A shift in procurement practices from awards based on price to awards based on value is much discussed and, for most people, long overdue. All the evidence suggests that many organizations continue to struggle with making the change.
Awards based on lowest price and measured on negotiated savings are simple to assess and manage. For many commodity products, they continue to make sense unless a supplier can prove otherwise. But more complicated acquisitions, and especially those involving services, demand a rather more holistic approach that takes account of lifetime costs and benefits (not all of which may be directly financial in nature).
Barriers to change
Several factors are impeding progress. The change is more dramatic than it sounds and impacts many areas of the business, as well as the supply base. Finance must buy in and contribute, often validating the benefit assessments. Business units need to supply relevant data and often product management or engineering will be required to provide input. This demands levels of collaboration and data that are hard to achieve. Also, suppliers need to buy in to the process and provide reliable information – much of which they may not possess.
Ultimately, many see the short-termism of markets as the major barrier. CFOs are reluctant to promote the shift from ‘negotiated savings’ to ‘’value’ because of the short-term impact this would most likely have on purchase price. However, this is neither inevitable nor insuperable. One contributor can be the shift from products to ‘as-a-service’. Another may be the need for buyers and sellers to negotiate shared-benefit agreements.
Making the transition
Transitioning to value for money represents a benefit to both customers and suppliers. Its achievement requires increased openness around financial data and a greater readiness for partnering. Until then, value for money seems set to remain the exception, rather than becoming the norm.
Do you have examples of ‘value for money’ contracting that you can share, and how they were achieved?
This quote, taken from the latest edition of Supply Management magazine, will be welcomed by many as recognition that it’s actually the results of an acquisition that matter. For too long, they will say, Procurement has been happy to oversee inputs, ignoring the fact that it is contract management that oversees outputs and the actual delivery of value.
I have never forgotten the words of one very senior executive who recognized this issue when he observed that “organizations frequently undertake a perfect procurement and achieve completely the wrong outcome”. He understood that ‘procurement’ is actually just one element of a much bigger process.
Many contribute to disappointing results
There can be little question that traditional procurement practices are increasingly misaligned with business interests and have not adjusted to the realities of today’s markets. However, it would not be fair to heap the blame for that onto Procurement functions. They do what they are told and trained to do. Well-managed procurements are frequently let down by others – for example, Legal providing inappropriate templates, the CFO demanding draconian savings, the business unit failing to manage supplier performance. If Procurement has failed, it is a failure of its leadership to challenge and be adequately vocal in pushing for change. In this, they have often been let down by external experts – the consultants, advisory firms and training organizations that should be assisting in preparing their teams and processes for the future but instead have focused on issues like compliance, commoditization and category management. Procurement has been led down far too many blind alleys.
Where IACCM enters the picture
The International Association for Contract & Commercial Management was founded precisely because of these chronic issues. Procurement – like Sales – is just one of many specialist disciplines. ‘Contracting’ is an overarching competence and capability. It needs ownership. When it’s left to chance, things go wrong. Often badly wrong.
For 20 years, IACCM has worked to overcome entrenched attitudes and innate resistance to change. During this time, it has directly engaged with and trained over 200,000 people who understood there must be a better way. Its research, training and advisory services have enabled massive progress for the organizations which have grasped the fundamental truth that customers and suppliers depend on each other for success and are working to develop open, cooperative relationships, founded on honesty and integrity. IACCM espouses collaboration and believes in inclusive behaviors that generate mutual, shared benefits for customers and their suppliers.
In the end, does this mean that contract management is ‘more important’ than Procurement? No, it doesn’t. They are different disciplines and they must complement each other. What is true – and the real issue here – is that both are subservient to the overarching ‘contracting process’ and must align with commercial goals and strategies. Unless there is focus on holistic development of commercial capability, simply changing names or expanding the Procurement remit delivers at best marginal improvements and could even make things worse.
IACCM’s recent benchmarking report provides insight to the current state of contract and commercial management organization and performance, highlighting also the leading practises that generate improved results.
Most business-to-business negotiations are destroying potential value. Rather than engendering trust, they sow the seeds for discord.
The problem
Ask any hostage negotiator about how to achieve success and they will tell you that it isn’t through intransigence, threats or deliberate tabling of unacceptable terms. Yet examine typical business negotiations and these are traits that frequently occur. The more powerful party tables one-sided terms and demands compliance. They typically claim ‘everyone else accepts these terms’ (I.e. if you don’t, we won’t do business); and in many cases, the counter-party responds by tabling their similarly one-sided terms.
This isn’t negotiation. In many ways, it is negotiation avoidance. It is based on a lack of trust and a fear of failure.
A different approach
If we want better results – and I hope we all do – there’s a need for a different approach. Here are three principles to consider:
- Confront perceptions. It is clear that many negotiations are compromised by unspoken assumptions or beliefs. Unless these ‘elephants’ are addressed, there will not be trust and without trust, confrontation is inevitable.
- Send negotiators, not roadblocks. Often, suggesting that negotiations are occurring is a bad joke. One or both parties frequently send people whose job is to enforce compliance. They lack authority and have no interest in showing empathy or acting as an advocate for the other side.
- Build common ground. Ultimately, high performing relationships are built on shared principles and goals. Yet because the elephants aren’t addressed and because the negotiators have limited authority, it is very unlikely that common ground will be explored or established.
Ultimately, while organizations are responsible for performance, it is people who set the scene. Until these three principles are addressed, we can’t expect results to improve.
“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.”
That quote comes from an edition of The Economist, almost 10 years ago, reviewing a book by Matt Ridley that addressed the importance of human optimism (a major theme for IACCM this year, with further research to be unveiled at the IACCM Americas conference in November).
Contracts and trade
Contracts sit at the heart of trade. They are the ‘boundary objects’ that define roles and responsibilities, reward and consequence. In addition, as other recent research by IACCM confirms, they influence whether or not innovation and continuous improvement occur (report available on the IACCM website).
It is this culture of striving for continuous improvement that drives and provides incentive for innovation, enabling human aspiration to become a reality. However, such aspiration is rapidly undermined in an environment that is seen as punishing or risk averse – the characteristics of many of today’s contracts. Assumptions of failure or disaster are frequently self-fulfilling. The IACCM research confirmed that those who place their primary focus on protecting against risk thereby discourage cooperation and limit the exchange of ideas.
A heavy responsibility
If indeed it is trade that sits at the center of our future success and, more broadly, our ability to prevent disaster (including, for example, from climate change), then the contracts community has a large and heavy responsibility to ensure it is not only removing barriers to innovation, but that it is also itself innovating in the methods 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.
Agility is defined as “the ability to move quickly and easily”. It is an attribute that today’s business considers highly desirable, yet typically struggles to achieve. Research shows this is particularly true for the contracting process and the management of external relationships.
Agility in the context of contracts
it is important to distinguish here between contracts for agility and having a contracting process that is itself agile.
‘Agile contracts’ are simply a form of agreement that supports the parties when undertaking agile performance. But the act of preparing an agreement is just one small component of the overall transaction or relationship and enabling agility through a set of contract terms is very different from actually having an agile commercial process.
There is little question that most people would like to make their trading relationships more agile. Quick and easy to identify the right supplier or customer; quick and easy to reach agreement on the terms; quick and easy to undertake delivery; quick and easy to make changes or secure improvements. But as IACCM’s 2019 Benchmarking Study shows, ‘quick and easy’ is not a description that can typically be applied to the overall contracting process. While the simplest transactions (such as buying off Amazon) may be ‘agile’, as soon as something enters the more formal sales and procurement process it becomes subject to delay and complications. And even when one aspect of that process has been made ‘agile’ (for example a catalog buy), it doesn’t guarantee that other aspects of the downstream process have the same characteristics. Indeed, fragmented action may even make the downstream process even more complicated and inefficient.
Tackling a mismatch
One major finding by IACCM – and now the subject of further in-depth research – is the fact that the contract terms and the governance models used to support each trading relationship are frequently not ‘fit for purpose’. There is, quite simply, a mismatch between what the parties want to achieve and the contract and contract management model that they deploy to achieve it.
Ironically, one major reason for this turns out to be that efforts to be ‘agile’ in entering into the contract result in overall rigidity and loss of flexibility in its performance. Specifically, both buyers and providers tend to be wedded to the use of standardized contract templates that are frequently designed to limit agility and which are themselves not readily adjusted to reflect specific aspects of the required relationship.
Becoming agile
Agility is itself often seen as complex. IACCM’s work with a group of major corporations (its Ressarch Forum members) is proving this not to be the case. What is perhaps the most challenging aspect is finding people with the mental agility to recognise that they really can make things better!
In a series of mini-conferences, which started this week in India, IACCM will inspire its members with the insights they need to drive new conversations and discover new levels of agility and value in their trading relationships. Key to this is starting to think and act holistically in managing the contracting process
Agility is defined as “the ability to move quickly and easily”. It is an attribute that today’s business considers highly desirable, yet typically struggles to achieve. Research shows this is particularly true for the contracting process and the management of external relationships.
Agility in the context of contracts
‘Agile contracts’ are typically thought of simply as a form of agreement that supports the parties in undertaking agile performance. But of course, preparing the agreement is just one small component of the overall transaction or relationship and enabling agility through a set of contract terms is very different from actually being agile.
There is little question that most people would like their trading relationships to be agile. Quick and easy to identify the right supplier or customer; quick and easy to reach agreement on the terms; quick and easy to undertake delivery; quick and easy to make changes or secure improvements. But as IACCM’s 2019 Benchmarking Study shows, ‘quick and easy’ is not a description that can often be applied to the overall contracting process. While the simplest transactions (such as buying off Amazon) may be ‘agile’, as soon as something enters the more formal sales and procurement process it becomes subject to delay and complications. And even when one aspect of that process has been made ‘agile’ (for example a catalog buy), it doesn’t guarantee that other aspects of the downstream process have the same characteristics.
Tackling a mismatch
One major finding by IACCM – and now the subject of further in-depth research – is the fact that the contract terms and the governance models used to support each trading relationship are frequently not ‘fit for purpose’. There is, quite simply, a mismatch between what the parties want to achieve and the contract and contract management model that they deploy to achieve it.
Ironically, one major reason for this turns out to be that efforts to be ‘agile’ in entering into the contract result in overall rigidity and loss of flexibility in its performance. Specifically, both buyers and providers tend to be wedded to the use of standardized contract templates that are frequently designed to limit agility and which are themselves not readily adjusted to reflect specific aspects of the required relationship.
Becoming agile
Agility is itself often seen as complex. IACCM’s work with a group of major corporations (its Ressarch Forum members) is proving this not to be the case. What is perhaps the most challenging aspect is finding people with the mental agility to recognise that they really can make things better!
At a forthcoming series of mini-conferences, starting this week in India, IACCM will be inspiring its members with the insights they need to drive new conversations and discover new levels of agility and value in their trading relationships. Key to this is starting to think and act holistically in managing the contracting process.
The ideas behind value engineering are not new. In fact, they go back to the 1940s, when the construction industry in particular was seeking new and more scientific ways to guide its purchasing decisions. It would not be unreasonable to assume that the methodology and its use would have matured by now. But you would be wrong; it has actually gone backwards.
In its latest edition, Architectural Products (a US industry publication) states the following:
“Today, value engineering in construction has fallen far from its origins, with products being chosen and changed out simply because
they are cheaper, many times sacrificing performance and longevity. This new process is no longer about creating actual value. Acknowledging that budget is always a concern, there must still be a better way.”
Is modern procurement practise ‘dumbing down’ decisions?
One conclusion clearly could be that the procurement practises of recent years (driven by an obsession with short-term financial results) are at fault. ‘Value’ has often been overtaken by ‘price’. Measurements are based on input costs, not outputs or outcomes over time.
It is clear that there is some validity to this view. In spite of (or arguably in some cases because of) the massive investments in technology, corporations seem to lack the ability and incentives to operate on objective judgments of value. And, as incidents such as the Grenfell fire and the Morandi bridge collapse illustrate, that can prove extremely costly in terms of lives, reputation and money.
But is it that simple?
Today, at least in principle, we are seeing a massive shift in those social values. The concepts behind sustainability demand a rethink of the measurements and behaviors that underlie the disposable culture. So will value engineering experience a rebirth? I like to think the answer is yes – and indeed it lies at the heart of work IACCM has been undertaking to redefine principles for contract governance and performance management. Those principles draw on another concept from the world of engineering – that is, uncertainty analysis.
As part of its research, IACCM has recognized the need to build strong connections between the methods deployed in engineering and those in contracting. Together, they can provide users (whether in Procurement, Project or Contract Management) with powerful tools to better segment their commercial decisions and supply relationships. The result, we believe, will be delivery of true value, both to business and to society.
Almost 90% of Procurement and Contract professionals expect major growth in ‘as-a-service’ offerings, with a quarter believing they will rapidly come to dominate the market.*
Is that a far-fetched prediction? In many ways not. As-a-service offers the buyer many benefits – eliminating capital outlay, providing greater flexibility, avoiding redundant or outdated systems and equipment. It is therefore very much in tune with our age, providing rapid gratification through on-demand, affordable access to products and services.
Suppliers in some cases face high set-up costs, due to the need for asset investment. But often they don’t – for example, in the case of platform providers who draw on the assets of others (Uber and Airbnb being the frequently cited examples). As the range of as-a-service offerings increases, it will become more and more difficult for traditional businesses to compete.
As IACCM’s recent study on as-a-service indicated, there is variability in offerings. They range from a one-size-fits-all standard, to mass customized, to fully custom design. This has a major impact on cost and commitment, hence there are significant variations in contract terms and negotiability. At the lower end, the contract is potentially fixed and non-negotiable. At the upper end, the customer may be looking for a guaranteed outcome and dictating many of the terms.
One key lesson from IACCM’s research is that many sectors of the market are not yet fully conversant or aware of the implications and practices associated with as-a-service offerings. This is in part due to the inexperience of buyers, but also suppliers have in many cases failed to think through key aspects of the capabilities needed to support such a fundamental shift – in particular the implications for Sales skills and the ability to ‘educate’ their customers.
As-a-service in many cases creates longer term relationships and an increased level of interdependency. Having appropriate contracts and contract management competency is therefore a critical component of these offerings.
Based on polling over 180 participants in a recent IACCM webinar (webinar recording available at www.iaccm.com)
Formal, institutionalized corporate governance is a relatively recent concept and still maturing, yet few today would suggest it is unnecessary.
Given this fairly recent focus, it is perhaps no surprise that contract governance is some way behind in gaining executive (and regulatory) attention. Yet arguably, the institutional management of an organization’s trading practices and relationships is just as important as the management of its internal relationships and controls. That is why it must become an area for serious focus and improvement.
Not entirely new
Just 10 years ago, Oliver Williamson was awarded the Nobel Prize for Economics, recognizing his work on transactional costs within contracting. Thirty years before, he had written a seminal paper on contract governance, in which he focused on commercial contracting and concluded: “The efficient organization of economic activity entails matching governance structures with transactional attributes in a discriminatory way”. In current terminology, that means transactions must be segmented based on specific characteristics (such as risk, value and uncertainty)and then a variety of contract management methods must be available to support them.
A serious gap
IACCM research has identified the continued absence of sophisticated segmentation techniques as lying at the heart of contract value erosion. Essentially, contract governance is at best partial in its coverage, with the greatest maturity applying to relatively low value and / or high frequency transactions. While these are important for efficient and reliable operations, they are rarely critical. When it comes to longer term or strategically important relationships, contract governance is rarely well defined or managed.
This matters for many reasons. It results in cost overruns, delayed or missed revenues, massive increases in transactional cost, contentious relationships and potential reputational risk. Yet while so many of these damaging issues could be avoided, traditional approaches remain intact, often resulting in inadequate supplier selection techniques, inappropriate forms of contract, value-eroding negotiations and poorly defined and equipped post-award operational teams.
Addressing the problem
Not all is doom and gloom. As with any problem, the initial challenge is to gain recognition that it really is a problem. Then comes the need to demonstrate it can be fixed. In the case of contracts – just like corporate governance – the big issue is the enormity of action required. Contracts and their performance permeate just about every corner of the business – as well as the counter-party’s business and potentially beyond. There is no ‘owner’ of contract governance in today’s corporations – it’s just too complicated.
But change is in the air. Executive awareness is growing and emerging technologies are starting to offer the critical components needed to drive integrated data flows, to provide on-demand information and knowledge – in short, to deliver a backbone that supports the mapping and implementation of differentiated contract governance structures.
As the world’s only non-profit association for contract and commercial management, IACCM has spent years researching and designing improved methods. Unique in its worldwide coverage and integration of both buyer and supplier perspectives, it has been able to develop ideas and methods that truly enable rapid and major advances in contract governance. These are exciting times!
Negotiating something as fundamental (and emotive) as Brexit was never going to be easy. In the end, it has turned into a fascinating case study that will doubtless be used and cited for decades to come.
What happened to BATNA?
Establishing a ‘best alternative to a negotiated agreement’, or BATNA, is a well established principle in every negotiation handbook. It is fundamental to each party’s power. So what happened with Brexit? In their wisdom – or perhaps determined to undermine the process – the UK Parliament promptly removed any possibility of a BATNA by insisting that there must be a negotiated agreement.
Any incentive that the EU may have had for meaningful negotiation was thereby removed.
And what about stakeholder management?
A second key to successful negotiation and a positive outcome is to understand and manage stakeholders. In the case of Brexit, this was perhaps an insurmountable task, given the multiplicity of agendas that needed to be considered. This was again evidenced by the UK Parliament where three years of debate yielded plenty of insight to what they didn’t want and very little on what they did want. Again, scarcely a backdrop for effective negotiation and not a credit to the democratic process.
In the EU, stakeholder management is a process of building internal consensus through compromise – a process that results in little flexibility and a culture of last minute decisions.
A lack of vision
Ultimately, the big problem with Brexit is the absence of vision. Without a meaningful goal, it is impossible to unite people in its achievement or to undertake a mutually acceptable negotiation. On this score, both the EU and the UK are at fault. It was in both party’s interests to establish a vision for the future relationship and the positive aspects this might bring, but neither could bring themselves to this level of maturity. Ironically, it was this very issue of ‘lack of vision’ that in my opinion led to the Brexit vote in the first place.
But that is another story!
Commitment Matters 