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Contracts gain Nobel Prize – would yours qualify?

October 10, 2016

For those who say that contract management doesn’t really matter, the announcement of this year’s Nobel Prize for Economics must come as rather a shock. It has been awarded to Professors Oliver Hart and Bengt Holmstrom  for their work on contracts.

The press release observed: “Modern economies are held together by innumerable contracts….. As such relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions.”

It’s a good moment for reflection: would your contracts merit an award for being “properly designed to ensure that the parties take mutually beneficial decisions?”

The point in the press release about ‘conflict of interest’ is not new. It is fairly obvious that a supplier would like to make as much money as possible, with the least possible effort. That is not the perspective of a buyer, who wants a guarantee of performance at the lowest possible price. So reaching and then recording agreement has always been a key role of the contracting process, along with establishing some rules in case things go wrong or someone doesn’t do what they promised.

The thing that has changed is that contract performance is increasingly surrounded by uncertainty. The volatility of markets, the actions of competitors, the introduction of new technologies, the unpredictability of geopolitical conditions – there are so many factors that potentially disrupt or derail the original agreement, even when both parties are entirely honorable in their intentions. It is those factors that lead to another quote from the Nobel press release:

“Contracts are incomplete instruction manuals. They cannot specify what should be done in every case. Instead, they must stipulate how decisions should be made.”

In other words, the issues we confront when we form a contract are often unknown or unpredictable. Therefore an effective contract creates a set of ground rules or techniques through which such issues will be addressed. Most contracts today fail in this purpose because they are designed more to achieve legal certainty than to drive economic performance.

Over the years, IACCM’s research and training has been driven by a conviction that contracts are critical instruments in generating economic and social value. It draws from academic theories such as those developed by Professors Hart and Holmstrom to promote practical solutions, such as performance and outcome-based contracts, innovative contract design, identifying pitfalls and discovering the true value-add of professional contract management. Progress has been held back because business and governments have been slow to appreciate the importance of ensuring that contracts (and their management) are “properly designed to ensure that the parties take mutually beneficial decisions”.

Perhaps this Nobel award will assist in creating greater momentum for change. Certainly it should cause everyone involved in the process of creating and managing contracts to reflect. Are we adapting our contracts and contracting practices to the needs of today, or are we still following the traditions of the past? Do we see contracts as weapons, or as instruments that encourage mutually beneficial decisions?

 

It’s not too late to register for the 2016 IACCM Americas Conference, where we will celebrate the success and recognition of this Nobel Award and equip participants with the insights they need to turn theories into business reality.  Join us in San Diego and return to your business equipped as a leader of change.

 

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