Perspectives On Contracting Today
Yesterday I wrote about one topic discussed at a recent IACCM executive forum – the use of virtual communication techniques. Subsequently the meeting turned to some of today’s big challenges in structuring deals and forming productive trading relationships.
“Always insisting on competitive bidding and driving for the cheapest means that from day one suppliers have to watch costs. That means we lose the ability to give stuff away and build collaboration,” commented one participant. The group agreed that collaboration is the only way that new sources of value will be uncovered and that the focus of so many deals on lowest cost and risk avoidance condemns many contracts to disappointment or failure.
By way of contrast, the discussion moved to the UK’s Heathrow Terminal 5 project, hailed by many as a great success. Mark David decribed key aspects of that project and the role that ‘contracting culture ‘ played in its results. The contracting authority – BAA – decided to retain risk and not to appoint a prime contractor. It also formed an approach that guaranteed margins, encouraged and rewarded innovation, offered team bonuses and established a pool of money to protect contractors from errors and oversights. This created an environment of cross-organizational teaming and cooperation, because no one had the need to engage in protective behavior.
So why aren’t similar approaches more common? “Because organizations are driven by a Finance / Procurement partnership that is obsessed by short-term savings and a belief that competition is the only way to achieve them”, commented one seasoned Commercial Director. In his view, relationships and value are sacrificed for these short-term goals. He suggested that many executives recognize the problem – but take the view “You are right, but we have to make this quarter’s numbers”.
The contract tools, models and measurement systems in use at most companies have not adjusted to a service-based world. They simply cannot assess the cost of short-term wins over longer term value. Another aspect of this problem is the ability to build ‘commercial agility’ – that is, being able to adapt to fast-changing business conditions. “For us, the Commercial role is to enable agility within the internal ‘regulatory’ framework,” said a commercial director at a major defense and aerospace company. Participants confirmed that they – and their contracts – must increasingly be capable of applying discipline to what may happen in the future. Change is more frequent, driving many to seek shorter term contracts or increased termination rights.
In the end, the issue of short-termism was felt by all participants to be the biggest challenge of delivering more value and innovation in trading relationships. And although they felt that Procurement practices play a major role in this, they also blamed the overall compensation and reward systems that continue to prevail in most companies. Sales behavior is also driven by short-term gain, and the role of contracts / commercial groups must be to offer an objective view unclouded by commissions or theoretical savings – and to identify bad business, but also to advise management on what would make it good.
Commitment Matters 
Tim’s article visits an age old topic and the conclusion all valid. the issue however is one step removed. What is at the heart of the problem is buying functions making the transition from price focus to value focus in sourcing decisions and supplier management. Too often the acceptance of needing strategic supplier relationships translates to long term contracts and a form of ‘tree hugging’ between buyer and supplier. What seems to be missed is that unlocking value requires a focus on rigor and objectivity in the same way that a sourcing process does. However the skill set is subtlely different drawing far more on lean principles and diagnostics to understand root cause and areas of ineficiency and waste. Until buying functions recognise the need to differentiate skills and competencies between main stream leverage buying and long term value based relationships these issues are likely to perpetuate. The Planter.
Thanks for this comment. I agree that skills are very important here, but would suggest that management has failed to address the question of procurement role and measurement. It is unfair to blame people for doing what they are asked to do and measured on. I am sure that some exisitng staff would not make the transition to higher value; and of course many talented people leave the ranks of Procurement because they are frustrated by the narrowness of the role. You are absolutely right that high value demands a focus on root causes of failure or inefficiency. But these are not entirely down to the supplier; any real efffort to bring value should focus also on understanding those root causes may be within your own organisation, making it inefficient in doing business or in its use of suppllier’s product or service. Procurement’s real challenge is to become an agent of cost reduction from whatever source.
Often times involving Procurements’ internal client (ie,operations, marketing,etc) is helpful in offsetting their obsession with best price, delivery, etc. Some Procurement groups do not understand the need to support and evolve a technical product (such as software and complex systems) over the long term. In addition, many times they will trade-off functionality and cost of ownership for short term savings. The end customer has a large stake in those aspects of a contract award and terms.