Should negotiations ever come down to price? Not according to INSEAD professor Horacio Falcao. In a thought-provoking article, Professor Falcao suggests that ‘a focus on price puts both sides at risk of leaving out other interests that are more important’.
I have sympathy with this view, which in large part reflects the eternal debate over price versus cost of ownership. There are certainly many examples where ‘cheap’ means also ‘low quality’ or ‘untrustworthy’, resulting in unexpected costs for the buyer. However, the article seems to be based on two assumptions that may themselves be questionable. First, it depends on detailed market or competitive knowledge. Second, it makes an assertion about supplier behaviour which, in my experience, is not entirely accurate.
Professor Falcao uses the procurement drive for ‘commoditization’ as the foundation for his ideas, on the basis that this is the philosophy that underlies intense price-based negotiation. He makes the point that there are always areas of value that go beyond the core product or service – for example reliability of supply or quality of service and support – and that these must be taken into account when agreeing a price. Clearly this is true. However, comparative competitive data may be difficult to find, so often a buyer tends to address such issues of performance through liquidated damages or service level credits. Arguably, a smart buyer will also embed rights of termination for consistent failures of performance. To the buyer, such terms represent a protection against the consequences of their price-based focus and do not represent a reason to agree a higher price.
So while these additional terms confirm that value is not based on price alone, it is often hard for a supplier with superior service to win a higher price.
The second hypothesis in the article relates to the way a supplier will behave if forced to accept a low price. Professor Falcao contends that this will result in degradation of service. Again, my experience on this is mixed. I have seen many instances where a focus on price actually has the opposite effect, with the supplier either:
a) working harder to show their value in the (often mistaken) belief that they will thereby earn supplier loyalty and potential for future higher prices or additional business; and / or
b) focusing on ways to improve efficiency and reduce their own cost base. Indeed, such price-based pressure is often the source of innovation.
It is indeed true that a smart buyer looks beyond price, but in many instances it is in fact the driver of value, not its enemy.
I want to share a question that appeared this week on the IACCM message board.
“Has anyone had any success in setting up and managing KPIs for Contracts Management. The intent would be to set internal KPIs for our contracts team. Since the ‘success’ of a contract (say a construction contract) is influenced by many factors outside of the Contracts Administrators control I don’t want to set up KPI’s on contract value/growth etc. Some obvious ones are timeline to execute contracts, timeline to review invoices, execute changes etc but they don’t really seem to add much ‘value’ – any thoughts?”
Censeo Consulting Group and the Public Spend Forum recently announced their findings on ‘the required skills of the public procurement workforce’. They discovered under-performance ‘in nearly 70% of identified competency areas’.
I am always a little skeptical about research reports from consultants. While they raise some great discussion points, there is this nagging feeling that the findings may be somewhat self-serving – essentially “Wow, we just discovered this massive problem – and it just so happens we have the services to overcome it”. And in this instance, the published data is actually close to the opposite of IACCM’s rather more extensive findings. Of course, that is not to say it is wrong, at least in the context of the 43 people interviewed, nor do I know what the objectives of the report’s authors may be. So let’s look at the broader questions that these findings raise.
Do skills and competencies matter? On this point, I think we would all be agreed that they do. And given the nature of today’s public services and their dependency on private sector suppliers, I presume there would be broad agreement that areas like negotiation, contracting and relationship management would be high on the list (though we might debate which of these is a skill versus a competency). It should be reassuring, then, that the Censeo research finds that the public sector workforce demonstrates competency in contracting and negotiation. However, anyone who has true competency in these fields may be rather shocked to learn that ‘proficiency decreased significantly for more complex skills, such as stakeholder engagement, risk analysis and problem-solving’.
I have never met a truly competent negotiator or contract manager who did not excel at stakeholder engagement, risk analysis and problem solving. These are fundamental attributes without which subsequent contract performance is almost doomed to fail. IACCM’s research into public sector skills actually shows advanced capability in problem solving and comparable competency to the private sector in risk analysis and stakeholder engagement. Where the public sector falls down is in negotiation (because they generally take the view that their contracts are non-negotiable) and contracting (because they tend to operate from templates which often reflect inappropriate forms of relationship and terms and conditions). And as we all know from the highly-publicized contract failures, contract management is an important area for public sector improvement (as a competency, rather than just a job role).
Today’s challenging business conditions certainly demand renewed focus on required skills and competencies, but pre-requisite is a coherent assessment of which skills and competencies are actually important to the future and then an objective appraisal of current gaps. Given the speed with which change is occurring, there are significant shortfalls in both public and private sector. Some of these will be addressed through training. Others may be filled by new organizational structures (redefining job roles, moving to more team-based structures) and some through automation. It is a demanding, yet exciting, time – and progress will be assisted if we focus on tangible and objective data and creative solutions to performance shortfalls.
IACCM undertakes regular capability assessments for its corporate members. We have data from hundreds of different organizations around the world, enabling individual results to be benchmarked against both global and industry standards.
Out of the nine areas that we test, one always stands out as a source of weakness – and that is the field of automation and knowledge management.
Given the focus by business and government on digitization, this is a serious weakness. It is certainly true that failure to invest in technology means that contract management remains highly inefficient and commercial policies and practices are too often based on instinct rather than facts.
However, on a positive note, the lack of past investment means that in general there are few embedded heritage systems, so for many, digitization is a green-field opportunity. This represents a real opportunity and a few leading companies (‘the dynamos’) are pushing ahead fast with transformation initiatives.
The possibilities are exciting because digital technologies revolutionize how we operate and the impacts we can have. There are four areas to consider:
- Operations and efficiency. This is largely about changing processes in ways that reduce cycle times and generate resource savings.
- Business model innovation. New commercial models are enabled by technology. There will also be impact from contract and negotiation analytics and understanding trends in required business capabilities.
- Technology innovation. Digital can reduce costs, change the nature and impact of risks and their management and enable simpler, more rapid integration across systems.
- Customer experience and engagement. Much deeper insight and understanding of purchasing methods and behaviors will create sources of competitive advantage through incremental value and ‘ease of doing business’.
It is essential to recognize that digitization is not a functional initiative; it transforms the approach to doing business. Since winning and awarding contracts lies at the heart of every business, the field of contracting and commercial management is a logical place to start. And that is exactly what happens during our capability workshops – the realization that the contracts and commercial function is transforming from a largely manual, operational role to a position of strategic leadership.
Its easy to write about the many areas where contract management could be improved. It is the failures that make the headlines. But sometimes it is important to reflect and recognize the success stories.
IACCM’s current series of in-depth studies on ‘the ten pitfalls of contract management’ offers exactly that opportunity. It is now 2 years since the initial work to identify the major causes of value leakage was undertaken. Many are familiar with the resulting infographic and the average 9.2% contract value erosion that occurs due to weaknesses in the contracting process.
Our current studies are examining each of the ten pitfalls in detail and they show encouraging signs of improvement. For example, the number one issue is lack of clarity over scope and goals. When we first explored that topic in 2013, there were significant disagreements between customer and supplier in 38% of contracts. This year, that number has dropped to 30%. Organizations are developing more sophisticated approaches, including improved contracting models, greater use of templates and checklists and investment in training operations teams. While there is still far to go, the scale of improvement is encouraging.
Subsequent studies have investigated timing of engagement of commercial resources and approaches to involving stakeholders. While both remain problematic, there is evidence that more sophisticated use of technology is leading to improvement. In some cases, this is due to streamlined procedures, in others it is through greater dissemination of knowledge leading to empowerment across the organization.
Each study is highlighting ‘best practices’ that reduce the value being eroded from historic weaknesses in contracting. Pitfall number 4 – protracted negotiations – is currently open for input (participate here) and reports on the other three are available to IACCM members on the website, http://www.IACCM.com.
Back in medieval times, the routes to a healthy mind and body were simple. Regular bleeding ‘to balance the humors’ could be accompanied by periodic flagellation, to encourage self-reflection and atone for bad thoughts or behavior.
When it comes to contracts, those medieval instincts have maintained a curious hold. The prevalent approach remains that they should first and foremost be instruments of pain and retribution. First we will extract all the blood we can (through aggressive price negotiation) and then we will apply instruments of torture (through maximised risk allocation).
Medicine has made massive progress over the years – and the digital age promises truly revolutionary change. It’s time for those who practice the dark arts of contracting to step back and see what we can learn.
First, medical practitioners have long understood that it would be far smarter to avoid problems than to treat them. Research is dedicated to understanding causes and to promote better ways of living. Technology – and especially artificial intelligence – is now being applied in a way that transforms insights because of the scale of analysis that can be undertaken. It is enabling understanding not only of cause, but also of likelihood – so individuals can better assess their propensity for medical problems. When it comes to diagnosis, digital devices are already actively monitoring our condition and in countries without well-established (and therefore more change-resistant) medical practitioners, are rapidly transforming the delivery of health care. Finally (at least for this example), doctors have recognised that ‘one size fits all’ treatment regimes often do more harm than good. Blood letting is no longer a universal solution. Indeed, technology now supports highly customised treatment and remediation plans suited to the conditions and preferences of the patient. As a result of all these changes, success rates will soar.
Similar results could be achieved with contracts and trading relationships. For example, we could be undertaking mass analysis of causes of ‘ill-health’ in contracted relationships. We could be applying diagnostic monitoring to predict when things are likely to go wrong. We could be developing treatment plans in the form of appropriate relationship models and terms and conditions, using technology to overcome ignorance and to eliminate the unhealthy fixation on standards and compliance.
Back in medieval times, most doctors (at that time largely self-anointed since there was no professional standard) were doubtless aware that their remedies did not work. But their continued employment depended on maintaining the myth that they knew what they were doing. It is time for contracts experts to step back and ask searching questions about our commitment to professional standards and the remedies and solutions that we apply. Far too often, they do more harm than good. And the sad thing is, many of us know that to be true.