An IACCM member wrote to me today to say “I am looking at contractual flexibility/agility and am keen to understand whether it is an area where the IACCM has undertaken much research? Customers increasingly (push for) long term partnering, combined with the ability to (make fundamental changes) at short notice. If there is any research in this area I would be keen to understand more”.
There is no question that this has become an important issue in many negotiations. In part because of experiences in the recession, and in part due to the overall increase in the speed of change, more and more companies want to have their cake and eat it; they want the benefits that come with committed relationships, but they want the flexibility associated with more casual encounters.
Clearly, suppliers who can offer greater flexibility will be at an advantage. Yet since most successful relationships require investment, how can this be offered without damaging profitability?
On one level, the question is of course simply a risk assessment. In reality, how much flexibility will customers actually require? And taken across a portfolio of customers, might the gain in competitiveness (and hence customers retained or won) outweigh the costs associated with greater flexibility?
At another level, while many sectors are experiencing growing pressure for more flexibility in contracts, the precise sources of pressure vary and that means the specific terms under pressure are also variable. Among the most frequent that I am observing are:
- IP rights
- Termination
- Revision of services
- Revision of service levels
- Options for additional services
- Volume adjustments
- Right to deal direct with sub-contractors
- Price renegotiation and benchmarking
- Delivery / shipment
- Delay / suspension
- Contract review
- Escalation procedures
Approaches that I am observing to handle this uncertain environment include the creation of shorter and more specific contracts; the use of milestones to trigger formal contract review / renegotiation; the use of ‘buy out’ clauses to enable investment recovery in the event of reductions or termination; and more specific understandings regarding IP rights, the management of confidential information and the exploitation of innovation etc.
There is a big dividing line between contracts for commodities, where buyers want to have flexibility on volumes, shipping, market pricing etc., versus higher value relationships where the goals may be directed more at innovation or collaboration over time, yet need to similarly recognize either that market conditions may change, or business goals may alter. Another factor influencing this is the relative size and power of the firms involved.
IACCM will most likely conduct some more formal research in this important area and is already interviewing a few major corporations about their experiences, but in the meantime it would be great to hear your thoughts and experiences.
There are, of course, many reasons why business relationships fail. And failure is itself relative. For example, if measured in terms of those that end up in court, the proportion is very low. It is more that the percentage where satisfaction is very high is also quite low – meaning that the majority are sandwiched somewhere in the middle – with emotions ranging from mild disappointment to outright frustration.
Proportionally, services relationships tend to have higher levels of disappointment than those covering products. In part that is because services may be harder to define and measure; they ae also more subject to human interventions and therefore error rates tend to be higher. But during my years at IACCM, there are several characteristics which I have noticed frequently causing problems.
- Service users are often remote from the process that defines requirements and drives supplier selection. Indeed, Procurement processes often create deliberate barriers between potential providers and the user community because they fear the ways in which this might compromise the selection process. This places a tremendous burden on Procurement to undertake effective analysis – and when they fail to do so, or overrisde the results for cost reasons or because it does not fit with their preferred sourcing methods, the supplier often bears the brunt of user dissatisfaction.
- Too many suppliers and customers display a fundamental lack of trust. Staff groups in particular make assumptions about the other side’s motives or behavior and make few attempts to validate them. These often lead to actions that are adversarial or dishonest and result in each side seeking to gain advantage over the other – for example, through exploiting change procedures or the use of liquidated damages clauses.
- Some organizations have a culture that simply does not lend itself to healthy external relationships – and their trading partners either fail to recognize these attributes or decide to ignore them. The key warning sign is when there is internal contention and evident antipathy between departments or functions; if they cannot collaborate with each other, they will certainly not be able to work consistently or cooperatively with their external partners.
- A failure to appreciate the impact that operational rules or metrics will have on the relationship. Public procurement rules are one obvious example; sales incentives are another. Trading partners need to explore and assess the effect that such issues will have on the competitive framework, the ability to have open discussion, the extent to which disclosure or behavior may be compromised. It is surprising how rarely bid, negotiation or implementation teams ask the other side to explain their operating rules or measurement systems in detail and use these in their bid / no bid decisions.
- Building on issue #3, organizations should be more honest about whether there is good cultural fit between them. This isn’t a case of right or wrong – it is just the need to admit that successful long term service relationships require an empathy and concern for each other that will not be achieved if there is a cultural mismatch.
- There is frequent failure by one or other party to allocate resourcves (or the right resources) to on-going oversight and performance. This is particularly true of client organizations. Even if the contract has good governance procedures (which they often do not), there is frequently a failure to use the mechansims it established, to hold reviews, to allocate accountable / empowered contract owners to address problems, dicuss improvements. Contract administration is NOT contract management!
- There are many pressures on supplier teams to close the deal and avoid ‘unselling’. Too often, sales organizations are reluctant to avoid the right people, or involve them at the right time, or to enable open discussion of value-add possibulities, because they fear it may delay sign-up or could create bigger questions that would derail the deal – even if the result is actually a bigger deal. So getting a deal is better than getting the right deal.
This list is certainly not exhaustive, but it reflects some common problems that should be on any deal-makers shortlist of things to consider and explore.
What would you add?
Jason Busch produced a timely article last Friday, acknowledging the importance of proficiency in contract management both in reducing cycle times and in realizing expected benefits.
His comments were timely, because just the day before I had interviewed Lee Coulter, former Senior Vice President of Operations at Kraft. In this role, Lee was the executive responsible for many of Kraft’s outsourcing and managed services initiatives – and he formed strong views about the need for greater focus on contract management skills.
“In most complex services engagements, there is lots of conversation on what can be done and the value that can be achieved,” observed lee. “But the contract often fails to capture this.”
“You can liken the range of business relationships to human relationships,” he commented. “We may be looking for a something casual, something that is convenient for the moment. Or maybe we want something that is closer to serial dating. And sometimes we need a real business partnership.” In Lee’s experience – echoing so many others – Procurement is very good at establishing ‘the pick-up’, a transactional relationship with no real commitment. It is generally equipped to manage serial dating. But it is lost when it comes to a long-tem, high value relationship.
Jason Busch similarly observes the need for much greater sophistication in the contracting process. Like Lee Coulter, his article implies that providers are actually much better at this than most of their customers – and are frequently frustrated by the traditional approaches followed by many customer Procurement and Legal functions.
“This is a real leadership challenge,” said Lee. “It is hard keeping organizations aligned”. And in his experience, far too many procurement and legal staff are inclined to find probelms and reasons why things cannot work, rather than exploring new directions. This, of course, is why it is often tempting to exclude the ‘contracts’ people until late in the process; and this, in turn, leads to delays and risk-averse behavior.
At Kraft, Lee did his best to drive inclusive teams and to create excitement around innovation. But success depended on radical new approaches to the contracting process and the roles and measurements of those who worked within it. The full interview, in which Lee Coulter explains his approach, is available in the IACCM library. Lee will also be a presenter at the next IACCM conference.
For many of us, if we think about the law at all, we associate it with principles of equity, fairness and predictability. It offers a foundation for social interaction at both individual and organizational level. The rule of law – and hence respect for the law – is fundamental to social integration.
Yet in reality, the law has also favored and been the tool of those with power. Lawmakers (typically drawn from, or representing, the powerrful) have often created rules that reflect or protect their interests, at both national and international level. Shifts in power are typically accompanied by changes in the law – and it has often been the case that attempts by ‘the old regime’ to use laws as a means of enforcing compliance have resulted in rebellion or revolt. There comes a point at which laws must have some level of social acceptance for them to work. And in addition, people must feel that there is broad equality of access to the law, that the possibility of recourse is real.
Contracts – as in some respects an extension of the law – follow similar principles. Most of us would agree that they should deliver clarity to relationships and the responsibilities of the parties, and predictability to the consequences of specific actions or inactions. Many of us would hope that they also represent principles of equity and fairness, in order to bind the parties together as willing partners, rather than some form of master / slave relationship. And it is here, of course, that contracts are coming under growing pressure, because far too often they are being used as instruments of power. Dominant companies and dominant cultures frequently impose terms and conditions that are clearly self-interested (and reject those that they did not invent, do not understand, or feel may shift the balance of power – for example, UNCISG). Emerging nations flex their muscles by acting selectively in their attitudes to contract terms, justifying their actions because they see these as unfair and reflecting power imbalances – for example, the readiness of some countries simply to override contractual rights (think Venezuela, Russia), or to turn a blind eye to areas such as breaches of intellectual property rights. These attitudes are compounded by a very real inequality of access, driven by the costs associated with litigation. There is no question that in most societies today, the law favors those with money and power.
Establishing greater balance is important not only because it is morally right, but also because the interests of both parties to a contract must be respected if the system itself is to survive and trade is to flourish. Just as the law has to adpat to changing social, political and economic realities, so must contracting. That is why debates over issues like the purpose of contracts is important. Those discussions must also extend to cover other topics, for example:
- contract standards (is it right that individual big corporations can dictate terms and conditions, or should there be industry standard frameworks, with freedom to negotiate certain principles?)
- access to the law (is it right that lawyers remain dominant in the contracting process, with the implications this has to cost, understanding and special interests?)
- principles of dispute resolution (already we see a trend to move away from the courts. How far should this go and what alternatives should be established to ensure that the system is not simply hijacked by other – or even exisiting – special interest groups?)
Today’s system of contracting is not yet broken, but it is clear (to me at least) that it is in relatively urgent need of reform. At present, aspects of that reform are occurring, but in a relatively unplanned and piece-meal fashion. We have entered an era where the ability of individuals and companies to engage in trade across jurisdictional boundaries is demanding a contracting system that supports clarity and ensures equity, fairness and predictability. For many engaged with the law, this is threatening – it challenges their core knowledge, their sources of income, their instincts to protect familiar institutions. At times, it may also involve questioning the perceived interests of their masters (the large corporations, the politically powerful and wealthy). Yet at some point change will occur – surely it is better that this is through consesnus and planned debate, rather than a result of suppressed frustration?
I am excited that these debates are beginning. I hope many more will become involved and put their weight behind the development of new contracting principles and methods that support a code of trading standards and practices fit for the 21st century.
In the old world, it seemed that most people could get by just by doing their appointed job. Indeed, in many organizations, those who pushed at the boundaries of their appointed task by proposing improvements in areas outside their immediate job role were seen as ‘trouble-makers’.
Today, it seems that working hard and efficiently is no longer enough. The big question is “What value have you added?” In other words, we are expected to contribute to the wider development of business process, practice or offerings through our ideas and insights, through our readiness ‘to go the extra mile’.
In order to do this, we have to spend time understanding the perspectives and motivators of the different stakeholders involved in our process area. In the case of internal executives or users, that most likely means responding to their needs. In the case of other internal functions or external providers, it may mean managing their behaviors to ensure they do not prevent or damage desired outcomes. This cannot be achieved without effective communication – both listening and sharing information.
In itself, this does not sound especially difficult to achieve. But the irony of our information age is that it has made communication more important, yet at the same time made it more challenging. There are four major factors that I observe many professionals struggling to manage:
- The volume of information is often overwhelming. It is increasingly hard to determine which communications really matter, so it becomes tempting to ignore all of them, or to enter a state of inertia and just do things as we always did them.
- The methods of communication are alien and hard to manage. Most of today’s senior professionals were raised in an era of physical communication. The extent of those communications and the rules under which they were conducted were widely understood. The networked world has disrupted those patterns and we do not really know how to operate. For example, who has been on a training program on virtual negotiation?
- The audiences with which we communicate are increasingly diverse. This means we are often unfamiliar with their values or perspectives, their cultural practices or norms. In such environments, the opportunities for miscommunication or misunderstanding are manifest.
- Finally, we face the challenge of time. Today’s pressures on doing everything faster often conflict with the need for more inclusive (or carefully considered) communications and behavior. Communication and time are often seen as directly opposed to each other – and hence we must continually compromise. This pressure for immediate answers also threatens good judgment – we are often forced to respond faster than we would like and left later to regret how we replied.
In combination, these factors mean that the opportunities for misunderstanding have perhaps become greater than ever. We are in a world where there is far more communication, but of much lower quality. Broadcasting to a wide audience is not the same as communicating – and often leaves us struggling to recover from the perceptions or reactions that were created. Similarly, we struggle to know which groups or networks to join, which sources will provide new ideas and opportunities to learn.
For a community involved in establishing and performing against business commitments, the ability to coordinate across varied perspectives and reconcile differences is fundamental to our success. Our readiness to share learning and experiences and to be open to the knowledge and ideas of others is also fundamental to our personal and organizational progress. These are tasks we simply cannot perform without good communication skills. That is why we must re-learn how to undertake effective communications in today’s networked world. It is not optional; it is a dependency for answering that fundamental question: “What value have you added?”
The Economist recently ran an article highlighting ‘the failings of Japanese corporate governance’. It suggested a need for more independent boards and for an ending to the heirarchical systems that prevent senior management learning the truth. The article calls for more external (ie non-Japanese) recruitment as one way to ensure change.
The concluding paragraph goes on to make a wider observation: “Many large Japanese companies are now responding to Toyota’s troubles by re-examining such matters as their use of outsourcing to drive down costs, their dependence on external suppliers (most of the accelerator pedals were supplied by an independent American partsmaker) and their relationships with non-Japanese firms. But they might want to use the incident to reconsider their own internal workings, too.”
As observed in previous blogs, Toyota was frequently ready to learn from the outside world – and indeed, its adoption of procurement practices more typical of Western companies was seen by some as contributing to its recent problems. By introducing more aggressive, cost-focused approaches to its supplier management, the loyalty and partnering implicit to ‘the Toyota way’ has been jeopardized.
At the same time, my sources suggest that contracting and contract management are not generally understood within Toyota or other large Japanese corporations. There is no centralized process or skill group, so post-award supplier management remains relatively fragmented. My suspicion is that this has resulted in increasing confusion and inconsistency. As The Economist points out, companies must become more sophisticated in the way they structure and manage trading relationships, especially now that so many of them cross traditional geographic and cultural boundaries. And that sophistication simply will not occur if contracting remains a fragmented, tactical activity with little or no management attention and starved of investment for the right systems and resources.
There is widespread agreement that collaborative relationships deliver superior results, so long as they remain focused on mutual value. But the role of contracts in enabling collaboration is less clear; indeed, there are many who believe that there is no real connection.
Some collaborative relationships emerge without a formal contract; and there are instances where collaboration develops even after a confrontational negotiation. But the evidence suggests that contracting strategy plays a large part in determining the nature of the subsequent relationship.
Last week, members of the IACCM Board of Directors were joined by executives from other major corporations to discuss collaborative contracting. There was general agreement that adversarial negotiaion and unbalanced risk allocations damage the potential for collaboration and that this, in turn, undermines innovation and realising value. It was also agreed that good contracts are those which introduce effective governance and performance management techniques. In view of this, the session sought to understand why organizations cannot make the transition to more collaborative contracting structures and procedures.
The discussion identified a wide range of barriers, ranging from ingrained attitudes to reward systems and distorted risk assessment. But it moved on to explore ways that the barriers might be overcome – and to establish an agenda for future IACCM initiatives. This included the development of a guide for collaborative contracting; continued focus on drafting balanced contract principles; and providing top executives with the data needed to understand the cost of today’s contracting practices.
This was the first of a series of IACCM ‘thought leadership’ workshops that will result in more detailed reports and action plans related to contracting and relationship management.
Global trade fell by 14.4% in 2009, based on World Bank statistics. According to the International Monetary Fund, export volumes showed some recovery over 2008, but most of this was in the third quarter (up 3.5%) and appears to have been driven largely by re-stocking.
Economies are growing at different rates and in different ways. That means trading patterns are changing – and that the contracts and commercial professional must adjust to a world that requires far more agility. We must be ready to grasp new market opportunities, to enter new territories, to manage change and deal with new sources of risk.
IACCM‘s October 2009 quarterly survey on The State of Global Markets reflected the growth in Q3, when a majority reported stabilization and increased optimism for trading conditions in Q4. The January 2010 report indicated that there was growth for most – but not all – and also revealed variations by world region and industry. It showed a decline in the level of price-focused renegotiation of contracts, but also revealed that cost cutting remains Procurement’s number one priority.
Looking forward, the IMF is predicting that the world economy will grow 3.9% this year . although for ‘rich’ countries this will be only 2.1%. All reports reflect this buoyancy in developing markets, especially in Asia -Pacific, but spreading into Eastern Europe and South Africa. China and India are of course today’s big drivers of growth.
This shift of trading strength and growth has several implications for the world of contracting and procurement. For example, it is likely to favor consumer good producers; it is likely to sustain commodity prices; and it is likely that the dollar will remain strong against the Euro.
Copies of the latest IACCM Global Trade Survey can be obtained from info@iaccm.com
At the most recent IACCM member meeting in London, one of the presentations led to a discussion on ‘commercial agility’.
The meeting focused on the interesting dichotemy that has emerged in the executive approach to risk management. Research has shown that many businesses believe they have become more cautious in their approach to risk – hardly surprising, given economic and governance conditions. Yet in reality, the need to respond to the dramatic impacts of the recession have actually led to a significant increase in risk-taking.
When looking at all the sources of increased risk (more outsourcing, greater readiness to accept high risk terms in order to win business, rapid expansion to new markets, drastic supply chain decisions), attendees observed that the recession had accelerated a trend, rather than leading to major new sources of risk. It is actually the hastiness of many decisions – often without ‘due diligence’ with regard to possible consequences – that is the real threat.
Adrian Furner, Commercial Director at BAE Systems, suggested that this is perhaps the ‘new normal’ and that contracts and commercial groups must adapt. “Traditionally, commercial management has been about certainty. How will we change to fit with a constantly changing world?”
Adrian provided dramatic illustrations, ranging from the challenges of new markets to amazing reductions in cycle times – for example, products that used to take up to 20 years in design and test now going through the same process in a year or less. He suggested that our role must increasingly be to manage commercial agility and highlighted six implications:
- contract and commercial frameworks must be designed to manage ambiguity
- organizations must enable flexibility
- the terms governing relationships must also support flexibility – for example, anticipate switching
- commercial resources must assess and become comfortable with managing risks in new ways – for example, across portfolios, rather than individual deals; through collective acceptance and management of risk across integrated supply chains
- encourage diversity and best practice
- balance passion (to win) with objectivity
A key question for any commercial professional, he suggested, is ‘are you associated with the accelerator or the brake?’
Recent IACCM research identified an interesting syndrome in negotiation effectiveness. It highlighted the contrast in where negotiators spend their time and the impact this has on results.
One group of negotiators operates in companies where the rules and standards are relatively well defined and understood. This group spends most of its time communicating with team members and the other side. Much of its time is either explaining the reasons and value behind positions, or evaluating and proposing variations from a mostly pre-defined set of capabilities.
The other group of negotiators comes from companies that like to believe they are either a) flexible or b) good at managing risk. These companies see negotiation as an individual art, rather than an organizational capability. Interestingly, the result is that more than 80% of the time spent by these individuals on negotiation is internal to the company. They are in fact trying to negotiate exceptions or understand capabilities.
The impact on the other side is significant. Negotiators from the first group are providing insights and information that enables the team on the other side to evaluate and commmunicate effectively. Negotiation cycle times tend to be shorter and the negotiation environment is more collaborative and open. Negotiators from the second group send confusing messages. There are often long gaps in communication and proposals are often unclear. This results in a lack of confidence and a sense of alienation.
The moral of this story is that companies which believe that negotiation talent is the answer to their business success are wrong. Of course negotiators should be trained; but those who are successful have clear understanding of the boundaries and the reasons for those boundaries. Their talent is having the judgment to understand the implications of ‘deviation’ and the ability to negotiate trade-offs, rather than compromises. Negotiation is not a substitute for business discipline; in fact, it can flourish only when there is underlying discipline.
Commitment Matters 