“We have to move from an environment where success is measured on concessions won, to where it is gauged by goals achieved, benefits that are shared’.
This statement was made by the head of contracting for a major state agency during a conference I am currently attending. I like the way it is expressed. On one level, it appears simply to be a statement of win-win, but I think it injects an important additional ingredient to that win-win calculation.
The problem I have with books like Getting to Yes is that they tend to see the moment of gaining agreement as the point at which value is realized and divided. In a spot trade, perhaps even in a typical commodity contract, that may be true. But increasingly we are negotiating agreements for solutions, services and long-term projects where results are only evident over time – sometimes a very long time. In this environment, we have to evaluate negotiation success by different criteria – essentially, as the initial quote describes, by ‘goals achieved, benefits shared’.
This is why the subjects that lie at the heart of good negotiations today are changing. They focus far more on the principles of how the parties will work together, how they will identify risks or challenges, how they will handle the need for change. Negotiators are establishing a roadmap or a blueprint for future engagement, not just a set of rules for a short-term transaction.
If negotiators remain fixated on winning points and gaining concessions, it means they will fail to establish the on-going governance and performance principles necessary for success. It also creates an environment where cooperation is threatened, where the party which was forced into concessions is seeking to gain revenge, or to rebalance the relationship.
IACCM research points to high – and in some organizations increasing – percentages of agreements that fail to deliver business goals and where neither party achieves expected benefits. I suspect that an investigation of their negotiation strategies would point to a traditional approach where negotiations proceed issue by issue, where there is no discussion of impact on value or behaviors, and where the focus is often on compliance and a ‘battle of the forms’. If your organization is one of those, it is time to push for change.
IACCM recently completed research with Newcastle University Business School and the University of Paderborn, exploring industry experience with performance or outcome-based contracts. Complete findings will be published shortly, but the results indicate that the use of performance or outcome based contracts remains relatively immature, even though experience in many cases is favorable. There is particular evidence that this approach to contracting results in more collaborative and longer term relationships, implying that they are capable of delivering increased value for both parties. However, success typically requires a level of investment by both parties in appropriate skills, processes and supporting tools or systems. Also, the level of adoption at present appears greater in contracts where payment is based on use, rather than those where payment is based on results over time.
Therefore any move by industry – or individual contractors – towards this contractual model requires a degree of planning and capability review; it also requires more careful and holistic review of trading partner culture, behavior and capabilities to ensure each party is equipped to operate with these models.
The survey – which gathered input from more than 250 organizations – reveals that most performance-based contracts are being constructed through ‘trial and error’ methods and then demand ‘improvisation’ for their on-going management, often including the need to challenge or change internal policies or practices.
Many performance / outcome based agreements today are quite rudimentary and for relatively standard, low-value services. This is reflected in the payment schedules, where rewards are mostly not based on outcomes, but on pay by use. This confirms the fact that many performance based agreements are more about turning services into commodities, rather than operating at a strategic level of delivering high value outcomes.
However, with some two thirds of respondents reporting favorable or very favorable results, it is clear that interest in this relatively immature type of contract will continue to increase. IACCM’s work has been focused on the approaches and structures needed to support success.
Yesterday I was involved in a webinar discussing the future of Procurement, which IACCM ran in partnership with Proxima. I very much enjoyed the discussion and thought that many good ideas emerged, but I was left with a nagging doubt over whether we had really addressed the key issue.
The program featured an extremely talented and successful CPO. He explained that his ability to contribute increasing value to the business was being achieved in large part through the development of talent and skills within the Procurement function. But he then made clear that most of this was due to hiring in a diverse range of professionals with no procurement background – for example, lawyers, accountants, risk and compliance experts.
Essentially, as I commented on the program, it sounds as though he is actually building a ‘business within a business’. And while I can see the short-term attraction of this, I wonder whether it is a sustainable model and whether it actually addresses ‘the future of procurement’.
The big challenge for successful procurements (which is similar to the challenge for successful sales) is the need to integrate internal resources and stakeholders, to reach consensus and ensure that commitments are supported. Of course, one way around this is to avoid the stakeholders. That certainly increases the speed of decision making – but usually spells disaster when it comes to implementation. Another route – which I suspect this CPO is pursuing – is to create a shadow organization, which can also make some decisions more independently, but may also be more effective in communicating with internal business groups and functions because they speak the same language.
The problem with this approach is that over time, there tends to be contention over authorities. For example, a lawyer in Procurement is not a Corporate Counsel and their authorities are accordingly restricted. For the individual in Procurement, those limitations can become galling and they also lose a natural career path within their own functional discipline. And from a business perspective, the perception of duplication of effort raises questions over costs and efficiency.
However, a different point of view could be to recognize that the biggest challenge to good trading relationships is the existence of internal silos and specialisms. This realization might lead to the creation of Procurement and Sales Contracting groups drawn from a diverse array of functional skills so that they can perform precisely the accelerated role and interactions outlined above. Perhaps rather than having people build a career in Procurement or Sales Contracting, they are individuals assigned from their function for a period of time, as a career broadening and development move. Indeed, this might be an excellent way to spread commercial skills and competence through the business. However, ultimately it would also be a recognition that there really is no such as thing as a “Procurement” profession – it is rather an amalgam of diverse business skills, employed to overcome the weaknesses created by today’s functional silos.
The issues created by complexity are at the forefront for most contracts and procurement professionals. The reasons for this are made evident in a recent article in Strategy+Business, which outlines three distinct levels of complexity and describes each in terms of the extent of interconnections and interdependencies. It highlights the third tier is reached when interactions become unknown or unpredictable – in other words, our ability to predict or build effective controls are limited.
This topic is very interesting because there is no doubt that contracts sit at the nexus of complexity and are tools which try to make sense of it. In fact, the three designations of complexity type listed in this article could be a very effective way to do contract and contract management modelling. In the realm of simplicity, standard templates can work. But attempts to impose the same standards in more complex situations will inevitably create problems. So contract design and associated management systems must be attuned to the complexity model.
When I led contracts re-engineering work at IBM almost 20 years ago, we actually stumbled onto this thinking. We categorized contracts into three ‘bucket’ – ‘commodity’, ‘integrated solution’ and ‘custom / first of a kind’. The first was a simple and independent product or service sale or acquisition; the second was a combination of products or services, which created interdependencies and more complicated commitments, but which had been done before and therefore risks were known and manageable. It was the third category that represented true ‘complexity’ because it involved levels of innovation and customization that took us into the realms of the unknown.
By thinking this way, we were able to identify the portfolios of contract terms needed for differing situations and to design contract models that would adjust to the nature of the transaction. Systems support and required skill levels could also be attuned to the varying levels of complexity and therefore directly linked to the management of risk.
A further benefit of this approach was that it provided a simple explanation to senior management about the role and purpose of contracts and the contract management function. They could quickly grasp the relevance of both in assisting management of the business. This thinking has continued to influence our work at IACCM, as we look at best practices in process, organization and contract template design.
According to research by The Hackett Group, the second highest priority for Chief Procurement Officers in 2015 is to increase scope and influence. This was among a range of data presented today at the Zycus Horizons conference in Florida.
This finding begs a number of questions. First, why do CPOs see raising their influence and expanding their scope as a priority? Beyond personal or functional ambition, is any one actually calling for an extension to their role? What benefits are expected to flow as a result? Presumably this ambition is driven either by a perceived need to fill gaps, or by the belief that the work currently undertaken by others can be done better by Procurement.
The second question relates to these areas of benefit. One would expect that other 2015 priorities would give some clue as to the new values that will be achieved as a result of greater influence. Reduced costs tops the list – and this is certainly not a new area of endeavor. Reduced supply risk comes third – again, hardly new, but certainly an area where there is room for improvement. At 32%, ‘deeper influence on complex market spend’ is a legitimate ambition for many; complex relationships often operate with limited Procurement involvement. Innovation – an area which you would think could yield significant extra influence – comes in at only 21% on the list of priorities.
So there are some useful indicators here regarding the possible approach to increased influence and scope. The main opportunities are likely to be earlier engagement and increased market insight, selecting suppliers on value and competence more than on price. And then also expanding performance oversight and the management of on-going change, including innovation. Together, these areas would actually tackle all of the objectives listed above.
But the question remains, does Procurement have the skills and tools needed to execute on these improvements, or the ambition to acquire them? I will comment on that tomorrow, in my second report from Horizons 2014.
Yesterday’s mid-term elections did nothing to resolve the underlying political inertia that has gripped the US for years now. The inability to enact any meaningful political reform, together with the adversarial social divisions between Democrat and Republican voters, promises a continuing vacuum in meaningful legislation.
The UK is in many respects in a similar position, with coalition government and the need for consensus having inhibited action beyond that of deficit reduction.
So it is interesting and worth noting that the US and the UK, among developed nations, are leading the way in terms of economic growth. Countries like France, with a highly interventionist government, are struggling to come out of recession.
On the other hand, high growth countries in the developing world often show opposite traits. A country like China flourishes as a result of government policy and intervention (though it might be argued that the growth actually results from a relaxing of control, thereby supporting the point that economic expansion is directly inverse to levels of government activity). But in many of these countries, strong government is needed to provide stability and the foundations for investment and productivity.
So what can we conclude? It seems to me that the US and UK have sufficient social strength to flourish without political intervention – indeed, politicians actually create disruption by many of their actions. A big difference in these countries is the strength of the rule of law, itself relatively independent of politics. Since Common Law does not depend on statute, it can offer a stable yet evolving framework for commerce. In many emerging economies, the principles of law – and especially commercial law – are weak and uncertain, often open to corruption. Therefore strong government becomes essential for business confidence.
Hence the continued deadlock in US politics is probably a good thing for US economic growth and overall world trade. Similarly, the probability that no single party will emerge with a majority in next year’s UK elections may also be good news for business.
One of the questions asked most commonly by contracts and commercial groups is how they should be organized and where they should report. These are not the right questions. The fact they are asked so frequently is in fact an indicator of the real problem – which is lack of clarity over purpose and goals.
It is in a way ironic that the biggest cause of lost value in contract management is disagreement over scope and goals. This is precisely the issue that ails many contracts and commercial groups. No one is quite sure of their purpose, or there are widely divergent opinions. This leads some executives to perceive no value at all, while others will have quite varied views and expectations. This inevitably means the function will disappoint many in its contribution or achievements.
In a recent IACCM workshop we provided four options regarding the primary value that comes from effective contract management. These were related to risk and opportunity; reputation and trust; revenue and profit; and operations and performance. We know, in reality, that high performing contract management processes contribute significantly to all these things. But the problem is that few executives see contract management as a process; in consequence, the debate over organization is generally focused on a much narrower area of value delivery – typically associated with either control and compliance, or with assisting business units to work around controls in a managed way. The workshop resulted in lively and healthy debate, leading to much greater understanding of the potential benefits and a refreshing discussion on what this might mean to the way contracts are formed, drafted and communicated within the business.
The start point for any business activity should be a clarity over its purpose and value. From this flows a definition of process, measurements and the skills or knowledge required for performance. Then – and only then – can there be meaningful discussion over the size, nature and reporting line of any associated group or function. A failure to follow this approach results in confusion, regular change and lack of investment – and hence the regularly recurring question ‘How should we be organized and where should we report?’
To gain respect and status, contracts and commercial groups need to rise above these organizational questions and challenge senior management with the much more fundamental question regarding their potential purpose and value. The good news is that IACCM offers extensive data to illustrate how substantial that contribution can be, if only management addresses the core issue of investing in a business competence.
When GT Advanced first spotted a major opportunity to supply Apple, I am sure their management were excited by the prospect. This could surely be a route to rapid growth. When they won a contract, the market clearly agreed – the stock price rose rapidly. Now, with the declaration of bankruptcy, the post-mortem begins …
For small and mid-size companies, the allure of the big deal with a major corporation never diminishes. Yet as the story of GT Advanced and Apple shows, it is fraught with risks and danger. Pierre Mitchell has written an excellent analysis of what went wrong, pointing out that even a highly acclaimed supply management function can show poor commercial judgment in how it structures and manages relationships. The problems here appear to have been badly defined and managed scope, inappropriate contract terms and absence of effective performance management.
I must confess that I do not know much about Apple’s supply management function. I am aware that it wins awards, but I have the impression that much of Apple’s innovation has been internally driven, or based on partner relationships which are relatively standard. I wonder to what extent the Procurement organization suffers the challenge of many – that it is far better at overseeing control and compliance than in managing innovation.
But what about GT Advanced? How did their management get things so wrong? After all, they did not have to sign the contract that was offered. Surely they must have had contacts at a senior level and could have influenced the structure of the relationship and the risk terms. However, like many others, they doubtless did not want to cause delay, did not want to risk derailing the deal and probably believed in their ability to manage the situation. Such over-optimism is not uncommon; as is the failure to grasp the importance of the contracting process, especially in an environment of considerable uncertainty and innovation.
Senior management in most organizations has not ever been exposed to the importance or potential contribution of effective contract management. It just does not feature in the majority of business schools or executive training. The wider topic of ‘commercial judgment’ is not really taught much either. That is probably because teaching still operates in functional silos and there is little integration or explanation of how disciplines interact or interconnect – finance, law, marketing, project management, operations. It is these interactions that should be caught in the commercial evaluation and within the contract terms.
The GT Advanced / Apple case study will doubtless be used extensively in the next few years and hopefully will lead executives to better understand the role that contracts and contract management can perform in ensuring thorough opportunity assessment and subsequent oversight of the performance of their key relationships. Even in SMEs, where management attention may be less distracted, the value of these disciplines is enormous – and their absence can, quite literally, cost you the business.
In a recent exercise, we had groups of business people discuss different aspects and attributes of contracting. They discussed the role and value of the process in managing risk, in establishing reputation and trust, in delivering revenue or profit and in supporting operations and outcomes.
Feedback revealed broad consensus that good contracting delivers benefits in all of these areas – or alternatively, poor or disjointed contracting causes damage and under-performance. Yet despite this realization, it rapidly became evident that few organizations have a well-defined process. For example, participants quickly highlighted major problems with input (unclear or badly defined scope and goals) and with transitions (transfer from pre-award to post-award teams). They mostly felt that contracts are not effective governance tools and often lack the terms needed to manage flexibility or change.
How much does this matter? What is the business case or the economic return from ‘good contracting processes’?
IACCM has approached this challenging question in several ways. The reason it is challenging is that data is limited – not least because so few organizations have a coherent process with regular performance measures. Research in 2012 focused on the scale and reasons for value leakage and identified that on average weaknesses in contracting are resulting in losses equivalent to 9.2% of annual revenue. In companies with the most integrated process, this reduced to as low as 3.4% – an impressive difference.
One finding from this study was that there are substantial differences between industry sectors. Therefore more recent research has compared companies within specific industries, exploring whether there is a link between overall profitability and the maturity of the commercial and contracting process. The answer is clearly yes. For example, in the outsourcing industry, profit margins are highly variable, even for companies offering similar services. In examining their approach to contracting, it was quickly evident that some saw this as a life-cycle process, while others viewed it more narrowly as an activity to oversee compliance or control. A few had little evident control; they delegated authority to business units and operated with many variants in contract terms.
Those who viewed contracts as control instruments or who operated with very few controls showed similar results and struggled with their market reputation. They were viewed either as inflexible or unreliable and failing to meet commitments. Both suffered from a high degree of fire-fighting and their contracts were not useful operational tools. They were also perceived as less creative or innovative – too busy fixing things to have time for added-value conversations.
In one select group of 10 companies, the typical margins of those with poor contracting processes were in the range 2% – 5%. Those with holistic approaches to contracting were recording margins of 14% – 16%.
Conclusive proof that good contracting pays a healthy dividend? Perhaps not; there are of course wider factors to take into account. But there seems little doubt that the quality of contracting is a significant contributor to profitability – or failure to develop competence in this area carries a heavy cost.
There is growing appreciation that collaborative relationships generate better results. On one level, it is surprising that anyone ever thought otherwise, but market pressures over recent years have caused fundamental realignments in buyer / supplier relationships. These changes have undermined trust and often created a high level of contention and adversarialism.
Now, the pendulum is swinging back, there is a new level of openness in business relationships and a greater readiness to discuss shared risks and responsibility. Achieving this demands a shift in the negotiation agenda and greater focus on governance and performance management principles and process.
However, the transition is not easy. Today I have been leading a workshop on collaborative supply relationships and the participants shared what they saw as the major barriers to change. Top of their list came a lack of trust – but of course this is a symptom of other things and will not be fixed without addressing the causes. Here are the top five (by frequency) that they identified:
- Resistance based on the view that collaboration takes too long (to reach decisions) and undermines accountability
- Different objectives / mismatched KPIs / silos between stakeholders
- Competitive bidding / re-tendering practices
- Unclear process, especially with regard to roles and responsibilities
- Unclear benefits of collaboration – both organizational and personal
I find it interesting that the group saw internal barriers as the major challenge. No one mentioned resistance or reluctance by the counter-party (though this audience was from the customer side and I suspect a supplier audience might generate a different list).
Fortunately, we were able to work on some immediate practical steps that will increase collaboration – but it is clear that there are significant obstacles to be overcome before the benefits can be realized.
Commitment Matters 