Technology has reshaped business capabilities and business relationships on a global scale. Yet somehow, the process and instruments through which those capabilities are expressed and by which those relationships are managed (that is, contracts) have largely managed to escape untouched.
The lawyers and contract managers responsible for contracting have (mostly) accepted the need to use email and some are very proficient with a variety of applications; many companies have implemented some rudimentary contract management software, though rarely is it enterprise wide and in most cases it covers elements of the process only. For example, the most recent IACCM benchmark data tells us that 77% of respondents have a repository. But that drops to only 52% who use software to support internal review and approval and other functionality falls away rapidly.
Much of this seems to be because senior management fails to take contracting seriously. It does not understand the cost to the business of the inefficiencies and value erosion associated with a fragmented approach to contracting. In most organizations, contracting remains activity- based, spread across multiple stakeholders, lacking clear authority and ownership. In such a situation, it is enormously difficult to build consensus for a solution, let alone gain funding.
But unfortunately, those within legal and contracts functions who could be leading the charge for new and better approaches in general do not do so. In some cases they may be technophobes; in others they lack confidence in the available technologies; and some who should be leaders simply do not lead.
Contract management technology should be transforming the way that the world does business. And before long, I am convinced we will see a true revolution, where software is not simply about raising internal efficiency, but is about creating more sustainable and higher-yielding relationships. Already a few encouraging signs are emerging. Two recent examples are of a system that oversees performance management – at a shared level, with both parties having direct access. This has resulted in a strengthened relationship and revenue growth for the supplier. Another is around the use of artificial intelligence that can remove the pain of dealing with individually negotiated agreements.
I am convinced that we will soon grasp the point that contract management software is not an extension of ERP – it is the application that helps business overcome the fundamental weakness of ERP in enabling or managing external relationships. And I also believe that advanced systems will drive us to adopt more industry standard agreements that avoid the time-wasting battle of the forms. Negotiation will be focused on true value trade-offs and this will be supported by powerful analytics. The contract management or legal group of the future will be targeted towards revenue and profit maximization through intelligent term selection.
And the technology that delivers this really will be something worth having!
In speaking with groups around the world, I find a degree of confusion over use of the term ‘sustainability’ when applied to trading relationships.
Increasingly, for specialists in the field of compliance, the term is used to refer to a range of environmental and ethical issues. it therefore tends to apply to the standards and behavior of suppliers or supply networks and whether or not they demonstrate ‘sustainable’ practices.
For many others, the term is used in the more traditional and rather broader sense of whether a relationship is sustainable – i.e. does it have a long-term future? in this context, it has mutual application and relates not only to issues of behavior, but also to questions of policy or strategy. This group often gives limited thought to the compliance issues that are fundamental to the emerging supply management specialists.
Does this matter? perhaps not, but it always seems unfortunate when the words we use create confusion and add to potential for misunderstanding. if we always have to define the context in which we are using a word, it makes its use somewhat inefficient and redundant. Perhaps we just need to think of qualifying terms – for example, to distinguish sustainable practices from sustainable relationships.
Winning contracts, placing contracts with suppliers, executing on contracts – the ability to undertake these activities successfully lies at the heart of any sustainable organization. Shifting business models are making capabilities in these areas ever more critical.
Yet for the majority of organizations, contracting remains one of the few undefined business processes and probably the least automated.
For most businesses, the ability to win contracts with customers has always been important. The significance of contracting with suppliers continues to grow, as a higher proportion of revenue is spent on external supply (in some industries, as much as 80%). But this is only part of the story because steadily, the role and importance of contracts has increased and the complexity of performance has also grown.
In the past, executive surveys revealed that most CEOs saw little importance in contracts except for their symbolic value in winning business. The exception to this was if they perceived significant risk or uncertainty. Today, risks and uncertainties abound – ranging from a myriad of regulations, through increasing internationalism in trade, into contracts that often commit to long-term outputs or outcomes. For many, gone are the days of simple commodity supply; the contracting process has become critical to addressing a wide array of business risks – financial, legal, regulatory and performance.
Yet old habits die hard and many organizations continue to operate with highly fragmented commitment processes, with ‘the contract’ viewed as a legal or administrative output. As a result, relationships often suffer from the wrong form of agreement, inappropriate terms and conditions and poor management of performance and governance standards. As IACCM research demonstrates, good contracts offer a framework for successful relationships and provide structure for subsequent performance.
There has been almost endless investment in defining and automating internal business processes and structures. In many cases, this has actually been at the expense of the external relationships on which organizations rely. It is time for executive management to shift focus from internal operations onto external effectiveness and the integration with trading partners. The contracting process offers the route to this integration, through insights to market needs and value as well as actual performance standards and capabilities.
It might be argued that all regulation is ultimately political, but notices issued by the Chinese Banking Regulatory Commission and the Ministry of Industry and Information Technology appear to cross new boundaries. They threaten operations in China by all foreign banks, undermine competition in the technology sector and show complete disregard for the intellectual property rights of non-Chinese software companies.
In common with most jurisdictions, China has concerns over cyber-security and wishes to ensure effective oversight of the banking sector. However, the authorities appear to be making this into an opportunity to either eliminate competition or to acquire trade secrets via access to source code and encryption keys. Presumably such access would also enable the Chinese government to mount cyber attacks of its own against foreign countries.
Speaking with representatives of the banking industry, there is of course massive concern. One executive explained to me that the regulations as currently published would leave banks with two options. One would be to leave the Chinese market and the other would be to create a unique entity, using only Chinese origin software and technology. The problem with the latter solution – in addition to the expense – is that such an operation would then prevent the bank from meeting regulatory obligations elsewhere, since it would no longer have integrated visibility into worldwide operations.
It is hard to know what goals the Chinese authorities are pursuing. Is their intent to eliminate domestic competition in financial services? Do they really believe that non-Chinese institutions will obtain and hand over source code (which they of course do not have and which would leave them in breach of license terms) which will then be used to enable Chinese firms to replicate and undercut foreign rivals? Or is this simply posturing and a negotiating ploy that leads to some other goal?
This incident reveals the hidden danger of regulation. The more we have, the more that Governments will be tempted to use it for domestic policy and political purposes. In a networked world, it becomes very easy for authorities to justify their actions on the basis of ‘national security’; sadly, we must anticipate a growing threat to world trade driven by many forms of protectionism, of which this example is just one.
“There is a profound shift going on”, according to John Elkington, Executive Chairman of Volans.
John was my co-presenter at the Ecovadis conference in Paris, discussing the progress and challenges of sustainability. The size and quality of the audience at this event, together with the growth being experienced by Ecovadis, are clear illustrations that sustainability is very much on the business agenda.
In my presentation, I highlighted the point that reputation is now of massive importance to boards and executive management. Indeed, recent CEO studies emphasize this point, with a survey in the Financial Times revealing that ‘honesty and integrity’ are now top of the CEO agenda. So if market perceptions matter so much, it is clear that there needs to be greater focus on ensuring the right relationships and the right suppliers. Organizations are growing increasingly dependent on their supply network – many now spend 70% or more of their revenue on external supply. So ensuring the integrity of supplier behavior is no longer optional – it is essential.
Several speakers illustrated this point, outlining how top corporations like Nestle, Nokia, Societe Generale and L’Oreal are embedding sustainability principles into the way they do business. They have moved beyond simple codes of conduct with steps that include:
– significant weighting is given to each supplier’s ethical behavior within the selection process
– individual buyers are measured and rewarded on their sustainability performance
– the frequency and rigor of supplier audits is increasing, with remedial steps identified and agreed
– sustainability issues now form part of the contract, with direct consequences for failure (including immediate termination)
These steps indicate that health and safety, remuneration policies, working conditions, compliance with environmental laws and regulations are all being take seriously.
Challenges remain. Among them, the question of how widespread ‘good practice’ actually is. And when it comes to increased costs, are companies willing to trade off savings for sustainability? Based on the CEO surveys, I think the answer increasingly is yes – executives understand that a failure to observe sustainable practices carries a very real cost.
For commercial lawyers, the practice of law is transforming. Acting as a semi-independent advisor on specialist risk and legal issues is no longer enough. Today, the business expects much broader appreciation of opportunities and challenges – and that the support and contracts produced by lawyers will directly contribute to the best possible outcome.
Lawyers are no longer operating purely at a transactional level seeking to protect assets and avoid worst-case scenarios. They are being called upon to assess the wider economic consequences of the agreements they help put in place.
Many in-house counsel – and some law firms – would argue that they have always been ‘business advisors’ and in some cases I would agree. But the demands today go much further. As trading relationships change, the nature of legal support must also change. Here are a few of the factors and examples of their impact:
1) many trading relationships now focus on longer-terms outputs or outcomes. This requires underlying agreements to be more flexible, more adaptive to change. Increasingly, it is evident that many existing contract models and underlying terms and conditions are not suited to this world of outcomes – so lawyers are expected to ensure the contracts they produce are ‘fit for purpose’.
2) business leaders are swinging away from adversarial models of contracting, focused on price and risk allocation, and switching to more collaborative, open relationships. These require quite different terms and quite different negotiating skills. Lawyers (trained in win-lose) are required to rethink their traditional approach and also to understand the elements of a ‘collaborative contract’.
3) litigation is very much the exception – and the switch to more relational forms of contract, plus the international nature of many agreements, is accelerating the use of alternative dispute resolution. Once a business realizes how unlikely litigation has become, the focus of the law department changes significantly. It must enable good business decisions rather than sit remotely as a reviewer and approver.
4) the business wants to know whether the contracting process is optimizing financial returns. Lawyers have rarely thought about the big picture of contract economics. Indeed, the impact of terms and conditions or contract structures on financial results can seem very theoretical when viewed at a transactional level. But it is not. Lawyers are being pushed to understand how the contracting process impacts the bottom line.
My recent conversations with General Counsel are noticeably different from those of the past. They want to know more about emerging contract models – for example, relational contracts. They appreciate that they need to be more engaged in understanding how contracts perform – for example, where do things typically go wrong and how could problems be avoided? They recognize the need – and value – of looking across portfolios of contracts to observe common risks and identify opportunities for improved financial results. And they grasp the point that if they do not show leadership in this area, the business is exposed and they are missing the chance to drive real value for their organization.
New technologies are changing the capabilities of the law department, enabling the collection and analysis of data on a massive scale. But also, the nature of business is changing. Traditional compliance and management of risk consequence will be managed through different and lower cost methods. The real art of lawyers must be in helping the business make things go right, not in simply protecting against things going wrong.
An IACCM member posted this question on the IACCM Forum. I am not a fan of such clauses: they always were open to manipulation and today they are even more so. They strike me as a lazy and ill-considered approach to a legitimate issue – and they carry various dangers that can undermine value.
Most Favored Customer (or Nation) clauses are inevitably problematic unless there are independent sources of price comparison. In many cases, even if there are research companies offering data, the most highly negotiated deals are protected by confidentiality undertakings. And even when some data can be accessed, it is usually possible for a supplier to claim that price variations reflect other differences – for example, in risk allocation, availability, volume or term of agreement etc. This means, in my experience, MFN clauses are of limited meaning or value.
However, this does depend to some extent on how much you trust the integrity of the supplier and whether you are clear about your own goals. For example, do you really need to have better prices than all other customers, or is your real sensitivity that you want better prices than your competitors? Must you really be best, or perhaps it is sufficient to be in the top 5 or 10%? Does price really matter anyway, or should you be measuring cost of ownership?
You might make such a provision subject to periodic confirmation by the supplier, making it clear that misrepresentation would be a fundamental breach of the agreement. You can require independent audits, though few large suppliers will agree to this and the cost may be prohibitive. You could commission periodic research which, depending on the market and the nature of the service, may yield practical results.
I would suggest that the real concern here is that you want to ensure pricing remains fair and reflects market trends. Often the only way to test this is by regular market testing via competitive bidding. Such an approach has little attraction for the customer or the supplier – it is expensive and potentially disruptive. So you might consider a clause modelled around the principle that the supplier has responsibility to demonstrate not only that the prices they offer you are the best they offer, but also that they are among the best available in the market. But be cautious that in your focus on price you do not lose sight of broader issues of value. There will always be someone cheaper, but what is the cost associated with ‘being cheap’?
Contract and commercial management may be increasingly important to business success, but that is not translating to significant investment in training or raising skills. The bottom line seems to be, if you want to improve your knowledge, watch your colleagues and learn ‘on the job’.
Of course, there are exceptions – and some companies are making serious efforts to raise the capability and the status of their contracts and commercial staff. Research suggests that their investment yields dividends in terms of profitability, contributing through increased revenues (for sell-side personnel) and lower costs (from buy-side personnel). There is also an apparent – though harder to measure – connection to greater innovation and continuous improvement.
Last week, IACCM produced interim results from its current benchmarking study. It showed a growing divide between leading corporations and ‘the rest’. For example, top quartile performers stand out in terms of the way they develop capabilities; they also use a wider set of measurements to drive organizational performance; and they see major gains in productivity, cycle times, the quality of contracted outcomes.
As an example, in the ‘also-rans’, the primary purpose of contracts and commercial staff is still seen as risk mitigation through oversight of compliance. But about a quarter of respondents see the function’s role in a more positive context of creating competitive advantage, improving business productivity, managing change and facilitating external relationships. It is not hard to guess which group is winning in the market.
The top quartile use different performance metrics; they also invest in training to ensure consistent capability. Their commercial groups operate as business enablers, not in purely review and approval mode. They are also typically holistic in covering the entire contracting lifecycle, rather than providing fragmented support at different phases of the process.
These findings are important and interesting. They support the growing belief that contract and commercial management are key to 21st century business success.
The benchmark study remains open for input and those who participate will be first to receive results. It can be found at http://www.iaccm.com/services/research/
As we all know, too many contracts fail to deliver expected results.
Growing complexity, market volatility, increased interdependence – there are multiple factors that contribute to those failures and are forcing change in the way that organizations interact. Relationships are often too vague, too reliant upon individual memory, to be sustainable ways of managing the performance of commitments and obligations. Contracts, on the other hand, are often too limited in the ground they cover and too difficult to understand and interpret. Traditional approaches to relationship management and contract management are no longer ‘fit for purpose’.
As a result of these changing needs, relational contracting – the integration of the relationship terms into the contract – has been an evolving reality, rather than a planned development. There are no generally accepted model ‘relational contracts’. Indeed, even research into the elements of a relational contract is limited. IACCM has developed core principles – for example, methods and types of communication, the importance of balanced incentives, approaches to problem solving – and is consolidating various research initiatives, but this remains at a relatively early stage. Individuals such as Andy Akrouche and Kate Vitasek have also led the charge in trying to define methodologies that support ‘collaborative relationships’.
Now, there is growing interest by the legal profession and by the courts in making sense of relational agreements, with a number of recent cases highlighting these developments. Andrew White, a partner at law firm Bird & Bird, presented at a recent IACCM UK member meeting and explained some of the impacts. For example, he observed that: “As contracts move towards clearer obligations, remedies move towards an obligation to perform rather than damages”. Such a shift has potentially massive significance, especially on issues such as ‘hardship’. Of even greater import, perhaps, is the increasing use of concepts of ‘good faith’ and their legal enforceability. This is a very new concept in most common law jurisdictions (in the US, it has been a traditional element of law, yet rarely seems to be imposed). For example, the English Court of Appeal recently concluded that contracts have two distinct elements – a performance element and a risk allocation element – and the performance element relies heavily on issues of intent.
So the law is catching up with commercial reality. But commercial reality still has far to go in designing approaches to business engagement that deliver better results. Partly this relates to better and more constructive approaches to market evaluation and subsequent negotiation. For example, suppliers are often held at arm’s length and there are too few opportunities to establish what it might be possible to achieve. Requirements and capabilities are frequently misaligned. Organizational culture or integrity rarely feature in selection criteria. Resources are fragmented, required skills overlooked. The list goes on. But at its heart, while we are beginning to understand the concept of relational contracting, we are not exploring its implications to the way we design, manage or motivate our internal organization or our external trading relationships. Simply writing things into a contract does not make them a reality.
Experience shows that most organizations can develop highly successful collaborative relationships. It also shows that most of them are unable to replicate those successes. In other words, they can occasionally rise to the challenge of doing things differently, but they cannot sustain the effort. They soon revert to form – and that form is generally one where trust is limited, cooperation is an exception and a readiness to blame takes over from a sense of shared responsibility.
This means we have a situation where contracts could be used to reengineer the company. By recognizing the nature of the commitments and governance procedures needed for successful outcomes, an organization can reverse engineer the required capabilities, measurements and management systems (an approach used successfully by the IBM Corporation during a past era of rapid market change). This, in fact, is what lies at the heart of ‘commercial excellence’ – another of the major topics being addressed at IACCM and delivered through its training programs. Unfortunately, senior management rarely thinks of contracts in this way. And that is a missed opportunity.
I am always surprised by the volume of ‘doom and gloom’ mail that I receive. Yes, there are many problems to be solved and some days they can feel quite overwhelming, but I have yet to see an instance where doom and gloom made them any better.
So my natural inclination is to delete the mail – the equivalent, I suppose, of executing the messenger.
Most of us in the world of contracts or law are talented at seeing problems and difficulties. It is a key reason why we are part of review processes. But sometimes, there are members of our community who get stuck and who think that raising issues and objections is a sustainable source of value. These are people who are frequently complaining about the ignorance of others, or the failure of management support, or are incredulous that others ‘just don’t get it’.
Many times I have observed contracts and commercial professionals and managers present to senior management, outlining issues or challenges associated with a particular deal or a policy. Far too often, their approach is to warn of the dire consequences that will follow from some particular action or inaction. Rather like a fire and brimstone preacher, they leave their audience with a fear of being overwhelmed.
Then they wonder why it is that no action is taken, or why they are increasingly left out from meetings. The answer is simple: like those emails I receive, they are simply deleted.
The reason, of course, is that our managers and colleagues want answers and solutions. They want positive proposals for action, not doom and gloom messages that generate inaction. They all have their fair share of issues and problems to fix; they don’t need ours put on top. As professionals, they expect us (rightly) to come with remedies, not complaints about the symptoms or predictions of imminent death.
So next time you hear a colleague on the ‘gloom and doom’ trail, help them off it. Remind them that it is not only a path to nowhere for them personally, but it also sustains a negative image of the entire profession. As one of my former managers used to remind me, if you are feeling negative about something, think the opposite. It is amazing what creative solutions a different mindset can generate.
Commitment Matters 