During a recent webinar, a participant asked whether there is such a thing as a ‘contract quality index’ – some method or algorithm by which an organization might judge its contracts.
A typical definition of ‘quality’ goes something like this: it is “the standard of something as measured against other things of a similar kind; the degree of excellence of something”. But of course for this to be meaningful or measurable, we must decide what represents excellence. And that is where the problem comes from.
Defining purpose
If I buy a car, or call a help center, I am quite clear about my purpose in doing so and can judge whether that purpose has been met. I will also be able to compare the experience with other cars or help centers. But what about a contract – what is its purpose? A recent IACCM survey illustrated the dilemma which is that contracts have multiple purposes and their relative importance depends a lot on who you ask.
However, top of the list – and therefore perhaps a good place to begin – is that the purpose of a contract is to ‘provide a record of the rights, responsibilities and obligations of the parties’. So if we use this as the indicator of quality, what measures might we use to determine success? The most obvious would be whether or not there are subsequent disagreements due to different interpretations of those rights, responsibilities and obligations. On that measure, a relatively high proportion of agreements fail the quality test and by understanding the causes of that failure, we could take steps to improve quality (e.g. was it poor drafting, poor negotiation, failure to involve the right people?). Such improvements could then be monitored, allowing a benchmark against both the outside world and against one’s own past performance.
Feature versus Function
But is a contract’s purpose really to provide a record of rights, responsibilities and obligations? On this measure, I could have thousands of perfect contracts and still go out of business. Contracts (certainly those related to sales of goods or services) are core business assets. The mark of a good contract – its function – is whether or not it generates profit. In that context, things like clarity of intent are indicators, not core purpose. Many would argue that the contract is just one contributor to profitability and they would of course be right, but there is increasing evidence that ‘good’ contracts (i.e. those of high quality) are actually major contributors. Contracts often set the tone (e.g. are they fair?) and the context (i.e. are they clear?). They set the framework for operations (i.e. are they understood?) and for managing change (e.g. are they adaptive?).
As these examples indicate, it is certainly possible to create a ‘contract quality index’ so long as you are first clear about the purpose your contract is beig designed to fulfil. Sometimes, this will require healthy internal debate – for example, over the relative importance of a contract being clear and easily understood, versus following traditional structure and wording; or (even more significant) over which terms and conditions really need to be negotiated to support the defined purpose. Such debates are held too rarely – and that, of course, is why very few organizations have any real idea whether their contracts meet any form of quality standard.
This update offers a summary of contracts and commercial news from the last week. In this edition:
- FCPA – Agents & Consultants strike again
- Complexity and Partnering in Construction Projects
- In-house legal and technology adoption
- Continuing momentum for blockchain
- Choice of Law in Cross-Border Sales
Panasonic Avionics settled for total fines of $280m for breaches of the Foreign Corrupt Practices Act. It was accused on entering into agreements with a third-party service provider in China and making payments to ‘consultants’ who never performed consulting work. This is the latest in a long series of accusations against corporations in the defense and aerospace sector, typically involving various forms of third-party intermediaries. Contracts and commercial staff must be vigilant and be ready to question the legitimacy of third-party involvement in major transactions.
In-house legal groups are working harder to control their budgets – in particular through increased use of technology. E-billing and automated invoice review, together with greater use of measured KPIs, are being used to improve the management of spend with external law firms, which represents over 60% of the typical legal department budget, according to research by The Blickstein Group and Exterro. A similar percentage of legal departments report that they are under pressure to cut costs – a topic that is also being explored by IACCM in a current survey (to participate, click here).
Blockchain and the Supply Chain show continuing signs of convergence, with committees from the US Congress due to hold a hearing on the use of the technology this week. Recent announcements from major corporations have confirmed the rapid spread of blockchain, especially in the filed of logistics, where is can automate many steps in the process, especially around traditional paperwork. Among potential break-throughs, blockchain clearly could be a key element in the continuing deabate between the European Union and the UK over how to manage customs controls post-Brexit.
Construction projects are well-known for long delays and substantial cost overruns. IACCM has not been alone in its investigations into why these issues occur with such regularity – and, more important, how they can be avoided. Already we have evidence that traditional contracting practices are a major element in driving the adversarial behaviors that tend to typify the industry. An article on Complexity & Partnering in Construction Projects has just been published in the latest edition of Connect, the magazine of the ICCPM. Members of IACCM will also benefit shortly from the release of findings from an IACCM study of successful major projects in the construction and oil and gas sectors, indicating the contract and commercial practices that underpin that success.
Choice of law in cross-border sales is often a point of contention and a new book seeks to offer guidance on the best ways to determine and resolve the issue. It makes the point that decisions are often not rational and the book seeks to provide negotiators with guidance on how to evaluate the issues and facilitate more efficeint outcomes. IACCM’s research indicates the importance of htis topic in assisting the development of more balanced agreements and also in reducing cycle times for concluding contracts. The book is called ‘Rethinking Choice of Law in Cross-Border Sales’ and is written by Gustavo Moser.
Not only are comic contracts not a joke, they are indicative of the way forward. And not only is it socially responsible to make contracts understandable, it is also good business.
It doesn’t matter what statistics you choose, most people cannot understand contracts and many don’t try – they just sign. And of course this attitude relegates ‘the contract’ to a position of limited importance. It is an annoyance when it causes delay, a source of celebration when signed and a potential weapon (or defence) when things go wrong. But a tool for communication? Not really. A brand promise? Rarely. A source of corporate pride? That really is a joke.
It can be different
A recent article by J. Kim Wright illustrates that things don’t have to be this way. For years, IACCM (the International Association for Contract & Commercial Management) has promoted contract simplification and has offered its Contract Design Award to those who design for users, rather than remain stuck in 18th century legal tradition. There are many good reasons for thinking differently – and of course it doesn’t have to involve turning the contract into pictures. Indeed, the section of the article that most struck me was this:
”As they took the long and cumbersome contract apart, they became more and more aware of terms that did not fit their values or culture. They had to reverse-engineer the complex lawyer-focused agreement to get back to the true intentions and needs they wanted to address in the contract. What were they really wanting to accomplish? How would their contract reflect their workplace culture and values?”
Do your contracts reflect your business values?
Throughout my career, I have found most top executives to be disengaged from the contracting process. They see contracts as necessary, but not of real interest or relevance. Yet as the above section illustrates, a contract tells you about a business, its true beliefs and ethics. It is their commitment – or lack of commitment – to the market. As former IBM Chairman and CEO Lou Gerstner once said:”Contracts are about brand image”.
In some of the best and most successful businesses, I have been fortunate in seeing a very different level of executive engagement, where the CEO actually wants to test and align ‘what we say versus what we actually commit’. For many, doing an honest evaluation is a scary, controversial and eye-opening experience because they come to realise the scale of mismatch between their public and marketing statements, compared with the actual commitments contained in the contract. But having that alignment is the real route to sustainable growth, to ensuring true ‘ease of doing business’.
Is it really the case that contracts should be about minimizing commitments or – far worse – trying to take advantage of people, of suppliers, of customers? Is that the standard of ethical behavior to which you and your business aspire? If not, then it’s time to undertake an evaluation, to bring your contracts into line with your value system – and perhaps to make them something that is designed for users, a source of pride, a communication that can be understood. Now that really would mean that your contracts were not a joke.
Business models must be adaptive and often need to change fast. Business models dictate required operational capabilities, commercial policies and practices and market relationships. All of these elements combine to determine the types of contractual relationships and terms that will be needed to support organizational goals and strategies.
There are multiple alternatives for a business model. For example, it might be based on the typical ‘razor and blades’ approach where something is given almost free in order to attract future high-margin sales; or it could be a low-cost model, where power is exerted over a supply chain to compete on price; a bricks and mortar model, as opposed to an on-line platform; a product and services model, as opposed to a lease or ‘as a service’ approach. The list goes on – and of course each of them has an impact on market relationships and the consequent approach to contract terms.
The business challenge
On the surface, it doesn’t sound like it should be especially difficult to shift from one model to another. Of course some are more complicated than others – for example, shifting from a bricks and mortar approach to an on-line presence has proven challenging for many. But doing something like changing terms and conditions is, after all, just a paper exercise.
In reality, it is much harder than that. Contracts are in part a promise to the market, but they are also a protection form the market. They are in many ways ‘where the rubber meets the road’ – what can I confidently commit without taking an unacceptable risk (or put another way, without lying or breaking my word)? And that is where the problem arises, because a shift in business model also requires a shift in capabilities – and often it turns out that intent has outrun reality.
But the problem is bigger than that. Contracts and legal groups frequently don’t have experience in tthe new model and may not know what form the new contracts should take. They also face the question of what to do with existing contracts and relationships, how to manage a transition. Often they encounter internal barriers from groups that either don’t understand or don’t want to make the change.
It’s all about agile
As mentioned in the introduction, market and competitive pressures are causing shifts in business model much more frequently than in the past. Traditionally, contracts and leagl groups tended to wait to be told what to do. That’s no longer good enough. Indeed, high value groups increasingly act as market obervors, proactively monitoring competitive terms and conditions so that they spot the shifts in offerings and identify sources of competitive advantage. Such groups remain in the minority; IACCM capability assessmetns frequently reveal the extent to which contracting practices and terms lag behind corporate goals and strategies. That is not a good thing; contracts and commercial teams need to become the eyes, ears and voice of the business when it comes to commercial policies.
Skills: “It is vital for you to have a system in place that can track and analyze the skills your people already have — and those they may need soon.” A PwC / Said Business School report highlights the fears of CEOs regarding skill shortages, especially as businesses need to adapt to new forms of automation. Commercial skills – especially related to aggregation of data, problem solving and business acumen – are high on the agenda. Traditional skills, such as contract drafting, obligation management and bid management, steadily decline in importance. IACCM members are increasingly testing their skills and future readiness by undertaking the on-line IACCM skills assessment, which also provides a benchmark against peers and guidance on how to address skill gaps.
Barrier or contributor?: this week’s conference of Corporate Legal Operations counsel featured a panel discussion on contract value. The debate highlighted the two faces of legal groups, with some appreciating that contracts are key business enablers and that Legal must contribute to ‘making their business the counter-party of choice’. Others still see the contract – and their role – simply as a legal instrument that operates as a barrier to claims and disputes. It is this latter group who too often limit the ability of others in the business to optimise value. When contracts act as a barrier, they stifle creativity – and for large corporates, that is still far too often the case.
Big Tech and contract terms: in yet another pushback on ‘unfair terms and practices’, the European Commission is drafting plans for small businesses to mount class action suits against big tech companies. Unfair practices include unilateral rights to change contract terms, unbalanced dispute resolution provisions and lack of ‘appropriate transparency’. Perhaps not surprisingly, the big tech companies are complaining, but IACCM predicts they will fail in their protests. Increasingly, unfair or unbalanced practices are being seen as an abuse of power that contributes to the erosion of social trust.
Does outsourcing work?: ultimately, organizations delude themselves when they think they can outsource risk. An excellent article http://www.publicfinance.co.uk/opinion/2018/01/lets-shed-some-light-public-sector-contracting challenges whether outsourcing really is the right solution. Too often, the short-term appeal of cost reduction outweighs the mid-term possibility of service disruption, reputational damage and added expense. Commercial staff in both customer and supplier organizations must become more proficient at checking capabilities and ensuring that contracts are economically viable.
A weekly round-up of stories and events from the world of commercial management.
Why do IT contracts fail? According to an article in Information Age, the number one reason is the way that buyers squeeze supplier margins. Starting with negotiations that focus on price rather than value, then inserting terms that seek recompense for any shortfalls, but no rewards for success. Ultimately low margins threaten outcomes. Of course, the situation isn’t helped by poorly prepared technical specifications, changing requirements and the buyer’s often one-sided view of flexibility. (While recognising these issues, IACCM’s experience is that providers are not blameless. Failures can also result from overstatement of capabilities and opportunistic pricing during development and implementation.)
Consultant contracts lack transparency, accountability: that’s the conclusion from a study by the Melbourne School of Government. They feel that far too many consultancy agreements are awarded by Government without real clarity of purpose and often that details are shrouded by confidentiality provisions. As a result, no one can evaluate value for money. This recurrent issue – especially as it relates to the scale of spend with the major consultancies – never seems to be any closer to resolution. Decisions on contract award often appear driven less by value and competence and more by the sense that ‘I can’t be blamed if I select one of the big four’.
Smart ledgers offer boost to world trade: IACCM was delighted to partner with Z/Yen, the Centre for Economics & Business Research and the Cardano Foundation on a research project exploring the impacts of blockchain technology on world trade. At a launch event in the UK parliament, the CEBR estimated a contribution to growth of up to $140bn and that is just the impact that smart ledgers could have on limited areas of the trading process for goods. Once their full benefit to goods and services is realised, the impact will clearly be much greater. As Samsung’s recent announcement illustrated, the momentum for blockchain’s use in contract performance is accelerating.
Which way Procurement?: Phil Ideson produced an excellent summary of some recent reports on the future of Procurement. It does not provide an optimistic outlook, with consultants and analysts apparently sensing a function without a rudder, moving nowhere. But the reports themselves seem to offer little direction, simply repeating calls to ‘become a trusted adviser’ and ‘be more strategic’. I find it interesting that IACCM offers its members a very clear vision for their future and sets out the path to get there, but perhaps that is because we focus less on the function and more on today’s business needs. As we discussed at the Supply Chain Research Council meeting this week, the gaping hole in most organizations is the field of contracting – a field that focuses on lifecycles and outcomes and of which Procurement is just a component. This is clearly where big opportunities lie, made more so by emerging technologies. But the reports are right when they identify absence of leadership as a key problem.
Over the millennia, specialism has served us well. Human progress and economic wealth have been built on increasing division of labor and the development of professional competencies.
But specialism also has downsides. Those ‘professions’ become protective of themselves and operate as barriers to change. ‘Specialists’ like to think they are ‘special’ – they lose context, they become self-important. And these traits soon become sources of cost, delay and barriers to change.
Pro’s and Con’s
Specialism is attractive because it tends to link to higher wages and greater status and power. So people seek to position themselves as specialist and to form tribes with like-minded individuals. On one level, that of research and ‘good practice’, this is beneficial. When it evolves to constraining others, it is not.
Today, we have myriads of specialists. Professions like law, medicine and accounting have splintered into hundreds of sub-areas of expertise. Other job roles have followed suit. We have the theories of Adam Smith operating on steroids.
And the result? For many organizations, it is virtual inertia and incompetence. It becomes almost impossible to build consensus. Expertise rules, at the expense of balance and good judgment. Decisions increasingly flow to the top due to the incapability at lower levels to reach or enforce agreement. Business and government is becoming overwhelmed by the complexity of specialism.
A new approach
The answer, of course, is not to dismiss specialist knowledge, but to deploy it in new and different ways. Much current specialism must be automated. In the same way as machines took the jobs of weavers, blacksmiths, joiners and turners, they will now take those of many specialists. History shows that we move through cycles during which power groups emerge, gain control and then implode under the forces of progress.
Artificial intelligence systems are making specialist knowledge far more accessible and will make it also more reliable and fact-based. But having rapid and immediate access is not the same as interpreting and, more important, collating all that knowledge to reach an informed and balanced decision. And that’s why commercial judgment is becoming increasingly important – an ability to synthesize and reconcile data that may often be contradictory or in conflict and to develop a viable solution.
Mechanization was highly disruptive, yet ultimately drove improvement in social wealth and welfare. It also required a new breed of mechanics to manage it. Automation will be the same. And just as those who failed to mechanize or to hire mechanics went out of business, so will those who are too slow to adopt automation or to build the skills to manage its output.
Payment always feature high in the list of most negotiated terms. The last ten years have seen a steady lengthening of the time it takes to get paid. Recent data showed an average of 57 days, but it is often much longer. Big corporations are creative in the way they measure their compliance with payment terms, with many only starting to count after the invoice has been ‘approved’ – an activity that can add weeks to the cycle.
IACCM research has identified that prompt payment is the number one factor in achieving ‘preferred customer’ status. Paul Humbert recently wrote an excellent article suggesting that this should be a key performance metric, commenting: “There is however at least one purely objective and important metric which is rarely measured; namely, PROMPT PAYMENT of accounts payable. Many organizations routinely fail to pay vendors on time in accordance with the terms of the contract. Why? A lack of priority? An attempt to capture “float”, essentially getting an interest free loan from the vendor? Aside from breaching the contract, failing to pay vendors on time causes serious damage to the relationship. Imagine if someone’s paycheck was delayed by days or even months?”
Business practices cause regulation
Delays in payment are especially damaging for small businesses, which are typically highly reliant on cash flow. Many large organizations remain wedded to a view that ‘might is right’, seeing no problem in using their power to exercise unreasonable – indeed in this case unethical – behavior. It is that inability to make moral judgments that drives the need for regulation.
But morality aside, is it really in a company’s best economic interests to punish its suppliers? What is the cost associated with delayed payment – the administrative cost, the supplier performance cost, the reputation cost? Over time, these costs certainly outweigh any benefit.
There is a lot of buzz about digital reinvention (a term popularized by McKinsey consultants), digital transformation and digital disruption. By whichever name you call it, it’s importance cannot be understated.
According to Mckinsey, only 8% of companies that they surveyed believe their current business models will remain viable through digitization. That’s significant because digitization no longer means simply revamping your e-commerce site or improving the digital customer service experience and calling it a day. Digital reinvention must run deeper. The companies that win will be those that digitally reinvent processes end-to-end.
Digital reinvention should be every bit as important to your contract management process as it is to the rest of your sales or acquisition process. It is, after all, a critical business activity and the quality of the process remains just as important in a digital world as it is today, perhaps more so.
We live in a time when customers’ expectations have never been higher. Research suggests that 58% of a customer’s loyalty is based on their buying experience—not on your product or service. The customer experience starts at discovery and runs all the way through contracting and beyond. A great deal of the customer experience has been digitized, so much so that customers can in many cases complete over half of their buying journey without even talking to a sales person.
The contract process, on the other hand, is behind. The overwhelming majority of companies — 85% in fact– are using manual processes to manage sell-side contracts. Contracting remains analog. It’s yet to be digitized. Not only is this slower, it also translates to lost revenue. It is estimated that a typical business with 1,000 employees wastes $2.5-$3.5 million each year searching for and re-creating lost documents. Recent IACCM research highlighted the average cost associated with creating and agreeing a contract – and even for relatively low risk agreements, that came to $6,900.
Does digitization of contract processes really matter? The short answer is, yes. As other pieces of the business digitize, the lack of digitization in contracting becomes that much more evident. Already we know of CEOs demanding ‘no-touch’ contracting – a fully automated, end-to-end process. While the rest of the journey speeds up, contracting will be the bottleneck unless we make some pointed changes. That means all eyes will be on you when a seemingly fast sales deal stalls at contracting.
We need to evolve beyond basic contract management and legacy systems. By digitally transforming the sales experience and refocusing our resources to deliver high value contract management, businesses can improve profitability by up to 9%.
It’s time to act. That’s why IACCM is so focused on helping the contracts and commercial community to understand the exciting technologies that are fast becoming available. Join us this Thursday for one of those sessions and see how contract lifecycle management technology can streamline your contract process in the webinar: Digitally Reinvent Quote to Contract to Maximize Revenue.
EU regulation: the European Commission is proposing action in two areas that would have major impact on business. One is the threat of introducing a universal code that would allow consumer class action lawsuits. The other is specific to the retail sector and would be legislation related to unfair terms imposed on suppliers, in particular in areas such as payment terms and unilateral rights to change contracts.
Procurement as a partner: according to a survey released by the Buying Legal Council group, collaboration between in-house legal and procurement yields average savings on legal spend of 21% a year. This drops to just 7% in organizations where collaboration is absent or weak. Of those surveyed, just 25% say that there is a good partnering relationship between legal and procurement.
‘Big Law’ under threat: Corporate Counsel magazine reports a shift away from the largest law firms. A survey by the Economist Intelligence Unit found that concerns over fees and increasing need for deep local knowledge is pushing more business to smaller and more specialized providers – 40% of large corporations surveyed expect this trend to increase over the next 5 years. At the same time, the Financial Times pointed to the continued consolidation of major law firms, predicting that we will soon see the emergence of the ‘$5 billion law firm’ – itself a response to those growing pressures on traditional fee structures.
NOTE: IACCM is currently conducting a survey on law firm fee structures and the success of negotiators in achieving alternative pricing models. To participate (and receive a copy of the report) visit https://www.research.net/r/legaldepartmentspendmanagement.
Cloud security: a report by HelpSystems highlighted the dangers of assuming that cloud infrastructure and applications are secure. It emphasizes that “IT teams, cloud providers and trusted vendors need to work together to establish and implement well thought-out policies to keep data secure”. IACCM’s conversations with leading corporations suggests they are giving thought to these ‘relational’ mechanisms in their selection of provider and within their contracts.
Machines v. Humans: in the continuing debate over whether machines can be trusted to exercize judgment, I was reminded of an article in the Economist from 2011. Researchers monitored over 1,000 applications by prisoners to parole boards. They discovered a direct correlation between the number of applications granted and the timing of lunch and snacks. A full stomach had a major impact on the level of clemency. Bring on the machines!
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