At times of uncertainty, the role of contracts in both protecting and delivering value becomes even more evident.
That is one clear result of Brexit, the unexpected decision by the UK to leave the European Union (EU). Law firms in particular have been quick to issue thoughts and guidance on the possible consequences for future trade and existing relationships. IACCM members have been anxiously seeking guidance on ‘which terms are impacted?’
Digging beneath the surface, the answer is itself mostly uncertain because there are many possibilities regarding what may happen. Volatile markets could move favorably or unfavorably; new trade treaties or revised regulatory environments may or may not emerge. And in reality, Brexit is just one example of a world where growing interdependence makes disruption and uncertainty both frequent and normal. In other words, good contracting now demands focus on how unexpected change and unpredictable events will be handled.
Many of the clauses that are impacted by volatile conditions are not new. Obvious examples are Force Majeure, payment and price adjustment terms, clauses relating to new or revised regulation, taxes or tariffs, rights of termination or renegotiation. But sophisticated negotiators are recognizing the growing importance of better structured governance provisions, bringing greater definition to the ‘rules’ under which the relationship will operate. David Frydlinger touches on this in his recent blog and IACCM highlighted similar points in a webinar that it ran just days after the Brexit vote.
Trading relationships – just like daily life – can never be free from risk. While some events are predictable, many are not. The longer the term of the contract, the more uncertain it becomes. Our best approach to dealing with that uncertainty is not to try to anticipate each possible eventuality, but rather to agree mutually acceptable procedures through which they will be discussed and equitably resolved.
Tania Seary of Procurious is the latest in a long line to suggest Procurement should be ‘at the top table’. Her article, Headed for the C-Suite, wisely suggests that a pre-requisite is to demonstrate relevance to business objectives and to do this through ‘ a new focus on key performance indicators’.
There can be little doubt about the importance of procurement and supply management activities in today’s business. As external spend increases, so does dependence on the quality and performance of suppliers. Ms. Seary rightly points to the value this can generate in terms of productivity, overall costs and potential innovation. Therefore, her suggestion to focus on areas such as these and measure Procurement’s impact is essentially a sound approach.
However, it seems to me that the problem for Procurement is that it is still only executing on other people’s ideas and strategies. Ultimately, no one needs Procurement if there are no customers. So to establish true strategic relevance it must visibly contribute to (and perhaps lead) product or commercial innovation. That would mean identifying new suppliers, new technologies, unique services that truly generate competitive advantage or open new markets.
Experience suggests that ‘the top table’ is where ideas are created, not where execution occurs. Of course the C-suite is interested in operational performance – and it pays great attention when it goes wrong – but those who undertake these roles are trusty lieutenants, not generals.
Should negotiations ever come down to price? Not according to INSEAD professor Horacio Falcao. In a thought-provoking article, Professor Falcao suggests that ‘a focus on price puts both sides at risk of leaving out other interests that are more important’.
I have sympathy with this view, which in large part reflects the eternal debate over price versus cost of ownership. There are certainly many examples where ‘cheap’ means also ‘low quality’ or ‘untrustworthy’, resulting in unexpected costs for the buyer. However, the article seems to be based on two assumptions that may themselves be questionable. First, it depends on detailed market or competitive knowledge. Second, it makes an assertion about supplier behaviour which, in my experience, is not entirely accurate.
Professor Falcao uses the procurement drive for ‘commoditization’ as the foundation for his ideas, on the basis that this is the philosophy that underlies intense price-based negotiation. He makes the point that there are always areas of value that go beyond the core product or service – for example reliability of supply or quality of service and support – and that these must be taken into account when agreeing a price. Clearly this is true. However, comparative competitive data may be difficult to find, so often a buyer tends to address such issues of performance through liquidated damages or service level credits. Arguably, a smart buyer will also embed rights of termination for consistent failures of performance. To the buyer, such terms represent a protection against the consequences of their price-based focus and do not represent a reason to agree a higher price.
So while these additional terms confirm that value is not based on price alone, it is often hard for a supplier with superior service to win a higher price.
The second hypothesis in the article relates to the way a supplier will behave if forced to accept a low price. Professor Falcao contends that this will result in degradation of service. Again, my experience on this is mixed. I have seen many instances where a focus on price actually has the opposite effect, with the supplier either:
a) working harder to show their value in the (often mistaken) belief that they will thereby earn supplier loyalty and potential for future higher prices or additional business; and / or
b) focusing on ways to improve efficiency and reduce their own cost base. Indeed, such price-based pressure is often the source of innovation.
It is indeed true that a smart buyer looks beyond price, but in many instances it is in fact the driver of value, not its enemy.
I want to share a question that appeared this week on the IACCM message board.
“Has anyone had any success in setting up and managing KPIs for Contracts Management. The intent would be to set internal KPIs for our contracts team. Since the ‘success’ of a contract (say a construction contract) is influenced by many factors outside of the Contracts Administrators control I don’t want to set up KPI’s on contract value/growth etc. Some obvious ones are timeline to execute contracts, timeline to review invoices, execute changes etc but they don’t really seem to add much ‘value’ – any thoughts?”
Censeo Consulting Group and the Public Spend Forum recently announced their findings on ‘the required skills of the public procurement workforce’. They discovered under-performance ‘in nearly 70% of identified competency areas’.
I am always a little skeptical about research reports from consultants. While they raise some great discussion points, there is this nagging feeling that the findings may be somewhat self-serving – essentially “Wow, we just discovered this massive problem – and it just so happens we have the services to overcome it”. And in this instance, the published data is actually close to the opposite of IACCM’s rather more extensive findings. Of course, that is not to say it is wrong, at least in the context of the 43 people interviewed, nor do I know what the objectives of the report’s authors may be. So let’s look at the broader questions that these findings raise.
Do skills and competencies matter? On this point, I think we would all be agreed that they do. And given the nature of today’s public services and their dependency on private sector suppliers, I presume there would be broad agreement that areas like negotiation, contracting and relationship management would be high on the list (though we might debate which of these is a skill versus a competency). It should be reassuring, then, that the Censeo research finds that the public sector workforce demonstrates competency in contracting and negotiation. However, anyone who has true competency in these fields may be rather shocked to learn that ‘proficiency decreased significantly for more complex skills, such as stakeholder engagement, risk analysis and problem-solving’.
I have never met a truly competent negotiator or contract manager who did not excel at stakeholder engagement, risk analysis and problem solving. These are fundamental attributes without which subsequent contract performance is almost doomed to fail. IACCM’s research into public sector skills actually shows advanced capability in problem solving and comparable competency to the private sector in risk analysis and stakeholder engagement. Where the public sector falls down is in negotiation (because they generally take the view that their contracts are non-negotiable) and contracting (because they tend to operate from templates which often reflect inappropriate forms of relationship and terms and conditions). And as we all know from the highly-publicized contract failures, contract management is an important area for public sector improvement (as a competency, rather than just a job role).
Today’s challenging business conditions certainly demand renewed focus on required skills and competencies, but pre-requisite is a coherent assessment of which skills and competencies are actually important to the future and then an objective appraisal of current gaps. Given the speed with which change is occurring, there are significant shortfalls in both public and private sector. Some of these will be addressed through training. Others may be filled by new organizational structures (redefining job roles, moving to more team-based structures) and some through automation. It is a demanding, yet exciting, time – and progress will be assisted if we focus on tangible and objective data and creative solutions to performance shortfalls.
IACCM undertakes regular capability assessments for its corporate members. We have data from hundreds of different organizations around the world, enabling individual results to be benchmarked against both global and industry standards.
Out of the nine areas that we test, one always stands out as a source of weakness – and that is the field of automation and knowledge management.
Given the focus by business and government on digitization, this is a serious weakness. It is certainly true that failure to invest in technology means that contract management remains highly inefficient and commercial policies and practices are too often based on instinct rather than facts.
However, on a positive note, the lack of past investment means that in general there are few embedded heritage systems, so for many, digitization is a green-field opportunity. This represents a real opportunity and a few leading companies (‘the dynamos’) are pushing ahead fast with transformation initiatives.
The possibilities are exciting because digital technologies revolutionize how we operate and the impacts we can have. There are four areas to consider:
- Operations and efficiency. This is largely about changing processes in ways that reduce cycle times and generate resource savings.
- Business model innovation. New commercial models are enabled by technology. There will also be impact from contract and negotiation analytics and understanding trends in required business capabilities.
- Technology innovation. Digital can reduce costs, change the nature and impact of risks and their management and enable simpler, more rapid integration across systems.
- Customer experience and engagement. Much deeper insight and understanding of purchasing methods and behaviors will create sources of competitive advantage through incremental value and ‘ease of doing business’.
It is essential to recognize that digitization is not a functional initiative; it transforms the approach to doing business. Since winning and awarding contracts lies at the heart of every business, the field of contracting and commercial management is a logical place to start. And that is exactly what happens during our capability workshops – the realization that the contracts and commercial function is transforming from a largely manual, operational role to a position of strategic leadership.