According to a report for the World Economic Forum, levels of trust have fallen by 44% in the last 10 years.
Whether or not we can rely on the precise statistic, the underlying message is important for anyone engaged in the world of contracting and relationship management. Trust is commonly understood to be fundamental to the health and sustainability of relationships. Its erosion therefore has significant consequences, many of which are in fact already evident in our daily work.
Globalization has been the key factor in the decline of trust. I suggest there are several reasons for this.
- As we work increasingly with new and unfamiliar companies and trading partners, often spanning jurisdictional, cultural and linguistic barriers, a sense of caution is inevitable and trust is a casualty.
- The networked world has disrupted traditional methods of doing business – in particular, face-to-face meetings are far less common. Many relationships are ‘virtual’ and lack the forms of bonding that are essential to establishing trust.
- It is widely understood that different cultures operate at different levels of innate trust. For example, Scandinavia is a high-trust region; the United States and Latin America are not. The dominance of US corporations and contractual models in driving international trade has undermined more trusting, relationship based models. ‘The transaction’ has replaced ‘the relationship’.
- Within business, a core reason for the explosion of international commerce has been the incessant hunt for the lowest price. Relational loyalties have been sacrificed in the search for perceived savings.
Among the consequences of this loss of trust has been the rise of the importance of the contract and formalized contract and performance management. During these 10 years, we have witnessed a drive for more and more precision over commitments and their measurement, accompanied by a steady increase in focus on ‘penalty terms’ – or the consequences of failure. Negotiations have become dominated by the allocation of liabilities and indemnities; battles over intellectual property rights, data protection and confidentiality. All principles of ‘my word is my bond’ appear to have been abandoned in the interests of low prices and the destruction of loyalty.
It is right to believe that many traditional relationships were too comfortable and had become inefficient. But it is also very clear that this pursuit of low prices has brought with it enormous additional costs and overheads. We see it in the need for prolonged validation of suppliers; longer lead-times in selection and negotiation; increased claims and disputes; more bad debt; longer payment cycles; growing focus on reputation risks – in fact, all the many costs that accompany more governance and administration.
Finance executives are typically sceptical about the extent to which ‘negotiated savings’ translate to the bottom line. They are of course right to be so – because self-evidently, they do not. Yet those executives remain addicted to cutting input prices far more than they seem ready to tackle the consequences this has on output costs. And while they sustain this behaviour, calls from other senior executives for ‘more collaboration’ and ‘improved relationships’ will continue to be frustrated.
The erosion of trust is not inevitable; it is a corporate choice whether or not to build sustainable relationships with its key customers and suppliers. But so far as I know, we do not have the economic data to demonstrate the relative value of trusting versus untrusting trading relationships. Isn’t it time for commercial experts to explore these impacts and to provide insights to the best performing contract and relationship models?
Recent research among senior in-house lawyers has resulted in three areas of major interest for 2011. These are:
- Global compliance
- Contracting and contract management automation
- Corporate governance and crisis management
These do not necessarily represent the areas of peak workload or required expertise for in-house counsel. The research was exploring the topics on which the legal community would most value more information, in order to grow their competence and capabilities.
These results therefore point to areas where many in-house groups today feel exposed. In some areas, such as contracting, this sense of exposure is in some respects caused by the challenges of rapidly increasing workload and inadequate staffing levels. Legal is in danger of becoming a roadblock unless it can find new and more efficient methods to deal with the complexities of today’s business.
There are many aspects to these problems. In part, it is the traditional approach to legal training, still largely based on jurisdictional knowledge and with limited acknowledgement of the needs of a lawyer in the world of business. This failing was recently highlighted in The Economist, in an article that was especially critical of the US law schools.
In part, it is due to the nature of lawyering. By and large, it is not a profession for risk-takers. Sometimes, this can lead to over-cautious attitudes and in particular a resistance to change. There is a tendency to create a centralized ‘command and control’ culture, rather than think about ways to empower better decision-making. In the words of Mark Chandler, General Counsel at Cisco, lawyers often want to be gatekeepers, rather than to build gateways.
This conservatism can reflect in some narrowness of vision. The global networked economy that has given rise to many of the new challenges confronting lawyers also potentially offers the solutions. The growth of new, on-demand information sources is one example. Process-based business applications are another.
Lawyers used to stand aside from the business, offering independent judgment on the legality and enforceability of specific policies or actions. Today, their increased accountability places them right at the heart of decision-taking by the business. Yet they cannot be involved in every decision. Therefore they need better and faster understanding of the implications surrounding proposed actions; and they need to increase their tentacles out to the business, both in terms of influencing decisions and in having visibility into what is going on (and specifically, whether it is compliant).
It is this new business reality that is driving the three areas of interest highlighted by the research. But having identified the problems, the real secret of success will depend on how in-house groups approach their resolution. If they try to remain a traditional ‘fount of knowledge’ around which the rest of the business must revolve, they will fail. Lawyers must become far more integrated into the fabric of the organization and its related business processes.
The pressure on procurement and supply chain groups seems certain to grow as more and more reports identify the embedded inefficiencies of today’s performance. But suppliers will also need to adjust to the changes this implies – many of which impact contracts and contract manaagement practices.
The most recent report to highlight supply chain failings comes from Sir Roy McNulty, who was investigating the UK rail industry. He found poor coordination across the range of companies and stakeholders involved in delivering services. He called for ‘much closer working and alignment of incentives’ across the industry and the adoption of ‘good supply chain practices’, which he estimates will save at least £1bn (US$1.6bn) a year, as well as delivering service improvements.
Among the specific failings, the report highlights:
- poor demand management
- failure to challenge requirements, plans or costs at an early enough stage
- inadequate focus on ‘value for money’
- absence of trust and collaboration with suppliers
Although the situation on which Sir Roy reports may be more extreme than many, the symptoms are found in many places. To be fair, a key reason for this is the obsession of many CFOs with purchase price savings and their refusal to allow ‘value for money’ judgments. Yet Procurement increasingly has evidence – through reports like this – that uni-focused, adversarial behavior does not deliver the best finaincial results. Procurement leadership must step forward to push this issue and illustrate that today’s more complex, outcome-based supply networks demand a new approach.
Suppliers must assist in this change. They should ensure that sales teams are far better equipped with the economic data to enable a shift in the way that relationships are established and managed. They will also have to learn ways to collaborate across a supply network, where necessary with competitors. As Sir Roy concludes, there are those who “appear to have been more successful at developing mechanisms to encourage partnership with suppliers while retaining the advantages of competition.” Those companies will be the ones to flourish in our networked world.
This week, the head of Corporate Governance at one of the major international audit firms told me that he was amazed by how many companies still cannot produce or describe a formal process for managing supply chain risk.
Of course, almost everyone uses one of the assessment agencies, such as Dun and Bradstreet, to assess financial risk. But when it comes to areas of business conduct risk – the sort of things that damage reputation and cause regulatory breaches – very few have a formal and comprehensive approach.
I spoke with one company this week that has attempted to build more rigorous risk assessment into their bid and contract process; the consequence has apparently been that cycle times have extended by several weeks. That doesn’t sound much like a sustainable approach; and of course it simply means one set of risks has been replaced by another (delayed revenues, loss of competitiveness, increased risk of internal process avoidance etc.).
So is there a better answer? In my opinion, yes. There are definitely ways that we can start to tackle these risk assessment challenges and I interviewed the CEO of one such solution today.
Richard Cellini is an attorney by background, but has spent many years in the field of corporate governance and compliance. His new company – Briefcase Analytics – offers a fast, practical and low cost solution to checking the integrity and performance of suppliers and customers. As the interview revealed, it is important that we undertake such checks not only at the outset of a relationship, but on an on-going basis. Indeed, regulatory requirements increasingly demand evidence of a robust and continuing evaluation process. Richard’s examples included some fascinating illustrations where major corporations have failed to act, even after there have been highly publicized cases involving key suppliers.
Briefcase Analytics is just one of a growing number of organizations using web-based data to provide creative new corporate services. In their case, they focus on seven major areas of business conduct:
Their services are global, so if you are Chinese and want to check out your potential US trading partners, or a North American company doing business in India, you can access the data.
I see so many organizations struggling with how to manage risk. But increasingly the answers to their problems are readily accessible, if only they would look beyond their traditional approaches. Far from managing risk, we seem far too often to create risk though an unwillingness to explore new ideas.
A recording of the webinar with Richard Cellini, which includes insights to the ‘most risky’ industries and some of the best and worst performing companies, is available in the IACCM member library – or send a note to info@iaccm.com for a copy.
Last week, I interviewed members of the senior management team from contract management solution provider 8over8. I was interested in their perspectives because they focus on software that supports major capital projects in the oil, gas and utilities sector.
This industry sector has always dealt in relatively complex, high risk activities that require massive investments (average around $11 billion per project, according to 8over8 CEO Clare Colhoun) and are frequently in the public eye. For a range of reasons, the glare of publicity is unlikely to diminish; indeed, energy policy is set to become an even more visible issue in today’s highly interdependent global economy.
8over8 has produced a set of interesting white papers recording their recent experiences in dealing with the industry (available from their website). In our conversation, they confirmed that ‘contracting is being elevated to a higher level’ and seen as a critical ‘strategic discipline’ in managing both the risk and the economics of these major projects. ‘There is a new perception of contract management value’, commented 37-year industry veteran Bob Spence. ‘It is no more a backroom function.’
In support of these comments, there are a number of discussion points I would like to highlight (the complete one hour recording is available in the IACCM Member Library).
First, the role and importance of contracting varies depending on the nature of the service or product being acquired. While many organizations are recognizing this, some (especially on the buy-side) still tend to see contracts and associated contracting skills as a relatively minor element in a wider procurement or sales process. They may apply similar approaches to project relationships as they do to general procurement. As a result, they fail to capture and share key data across the organization. This means that contracting principles and performance indicators are frequently not used in supplier selection (resulting in either the wrong suppliers being appointed, or failure to learn from past experience).
Second, in the experience of the 8over8 team, many companies lack a team that is dedicated to supplier performance management, equipped with the tools that enable it to oversee the best measures and KPIs, undertaking analysis and feeding back into the system to assist in future selection and performance management.
Third, the trend to Global Supply Agreements can be extremely helpful – for example, such standards assist in more consistent and mutual assessment of metrics and lessons learned across a portfolio of contracts. This capability, when used well, can operate to the advantage of international suppliers – but of course it depends on the readiness of both parties to adopt collaborative behaviors and demonstrate a mutual commitment to sustained improvement.
Finally, we talked about the characteristics of ‘good relationships’. Many organizations encounter local resistance to ‘central’ policy and the imposition of global or regional ‘preferred suppliers’. The local teams argue that the tight relationships with familiar suppliers lead to more closely-knit teams, committed to high performance. The 8over8 executives confirmed that ‘local clusters (of suppliers) lead to tight relationships’, but they observe mixed impacts on risk. ‘Local relationships may override procedural relationships, resulting in a more informal approach where there is a lack of documentation and decision making can become rather opaque’.
Automation is of course only one piece in the overall development of contracting competence, but its benefits are daily more evident. However, automation for capital projects is not the same as that for general contracting. Most companies have established good transaction management systems. The key for capital projects is to find systems that assist in managing interfaces (internal and external), facilitating high quality communication and supporting management judgment and decision-making. And when things go wrong – as inevitably will sometimes be the case – it is increasingly critical to have the record of who made what decision, when, on what basis and with what expectations?
In recent years, talent surveys have often shown an aging workforce. Those undertaken by IACCM have confirmed this is the case in areas such as Procurement, Contract and Commercial Management. Senior managers have expressed concern about the availability of future skills and capabilities as many of their seasoned practitioners approach retirement.
Yet how different the world – and the challenge before us – now looks. This summary from a recent report by Wharton Business School captures the point nicely:
“The aging of the global population is changing the face of retirement. The combination of increased longevity, distressed pension funds and economic hard times is causing people to remain in the workforce longer than ever and forcing governments to raise retirement ages around the world. By 2050, nearly one third of those living in developed countries will be age 60 or older, according to the United Nations, up sharply from less than 12% in 1950.
Yet this is only part of the story. In the United States, many members of the baby boom generation want to work past the traditional retirement age of 65 for the personal fulfillment that employment brings. Such views are replacing the notion of retirement as extended leisure that became popular in the last century, thanks to the advent of Social Security and private defined benefit pension plans that are now being phased out of the workplace.”
So what will this mean?
Increasingly, the concerns facing managers may be how to find growth opportunities fro younger employees who now feel stifled by the older members of staff; we may also hear complaints about the resistance to change among this ‘old guard’. Introducing new methods, new technologies, new working practices could prove difficult in a generation tha managed work in quite different ways from today’s technology-literate newcomers.
The answer appears likely to lie in careful consideration of the ways that generational skills and attitudes can be effectively blended. For example, if the younger generation likes technology and the broader networking this offers, then they may excel at handling specific types of research and particular segments of the customer or supplier base. The older, retained staff may be quite happy to relinquish people-management tasks and instead combine their physical relationship skills with mentoring and advisory services to the business and their younger colleagues. For example, they may make excellent Supplier Relationship Managers or key account negotiators.
At present, management thinking does not appear to have caught up with the new realities of a post-financial crisis world. It had better move fast – because those new realites are very much with us.
We have all seen movies where an unfortunate messenger is held accountable for the news they bring. Throughout history, communication services have been a sensitive area; in the 18th century, US colonists set up a rival to government controlled mail services because they suspected spying by the authorities.
Today, we have growing concerns about the internet, with ‘wikileaks’ prompting calls for increased controls.
It is essential to remember that communications lie at the heart of human progress. Without the ability to communicate, we would have remained in a primitive state. Each major advance brings with it a new set of challenges. The internet is the latest – and among the most dramatic – development in human communication. it creates a universality, speed and ease of information flows that is both energizing and threatening.
At the same time as wikileaks are causing angst to politicians, news comes of the son of a powerful police chief in China being brought to justice because of the same ‘power of the internet’. This individual killed a student and badly injured her companion while drunk driving. In the old world, there would have been a cover-up. The internet enabled exposure and growing public outrage that has called him to account.
When people discovered speech, printing and mass mail services, they soon learnt that these new capabilities must be handled with care. There were boundaries in what should be said or written. Controls depended on a combination of laws (for example, slander and libel) and control (maintaining secrecy). But increasd communication has also always had the effect of holding people – even powerful people – to greater scrutiny and account.
All previous communication methods were to a large extent localized. The immediacy and the global penetration of the internet has changed the rules. It will require all of us to think about how, when and what we communicate. Over time, it should lead to increased global standards over legitimate use and content. But most of all, it will hopefully result in new levels of honesty and truth – because these are fundamental to our peaceful development and to the conduct of trade and commerce.
And that, of course, is why all of us in the world of contracts and negotiation should be fasscinated about the internet and its impact on how we do our job. As with the world at large, we are at the beginnning of this particular voyage of discovery.
“Sustained success is largely a matter of focusing regularly on the right things and making a lot of uncelebrated little improvements every day.” This quote from Theodore Levitt appears in an article in this week’s Economist magazine.
The article examines the success of the German economy, which has been sustained even in today’s challenging markets. It suggests that a significant factor in Germany’s continued strength is the resilience of its mid-market firms, or Mittelstand. These firms tend to operate in very specifc and targetted niches. What is especially interesting is that they have focused on core expertise, often producing items of little apparent interest (castors for beds, shaving brushes, car license plates, snuff, cleaning products). They have not sought mass expansion through acquisitions or development into new market sectors – indeed, it is said that they deliberately avoid competition with global giants (‘Don’t dance where the elephants play’). Some 90% operate in the business-to-business market and most have achieved sustained growth over many years.
So is globalization a threat to these companies? Apparently not; in fact , the reverse is true. On average, they now have sales and support operations in 24 countries and for many, Germany represents a relatively small share of their income. In other words, they have grasped the opportunities presented by global markets and flourished within them.
What are the secrets of success? There are four consistent characteristics, none revolutionary, but of great effect when combined:
- They constantly innovate to stay ahead of potential rivals.
- They are relentless about customer service.
- Their salespeople are passionate about their products.
- They are dogged in their determination to open up new markets.
Niche opportuinities can become very attractive in a global context. This appears to be a message especially understood in Germany and Scandinavia – the article reveals that 80% of the world’s medium-sized market leaders are based in Germany and Scandinavia. But to win in that global context requires a readiness to develop offerings that are differentiated. Typically, that means attention to overall quality. It is interesting that many of the Mittelstand are now driven by service revenue, rather than the previous product-based income. They also tend to think far more in terms of their commercial offering, rather than the terms of contract. They are not risk averse; but by understanding their product, researching their markets and ensuring high quality, they manage their risk through performance, not through the legal terms of a contract.
It is, in fact, a story of “focusing regularly on the right things and making a lot of uncelebrated little improvements every day”. Not a bad philosophy for how we run our operations. Perhaps, as we enter 2011, it might be worth encouraging such an approach within your organization – maybe even building a documented record of achievements to which all are contributing. For those in Legal, Procurement, Contract and Commercial Management, let’s make it a year in which we exhibit those winning characteristics – innovation, service quality and passion for our products!
At a recent roundtable discussion, I was explaining IACCM’s annual study of the most frequently negotiated terms to a group of senior in-house counsel. One of them very intelligently raised the question ‘What terms lie at the heart of most disputes?’
Now this is a prespective we have never directly researched. Each year, we agree that the focus of many negotiations tends to be negative and risk-averse. We have established the areas that should receive more attention. But we have not directly tackled the question of how many contracts go wrong, and what is in dispute when they do. So this year, we have set about fixing that deficiency with some new questions.
IACCM is currently in the process of collecting data for its latest ‘most negotiated’ study and has inserted questions relating to the frequency and source of claims and disputes. (You can see / respond to the survey at https://www.surveymonkey.com/s/topterms2012). While there is a long way to go before the final results (the study was only launched a week ago, so at this point there are about 800 replies), I thought you might be interested by a snapshot of the answers to date.
Based on those answers, the ‘top 7’ areas which engender claims or disputes are:
- Delivery / acceptance (cited by 43%)
- Price / charge (38%)
- Change management (33%)
- Invoice / late payment (29%)
- Performance guarantees / undertakings (28%)
- Service levels (27%)
- Scope and goals (23%)
Of the clauses on which we spend most time during negotiation, confidentiality, IP rights and data security are apparently the least invoked. When there is a significant claim or dispute (which occurs on average less than 10% of the time), these terms appear to be relevant in only 10 – 20% of cases. So it would seem these particular clauses actually matter about 1 time out of 50; indemnities appear to be important about 1 time out of 40; and liabilities one time out of 30.
As the study progresses, we will need to consider what this data tells us about negotiation and increasing its effectiveness and efficiency. Certainly a good topic for a future roundtable!
If you would like to encourage your contacts and colleagues to participate in the latest survey (which means that they will of course receive a copy of the results), please feel free to do so.
FOOTNOTE – July 2011. The final results have now been published and can be viewed at http://www.iaccm.com/library/?id=3958&src=plc
Commitment Matters 