Do people in your business take contracts and contract management seriously enough?
For most of us, the answer is no. The contract document and the process through which they are designed, implemented and managed is too complicated. Roles, responsibilities, authority, accountability – they are often unclear. This generates a level of frustration and management often seems uninterested in addressing the problem. As a result, contract users may see the contract itself as having limited purpose.
Such an attitude is a big mistake – and contributes to poor performance. Contracts should provide a mechanism and expression for unifying participants. They are a coming together of needs, capabilities and interests – a meeting of minds. The process through which they are established is itself a negotiation, internal and external, to align interests.
At least, that’s the theory.
But in reality, key participants are disengaged, they feel alienated from contracting because it seems irrelevant or – even worse – a barrier to getting things done. Among these key participants are the users – the people who need it to guide or control activities or to ensure benefits or obligations are delivered.
We must ask ourselves why companies like Apple are so successful? A major factor is because its products focus on users, because they are easy to access and use, because they complement their lives.
Can you say the same about your contracts?
“Why is it called contract failure? It’s failure of a relationship.”
That was the reaction of a group of law professors in Tokyo this week, when I showed them a set of newspaper headlines highlighting ‘failed contracts’.
In a culture where relationships have traditionally dominated and contracts have been deemed of little importance, such a reaction is understandable. The contract is not seen as a specific commitment vehicle or a significant management tool. Therefore, it cannot ‘fail’ and those headlines are more likely to lead to a questioning of the relationship.
For cultures that make substantial use of contracts, it is often the case that an individual agreement can fail without inflicting lasting damage on the overall relationship.
These differences of approach and perception are important to understand because they may reflect quite fundamental variations in the way that agreements are established, viewed and managed. In Japan – and some other parts of Asia – the relationship may precede the contract; a contract is created only when a relationship has shown its value. In the United States – and most other common law jurisdictions – the contract comes first and a relationship may follow.
Similarly, relationship cultures tend to rely on personal contact or connections to review performance or address problems, without reference to a contract (which may or may not exist).
These apparently simple differences can have significant implications. For example, when one side wants to push for a contract and the other wants first to develop a relationship, there is real potential for misunderstanding. One side may feel the other is not to be trusted because it is avoiding commitment. The other may feel that it is being pushed into a rigid structure before it is ready. Similarly, attitudes to how performance will be managed, or changes agreed, will inevitably differ in their level of formality.
The differences go deeper. For those in a relationship-based business culture, ‘relational contracting’ implies a reduction in the role of the contract. For those who come from a contract-based culture, relational contracting implies an expansion of the contract’s role, to include increased clarity over approaches to governance and performance.
Given the uncertainties and underlying risks and complexities of global business, it seems more likely that contracting discipline will increase to ensure that there is shared understanding and agreed methods of management. Of course relationships are important, but the challenge of increasingly virtual business, operating across language, law and business culture, demands mechanisms that increase clarity, not those that entirely depend on human memory and goodwill.
Across industry as a whole, lack of clarity in scope and goals is a common problem – it is in fact the first issue highlighted in IACCM’s ‘top ten pitfalls in contracting’ study.
Over half those who responded to a recent IACCM survey estimated that disagreement over scope and goals is an issue affecting more than 20% of their contracts. For those with a lower incidence, it tends to be their higher value agreements that are affected. Overall, the data indicates that around 30% of contracts suffer from levels of disagreement that result in significant concessions, or lead to a claim or dispute. While the financial impact varies substantially by industry and by organization, on average it is estimated to cost between 0.5% and 6% of annual revenue.[1]
In some organizations, this percentage is much higher – indeed, approximately one in eight encounter such disagreements as a norm, affecting more than 60% of their contracts. These high-contention environments are more likely to arise in the telecommunications, outsourcing and engineering and construction sectors. However, they also vary by type of agreement – for example, on capital projects, bespoke software or IT systems where precise outcomes or requirements may be hard to define or volatile to manage.
While this data indicates that there is major room for improvement, the good news is that the incidence of such disagreements has reduced by 8% since our last research on this topic, conducted in 2012. This reduction reflects a growing focus on contract management as a business discipline and indicates that concerted action can deliver rapid benefits.
The full IACCM report – including leading approaches to reduce the incidence of problems – is available to members of the association in the member library. There is also an associated webinar recording that features highlights from the report and a live Q&A session.
[1] This calculation is based on reported concessions (typically by suppliers) and price or charge increases accepted by customers without changes to their original understanding of scope or goals. It also includes identifiable charges associated with a formal claim or dispute arising from disagreements over scope and goals. It does not include additional costs arising from a full renegotiation, since a change of this nature implies that the original scope and goals were under-costed and that the revised price is therefore a correction, rather than an avoidable cost.
Economist John Kay has highlighted the importance of ‘distinctive capabilities’ in establishing competitive advantage. The correlation to contracting and commercial terms is immediately evident – not least because he sees these capabilities being delivered in the context of external relationships.
“Distinctive capabilities are a relevant factor of an organization’s resources. Companies with distinctive capabilities have attributes, which others don’t have and cannot replicate. There are three distinctive capabilities which a company can possess to achieve competitive advantage through relationships:
- Architecture: It is a structure of relational contacts within or around the organization with customers, suppliers and with employees
- Reputation: This includes customer’s own experience, quality signals, guarantee, word of mouth spreading, warranty, association with other brands and staking the reputation, once it is established
- Innovation: Provided that the innovation is translated to competitive advantage successfully.”
There is, of course, a counter-side to this position – which is that contracts and the contracting process can distinguish an organization for its negative capabilities. In other words, if contract terms and approaches to negotiation are risk averse and seeking to limit commitment, they damage architecture, reputation and innovation.
So distinctive capabilities are created through contracting and commercial skills – but require a real shift in attitudes to risk.
Increasingly, the winners in the marketplace are those who consciously endeavor to meet – rather than resist – market aspirations. Often that means a need to consider how to embrace levels of risk that were previously unthinkable. For example, in industries such as telecoms or oil and gas, clients are demanding ever more onerous terms from their suppliers. Rather than resist, there will be some who start to ‘think the opposite’ – in other words, how can we accept these risks? The answer will often be to take on greater responsibility and control, to reduce the extent of dependency on the customer’s capabilities or actions.
This was the revolution that happened to much of the IT industry, when it moved from supplying products to undertaking long-term outsourced services. Initially reluctant to accept increased liabilities, the industry has steadily realized that many perceived risks are actually a phantom and that many others can be effectively controlled through appropriate forms of governance. The best suppliers have focused on improving their capabilities – including their contract management skills – so that they can offer distinctive commitments.
This thinking is just one more illustration of why contracting and commercial skills have become so important – and why, as practitioners, our attitudes must shift from a focus on protection and avoidance to instead being a force for creativity and enabling.
The UK government is at the forefront in its recognition of the importance of contract and commercial management. It is leading many private sector organizations in its efforts to transform. On March 23rd, the powerful Public Accounts Committee of the UK Parliament issued its review of progress. Here is IACCM’s perspective on that report.
“The Public Accounts Committee has rightly identified the need for ‘transforming contract management’. The challenging environment for delivering high quality and affordable public services necessitates far greater focus on integrated commercial competence and contract management capability. The committee highlights continuing gaps and urges an increased sense of urgency and control.
The scale of change implied by this ambition must not be underestimated. Private sector organizations face a similar dilemma and in many cases are not demonstrating great success in their change initiatives. Essentially, today’s business is struggling to adapt to a networked world in which digitization is now fundamentally disrupting trading relationships, business capabilities and the terms of trade. Contract management sits at the nexus of these forces and is transforming from a largely administrative task to a dynamic role that orchestrates change and makes sense of market volatility.
In its March 23rd report on the state of contract management in the UK government, the Public Accounts Committee observes:
“While government has made encouraging progress in some areas, the pace of change is disappointing. We expect the Cabinet Office to raise its game, be more assertive and challenge those departments that are lagging behind, as well as supporting them where necessary. Given the increasing scale and complexity of government’s contracts, departments need to focus on the governance, systems and assurance frameworks around their major contracts, as well as recruiting more commercial staff. The government also needs to tackle the longstanding problem of a civil service culture that does not place enough value on commercial expertise. We expect the Cabinet Office and individual departments to accelerate the pace of change and be able to demonstrate tangible improvements by the end of this parliament, so that we see a civil service which is first rate at managing commercial contracts.”
IACCM’s unique experience in this field leads to the following observations.
The issue of assertiveness and challenge is a valid criticism. Contract management is a pervasive discipline with a myriad of stakeholders and interested parties. It is not simply about overseeing the performance of a signed agreement; it is essentially about ensuring that the agreement is fit for purpose. Many government contracts quite simply are not fit for purpose and there appear to have been limited efforts to challenge the historic models or their suitability.
When it comes to competence, there have indeed been efforts to assess contract management capability at a departmental level, but I would suggest that the model being used is timid and outdated. The assessment framework that has been deployed is almost 10 years old and it does not reflect the dramatic change in environment and needs that followed the financial crash and the massive re-think in public service delivery models. Departments are being tested for their ability to manage the past, not the future.
Some of the work that has been undertaken on skills is truly world-leading. However, it needs to move at a faster pace and the tone needs to impart a greater sense of urgency to individuals. Existing commercial staff will become an impediment to change if they are not energized and excited about the opportunities ahead and if they are not engaged in new ways of working that include the requirement to raise their skills. Too often, contract management is being seen as a sub-element of Procurement; this is a fundamental mistake and prevents rapid progress.
The Committee is mistaken in its apparent belief that increased recruitment is the answer and the Cabinet Office is similarly wrong to cite pay as the primary issue. While selective recruitment will assist, the real problem is a general lack of candidates with the skills that are needed. Industry is facing a similar challenge because there has been insufficient investment in these core competencies. Therefore, an urgent focus on skills development and training is critical, as well as more focus on implementing tools that will support commercial capability and efficiency.
Several departments have increased their focus on ‘contract owners’ and their accountability for driving performance and achieving outcomes. This is an insightful approach and there has been excellent work in designing and defining the program. Many of these contract owners are commercially astute and ready to challenge outdated contract and commercial practices. However, they need greater support and more opportunities for mentoring.
It is especially interesting to note that, while technology is fundamental in creating this challenge, there is no mention of it in the report. This is a massive omission and should be a core focus of any improvement. For example, last week the head of the US Armed Services Committee concluded that contracting today is so complex that it demands the application of artificial intelligence. Such vision is a glaring omission in the report and appears to be absent in a substantive way from the plans of the Cabinet Office. Without creative use of technology, the task of transformation will prove overwhelming and it will fail.
In conclusion, contract management transformation demands sustained executive focus and courage in the vision of what it must become. Given our experience at IACCM, the scale of change implied by this transformation will be achieved only through a fully integrated plan led and overseen by powerful executive sponsors. Right now, while there are some excellent individual initiatives, there is no evidence of a coherent master plan accompanied by a clear and well-communicated sense of future mission and purpose. To succeed, transformation demands a spirit of enthusiasm and excitement over what lies ahead. Instead, there is a real risk that the move to increase commercial skills and contract management capability becomes seen as an imposition and a threat.”
IACCM’s theme for its 2016 conferences is ‘transformation’. We understand the challenge this represents for so many organizations and individuals; hence our focus on the practical steps that can be taken to drive progress and create that sense of excitement in what can be achieved. For details of the conference series (Europe, Americas, Asia and Australia) visit https://www2.iaccm.com/events/
Imagine for a moment that the stakeholders in your contract formed an orchestra. Each has their specialist skill and plays a different instrument. But how would that orchestra typically sound? Would there ever be agreement over the speed or the relative roles of each player? Would they even be able to reach accord on which tune they would be playing?
Polarization, failure to build consensus, the use of power to impose solutions – these are the sort of factors that undermine cohesion and guarantee disharmony. Just as an orchestra needs cohesion, so it is with contracts. Unbalanced responsibilities, ill-considered commitments and unfair allocations of risk ensure that the output is discordant, that the players become self-centered and self-interested. An then, of course, they blame each other for the resulting discord.
I was reflecting on this challenge of stakeholder engagement because of the dilemma being played out over the appointment of a new justice to the US Supreme Court. Many might think that justice should be objective, that it should be balanced and reflective of diverse social opinions. Without such balance, one might argue, we are alienating a large portion of the population who then believe that justice is based not on good judgment, but on arbitrary exercising of power. Such feelings inevitably split society and result in growing conflict – essentially, the orchestra becomes not only discordant, but ultimately it splits into competing orchestras.
If we want harmony – whether in society as a whole or in the performance of contracts – we need processes that build consensus, where those impacted by decisions feel they have a voice. Today’s communication technologies have made inclusiveness increasingly important. It is demanding to take account of multiple and diverse views. The need for speed often encourages us to ignore or bypass inconvenient opinions. But we do so at our peril.
There are perhaps two key lessons for the contract manager. One is that we must think about how to make better use of the technology now available to us. Rather than seeing inclusiveness as a problem, we must consider more carefully how and when we communicate. But perhaps more important, we need to think about what we communicate – to put our message into context for the recipient. Our communications must be easy to understand, designed for the recipient, not for us. They must show appreciation for their interests, not ours. Ty must illustrate how our planned agreement is in harmony with their needs, interests or wishes.
The modern contract manager is in many ways like the conductor of an orchestra. Our job is to ensure everyone is playing to the same tune and that the tune is something that the audience wishes to hear.
Supply Chain Digest recently reported on barriers to collaboration between vendors and retailers. In a finding consistent with IACCM’s annual surveys, they discovered that ‘it’s not me who fails to collaborate, it’s them’.
Many may be surprised that most major retailers would ever think of themselves as ‘collaborative’ with their suppliers. In many cases, there is a massive gulf in relative power and the media headlines frequently suggest that this imbalance is something that the industry exploits. If commercial terms are anything to go by, there appears little room for collaboration. The research points to lack of trust as a fundamental issue – but of course this is generally a symptom, driven by other factors.
There are clues to those other factors in some of the scores. For example, the highest ranked difficulty identified by retailers is how to apportion gainshare, whereas for vendors the top challenge is the lack of collaborative skills exhibited by their customer. Vendors also see real problems in the availability of tools, data and executive support – this last item being perhaps linked to the fact that they see little evidence of a good return on investment from collaboration.
Ultimately, it is most likely the absence of any apparent financial benefit that is killing collaborative relationships. The fact that the retailers see the allocation of benefits as the biggest issue speaks volumes for industry behavior and attitudes. It confirms that for many, it is better to generate no benefit at all than to face the prospect of sharing that benefit with a vendor.
In an industry where margins are low, collaboration is a major source of cost reduction and innovation. But right now, a transactional mentality is in many cases destroying the possibility of value-add negotiations. Case studies have shown the opportunities that exist, especially when collaboration is handled across a category portfolio, not just with individual suppliers. However, this requires far more expansive thinking and a focus on value rather than price – something that the research shows is a distant dream for many in the retail sector.
84% of commercial and contracts practitioners believe they have the skills and competencies needed to perform a strategic role within their business, yet just 32% perceive themselves currently having substantial strategic influence or input.
Taking another statistic, 56% say that executive management considers the commercial and contracts function to be critical and strategic for business success, yet just half that number are receiving executive support for the investments needed to perform a strategic role.
IACCM recently worked with The MPower Group to produce two webinars in which we discussed the growing potential for strategic contracting and relationship management, versus the purely operational role that is common within many organizations. This operational reality is confirmed by much of the survey data that was collected in conjunction with the webinars. For example, almost two thirds recognize that the function is not seen as conferring competitive advantage (and therefore, one must assume, is not really seen as delivering significant revenue or margin improvement). 60% are struggling to persuade the rest of the organization that the function has value and – perhaps not surprisingly – 72% acknowledge that the function is not being raided for talent and future leaders.
So how can we explain the dichotomy between the belief in existing strategic skills and executive approval, versus the reality of actual status? Unfortunately, it suggests a lack of readiness to face the truth and a wish to be something that – in many cases – we are not. While a growing number of executives are embracing the importance of commercial and contracting skills and competencies, they do not automatically associate those attributes with the incumbent contracts and commercial staff. And that, quite simply, is why they are not investing or engaging the function in strategic decision-making.
There are certainly exceptions and some commercial groups are flourishing. They have focused on how to offer broader insights and advice, ensuring they have access to unique data on performance and improvement opportunities. They are not limited to work at a transactional level; nor are they excessively focused on issues such as compliance, escalations or post-mortems on failed contracts. These groups truly are looking at commercial and contract management as a source of competitive advantage – their message is about creativity rather than control. They work on developing capabilities to manage risk, rather than seeking to avoid it. They have compelling reasons to meet with top management, rather than having to wait to be called.
Many of those who read this blog will be among the small percentage who have grasped the challenge of continuous improvement and who have the personal and leadership qualities to offer strategic value. On the positive side, we also have growing numbers emerging from IACCM learning and certification programs, which are visibly impacting skills, knowledge and the confidence to engage with executive management. I firmly believe that this is of real importance to the contracts and commercial community; transactional work will steadily decline. We must step into the strategic gap that today’s market conditions have exposed.
Yesterday I was listening to a highly respected trainer in negotiations. He set out the sequence of activities needed to deliver success. His start point was to develop a negotiation strategy and he suggested that this should be based on an analysis of relative power.
I understand that power has a major influence in a negotiation, but should it really provide the framework? Surely this approach perpetuates negotiations as being akin to ‘the art of war’ – essentially an adversarial model where each party is wrestling for individual advantage?
It seems to me that negotiation strategy should instead be founded on an understanding of need, both perceived and potential, and the relationship required for success. I appreciate that it might be argued that a good power analysis should lead to the same place, because you would explore how to counter power through value, or alternatively how relative needs influence power. But in my experience, the focus on power often leads to the more negative master-slave approach and frequently results in the wrong conversations.
So I prefer to focus instead on the potential of the deal or relationship and the ingredients needed to make it work. For example, to what extent does it require collaboration and harmonisation of resources? What is the best division of responsibilities and what interfaces do we need? Analysis on this basis sets a very different tone for planning and subsequent negotiation. It also assists in highlighting comparative risks for the parties and therefore early thinking about the various terms and techniques through which they may be mitigated.
Indian outsourcing firms have had a major impact on the industry, especially on pricing, but also in some areas of innovation. Yet when it comes to negotiating with their potential clients, they are struggling to keep pace with providers from North America and Europe.
IACCM recently undertook a survey ‘Negotiating with IT Service & Outsourcing Providers’, which gathered comparative data on the largest providers. Three of these are from India, four from Europe and the remainder from North America. Each region has distinct characteristics, though with some blurring between common law and civil law jurisdictions.
Most IT service and outsourcing providers appreciate the critical role that negotiation plays not only in winning business, but in ensuring that it is good business. However, our latest study reveals a growing divide in this appreciation and also in the way that negotiation is being handled. The twelve suppliers included in the study fall into three distinct groups:
- The collaborators: a group that appreciates the importance of working closely with their customers to agree shared goals and objectives and to establish terms and conditions which support likely success. These firms focus increasingly on internal enablement and empowerment and are more likely to be based in Europe (though one US provider has entered this group and a second is on the margin).
- The adversaries: a group that continues to see negotiation as a battle over risk allocation and operates with relatively rigid policies and principles. Some of these firms struggle because they have few ‘standard’ offerings and therefore each contract is intrinsically more risky; others are influenced by the more litigious – and legally-driven – culture of North American business.
- The opportunists: a group that focuses on ‘win first, worry later’. Contract terms are rarely allowed to be a barrier and resources applied to contract negotiation are limited. These firms are either very easy to do business with (they say yes to almost anything), or very difficult, because detailed answers are hard to extract. While Indian providers tend to be in this group, it is also typical of finance-led organizations which have entered the market to take advantage of public sector outsourcing.
In many ways, these variations reflect the behavior of potential customers. The sophisticated buyer increasingly understands that value is not the same as the lowest price and that cultural alignment is important. Others try to drive performance through adversarial negotiations and unbalanced risk allocation, often using a third party as their interface to the supplier. And there are, of course, the commodity buyers – those for whom getting services cheaper is the core objective.
Indian providers appear to do well in winning and performing on relatively standardized business. Their low labor costs are increasingly supplemented by efficient use of technology to deliver better pricing and reliable performance. But in situations demanding a greater appreciation of customer needs and a more adaptive capability to deliver innovation, the survey suggests that they do not inspire confidence.
Commitment Matters 