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Carrots, Sticks & Contracts

April 12, 2012

In an excellent contribution, Ian Heptinstall commented on my recent blog ‘Getting the organization to care about contracts‘.

Ian observed that the blog “highlights one of our core dilemmas – that there is a strong view that you can’t have both carrot and stick in a business relationship”. He rightly goes on to question that view, while acknowledging “to give the naysayers their due, they have often had experience where so-called partnerships have failed and/or exploited the client”.

Thinking back through my own career, and the many stories we hear at IACCM, there is indeed truth to this comment about ‘exploitation’. In most cases, whether as individuals or businesses, I don’t think we enter into agreements with anything other than honest intent. At the time, we believe we can meet our commitments and we feel a sense of optimism about the outcome. In these circumstances, we feel offended if the other side pushes for onerous consequences for failure – it is seen as questioning our integrity or good faith. (Of course there are exceptions. As good skeptics, those of us who review Sales commitments may often question the quality or accuracy of the proposal being made and in that case, we may well be resisting liabilities for a very good reason. For the buyer, it is of course hard to know which scenario is driving our behavior).

But even if our intentions at the outset are entirely honorable, both as individuals and as organizations we have a tremendous ability to perceive ourselves as innocent and without fault. So when things go wrong, we are quite capable of telling ourselves that it was somehow the fault of the other side, or that mitigating factors mean we really should not be held to account. I think here of the case of a small software company that banked its future on a deal where an large technology provider was planning the software in a world-beating retail solution …. that unfortunately they never got around to marketing. Or the aerospace company that ordered a new engine to be developed, but then abandoned the new aircraft to which it was going to be fitted. Rather than compensate the manufacturer for the $ multi-million development work, they exercised a delay clause and never actually cancelled ….

Hence Ian is right that good contracts need carrots and they need sticks. Our memories are often imperfect and our moral standards are frequently subjective. But as good contracts or commercial experts, we should be able to build agreements that reflect the most appropriate carrots and sticks. For example, our options are quite different if this is a first time relationship, rather than a long-term strategic partnership. They are different if it is with someone committed to our industry, versus a new or bit-player. The reason for this is leverage. Long-term relationships with multiple sub-components are likely to cause both parties to operate with greater balance in their judgment because they have more to lose than just one deal. Similarly, a serious player within an industry is going to be conscious of the reputational damage that could occur in the event of default. So in those cases, the need for ‘sticks’ based on onerous liability clauses, indemnities and liquidated damages may be rather less.

On the other side, I believe that commercial experts need to become far more skilled at devising ‘carrots’ and in part that is about creating a strong relational frameworks in which both sides can feel secure and informed. To avoid making this blog too long, I will come back to that subject another time and outline a few thoughts on how those relational frameworks should be created.

  1. B.R.Srikanth permalink

    I am not too sure about the Stick- I work in the oil and gas industry – and delays are often the major challenge in most situations – and in most cases, the Client never accepts any blame or delay and simply offsets claims against LD and generously wiaves it off although in may instances, it is culpable. In most cases, they get away because of this “long term business relationship” issue – so, LDs are rarely levied, Clients very often delay during execution and Contractors take lightly the time scheudle as they think they need not spend extra money to complete as quickly as possible as they can get extensions

    • You are quite right in your observations – and of course these illustrate the point that so much of today’s focus in negotiations is a waste of time and a diversion from the real issues. Our efforts should be focused on the real performance issues and exploring effective ways to address them – for example, through a better balance of risk and reward, more transparent reporting, joint problem solving etc.

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