One of the most common questions I receive is from people struggling to demonstrate the value of contract management or, more specifically, the return that might be achieved from investment (for example in contract management software).
There tend to be three different, but linked, scenarios leading to these questions. In one, the contract management function is struggling to explain or justify its existence; in the second, there are efforts to justify added headcount or centralization of existing resources; in the third, there is resistance to investment in automation due to the lack of any compelling business case.
In my experience, there is a common problem in all three of these situations – the return on investment (ROI) is being sought in the wrong place.
Most contract management groups lack meaningful data to support the value of their business contribution. Their work involves coordination, support, oversight, reporting – not the types of activity that easily lend themselves to clear measurements. As a result, they tend to claim value based on risks avoided (“terrible things would happen if we weren’t here”), or the volume of contracts handled, or compliance rates achieved (neither of which necessarily represents a benefit). A few offer more tangible measurements, such as incremental revenues, margin or savings achieved during negotiation or in post-award management.
For those proposing automation, the issues are similar (little base data), but supplemented by the fact that any direct savings from new systems are typically small. The volume of full-time resources allocated to contract management is simply not enough to generate meaningful headcount reductions. This problem is compounded by the fact that software adoption levels are often low because many of the systems currently available are not suited to the environment in which they are being installed.
These issues arise from a common misunderstanding – that is, a fundamental failure to appreciate the true source of contract management value. This misunderstanding goes back almost 20 years, to the time when analysts first started to take an interest in contract management and its automation. Their limited experience (primarily in sectors such as retail) led them to think of contract management as essentially an administrative function, primarily focused on procurement of goods. In such environments, the purpose of automation is focused on internal efficiency, supplemented by the possibility of savings from reduced errors (e.g. failing to spot a renewal or expiry date) or compliance (ensuring use of standard terms).
This thinking has permeated through into the wider view of contract management and, as recent IACCM research reveals, has resulted in the discipline failing to adjust to the needs of today’s business. Only one in six people are satisfied with the contracting process and the way it supports their personal performance – so there is an enormous opportunity to drive improvements.
In Part 2 of this blog, I will provide more details about the research and suggest where the true source of contract management value can be found.
“Why not be the CEO?’
The mood at this week’s IACCM Europe Conference was optimistic – at times one might almost say euphoric – as delegates explored the changes and opportunities that lie ahead. The theme of the event was ‘transformation’, exploring the impacts of digitization and the dramatic shifts that are implied for contract managers, commercial managers, procurement and legal.
Among the many quotes (and I will share more over coming days), one came during an executive workshop on ‘Accountability & Leadership’. We were discussing the findings of IACCM’s recent ‘Future of Contracting’ study, which reveals a widespread belief that within 5 years, many commercial and contract management groups will report direct to the CEO (shifting most notably away from reporting to the General Counsel or Chief Financial Officer). There are many reasons for this, but among them are the fact that commercial policies and practices must be functionally independent and the belief that, increasingly, contracts and commercial must be at the heart of business integrity, operating almost as a ‘conscience’ for the organization in its trading relationships.
As the conversation began, one delegate immediately challenged the idea that reporting should be to the CEO and said: “Why not be the CEO?” Conversation then turned to the question of how many of today’s CEOs have benefitted from a contracts or commercial background, or experience in this role. The number of examples that arose would surprise many, but clearly it is not a high percentage. However, how realistic is this suggestion?
There is no question that the contract and commercial role (when implemented well) offers critical insights to every part of the business as well as to external stakeholders. An experienced and high-performing contract or commercial manager has to appreciate the full range of stakeholder interests, the opportunities and the risks they create, and how they might be reconciled. In that sense, it can indeed offer an excellent grounding for today’s CEO, dealing with fast-moving, often conflicting trends and views. But today, many would suggest that commercial teams are too strongly focused on identifying problems and lack the optimism and creativity needed to lead a business. It is a fair criticism – but the spirit that was evident in Rome this week suggests that is increasingly an issue of the past.
Delegates recognized that the digital age provides opportunities to embed advanced commercial and contract capabilities within their organizations and to achieve this not through traditional ‘review and approval’ techniques, but through enabling and empowerment. By focusing on users, the function will steadily transform the business with high-performing, high-integrity trading relationships – and it is this that will turn contracts and commercial practitioners into the CEOs of the future.
Yesterday, IACCM and Revitas (a leading application provider) produced a webinar exploring the impact of digitization on contracts and contract management. It generated excellent questions – including the perhaps inevitable “Does this mean that people in sourcing and contract management will no longer have a job?”
The answer depends on our readiness to adapt. Digitization brings new discipline to activities that have traditionally been steeped in uncertainty and driven by individual judgment. Contracts are a case in point. They provide variable – and often unclear or ambiguous – guidance to those charged with fulfilling some particular set of obligations or objectives. Digitization promises to standardize terms and conditions in a way that speeds negotiation, production and dissemination of contracts.
Certainly this will empower business users because, before long, they will be able to enter parameters for their deal or relationship and generate a model agreement, with defined negotiable options and parameters. They will also operate independently of political geography or language.
So what is left?
Organizations will still need commercial policies and strategies. The terms they are willing to use must be supported by business capabilities or reflect business needs. The relationship types they offer must reflect business goals and market competition. Performance challenges – and opportunities – must be addressed. There are still many areas where judgment will be required – and those areas are where meaningful jobs will exist.
The Financial Times this week reported on a study that investigated the behavior and attitudes of New York cab drivers. The research led them to conclude that ‘regulatory constraints can prompt sharp practices (including fraud) to recover lost ground’.
When taking passengers to Staten Island or to Newark airport, the ride involves passing through a tunnel and paying a toll. There is a special lane for cabs, to speed the journey. However, in some cases the driver deliberately avoids this lane and instead queues – often for lengthy period – in the ‘standard’ lanes. The reason, of course, is because the meter keeps ticking and they charge their passenger more money.
The researchers found that this behavior is 50 times more frequent for journeys to Newark than it is for journeys to Staten Island. The reason? It appears to be because cab drivers from New York are not allowed to pick up passengers at Newark – so must drive back empty.
Understandably, drivers feel aggrieved by this regulation, but rather than campaign against it, they take revenge on innocent and unsuspecting passengers. They see no moral issue with transferring their issue with the regulators into cheating the general public.
The Financial Times article makes the point that similar self-justification could apply at many levels. It may subconsciously affect the actions of corporate executives when they face rules that they consider unfair, or which stand in the way of meeting their goals. And for those of us in legal, procurement or contract management, it suggests we must think carefully about the rules we impose and the extent to which these induce negative behaviors by others in the business.
Back in 2014, IACCM identified the ‘ten pitfalls’ of today’s contracting process and practices – the areas where value is lost or eroded. Pitfall number nine is lack of suitable technology.
Our findings generated a lot of interest and many organizations are using the data to undertake their own analysis or ‘contract audits’ to validate the findings and implement improvements.
The research base for our initial work was predominantly in the most developed markets – North America, Western Europe, Australia – and ‘common law’ jurisdictions such as India and Malaysia. The results seemed to hold good everywhere we went. So it has been with great interest that we have now started testing our findings in Asian markets. With IACCM’s rapid growth in China and Japan, we have been able to check the relevance of these ‘pitfalls’ in markets with a quite different business culture.
In a series of member and corporate meetings over the last two weeks, it has become evident that the issues remain largely consistent – though with one or two interesting twists. One of those is the availability of the right technology to streamline contract management and support improved performance.
At first, hearing this reaction, we tended to assume that our audience simply did not understand, that they lacked appreciation for the value that advanced contract management and analytics solutions can bring. But that turned out not to be the case – or at least, it was only sometimes the story.
Many IACCM members in China have worked for both Western and Chinese corporations. Their experience is that technology in the latter is often far ahead of the former. Two reasons emerge. One is purely local and driven by government policies that restrict access to overseas servers. Clearly, that is not helpful to those businesses except to the (considerable) extent that it limits their international competitors and protects the domestic market.
The second factor is the standard ‘early mover’ issue. While Western businesses may have invested in technology for longer, that doesn’t make it better. In fact, on the contrary, large international corporations are typically struggling to adjust heritage systems and software, leaving them challenged by inconsistencies, incompatibilities and lack of integration. China started investing many years later and reaped the advantage of avoiding mistakes and benefitting from superior networked solutions – systems that actually do integrate and speak to each other.
So while China may currently lack some appreciation of the value that advanced contract management can deliver, they are arguably much better equipped with a systems architecture that drives performance. For them, IACCM pitfall number nine is seen as a molehill, rather than a mountain.
The starting point is people”. Those are the concluding words in a blog on ThinkProcure.
The author, Stephen Ashcroft, is a procurement leader with an inquisitive and open mind. In his blog, he compares and contrasts findings from a recent survey (which he finds depressing) with the inspirational presentations he encountered at a recent conference.
He found those presentations inspirational because it involved leaders with a vision for the future, of how to ensure that supply and supplier management delivers real value.
He found the survey depressing because it paints a very different picture, of practitioners struggling to do more than negotiate transactional arrangements with (often) the wrong suppliers and then failing to manage their performance. That’s exactly what the rest of the business sees – a group that is frequently focused on the wrong thing, or on just a minor element of the overall process. Indeed, recent data from one CEO suggested that today’s procurement practices focus on only 20% of the available value.
The optimist in Steve then makes the leap to envisage a future where all those practitioners have seen the light and suddenly they are ‘breaking down barriers’ and leading an ‘integrated approach’ across the business. All it needs is for inspired leaders to ‘assemble talented Procurement people’ and everything will change …
But the challenge, it seems to me, is finding those talented people. If Procurement had many of them, surely the current situation would not exist? The problem I find is that most people do not have the knowledge or the skills or the tools that are needed to change results – and the majority would prefer to be left alone to do what they are doing. They convince themselves that a) the skills they have really are the right ones anyway and b) if they hold out long enough, these ‘visionaries’ will go away and take their change agenda elsewhere.
On what basis do I say this? Through a combination of research and on the ground observations. And of course the issues I highlight are not unique to procurement. Our surveys show that around 80% of practitioners believe they have or are acquiring the skills they personally need for the future; and a similar percentage believe their colleagues do not have those skills or the enthusiasm to acquire them.
And if further evidence is needed, it is worth noting that the names Steve cites – those leaders who inspired him – do not actually have background in Procurement. Like many other functions today, the leadership is being recruited from outside. (hence the similar debate for legal groups “Should the General Counsel of the future be a lawyer?”).
So Steve, I agree that today the starting point is people. But the challenge is finding the right people for the work of the future – and maybe, just maybe, they are not today’s incumbent community.
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.
Commitment Matters 