The Economist recently ran an article highlighting ‘the failings of Japanese corporate governance’. It suggested a need for more independent boards and for an ending to the heirarchical systems that prevent senior management learning the truth. The article calls for more external (ie non-Japanese) recruitment as one way to ensure change.
The concluding paragraph goes on to make a wider observation: “Many large Japanese companies are now responding to Toyota’s troubles by re-examining such matters as their use of outsourcing to drive down costs, their dependence on external suppliers (most of the accelerator pedals were supplied by an independent American partsmaker) and their relationships with non-Japanese firms. But they might want to use the incident to reconsider their own internal workings, too.”
As observed in previous blogs, Toyota was frequently ready to learn from the outside world – and indeed, its adoption of procurement practices more typical of Western companies was seen by some as contributing to its recent problems. By introducing more aggressive, cost-focused approaches to its supplier management, the loyalty and partnering implicit to ‘the Toyota way’ has been jeopardized.
At the same time, my sources suggest that contracting and contract management are not generally understood within Toyota or other large Japanese corporations. There is no centralized process or skill group, so post-award supplier management remains relatively fragmented. My suspicion is that this has resulted in increasing confusion and inconsistency. As The Economist points out, companies must become more sophisticated in the way they structure and manage trading relationships, especially now that so many of them cross traditional geographic and cultural boundaries. And that sophistication simply will not occur if contracting remains a fragmented, tactical activity with little or no management attention and starved of investment for the right systems and resources.
There is widespread agreement that collaborative relationships deliver superior results, so long as they remain focused on mutual value. But the role of contracts in enabling collaboration is less clear; indeed, there are many who believe that there is no real connection.
Some collaborative relationships emerge without a formal contract; and there are instances where collaboration develops even after a confrontational negotiation. But the evidence suggests that contracting strategy plays a large part in determining the nature of the subsequent relationship.
Last week, members of the IACCM Board of Directors were joined by executives from other major corporations to discuss collaborative contracting. There was general agreement that adversarial negotiaion and unbalanced risk allocations damage the potential for collaboration and that this, in turn, undermines innovation and realising value. It was also agreed that good contracts are those which introduce effective governance and performance management techniques. In view of this, the session sought to understand why organizations cannot make the transition to more collaborative contracting structures and procedures.
The discussion identified a wide range of barriers, ranging from ingrained attitudes to reward systems and distorted risk assessment. But it moved on to explore ways that the barriers might be overcome – and to establish an agenda for future IACCM initiatives. This included the development of a guide for collaborative contracting; continued focus on drafting balanced contract principles; and providing top executives with the data needed to understand the cost of today’s contracting practices.
This was the first of a series of IACCM ‘thought leadership’ workshops that will result in more detailed reports and action plans related to contracting and relationship management.
Many contracts and sourcing experts have struggled with the idea that ‘outsourcing’ is somehow distinct and unique. It simply appeared to be a variant on other complex or complicated trading relationships.
And indeed, as the years have passed, this judgment seems more and more correct. Outsourced relationships have intoduced some distinctive contract terms and demanded re-thinking of ways that relationships are managed, but as our world transitions to a networked and service-based economy, it is time to eliminate the myth that outsourcing requires fundamentally different approaches.
In the beginning, it was helpful to service providers to come up with a unique name and represent outsourcing as a transformational experience. Clients bought into this idea for several reasons: for executives, it suggested radical action to streamline their business; it also ensured internal focus on relationships that frequently involved significant organizational change. External consultants were enthusiastic drivers of ‘outsourcing as an innovative idea’ because they were able to suggest that success depended on specific expertise that they alone possessed.
So for a variety of reasons and motivations, business bought in to the myth that outsourcing required separate skills and reosurces. But today, it is increasingly obvious that outsourcing is simply another ‘make or buy’ decision. Business relationships run across a spectrum of complexity and the way we contract and manage them must reflect the extent and duration of that complexity. Segmentation into relationship types is helpful, but only if the distinctions between them are meaningful. Outsourcing is not meaningful; it actually confuses the picture and creates internal rivalries and unnecessary fear.
As we move to the next phase of services provision – for example, cloud computing – it is time to recognize that businesses must build an integrated contracting and relationship management capability that spans the portfolio of external partnerships that they need to compete in the market. They will need to manage this portfolio of relationships in ways that enable increased commercial agility – the flexibility to respond to fast-changing and unpredictable market conditions and risks.
Outsourcing has had its day.
Global trade fell by 14.4% in 2009, based on World Bank statistics. According to the International Monetary Fund, export volumes showed some recovery over 2008, but most of this was in the third quarter (up 3.5%) and appears to have been driven largely by re-stocking.
Economies are growing at different rates and in different ways. That means trading patterns are changing – and that the contracts and commercial professional must adjust to a world that requires far more agility. We must be ready to grasp new market opportunities, to enter new territories, to manage change and deal with new sources of risk.
IACCM‘s October 2009 quarterly survey on The State of Global Markets reflected the growth in Q3, when a majority reported stabilization and increased optimism for trading conditions in Q4. The January 2010 report indicated that there was growth for most – but not all – and also revealed variations by world region and industry. It showed a decline in the level of price-focused renegotiation of contracts, but also revealed that cost cutting remains Procurement’s number one priority.
Looking forward, the IMF is predicting that the world economy will grow 3.9% this year . although for ‘rich’ countries this will be only 2.1%. All reports reflect this buoyancy in developing markets, especially in Asia -Pacific, but spreading into Eastern Europe and South Africa. China and India are of course today’s big drivers of growth.
This shift of trading strength and growth has several implications for the world of contracting and procurement. For example, it is likely to favor consumer good producers; it is likely to sustain commodity prices; and it is likely that the dollar will remain strong against the Euro.
Copies of the latest IACCM Global Trade Survey can be obtained from info@iaccm.com
At the most recent IACCM member meeting in London, one of the presentations led to a discussion on ‘commercial agility’.
The meeting focused on the interesting dichotemy that has emerged in the executive approach to risk management. Research has shown that many businesses believe they have become more cautious in their approach to risk – hardly surprising, given economic and governance conditions. Yet in reality, the need to respond to the dramatic impacts of the recession have actually led to a significant increase in risk-taking.
When looking at all the sources of increased risk (more outsourcing, greater readiness to accept high risk terms in order to win business, rapid expansion to new markets, drastic supply chain decisions), attendees observed that the recession had accelerated a trend, rather than leading to major new sources of risk. It is actually the hastiness of many decisions – often without ‘due diligence’ with regard to possible consequences – that is the real threat.
Adrian Furner, Commercial Director at BAE Systems, suggested that this is perhaps the ‘new normal’ and that contracts and commercial groups must adapt. “Traditionally, commercial management has been about certainty. How will we change to fit with a constantly changing world?”
Adrian provided dramatic illustrations, ranging from the challenges of new markets to amazing reductions in cycle times – for example, products that used to take up to 20 years in design and test now going through the same process in a year or less. He suggested that our role must increasingly be to manage commercial agility and highlighted six implications:
- contract and commercial frameworks must be designed to manage ambiguity
- organizations must enable flexibility
- the terms governing relationships must also support flexibility – for example, anticipate switching
- commercial resources must assess and become comfortable with managing risks in new ways – for example, across portfolios, rather than individual deals; through collective acceptance and management of risk across integrated supply chains
- encourage diversity and best practice
- balance passion (to win) with objectivity
A key question for any commercial professional, he suggested, is ‘are you associated with the accelerator or the brake?’
Trade depends on trust. And in the consumer market, the emergence of ‘trusted intermediaries’ will be critical in enabling an expansion of trade, especially across borders.
For trust to flourish, buyers and sellers must each feel that there is meaningful recourse in the event of dishonest or fraudulent behavior. And based on a situation recently referred to me by a friend – and member of IACCM – eBay and Paypal currently fail that test. They have jointly created a trading forum with the appearance of a dispute resolution system, but in reality there is little substance behind it.
In this particular case, a selller had misrepresented their goods (a table), which on arrival turned out to have serious structural damage. Following the complaints procedure mandated by eBay did not work; the seller went around the system, sending increasingly abusive and threatening e-mails. He knew precisely how to play the system. Complaints to both eBay and Paypal drew no response. The only recourse against this clearly unethical seller was to leave negative feedback on the eBay site.
This drew an immediate response from the seller, who offered a substantial refund if the negative response was altered to positive feedback. He even had official forms from eBay on which this change could be made. Of course, once the review was made favorable, he simply sent a sneering note – essentially ‘Ha ha, I fooled you!’ There is, of course, no way to change the comments on eBay once the input has been made favorable.
This vendor sits on eBay right now with a 99%+ approval rating. He clearly knows how to manipulate the system – and neither eBay nor Paypal appear to care. Despirte extensive e-mail evidence of this illegal behavior, their is no mechanism for referral – except of course via litigation, which (as the seller is no doubt aware) would be far too time consuming and costly to pursue.
Does this matter? I think the answer is yes. Paypal today offers the world’s largest dispute resolution system. eBay is a core provider of trading services. It is important that global brands of this type build a robust process that can support ethical and principled trading relationships.
I am sure this is not an isolated incident – what are your experiences and what do you think should be done by way of improvement?
Recent IACCM research identified an interesting syndrome in negotiation effectiveness. It highlighted the contrast in where negotiators spend their time and the impact this has on results.
One group of negotiators operates in companies where the rules and standards are relatively well defined and understood. This group spends most of its time communicating with team members and the other side. Much of its time is either explaining the reasons and value behind positions, or evaluating and proposing variations from a mostly pre-defined set of capabilities.
The other group of negotiators comes from companies that like to believe they are either a) flexible or b) good at managing risk. These companies see negotiation as an individual art, rather than an organizational capability. Interestingly, the result is that more than 80% of the time spent by these individuals on negotiation is internal to the company. They are in fact trying to negotiate exceptions or understand capabilities.
The impact on the other side is significant. Negotiators from the first group are providing insights and information that enables the team on the other side to evaluate and commmunicate effectively. Negotiation cycle times tend to be shorter and the negotiation environment is more collaborative and open. Negotiators from the second group send confusing messages. There are often long gaps in communication and proposals are often unclear. This results in a lack of confidence and a sense of alienation.
The moral of this story is that companies which believe that negotiation talent is the answer to their business success are wrong. Of course negotiators should be trained; but those who are successful have clear understanding of the boundaries and the reasons for those boundaries. Their talent is having the judgment to understand the implications of ‘deviation’ and the ability to negotiate trade-offs, rather than compromises. Negotiation is not a substitute for business discipline; in fact, it can flourish only when there is underlying discipline.
Yesterday I featured a discussion that I had with auto industry expert John Henke, in which he highlighted the decline in supplier relations between providers and the non-US OEMs, such as Honda and Toyota. He observed that relationships have become ‘more adversarial’ and that one cause was a growing number of new staff who were not versed in ‘the Toyota way’.
There are of course key questions that must be asked regarding why this happened. The most obvious answer appears to be that Toyota has joined the cost-cutting frenzy that appears to have overwhelmed good judgment in a number of industries in recent years, especially many consumer-facing companies. And then we must ask, to what extent are Procurement groups the culprits or the victims in this story?
Of course input costs have always been a subject of focus for senior management and the consolidation of Procurement – and its emergence as a ‘core discipline’ – reflected that focus. However, has the discipline now moved out of control, or become too singularly focused? Driven by external consultants, there appears to be a belief that whatever we pay, it is too much. The advent of globalization, spend management tools, e-auctions, ‘commoditization’ techniques all led to more and more aggressive behavior towards suppliers, where the only value seemed to be low cost.
Recent developments in ‘supplier relationship management’ do not appear to have made things much better. I remember one CPO of a Fortune 50 company telling me that ‘The closer we get to our suppliers, the more we tell them that we value partnership, the more their margins fall’. This is just one of many stories I can recount where the pressure on price – often accompanied by thoughtless allocation of business risk – has undermined loyalty and prevented collaboration. Supplier relationship management is meant to fix this, but in general the way it is being implemented does not drive improvement. Firstly, it is far too narrow. Anyone who believes that just a handful of suppliers are important is fooling themselves. And even this handful are frequently subjected to the same on-going pressures on price .
The result of this focus on input cost is that everyone has been forced to cut back. Suppliers cannot afford to support the numbers of staff or the extent of the customer interfaces that would allow more integrated teams or more collaborative product development. Trust has eroded and ‘partners’ have become more secretive and protective. In an era when communication tools are proliferating, communication quality is declining. Cost cutting has resulted in many relationships becoming virtual – and none of us has yet discovered how to replicate the loyalty that results from personal interactions. Procurement has added to these changes by draconian controls over travel and meetings, by interjecting itself between suppliers and users, by eliminating even basic interactions through the use of e-auctions and similar techniques.
On one level, Procurement has been doing what it was asked to do – cutting input costs and delivering savings. On another, that unrelenting focus and the techniques that accompanied it have perhaps destroyed fundamental value and left business reputations exposed.
Any group that positions itself as ‘professional’ is surely responsible for analyzing the consequences of its own actions. Executive management may ultimately be accountable, but the Procurement community (and its professional associations) must surely have responsibility to alert management to the consequences of those actions.
It is time for Procurement to hold itself to account and ask some tough questions about the broader role it plays in corporate success. It must learn the fundamental value and techniques of collaborative behavior, as well as analyzing more thoroughly the performance impacts of some of the tools and techniques that are now commonly used. It is a great opportunity; and the Toyota experience indicates that this evaluation is urgent.
The warning signs have been there for a couple of years, according to industry expert John Henke. “Toyota relations (with suppliers) have dropped precipitously during the past two years. New people hired in North America in the last three years or so have not learned ‘the Toyota way’. As a result, supplier relations are not as close today as they were for years.”
John Henke was commenting on the recent recall crisis that has dented the Toyota image. He was talking to me on an IACCM ‘Ask The Expert’ interview, where we discussed supplier relationship management (recording of the full interview available at www.iaccm.com) John knows what he is talking about. As a Professor of Marketing and President of Planning Perspectives Inc., he has undertaken studies of manufacturer – supplier interfaces in the automotive industry for almost 20 years. Throughout the last decade, he consistently warned the big US OEMs that their market behavior was destroying supplier trust and loyalty … but of course, they chose not to listen.
In the interview , John outlined the ‘Working Relation Index’, a method he has developed to test the health of supplier relationships. “Toyota still has relatively good supplier relations,” he observes. “But in recent times, there has been more evidence of an iron fist. There is still a sense that if you meet requirements, you can be a supplier for life. There is still a sense of the kindness that if you fail once, you will get help to restore and maintain performance.” But that kindness seems to be eroding, with the culture moving towards cost-cutting and some of the more aggressive practices that are typical in the United States.
Market conditions demanded rapid actions on cost reduction and this led to ‘heavy-handed’ actions which have been noticed by suppliers. “The issue is ‘adversarialism'”, says John. “A study in 2008 showed that price reduction pressure in itself has no impact (on relationships), it is the manner in which it is done that matters.”
The way that the relationship is structured and negotiated is key to setting expectations – and therefore contracting and terms and conditions really matter. Good performance depends on a sense of fairness, on good communications, on mutual opportunities to make money. John listed examples such as shared benefit from supplier-created savings, visible rewards for doing a good job (for example, more business), a sense of partnership in raising quality or efficiency. Without these characteristics, there comes a time when the supplier asks “Is it worthwhile doing business with this customer?”
John observed that within most companies, there are dramatic differences in supplier satisfaction, varying between geographies or business divisions. Yet few companies are good at analyzing or sharing this information, in order to understand and adopt improved practices enterprise-wide. The growth of interest in Supplier Relationship Management as a discipline is in part a response to this inconsistency and also to the need to better manage risk. However, there is no agreement on the form that SRM should take. For example, is it a special program restricted to a select few suppliers? Is it an extension of Procurement or a separate businesss discipline?
I will write more on John Henke’s opinions and research on those topics shortly.
Many who emphasize the importance of good relationship management are dismissive of the role of contracts. Even those who acknowledge their significance often take the view that the importance of the contract diminishes over time. For example, an article I read in the Financial Times last week took the line that ‘Contracts matter at the inception of a relationship, but steadily fade over time’. And in some cultures, the contract is variously seen as irrelevant, purely a legal instrument, or a Common Law intrusion.
I sympathize with these perspectives. After all, many companies have flourished without spending time or money on creating contracts. They built and managed satisfactory supplier and customer relationships without a need for lots of legal mumbo-jumbo.
But times have changed; business models are quite different from the way they were 20 or 30 years ago; organizational structures are flatter and leaner; relationships are more global and frequently more volatile; the demands of society, shareholders and regulators have altered. And whether or not we like these changes, they are forcing us to adapt the ways we establish and govern trading relationships.
Much of the complexity we face today is due to the fact that we are dealing increasingly with the unfamiliar (new markets, new partners, new technologies etc) and also with a greater speed of change. In combination, these factors create fascinating opportunities for success – but they also represent a source of major risk. This blog has highlighted both extremes in recent articles.
There is no question that the quality of relationships and their management is key to business success. After all, trade depends upon some level of trust and this in turn implies an appropriate relationship. I am also firmly of the view that many aspects of the traditional contract do become less significant over time, as a relationship matures. But at IACCM, we have always differentiated between the ‘passive’ areas of contract (the parts such as liabilities, indemnities, force majeure that require no day to day oversight), versus the ‘active’ clauses, such as change management, payment terms, service levels etc. It is in these active areas that the potential for misunderstanding arises; and with the increasing volatility of markets and business requirements, there is always a need for a relationship – no matter how strong it is – to have good governance procedures. These include the need for clarity and communication between the trading partners and within their organization.
So in my opinion, 21st century business depends on more formal methods to establish and oversee the performance and value of trading relationships. Commitments and obligations need to be recorded and monitored far more rigorously than they were in the past. As many of us know, if these activities rely on informal procedures, they do not work well – and tend to lead to either under-performance or dispute.
This is why – in my view – we are seeing a growing integration between relationship management and contract management. Successful business relationships require clarity, mutual understanding and agreed channels for performance and change management. Whether or not we choose to think of the capture, communication and recording of commitments and obligations as ‘contractual’, the truth is that good business relationships depend upon the disciplines that result from sound contracting practices.
Commitment Matters 