largest exporter since 2006)
• Eco-friendly business:  from the dark days of deforestation, the entire soy industry is striving to be environmentally friendly and energy-independent.  But there remain struggles to balance supply chain efficiency and the environment (see below)
• Innovation and sustainability:  while I think of soy as tofu, the products that now include soybeans as a critical component include:  cotton blends, spandex, shampoo, conditioner, soap, flashing tape, caulk, outdoor paint, glue for plywood cabinets, foam (including for a forth-coming Ford Mustang) and more!

Of particular interest in this article however is the critical role of the supply chain (physical, the article did not explain how information was moved).

Following on the trend from my last post, one “self-contained” supply chain uses soy products to produce fuel and feed for the largest chicken operation in South America.  The farm, processing plant and chicken buildings are literally built in one continuous line, with the trucks carrying the product to market fueled by bio-diesel — talk about a localized supplier network.

The second set of supply chain issues are more complex however, as actual soy consumption within Brazil is very limited.  The challenge is to export the bounty in a cost efficient manner through some of the most environmentally sensitive forests and rivers in the world.  The extensive discussion of the struggle to get the product to market without arousing the ire of the major markets (Europe, US) because of environmental damage is a fascinating twist on the influence globalization has.

We do a lot of business in Brazil, and I hope we have the opportunity to continue to grow in one of the world’s most exciting economies.

The folks over at Supply Chain Digest have put together a collection of thoughts from industry and academia about what is going on in 2008.  Often collections like this are nothing but aphorisms, but this one is different.  Among the gems:

• Jeff Karrenbauer of Insight, Inc — “the obvious outsourcing choice of , for example, the Pacific Basin, is often simply wrong”
• Jon Kirkegard of DCRA, Inc — “Postponed manufacturing state-side of imported key components will increasingly be seen as a major solution to supply chain and business challenges….”
• Larry Lapide of MIT — “Many companies will ’slow down’ their supply chains by using less expensive and slower transit modes”

While there are some areas of agreement, there are far more areas of disagreement about outcomes and effects — which is why I like this article.

For my part, what I find most interesting is the looming impact of fuel and energy costs (combined with changes in currency valuation).  If companies respond — as I hope they will — with much more aggressive leveraging of logistics information and a “postponed manufacturing strategy”, our payback for this more challenging period could be improved productivity, and progress in the quest for a demand-driven supply chain.

GXS spends a lot of time working on the concepts of “the hybrid model”, where software and services are integrated to work together to optimize B2B, but this hardware and services combination is pretty interesting as well!  The idea of hardware service combinations is old hat for cell phone users already, but this is a new approach.  I wonder if this could lead to the sale of USB hard drives that feature online backup services as well?  Could this catch on in the commercial space as well as for consumers?

The attraction of services in this kind of application is the universal availability characteristic.  I have often found myself using Google web applications — like Documents — not as application substitutes (I know it is not cool to speak well of new Microsoft versions, but I am really fond of Office 2007 — best yet!), but to have data available across systems and locations.  This is also a major advantage for companies that utilize supply chain applications running on the grid, as they can access — through a web UI — their information from anywhere they can connect, and know that they are looking at the same data as their partners.  To date the enterprise software market has approached software and SaaS as rivals (note the models of SAP), but I wonder if — like the USB disk — the future is more likely innovative combinations that combine the strength of both.

Hope you are having a wonderful holiday season, full of peace and joy — but courtesy of a recent customer visit, I learned it is not at all restful for some elements of the retail supply chain…

Many people don’t realize that much of the supply chain activity (ordering, forecasting, etc) is in the distant past when “Black Friday” hits after Thanksgiving — but it is.  Aside from the understandable need for advance planning, there is the small fact that information may fly around at the speed of light, but goods for store shelves must still be shipped great distances!  But modern supply chain practice goes far beyond just orders, and not every category of good must be shipped thousands of miles.

Some retail goods that are produced (or warehoused significantly) closer to their ultimate markets have the ability to respond do “demand signals” much more rapidly.  This can be because the goods are shipped by air, or manufactured locally (”locally” meaning within reach of high speed transportation), or warehoused in different regions that are capable of supplying one another.  Traditionally the domain of industrial parts that were JIT (just-in-time), it appears that key consumer goods are now capable of rapid response to demand.

This is of particular interest to me because of the role played by rapid information exchange — especially consumption and forecast data.  As goods fly off the shelves, that information is shared back into the supply chain, which then scrambles to refill the void.  This is an especially lucrative practice for goods that experience enhanced value during the first several days they are on sale, like music, books, movies, and video games (software, not the consoles — alas, see Steve’s column for the realities of complex hi-tech gadgets….).

Assuming you buy that such items can be more flexibly resupplied than many other goods — why the surge in demand?  This was the piece I didn’t understand, but GXS is not a consumer goods company.  The recent swelling of gift card sales, combined with retailer skill in attracting shoppers in the post holiday season has made the few days after December 25th some of the biggest shopping days of the year!  The only challenge is that those stores have been heavily shopped right up to Christmas Eve, and need to be replenished as much as possible to capture all that spend.

It seems that Christmas comes both early and late for retailers, and in those categories where the supply chain has the shortest latency, information can maximize profits for businesses, and satisfaction for customers.

Happy Holidays!

Thought leaders from across GXS bring you what we have seen in the industry during 2007 and what we can expect to see in 2008 based on the research, news, trends, industry discussions and our observations. Here is a list of our top predictions for B2B e-commerce in 2008…  

B2B Strategies  

1)     SaaS Platforms will ignite Global Innovation  

Prediction by GXS’s Chief Technology Strategist, John Radko  

The barriers to entry for providing services to a global audience are on the verge of collapsing completely from an infrastructure perspective. As the costs of infrastructure software has fallen due to both economies of scale and open-source initiatives, the last barrier has always been the cost of setting up and operating an infrastructure to handle the computing, networks and storage—and now that infrastructure will be available in a service format. Not only are several very innovative infrastructure services now available, but a fiercely competitive market appears to be forming, centered around Amazon (S3, SQS, EC2), Microsoft (Live Services) and Google.  

But even beyond base capabilities like storage, platforms offered as services are sprouting up in many additional places like SalesForce.com, Facebook, GXS Trading Grid^®, etc. The next generation of business software and services will be building on these platforms, which will enable them to offer new products faster and at much greater scale. Small companies will be distributed through these channels in much the same way that musicians and performers are channeled through music companies. Beyond just infrastructure, platform companies will provide provisioning, billing, authorization, etc. The best platform companies are already offering the ability for partners that build on them to integrate not only with infrastructure services but also other services built on the same platform—the natural evolution of the current mash up craze, but taken beyond the web.  

The freedom to build services on pre-existing infrastructures offered as a service and priced as utilities will dramatically lower the barriers to entry for innovators, and that will unleash the next wave of innovation.  

2)     BPO for B2B Goes Mainstream  

Prediction by GXS Industry and Product Marketing Manager, Ryan Kraudel  

The past two decades have seen a fundamental shift in business models driven by the modularization of the functions of a company and emphasizing focus on the core business functions and differentiators that create value for customers. This has lead to an explosion in outsourcing of business functions that are critical to the business operations, but do not differentiate the business from its competitors. This includes functions such as manufacturing, HR/payroll, logistics and some IT functions. The primary drivers of these outsourcing arrangements have historically been focused on cost-takeout and eliminating depreciating assets. However, we are now seeing new areas of outsourcing driving key top-line revenue and business efficiencies that are shifting the outsourcing focus from cost-elimination to business benefit.  

One example of this is B2B outsourcing, the outsourcing of the people, processes and technologies required to operate and maintain a global B2B e-commerce program. A recent study by the Stanford Global Supply Chain Management Forum has identified key business value from B2B outsourcing that led to an average of 245 percent ROI for B2B outsourcing. These include benefits such as automating more trading partners faster and more effectively with global B2B capabilities and supporting a broad range of B2B technologies, which has a direct impact on customer satisfaction. In fact, the Stanford study showed companies using B2B outsourcing showed an average of 62 percent improvement in customer satisfaction, which directly contributes to top-line benefits such as revenue generation, customer loyalty and customer longevity. These are just a few of the results and benefits that demonstrate why the rapid growth in B2B outsourcing around the world is expected to continue through the foreseeable future.  

3)     File Sizes to Multiply in B2B     

Prediction by GXS Vice President of Industry Marketing, Steve Keifer  

There is an increasing trend in B2B towards business partners sharing higher volumes of data packaged into much larger files. Historically, the typical B2B transaction exchanged between companies was on the order of kilobytes. The most commonly exchanged transactions are invoices and purchase orders which are only a few kilobytes in size. However, over the past 24 months, there has been a substantial increase in the exchange of larger files—megabytes and gigabytes in size. The phenomenon is occurring in nearly every industry sector. Examples include product images in retail, check image files in banking, call detail records in telecommunications, satellite images in logistics and CAD diagrams in manufacturing.  

The trend towards larger file transmission really should not be very surprising given the growth in file sizes that we have seen in the consumer segment. For over five years now consumers have been downloading and sharing large audio and video files for home entertainment. With the dramatic decreases in the cost of storage and networking, it is only logical that this trend would extend to business communications as well. In fact, demand for large file transfer in the workplace has increased steadily in recent years. Do you give a second thought to sending a 5MB email attachment to a colleague at one of your business partners?  

Unfortunately, all of the popular IP standards used for B2B lack the features such as compression or checkpoint/restart necessary to support high volumes of large file transfer. As a result, many companies are forced to license expensive, proprietary “managed file transfer” software to support their needs. It is too early to predict what will occur in 2008. But one thing is for sure, with customer demand rising quickly, large file transfer is becoming a mainstream B2B function need rather than a niche technology.  

Supply Chain Strategies  

4)    Global Trade, Local Trade-offs  

Prediction by GXS Director of Product Management, Pradheep Sampath  

In recent years, supply chains have been constructed and modified to become nimble, agile, demand-driven and of course global in response to the proliferation of global trade. Global trade will become so mainstream that consumers and organizations will no longer subject themselves to local supply chain trade-offs just because products happen to be sourced a dozen time zones away. Retailers who historically have carried separate sets of inventory to fulfill demand from brick-and-mortar, web and catalog channels will drive to further optimize and unify stock. Manufacturers who have traditionally shipped ocean containers or multi-case lots to automated distribution centers will pledge to streamline their direct-to-consumer shipment of “eaches” to suburbia.  

Manufacturers and retailers alike have for some time evaluated B2B integration platforms that help obliterate the divide between transactions and trade. In 2008, these platforms will no longer be perceived as bleeding edge, but as mandatory tools that oil the global trade engine. Speaking of oil–$100+ a barrel will mandate levels of supply chain efficiency that even academicians have only evangelized behind closed doors. Consolidators, contract manufacturers, customs brokers and suppliers will all strive to exchange logistics transactions that are accurate and actionable. Simple on-demand applications will serve as “windows into global trade” and will enjoy mass adoption, shielding both multi-national corporations as well as four-person factories from complexities of the transactions that define trade.  

5)    Physical and Financial Supply Chain Convergence Will Show Early Wins Among Early Adopters  

Prediction by GXS SVP Marketing and CMO, Bobby Patrick  

Leading supply chains will seek opportunities to inject working capital into their supply chains and optimize business performance for themselves and their trading partners. The convergence of the information flows in the physical and financials supply chains will enable financial institutions and logistics providers with new ammunition to benefit their customers and solve real business problems, such as dramatically increasing days payable outstanding (DPOs) for buyers and reducing days sales outstanding (DSOs) for suppliers.  

6)    It’s Time. The Greening of B2B  

Prediction by GXS Industry Marketing Director, Bryan Larkin  

In 2008, companies will look at B2B as a way to address their corporate responsibility with respect to green initiatives. Corporate Social Responsibility (CSR) and Environmental Health and Safety initiatives have started to include B2B in their scope, but in 2008 this will become a significant issue for companies. Companies that have not fully automated their supply chain will see that doing so will not only make their business more effective, it will also play a significant part in meeting their Corporate Social Responsibility initiatives.  

Best Practices for Success  

7)     Supply Chain Intelligence Is the Next BI  

Prediction by GXS Vice President of Product Management, Andrea Brody  

The demand to make sense out of the B2B transactions that move across the Internet and VPNs will increase 20 percent year over year. Since the movement of supply chain data via EDI and other formats has become mainstream, corporations now want to obtain valuable information from that data by correlating and providing business rules in order to effectively manage their supply chain to improve financial performance and exceed customer expectations. In today’s world of globalization, outsourcing and vertical disintegration, over 80 percent of the events that matter to a business will come from outside of the business. Investments in business intelligence and business activity monitoring software will require operational signals that transcend geographies, integrate widely diverse technology and break the barriers of standards and languages.  

8)    B2B Master Data Management: It’s the Data Stupid.  

Prediction by GXS Senior Global Product Manager, Melanie Ligons  

2008 will be the year when companies finally understand that the real challenge holding them back in the automated supply chain is lack of data quality. Information integrity issues associated with products and transactions reduce the ability of an organization to make appropriate short and long term decisions. Corporations have been hording data for years while analysts and consultants told them to do something with it. Now that business intelligence solutions are taking a primary place in the spotlight, companies are realizing that the data they’ve been hording is flawed—and so is the data they are using to run their business on a day to day basis.  

For years the retail and CPG space have struggled with new ways to share product data, only to be dismayed by the exorbitant costs and miniscule returns. High-tech manufacturers scoff at the idea of trying to adopt the Global Data Synchronization Network because they see it for what it is: just another way, using another technology, to share data. Sharing data isn’t the issue. Making sure companies have complete and accurate data, and then keeping it that way, is the real challenge.  

Leading companies will step up to the plate in 2008 and address the data quality issues by taking the first steps towards implementing solid B2B Data Management programs. They will follow in the steps of a few groundbreakers that have already paved the way. These data governance initiatives will need to address cultural, process and technical roadblocks that keep companies from successful supply chain execution. Most important will be changing the cultural aspect, as data accuracy will need to become part of the fabric of the business. The processes can be defined and supported by technology, but adherence and commitment will be the key to eliminating data quality problems.  

While numerous tools have been introduced to address information management over the past several years, the focus of the tools themselves, those selling the tools and the analysts covering them have been primarily on utilizing the tools to provide workflow for managing the flow of a subset of data within an enterprise (think Product Information Management in the B2B Data Management space). Now we are starting to see (Gartner 30 November 2007 - Methodologies: Blueprints for Success With Data Quality Improvement) the focus of analysts shift to actually addressing data quality. Smart executives will listen because this is something they can get their hands around. If the decisions they are making are based on flawed data, if the financial statements they are signing are based on inaccurate numbers, if the deals they are agreeing too might not be what they think they are, then they and their companies are in trouble.  

9)    e-Invoicing Adoption Continues to Skyrocket  

Prediction by GXS Senior Marketing Manager, Rochelle Cohen  

2008 will see a veritable explosion in the adoption of e-invoicing to help businesses automate their accounting processes. Businesses are increasingly applying technology to automate their procure-to-pay process and gain the dramatic business benefits that have been documented in numerous case studies and benchmarks. When e-invoicing is integrated with automated workflow and e-payments—which over 90 percent of large enterprises are doing or planning to implement—it enables companies to not only reap significant hard dollar cost savings from reduced operational costs associated with handling paper, but also to take advantage of discounts that can add millions of dollars to the company’s bottom line. Furthermore, more companies are taking advantage of the opportunity brought about by this “perfect storm” of automation to gain even greater savings by leveraging prorated discount structures or discounts negotiated once invoices are ready to be paid.  

Further fueling the adoption of e-invoicing are electronic invoicing legislation, such as the EU Council Directive 2001/115/EC which allows the electronic invoice to serve as the legal invoice in the European Union, and the availability of third party service providers that now offer a broad range of translation, protocol mediation and regulatory compliance services. These services enable companies to overcome the barriers that have prevented 100 percent trading partner participation in the past. For example, now even small trading partners can participate in e-invoicing programs without changing their current processes. And, suppliers are beginning to welcome the opportunity because they recognize the benefits they too will receive; this is particularly true when buyers promise faster payments in return for electronic invoicing. Furthermore, buyers who do business with international suppliers can rely on the third party service provider to ensure that varying local government regulations are satisfied. 2008 will be a breakthrough year for e-invoicing. The business case is clear, technology options providing seamless integration with in-house are readily available and the e-invoicing adoption rate has been growing steeply and steadily.  

Marketing  

10)   B2B Service Provider Blogs Become More Common and More Personal  

Prediction by GXS Global Product Manager, Justin Duewel-Zahniser  

Dialog with customers through blogs will increase, whereas using blogs as a medium for company promotional content will decline. Companies are increasing the use of blogs as an avenue for communicating with customers and the market, as evidenced by new supply chain vendor blogs started in 2007. Companies traditionally begin blogging externally in the Marketing organization since the focus there is naturally on external communication. In 2008, customers will continue to engage blogs as an avenue for dialog with their service providers and the value of provider blogs will become more evident in organizations outside of Marketing. Additionally, blogger voices from the user community will begin to increase and take on more authority in the space, consistent with what has been happening in politics, fashion and media.  

The past couple of weeks I have been busy helping with the roll-out of our new integration offering between the GXS Trading Grid and Microsoft BizTalk 2006 R2, a very exciting collaboration between GXS and Microsoft (and worthy of a blog entry of its own, very soon…).  Having wrapped up a couple of key activities, I started — as is my custom — to wade through a 10 inch stack of magazines (I checked!), and who knows how many emails…

Back in September, CIO Magazine started talking about the balance between outsourcing and innovation, referencing an innovation crisis (this is a blog entry, the print version of CIO had a longer and very interesting piece, but this gives you an idea).  This is the latest of a series of well-written articles on the dangers of leaving innovation to others (another I enjoyed, around manufacturing, back in 2005, is here).  R&D is a topic near and dear to my heart, as it is part of my role here at GXS, and the dangers as I see it fall into two categories:

1. Leaving R&D to outsourcing companies (traditional) may result in no innovation beyond cost-reduction
2. Too much dependence on even innovative partners can dull the innovative edge of your own team

I have a strong belief that every company needs to look for the opportunity to innovate in their core business, and one of the best ways to accomplish this is to free up resources in every other part of the business by partnering with companies who do that as their core business.  While this may address #2, it can put you in jeopardy of the first danger, which brings me to the knock-down, drag-out SaaS versus outsourcing.

What really got me thinking about this was a string of articles/blogs/etc along the lines of SaaS doesn’t matter, business value does…  On the surface this is really hard to argue with, as most generalizations are.  But like most generalizations, taken to extremes this is a dangerous idea.

In the CIO Magazine article, the problem surfaced was that most outsourcing contracts are based on the achievement of SLAs (service level agreements).  Traditional outsourcing companies have an enormous incentive to standardize and drive cost down, and pretty much nothing else.  This is the complete opposite end of the spectrum from commercial software vendors, who live and die by new license revenues, and have an enormous incentive to innovate.  Unfortunately, this innovation can only be realized through upgrades and installations, so customers receive benefits unevenly, only as the upgrade.

So how does this translate into SaaS out-innovating Outsourcing?  SaaS (software as a service), is a service based model like some traditional outsourcing, with the economic incentives of commercial software (if we don’t innovate, we quit winning new business…).  Unlike traditional outsourcers, who contain costs by limiting change in a given client (admittedly to preserve service levels), a SaaS based offering controls costs by applying its innovations to all customers.  If this sounds crazy — it’s not.  Change, in the form of innovation, is much less expensive than variation.  If I add new features and capabilities to my entire customer base, I have a better cost model than a software company supporting 3-5 different versions of their software (which is why most software companies “end-of-life” versions with depressing regularity).

This is the best answer to the conundrum posed in the CIO article about how to leverage the expertise of outside companies without risking loss of innovation — work with organizations that must innovate to survive.  SaaS is a marketplace with many of the cost efficiencies of outsourcing and an incredible pressure to innovate and invent (don’t believe me, look at Salesforce.com, Amazon’s web services, Microsoft’s Live Services, etc). 

And if people tell you that the business model doesn’t matter (SaaS, outsourcing, etc), tell them to talk to the music industry about iTunes, or the CRM industry about Salesforce.com.  Business models matter, they drive behavior and economics.  Innovation will always be strongest where companies need it to win, and that is the team I want to be on.