IACCM’s recent survey on contract flexibility found that Procurement groups are well aware of the need for more flexibility and innovation in their terms and conditions, but are struggling to respond. The United States is falling behind other regions in its introduction of terms that better reflect today’s risks and opportunities.
More than 92% of those responding to the IACCM survey believe that it has become more important for their company or organization to innovate in its terms and conditions and 77% report that their company has taken steps to introduce ‘more flexibility and responsiveness’. 65% agree, in whole or in part, with the statement ‘Executive management at my company / organization is aware of the need to find new mechanisms to manage risk and opportunity through changes in contract and relationship terms and practices’.
The IACCM report revealed substantial variations between functions, geographies and industries, reflecting different pressures, but perhaps also sources of competitive edge. For example, almost 60% of buyers ‘strongly agree’ that it is important for their company to innovate (compared with 38% on the sell-side), yet just 24% report that their company is becoming more flexible or responsive. Of course, ‘innovation’ and’ flexibility’ are not always the same thing, but this result certainly suggests that the problem of compliance-driven Procurement groups, lacking real negotiation authority, remains a problem. Certainly my experience is that the Legal function in most large corporations stifles meaningful negotiation by buyers.
Integrated commercial groups, responsible for both buy-side and sell-side contracting and negotiation, show a significantly higher proportion that have successfully increased their flexibility, with almost 40% ‘strongly agreeing’. This may in part be due to the fact that such integrated groups are typically not in the largest companies and therefore lack the same power to resist market pressures. However, past research has shown that such groups are also far better at gathering and responding to market intelligence and generally have greater influence and status within their company.
Industry variations also throw up some interesting perspectives. For example, in Banking / Insurance and Healthcare / Pharma, more than 60% of respondents strongly agree about the need for more innovation. In Public Sector, (where one might think that current conditions are creating especially strong pressure) the number falls to just under 40%.
At a geographic level, Asia is the region most concerned about being more innovative, although professionals everywhere see this as important. However, the United States is substantially behind all other regions when it comes to taking action to be more flexible, or in terms of executive awareness that change is important. Whereas nearly 50% of professionals in the US see innovation as ‘strongly important’, less than 20% ‘strongly agree’ that their executive management is aware of this need.
Key messages from these results appear to be:
- Today’s market risks and iopportunities demand greater flexibility and agility in managing contracts and terms and conditions.
- This demands attention to new contract structures and a re-think of some commercial policies and practices.
- Companies must re-assess internal authorities and review / approval procedures.
- Integrated contracts / commercial groups (buy and sell) appear to deliver better performance.
IACCM’s report on Commercial Agility was issued on May 17th, 2010 and is available at no charge to IACCM members.
IACCM has just issued its quarterly report on the state of the global economy. It noted continued volatility in market conditions and the emergence of significant trends that are impacting negotiations, in particular the focus on methods to reduce costs and a growing focus on pricing mechanisms. IACCM also commented on the impacts of public procurement and policy shifts, both in terms of economic activity and in respect of the impacts of new governance and oversight initiatives.
The survey is unique in bringing together both buyer and seller perspectives (which it will be no surprise, are often not aligned!). It discovered a continued battle over terms and conditions, especially price-related, but increasingly those complaints come from both sides, suggesting that the imbalance in negotiation power that was created by the recession is fast receding. However, circumstances vary considerably between regions and within industries.
Asia-Pacific continues to show the greatest buoyancy in market sentiment, with net positive index of 42% (up from 22% in the previous quarter). The Americas are now close behind, with +38% (previously +16) and Europe / Middle East / Africa continuing to lag, with +13% positive sentiment, up from +4% last time. The frequency of renegotiation has continued to decline, with primary focus now on new contracts or extension / expansion of existing relationships. This suggests a change of pressure in negotiation.
Most negotiators remain concerned about price-related pressures – though in both directions. While sellers report continued ‘unilateral actions’ by their customers to force reductions (or to leverage other cost-related terms), there is now evidence that many suppliers are using the recovery – and supply shortages – to push up margins. While some are doing this through direct increases, others appear to be improving their P&L through cut-backs in service or support or more draconian attention to change management.
There are substantial variations in the fortunes of different industries, and sometimes within industries. Automotive is a good example, with a substantial fall in those reporting positive conditions in the last 2 months, though a similar number reporting improvements – clear evidence that bad news for some suppliers is good news for others. The strongest industries – in terms of recovery – are Electronics, Retail, Manufacturing / Processing and Transportation / Logistics. Those showing greatest weakness and uncertainty are Aerospace and Defense, Automotive, Engineering and Construction and Public Sector.
In their webcast accompanying the report, IACCM highlighted a number of trends for negotiators to consider. These included the weakness of the Euro and associated actions within a number of EU countries to cut public debt; the fragility of supply chains, which has been exacerbated by the cost-cutting actions of the recession; the steady increase in regulation and oversight, which is increasing nervousness in trading relationships and may lead to large-scale reconsideration of bonus and incentive schemes (a welcome development for many negotiators); the wider impacts of public procurement cut-backs and delays, especially in areas like IT, defense and construction. The summary also touched on the switch of market focus to the Far East and the impact this may have on negotiation practices and terms, plus the recent collapse of the traditional annual agreements in the metals industry and the extent to which ‘spot pricing’ may become more prevalent. IACCM believes that pricing mechanisms and indices will be a major area for focus in contract negotiations over the coming year.
In advice to contract negotiators, IACCM observed that they must be flexible in their approach and do their market and competitive research before entering the negotiation (the latest IACCM report represents a good starting point). Negotiating power and positions will be significantly impacted by the state of conditions in the negotiator’s industry and that of their trading partner. The survey shows that many suppliers felt unfairly treated during the recession and that unilateral action by buyers has tested supplier loyalty. As these established suppliers now start to push back in an attempt to recover lost margin, some buyers will be more inclined to consider switching their source of supply, providing competitive opportunities.
Competitive intelligence is therefore more important than ever in negotiation planning, with terms and conditions increasingly a factor in winning or losing. Among the areas to research when preparing to negotiate are whether companies are engaged in major cost-cutting; whether they are changing their service and support model; whether major customers are imposing price cuts, changing volumes or amending payment terms.
IACCM also commented on the erosion of trust that has accompanied the recession and the rapid shift in confidence over supplier and customer financial stability. A recent report from the International Chamber of Commerce noted a sharp up-lift in requirements for Letters of Credit or bank guarantees, as well as growth in requests for Performance Bonds or guarantees. With the banking industry itself in a risk-averse state, it is proving both hard and expensive for many firms to obtain the required support. Once again, an important area for negotiators to consider and prepare.
All these factors suggest extreme variability in the flexibility that negotiators will encounter. They may also offer increased opportunities for value trades and perhaps, in some instances, a greater understanding that partner loyalty and collaboration is often more important than the superficial transaction cost. As we recover from recession, it may indeed become evident that the world of negotiation will never be quite the same again.
A recording of the IACCM webcast introducing this report and discussing its findings is available to IACCM members at www.iaccm.com
Several years ago, the hot issue for IT Procurement was whether or not it should be consolidated within the general procurement organization. The development of category management resulted in many specialist IT Procurement groups being swallowed up. While CIOs may not have been enthusiastic about losing their dedicated resources, most understood the business logic.
Today, we are seeing counter-arguments and a growing number of CIOs are appointing dedicated procurement and commercial staff within their organization. Sometimes they are fighting to reclaim the relevant category management teams; in other cases, they are looking to supplement these resources. In all cases, the driver seems to be a recognition that IT service delivery depends less on technical know-how and more and more on commercial competence. A CIOs success is increasingly measured by theeir ability to select and manage the right supply base.
Contract management, performance management and relationship management are critical issues in this new IT delivery environment. CIOs have regularly been exposed to the challenges of managign outsourced providers, so they know from experience how important it is to ensure accurate scope and goals, to respond to changing user needs and to ensure stringent performance oversight. Now, with the advent of cloud and mobile computing, there is every likelihood that the residue of technical and facility management will move to external providers – and hence the CIOs success will depend on their ability to select the right partners and manage their performance, while also retaining the ability to manage change through versatile terms and relationships.
IACCM has written about this trend several times over the last year, but a couple of months ago we decided that it was time for action. Our IT Procurment ‘community of interest’ has almost 2,500 members, so we recruited Bill Huber (former IACCM Chairman and today Director of CPO Services at TPI) to lead group discussions on some of the key issues. We started by running a survey that asked our commnunity members to rank their priorities.
As the graph shows, Cloud Computing is the number one issue, but closely followed by the challenges of relationship and perfromance management and the question of skills and training. Illustrating the point that software is very much the issue of the future, interest in ‘the cloud’ was supplemented by the broader question of software asset management.
IACCM has of course undertaken extensive work on the skills profile for IT Procurement and its assessment tools are in strong demand. Our Managed Learnig tools are also very relevant to the trainign needed by groups that increasingly need contracts, commercial and relationship knowledge in order to oversee supplier negotiations and performance.
Whether or not the trend towards organizational change continues, it is very clear that the need for skilled contract and relationship professionals in the IT and services procurement field will continue to increase. This represents a strong area of oppportunity – and one that is increasingly urgent.
IACCM members can join the IT Procurement community of interest as part of their membership selections at www.iaccm.com. Participation in the community conference calls, webcasts and surveys is free to IACCM memebrs.
“President Obama called the finger-pointing among the companies tied to the (Gulf of Mexico) oil spill a “ridiculous spectacle,” and vowed to end the “cozy relationship” between regulators and companies.” (New York Times, May 17th 2010).
I strongly endorse an end to the culture of blame that permeates so many of todays’ trading relationships. However, I am fearful that the term ‘cozy relationships’ may be misinterpreted and that we will see its replacement by increasingly adversarial relationships, which create similar results. While this epidemic of finger-pointing is not unique to the United States, it does appear more frequent here. Is that because of a more open and honest system, or is it because of the litigious nature of society and the role of lawyers in forming adversarial agreements?
‘Cozy relationships’ and an absence of real competition is a problem in public procurement in many parts of the world. Public procurement policy has tried to address this through open competition rules (which the US Senate and Congress have undermined) and laudable anti-corruption rules. In the private sector, while abuses remain, there is greater freedom to decide whether the balance of economic benefit is achieved via open competiton, or through established relationships. It is in part this absence of choice that creates problems for the public sector, because strict bidding rules often prevent open discourse with individual suppliers.
There is a big difference between cozy relationships and open, collaborative relationships. I hope that the frustration with governance failures does not result in a break down in buyer / supplier communications and a belief that the only way forward is to impose even greater risks and penalties on suppliers. It is right that President Obama questions the way things work right now, but once again we are seeing the results of measurement and reward systems that distort behavior. Successful relationships depend on people who exercize judgment based on objective measures of success, absent of personal financial rewards or incentives. Just over a year ago, Presidnet Obama was one of the leaders to sign the G20 communique which read: “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 ….”.
This statement referred to the abuses within the financial services industry. Today, it could be applied to public sector procurement and regulation. The principles within this statement point to the need for high quality contracts and negotiations professionals, driven not so much by rules (though these matter), but more by a code of consistent and high quality judgment.
Earlier this week, I attended a series of presentations at the Rothamsted Research Station in the UK. The focus was on the challenge of food supply and whether the world could adjust to the needs of a fast-growing population and the uncertainties created by climate change.
Ultimately the conclusion was quite optimistic. Scientists believe that new technologies – in particular genetically modified crops – will allow massive improvements in production that can support a world population f 9 billion people. They also believe that the population level will stabilize at around that number . The ‘wild card’, according to the scientists, is the price of energy; so long as energy prices can be controlled, then not only will we have adequate food, but also its price will remain relatively stable.
I emerged from the meeting feeling that advances in science do indeed often prevent ‘disaster scenarios’ becoming a reality. Yet at the same time, scientists may not be especially reliable sources when it comes to predicting the overall condition of the economy and society. Their optimism over food supplies and prices seemed to me to be based on three fairly unreliable factors – one, that population growth would slow; two, that we will soon find alternative energy sources or cut our energy requirements; and three, (which they did not mention) that complex, global supply chains will prove a reliable way to shift goods to the point of need.
However, I then read a review of a new book by Mat Ridley – ‘The Rational Optimist: How Prosperity Evolves’ – and was cheered by his conclusions. More importantly, I once again recognized the relevance of the contracts and commercial community in assisting this optimistic view of the future.
Some may recall my past writings abou the work of Nicholas Wade, author of ‘Before The Dawn’. Ridley is an economist; Wade is a scientist. But they reach remarkably similar conclusions that trade, in essence, lies at the heart of human innovation. In its summary of Ridley’s book, The Economist observes: ‘Trade is the spark that lit the fire of human imagination, as it made possible not only the exchange of goods, but also the exchange of ideas. Trade also encouraged specialisation since it rewarded individuals and communities who focus on areas of comparative advantage. Such specialists had the time and the incentive to develop better methods and technologies to do their tasks.”
It is the culture of continuous improvement that drives and provides incentive for innovation, without which the disaster scenario will become a reality. There have been those who predicted disaster from the very beginnings of time and insisted that we should all adjust or prepare for the apocolypse. Yet always we have survived, although not without tensions and problems. Today, the solution remains our readiness to innovate and our ability to collaborate. The enemies of these succcess factors are those who constantly focus on protecting against risk and therebydiscourage cooperation and limit the exchange of ideas.
If indeed it is trade that sits at the centre of our future success and our ability to prevent disaster, then the contracts community has a large and heavy responsibility to ensure it is not only removing barriers to to innovation, but that it is also itself innovating in the mthods through which trade occurs. We have a duty to ourselves and others to ensure that we contribute to the cultural and economic forces behind human progress.
“Thanks to the liberalising forces of globalisation, innovation is no longer the preserve of technocratic elites in ivory towers. It is increasingly an open, networked and democratic endeavour”, says Ridley. Contracts can – and must – create environments where openness, transparency and networked communication are encouraged and rewarded and where cultures of blame, risk allocation and punishment are avoided.
The decision by the Obama administration to split the responsibilities of the Minerals Management Service is just one more acknowledgement that organizations need clarity and compatibility in their goals. In this instance, creating a single organization that oversaw both revenue generation and compliance led to inherent weaknesses in oversight (see New York Times article for details).
In acknowledging that Federal authorities were to some extent lacking in their management of the industry, it seems unfair to also contemplate retroactive legislation to increase the liabilities that BP may face as a result of the oil rig explosion in the Gulf of Mexico. These threats are also potentially quite counter-productive – surely the issue right now is for all parties to collaborate in fixing the problem, rather than spending time on allocating blame? Yet that is exactly what is happening, with politicians leading the way. Once more, this illustrates how politics seems far more about finding fault in others, rather than acting in the public interest. What purpsoe was served by an inqisition of BP, Transocean and Halliburton executives at this stage? Clearly, such action was a distraction from the real issue and can only result in mutual finger-pointing by each party, none of which wants to face the potential for massive liability associated with this incident.
The break-up of the Minerals Management Service will ensure that one arm is working to maximize revenue, while the other is ensuring proper levels of compliance and quality control. The need to manage these tensions is well understood within the business world, with the pursuit of growth always needing to be tempered by the potential exposures and risks that growth entails. Certainly not all managements get it right – and at times of economic stress, the presures to cut corners can be extreme. In addition, the BP incident is just one more reminder of the complex web of relationships on which performance depends. It highlights the major significance of choosing the right trading partners, providing effective on-going oversight, and reconciling the pressures for innovation and growth with the need for proper business control and judgment.
Organizations have changed and the speed with which decisions must be made has increased. This has placed many of the ‘check and balance’ processes under great strain, sometimes because of resource levels, but also because of the scarcity of relevant skills or the lack of clarity in precise roles and responsibilities. IACCM has long focused on some of these uncomfortable questions and challenged its members and their management to address them. For example, we have opposed the idea of contracts professionals being motivated by deal-based incentives (because we believe that will impact their core role of good business judgment); we have questioned whether the skills profiles required for deal-making are the same as those in implementation and on-going management; we have highlighted the problems that arise when commercial staff are introduced too late into a business requirement or opportunity. We have also emphasized the urgency of developing commercial competence and the need for this to be supported by consistent professional standards.
The Obama administration’s move raises questions over the division of responsibilities that shoud be given careful thought by lawyers, contracts and procurement executives. To give just two examples:
- Is it right to have Procurement staff measured on savings, while at the same time having them make judgments over supplier quality and reliability?
- Should a commercial or contracts group charged with deal negotiation and management be part of a legal group which has responsibility for regulatory and risk compliance?
In both cases, this duality of role may create precisely the tensions that have been recognized within the Minerals Management Agency. By clear division of roles, we do not eliminate the tension, but we ensure it is visible and, where relevant, that issues are escalated to senior management for resolution. Through collaborative organizational models, designed around key business processes, we can also ensure joint and several accountability for outcomes, to drive cooperation in anticipating and fixing problems, rather than a culture of finger-pointing and blame.
Last week, I summarized a conference that I attended in Barcelona and undertook to write about some of the presentation highlights.
One was a session led by Sammy Rashed and Gerardo Aguilar from Novartis. They have been ‘evolving sourcing into the organizational productivity champion’. This is a cause dear to my heart because, in my experience, support functions that do not lead change are in for a sorry ending.
At its heart, the work at Novartis has transformed Procurement from being ‘a buying organization into an organization that manages buying organizations’. Internally, it has transitioned from being a service provider to becoming a business partner. This has been achieved by three core steps:
- Integration of the function into the business and a more strategic leadership, two levels below the CEO
- Category heads sit on relevant functional boards – for example, Marketing.
- The operational staff operate within the business untits, rather than as category teams.
These changes have been driven by a desire to move up-stream in terms of value and influence and to outsource traditional Procurement activities (in this case to Genpac). Re-defining the process also led to re-allocation of certain tasks – for example, efficiencies were realised by moving the issuing of orders to Finance, to sit alongside accounts payable. Internal transactional activity has largely been eliminated.
The project tackled core issues, such as demand management and cost of ownership, through the introduction of disciplines that look at what is being bought relative the value of the need being satisfied; and which introduce discipline over ‘must’, ‘nice’ or ‘smart’ to have.
The presenters summarized their efforts by explaining that they addressed ‘the need to develop cross-functional project leadership and business partnering as core capabilities’. This change was fundamental to altering the image of Procurement and the value it is able to deliver.
IACCM will soon feature Sammy and Gerardo in an ‘Ask The Expert’ interview, to provide its members with a more in-depth insight to this fascinating reengineering project which, in my view, provides a powerful insight to the future.
Whether or not you live in – or care about – the UK, there is so much we can draw from the remarkable process that has ensued from ‘the hung Parliament’ (which, according to one Russian commentator, means that all elected Members of Parliament have been hung! Perhaps in reality a move that would be greeted with the greatest public acclaim).
First, it is interesting that the media and politicians are so fixated on ‘a strong Government’ and the belief that a single party with a strong majority is desirable. They decry the need for coalitions and point to the ‘weak’ governments that result. For example, they cite Germany, where the need for behind-the-scenes compromise is invariably required. I find this observation quite remarkable when you compare the economic success of Germany with that of the UK. Perhaps compromise is not such a bad thing.
In fact, when you think about it, the countries with an adversarial, winner-takes-all political system are also those that tend to be adversarial in their contract negotiations. So perhaps a cultural shift to a situation where negotiation and compromise become the norm will lead to greater collaboration in other areas – and equip the Anglo-Saxon, common law model to fit better in an increasingly global environment.
A second fascinating aspect of the UK situation is the inter-party negotiation, with the Liberal Democrats being courted by both the major parties, giving them great strength, but also exposing them to massive future risk. Behind the scenes, there are many conversations taking place; the negotiations have many faces and represent the potential for a remarkable case study. And of course, time alone will tell us who really won as a result of their outcome.
Meantime, the Conservatives court the Liberals, while the Labour party operates a disruptive campaign behind the scenes. Gordon Brown persists as Prime Minister and demonstrates his devious methods as a deal maker or deal breaker. Will he resign or won’t he? Is the deal he offers really a cup of good cheer, or a poisoned chalice? The tricks and techniques being used to shape public opinion and to impact negotiating positions are truly fascinating. Machiavelli would have been proud of his pupils!
Leslie Willcocks, author and London School of Economics professor, recently suggested that contract management and relationship management will steadily integrate into a single competency. I discussed this idea with Dalip Raheja, CEO of The MPower Group, in an IACCM ‘Ask The Expert’ interview (see recording in the IACCM Member Library).
Dalip opened by observing that today’s contracts are used to allocate risks between the parties and ensuring rewards are set accordingly. Relationship management is typically viewed as a separate activity.
However, we agreed that ‘contracting’ should be a wider discipline, offering a strategic view of the best relationship to achieve desired results. ‘The contract’ is an output – and contracting strategy may conclude that the best approach in some circumstances is in fact to have no formal contract. This simply represents an extension of the decision on how to allocate risks.
Organizations must distinguish between the contract and the contracting process and strategy, ensuring that the form of contract reflects the nature of the required relationship. In other words, relationship definition comes first. And in the event that the relationship changes, then the contract must also be adjusted. Also, for longer term and more complex deals, the risk focus should be more on how they will be managed than on how they will be allocated.
Good contracting starts with defining the best form of relationship to achieve the desired business results. Since ‘the relationship’ will often continue well beyond contract signature, it is essential that the parties include governance principles. Dalip suggested that negotiators should think in three phases – first, relationship models; second, contracting models; and third, communication models.
Traditional Procurement and sourcing processes focus on price, rather than value. They are built on assumptions that ‘suppliers take advantage of us’. Many suppliers, on the other hand, feel that customers are ‘confused about what they really want’. This stand-off frequently results in poorly established relationships and a failure to focus on ‘value extraction’.
Our conversation confirmed Professor Willcocks’ view that contract and relationship management must integrate in order to deal with the growing complexity of today’s trading relationships, but also recognized some obstacles to this transition. One is the need for different skills among procurement and contracts staff; another is a shift in measurements; and a third is to address the challenge of organizational models and perceptions – in particular, on the sell-side, to resolve the relationship between account management and contract / commercial management.
A majority of contracts and legal professionals believe that they face growing complexity. This view is confirmed in the most recent ‘European Legal Pulse Survey’ from Equaterra.
The survey focuses on outsourcing agreements and states:
“When asked about contract complexity over the past few quarters (e.g., service levels, contract structure, pricing models, use of global sourcing, etc.), 52 percent of the survey respondents answered that the degree of complexity in contracting for outsourced services has increased (see Figure 3). When combined with the respondents who stated that complexity has remained static in recent years, the total is 96 percent. The results confirm a consensus that the contracting for outsourced services is not getting simpler through standardisation. A majority of respondents who believe that transactions have become more complex specified pricing and service level mechanics as the foundation for their conclusions. Managing and allocating risk was the second choice, with respondents pointing to transition/transformation and termination rights and fees as the areas driving complexity in contracting.”
These findings accord with the wider views expressed by the IACCM community. And they are not, of course, especially new. Indeed, there has yet to be a study that suggests people feel that contracting has become simpler. In large part, this is indicative of the fact that terms and conditions reflect the intricacies of trading relationships and the unending efforts of buyers and sellers to find new sources of advantage and success. As the Equaterra results indicate, the parties constantly seek fresh ways to allocate or manage risks, or to manage performance, or to apportion costs and rewards.
There is nothing to suggest that complexity will reduce. Indeed, it is this continuous growth in complexity – and the need for its effective management – that drives the need for commercial and contracting expertise. Through our professionalism, it is our duty to manage this complexity in ways that make it simple and understandable for our colleagues and management. And of course, we must strive constantly to deliver simplification in today’s process and tools, so that we can successfully move forward with further innovations.
Commitment Matters 