For years, Western (democratic) nations argued that collaboration with autocracies and dictatorships would lead to greater distribution of wealth and growing internal pressures for democratic systems.
In reality, the results appear rather more variable. For example, the collapse of Communism has led in many cases to the growth of corruption and an unaccountable elite. The early hopes of democratic reform in countries such as Russia and the Ukraine have been stifled by the emergence of strong leaders who appear selective in their application of the law. Now we see similar turmoil in the Middle East, causing us to question many of the political assumptions that were made regarding the path of progress in the region.
An editorial in The Jordan Times by former Jordanian Foreign Minister Marwan Muasher(now a senior fellow at Yale University) addresses some of the myths and realities exposed by the current unrest. Of particular interest for those in the commercial world is his observation regarding economic liberalization. Mr Muashar says that Western governments (and large international corporations) convinced themselves that ‘economic liberalization should precede political reforms’. This was perhaps a convenient excuse for doing business with unpleasant and repressive regimes; we could convince ourselves that this was morally justified since it would. over time, lead to greater distribution of wealth and thence to growing freedom for the people. Co-incidentally, it also served the short-term exconomic interests of those governments and corporations.
But in reality, says Mr Muashar, the benefits of privatization, economic reform and increased international trade went largely to ‘political and business elites’ because it occurred in an environment where there was no system of checks and balances. As a result, the Arab people ‘have come to view liberalization and globalization negatively’. The article suggests that to be successful and sustainable, economic reform must be accompanied by the creation of institutional mechanisms of accountability. The real sources of public anger are not high prices or unemployment, but rather they are driven by a sense of inadequate governance and fundamental unfairness.
This suggests that governments and international corporations from outside the region face a challenge of building trust with local populations. But they also face a period of sustained uncertainty, because the implosion created by popular unrest has revealed the lack of established institutions for improved governance and hence it is hard to predict what systems may emerge. In some respects, making investments at a time of such uncertainty will be risky, but failing to make them is probably even riskier. We must show the positive aspects of economic liberalism and globalization or otherwise face the prospect of a potentially hostile and alienated world region.
The New York Times carries an interesting article on the subject of transparency. It highlights the extent to which data availability is putting new levels of control into the hands of buyers and consumers, in particular through the growth of computer applications. Examples include the ability to monitor the arrival of buses or trains, the chance to check product performance and – of course – the potential to monitor prices.
The article makes the point that not everyone welcomes this transparency. Airlines in particular appear to hate the idea that anyone might be able to understand or compare their charging practices. But they must surely be standing in the way of progress.
However, are they alone in this skepticism? On one level, business has jumped at the opportunities created by today’s technologies. They monitor markets, they create demand-based pricing models, they welcome web-based selling and procurement programs. Yet they have been reluctant to grasp the opportunities that could flow from more extensive and rapid exchanges of information between buyers and sellers – for example, shared performance management systems, proactive visibility of risk, on-demand financial information.
Over the last 20 years, there has been massive investment in Enterprise Resource Planning (ERP) systems which were focused on internal efficiencies. In some ways, these made relationships between businesses harder to manage. I believe the next 20 years will be dominated by systems that facilitate the management of business interconnections – first among them an increased level of transparency and the enabling of new levels of customization.
Many companies will doubtless be hesitant about these changes, yet they are fundamental to the growth of trust and to the strength of corporate reputation. This is especially significant in the supplier selection process, during negotiation and in post-award contract and relationship management.
In a global market, these attributes of trust and reputation will be critical to success – so it is time to start thinking about transparency, in particular as part of the contracting process.
Another of the major themes from the IACCM Americas conference was the challenge of uncertainty.
Many presentations touched on this topic and the demands it is placing on contracts and legal practitioners. In my opening presentation, I suggested that ‘the management of uncertainty’ is a key role for the contracting process, demanding a new and more flexible approach to contract terms and structures. This is reflected in the growing emphasis that negotiators place on change management, communications and other post-award governance principles. It also helps account for the lack of clarity over scope and goals (because these also become uncertain).
Dalip Raheja, CEO of the MPower Group, focused on the impact uncertainty has on skill requirements. For communities accustomed to dealing with relatively precise requirements and standards, the need for increased flexibility and more agile responses to rapidly changing conditions are challenging. They require much greater focus on collecting and analyzing business and market information. Dalip suggested that traditional strategic sourcing ‘is dead’, because organizations must discover more sustainable ways of achieving value. This will be through more balanced selection criteria, resulting in greater collaboration between trading partners so that they can drive greater innovation, and also adjust more readily when faced by uncertainty.
Tim Minahan, head of Marketing at Ariba, presented the results of a joint IACCM / Ariba study on the current state of sales contracting. These also reflect the growing challenge of managing customer requirements. The growth of uncertainty has made it increasingly difficult to define and manage contract scope and the research confirmed that companies with contract management software are coping much better than those without. Cycle times, communication and cooperation are all beneficiaries of automation.
Dan Mahlebashian, Chief Contracting Officer at General Motors, reflected on the challenges that GM confronted over the last 2 years and explained how the approach to procurement and supplier management has changed. He discussed the importance of increased collaboration as a way to handle unpredictable markets and ensure innovation. Achieving collaboration has required GM to rethink its approach to contracting – and in particular, to ensure a greater connection between front-end negotiation and post-award contract and relationship management.
Overall, the message was that uncertainty and change appear to be here to stay. They have made contracting far more important, both to ensure a common baseline and to enable the management of change. Organizations therefore need to invest in the tools, processes and skills for contract management – and existing practitioners must adjust their approach and focus on learning new ways.
Supply & Demand Chain this week carries a useful article on transfer pricing, with a warning that Governments are becoming increasingly energized by investigations into tax avoidance.
At a time of recession and public expenditure cuts, it is no wonder that Governments will be looking at every opportunity to raise revenues. Higher taxes will also increase the inclination of international corporations to become creative in their tax minimization techniques. The benefits of effective tax planning are enormous and with so much activity now undertaken offshore, the chances to take advantage of low-tax regimes abound.
Transfer pricing is of course the price or charge that applies when goods or services are transferred between different parts of the same enterprise. Tax authorities fear that such transfers could be manipulated to avoid taxes and therefore generally insist on an ‘arm’s-length’ principle. “The arm’s-length standard requires that the amount charged by one related party to another for a given product or service must be the same as it would be if the parties were not related. An arm’s-length price is the price that independent companies would pay for the same good or service purchased under the same or comparable circumstances.”
This apparently simple principle is in fact very complex, since many factors can be used in determining what is truly ‘the same’. In addition, many companies may embed royalties or other charges into the price, and of course those royalties tend to be payable to a low-tax jurisdiction (for example, most software companies register ownership of their software products in a tax-friendly offshore location).
For companies with multinational operations and clients, there are also interesting opportunities to decide where title to goods will pass, or (in an internet age) where services will be provided. The implications of who takes ownership, where and when, can have significant impact on the eventual price and profitability. That isn’t simply because of taxes on income; the effect of charges such as import or export duties or sales taxes such as VAT are also of major significance. For example, I recall one deal in which I was involved where, by providing goods on consignment to the customer and retaining title until the eventual point of installation, total cost was reduced by more than 30%.
Not all companies have close links between their contract and financial staff, so the commercial opportunities from price and tax optimization are sometimes missed. Equally, this disconnect may result in substantial exposures if the terms of inter-company trade are not fully understood, or if actions by a particular country organization could lead to unexpected tax liabilities.
Knowledge in this area has always been important for a rounded contracts or commercial professional. Today, as the risks increase and Governments become more vigilant, it is essential.
IACCM research has revealed widespread concern about the integrity of the bidding and negotiation process. Contracts and Legal practitioners recognize that this is the phase when foundations are laid for future claims and disputes. A recent survey suggests that failure to properly describe, understand or respond to requirements accounts for 40% of failed or troubled contracts. Other data implies that the percentage may be as high as 65%.
This should come as no surprise. Firstly, as with all mating systems, competition creates an incentive for the parties to maximize their attractiveness. Even if that does not lead to outright misrepresentation, it certainly encourages exaggeration of positive attributes and minimization (or omission) of those that are less attractive and could be the source of higher prices or future problems.
In business, the situation is made worse by a tendency to limit interactions between the parties during the bidding phase and to indulge in a negotiation process that they have been trained to view as some sort of game. This results in buyers defining requirements behind closed doors and often divulging only part of the truth to their potential partners. The supplier similarly prepares a proposal behind closed doors and works out how to obscure weaknesses in their capabilities. Each side then excludes participants who might ask awkward questions or probe for the truth, or delays their involvement until it is too late for them to ‘derail’ the deal.
In theory, partners who have worked together over time should be in a better position to judge the truth, but even that is no guarantee of increased success. Changes in personnel and the constant drive for innovation are two factors that may undermine the integrity or validity of the selection process. It is also often derailed by fundamentally incompatible goals that distort the performance of the parties in the execution of their agreement. Prime among these is the issue of price, though the allocation of risk comes a close second.
Ultimately, price is not in fact the most important thing to a buyer. It is the outcome cost that really matters. By focusing on lowest price, they frequently drive up the cost and force dishonesty by the bidder, who can win only by compromising their performance capabilities, and who then spends the post-award phase attempting to recover margin through highly contentious change procedures.
For the buyer, their belief that the supplier will try to avoid or amend their obligations causes the imposition of onerous risk terms, which divert the negotiations from the terms that might assist in reducing risk probability. These weaknesses are compounded by an attitude that it is the supplier’s job to succeed. This causes the customer to ignore key governance and accountability principles, in particular a failure to share in responsibility and allocate the right resources or mutual review procedures to oversee successful delivery.
In summary, we face a syndrome where bidding and selection processes lack due diligence and open, honest interactions between customer and supplier. This leads to unrealistic requirements and commitments. These in turn lead to a risk-allocating contract that establishes an environment of fault and blame. And from there, the relationship governance process offers little opportunity to keep the deal on track. It may sound complex to fix, but it is not. The situation demands a better planned and more integrated approach, which can best be driven by the customer and will require executive leadership to implement.
‘Partnering for performance’ was the theme of the 2011 IACCM Americas conference. And speaker after speaker confirmed the importance of contracting to overall business results – and the value that can be gained from greater collaboration.
A number of presenters highlighted the annual IACCM study of the ‘most negotiated terms’ and the terms that negotiators believe would deliver value. In the words of Craig Silliman, General Counsel at Verizon, “We don’t negotiate the things we see as important > There is a misalignment between what we do and what is important. Why is that?’
Jon Hughes, from Vantage Partners, spelled out some of the costs of adversarial negotiations. For buyers, these include likely loss of expected innovation, scope changes that lead to additional costs, higher probability of project delays or off-contract purchasing and increased quality problems.
In the opening presentation, Tim Cummins, IACCM CEO, suggested that contracts and legal staff must focus on improved risk management. This is one of the top issues on the CEO agenda and, Tim suggested, key to their demands for more creativity and less bureaucracy. He advocated that we stop worrying so much about reforming attitudes to the traditional ‘top ten’ negotiated terms, and concentrate instead on reducing the probability of bad things occurring. That could be achieved through the governance and management terms such as scope and goals, change management, communications and reporting and service levels. Tim stated that IACCM will continue its focus on researching and promoting ‘good practice’ in the construction and drafting of provisions in this area.
Kate Vitasek presented a lively counter-point in a debate over service level management. A presentation led by Claude Marais, from TPI and featuring the CIO of Walgreen’s advocated rigorous measurement s and monitoring, which could yield ‘millions of dollars a year’ in savings and credits. While acknowledging the validity of this approach, Kate suggested that it was reflective of a contracting mentality where ‘ we acquire transactions, rather than outcomes’. She advocated an approach based on objectives and value, rather than micro-management. Research at the University of Tennessee has shown such methods to bring far greater success and business contribution.
In my next posts, I will highlight some of the other major themes to come from the event.
If you like the sound of this event, don’t despair! The IACCM EMEA Conference will take place in AMsterdam in May and feature a number of the same speakers and many of the same themes. Visit http://www.iaccm.com/emea for details
We all know that most large companies would never sign their own contracts. The terms and policies they offer when selling are diametrically different from those they demand when buying.
As our understanding of the impact that terms and conditions have on business outcomes increases, more and more suppliers are advocating more collaborative and risk-sharing contract models. They point out to customers (especially those in the public sector) that creativity and innovation are closely linked with greater mutuality in key terms and that there is a joint responsibility to ensure success. All the research – from IACCM and a growing body of academics – continues to point to the validity of this conclusion.
But unfortunately, most suppliers continue to undermine the sincerity of their position because if more balanced contracts indeed result in better outcomes, why are they not applying this principle to their own procurement contracts? Why do they continue to impose burdensome terms on their supply base?
This is an important question for executives, lawyers and contracts professionals to answer. And it is something that any negotiator should be exploring as they seek to improve contract terms with their trading partners, or to understand the sincerity of their corporate culture. Addressing this hypocrisy would represent an important break-through for the integrity and quality of contracting – and a few market leaders have started to understand this point. For example, I was talking with a major service provider that is looking to eliminate the flow-through of burdensome terms from its customers, because it truly believes that this will be an important market statement and will generate new and higher levels of collaboration within and from its supply network. In the product world, SKF is a company that has similarly embarked on harmonizing its buy-side and sell-side contract principles because they are convinced that better balance results in the creation of greater value.
These are encouraging signs; but are they just aberrations? I hope that more of us will at least start asking the question. In these days where management is increasingly concerned about business integrity, reputation and value creation, should we not at least be reviewing the hypocrisy that underlies our own contracting practices?
And if you know examples of organizations that have already addressed this issue, then let’s share their names and celebrate this progress in corporate thinking.
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?
Many customers are not capable of collaborating – and that limits their ability to innovate.
That is one of the key conclusions that came from my discussion yesterday with Jesper Langemark, seasoned IP attorney and developer of a model contract for agile software development. Jesper’s observations very closely mirror my own. A big problem is that most customer organizations lack adequate follow-through from supplier selection and negotiation, to supplier and contract management. The hand-over from pre-award to post-award is often poorly defined and the accountability for outcomes frequently confused. As a result – and I say this from experience – it is sometimes impossible to reach decisions on critical performance issues.
This topic was raised because we were discussing agile contracts – the type of arrangement that is critical to innovation. Increasingly, it is recognized that such developments benefit from a collaborative, risk-sharing arrangement, but as Jesper highlighted, this demands committed resources and streamlined decision processes. Agile and innovative relationships will encounter challenges, issues and opportunities. And many customers – especially those in the public sector – simply do not allocate the right resources and do not ensure appropriate authorities.
Commitment Matters 