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Managing Risk: Contracts & Product Development

July 2, 2009

A recent article in the Financial Times has highlighted one of my favorite topics – the fact that ‘few managers take risk into account in creating new offerings’. An Ernst & Young report has highlighted that risk is frequently ignored during product development (I would add to that the fact that it is also mostly ignored throughout the product lifecyle managment process as well). 

Of course not all risks are overlooked. But as I speak and work with companies worldwide, I continue to be struck by the absence of structured commercial discipline in bringing products or services to market. In particular, there are very few organizations which ensure careful integration of the product or service with the contract or ‘market promise’. As a result, the terms and conditions sought from suppliers also frequently fail to meet on-going needs, leading either to the inability to make customer commitments, or forcing renegotiation of agreements (often having lost negotiation power).

As we teach in the IACCM ‘body of knowledge’, top performing companies seek to build quality into all their activities – whether manufacturing a product or delivering against a commitment. To win in the market, products and services need to be clothed with terms and conditions that are distinctive (or at least competitive), that reflect policies and practices that are deemed fair and that it consistently honors. Yet remarkably few companies really research what terms and conditions are offered by their competition or would be of value to their customers. Many times products or services are brought to market and retro-fitted with a set of company standards, regardless of whether they make good business sense in the target market. 

As a result, market requirements are often either ignored (with what financial consequences, no one really knows), or they are addressed through situational negotiation (again, at what cost in both physical terms and in terms of the risk of non-compliance, no one knows).

The contract and commercial evaluation process should involve a rigorous examination of competitive terms and conditions. It should also be accompanied by market research that would identify customer values. Some of this is usually done – for instance, the nature of warranties (duration, level of coverage, service delivery). But many things are not considered in depth. For example, what value might different market segments place on right of return or trial offerings – and how risky would that be? What value might they place on differential payment terms and how would those be managed? What differences might there be in the strategic importance of the product or service to their business and what might this mean in terms of performance guarantees and their relative value? How might such factors affect the need for maintenance services, or perhaps even spawn an alternative offering? How might product or service updates be handled? What flexibility could be offered over the ability to upgrade or downgrade service levels or volume requirements? How sensitive is delivery and are there ways it could be made more flexible?

All these factors and many more represent items of possible value to customers. But those values are not equal. They represent a source of market segmentation that is rarely used – with the resuylt that we find ourselves either excluded from particular opportunities, or forced into high levels of negotiation. By failing to understand and price these risks and opportunities, we have no idea what revenue is being lost (through missed opportunity or sub-optimal pricing) – or what losses are being incurred (through commitments that are costly to perform).

In my experience, many companies view product development and their commercial market offering as two distinct activities. Their failure to use contracts as a pre-formed and readily available checklist to ensure alignment with selected markets forces them instead to manage risk of product or service failure through terms and conditions that are by their nature inappropriate and risk averse.

As a result, opportunities for market share and revenue are missed; business efficiency is undermined; and companies simply make themselves far too complex to do business with. Building in quality through market alignment is by far the best way to manage risk – and it can be done with less resources and far less pain than today’s fragmented approach to the management of market risk.  Simply stop viewing contracts as an operational fall-back for poorly managed risks and start using them instead as a strategic quality control instrument that reduces the probability of the risk occuring.

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