Can You Hard-Wire Performance?

by James Heskett

Summing Up

Hard-wiring Performance Is Great In Concept...but....

The responses to the concept of promising and delivering results rather than selling products or services are in, and you've agreed that hard-wiring performance is a winning concept that provides benefits for customers, great marketing positioning in a customer's mind, and a way to keep an organization on its collective toes.

photo of James Heskett

But the concept is, in the opinion of readers, one that in application raises more questions than it answers. Among these are: (1) Are you good enough to use it?; (2) Are you organized to implement it?; (3) Can you design processes to reflect the promises implicit in hard-wiring?; (4) Do you have the people, incentives, and technology to deliver on the promise?; (5) Are you big enough?; (6) Do you have the financial capability to protect against downside contingencies?; (7) Do you have the legal capability to draft documentation that protects against all contingencies?; and (8) Can there be a gap between the promise and the capability (a way to improve an organization's performance), or is this too risky? In short, there was a preoccupation with the potential downside of such a strategy. The idea was that maybe it was alright for GE, but could a smaller, less well financed organization employ it? And how safe should an organization play it when employing such a strategy?

Several of you offered other examples of performance hard-wiring. David Hawkins cited it as a motivation for consulting divisions of Big 5 professional service firms to separate themselves from their auditing colleagues in order to enable consultants to take equity positions in their clients' firms. Ilyas Naibov-Aylisli suggested it would be a good way to sell computing "power" rather than just equipment or software.

Jim Heskett Others of you cited examples of your use of hard-wiring. Jay Cross offers it as an alternative to traditional pricing. Although clients don't bite, he claims that it gets him credibility points, more business, and clients that are more satisfied with his regular fees.

Darrell Berglund, from whom I might have expected as much as one of my former students, asked whether I was asking the right question. He proposed what was for him the real question: "Does it make sense to shift (to a supplier) the risk a purchaser normally bears to itself at no (or little) incremental payment ... over and above the "normal" selling price?" Berglund answers his own question in suggesting that it depends on the extent to which the new (GE aircraft) engine (used in the hard-wiring example) differs from past models. And of course that's the point. Hard-wiring can deliver better products and services that command different prices, costs, and margins.

The questions comprise a pretty good starter checklist for those contemplating the hard-wiring of performance. In total, they suggest the benefits of sharpening an organization's capability to the point where it is a viable alternative.

Original Article

Several months ago, the General Electric Company announced that it had closed a deal with Boeing that specified that only GE aircraft engines would be installed on the newest version of 777 aircraft built and sold by Boeing. This surprised industry observers for two reasons. First, aircraft engines generally are purchased separately from aircraft by the airlines footing the bill. Second, GE engines are not the first choice of all aircraft purchasers. But GE made Boeing an offer it couldn't refuse both by co-investing in the development of the engine with Boeing and by selling time rather than engines—up-time, that is. The deal guaranteed that GE would keep the engines running for a quoted cost per hour, providing whatever parts, service, and related support might be needed over the life of the engine. In short, GE Aircraft Engines hard-wired its success to the success of its engines in delivering valuable up-time to ultimate customers. But it did much more than that.

By guaranteeing up-time at a given cost, GE's management created a built-in incentive to improve the product and lower the cost. In fact, GE's management is betting that the incentive—given other management initiatives already in place—will, if it works, insure that GE's organization in the future will deliver the greatest value (best results at lowest cost), thereby enhancing customers' performance and GE's profits.

Xerox had the formula and discarded it. Until the early 1970s, nearly all Xerox copiers were leased, with revenues dependent on per-copy royalties. If the machines malfunctioned, it was in Xerox's best interests to get there as fast as possible and keep the machines running as much as possible. Xerox's service, delivered by a veritable army of service technicians, was legendary. Xerox hard-wired its success to results achieved for customers.

Then the lure of improved cash flow combined with competitors' practices led to the decision to encourage machine purchases by users. Within a short period of time, sales far outpaced leases. No longer was Xerox's success hard-wired to results achieved by the machines. The trade-off between service levels, revenues, and profitability became less obvious, particularly given the intense price competition from foreign manufacturers experienced by the company. Perceived declines in service levels were inevitable. Even today, Xerox old-timers debate the decision.

But hard-wiring incentives can have a downside. Just ask the management at eBay, which supplies an internet vehicle by which its subscribers can trade practically anything with one another. Ebay's system failures last year evoked immediate, painful outcries from its subscribers, who could calculate their hourly cost of being unable to do business through Internet trading site.

Does it make sense for a company to hard-wire its success to that of its products, services, and customers? Under what conditions? Does it require a redefinition of the business from one providing products and services to one delivering results? What impact does this have on organization, performance measures, and incentives?

    • From an HBS alum (MBA '98)

    I agree with the concept of providing Service Level Agreements that ensure "product performance." In the end, all companies, whether defined as a product or a service company, must still provide a service(s) to their customers. The challenge for "product" driven companies is that they are not generally designed, from a process, people, or technology basis, to ensure service delivery. Unless an organization dedicates its entire being to providing services rather than products, I believe it will be difficult for them to succeed, as experienced by Xerox. The driver for most companies seems to be total sales volume — not long-term service provision.

    • Cyril Comte (HBS MBA '99)
    • President, CCIE - TOYOTA Martinique

    Hard-wiring your performance seems like a very powerful way to give to your organization the sense of urgency on a daily basis it can quickly lose when times get better. No surprise though that it is pioneered by the likes of GE as it is so hard to do and a big leap of faith, especially for smaller companies with finanical margin for errors. Clearly, I would love to develop that kind of concept in my own organization but we do not have the operational capability right now to provide it. And even if you have, it can be a fair challenge to draft a contract that can protect you from a heavy downside due to external circumstances. Clearly GE has the kind of legal resources and staff to effectively deal with that. This is clearly the way though. The issue is in the degree of performance that you are ready to hardwire (better use up analytical capabilities upfront), and be prepared to make good on it under current circumstances as well as worst case scenarios.

    • David Hawkins (HBS MBA '96)
    • Principal Consultant, PricewaterhouseCoopers LLP

    My reaction is that hard-wiring your success to the performance of your product or service is a good differentiator from your competition and if done right can increase your profitability.

    Two cases in point: One, the move of consulting divisions of Big 5 professional services firms to separate themselves from their audit practices (where independence requirements lie) in order to expand the potential relationships that they can have with their customers, i.e., take equity positions rather than consulting fees(therefore, their services must deliver the shareholder value improvements that they promise); two, Disney Consumer Product's closer tying of its royalty agreements with their licensees. My understanding is that they're tying warrants in with their royalty contracts to extract a greater portion of benefit created by the use of their characters.

    In both cases, where the product/service exceeds so does the originator. As you pointed out, the risk lies there as well. From a marketing or competitive position, who are you more likely to believe can deliver? One that puts its life on the line or one that plays it safe?

    Are you sure there is an alternative to NOT doing this?

    • Ilyas Naibov-Aylisli
    • Assistant Brand Manager, Procter & Gamble

    I've been considering a notion of such hard-wiring for the personal computer industry. The PC producers may sell computing power rather than a product, charging a monthly fee. This would not be an "absolute" computing power, but one relative to the state of the industry. This computing power would be delivered via hardware/software replacement and/or upgrade.

    Let me provide an example. Say, Mary is a power user and always wants to have the most powerful, latest-features-loaded PC on the market. I'd then get, say, a "100%" package. Her machine would then be regularly upgraded or replaced, but my monthly fee would remain flat. John, on the other hand, may only require a "70%" package, which still may provide him with more a satisfying computing experience than the one of the "conventional" buyer of the most powerful PC.

    Let's imagine that average user purchased a new machine that is somewhat above her current need for computing performance. Say, roughly, it is 75% of the performance of the best machine in the market. As the machine ages, this number goes down. In a year, this number can be, say, 40%, in 2 years 25%… At a certain point, the PC performance is below her need. So, the consumer has to upgrade, and, eventually, buy a new machine. Since there is time between the moment the machine does not fully satisfy her needs and the time she buys a new one/upgrades (and quite often it's a pretty long time), there's clearly frustration for a consumer and also a missed opportunity for the PC manufacturer.

    To hedge against the risk of the PC becoming outdated too early, consumers have to buy a machine that is significantly more powerful than they may currently need. Which is clearly not in consumer's favor, and, thinking long-term, may not necessarily be a clear benefit to the manufacturer, as it postpones the next PC buy.

    Overall, I think "hard-wiring" is the ultimate model for the future, and we will see an eventual shift to that model in many different industries. This model will gain huge acceptance with enterprise customers, and, eventually, with the consumers.

    • Jay Cross (HBS MBA '74)
    • Chief Scientist, Internet Time Group

    Pay for performance. It's a wonderful concept. It's also a great sales tool, even when the offer is not accepted.

    I help major firms implement eLearning. Many times, I've offered services in exchange for a cut of the improvements they create. This alone demonstrates my confidence in what I'm offering. More importantly, it forces the prospect to evaluate its ROI to estimate the price implied by my offer.

    In every case, the prospect has preferred to pay a fixed price rather than put up the value of 20% of the performance improvement. And they always feel they're getting a great deal.

    • Darrell Berglund (HBS MBA '75)
    • Litigation Attorney/President,

    Whether it makes sense for a company to hard-wire its success to that of its products, services, and customers is not the appropriate question, given what GE did—for by every sale or lease to a customer by every vendor, that vendor has "hard-wired" its success to that of its products, services and customers. Indeed, if any product or service is a lemon, chances are that that customer ain't coming back!

    The real question in re GE is, with respect to a new model of a overall product with which they have considerable familiarity, does it make sense to shift the risk a purchaser normally bears to itself, at, if I read the facts correctly, no incremental payment from the customer up front, over and above what would have been the "normal" selling price otherwise.

    The answer to this question probably turns on the extent to which the new engine differs from past models — given that to the extent it is similar, the expected economics of providing upkeep are probably similar. Also relevant — to even a customer — would be the ability of the vendor to absorb adverse economics. In this regard, I might not buy at all from a company offering "such a deal!" if it were not a strong one financially (unlike GE, presumably).

    Taking on the risk that usually accrues to a purchaser may — may — prove — after the financial returns are in, though — to have been a smart move. However, I personally believe the smarter move was luring the relevant Boeing decision-makers into bed re design of the 777 engine and interface (think of the possibilities for enhancing the interface so as to at least appear to create incremental value — and keep a customer hog-tied to you!).

    Had I been Chairman of Boeing at that time, I would have at least wondered whether one of my key decision makers had been bribed, given the likelihood of this jumping into bed with one supplier ticking off customers who didn't want GE engines for some reason. Also, I would have run this possible deal by my attorneys (good, old fashioned competition, or tortious interference with prospective economic advantage, fueled by bribery?). Also, how well did my managers analyze GE's business health before signing — because, in this deal, GE is acting as an insurance company! Would it have even been the lowest cost provider of insurance for Boeing and its customers here?!