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Contracts & Innovation

March 1, 2011

Several of IACCM’s recent Ask The Expert interviews have focused on the subject of innovation.

This topic is relevant to contracts and commercial practices in two ways. One is the effect they have on the process of innovation – to what extent do they encourage or – more likely – discourage innovation from occurring? And second is the question of contract and commercial innovation in its own right; to what extent can new terms or approaches to contracting yield a competitive advantage?

On both counts, our experts consistently suggest that contract terms really do matter. They reinforce the growing swell of opinion that rigid and one-sided contracts stifle innovation and make an organization less attractive to do business with.  Given the fact that most innovation – probably around 95% – comes from external interactions, it appears fairly self-evident that there is a very high cost associated with inappropriate forms of contract.

What does this mean in practical terms? Over the last two years, I have offered many practical examples in this blog. Perhaps first and foremost, an organization must have a contracting strategy that aligns with its relationship strategy. Different relationships have different goals. Some – in fact a majority – may be for the sale or purchase of relatively mundane products or services where the ‘relational investment’ will be small or non-existent. Standard forms of contract are probably quite adequate to deal with those. It is as we go up the spectrum of potential value (for supplier, customer or both) that organizations must invest in developing a alternative contract terms and forms.

At its simplest, the more important a relationship becomes, the more the focus of the negotiation and contract content must change. The key terms shift from simple commitments to price, volume, delivery and the consequences of failure, and move instead to the commitment to resources, the nature and quality of interactions, the procedures for review and the management of change. And these terms become increasingly bilateral in their nature.

On the surface, this seems trivial and many will probably say ‘But we do that anyway; there is no need to put this stuff in the contract. It’s procedural.’  And they are right (it is procedural), but wrong (there is a need to put it in the contract, or at the very least to apply contractual discipline in its definition and maintenance).

It is these governance and relationship terms that create the framework for greater balance and trust. It is these shared responsibilities that alter the discussion over risk allocation. For example, if the parties must each contribute resources, the idea of a one-sided clause for liabilities or indemnities soon goes away. But the shift is more important than this. Far too often, today’s contracts are undermined by an underlying dishonesty in the bidding and selection process. As with all human mating rituals, there is a tendency to exaggerate capabilities and minimize possible problems or obstacles. Lawyers, Procurement and Contract staff are well aware of this – and it is one of the main reasons why they then play their particular dance over the allocation of risk.

The end-point of a negotiation is generally a signed contract. At this point, most customer organizations pass the agreement to the business unit or to a project team to oversee implementation. Performance management – to the extent it occurs – is usually a one-sided critique of the supplier’s effectiveness at meeting obligations.. This reflects a deep-seated view in the customer that it is the supplier’s job to ensure success, not theirs.  And the result of this is that there are no structured opportunities to learn, to improve or to innovate. The interfaces are generally at too low a level and the tone of the relationship is defensive, not creative.

That is the price we pay for failing to develop a contracting strategy and appropriate terms and conditions. If you would like to hear more on this topic and to gain from the experiences and approaches of the experts, there are four recent recordings that spring to mind. One is ‘Negotiating with the non-negotiator’; another is  with Todd Snelgrove, on the topic of price versus cost; then there is Kevin McFarthing on Open Innovation; and finally  Jesper Langemark on Agile Contracting.

Contracts can continue to be blunt instruments that are used primarily to defend the perceived interests of the more powerful party. Or they can truly become business assets that drive value through innovation. Surely it is the role of the contracts expert to explore and understand the difference; or must we wait until others force the change upon us?


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