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Rip Up Your Contracts: The Revolution Must Begin

September 10, 2009

Many trading relationships have become more complex in recent years. They are taking us into new and uncharted waters, yet the methods and equipment we are using for navigation remain firmly stuck in the past. As a result, a high proportion of those relationships prove disappointing and fail to realize their potential value. Neither side feels satisfied with the journey or its final destination.

The factors behind this complexity are varied. They include:

  • Globalization, which has caused many of us to establish relationships in unfamiliar territories, with different rules and values.
  • A shift towards solutions and services, which depend on better definition of requirements and capabilities to ensure that customer needs will be met.
  • The speed of change, which affects the selection process and on-going relationship management, as both parties struggle to deal with shifting requirements, new competitors, innovative technologies, altered regulations and social values etc.
  • Greater inter-dependency, as enterprises depend more and more on external partners to deliver core capabilities; for example, business process outsourcing shifts the entire focus of contracting onto achieving long-term (and often unknown) outcomes.

Given all these factors, we might expect that the process and structure for contracting and relationship management would be undergoing revolutionary change. Yet in general it is not. Organizational models to establish and oversee trading relationships remain unreformed; contract terms show only incremental shifts; internal rules and practices remain stubbornly tied to historic business values; performance incentives – internal and external – have remained stuck in the past.

There are some who say ‘the contract doesn’t matter’. But they are wrong. Complex relationships need agreed goals, agreed methods of governance, agreed rewards. And because they affect so many people, over such long periods of time, and rely upon coordinated action for their success, ensuring these agreements are documented and can be communicated coherently and consistently is critically important. Both sides must have a shared understanding of what they are trying to achieve, how they will achieve it and what they must do if things are not going according to plan. Anyone who believes they can achieve this in a long-term, high value relationship without discussion and recorded agreement is wrong.

It is therefore time for a great debate on fundamental change. We must engage in substantive discussion over how complex business relationships shoud be formed and managed. For example:

  • What are the criteria through which long term and high-value relationships should be evaluated? It is obvious that  input cost has little relevance; hopefully we do not select our long term partners on the basis of how cheap they are, or whether they superficially look good. So how do we make a better job of aligning culture and values and ensuring we really are likely to have a productive and collaborative relationship a year or two from now?
  • What is the right balance of obligations within a relationship? Spending our time arguing over the consequences when things go wrong hardly seems the best way to ensure mutual commitment to achieving sucess. Yet that is exactly where so much of the formal negotiation is focused. The dominant party (or both parties, if neither dominates) puts forward its (one-sided) proposals for the relatinship foundations and then the battle begins. This causes risks to be overlooked; it results in defensive behaviors and a lack of transparency and honesty which would prove damaging to any meaningful relationship. 
  • Who should be responsible for monitoring and ensuring performance? Today’s approach creates an environment in which neither side has any incentive to admit weaknesses or to accept accountability. Open discussion and timely escalation are rare. It does not have to be this way. Contract terms and improved tools and methods could be used to support much greater openness and visibility within each organization and between organizations. Contract terms could include incentives for honesty and early identification of risk, rather than incentives to point fingers and hide the facts.
  • What is the right governance framework? The framework must reflect the nature of the relationship and its desired outcome. Instead, in most cases, the relationship is force-fitted to standard and pre-approved contracting models which were designed for a different era and a different understanding of economic value.

Identifying what must change is not in itself hard. But achieving the change is made hard by the levels of resistance and the need for cross-functional and cross-organizational collaboration. We are in desperate need of champions who really care about business and economic performance.

Contracts are among the most conservative of instruments; the contracting process is overwhelmed by rules and restrictions that crush innovation and undermine collaboration. It is time for the revolutionaries to step forward!

  1. Tom Kauf permalink

    It seems to me that revolutions which are based on ripping things up rarely succeed, particularly when those leading the revolution have played a significant part in contributing to the issues that have fomented it in the first place.

    While it is true that “many trading relationships have become more complex in recent years”, it is disingenuous of those of us who work in commercial and contract management to blame that complexity primarily on external factors such as globalization, a shift to solutions and services, speed of change, and inter-dependency, rather than on the part we have played in enabling that complexity to make its way into our agreements. It’s generally not our business clients who drive that complexity (ever heard a CEO ask for us to make something more complex, to add more clauses or exhibits?) but rather our compulsion as contract and commercial managers and the lawyers who support us to cover all of our bases, to identify every contingency, and to create the “perfect” agreement which completely documents the intentions of the parties.

    Rather than labeling those who argue that “the contract doesn’t matter” as wrong or misguided, we might want to look more understandingly into why they hold that belief, and drive to mutually agree on what does matter if it’s not the contract. In my experience, many hold that belief because in their daily business life, the written contract doesn’t matter at all, because they are guided by more basic principles like fairness, simplicity and directness, and they don’t need a written contract to tell them how to be any of those things. If we can capture guiding principles, rules of the road, simple processes and transparency in the contractual document, maybe the contract will matter to all of us.

    Rather than a revolution, I’d suggest a path of evolution . Let’s articulate a position to our clients about what the desired state should be from our perspective, and engage in a healthy dialog about how our perception may miss the mark from their point of view.

    Let’s not take as givens things presented as facts when they are really conclusions based on anecdotal evidence – i.e “the methods and equipment we are using for navigation remain firmly stuck in the past” or “Organizational models to establish and oversee trading relationships remain unreformed” or “contract terms show only incremental shifts” or “internal rules and practices remain stubbornly tied to historic business values” or “performance incentives – internal and external – have remained stuck in the past”. Maybe these are all true for some places at some times, but there are numerous examples where businesses have shifted to a new paradigm and embraced a conscious effort to evolve their processes. As contract and commercial management professionals, let’s not try to address complexity by contributing to it ourselves. Rather than trying to define the rules of the game, and the questions to be asked for someone else to answer, let’s provide our view of the answers, and play the game as it is currently defined.

    Revolution is sexy and dramatic – evolution goes on forever and enables continual adaptation and improvement. tkk

  2. Tom,
    Thanks for this excellent contribution to my primary goal – which is to generate debate that leads to action! I agree with the desirability of evolution; but there comes a time when the opportunity to evolve is past and revolution becomes the answer. And yes, these are often led from within (I guess the Founding Fathers represent a good example, if you feel that the American Revolution was indeed revolutionary!).

    Nor do I suggest that the changes going on around us represent any form of excuse; my point is that in general the leaders in our community have not engaged sufficiently with each other or with the business to consider how change must occur.

    I must challenge your point about ‘anecdotes’. It is precisely this anecdotal approach that has constrained progress. It is the tendency to use specific examples to generate wider fear (of meaningful change) that is typical of a case or deal-based community. IACCM has changed that. We have built a global network that allows regular research and monitoring – for example, our annual ‘most negotiated terms’ study; our regular benchmarks of skills and process; our studies of the ‘most admired companies’.

    So this call to action is based on more than a simple opinion. It is based on a very real concern that the world has moved on and we are trailing some way behind. Either we take our product (the contract) and make it relevant to the new world; or we risk being cut off.

    Revolution or evolution – I don’t mind. But we do appear to agree on the need for change and that this should be led by debate. So now we need some leaders to join us on this mission.


  3. 1. Complexity in a contract can be a good thing, if it takes the form of a rich repository of experience in effective handling of various contingencies.

    2. Tim writes: Spending our time arguing over the consequences when things go wrong hardly seems the best way to ensure mutual commitment to achieving sucess. Yet that is exactly where so much of the formal negotiation is focused. The dominant party (or both parties, if neither dominates) puts forward its (one-sided) proposals for the relatinship foundations and then the battle begins.

    As Charlie Munger says, let’s look at the incentives:

    (A) Time is a scarce commodity, especially time for negotiation of “the legal stuff” as the shot clock runs out in the fiscal quarter;

    (B) Lawyers’ and contract professionals’ tend to be biased toward spending the available time on identifying and covering risks, in part because those risks could cause them future career problems — if a deal were to go sour over something that could/should have been covered in the contract, fingers would immediately start to be pointed at the lawyer;

    (C) Lawyers have little incentive to champion the kind of strategic thinking Tim proposes — when they do, their clients often hint that they should leave business thinking to the business people.

    And in any case, to adapt an old Navy saying, 10,000 attaboys from championing strategic thinking will be wiped out in the blink of an eye by one aw-sh_t arising from a problem that supposedly could have been prevented in the contract.

    (D) So it’s small wonder that lawyers and other contract professionals tend to spend their time trying to manage as many risks in the contract as they can, as opposed to championing strategic thinking.

    And an inexperienced lawyer — or even one who has experience in transactional work but has never tried cases — might well feel some nagging insecurity about his own judgment in assessing legal risks.

    3. For Tim’s excellent suggestions to have a chance, the risk-management aspects of contract negotiation are going to have to be commoditized, so as to free up time for what Tim is urging.

    What it’s going to take, I think, is for a broad consensus to evolve, over time, about what constitutes a “fair and balanced” way of handling various known risk contingencies (please don’t sue me Fox News).

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