• Cognizant 20-20 Insights

Blockchain’s Smart Contracts: Driving the Next Wave of Innovation Across Manufacturing Value Chains Smart contracts with embedded business rules promise not only to reduce transaction costs but to create more agile value chains that enable closer cooperation and enhanced trust across the extended manufacturing ecosystem.

Executive Summary require overcoming resistance from both gov- ernment and established intermediaries such as — the technology banks. with the potential to eliminate financial services intermediaries — may also have the power to fun- This white paper explains blockchain, what it damentally change the manufacturing industry means for the manufacturing industry and how as we know it. By allowing supply chain partners to begin using it to drive quantum leaps in effi- to create trusted relationships without the need ciency, agility and innovation. for banks or, perhaps, even traditional purchasing processes, manufacturers, suppliers, customers Blockchain Explained and machines can find each other and do busi- Blockchain is a software mechanism, now primar- ness much more quickly and inexpensively. ily known in the form of in the financial Even more importantly, they will be able to form services world, that provides a distributed system more agile supply chains through “smart con- of trusted assets and transactions without the tracts” that automatically find, negotiate with need for a central trust authority. and close deals with partners the world over. This For manufacturers and their suppliers or logis- will help all participants across the value chain to tic partners, an individual transaction in a block speed new products to market that meet ever- might contain bills of lading for raw materials changing business needs, and will enable more or finished goods, proof of the origin, quality or trusted and fruitful relationships. operations performed on a part or instructions But leveraging blockchain will require carefully for the place and time of a delivery. In each case, balancing risks versus benefits, integrating new the information could be stored, trusted, shared technologies and processes with legacy systems and changed by the partners without going to the and evaluating the maturity of the required tech- cost, expense and delay of negotiating formal con- nologies, standards and providers. It will also tracts or paperwork such as letters of credit from a bank or a bond for a transportation provider.

cognizant 20-20 insights | june 2016 Unlike in a traditional supply chain, where these Blockchain enables the creation of documents and contracts are maintained by each smart contracts, with terms and partner’s purchasing, accounting or legal depart- ment, in a blockchain these elements are stored conditions both sides can specify on many decentralized nodes. Their privacy and and that assure trust in the integrity is maintained by “miner-accountants” enforceability of the contract and rather than by a counterparty or a third party such as a bank (see Figure 1). the identity of the counterparty. of the contract and the identity of the counter- Blockchain enables the creation of smart con- party. This system of distributed trust allows for tracts, with terms and conditions both sides can lower transaction costs in the short term, but this specify and that assure trust in the enforceability

How Blockchain Works A distributed database running on multiple servers continually checks the security and integrity of each transaction or data entry. Blocks chained by hash values and incentivized provide a foundation for distributed trust in blockchain.

BITCOIN BITCOIN APPLICATION APPLICATION

TRANSACTION Private Key Private Key A B Public Key Public Key B Public Key A B

Bitcoin Transaction Bitcoin Transactions Hash Transactions A Hash 101001 101001 101001 101001 B 001101 110001 001101 110001 Received 101001 011010 Signed by 101001 011010 A 101001 101001 001101 110001 Confirmed 101001 011010A

Hash Nonce B BLOCKCHAIN 101001 101001 001101 110001 Block 101001 011010 A OF BITCOIN Hash Nonce

101001 101001 001101 110001 Block 101001 011010A Hash Nonce

101001 101001 001101 110001 101001 011010

Miner Z solved the proof of work challenge and received reward in .

MINER Z MINER X

MINER Y

Figure 1 cognizant 20-20 insights 2 is just the beginning. In the long run it will enable peer network that makes up the blockchain. Other more agile value chains, closer cooperation with nodes accept the block, validate it and store it business partners and faster integration with the locally. The nodes then Internet of Things (IoT), among other things. collect the next set of The blockchain concept transactions and start has been extended Blockchain: A Deeper Dive another proof-of-work over the last six years The initial objective of blockchain technology was challenge. The node to enable trusted financial transactions between that solves the hashing for use not only with any two parties without the need for a third party challenge gets a reward currency but other such as a bank. While it’s best known in the finan- in the form of bitcoins. types of records cial services world, it can be used in any industry to enable faster, less expensive transactions and The blockchain concept as well as smart to support more agile supply chains that would has been extended over applications that can be impossible otherwise. the last six years for use not only with cur- conduct transactions When Satoshi Nakamoto introduced bitcoin in rency but other types of independently. a white paper in 2008,1 he did not use the term records as well as smart blockchain. But he laid the foundation for it by applications that can conduct transactions inde- identifying the need to prevent “double spend” pendently. Innovations such as the Ehtereum2 (two parties spending the same currency) without platform for decentralized applications and the relying on a central trust authority such as a bank. Hyperledger3 project to create a cross-industry open standard for distributed ledgers are making Solving this problem requires: distributed, trusted and secure blockchain • Publicly “announcing” all transactions or technology increasingly relevant for the manu- changes to any of the currency, documents or facturing industry. transactions to all participants in a blockchain. Blockchain in Manufacturing • Creating a system that allows all participants to agree on the transactions and their sequence. The need for compressed product lifecycles has led to increased conflicts between manufacturers It is the second requirement that gave birth to and suppliers. One particularly sensitive issue is # blockchain, a distributed database maintained by managing the development and engineering of a 2 a series of servers. One server preserves a time complex product in a way that protects both the stamp on all transactions on the blockchain. This manufacturer’s and supplier’s competitive edge server collects a set of transactions in blocks and and differentiation. Other issues over the lifetime publishes a hash (a unique set of numbers that, if of a product, such as fixing the responsibility in changed, shows the data or transaction is invalid) automotive recalls, are made more difficult and for each block of transactions with a time stamp expensive by the lack of trust between partners to verify their authenticity. As illustrated in Figure on both the transactional and strategic levels (see 1 (previous page), each owner of a transaction or Quick Take, page 6). document transfers the coin to the next owner by digitally signing a hash of the previous trans- Imagine a not-too-distant scenario where smart action and the public key of the next owner and products on the IoT must securely run embedded adding these to the end of the block. software, and instantly and securely share mas- sive amounts of data among those applications. However, that leaves the problem of how to These capabilities will add more tiers to the supply ensure the validity of each block without a cen- chain and dramatically increase the number of tral authority to track all transactions. Blockchain players and latency for root-cause analysis and solves this by providing an incentivized proof- corrective actions at the design level. of-work task for each participant. This process, called “mining,” involves attempting to find a If the past is any indicator, the emerging complex- numerical value, known as a “nonce,” that when ity of products and business models will make a combined with all open transactions in a block lack of trust an ever greater drag on manufactur- can be “hashed” into a value that satisfies a cer- ing supply chains. Manufacturing organizations tain “difficulty” but is also easily verifiable. Once must spend large amounts of time, money and the nonce is found by a miner, the miner publishes effort on negotiation, communications and paper- the block with a hash to the rest of the peer-to- work to overcome this absence of trust. This is

cognizant 20-20 insights 3 where the transformative power of blockchain Two important examples of how blockchain can lies, delivered by three critical capabilities: change manufacturing and logistics are: • Distributed integrity and reputation. • Smart contracts:4 A blockchain Blockchain gives a trading partner immediate between a supplier and a buyer would consist and low-cost trust in the identity and not of a paper document in a drawer or a word reputation of the counterparty processing document on a computer server. It Blockchain gives in any financial or trading would take the form of a computer program a trading partner relationship. This not only that runs on the blockchain and is executed immediate and reduces the cost and time by the entire blockchain network. Its program of transactions with known code — the terms and conditions of the contract low-cost trust in partners, but reduces the time — cannot be changed, and thus provides the the identity and and cost required to establish trust that used to require elaborate control reputation of the new business relationships. It and audit processes. Not only can blockchain also expands the universe of contracts contain the same level of detail as a counterparty in any suppliers and customers for physical contract, they can do something no financial or trading everything from raw materials conventional contract can: Perform tasks such relationship. to shipping and repair services, as negotiating prices and monitoring inventory delivering quantum leaps in levels. This, again, replaces expensive, manual efficiency and agility. effort with automated, dynamic tracking of supply chains, inventory levels and prices to Built-in monetary incentives to assure the • reduce costs and maximize profits. security of every transaction and asset in the blockchain. This allows blockchain To understand the potential of such smart con- technology to be used not only for transac- tracts, think back to the “digital marketplaces” tions, but as a registry and inventory system for of the late 1990s and early 2000s. They served recording, tracking and monitoring all assets the role of a centralized trust and transac- across multiple value chain partners. This tion processing hub which connected multiple secure information can range from informa- supply chain partners. Blockchain technology tion about raw materials or work-in-progress to can transform the vision intellectual property such as product specifica- of an “any-to-any” market- tions, purchase orders, warranty recalls or any place into reality. Imagine, Any buyer on the currency or contract. for example, a commodity blockchain can seller publishing a smart The ability to tap rules-based intelligence • contract on a blockchain find and act on the to perform business functions. platform such as contract, acquire enable the creation of intelligent, embedded that includes exact terms and trusted program code, letting participants the needed product and conditions for product build terms, conditions and other logic into specifications, delivery and or service and pay contracts and other transactions. It allows payment. Any buyer on the for it without the business partners to automatically monitor blockchain can find and act prices, delivery times and other conditions, processing overhead on the contract, acquire and automatically negotiate and complete the needed product or ser- of the early digital transactions in real time. This reduces trans- vice and pay for it without marketplaces. action costs, maximizes efficiency and allows the processing overhead of manufacturers to use data in different ways. It the early digital marketplaces. also opens the door for machine-to-machine transactions across the IoT. • Smart equipment and products: Consider, These capabilities enable the transformation of a for example, a smart vending machine that traditional supply chain, where transaction doc- registers itself on a blockchain platform and uments and contracts must be maintained by tracks its own inventory and cash position. The each partner’s purchasing, accounting or legal machine will not only issue a replenishment department. With blockchain technology, all order when it needs restocking, but can find transactional elements are stored on decentral- the needed products at the best price, and ized computing nodes by various partners. order and pay for them without manual effort or the involvement of its owner. We believe this ability of smart machines to decentralize

cognizant 20-20 insights 4 Order-to-Cash Process with Smart Contracts By providing trusted, automated transactions without the need for third parties, blockchain enables efficiency and agility wherever products, information or payments change hands.

Smart Contract 1 Smart Contract 2

Buyer or Smart DUE Equipment Purchase Receive products Accounts payable Payment order

Supplier PAID Accounts Cash Product catalog Sales order Shipment receivable application with pricing

Carrier or Smart Container Product movement using carrier

Bank Payment processing

Figure 2

decision-making and execution will bring a new fees and shipping time.” The supplier will accept era of efficiency to the manufacturing value the smart contract from the carrier. When the chain. This concept is also relevant for IoT and product is delivered to the buyer, the delivery machine-to-machine (M2M) integration using confirmation will close Smart Contract 2 and the distributed blockchain technology. supplier will pay the carrier the shipping fees in cryptocurrency. As illustrated in Figure 2, a supplier or manufac- turer issues a smart contract (Smart Contract 1, The delivery confirmation will also trigger a finan- highlighted in light blue) on a blockchain including cial settlement in Smart Contract 1 between the product definition, quantity, price, availability date supplier and buyer. In traditional supply chain pro- as well as shipping and payment terms. A buyer cesses, banks are used as the intermediary in the looking for the product can use the blockchain to payments process. With smart contracts, the use find the smart contract, verify the reputation of of within blockchain will handle the supplier/manufacturer for quality and timeli- the settlement of funds. ness and complete the transaction. This replaces the more difficult and expensive manual process- The advantages of this approach include: ing required to issue a purchase order to the Low barriers to entry for a supplier and a supplier. • buyer to conduct the transaction. Next, a supplier will search for a smart contract • The “reputation” of blockchain participants' (Smart Contract 2, highlighted in gold) from a performance on past smart contracts will carrier with details such as “origination, des- help the highest-performing companies to tination, capacity, shipping conditions, carrier demand premiums.

cognizant 20-20 insights 5 Block Miners Hash

Nonce Smart Quick Take Contract Blockchain in Manufacturing: The Art of the Possible The applications of blockchain technology across injuries or death. Automakers the manufacturing space are endless. What fol- can reduce their liability, as lows are a few examples. well as their customer and vehicle tracking costs, by • Audit trails: Blockchain audit trails prove that more quickly identifying a shirt was made in a factory paying a fair wage the vehicles in which that provides good working conditions. This the airbags were allows the retailer to charge a premium, the used. Customers know customer to feel good about the purchase and more quickly whether their the workers to live better. Using blockchain vehicle is affected, increasing audits to prove that organic food (or cage-free their satisfaction with the auto eggs) is genuine, for example, can help justify brand and reducing their risk of injury premium pricing, while fostering more humane/ or death. sustainable agriculture. • Tapping data from IoT: Easily tracked and • Real-time negotiation: Intelligent blockchain authenticated blockchain data from IoT gives contracts continuously query all other nodes in manufacturers more and better data about a blockchain for the best pricing, delivery times, how their products perform over time, enabling and other terms and conditions for specialized them to improve quality. This also helps them aircraft engine parts. An engine manufacturer, move beyond production to more lucrative sales for instance, can ramp up to meet demand and services such as proactive replacement of more easily while cutting costs, while a smaller failing parts. manufacturer can more easily fill demand from major customers. • IP management in product development: Blockchain technology makes it easier and less • Supply chain visibility and traceability: expensive to securely share intellectual property Blockchain production records, for example, such as designs, bills of material and production can trace which automobile airbags were made schedules among suppliers, manufacturers and with an explosive compound that can cause shippers.

• Smart equipment can replace human con- ferent financial and regulatory intermediaries, tracting parties for certain transactions, as as well as its own contract in our example of the vending machine. and trust relationship among the parties. The The immediate and • Devices on the IoT can communicate with immediate and low-cost smart contracts to keep track of the status low-cost assurance assurance of trust provided and state of smart contracts for settlements. of trust provided by by blockchain technology Smart shipping containers could, for example, can unleash disruptive inno- blockchain technology automatically sell their surplus capacity. vation by allowing any can unleash disruptive Faster settlements using cryptocurrencies. • supplier and any manufac- innovation by allowing turer to instantly find one Getting Ready for Blockchain another and begin a trad- any supplier and Manufacturing value chains are complex, multi- ing relationship. any manufacturer to tiered combinations of various types of organiza- tions providing design, sourcing, manufacturing, So far, disruptive innova- instantly find one delivery and service across multiple geographies. tion in blockchain is being another and begin a Producing even a single component of a single driven primarily by tech- trading relationship. product may involve a myriad of transactions, nology start-ups with a ranging from requests for quotes to the transmis- high tolerance for risk. Nonetheless, the overall sion of purchase orders and engineering change trajectory of blockchain technology is extreme- notices. Each transaction type may require dif- ly high (see Figure 3, next page). As a result, we

cognizant 20-20 insights 6 Pace of Blockchain Adoption We expect the pace of blockchain's disruptive innovation to accelerate in the next 18 to 24 months.

Progress by sustaining innovation of “non-blockchain” technology (e.g., centralized ledgers for IoT)

Performance demanded Progress by disruptive by risk-averse adopters innovation of blockchain (e.g., stable and proven IoT technology (e.g., blockchain- ledger and smart contract based IoT by Filament) platform) Performance

Performance demanded by early adopters (e.g., faster, global and seamless payment settlements)

2008-2009 2014-2015 2016 Bitcoin launched Bitcoin cryptocurrency Maturity of blockchain stable technology Figure 3 expect the next 12 to 18 months to be extremely A second useful tool to identify “low hanging fruit” important for companies looking to develop their blockchain opportunities is the functional com- blockchain innovation strategies. plexity-automation capability framework shown in Figure 5 (next page), developed by authors and As is typical with disruptive technologies, we scholars Don and Alex Tapscott.6 recommend first executing proofs of concept to understand its potential and limitations, rather Applying these two tools to the use of smart than measuring early deployments on their contracts in two manufacturing value chain trans- return on investment. actions — the selling and purchasing of goods and services — produces a sound decision framework, To help companies understand the relevance of as seen in Figure 6, page 9. blockchain smart contracts to them, and target their proofs of concept most effectively, we use Challenges and Risks two tools. Blockchain carries all the risks of any emerging technology. These range from the maturity of the The first is the decision chart shown in Figure technology itself to the standards surrounding it 4, next page, which helps identify areas where to the challenges of integrating it with existing blockchain technology can deliver value. platforms and business processes. The instant One such area is in transactions where both provision of trust among trading partners, and parties lack trust in the definition and verifica- the ability of smart contracts to negotiate and tion of a successful transaction. For example, finalize transactions, may require major changes Blockcharge5 uses blockchain technology to pro- in workflows and business processes. vide the authentication of users and billing for Due to its disruptive nature, however, blockchain a peer-to-peer network of charging stations for also carries two unusual risks potential adopters electric vehicles without the need for a middle- should monitor carefully. man such as a bank.

cognizant 20-20 insights 7 Blockchain Smart Contract Relevancy Decision Chart for Manufacturing Value Chain Transactions

Product/service/ NO information required is structured and well-defined YES Not relevant for blockchain smart Business partner can provide contracts (i.e., NO identity, authorization and advisory services) reputation for the product/ service/information transaction

Prime candidate YES for disruptive innovation NO Terms of the transaction can be defined without ambiguity by the participating parties in the transaction YES

NO Success of the transaction YES Relevant for blockchain can be easily measured, smart contract observed and verified by the involved parties

Figure 4

The Low-Hanging Fruit: Where to start with Blockchain Innovation

HIGH

• Academic concepts that will need 18–24 months to realize (e.g., distributed autono- mous organizations)

EMERGING PRODUCTS, PROCESSES Functional Complexity Functional AND SERVICES

• M2M integration • Management of product design and specifications • Distributed IoT ledger

• EDI, B2B transactions • Payments • Product definitions

LOW HIGH Automation Capability

Source: Adapted from Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World, by and Alex Tapscott, Penguin Random House, June 2016. Figure 5

cognizant 20-20 insights 8 Where Blockchain Works Best

Pricing Established Discovered

• Personalized view • Items with complex of data descriptions and Complex • Community membership characteristics, requiring RFQs Relationship Smart Contract Not suitable for Smart Contracts

• Standard items • Bid/ask format • Content indexed or • Commodities or near-commodity aggregated across suppliers • Anonymity on both sides of the transaction Simple • Prices set away from the intermediary • Seller and buyer auctions

Goods/Services/Content Relationship Smart Transactional Smart Contract Contract

Figure 6

• Government acceptance of or interference suppliers with the manufacturers that need their in blockchain peer-to-peer networks. Many products, and slash the costs and delays asso- governments have not authorized the use of ciated with traditional accounting and vendor blockchain cryptocurrencies due to their lack management. of control over the monetary effects of cryp- tocurrencies and concerns over the criminal But blockchain technology and standards are exploitation of the decentralized peer-to-peer still emerging. Resistance from governments and network. When choosing blockchain opportu- existing intermediaries could slow its progress. As nities, organizations should carefully consider with any new technology, integrating blockchain where such lack of government acceptance with existing technologies and new platforms would reduce or eliminate the value of such as IoT, and adapting skills and business pro- blockchain in its value chains. cesses to it, will require investment. • Resistance from established players such Enterprises should proceed cautiously, with as banks, exchange networks and other proofs of concept executed with partners, as they trust intermediaries could delay blockchain identify the “sweet spots” for this powerful new adoption. Manufacturers may want to trial capability. We recommend that manufacturing initial blockchain rollouts with smaller, newer companies do the following: “true digital” trading partners than larger Implement block chain technology evaluation partners unwilling to endanger their relation- • and selective proofs of concept. ships with existing intermediaries. Begin developing and testing innovative block Looking Forward • chain business models and products. Blockchain isn’t just for banking and currency. Leverage experienced partners to build a Deployed correctly, its central benefit of rapid, • blockchain technology (hardware and software) easily established trust among trading part- lab to best understand the ever-changing ners can enable disruptive innovation in areas potential and challenges. ranging from audit trails, real-time negotiation, supply chain visibility and tapping data from the IoT to managing intellectual property in product development. This trust can more quickly match

cognizant 20-20 insights 9 Footnotes 1 https://bitcoin.org/bitcoin.pdf 2 www.ethereum.org/ 3 www.hyperledger.org/ 4 Nick Szabo, http://szabo.best.vwh.net/smart.contracts.html. 5 www.youtube.com/watch?v=0A0LqJ9oYNg 6 Don Tapscott & Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World, Penguin Random House, June 2016, http://blockchain-revolution.com/ the-book/.

About the Authors Prasad Satyavolu is Global Head of Innovation within Cognizant’s Manufacturing & Logistics business unit, where he focuses on the connected world (connected products, processes and infrastructure), including connected car and telematics services, IoT solutions for urban mobility and smart cities. He also focuses on customer fulfillment (integrated supply chain management that spans visibility plan- ning and manufacturing execution) and general manufacturing industry challenges. Over the last 25-plus years, Prasad has held leadership roles in manufacturing and logistics and incubated a start-up in IT services and consulting that served the manufacturing industry. He holds an advanced degree in mechanical engineering from Dayalbagh Educational Institute, Dayalbagh, Agra, India, and completed a General Management Program (MEP) at Indian Institute of Management, Ahmedabad, India. He can be reached at [email protected].

Abhijeet Sangamnerkar is a Senior Business Transformation Leader and AVP within Cognizant’s Manufacturing & Logistics business unit. He has over 20 years of consulting experience in the automo- tive, pharmaceuticals, chemicals and A&D industries. Abhijeet provides advisory services specializing in digital transformation strategy, business cases and roadmaps, and has managed several global transformation programs in the manufacturing industries. He holds an MBA from the Kellogg School of Management, Northwestern University, and a B.E. in electronics engineering from Gov’t College of Engineering, Pune University, India. Abhijeet can be reached at [email protected].

About Cognizant Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process out- sourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 100 development and delivery centers worldwide and approximately 233,000 employees as of March 31, 2016, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performing and fastest growing companies in the world. Visit us online at www.cognizant.com or follow us on Twitter: Cognizant.

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