It’s a confusing time for buyers and suppliers, as they seek to navigate the complexities created by our increasingly global market. Each day there are fresh examples of the challenges we face in selecting the right partners. In their different ways, each new story illustrates the need for new sources of information, new levels of communication and more sophisticated methods of analyzing cost and risk.
A few weeks ago, I highlighted two aspects of international trade. The first was Leadership, Values & the Role of International Contracting, in which I highlighted a book by Harvard professor Paul Lawrence which argues for greater regulation of world trade. Professor Lawrence makes the case that much of today’s outsourcing actually results in a reduction in global wealth and therefore operates contrary to human interests. As if to recognize this point, Supply Chain Review then published an article suggesting that US corporations have learnt the error of their ways and supply relationships are being brought back on-shore – see Overseas Sourcing: The End of an Era?
However, a report in last week’s Financial Times suggests otherwise. A study by KPMG suggests a continuing trend to low cost sources of supply, with 66% of global manufacturers citing cost reduction as their number one supply chain priority. But this study also suggests a growing maturity of judgment, with increasing concerns about doing business with China and heightened interest in India as a manufacturing base. As IACCM recently illustrated, many low cost markets are not truly low cost when all factors are taken into account. There are many hidden risks and expenses when companies engage with overseas suppliers in non-traditional markets.
A stark illustration of this was contained in the same edition of the Financial Times. In ‘A Future on Track’, the article describes how ‘having transferred high speed rail technology to (Chinese) state-backed groups in exchange for access to a vast market, multinationals find they have created their own low-cost competitors’. Even worse, these multinationals have also discovered that their access has limited value, because their market share has stalled. Small wonder, with stories like these, that companies are forced to re-think some of their sourcing and market entry strategies.
All of this data suggests to me that there is potentially an open door for suppliers and customers to reach a new accord, if only they will engage in new and proactive conversation with each other. Just last week, I reported on the frustration felt by buyers at a meeting I ran in Dallas. They highlighted the reluctance of many suppliers to discuss issues related to cost reduction and service improvement; they felt forced to use competition as a weapon, largely through regular RFPs, in order to drive improvements. This sentiment was echoed just today at an IACCM member meeting near London. And I hear it often from contracts and commercial professionals who feel excluded from customer discussions by the account / sales team, who are reluctant to discuss value and just want a quick fix on price.
We talk a lot about collaboration, but the real issue here is communication and ensuring the right people are engaged. Perhaps a core problem is the traditional sales model, the reluctance by many sales teams to adopt inclusive behavior, their reluctance to engage with procurement and supply chain. I understand the pressures on sales people, especially at a time of economic turmoil. But it may well be that the secret to unlocking value and building more harmonious relationships depends on addressing their role and motivation systems.
What is the scope of contract management?
That is a source of endless debate. For many, it is seen primarily as a transactional activity, focused on ensuring compliance with standards, or that ‘deviations’ are adequately reviewed and monitored. In some cases, ‘contract management’ is seen as purely a post-award activity – on the basis that until it is signed, the contract does not exist.
A growing number of companies have grasped that contract management is a much broader discipline, that oversees the integrity of obligations, commitments and behavior with external parties. The need for this wider view has been illustrated by three cases that have arisen in the last few days – Novartis, Verizon Wireless and the mortgage documentation of several major US banks.
Although the situations that have resulted in regulatory and media attention are very different, each of them demonstrates a lack of integration in the way that markets are handled.
Novartis agreed a settlement of $422.5m related to marketing practices that promoted drugs for non-approved use, with incentives to the medical community. Not a contractual issue? It would be viewed as one by a best practice contracts organization, where business and market practices are always reviewed. Firstly, such a group should have ensured that there was no misrepresentation of the product; secondly, it should have checked that marketing promotions were in compliance with competition law and regulations.
Verizon Wireless is set to refund an amount ‘between $30m and $90m’ to customers in the US who were wrongly charged for data and internet services. Once more, not a contractual issue? To the extent that there was a technical issue in the design of handsets, it could indeed be argued that, while there was certainly a contractual consequence, it was not something that any contracts group would have anticipated. However, when customer complaints started flooding in, I think that the position rather changed. I am sure there are some who would say that this was an invoicing problem, nothing to do with the contract. Of course I would disagree – and I hope any professional contract manager would take the same position. Contracts govern pricing, charging and payment mechanisms. Implicit within any contract relationship is the importance of trust and integrity. That includes ensuring the bill is correct and addressing complaints in a timely manner. If those responsible for contracts were not aware of the problem, then it points once more to a fragmented process for contract commitment and oversight. It should not have happened. (As a footnote, experience shows that high volumes of invoicing errors are almost inevitable when companies create high levels of granularity in their pricing structures. The business complexity that such structures introduce means that the supposed benefits are often outweighed by the internal administrative costs – which is once more a problem that can often best be highlighted by an alert contract management function.)
Finally, we come to the US banks. The story there is that the major banks appear to have been unable to coordinate their paperwork, resulting in growing challenges to their foreclosures on mortgage defaults. Problems range from incorrect or missing data on contractual or regulatory forms, confusion over which company actually owns the mortgage and questionable internal controls and notarization procedures. It sounds like a system that has gone haywire, partly due to the volume of business that was being undertaken and also due to the fact that the system was not designed to cope with the financial industry meltdown and resultant volume of repossessions. The lesson here appears to be that fast-growth markets often place immense pressures on back-office systems, such as contract management. But fast-growth markets are also risky, making investment in supporting systems a high priority. It is frequently tempting to chase business and believe that the systems will catch up – but often they do not, and certainly they do not if there is no one focused on driving the catch-up. In general, modern banks appear not to give sufficient attention to the management of external relationships, either buy-side or sell-side.
In all these cases, the costs of poor contract management have been high. In reality, the headline figures are of course a massive understatement of the true costs – the need for investigation and review, the reputational damage, the on-going costs of increased regulatory oversight ….. it would certainly have been far cheaper to have invested in the development of an holistic contract management process and related tools in the first place.
I recently received the following question from an IACCM member:
“I am reaching out, because the statements below are being tossed around at a client organization where I am engaged on a project with the General Counsel:
PricewaterhouseCoopers suggests that a company can realize savings of 2% of their annual costs by eliminating inaccuracies and non-compliance through contract management on both the buy and sell side.
Goldman Sachs estimates that contract automation could accelerate negotiation cycles by 50%, reduce erroneous payments by 75 to 90%, and cut operating and processing costs associated with managing contracts by 10-30%.
One, do you believe these? Two, are there other named organizations making such statements? If so, what are they?”
I am sharing my reply – and will welcome input that may add to the data available for those contempating contract management investments.
“As you will note, the two statements represent very different measures. The PWC data implies process improvement leading to a specific 2% reduction in business costs. The Goldman claim relates specifically to automation and is only in the context of improvements to the contracts activity – clearly a much smaller number (and on base measures that most likely no one currently knows).
Should these be achievable? Yes, in general I think they are. It really depends on the nature of the business (types of contract) and how good they are at present. Our data suggests the potential for much larger benefits than these if you compare bottom quartile with top quartile performers. There is the possibility not only of cost reductions but also revenue improvements.
We see buy side and sell side ‘value leakage’ affecting companies that:
– select the wrong suppliers / customers
– apply the wrong form of agreement or terms
– fail to provide the correct contract governance and oversight in post-award
Obviously, addressing all of these requires a holistic review of procedures and ownership for the contracting process, but has been seen to generate overall improvements of around 7% in cost reduction and 5 – 7% in revenue improvement.
Automation alone will have much less impact – and indeed may have virtually none if the process itself is not reengineered.
This task is of course far bigger than the GC’s remit and if it is confined to a purely legal perspective, returns will be fairly small. However, it is certainly possible for the GC to sponsor such a project and a growing number do so.
Various analysts have published data, I imagine Deloitte and other consultants also have a view. But these tend to be highly generalized, with limited indications of the source of savings or improvements, and also assume a fairly standardized, compliance-driven business model,which can actually be quite dangerous for competitiveness in today’s markets.
Our model assumes contracting has a more strategic role in the business and that a key element of value is to increase empowerment and agility, coupled with increased oversight and central governance.”
At a recent IACCM member meeting in Dallas, there was a lively conversation about the best ways for buyers to ensure they are getting a good deal.
I had commented in my presentation on the potential risks of ‘using competition as a weapon’. The frequency of bid activity has increased in recent years, prompted in part by economic conditions, but also because the advent of electronic tools has simplified the process for a buyer. However, developing a full response remains relatively expensive for suppliers and inevitably, if they are approached too regularly without winning business, a level of cynicism sets in.
A senior procurement manager challenged these remarks with the observation that he had found regular bid events to be the only way to stay abreast of market conditions and offerings. In general, his organization aims to go to the market every 2 years, to test offerings and to force action by incumbent suppliers. These events typically lead to price reductions and often also to enhanced services or product features. In his experience, many suppliers simply are not proactive in delivering improvements. They have to be pushed.
Opinions in the room varied, but I can certainly appreciate that many suppliers probably do fail to keep their customers adequately updated on product or service enhancements – and certainly they are not always proactive in reducing the price to existing customers to reflect market trends. This failure is not always deliberate, especially for customers that are not viewed as ‘strategic’ and therefore have limited resources allocated to them.
Suppliers dislike regular bid activity. They say it is costly and undermines strong relationships. But strong relationships are based on trust – and that means not taking advantage of established customers by withholding price reductions or product / service enhancements. Unless they can propose a better alternative, suppliers are likely to see growing use of competitive bidding as a way to more frequently check prices and spur incumbents to greater effort.
Contracts provide a record of needs and obligations. They also include a range of provisions that relate to the performance of the contracting parties, both defining expectations and also establishing consequences for failure or ‘misbehavior’.
The extent to which performance expectations are defined within a contract has grown steadily in recent years. The terms frequently specify obligations regarding confidentiality, security, the quality of staff, non-compete undertakings, service levels and compliance with a range of rules and regulations. They then proceed to define a variety of penalties that will apply in the event of non-compliance. These range from specific indemnities to rights to damages, termination and perhaps even reimbursement of consequential losses.
Given the extent to which contracts address issues of behavior, it is interesting how little attention the contracts and legal profession has paid to the field of behavioral economics. The principles of most contracts remain firmly wedded to classical legal theory, which is primarily fixated on punishment for wrong-doing. It relies on a legal system in which courts of law determine right and wrong. While this method aligns with the adversarial techniques taught within many law schools, it is questionable whether it operates to the benefit of business.
As behavioral economics permeates deeper into other disciplines – finance and marketing in particular – it is important that we start to assess the effect of terms and conditions on behavior. A simple example is liquidated damages, on which I have written before. The standard approach to liquidated damages causes the supplier to hoard information which will protect them from blame, rather than engage in proactive discussion to reduce the consequences of failure. It is also clear that many of today’s ‘key performance indicators’ result in negative consequences. For example, demands for low cost frequently cause a steady fall in quality. Demands for high levels of availability may cause compromises on safety.
Overall, penalty-based contracts tend to result in behaviors that increase the risks of failure and therefore jeopardize the economic interests of both parties. However, with small suppliers, that may not be true. A small supplier is less intimidated by onerous penalty clauses because their customer would generally be unable to collect, or collection would not be economically efficient. Therefore the small supplier may in fact be incented to find more creative ways to avoid risk.
As behavioral economics moves to the mainstream of business thinking, the contracts profession should be at the forefront of those reviewing how the way we structure our agreements and individual terms and conditions affects the behavior of the contracting parties – and the impact this has on business risk and contract outcomes.
Today I interviewed DalipRaheja, CEO of The Mpower Group, to discover the thinking behind his recent article, ‘The Death of Strategic Sourcing’.
Dalip has received wide recognition for his contributions to the supply management profession and was an early leader in the foundation and implementation of strategic sourcing. I was therefore delighted to learn that his thinking is driven by a belief that the next phase of evolution is towards the model endorsed by IACCM – the combination of buy-side and sell-side resources to devlop an integrated corporate capacity in the management of trading relationships.
During the interview, Dalip acknowledged the major benefits that sourcing and procurement have delivered in recent years, but emhasized that it was not as much as was hoped for. And he feels that continued progress demands a new model, better equipped for today’s volatile market conditions. ‘Crisis management’ is now the norm – so organizations must design for the unpredictable, the unexpected. This means much tighter integration between the needs of the market and the capabilities created by the supply base. Organizations can no longer afford the consequences of poor information flows that result from functional silos.
Dalip also acknowledged the difficulties created by the compliance and control approach of many procurement staff. These ‘left brain’ characteristics have tended to be strong in many top managers, whereas the real need is for leadership skilled in collaboration and creativity. ‘Trading relationships are key. A lack of collaboration means that risk events are handled in boxes and organizations lack absorption capacity.’
Dalip’s proposals include the creation of an integrated ‘trade enablement group’ looking at the market and the supply base. He sees an urgent need for procurement to become part of the sales process, operating with far more sophisticated supplier selection criteria, stronger alignment with the executive agenda and with focus and incentives based on outcomes.
In response to a question regarding the steps needed to achieve this integration, Dalip and I agreed that today’s procurement image will in many cases be an obstacle. It is essential that any merger with sales contracts / commercial teams is performed collaboratively, not atttempted through some sort of hostile take-over. The business case is strong; the skills are coalescing; the need for far better integration of marklet and business intelligence has become urgent. And there are a growing number of groups that have moved successfully down this path, which provide benchmarks and evidence of success.
Anyone interested in discussing or exploring this new way forward is invited to contact either Dalip or myself and join the developing band of believers in an integrated ‘trade enablement’ function.
The interview recording is available in the IACCM Member Library.
Last week, the European court re-affirmed its position limiting the client-attorney privilege accorded to the advice provided by in-house lawyers to the business. This view is in direct contrast to the position in the United States.
In-house law groups are already typically smaller and less involved in day-to-day business operations than their US counter-parts. But will this decision lead to cut backs in existing staff? On the surface, it certainly appears to be good news for the external law firm, including perhaps the providers of legal process outsourcing. It might also mean a transition of some legal work to lower paid contracts and commercial staff.
My recent observations about the negative perceptions of contracting generated a healthy discussion. I had commented on the growing threat to the relevance of contracts and legal professionals if they cannot find a way around their anachronistic debates over precise forms of wording.
Not surprisingly, my mail box split between those who shared my concern and others who went to great lengths in describing the legal and jurisdictional background. Unfortunately, the latter group is clearly entrenched and does not want to change and the former group appeared largely fatalistic, believing that change will not be achieved in the foreseeable future.
Those responses caused me to think further and to recognize that perhaps the key issue here is Common Law. Maybe, specifically when it comes to international contracting, the system that is currently dominant simply is not ‘fit for purpose’. It is a system that relies on precision, in an era when cultural and linguistic variations demand far greater focus on intent. We need to bridge these gaps with agreements that reflect the spirit, not the letter.
Common law has become dominant because the English-speaking world has tended to drive the world trade agenda, especially in business-to-business contracting. Because so many of the big global companies came from this English-speaking world, it also suited their view of risk management to use the system (and generally the courts) with which they were familiar. In general, they rejected alternatives out of hand – for example, UNCISG or industry standard agreements. Often, there was not even an assessment of whether these alternatives were good or bad – they were different and that was cause enough to reject them.
It is only natural that incumbent groups feel threatened by change. They want to remain important and they do not want to relinquish their ‘specialist’ knowledge. But in today’s already complex trading conditions, the last thing we need is a contracting model that adds to the complexity. Contracts should be about clarity, understanding, a joint record and a vehicle for communication. Today, most of them lack these characteristics. Indeed, many lawyers feel that the contract should not be circulated precisely because ‘the layman’ will not understand it.
So perhaps it is not the question of archaic language and excessive word-smithing that must be attacked. Maybe it is the entire system of Common Law contracting that needs to be challenged and replaced. Human history is littered with examples of tools, technologies and skill sets that either became irrelevant or simply could not adapt. Why would this not be another on that list?
The British Broadcasting Corporation (BBC) has been delivering nightly newscasts for almost 100 years. I am told that one evening, back in 1930, the program simply announced ‘Tonight, there is no news’.
I was reminded of this story when I was talking with Katherine Kawamoto, head of research and advisory services at IACCM. Katherine and I have both been on the road this week, speaking at conferences in Boston and Dallas. When we caught up by phone, each of us asked the other ‘So what did you learn? Who is doing something new?’
For each of us, the answer was no one. Despite an array of worthy speakers, recounting interesting stories and initiatives, neither of us had felt inspired to take notes, to put pen to paper – because there was no ‘new news’.
That is an issue of real concern. It seems like the commercial, contracts and procurement community is in limbo. We know the world is in a state of great uncertainty, we can see the signs of fundamental change – and in far too many cases, we are waiting for someone to tell us what to do about it.
The changes going on around us demand new approaches to commercial management. They require new contract models, new procedures to establish and manage customer / supplier alignment. They demand new forms of performance measurement, internal and external. Overall, the market is screaming out for commercial innovation that will support the technical innovation created as a result of network technologies.
The opportunities for commercial leaders to make their mark have never been greater. By failing to rise to the challenge, the incumbent community – lawyers, contract managers, procurement professionals – risk being seen as part of the problem, rather than part of the solution.
What is your news bulletin? What highlights of your day can you report to senior management with confidence that it truly is ‘a highlight’ – an idea or an initiative that will really contribute to their agenda? How are you and your colleagues poised to make a difference – or are you also just waiting until someone tells you what to do?
In Supply Chain Management Review, Robert Rudzki has written a guest blog ‘Made in the USA – the New Frontier for Sourcing‘.
In the article, Robert observes how in recent years sourcing has moved from one ‘trendy’ offshore location to another. Often (I suspect) driven by consultants, this frantic activity revealed the immaturity of much sourcing judgment. Essentially, it confirmed the narrow ‘sticker-price’ mentality that drives far too much purchasing activity – and the lack of commercial acumen of the executives who stood behind it.
Of course it is easy to blame offshoring decisions on the demands of the CFO or CEO for ever-greater savings, but the truth is that savings could be achieved by working closely with established suppliers. As explained by a series of IACCM reports and articles, those attractive price reductions frequently had hidden costs behind them, not least because buyers were dealing in unfamiliar markets, with untested suppliers and unknown areas of risk. That is why many of these massive cost-saving deals have now (according to Robert) come back on-shore.
The article focuses on the United States. The phenomenon on which Robert writes was certainly not unique to the US, but was perhaps most pronounced and more exotic in the locations it was willing to choose. Those staid Europeans were castigated for being much slower to leap at the opportunities offered by globalization and for staying much clsoer to home – for example, developing relationships or investing in Eastern Europe, Turkey and former CIS countries. Perhaps now those decisions – and the closer oversight and management control that they offered – do not look so unwise after all.
Some of the offshoring deals went badly wrong, leading to highly publicized reputational exposures on issues such as product contamination or the use of child labor. But most did not have problems of that sort – the issues typically went unreported. They were sometimes just recurrent quality or delivery challenges. Or maybe disputes that could not be resolved. The recent IACCM survey on ‘ease of doing international business’ highlights nine areas of risk that frequently were not understood or costed when these sourcing decisions were made.
There is mounting evidence that not all is well and this leads me to wonder whether there is a deeper malaise of more fundamental trust and integrity that is eroding offshore supply contracts. Not only are there the often public stories of fall-outs with outsourcing suppliers, but I heard last week that Chinese suppliers are owed at least $25bn in bad debt from US customers. Now is that because they can’t pay, or because they don’t want to pay? What hidden issues lie behind this number, if indeed it is true? Might some of the outsourcers see their remoteness and the limited ability of suppliers to take action against them as an opportunity not to pay the bills?
But of course Robert’s article may be missing a fundamental point. As reported previously in this blog, buyers did not always leap to an overseas source. Often they issued an ultimatum to their existing ‘partners’ to reduce prices dramatically or else … and of course, the way that lower prices were achieved was through outsourcing. So I guess the comforting idea that business is returning home may just be an illusion after all …… It would certainly be interesting to see how many of these ‘repatriated’ deals are in fact resulting in production in US factories.
Certainly there are some important questions to be answered about the ‘real’ sourcing trends and the actual behaviors and experiences of both buyers and suppliers. Far from bringing us closer, it may be that the last few years has simply demonstrated the size of the remaining gaps in broader business understanding; and in the honesty and integrityof today’s corporate behavior. Good topics for IACCM to research – and your comments will be very welcome!
Commitment Matters 