What is a contract?
It may seem amazing to ask, but what is it that constitutes a contract? More specifically, how would the average person in business answer this question?
Every day, there are millions of transactions around the world, each covered by some form of contract, but often no clear view of the elements that formally constitute part of the binding agreement. I have even heard a lawyer say “Oh, you mean the scope of work …. I was talking about the contract”.
Or take this example, which comes from one of the world’s biggest business software companies, which claims to cover the contracting process: “Typically contracts are focused on language and wording. Although there is negotiation on some terms, the primary focus of contract negotiation is to finalize the wording. In Sourcing, the primary focus is to get agreement on pricing, terms, and what is being sourced.”
I understand there are different sections of ‘the contract’, but ultimately it needs to operate as a coherent basis for performance. The driver for establishing an agreement is economic, because there is a belief that mutual value can be achieved. A contract defines that value, it sets the terms under which it is to be delivered, the responsibilities the parties have to each other and the consequences if they fail. Negotiation may or may not be needed – but shared understanding and commitments are essential. That is about far more than ‘finalizing the wording’.
Today’s confusion creates a wide range of problems – many of which are outlined in IACCM’s ‘ten pitfalls’ and analysis of the cost of poor contracting. It leads to absence of understanding, late engagement of commercial resources, a focus on risk transfer rather than risk management …. the list goes on.
Contracts are a reflection of business intent and capability. In my experience, organizations that place little value on contracts are often among those that experience low growth and margin, quite simply because they lack internal discipline and cooperation. While this may have limited impact in the world of commodities and catalog buying, it spells potential disaster for more significant acquisitions.