Many in Procurement see the continued emphasis on cost reduction as good news. It seems to make their jobs secure and surely, one day, their status will also increase.
But those who have now lived through 20+ years of pressure on cost may be a little more skeptical. Indeed, Procurement itself is victim of those executive purges, with overall headcount and budgets for Procurement functions expected to reduce in the coming years.
The truth is that the only route to security is through the addition of quantifiable value – and traditional procurement savings are not in that sense a headline item. In today’s more complex world, the aggressive pursuit of savings often damages value and overall company performance. Procurement in this traditional form attracts more enemies than friends. And executives know that automation will steadily allow most purchasing decisions to be made elsewhere in the business.
Businesses are becoming ever more dependent on the quality of their trading relationships and the commercial competence with which these are structured and managed. They must achieve balance in their decision making (weighing the different needs and perspectives of multiple stakeholders). They must achieve balance also in the integration of what they sell with what they buy – so customer needs must be mirrored in their purchasing contracts.
Today, that balance is lacking in many ways because it is distorted by unbalanced measurement systems. Requirement gathering and validation is often flawed, leading to weaknesses in supplier evaluation and selection. The criteria for selection and the resulting contract terms (which then guide supplier behavior) are often misaligned with business goals. The post-award contract implementation and supplier management rely on untrained staff with quite different objectives and limited understanding of their role.
Each of these areas represents a glaring opportunity for added value. And we haven’t even touched on areas such as innovation, which is another possibility.
But it seems to me that most Procurement groups are struggling to move into these areas. In part it may be an issue of skills, but I think it is more often because top management is confused about what it really wants and the Procurement leadership team is not convincing in its arguments for change. While Procurement continues to be measured primarily on cost savings, it remains just one more stakeholder in the overall commercial process. It cannot lay claim to balanced judgment, nor to being responsible for wider business outcomes, while its measurements of success remain so limited. Other groups and functions will continue to see Procurement as reflecting an important, but narrow, interest.
Certainly, if top management wants to secure greater value from its trading partners, it should be thinking hard about changing the business dynamic. And if Procurement wants to be key to the future, it really should be pressing for changes in its role – and especially for rebalancing of the measures used to gauge its success.
Drawing once again from the National Law Journal, it has recently been announced that law school enrolments in the US are down once more. This is the fourth successive year of decline and numbers have fallen by 28% since 2010.
I tried to find statistics for other jurisdictions, but that isn’t always easy. However, a recent article in The Diplomat highlights the rapid growth China, suggesting that there are now 150,000 new lawyers graduating annually (up from about 1,000 in the 1980s). Japan has also witnessed a big increase in the number of lawyers. Public policy encouraged this growth – but only to a level of around 3,000 a year and the grand total is only just over 30,000, compared with 1.2 million registered attorneys in the United States. The Japanese government feels that there may now be too many lawyers because some are struggling to find work.
Growth continues in India, averaging about 4% per year. And in fact, in gross numbers, India has now overtaken the US, with statistics suggesting a total of around 1.3 million. I could not find data to tell me how many of these are engaged in offshore or outsourced legal and contract management centers, though the high volumes appear to be concentrated in states where such service centers are typically located.
Numbers in the UK tripled in the last 30 years, but appear now to be static. With around 150,000 lawyers in total, the numbers per head actually lag behind some European countries (Spain, Italy) and significantly exceed those in Germany and France. A significant proportion of UK lawyers work in the financial services sector, which has offered significant job opportunities in compliance and regulatory affairs.
One reason for the US student decline may well be a drop in the number of overseas students. As the US economy becomes less dominant, the need to study US law also becomes less relevant. Instead, students may stay in their home country (especially China and India) to learn within their own jurisdiction. These changes are likely to reflect in reduced dominance by common law systems and perhaps, over time, the emergence of more widely established global practices, especially in business transactions.
Mark Harris has written an excellent article in The National Law Journal (“A New Way To Manage The Mountains Of Contracts”, December 8th, 2015). He introduces his topic with the following comment: “Contracts are the most important point of interface between companies, their customers, suppliers and employees. They form the bone and connective tissue that gives the company structure and movement.”
While many may question whether contracts are the ‘most important’ point of interface (I am sure many sales reps might disagree), his point is correct that good contracts truly do offer ‘connective tissue’. Mark goes on to provide some excellent examples of why contracts are so important – and becoming more so. He also makes the key observation that what really matters is the contracting process and that in most organizations these are currently obsolescent. I would go further: I don’t believe most organizations actually have a defined contracting process, covering the full lifecycle of a contract.
This weakness creates exposure to many risks. Details like the inability to find contracts or to properly communicate obligations are actually quite minor compared with the growing frequency with which an inappropriate form of contract is used, or the terms are wrong, or post-award management is chaotic. Mark draws on an example of good practice in which a company has deployed “technology to enable the systematic capture of contract requests and information; distribute and execute work efficiently; and then track obligations, risks and performance. By applying process (including clear workflow rules based on contract risk and complexity, a dedicated contracts team designed to alleviate bottlenecks, custom playbooks) and technology innovation, Allergan is reducing risk, liberating valuable data, and capturing incremental revenue by bringing products to market faster.”
Where I diverge from Mark’s analysis is when he presents the issues as ‘legal problems’. Lawyers are key stakeholders in any contract. That does not naturally or necessarily make them owners of the contracting process. Indeed, the article acknowledges this when it says: “For years, companies have tried to solve complex legal problems with more lawyers, when the right answer is often fewer. High-volume contracts operations don’t call for a legal-only solution.” But having recognized that contracting is actually a multi-disciplinary, collaborative activity, Mark then proposes that the lawyers should be top of the pile when he says that these operations “require a combination of technology and processes that allow a pyramid of negotiators and subject-matter experts to work under a smaller pool of strategic lawyers who set policy, anticipate important risks and provide high-value counsel to their business clients.”
While I have seen well-intentioned General Counsel show invaluable leadership in having their company tackle weaknesses in contracting, I am far from convinced that a stakeholder with specific interests can ever fully represent the wider interests of the business. Indeed, I think one reason why contracting processes are so weak is precisely because individual stakeholders jealously guard their power and prevent anyone from within their number taking ownership and control. Many might argue that much of the problem with contracts today is due to the conservatism, traditional thinking and resistance to technology shown by many in the legal profession.
To be effective, a contracting process must be balanced and visibly reflecting good judgment. Its owner has to be measured on the effectiveness of its output throughout the life cycle. I do not believe this is consistent with the role or skills of most legal departments and I am unsure that it is something they should aspire to. I think true excellence in contracting process requires an independent owner – who may indeed have legal qualifications, but will not be driven by the specific measures or purpose of the in-house counsel.
A relatively high proportion of business deals or relationships fail to deliver expected results. This proportion increases in situations where there is a high degree of negotiation. For example, it is often suggested that 60 – 70% of outsourcing contracts underperform. So to what extent are contracts themselves at fault? Or alternatively, if we had better contracts, would success rates improve?
Building and managing a contract is rather like building and managing a house. Success depends on the effective coordination of a team of experts, working to a common design or plan. That design or plan must be based on a clear sense of purpose or goals. It also requires a responsible ‘owner’ at each point of its life, providing guidance and instruction and taking responsibility for ensuring the right outcomes.
In the context of a house, the property developer engages experts – architects, engineers, a builder – who in turn coordinate relevant professionals – electricians, plumbers, bricklayers, landscape gardeners. On completion, the property may be turned over to a new owner, who then assumes responsibility for ongoing repair, maintenance and improvement – once again engaging experts as needed to perform these tasks.
Things go wrong if the developer fails to ensure clarity of purpose, or if the architect fails to design for that purpose or to communicate clear instructions to the builder, or if the builder fails to coordinate and oversee the contractors ….. The list of possible problems goes on and each of them contributes to potential delays, cost overruns and disputes.
I think the analogy to a contract is clear. At the first level, the contract should be the design drawing that represents the vision of what the developer wants; it is then the model to which experts contribute their ideas and explain their limitations – areas such as finance and pricing, intellectual property, tax and intercompany, operations and project management. Failure to coordinate or reconcile these areas will cause problems – delays, overruns, disputes.
What makes contracts incrementally complicated is the fact that there is usually a stark contrast between the ‘design’ stage (contract drafting, negotiation) and the ‘build’ stage (performance after signature). It is often the case that the people charged with performance had little involvement with the design. Indeed, they are rarely even given the opportunity to review the signed agreement and confirm their readiness or ability to perform against it. And those who undertook design are rarely held to account for whether their work supported a successful outcome.
In situations which use a standard form of contract to undertake a regular set of tasks, problems are of course rare. The issues arise when the activities being committed are not standard, or are customized. Then, the contracting process becomes fundamental in determining the value of the outcome because it provides the discipline that ensures clarity of purpose, stakeholder engagement, reconciliation of differences or variations and a tool for guiding and overseeing performance. The absence of that discipline is rather like constructing a house with only vague concepts of what purpose it is to serve and without structured drawings or plans.
So poor contracts do lie at the root of many underperforming deals and relationships. However, the poor contract is a direct result of failure to ensure a robust contracting process, with clear ownership and accountability for defining requirements and producing agreements that deliver desired results.
There is growing momentum for fundamental change in the way that trading relationships are formed and managed. It is increasingly clear that the way businesses approach selection, engagement and management of their trading partners results in too many failures.
The news stories indicating these problems appear on an almost daily basis. Earlier this week, the UK’s powerful Public Accounts Committee was back on the warpath with regard to Government procurement. They were once again promoting various remedies to the perceived ills of major contracts and value for money. Their solutions include increased use of SMEs and enforcement of open book accounting.
I will comment in greater detail on these specific proposals in a subsequent blog. However, regardless of their merit, I think we have a much bigger problem.
Network technologies will continue to transform ‘the nature of the firm’. It is time for a new Ronald Coase to emerge and define the business model of the 21st century – because it is this that determines the means of supply and the consequent need for trading relationships and how they are formed and managed.
Right now, I think we leap from one quick fix to another – picking on symptoms, not causes. We had compliance, we had category management, we had more adversarial allocations of risk, we had spend aggregation. Now we have a push to shorter term contracts and disaggregation to encourage SMEs and the growth of competition. But not surprisingly, these initiatives provide little improvement. The need is to redefine the environment within which trading relationships are formed and to design commercial and contracting models that support it. Already IACCM research is pointing to many of those answers – things like relational contracting, outcome-based structures, the need to shift the role and purpose of traditional contracts, commercial, legal and procurement groups.
Drawing on all the evidence, IACCM is preparing a definitive view of how we prepare for and build this future. You are welcome to join us, or to share your views of how trading relationship management should be redefined.
Michael Casey wrote an excellent comment on one of my recent blogs about contract and commercial skills. He observed that many practitioners tend to believe (or at least portray) that they ‘know it all’. And in Michael’s experience, they do not. He asked whether there is any data regarding the benefits of training.
I strongly agree with the point Michael makes – and indeed the issue he highlights lies at the heart of IACCM’s reason for existence. Like so many, I ‘stumbled’ into contract / commercial management and found a group of well-meaning, often talented, individual practitioners, but with no consistency of training and in many cases little consistency in their perception of the role to be performed. Within customer organizations, the contracts / commercial discipline was generally absent (outside their law department) and – as Michael observes – in many geographies contracts were either seen as culturally alien or purely administrative.
IACCM was formed to change that environment. It is 10 years since we developed the first unified ‘body of knowledge’ for the community and there have been some 12,000 practitioners enrolled into that program. That remains the tip of an iceberg, but it is an important start. Unfortunately, those who are most resistant to ‘professionalization’ and standards of practice are often the ‘leaders’ of the function. Either because they feel no personal need, or perhaps feel threatened by the idea of consistent training, there is frequently denial of benefit from consistent knowledge, practices and certified competence.
It is this attitude which ultimately undermines the growth or status of the function. As an example just this week, I heard from the CEO of a large, international company who observed “I am told that the people in my commercial department work really hard, but I have no idea what they do”. In these challenging economic times, you can imagine that is not a good way to be viewed – but it is inevitable while we remain scattered individuals without a professional standing or ethos and without reliable data that demonstrates the value that we bring.
There has been a surge of interest in contract management in the last two years. Organizations have increasingly recognized its importance in delivering business results and, in many cases, have been driven by concerns raised through their Audit Committee. A range of factors underlie this shift – regulatory compliance, reputational risk, performance management, financial returns. It has resulted in extensive process reengineering and frequent attention to organizational design.
For many, the question is ‘how do we build capability / competence in contract management?’ This is quite distinct from questions about a contract management function. Decisions on organization should flow from the broader conclusions over purpose, process and systems. While many are taking steps to ‘professionalize’ their contract management staff, they are doing this within a context of overall efficiency and effectiveness of the process, which often includes greater quality of judgment at the business unit level.
Any successful implementation depends on clarity of goals. What purpose does contract management have? Frequently there is no consensus within senior management on this question, which then results in confused implementation and unsatisfactory performance. Many seek market reviews and benchmarks, but it is important to recognize that different models are designed for quite different purposes. For some, the drive is to improve the bottom line. For others, it may be to ensure greater agility and flexibility in meeting market needs. Many – especially in Procurement – are more focused on compliance and control.
IACCM is involved in multiple reengineering projects, providing its insights on ‘best practices’ for contract and commercial management. In support of this, we are about to undertake a major update on benchmarks, to supplement our wide range of existing data. If you would like to participate (and receive the results of these studies), the surveys are https://www.surveymonkey.com/s/PerformanceMeasurement2014
At an IACCM member meeting in the UK, I presented on the topic of ‘Weaknesses in Contract Management’, focusing on the incremental value opportunities that are realized if we focus on driving bottom-line benefits.
Research consistently shows that a major contribution to financial results can be achieved by a more holistic, process-based view of contract management. To achieve this, organizations must shift from viewing contracts as individual events and explore their performance as portfolios – for example, looking at individual relationship or contract types.
The incentive for doing this is based on the relatively high rate of under-performing contracts. IACCM research has shown that on average 35% of an organization’s contracts fail to reach expected value by 10% or more and that a significant proportion of this value loss is avoidable.
David Hodges, Commercial Director at CGI, followed my presentation with a complementary session, “Do Projects Fail Because of Poor Contracting?” He started by defining the nature and potential degree of ‘failure’ as it relates to both customer and supplier. Following some web research – which focused largely on IT and technology services contracts – David came up with some even more dramatic numbers: CIO magazine, for example, estimates a failure rate of around 50% and other data revealed that “93% of contracts do not achieve what was envisaged”.
Based on his own investigations, David then explained what he had discovered as the primary causes of this value loss. His findings supported the IACCM research in pointing at issues of poor commercial discipline and judgment:
- Definition and management of requirements
- Availability or management of resources
- Unrealistic or over-optimistic schedules
- Weaknesses in planning
David made the point that while these are not traditionally seen as ‘contract management’ issues, investigation shows that in many ways they are. When it is recognized that they are repetitive problems, a high performing commercial team explores how they can be reduced or eliminated. He went on to explain his conclusions about the role of contract management (buy and sell) in driving improvements. These included greater engagement in requirement definition, ensuring the right contract model, improving governance and performance provisions and more active monitoring of change.
Both presentations are available in the library at www.iaccm.com.
Wherever we turn, risk is high on the agenda. There are always perceptions that risk is increasing, but in reality it probably just changes. Many challenges of the past are no longer significant or relevant; many risks of the future have not even been envisaged.
Business inevitably involves risk and you could say that its management lies at the core of competitive advantage. I think that this issue sits at the heart of the contract and commercial management role – but what position should a contract or commercial manager be taking?
There is a tendency in many standard forms of contract or during negotiations to engage in relatively mindless games of risk allocation. This is done in the name of efficiency and without giving thought to its consequence in terms of missed value opportunities or subsequent impact on the behavior of our counter-party. We know that this approach often makes little sense, but it serves the interests of time and expediency.
Making commitments always carries a degree of risk. Receiving commitments is also risky, since it implies reliance on another party who may not perform. Contracting is often an exercise in minimizing our own commitments and extracting not only commitments from the other side, but also imposing unpleasant consequences for their failure. To some extent, this will always remain a significant component of the contracting and negotiation process.
But I believe that contracts and commercial professionals have another and more valuable role to play. Their skills and experience can lead them to a superior understanding of their own organization’s capabilities, the limits of which place constraints on what can be negotiated. Since competitive advantage comes from superior abilities in risk management, it is my contention that contracts and commercial staff should always be exploring ways to improve their commitment capabilities, making business performance safer, but also making their organization a customer or supplier of choice.
We all like dealing with highly competent people. We are more likely to trust them. The same is true of business. If we are seen as constantly battling to avoid risk, what does that say about our organization and its competence, its trustworthiness? So for the commercial expert, the opportunity is to identify areas where commitment is valued by our counter-party and seek creative ways to accept it. It is my contention that over time, responsible risk adopters will always win out over risk avoiders.
On Spend Matters, Peter Smith recently made interesting observations about the growth of Procurement influence. He suggests that two major factors have raised its profile and purpose, one being the dramatic growth of external spend (largely driven by outsourcing) and the other being globalization. Each of these has taken organizations into uncharted waters, stretching internal skills and experience and exposing unfamiliar risks.
One obvious effect of this shift has been the centralization of most Procurement functions, as management realised the importance of greater controls, more consistent policies and the consolidation of spend in a group outside the control of individual business units.
But as Peter points out, spend volume cannot go on increasing for ever and many of the risks associated with global procurement are becoming better understood and managed. So what is the next big thing that will maintain the influence of the Procurement function – or isn’t there one, was this growth just an aberration?
This is certainly a point of growing debate, with more and more forums reflecting the apparent uncertainty and insecurity of the Procurement function. I have been involved directly in three such discussions in the last week – one with Proxima on a webinar, one at the Zycus ‘Horizons’ conference and most recently at this week’s Virginia Public Procurement Forum. CIPS has even advanced the idea that anyone buying goods or services should be a licensed practitioner – hence trying to institutionalize the function, rather than address the more difficult question of its real or sustainable value. Unlike the lively and motivational discussions at the events I mentioned, the licensing route seems to me entirely the wrong way to go – and indeed is in direct contrast to the general trend of liberalization within professions.
A point that is not often mentioned is the extent to which other (and much more established) professions are asking themselves similar questions. The reason for this is not hard to find; networked technologies replace the need for many lower level activities and also increase access to knowledge. McKinsey says that 47% of professionals will not be needed in a few years time. Hence, Procurement should survive only if it is needed; it cannot succeed in fighting the tide of ‘knowledge commoditization’ and task automation.
So what activities are needed? Certainly there is value in market evaluation and research, which is increasingly important as organizations race for competitive advantage and innovation. There is tremendous value in aligning business requirements with market capabilities, a frequent source of value loss in today’s supply management. There is value in assembling and reconciling stakeholder interests and perspectives, an often contentious, time consuming and incomplete activity. There is value in negotiation and in ensuring effective implementation of resulting agreements, focusing on users and their needs. Finally, there is value in overseeing results and outcomes, including avoidance of problems, resolution of disputes and dissemination of learning. Procurement is already active in some of these areas, but in many it is seen today as just one of the stakeholders or even an obstacle, rather than an organization that effectively coordinates, exercises judgment and takes responsibility for outcomes.
I believe there is a sustainable role for Procurement, but it will be quite different from the role of the past and it will encounter competition from others also seeking self-preservation. It also demands a radical shift from the control and compliance mentality that has dominated many of the discussions and growth of the past. So there is some urgency in moving ahead. But right now, I see no consensus of vision either within the practitioner community or among those who represent them – and that is a real threat.
Commitment Matters 