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Contracts: are there no limits?

festival-583442_1280While many continue to question the value and relevance of contracts, there are indications that our world is becoming more driven by rules and litigation.

Society, ever less tolerant of ‘bad behavior’, seems to welcome regulation. Perhaps this is an inevitable consequence of the breakdown in trust, itself caused by the erosion of traditional loyalties and communities. So while regulation has influenced many aspects of human tolerance in a positive way, general levels of polite behavior often appear to have fallen.

What exactly are the standards when it comes to a 5-year-old’s birthday party? That is the question being put to the test in Cornwall, England, where no-showing for a party has resulted in an invoice and threats of court action to recover resulting costs. The offending child (or parents?) accepted the invitation and then had second thoughts. Their host incurred fees of approximately $25 which could have been avoided if there had been a cancellation.

Justified annoyance? Probably. Appropriate reaction? I suspect not. And indeed, not only is this attempt at recovery most likely doomed to failure (for background and expert opinion, click here), but the host parents would seem not to have undertaken effective stakeholder analysis when launching their attempted recovery. For example, what will other parents think? What will other children at their son’s school say? There is every chance that next year, the boy will celebrate his birthday alone. Play dates? Forget about those – they are too risky.

In the end, every smart individual (and organization) must weigh their desire for recovery (or revenge) against the wider impacts on their brand or reputation. That is why litigation is so rare. Most times, it is far smarter to simply write off the losses and forget about them, or to seek compensation through reasoned discussion.

Opinions versus facts

Fact-based decision making is gaining the attention of business leaders worldwide. That is because they recognize it has critical importance to survival in today’s volatile, competitive and complex markets.

Many of today’s business decisions are based on opinions or flawed data. For example, there are people who believe all suppliers are intrinsically dishonest, or that all customers are unreasonable. There are those who believe that good performance is best achieved through consideration and encouragement, while others think that the threat of punishment is more effective.

Most of us have plenty of opinions and we find comfort in them. Sometimes these are based on facts. Often they are influenced by specific experiences or education, which may or may not be indicative of norms or reality.

When we look at how contracts are drafted, or how business relationships are conducted, we rapidly see evidence of very different opinions. Indeed, we need only to conduct an internal review and approval process to discover wide variations in the underlying attitudes of different functions or individuals. When challenged, we may often hear about specific incidents, or about ‘someone who told me’, but it is rare to find positions that are well supported by factual data. For example, what is the actual impact if commercial staff are involved late or whether or not a ‘professional’ contract manager or lawyer oversees performance? What is the actual impact of onerous liability clauses or liquidated damages? What is the actual effect of extended payment terms or more generous rights of return or of mandatory arbitration rather than litigation? And how do these answers vary according to the type of relationship, or the culture within which events are occurring?

Ask around and you will receive a multitude of different opinions. I challenge you to unearth many facts.

Effective management seeks to harmonize these viewpoints. It recognizes that diversity of opinion can be a creative force, but unless there is control and balance it will rapidly lead to destructive contention. We see plenty of evidence in the world today where strongly held beliefs, often lacking a factual basis, become a source of massive destruction.

Developing harmony in the way we construct and manage our trading relationships is surely the key to improved performance, but it is unlikely to be achieved while so many decisions and behaviors are based on individual opinions. That is why organizations are becoming so interested in data that can lead to fact-based decision-making. In a recent article, The Economist pointed to this development in the world of economics, where the long-ignored field of microeconomics is now surpassing macroeconomics in terms of interest and influence. That is because we live in a data-rich world with technologies that can now undertake meaningful analysis. The result? A mass of hitherto unknown facts, which increasingly drive business strategies and offerings. Take for example the recent collapse in the oil price. The ‘macro’ world should have been forecasting this – but it wasn’t. So the ‘micro’ world now kicks in, helping management to decide what steps to take to address this situation.

The world of contracts has remained largely immune to the influence of data analytics. Even though there are millions of contracts available, a lack of clear structure and the diversity of wording has made data extraction difficult. But perhaps more important, we have a professional community that is resistant to change and which continues to place value on individual opinions, collective wisdom and the interpretation of precedent. That is perhaps the major reason why we now see a new field of ‘Commercial Excellence’ emerging. Organizations are determined to extract more value from their market relationships, especially on the supply-side (though it is my opinion(!) that this won’t take long to flow through into procurement as well). To achieve this, they are focusing on new approaches to market segmentation, more adaptive market offerings, differentiated sources of value through commercial terms – and to get there, they need much more integrated data collection, tools and systems to perform analysis and skilled staff to oversee these activities and apply business judgment. Right now, those being recruited into these posts are not from traditional ‘commercial’ functions.

Where does this leave today’s contracts and commercial staff, including lawyers? Perhaps rather like the macro-economists, we will find ourselves relegated to a subordinate role, still muttering our opinions even when no one is listening. Or, of course, we can ensure a very different future by grasping the need for change and becoming the owners and purveyors of facts.

Commercial Management: jelly or blancmange?

A repetitive issue with commercial management teams is the imprecision over their job role.

Yesterday I was speaking with the head of commercial at a major outsourcing company about the challenge he faces with staff retention. It became clear that lack of role clarity is a significant factor. While there is heavy demand for commercial services, there is little definition of what precise activities are provided, or of what value these deliver.

My colleague observed: “It all sounds a bit like a large jelly – absorbing whatever is thrown at it”. But we concluded that actually it was more like blancmange, since jelly is transparent, yet commercial services are often opaque.

This absence of defined value is a problem, not only in offering high caliber staff a meaningful role and career path, but also because senior management shares that confusion. At a time when ‘commercial excellence’ is becoming a key issue for business, it is far from clear whether existing resources are capable of meeting the challenge.

Are you delusional?

Most people do not rate their skills or capabilities accurately. There are those who over-estimate (and therefore tend to blame others when things go wrong); and there are those who under-estimate (and therefore tend to blame themselves even when it is not their fault).

Last month, the Financial Times ran an interesting article on the impact of these tendencies in the workplace (‘Bloated and shrunken egos both prove bad for business’). It concluded that some level of misperception is normal; that over-estimating (at least among managers) is more prevalent; and that in general this is not a problem. However, understanding our tendency can be helpful – and people at the extremes can create problems for themselves and for their organization.

Those who over-estimate their ability often feel they have little to learn or to correct. Those who under-estimate are often very hard workers (compensating for their lack of self-belief), but they generally fail to take responsibility for their own development.

Experts in organizational behaviour attribute an increase in numbers over-estimating and attribute this to modern education, which tends to praise mediocre work in order to build self-esteem. The more people are encouraged to feel special, the more they develop a sense of entitlement and an exaggerated view of their skills.

It is interesting that in both cases (over-estimators and under-estimators), there tends to be a rejection of structured learning programs. Also, career success adds to the dilemma of the over-estimator, because the higher they go, they tend to be insulted from problems and bad news. They may also surround themselves with people who admire them and rarely challenge. Indeed, when challenged, the individual with inflated ego is likely to become defensive and may even exclude anyone with opposing views.

Any contracts or commercial manager needs to manage stakeholders. In order to do this, they need to understand the drivers for that stakeholder – and this analysis helps in how best to motivate and communicate with them. But a good commercial expert will also hold the mirror to themselves and challenge their own self-perceptions. Based on the skills assessments we undertake at IACCM, both categories are quickly recognizable. And we also regularly experience the resistance to learning that the experts associate with an inability to make an honest appraisal of our capabilities …. So where do you sit on the scale?

Contract audit: establishing value

It has been some years since ISG introduced an audit service for outsourcing contracts. I recall that they estimated clients could save up to 7% of contract value through corrections of supplier over-billing.

Recently, I conducted a webinar with SC&H Group, a company that offers more holistic contract audit services. Their estimate of savings is a little more conservative, but still very significant. It seems to me the sort of service that any value-minded supply management group should be adopting – and indeed, worth considering by any supplier wanting to establish competitive advantage.

Billing accuracy is important. At one, extreme level, there is a risk of outright fraud, which every organization must be anxious to avoid. At another level, there is error. And somewhere in between is complexity – the growing volume of services contracts that are based on complicated algorithms or precise volumes of activities delivered, often utilizing personnel with varying hourly rates.

The concept of audit is obviously not new and it is used quite extensively in some industries. But in many, especially where Procurement focus has historically been on direct purchasing, there is little attention paid to contract outcomes. As indirect procurement has grown as a proportion of spend, the chances of waste and overpayment have increased.

One option for tackling this problem is to deploy internal resources to check and validate supplier invoices. However, in addition to asking whether this is an area for internal core competency, there is the drawback that such reviews may prove adversarial and damage the wider customer – supplier relationship. Using a third party can bring a degree of independence and objectivity, reducing the chance of confrontation.

For suppliers, there is growing demand for greater integrity in business dealings and key to achieving this is increased transparency and openness. It seems to me that a source of competitive advantage in the next few years will be proactive efforts to embed transparency within contract relationships. The accuracy of billing and charging practices is an area of major concern for customers. What better way to demonstrate not only honesty, but also confidence in process quality, than to establish third party audit as a contract term?

And the list continues to grow …

protectionismYesterday I was involved with a briefing call for the IACCM Advisory Council. We discussed a number of emerging trends – including those which I outlined in my blog ‘A new year makes no difference’.

Several additional items arose during the conversation, illustrating the tremendous diversity of challenges facing the commercial community.

1. In a number of industries, some large suppliers exhibit almost monopolistic or oligopolistic behaviors, evident in their ‘take it or leave it’ terms and conditions and some of their business practices. I find this interesting and I suspect many on the supply side, rather than sympathizing with customers, would say ‘it serves them right’. Years of aggressive procurement practices, forcing ever lower prices and ever greater risk onto their suppliers, has certainly not created a sympathetic environment. It has also forced industry consolidation and driven competition out of the market. The ‘oligopolistic behavior’ is in part also a result of more frequent teaming between a small group of large suppliers. Yet even now, customer organizations seem slow to learn that they need to alter their approach to the supply base. In most cases, procurement has not altered its unrelenting focus on lower prices and a heavy burden of risk.

2. There is growing protectionism and this distorts markets. It is certainly true that demanding economic conditions and broader social unrest are leading to market distortions. These include preference to local suppliers or more onerous demands for counter-trade and local content. Rather than protest, I think commercial teams need to adjust to these realities. Politicians will respond to the concerns and pressures within their jurisdiction. Suppliers must become smarter at anticipating and enabling these needs. Commercial managers need to establish proactive capabilities in raising local content or developing local skills and make this a key part of their value offering.

3. We need to invest more in supplier development. The issue here is the lack of availability of skills. Despite high levels of unemployment, many countries lack the skilled labor needed by today’s business. This ties to the point on protectionism, where free flows of labor are also now being constrained. However, the answer may also be the same: smart suppliers (and buyers) need to look at how they build competitive advantage through programs and offerings that alleviate skill shortages. This is a commercial challenge to be fixed, not an insoluble problem.

4. It is getting harder to get paid. I found this an interesting comment and not one I have heard elsewhere. Certainly payment terms have lengthened – I have written on that topic several times in the last year. And the volume of debt written off is truly remarkable. But this comment was made especially in the context of Europe and the fact that companies there are lengthening payment periods and then often failing to pay even when due. I would be interested to know if others are experiencing this challenge. I certainly know that factoring is growing fast in Europe and perhaps that will provide a solution.

Interesting topics and just more evidence of the scope of the challenges facing commercial professionals. Perhaps a key point is that individually and on a deal-by-deal basis we cannot find answers. The real value of commercial management can be realized only when the community starts to combine and develop campaigns or design solutions that address these issues more holistically.

Commercial excellence: from concept to reality

projectThose who follow the work of IACCM will be familiar with our assertions that commercial competence is becoming a major topic for business leaders. Faced by the growing complexity and competitiveness of a networked world, the ability to make better commercial judgments and to act fast upon them is a critical source of differentiation. Businesses are moving from a focus on efficiency in managing the internal enterprise to effectiveness in managing external markets.

Anyone who still doubts those IACCM forecasts should do a search on ‘commercial excellence’. You will find that all the major consultancies are now active in this field and that there are significant employment opportunities for ‘heads of commercial excellence’, including examples of ‘commercial excellence job families’. The internet search implies a strong focus on sales and marketing, with the role very much geared towards segmentation, analytics, portfolio management and oversight of channels. It is – quite correctly – a market management and sales enablement role, drawing widely on the development of standards and the use of technology. In most cases, the goal is quite clearly to improve sales and raise margins. Hence responsibilities frequently include contracts and pricing.

This development is increasing the gap between the more strategic role of a commercial manager, versus the more tactical and operational activities of contract management. A strong interdependency remains, but the way that ‘commercial excellence’ is evolving suggests that this will be the role to undertake detailed market research, to focus on analytics and to define commercial practices and offerings, whereas contract management will be more aligned with specific deals and negotiations.

One of the most important points is that these roles are quite clearly about generating revenue and profit. While issues of control and compliance obviously remain important, they are the backdrop, not the purpose. This shifts commercial (and in that sense contract management also) away from the Legal orientation that has been an increasingly dominant feature of the last few years.

And what about Procurement? We know that in many organizations, Procurement wants to be seen as ‘commercially competent’. As I have observed in several recent blogs, that is problematic while existing performance metrics remain in place. A focus on savings and risk allocations  inevitably undermines rounded commercial judgment. It is also notable that at present Commercial Excellence is being defined in very much a sales-oriented context (which is much more in line with the traditions of this title). However, my view remains that organizations can flourish only if they align their sales and procurement activities. Over time, I believe we will see an integrated commercial function looking at markets and their management holistically. The dependence of sales on the quality of the underlying supply network is now so strong that a disconnect immediately impacts performance.

As the only professional association representing commercial management, IACCM will continue to define and report on the emergence of ‘commercial excellence’. For the last year, we have been working on new and updated training programs and expanding our research to inform and equip the market. For those with an existing commercial role or title, these changes will often be challenging because they represent a significant shift in responsibilities and skills.


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