What makes a contract risky – and what are the causes of value loss?
You might think the answers to these two questions would be the same, but it seems they are not. At least, that’s what the input to World Commerce & Contracting’s survey on contract value erosion is telling us. In fact, the picture is quite complicated:
- Buyers and suppliers have different views about why value loss occurs.
- Different industries have different views about the factors that make a contract risky.
- There are multiple views on which types of contract represent the greatest source of risk and value erosion.
Making sense of this data will provide us with far greater insight to the ways buyers and suppliers might work together to reduce risk and secure value. To date, over 200 organizations have submitted data, with a further 30 engaging in detailed interviews. In early November, participants will receive an exclusive report helping them to better evaluate their exposure to risk and loss – and how they might improve the situation.
The survey remains open for further input and can be accessed here.
Markets are in turmoil, businesses face massive uncertainty. In this situation, how and what should I be negotiating?
COVID-19 is transforming the landscape for trading relationships, creating an environment that is unstable and unpredictable. Commercial negotiators are uncertain whether to address this through increased collaboration, or increased confrontation.
The 2020 worldwide study of the Most Negotiated Terms (released on October 7th) reveals a growing gap between industries. Some – like aerospace and oil and gas – can only recover through increased cooperation. Others, like the garment industry or hotels and leisure, have opted for more draconian measures, cancelling contracts and withholding payments. For many, that choice has often depended on the strength of their balance sheets. Do I play tough – and perhaps drive my customers or suppliers to the wall.? Or do I play fair – and try to sustain my customers and suppliers for better times ahead?
Hard choices
The last few months have presented hard choices. Decisions about what and when to negotiate can be critical to survival. Many contract negotiators hope that COVID-19 represents a catalyst for lasting change. For years they have recognized that negotiations tend to be competitive, focusing on risk allocation and price, rather than mutual value. ‘Win-win’ has been little more than an aspiration. Now, almost 60% believe that the pandemic is a catalyst for increased collaboration, for greater transparency of data and improved communication (65%) and for fairer allocation of risks (44%).
To achieve these positive changes, the focus of negotiations must shift to areas of shared interest – increased clarity over mutual goals and objectives, clearer definition of roles and responsibilities, better approaches to the management of change. In the virtual world created by COVID, technology has come into its own – and will be a critical element in enabling change. As case studies increasingly show, it can provide improved data flows, faster and more timely communications, greater inclusion and diversity of ideas and opinions.
Trade – and with it the speed and depth of economic recovery – depends on trust and cooperation. How and what we negotiate has direct impact on whether there is trust, whether there is cooperation. This report shows that the world is finely balanced between forces that increase competition and those that will support collaboration. Each has its time and place. The secret of good negotiation is to understand when to compete, when to compromise and when to collaborate. COVID has perhaps helped us understand the criticality of this evaluation – and that in recent years, we have go the balance wrong.
The Most Negotiated Terms features as one of the major topics in World Commerce & Contracting’s TASK series of free learning programs, including a webinar with leading technology provider Icertis on October 7th, 2020.
When it comes to the most negotiated terms, ‘governance’, along with communications and reporting, does not even make it into the top 30. Why is that, and does it matter?
The quality of governance is widely understood to have critical importance for business performance. Indeed, many organizations have gone overboard in their implementation of governance boards, sometimes to the point that they are almost operationally disabled. But of course that overkill does not represent quality. Nor does relegating it to a contractual after-thought.
Some thoughts and ideas
There is no doubt in my mind that good contracting depends on coherent forms of governance and that contracts should reflect and support that governance in both form and purpose. Their effectiveness in doing this depends on multiple factors, but among the most critical are:
- the governance provisions must be universally understood and accepted within each contracting party. Today, often, they are not – they are just words.
- contracts must be structured and then disseminated in a form that renders them a useful and usable operational framework. Today, in general, they are not – and hence a tendency for many governance provisions to sit outside the contract as guides, manuals or charters, which may then be viewed as optional.
- building from this point, it may only be when embedded in contract that there is a concern and effort to ensure compatibility between the core terms of contract and those of governance – e.g. in areas such as an appropriate allocation of risk and reward to incentivise the cooperation implicit to good governance.
- a recognition that relationships operate across a spectrum of dependency and value and this implies a similar spectrum of appropriate governance. There is a steady graduation in the formulation of governance provisions from imposition to mutuality. We must recognise that while mutuality is optimal for theoretical value, in practice it is very hard to develop and sustain because it implies exceptions to standard operating procedures for both parties. That’s why things like industry codes are emerging and may prove to be the way forward.
There is a lively and growing debate over governance and performance management, further accelerated by the experiences of COVID-19. The depth of dependency on contract relationships, the challenges of limited transparency, the need for increased cooperation – these are just some of the factors requiring improved definition of day-to-day operational procedures and practices.
Improvement is challenging
Behind all this there are pressure points that can help or stand in the way. For example, as this year’s Most negotiated Terms report will show, procurement and legal continue in many cases to drive a preventist approach to contracting. Without direct intervention from the CFO, it is proving hard to make the switch from judgments of value at point of input to a more holistic measure of lifetime cost and value. It is also complicated to start thinking about relationships more holistically, for example basing approaches to cooperation across networks or ecosystems rather than apply them one relationship at a time.
Governance matters and people do care. But the journey to better governance is going to require sustained effort and focus from across the organization.
It seems to me that our real challenge is to formulate a governance design model that operates across the full spectrum of a business’s external relationships. In this time of major change and uncertainty, there is an added urgency for us to deliver some practical ideas.
Contract value leakage – the amount by which contracts under-perform against potential – is highly variable. It depends on which industry, what type of contract and on market factors that may lie outside your control. But even allowing for these factors, there are big differences between similar companies – and that is indicative of factors that can be controlled.
Back in 2012, IACCM research indicated average value erosion of 9.15%. Subsequent studies – by IACCM and others – have largely endorsed that number, though recently I have conducted a number of interviews that suggest things may be improving.
Taking the mystery out of value leakage
Building from those conversations, IACCM (now World Commerce & Contracting) is conducting a survey to pinpoint the continuing causes of value loss and to analyze these by industry and type of contract. The report will provide participants with useful insights against which they will be better able to assess and benchmark their performance against industry peers.
For many organizations, revenue improvement and cost reduction are at the top of the agenda. Improved understanding of value leakage and how it can be stemmed is therefore a critical issue to commercial and procurement teams. The World Commerce & Contracting study will provide an invaluable backdrop to internal review and the development of improvement plans.
With less than 8% of organizations ranking their contracting processes as ‘excellent’, there is clearly plenty of opportunity for improvement. Start your discovery by taking the survey here!
For all their depth, Finance departments frequently lack breadth. Like so many professions, the last 30 years have seen ever greater specialism and with it, they often risk a reduction in understanding of overall context. This is not helped by the disconnected nature of data, stored in specialist systems that reflect organizational divides.
The pandemic rapidly brought these weaknesses into stark relief. Financial publications are full of stories about the lack of reliable data to support CFO decision-making. Much of that data relates to contracts, since they fuel most businesses’ income and a large part of their expenditure.
Commercial and contract teams need to engage. They have a massive impact on financial performance and also on the ability to extract and report on the data needed to predict and measure. Here are the primary areas where we should be leading or contributing.
Scenario planning to the fore
One consequence of current uncertainty is that many finance teams have changed their approach to budgets and forecasting. For example, one $85bn group now develops rolling forecasts for the next 18 months, combined with scenario planning to provide a flexible response to fast-changing global conditions. “We don’t have one point of view for the next 18 months, we have multiple points of view of what would happen in different sets of circumstances and assumptions,” says their CFO.
“We need to be agile”
In line with this scenario-based approach, agile budgeting is back on the agenda, with a need to be far faster in setting budgets and more flexible in their management. This is also true of the way we form and manage contracts. Gone are the days when contracts should be designed to constrain change. Instead, they must anticipate that change is the norm and enable it to occur in a timely and disciplined fashion – essentially mirroring the scenarios adopted by their Finance function.
Cash is king (and queen)
Interviews tell us that organizations are streamlining their cash flow and forecasting. Again, since cash flow is driven by contracts, they have a fundamental role to play. Better understanding which terms have impact on cash is one element. Another is to establish dashboards and analytical tools to monitor the contracts portfolio. As Treasurers focus on the centralization of payment processes, forward-thinking commercial teams have been building tools to monitor customer performance – who is paying late, who is asking for payment holidays, who is pushing to reduce commitments. All of these factors provide indicators of where there is risk of default or delay, allowing protective measures to be put in place.
Do we want this customer?
There is extensive conversation within Procurement teams about diversifying supply and holding suppliers to account. But what about holding customers to account? Financial fragility goes in both directions and suppliers do not want to be caught out by customers who fail to pay their bills. Again, contracts teams are being called upon to explore the performance of customers and to devise commercial terms and strategies that protect the business – including ‘no bid’ decisions.
CFOs love connectivity
“RPA ‘accelerating digital transformation’ in providing end-to-end integration of data flows”. This was the recent headline in one financial publication. CFOs have recognized the exposures that arise from fragmentation of data across multiple systems – which means their attention is turning to the need for investment in the contracting process. Even now, they may not think of it as a process, but they do at least appreciate that data needs to be linked to the relevant contract, not hidden in different functional software. Contracts professionals have a critical role to play in supporting or leading this digitization initiative. They face many challenges – not least identifying and making sense of current data. This has indicated the urgent need for consistent metadata extraction and storage, using consistent naming conventions – itself a massive challenge in the typical highly distributed world of a large organization.
Urgency is not an option
The situation we face requires immediate action. It provides an opportunity for forward-thinking contracts and commercial professionals to demonstrate their relevance and to build a stronger relationship with their CFO.
At its best, negotiation is an activity that supports discovery and establishes an alignment of interests to secure mutual value. Too often, what we call ‘negotiation’ is in fact the opposite – it is an exercise that prevents or constrains discovery and results in terms dictated by the more powerful party.
Will the pandemic and the disruption it has created alter our approach to negotiation? I believe that it will, both directly and indirectly. Here’s how.
- Organizations recognise that there is increased vulnerability. For many, financial health is fragile and this is increasingly factored into negotiations – in both directions. Suppliers are concerned about being paid; customers are concerned about receiving supply. This drives a need for better understanding of sources of funding, cash flow and on-going reporting, as well as possible payment guarantees.
- There is also recognition that re-negotiation in some form is likely to occur and hence greater attention is being paid to the terms that may be the subject of those future discussions. Examples include rights of delay, change management provisions and revisions to payment terms. When the pandemic hit, many organizations resorted to the Force Majeure clause as a way to initiate contract review. Negotiators are becoming more sophisticated and recognizing that FM is a blunt instrument and in any event rarely applies, nor does it eliminate obligations.
- Most negotiations will continue to be conducted virtually. Negotiators are becoming more comfortable and more skilled in their use of technology. In reality, it has some advantages – for example, it allows greater inclusion of experts; negotiation sessions can be better phased, with more regular breaks. On the other hand, there is a risk of increased fragmentation when more people are involved and those informal side-conversations and social activities that build trust and explore options are inevitably lost.
- Technology adoption is being accelerated and bringing some real benefits to the (virtual) negotiating table. The use of artificial intelligence and machine learning to undertake contract analytics is equipping some negotiators with far more knowledge – for example, about historic dealings with a specific customer or market, their preferences and past performance issues. Better knowledge can streamline the process – for instance, starting from a more realistic position or reducing the need for extensive discovery. That knowledge is also powerful in influencing – a key skill for any successful negotiator.
- The form of the contract is changing. A by-product of the pandemic is an acceleration of simplification and digitization. The importance of ensuring shared understanding across stakeholders is promoting greater thought about contract design, structure and even the medium being used. This could have massive implications, such as negotiations being recorded on video and therefore providing an absolute record of the conversations and terms of agreement. A digital record facilitates faster and more accurate contract implementation – but it also creates the need for non-traditional skills as part of the negotiation, such as programming or graphic design.
The changing form of negotiation is the subject of the World Commerce & Contracting TASK program being made available on September 21st. It will also feature in the up-coming Most Negotiated Terms Report to be published early October.
Contracts and commercial management are fascinating because they are interdisciplinary. They touch and require a degree of understanding of every facet of a business or organization.
My first exposure to contracts was from a financial perspective, working with Procurement to analyze and control purchase cost. In my role as a Financial Analyst, I discovered the multiple economic factors influencing prices, including government policies and interventions. In 1977, I recall presenting to members of the UK parliament on how prices and incomes legislation, far from subduing inflation, was in fact embedding it within the contracting process.
At that time, most contracts were letter agreements. In the context of local, long-term relationships, this level of informality worked well. But then my responsibilities expanded and shifted to supporting sales in export markets. There, a lack of formality frequently led to a lack of clarity and understanding, resulting in later disagreements. In driving a shift from the exchange of letters to a jointly signed agreement, I recognized my ignorance of law, so made that my next field of study.
Over the years, I have been in roles that brought me into direct contact with Sales, Marketing, Engineering, Product and Project Management, Risk, Audit, HR, Logistics – the list goes on, because in different ways and at different times every one of them impacts and is impacted by contracts and commercial policies and practices.
Today, those impacts and interactions are frequently described as ‘friction points’. In that sense, it takes me back to the beginning, to cost analysis, because every friction point represents a cost. Yet I have learned that we often seek to eliminate costs at our peril. By limiting interactions and constraining conversations, we may destroy opportunities to create value or we simply shift costs to another point in the acquisition or delivery cycle. We also lose opportunities to innovate, to introduce new ideas or methods.
Commerce and contracting are never static. They lie at the heart of business complexity and design. Because they are so multi-disciplinary, they have received limited attention from academia and often defy the attentions of top management. Yet slowly their central role in improved economic and social understanding and cohesion is becoming appreciated. Today, organizations need dedicated contract and commercial professionals and, for 21 years, IACCM has supported a growing body of highly-qualified practitioners. But that is not enough. The world also needs a powerful institutional champion for better commerce and contracting, for the research, standards and advocacy that will better serve the many disciplines which depend upon them.
This is the reason behind changing our name to World Commerce & Contracting, for expanding the role and mission performed by IACCM. Through increased knowledge and understanding, we can aspire to a world where every trading relationship delivers social and economic benefit. It is a big ambition that may never be fully realized, yet its benefits are obvious.
And that is the reason why I care.
Twenty-five years ago, I was leading a project at the IBM Corporation to develop a worldwide contracting process. The world was in a state of turmoil, with new technologies breaking down boundaries and geopolitical change challenging established norms.
At IBM, we knew that we had to change – and we had to do it fast. The market was demanding products and services that would equip them for this altered environment. Our management systems, our measurement and reward systems, our internal technology – the Corporation faced a need for fundamental transformation.
The role of contracts …. and the contracting community
Until that time, contracts had been designed to support local markets. Transactions occurred at a country level. Processes and resources were also developed locally. So even as we rapidly re-engineered our contract terms and models, we still faced a critical challenge – the people to support them. Back then, we did not even know who those people were, whether they actually existed. It took months to explore how contracts were assembled, negotiated and managed in the different operational teams around the world. And even when we had found those answers, we had no insight to levels of skill or knowledge.
That is where a formal Competency Assessment became critical. We had to develop a consistent definition of the skills and knowledge we considered critical. We had to develop a tool to assess the community of people performing contract and commercial roles. We needed to understand the extent, nature and geographic variability in strengths and weaknesses. Only then could we start to design and build a worldwide team capable of supporting the business.
Making your team stack up
The re-engineering project was a massive success. It equipped IBM with a high-performing contracts and negotiations function that was an important pillar in its survival and growth in those uncertain and demanding times.
My learning from that time was put to use a few years later, with the formation of IACCM (now World Commerce & Contracting). The Association developed a world-leading approach to Competency Management, not only drawing form that experience at IBM, but with the added ability to provide in-depth benchmarks. Today, an organization can undertake the skills and knowledge assessment, it can identify relative strengths and weaknesses across its team – and it can also make comparison with the outside world, answering questions like ‘How do my negotiators stack up against industry norms?’ or ‘How diverse is the knowledge and experience of my commercial team against those of our top competitors?’
Insights such as this create a true capability to ensure that your team stacks up. It informs talent development and acquisition. It supports targeted investment in training. It enables monitoring of progress. In the words of one Vice-President of a large contract management team: “The skill-set upgrade initiative is based on talent scouting/hiring, investments in training, and the World Commerce & Contracting certification program. We have been using the World Commerce & Contracting Competency Management Program for the purpose of comparing our contract managers against the market. Whilst I am fully aware of potential constraints, it is the best model we could think of and has helped big time to show the needs and the progress in terms of people investments to our senior management.”
We are once again in turbulent times, with boundaries shifting and a need for highly adaptable people and systems. In the context of these demanding conditions, how does your team stack up? And how do you, as an individual, stack up? World Commerce & Contracting provides its members – both individual and corporate – with the ability to discover the answers.
Starting September 14th, the World Commerce & Contracting TASK program addresses the topic ‘How do you and your team stack up?’
Rapid adaptability and a readiness to change: those are critical characteristics if we want to flourish in times of uncertainty. So that means we must be ready to do things differently, to respond to change by quickly grasping the ways that our work and output must adjust.
Not everyone gets this – many feel challenged or even immobilized by change, especially those whose job role and training has focused on avoiding risks and ensuring compliance.
The way ahead
The current IACCM study of the Most Negotiated Terms confirms this tension. Most current negotiations remain focused on traditional areas of risk allocation, yet beneath the surface there is an encouraging shift towards terms that are important in managing uncertainty. A high proportion of respondents indicate that they sense the need for a change of approach, towards a greater focus on collaboration, transparency and terms that will support on-going management of the contract and relationship post-award.
This wish for change is not new, but COVID-19 makes it more pervasive and urgent. Yet for all the aspiration, there remains a sense of resignation that it won’t happen. Many feel there is just too much resistance, internal and external.
So should we give up? Clearly not – developing more sustainable trading relationships is an economic and social priority. We must develop commercial frameworks that support recovery and future growth. And an encouraging finding from the IACCM survey is that about a third of negotiators recognize that they are currently part of the problem – that they do not have the skills and training needed for this new era.
What is missing?
Although many negotiators espouse ‘win-win’ in concept, very few have really grasped what this means in practice. The talent we need today is to develop influencing skills that can be applied across the lifetime of a program or relationship. This means commercial teams need to be involved from inception of the opportunity; they must engage with customers or suppliers to ensure a common sense of how value will be achieved; they must understand the concerns or needs of all stakeholders and build empathy and trust that those concerns and needs will be addressed.
Changes like this don’t just happen. We make them happen by being ready to adjust our behavior and approach: so what must we do to develop influence?
- Make others believe they will get what they want or need;
- Make others feel important;
- Connect with positive emotions;
- Make others feel empowered;
- Show respect for their opinions;
- Work to coordinate, not to instruct;
- Demonstrate sympathy.
How many of those attributes do you and your commercial colleagues exhibit today? Without them, you do not have what it takes to support the future.
Visit IACCM for the next phase of its TASK program, addressing the topic ‘Developing Talent & Building Your Resume‘.
People want change. Many believe there will be change, real change, as we emerge from the pandemic. Even politicians are being forced into fundamental reassessments of their policies, proving adaptive, acknowledging their mistakes and errors of judgement.
The current IACCM survey of the Most Negotiated Terms reveals a similar hunger and aspiration for a fresh approach. Commercial and Contracts professionals grasp the importance of increased transparency, better and more efficient communication, more intelligent approaches to the allocation and management of risk. They want to increase the level of collaboration between customers and suppliers because they know it is the right thing for their business and its future resilience.
Has anyone told the lawyers?
I am worried. That’s because, in a series of interviews with in-house counsel, we are hearing that many are going in the opposite direction. Take this quote from a senior lawyer in a large technology and services company as an example:
“Negotiations now are definitely different because of the future uncertainty – we are all trying to work out how best to handle it. But things go downhill once the buyer’s lawyers get involved. They seem to see these increased risks as a need to become even more unreasonable, to impose even more onerous terms on the supplier.”
The challenges created by the pandemic are universal. It did not discriminate between buyers and providers. Successful emergence requires a spirit of compromise and a readiness to work together to identify and resolve future issues. A narrow focus on protecting ‘my client’s interests’ at the expense of the counter-party is sure to backfire. Negotiation has to move attention towards terms that support open communication, reporting and governance. This includes an honest conversation in sensitive areas such as change management, rights of delay, ways to reduce the likelihood of supply disruption. Organizations that fail to address such topics and simply seek to place all risk on the counter-party either lack understanding of the market, or are operating in denial. They are probably best avoided.
A shift of thinking and approach
We know from our interviews and surveys that this problem of legal attitude is not universal. For example, the recent webinars that IACCM conducted with law firm Baker McKenzie illustrated how highly experienced lawyers appreciate the need to think across the entire acquisition lifecycle and set terms accordingly. But a universal shift of thinking and approach is urgently needed. No matter who is negotiating, they must do three things:
- Make an honest appraisal of their own organization’s position and the potential threats to its ability to honor commitments.
- Perform a similar analysis of their counter-party, where necessary asking tough questions and gathering data to understand their strengths and weaknesses.
- Have an honest conversation about ways they can best work together to either reduce or handle the risks they anticipate or the areas of potential weakness they observe.
This expanded view is not customary for many law departments, often because they are not involved early enough in the process. That must change. Every in-house lawyer should ask themselves whether they are doing what is needed to support growth and recovery.
Commitment Matters 