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Performance-based contracts

There is growing evidence that the form and design of a contract has substantial impact on the results achieved. The evidence ranges from studies on major projects, which often suffer from use of the wrong contract model, to more focused investigation of the behavioral impact of specific terms, such as the liability or indemnity provisions.

The steady move away from traditional product-based sales into a world of solutions and services is changing the emphasis of contracts. Rather than each transaction being driven by a specific delivery or input, many agreements now relate to phased activity where ‘completion’ is rather less precise and ‘success’ can be gauged only over time and linked to an extended output or outcome.

Inevitably, this leads to a growing interest in outcome and performance based contracts. Yet according to the input to a current study, their use remains limited and contract professionals generally develop them through ‘trial and error’. There are also some important differences in perspective between the customer and supplier community. For example, suppliers have recognized the extent to which extended performance periods depend on active cooperation with their customer (and potentially their numerous sub-contractors); buyers seem slower to grasp or accept this point. Both buyers and suppliers appear slow to accept the organizational and operational implications of this enormous shift in the contracting model.

These are among the early, high-level conclusions from a survey IACCM is undertaking in partnership with Newcastle University Business School (UK) and the University of Paderborn (Germany). The research includes insights to the types of outcome based agreements most commonly used, the nature of the benefits and the challenges with their implementation and management. The overall output from this study will include not only the research results, but (over time) more detailed recommendations on different models for outcome and performance based contracts.

If you complete this survey, you will of course automatically receive a copy of the results and be invited to a webinar with the academics conducing the research. Please visit to participate.

Efficiency doesn’t end with contracts

Last week I was running a capability review with an IACCM member company. During a break, one of the attorneys said that he had been struck by the session we had just done on communications and told me a story about his former company.

He explained that this organization was a leader in its field and based its success on engineering excellence. Its technical and production teams were especially proud of the quality of their designs and their associated documentation.

However, like so many manufacturers, they faced market pressure to cut costs and therefore decided that manufacturing must move to low-cost facilities; they opened a plant in Mexico and transferred all their know-how via the manuals and instructions used in the US and Canadian facilities. Unfortunately, quality plummeted. Many were quick to blame Mexican workers – they were accused of being less skilled, having bad attitudes, being incapable of training. But someone in senior management was smart enough to understand that all that state-of-the-art documentation (of which the production engineers were so proud) was actually the problem. It was too difficult to understand – not only because it was in English, but also because it used words and was complex to follow.

Translation was not enough; the documents needed a re-think in both form and structure. They were re-designed to maximize use of graphics and to be visible at understand them. each phase of the production process, to the people who needed to understand them. Quality levels soared, soon surpassing those of the other plants.

The analogy to contracts is obvious. These increasingly complex documents contain a wide array of operational instructions, yet are rarely designed to make things simple or obvious. As a result, there is then either an expensive translation process, or quality of performance suffers.

Those engineers in my story were among the best professionals in the world, but if someone had not intervened to make their work comprehensible they might have destroyed their company. As contract and legal professionals, are we similarly putting our companies at risk?

So there are limits to IPR

Intellectual Property lies at the heart of many litigations. Negotiations over IP have boosted this topic into the top five negotiated terms and there is hardly a contract these days that does not include some sort of IP clause.

While most of us applaud the concept of IP rights and the ability of inventors and artists to gain rewards for their work, many are also concerned about the constraints this can impose on future invention and creativity, as well as the scope of what might be deemed ‘an invention’. Too often, patents and copyrights appear more as ‘get rich quick’ schemes or deliberate restraints of trade.

It may therefore come as a relief to learn that self-portraits by animals are not deemed registrable by the US Copyright Office. The latest draft of its Compendium’s third edition states that registration of “works produced by nature, animals or plants” shall be rejected, and only original works performed by human beings shall be registered.

The issue has arisen because a monkey stole a camera and proceeded to take multiple photographs, including a ‘selfie’. Some of these pictures were reproduced on the internet and went viral. Wikipedia was challenged by the camera owner, who claimed copyright.

Given the constant drive to reduce costs through labor arbitrage, this should act as a warning to anyone intending to use animals in the production of intellectual property.

The cost of failure

When business travel plans go awry, the impact is substantial. That’s according to research conducted by the Global Business Travel Association.

A delayed or cancelled flight, by far the most common issue, affects 87% of business travelers each year. And the impact is significant, causing lost hours. missed meetings, incremental costs to re-arrange … In fact, the survey suggests the average cost is $1457, plus missed work hours.

The reason I find this interesting is because disrupted travel is essentially similar to a disrupted contract. We thought we had a commitment, we planned on it being executed … and the commitment was not honored. Assessing the cost impact in this way is relatively rare. Also, as the survey points out, if travel managers understand the relative frequency of different types of disruption, they can better plan for them and reduce either the likelihood or the consequences that arise.

Essentially, this is just another example of the importance of contract managers assessing impact and monitoring overall frequency so that they can drive improvements for their business, both as a buyer and a seller.

Commercial competence

Tesco, a major retailer, becomes the latest in a growing line of private sector companies that appear unable to properly manage their contracts. In this case, there is a black hole of more than $400m from over-stated revenues, apparently stemming from commercial agreements with suppliers. Essentially, I presume, Tesco has counted forward revenue (rebates) and applied it in the wrong accounting period, in order to boost results.

The Chairman dismisses the incident with the words ‘Things are always unnoticed until they are noticed” – an obvious truism, but scarcely an effective response. Today, regulatory authorities, shareholders and society rightly expect more. In this era of automation and ‘big data’, top management should have better insights to what is going on, especially in the performance of contracts.

And it is in the area of contracts and external trading relationships that most of these commercial issues seem to occur. Whether it was the financial crisis, the repetitive issues over bribery and corruption, the scandals of overcharging or the inability to properly count revenue, weaknesses in overall contract oversight are a common theme.

No wonder, then, when we talk about the growing need for commercial competence, we see a direct link to the quality of contract management – both within individual deals and across the contract portfolio. But executive action in addressing weaknesses in contract management are woefully slow. Levels of automation lag well behind other functions. The role is still seen largely as administrative, rather than analytical. And until this changes, situations like that at Tesco are bound to be repeated.

Acquiring skills: first recognise what you need

According to Workforce magazine, “It’s easy to recognize a vacant position in your company, but it’s much harder to identify the skills a potential employee will need to fill that void. The inability to match qualified people to vacancies is costing companies billions of dollars in lost revenue.”

When it comes to contract and commercial management, this statement certainly appears true. We know that weaknesses in these areas are indeed costing billions of dollars a year. We know that the market for suitably qualified staff, already tight, has become almost impossible as demand levels grow. We know that the sources of new recruits are very limited – this is not a traditional career path and there is virtually no graduate-level recruitment or training.

There is every sign that demand for contracts and commercial staff will continue to grow at a rapid rate, especially now that Government and companies have awoken to the need for these skills to supplement (or in some cases absorb) traditional procurement activities. Unfortunately there is no quick fix that will suddenly generate large numbers of suitably experienced candidates. Therefore the point made in my opening sentence is crucial – the importance of ‘identifying the skills a potential employee will need’.

At IACCM, we have a well-established skills profile for people filling a contracts or commercial role. It is used as part of our professional certification program. But given the shortages of supply and the relative immaturity of defining the contracts / commercial job role, we know very well that organizations must be open-minded in their recruitment or development of contract and commercial staff. This means that they must be ready to use skills assessments as part of their recruitment process (several major corporations already use the IACCM skills profile). It is an approach that enables them to look beyond established practitioners and potentially identify people from other – often related – job roles who can successfully make the switch.

Some organizations consider that the best way to tackle their needs for improved contracting may not be through recruiting specialist contract / commercial managers, but instead by raising competence levels in other functions. Once again, the smart way to do this is by first assessing current skill levels, thereby identifying the people best suited to an enhanced role and also identifying major gaps in proficiency.

Either way, whether recruiting new staff or improving the capability of an existing workforce, it is essential to have clarity over the skills required and a robust method to assess and test the personnel who will ‘fill the void’.

The role and purpose of contract management

This week I have focused on the findings of the UK National Audit Office in its investigations on the state of contract and commercial management.

Few of its observations will come as a surprise to practitioners in this field. Indeed, it reflects many of their pent-up frustrations in the misalignment of contracting discipline with business value. The relegation of contract management to a subordinate and largely administrative / quasi-legal role has significant cost and revenue implications, as revealed by many IACCM research reports.

The NAO describes these issues in the following way:

Government fails to recognise the value of contract management. The purpose of contract management is to use commercial mechanisms to improve services and reduce costs. Too often contract management has been seen as delivering the deal that was agreed when the contract was signed. This has meant that contract management has been seen as a way to avoid things going wrong, rather than unlocking value.

Government needs to recognise that value is achieved over the life of the contract. This means designing policies it has the capability to deliver, planning for the contract management stage earlier, and paying it more attention.

Senior managers in central government departments have not taken contract management seriously. Central government has yet to adapt to the commissioning role it aspires to. Departments have not adapted governance to the expanding role of government contracting: they have lacked the basic infrastructure of oversight, senior engagement, challenge and scrutiny. Systems of governance have focused on approving new projects, as if government’s responsibility ends when the contract is signed.

Senior managers have not demanded visibility over their contracts. Senior managers have not always acted as if they recognised that departments are responsible and carry the risk for the services they have contracted. Managers have rarely demanded combined portfolio information to scrutinise and challenge operational contracts. Senior managers have often only engaged on contracting issues to firefight problems. As a result, they have put little pressure on teams to improve the information they rely on to manage the contract.”

The highlighting is mine. I challenge private sector organizations to demonstrate that these same weaknesses do not largely apply within their operations. The truth is that contract and commercial management are typically weak and often ignored as disciplines. As the National Audit Office points out, it is time to change.


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