Many trading relationships have become more complex in recent years. They are taking us into new and uncharted waters, yet the methods and equipment we are using for navigation remain firmly stuck in the past. As a result, a high proportion of those relationships prove disappointing and fail to realize their potential value. Neither side feels satisfied with the journey or its final destination.
The factors behind this complexity are varied. They include:
- Globalization, which has caused many of us to establish relationships in unfamiliar territories, with different rules and values.
- A shift towards solutions and services, which depend on better definition of requirements and capabilities to ensure that customer needs will be met.
- The speed of change, which affects the selection process and on-going relationship management, as both parties struggle to deal with shifting requirements, new competitors, innovative technologies, altered regulations and social values etc.
- Greater inter-dependency, as enterprises depend more and more on external partners to deliver core capabilities; for example, business process outsourcing shifts the entire focus of contracting onto achieving long-term (and often unknown) outcomes.
Given all these factors, we might expect that the process and structure for contracting and relationship management would be undergoing revolutionary change. Yet in general it is not. Organizational models to establish and oversee trading relationships remain unreformed; contract terms show only incremental shifts; internal rules and practices remain stubbornly tied to historic business values; performance incentives – internal and external – have remained stuck in the past.
There are some who say ‘the contract doesn’t matter’. But they are wrong. Complex relationships need agreed goals, agreed methods of governance, agreed rewards. And because they affect so many people, over such long periods of time, and rely upon coordinated action for their success, ensuring these agreements are documented and can be communicated coherently and consistently is critically important. Both sides must have a shared understanding of what they are trying to achieve, how they will achieve it and what they must do if things are not going according to plan. Anyone who believes they can achieve this in a long-term, high value relationship without discussion and recorded agreement is wrong.
It is therefore time for a great debate on fundamental change. We must engage in substantive discussion over how complex business relationships shoud be formed and managed. For example:
- What are the criteria through which long term and high-value relationships should be evaluated? It is obvious that input cost has little relevance; hopefully we do not select our long term partners on the basis of how cheap they are, or whether they superficially look good. So how do we make a better job of aligning culture and values and ensuring we really are likely to have a productive and collaborative relationship a year or two from now?
- What is the right balance of obligations within a relationship? Spending our time arguing over the consequences when things go wrong hardly seems the best way to ensure mutual commitment to achieving sucess. Yet that is exactly where so much of the formal negotiation is focused. The dominant party (or both parties, if neither dominates) puts forward its (one-sided) proposals for the relatinship foundations and then the battle begins. This causes risks to be overlooked; it results in defensive behaviors and a lack of transparency and honesty which would prove damaging to any meaningful relationship.
- Who should be responsible for monitoring and ensuring performance? Today’s approach creates an environment in which neither side has any incentive to admit weaknesses or to accept accountability. Open discussion and timely escalation are rare. It does not have to be this way. Contract terms and improved tools and methods could be used to support much greater openness and visibility within each organization and between organizations. Contract terms could include incentives for honesty and early identification of risk, rather than incentives to point fingers and hide the facts.
- What is the right governance framework? The framework must reflect the nature of the relationship and its desired outcome. Instead, in most cases, the relationship is force-fitted to standard and pre-approved contracting models which were designed for a different era and a different understanding of economic value.
Identifying what must change is not in itself hard. But achieving the change is made hard by the levels of resistance and the need for cross-functional and cross-organizational collaboration. We are in desperate need of champions who really care about business and economic performance.
Contracts are among the most conservative of instruments; the contracting process is overwhelmed by rules and restrictions that crush innovation and undermine collaboration. It is time for the revolutionaries to step forward!
Anyone who wants to study the effects of regulation might start with public procurement. It is a sector apparently fraught with failing contracts and massive project overruns. It is also a sector surrounded by rules and procedures designed to ensure open competition and ethical standards. Is there a connection between these two characteristics?
First, of course, we must establish whether the public sector does indeed suffer a disproportionate number of failures. The fact that public money is at stake, plus the level of transparency in democratic societies, means greater scrutiny and more publicity for government-funded projects. So far as I am aware, there is no specific evidence to show that the proportion of ‘troubled projects’ is higher in the public sector than it is in the private sector. But given the scale of many such projects, the level of failure and the resulting waste of resources is unacceptably high.
Second, there is evidence that public sector procurement policies carry a cost. A recent Rand Corporation report on EU public procurement (supported by research from IACCM) suggested a 28% price premium due to the risk-averse nature of public sector contracts.
And Governments themselves clearly believe that their procurement and contracting capabilities leave much to be desired. The Obama initiatives in contract reform are not the only example of growing government interest. Australia, Canada, New Zealand and the Scandinavian countries have all focused on this topic in recent times. In the UK, work has been led by the Office of Government Commerce, until recently largely depending on its powers of persuasion, but at last perhaps being given the resources to drive real improvement.
One issue with regulation is that it tends to drive out judgment and broader organizational competence. Those charged with managing the process become administrators rather than managers. To this is added the natural inclination in public sector agencies to avoid accountability – everyone (from the top down) wants to be able to point fingers elesewhere, so roles and responsibilities often remain vague and there is little incentive to build personal skills (except to achieve a higher salary).
The Institute for Public Policy Research recently illustrated this point when it highlighted the reasons for public sector underperformance: tolerance of underperforming staff, lack of training in specific skills, hostility to change.
In an era when so much is changing so fast, when success increasingly depends on the ability to manage collaborative projects, the rules surrounding public procurement must be updated. Rigid procedures are not the only way to enable proper scrutiny and rules are not the only way to establish and manage principles.
It is time to place greater demands on public sector employees, forcing them to develop professional competence in contracting and project delivery. For those that have the right talents (and many do), the introduction of more rigorous performance management will be welcome – especially if these are accompanied by criteria that enable objective oversight of ethical and moral principles and enable greater professional judgment.
Politicians are right to be focusing on this aspect of government performance. Major suppliers are right to make noises about the inefficiency of today’s practices. Taxpayers should be demanding rapid improvement. And those who question the wisdom of regulation should be pointing to the problems and weaknesses it has created in the public sector.
As a company that has built its success around the internet, it is perhaps not surprising that Cisco leads the way in thinking about the power of networks and network technologies. That thinking permeates the way that its people think – and also how they organize and perform their work.
A recent article in The Economist (‘The World According To Chambers’, August 29th) describes the Cisco strategy “to become the main supplier of the essential elements of an increasingly connected economy, and to be a shining corporate example of how to use them”.
The product and acquisition strategy is itself interesting and should be studied for insights to how our working lives and roles may change in an increasingly networked world. But my comments here will focus more on the innovations that Cisco has introduced to its organizational model.
Of all the companies that I deal with, Cisco seems to me the most advanced in developing a model for the future (other contestants please step forward). First, when the dotcom bubble burst, it eliminated traditional lines of business and moved to a set of centralized business functions. This eliminated much of the confusion for customers by transforming the way that markets were segmented; but of course strong business functions often become bureaucratic and fail to cooperate with each other. These tensions lead most companies to move back and forth between centralized and decentralized organizations.
Cisco took a different path and has built a system of cross-functional committees that handle different markets or business processes. It is a structure that seems to be working. Such an approach relies on collaboration between the various stakeholders, which in turn may depend on the right performance measures that incent teaming behaviors. Apparently individual performance in teams determines 30% of a manager’s bonus; and failure to work well with others leads to much diminished career opportunities.
For groups like Legal, Commercial Management and Procurement my observation is that there is a real sense of ownership, an understanding that they exist to serve the greater good. I see no evidence of territorial disputes. Instead, time seems to be spent challenging traditional assumptions or methods and a determination to understand market and stakeholder needs. A collaborative committee results in a sense of shared ownership for results; and peer pressure ensures that each function is anxious to perform.
Of course, I have never worked in Cisco so I can only comment on what I have seen and the experiences that IACCM has had in its conversations with Cisco members. I am sure that its contracts and contracting practices still have room for improvement – but I suspect that its staff would themselves be the first to acknowledge this and to be asking what it is they need to do.
The new organizational model – which I see as the most mature version today of shared service concepts – depends on using Cisco’s network technologies to support internal networking. According to The Economist, the annual travel budget has fallen by almost $300m due to the use of Telepresence and other virtual meeting tools. Cycle times have been slashed and the cost of inclusion is so low that reasons to exclude participants from decision-making almost disappear.
I will continue to observe Cisco’s progress, but for anyone wishing to explore new organizational models, this is certainly one of the company’s to study, especially given John Chambers’ goal of making Cisco “the best company in the world”.
The idea of commission-based pay structures for those involved in negotiating and managing trading relationships certainly is not new. Indeed, there are examples within the contracts and commercial community where deal-based bonuses have been introduced (though I believe most were subsequently abandoned).
I find the timing of the call by Procurement Leaders for more commission-based incentives quite remarkable – and the antithesis of the direction that any group aspiring to status and leadership should be taking (“Taking A Fair Cut”, Procurement Leaders magazine, 2009). At a time when there is such public and political hostility to the distortions that are created by a bonus-based culture, why would anyone wish to emulate such compensation systems?
The article in Procurement Leaders magazine makes comparisons with Sales and argues that if they can achieve bonuses for closing deals, Procurement (as their opposite number) should be bonused for savings. One of the key reasons advanced for such a shift is that ‘Procurement will finally get the salary it deserves, the kudos in the business and a presence on the board’.
Fortunately, not all those interviewed for the article share this muddled thinking. Among the difficulties highlighted are those which apply generally to deal-based bonuses for the contracts and commercial community – the difficulty of accurate measurement, the threat to objectivity and ethics, the negative reaction by other business functions.
There are several fundamental points that I would add to these:
- Commercially astute, high-value groups are rewarded for their objectivity. That means they must make judgments over the desirability of a deal, not just its closure. Sales are frequently divorced from this level of judgment; Procurement and Contracts groups should not be.
- Driving savings, just like driving sales, is indeed a critical aspect of business. However, it is not typically a high-status professional talent. Indeed, it is interesting to note that Sales is one of the few unprofessionalized fields of business activity. To the extent that their is status for Sales people, it tends to apply to those in senior account management roles – people whose rewards tend to be based more on performance over time and whose skills are directed at sustaining relationships and ensuring growth. If it really wants status and influence, this is the direction that Procurement should be taking (yet interestingly in many organizations is being denied).
- Given the debates within the G20 over bonuses and corporate risk, together with continued examples of the ethical challenges in Sales motivation (see Ethics Take The fiz Out Of Pfizer), any leadership function should be engaging in the debate over how to rebalance motivation systems and drive more collaborative business structures – not how to grab its share from the feeding trough.
Performance-based bonuses remain a legitimate component of any pay structure and the IACCM community (Lawyers, contract managers and procurement) all benefit from some form of incentive. Interestingly, (based on our annual salary surveys), the levels of those incentives were similar, but in the last two years there has been a trend for larger bonuses within procurement. However, in the majority of cases the basis for the bonuses remains a mix of overall company performance plus functional or group achievement of specific KPIs.
The subject of salaries and incentives is certainly important and it is one in which our community should be much more actively engaged. But where we should be spending time is in devising an approach that supports honesty, integrity, ethics and good business judgment. High-status professionals and business leaders are those that build value and reputation, not those who place it at risk.
The news that Pfizer has been hit with a $2.3bn fine by the US Government is just the latest in the continuing dilemma over governance and ethics.
According to ABCNews “The main whistleblower, a former company sales rep, said in a statement, ‘at Pfizer, I was expected to increase profits at all costs, even when sales meant endangering lives. I couldn’t do that.'”
The charge against Pfizer is that their sales reps. consistently misrepresented the qualities of certain drugs, deliberately encouraging unauthorized use to boost sales.
In the end, the issue here is not dissimilar to that which caused the collapse of the financial system. The pressures for growth and increased profits lead to the creation of bonus and incentive schemes that generate undesirable behavior and reckless risk-taking.
Once again, I turn to the final communique of the April G20 Summit, assembeld to consider the fiancial meltdown. World leaders concluded: “Staff engaged in financial and risk control must be independent, have appropriate authority, and be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the firm. Effective independence and appropriate authority of such staff are necessary to preserve the integrity of financial and risk management ….”
The Pharmaceuticals industry – like financial services – is among the most regulated, yet despite (or perhaps because of?) that, it continues to struggle with these fundamental governance problems. In part, the challenge is endemic to the role of Sales and its continuing bonus culture. Yet other industries appear able to achieve greater balance and to control the inclination of the Sales organization to exaggerate product or business capabilities.
One way that control is created is through the use of contracts. Sales statements are constrained by the specific commitments contained in the terms and conditions. A feature of large-scale, ethical misrepresentation appears to be that it occurs more frequently in the business-to-consumer market, especially where there are intermediaries (brokers, car dealers, doctors etc). These intermediaries are also often swayed by incentives – in the Pfizer case, it was claimed “in exchange for hearing company sales pitches, doctors were paid up to $1,500 to attend meetings, and were treated to conferences at lush resorts, given air fare, hotels, meals, even massages.”
Once again, this case points to the fundamental role and value of an organization that oversees commercial practices and policies and ensures appropriate vehicles for their implementation – just like the G20 Summit envisaged necessary for the finance industry. Such a group could certainly have saved Pfizer a lot of money. And I am sure there are many IACCM members who would be willing to help set it up!
Since records began, there have been those who predict the apocalypse and those who are ready to listen and react. Popular media understands and exploits this tendency to the full. To what extent should those in the business world pay attention?
The dire forecasts associated with swine flu are the latest ina series of warnings related to health risks that might disrupt trade. Add to these the growing concerns over severe and extraordinary weather events, or the on-going threats of terrorism, or the possibilities of political instability and the world soon seems a scary place.
So the risk manager faces a daunting task in seeking to anticipate these awful events and work out how to protect against their potential impacts. What should they do?
The answer often is ‘Nothing’. The economic impact of such disasters is typically far more limited than forecasters predict. Activity may slip slightly, but overall economies remain resilient, according to a recent report for the Canadian Finance Ministry.
Of course, this might be because we have become so good at managing these ‘exogenous risks’ (those which occur outside the financial system). But the evidence appears otherwise, at least according to a recent article in The Economist (Cold Comfort, July 25th). For example, the Canadian report found: “People adapt and work around the shock; those unaffected work harder and longer to pick up the slack.” It is this type of finding that is hard for a risk manager to highlight as a reasonable source of mitigation, yet which in reality typically eliminates the risk.
There is no question that events like the Great Plague in the 14th century caused massive dislocation – but in this case, it transformed an economic system, something which even the most sophisticated risk manager might struggle to predict or mitigate. It seems the real risks we should focus on are those which occur within the system – so certainly financial disruptions or those which are localized within a specific supply network merit full attention. But it would seem that those which are media favorites are generally best ignored.
The recent, very active discussions on this blog about the role and value of contract management have highlighted growing consensus on the need for improved financial skills and knowledge.
One of the distinctions that I observe between Contract Managers and Commercial Managers is that the latter often play a much more significant role in financial modelling and oversight of cost or revenue performance and risk. This is obviously a powerful source of functional value and acts as a counter-balance to the narrower role of managing only legal risk. The current credit crisis – and broader market volatility – has rendered the need for strong financial skills and awareness even more important.
It is not always obvious where the contracts professional can look for broad financial updates. One source that I find useful is gtnews. While many articles are very focused on detailed corporate finance or treasury issue, there is a good mix on wider market updates and trends. Last week, for example, there was a series on the Financial Supply Chain and the challenges being created by current credit conditions (pretty important stuff for anyone establishing trading relationships).
I was able to learn about the emergence of pre-paid cards and the development of industry standards in Europe. This is expected to reduce fraud and simplify a wide range of consumer or small business cross-border transactions. This issue of standards (or the lack of them) is apparently a major inhibitor to supply chain efficiencies in Asia Pacific, where trends to e-invoicing are limited by the lack of common platforms within the banking and commercial sector. So contract negotiatores need to be aware that deals involving trade within Asia Pacific may face limitiations in their use of e-commerce.
The article on e-invoices highlighted a number of further trends and opportunities in Asia. One interesting fact was a trend back to the use of Letters of Credit in trade finance. Open account, in which the importer pays after receipt of invoice, is currently the norm for some 80% of international trade business. But credit concerns have led to a re-think and the push for more security that LCs in theory provide. However, teh article warns that credit shortages have resulted in many banks becoming far more bureaucratic in their management of letters of credit and using the smallest excuse to delay release of funds. Again, important information for the contract manager.
The credit crunch is also apparently leading to a spate of mergers and acquisitions in the banking sector in Asia, leading some to suggest that international trade is best entrusted to the large international banks, with a consequent shift away from smaller, less technologically enabled local banks.
Finally, I turn t0 an article on Eastern Europe, which reveals the continuing challenges faced by the region as a result of the global economic crisis. Western European banks continue to tighten credit lines and in some cases withdraw from the region; sovereign credit-worthiness is still declining; and commodu=ity price drops have had substantial impact. The report identifies two distinctive segments, one being countries that are within the EU and part of the Euro-zone, the other being those countries outside the Euro-zone and are far more exposed. “In the current climate, a company’s corporate governance, which includes the trust and integrity of the management and owners, has become much more important”, according to the article – again, a consideration for the contract manager in assessing risk and seeking relevant disclosures.
Logica has this month published an excellent whitepaper entitled ‘Step Change: Collaborating To Innovate’. The authors are two highly respected experts in the field of outsourcing, past IACCM conference presenter Professor Leslie Willcocks and Andrew Craig. It represents a ‘must-read’ for anyone involved in establishing, negotiating or managing any form of complex or high-value contract or business relationship.
The authors set out to study how organizations maximize value from outsourcing and in particular, how they achieve innovation. Many past studies have bemoaned the failure of most outsource contracts to get past cost reduction and move into true high value partnerships. IACCM’s work in this area has confirmed that disappointment is frequent, and has also described the dependencies for greater success. It is good to discover that Messrs. Willcocks and Craig have reached similar conclusions.
First, they highlight the key role of leadership. Like IACCM, they found a direct link between executive interest and ownership and the ability of the team to deliver good results. But they also saw leadership in the context of the customer’s readiness to embed major suppliers in the planning and development phases, to shape how the future vision would be accomplished. As I have highlighted in previous blogs, traditional sourcing often tends to hold suppliers at arm’s length and to limit their opportunities to engage directly with users, particularly in the pre-award phase (see, for example, A Simple Way To Undermine Procurement Success).
The other two critical areas that the paper examines are contracting and organization. “New forms of contracting are required for collaborative innovation to succeed. Such contracts share risk and reward in ways that incent innovation, collaboration and high performance to achieve common goals.”
This statement could well have been extracted from any number of IACCM research studies over the last few years. Each year our report on the ‘Most Frequently Negotiated Terms” has called for refocusing. Indeed, the most recent study not only pointed to the negative impacts of today’s negotiation focus, but highlighted specifically where future attention should be paid. The areas of the future – which were endorsed by the IACCM worldwide membership – go right to the heart of the Collaborative Innovation message – they are essentially the terms needed to ensure clarity of intent and on-going organization and relationship governance.
There is one other very important finding in the Willcocks / Craig study – and that is their depiction of client behavior (I would suggest they should expand this to also cover supplier behavior, because collaboration depends on trust and that must be driven by mutual actions). They include a chart entitled ‘The Global Sourcing Learning Curve’ and in this they describe four phases of maturity:
- Contract administration or negativity
- Contract management
- Supplier management
- Collaborative innovation
The reason I find this so fascinating is that it is the first time I have seen external endorsement of the direction in which IACCM has been steadily moving. Our research, our executive roundtables and our overall strategic thinking have been pointing to this sort of evolution for our members. Most IACCM adherents have moved past contract administration; but for many, the conversion from contract management to suppplier management remains confused, with internal politics often causing a battle over what exactly the supply management activity includes and where it belongs.
As we continue to debate and steer the evolution of contract management and the contracting process, this paper offers a timely and profound contribution. Read it!
In the overall list of risk management concerns, information security has been a topic for increasing focus. With Internet usage forecast to grow 45% globally over the next four years, the web has become ‘a paradise for cybercriminals’, according to Andrea M. Matwyshyn, professor of legal studies and business ethics at Wharton and the editor of a forthcoming book titled, Harboring Data: Information Security, Law and the Corporation .
In an interview, the authors explain why this is happening and the reasons for concern. In the context of businesses and large organizations, they highlight studies by PriceWaterhouseCoopers which reveal that a large proportion of corporations admit to having no comprehensive information security policy.
According to the authors: “The biggest mistake … is not having a clear handle on where the information lives. The design of large systems calls for a lot of redundancy. Data is copied, duplicated, backed up, sometimes sent to different partners, data warehouses, shipped off site in case some catastrophic event destroys your data center. So data has a tendency to replicate itself. And one of the big challenges is when companies lose track of where the information is. It’s very hard to point to a particular computer or a particular rack and say, “This is where all the credit cards live.” …. The problem is that the more spread out they are, the more points of failure you have to worry about…. The first challenge [arises by] not having an inventory of what you’re collecting, even if you know where you collect it, not knowing where exactly you put it.”
Over and above this challenge of tracking, there is of course also the concern over internal process and practice – for example, employee actions that may compromise data or increase vulnerability to cyber attack.
Many business-to-business contracts now contain provisions related to information security undertakings. They frequently seek indemnities and may demand rights of audit as well as detailed access to the supplier’s information security policies.
However, are such measures adequate? Probably not. In some cases, it seems probable that companies are signing up to commitments with which they cannot in fact comply. They simply hope that a significant exposure does not arise. If you read the book you may feel that a wish and a prayer are no longer sufficient protections from the major exposures that exist.
IACCM will invite experts to comment on recommended contract terms and monitoring procedures. In the meantime, please share your ideas and experiences by recording your comments below.
Contract managers from around the world (and some users of their service) were brought to life by the challenge of defining their role.
More than 2,000 clicked through to read the definitions proposed in my earlier blogs (The Role Of A Contract Manager). Some posted their comments, many more took the chance to write (we will add those inputs to the overall comments).
There have been some great additions; but perhaps more importantly, the community showed a real hunger to reach common definitions and to advance the role in terms of its business contribution. There was enthusiasm to position the strategic value and financial impact of competent contract management and an understanding that this demands greater rigor in measurements and more proactive intervention and leadership.
So where next? We will consolidate all the input and then be looking for senior representatives of the community to join us in developing and agreeing an overall role scope and definition. It is likely that we will want to segment this, to show how industry or business complexity may affect the overall definition of tasks to be performed.
Our goal is to establish clarity over the content of ‘contract management’ and to validate this against the body of knowledge that was developed and maintained by IACCM members over recent years. I suspect that this working group will also wish to promote the importance of international professional accreditation and again we will welcome their review of the existing professional standards.
Overall, it is an exciting time and we have the opportunity to be among the first with truly global standards of practice. With so much investment already made, this project is not daunting, but demands some of the best minds in our community. If you are one of them, and if the worldwide professional status of contract management matters to you, please step forward!
Commitment Matters 