“The impact of today’s global trends is radically changing society’s expectations of business. And the extent to which a business behaves in line with these expectations determines how trustworthy it is perceived to be. Trust is pivotal because it is the basis of every human relationship, every transaction, and every market. Trustworthiness is the foundation of a business’s “license to operate” in any region or industry.”
This is the major conclusion from PwC’s most recent survey of CEOs. It is driving them to think not just about growth, but about ‘good growth’. That means growth that is ethical, sustainable and can be realistically positioned as representing social benefit. Many CEOs feel that things are already improving, that the collapse in trust that accompanied the financial collapse of 2008 is reversing. The most recent trust indicators suggest they are right, with the latest Edelman Barometer showing 58% of people now trust business, versus just 50% in 2009.
This shift in emphasis may explain why so many executives are talking more about collaboration and why IACCM’s top negotiated terms survey has started to show a subtle change in the focus of negotiations. Last year, we observed some reduction in the adversarial, risk-allocation style and increased attention to governance and performance oversight. This perhaps reflects an even greater unwillingness to engage in litigation – high-profile lawsuits are unlikely to help either side in the battle for trust. So if contracts are not about litigation, it further reinforces the point that they are primarily about creating certainty and enhancing relationships.
But it seems to me that ‘the trust agenda’ begs questions that go beyond the purpose of contracts or the way they are negotiated. It should be causing all those in Legal, Procurement and Contract Management to reflect on their precise role and contribution to the business. The answers vary a little. For example, in Procurement it must surely mean that efforts at cost reduction must be tempered by questions of social consequence; that purchasing activity will often be driven by the benefits to market image through longer term partnering or visible investment in socially desirable business. On the sell side, there are already growing trends in establishing off-set agreements or local content. Projects are assessed for community impact and stakeholder concerns are addressed through socially beneficial investments or development activities, such as improved schools or medical facilities, or boosts to local employment and skills.
Going beyond these transactional elements, business leaders are also looking for new commercial offerings that can alter the image of their business. A great example is in the energy industry, where leaders have understood that growth and profitability can actually come from reduced energy use. Therefore, rather than simply operating as a volume-based commodity supplier, large energy companies are developing contracts that offer facilities management and shared benefits from cost reduction. It helps them grow; it assists their customers in reducing costs; and it shows leadership in the social and political agenda for reduced energy use and environmental protection.
All of this implies that there are exciting opportunities for professionals in Procurement, Legal and Contract Management to be active contributors to the trust agenda. But I think there is actually an even bigger question regarding our potential role – and I will write about that tomorrow!
Meantime, I’d love to hear examples where you have observed a shift in approaches to contracting or trading relationships that illustrate this response to ‘changing social expectations’.
High-performing contract and commercial experts have always grasped the importance of understanding taxes. A smart approach to issues such as delivery or country of origin can have a substantial impact on price or profitability. But the stakes are about to get higher, if we believe a report by tax experts at Ernst & Young.
‘The Future of Tax’ is an excellent publication that outlines the E&Y view of trends in global taxation – and I think their predictions are right. At least five of the major trends have significant impact on contracting and should be influencing contract development and negotiation of any long-term agreement (i.e. exceeding 1 – 2 years). And they are unquestionably correct to say that Governments worldwide are focused on taxation issues and this will result in a multitude of changes over the next few years.
The five areas that have an obvious impact are:
- Legislation: more of it, form more places, as Governments seek to address the issues created by a global economy
- Transparency: greater disclosure, internal and external, including in key areas such as transfer pricing, governance and risk management
- Big data: improved analysis and scenario planning to inform commercial decisions
- Tax competition: as nations compete for business, where to position sources of production, supply, integration and jurisdiction
- Conflicting interests: weighing and reconciling the perspectives of key stakeholders to balance opportunity with potential loss
This scale of change means that contracts must be drafted in ways that enable flexibility and that contract management will involve more active monitoring of shifts in policy or practice. For example, the country where supply or delivery occurs may need to alter. The assumptions on transfer pricing may change. The reputation impact on past decisions may mean they are no longer sustainable.
In addition to this need for flexibility and monitoring, such a volatile and sensitive issue raises the question of the contracts and commercial professional’s role in making judgments on ethics or fairness. As social and political expectations shift and transparency grows, getting this right (or wrong) may result in significant reputational impact. And the issue is not confined to supplies since taxes represent a significant proportion of the purchase price. But against the wish to buy at the cheapest price, the buyer will need to be increasingly alert to the taxation ethics of their suppliers and the possibility for adverse publicity flowing from their relationship.
Overall, the subject of tax will be high on the commercial and contracts agenda for the foreseeable future and is an area in which professionals had better increase their awareness and understanding.
Supply management faces a real dilemma. How does it balance its desire to cut costs with the need to ensure competition?
Essentially, there is a conflict between the tactical desire for lower input costs with the strategic imperative of maintaining a competitive market. And as industry after industry is discovering, maintaining a balance is not easy.
Already we have seen major industries such as oil and gas and automotive suffer from the consequences of their own success in driving down supplier prices. A consequence of these more aggressive procurement practices has been supplier consolidation. Taken together with growing business complexity and the need for higher capital investment to support innovation, we can see a steady shift in power away from producers and into their major suppliers.
Government initiatives are starting to have similar effect. Social demands for more and better services are accompanied by an expectation of steady or reduced taxation. That means Governments worldwide are squeezing suppliers to cut costs. The new healthcare regime in the US is a great example. Wider coverage of the population means greater demand for drugs and services. But in return, the Government wants to pay less per unit of supply. So the major providers are under pressure to cut their costs – and one way to achieve this is through merger and acquisition. Already we see consolidation occurring – with some efforts such as Pfizer’s attempted take-over of AstraZeneca on a massive scale. But the consequence of all this will be fewer – and more powerful – suppliers.
One implication of this is the need for buyers to weigh carefully the likely tipping point in the power equation – in other words, when will the pressure on pricing shift from demand-led to supply-led? Just before that point is reached, smart buyers will surely be looking to tie down long-term contracts with index-based escalation clauses. Alternatively, we may see some growth of vertical integration as management reverses decades of outsourcing and starts to re-build internal capabilities.
Either way, it suggests an interesting and challenging future for talented commercial staff.
The news that new trains worth $20bn will not work has not amused the French Government. The Transport Minister has laid the blame on the fact that the rail operator and the train operator are separate entities.
The problem is that the trains are apparently too wide for the track and cannot enter many of the older stations. That means more than 1,000 platforms have to be adjusted. The incremental costs will be significant.
I am not sure whether the separation of entities is really the issue here – there are plenty of countries where such separation exists and I am not aware of this problem having arisen there. In this case, since both are state-owned entities, it seems somewhat disingenuous to advance this as a reason, since the Government clearly controls the separation and ultimately, the taxpayer is left to foot the bill.
It appears the rail operator failed to check dimensions at sufficient locations before specifying the dimensions of the trains – but it seems to me that this error could equally occur in an integrated operation.
The point that most interests me is whether we see this as a ‘technical’ error or a failure in contracting. In a current survey, I note that IACCM members see technical issues as the greatest risk. It is unclear whether they feel that this reduces their responsibility for an unexpected or failed outcome, but the implication is that many do see things that way. I do not agree with that perspective, because surely a good contracts or commercial professional must ensure mechanisms within the contract to mitigate against both probability and consequence of all risks, including technical issues.
For example, in this instance, surely there could have been a test program at an early stage of development to ensure compatibility? Equally, why did the rail operator feel the need to provide the specifications? Might it have been smarter to have the companies responsible for building the trains (Bombardier and Alstom) undertake the analysis?
Good contracting anticipates risks and addresses them through appropriate allocation of responsibilities and through effective test and validation procedures. It seeks to address potential uncertainties and reduce the probability of them causing loss or incremental cost. It is true that not every eventuality can be covered and many cannot be eliminated – but smart developers are constantly asking ‘what if …?’ and seeking to have risks covered by appropriate contract relationships and terms.
Recent research reveals that companies in Europe wrote off €360bn last year in bad debt. That comes on top of continuing problems with late payment, which averages 47 days beyond the number of days set out in the contract.
A report in the Financial Times includes a ‘call for action’ – though quite what steps they envisage is not clear. I think a more fundamental question is to ask what contract and negotiation experts should be doing to improve the situation.
Getting paid is fundamental to contracting. Therefore thinking through how best to avoid non-payment is a critical activity – and the numbers cited in the Financial Times report suggest we are not doing a very good job. I would suggest that one issue is that payment terms, trade finance and practices have not adjusted to commercial shifts. Markets, the nature of contractual offerings, the companies we do business with – there have been substantial changes in recent years and thinking on payment principles and guarantees has not kept pace. A few examples may help.
We are all aware of the continuing transition from product sales to services and solutions. By design, suppliers have sought to differentiate their offerings in ways that add complexity and increase apparent customization. At the same time, a continuing drive for standardization and automation of internal processes has reduced the capability to manage exceptions. Taken together, we see an increase in invoicing errors, a growth in the frequency of claims and disputes. Customers see payment as a lever; they like to delay it as long as possible. Increasingly, they also feel the need to check every invoice. And since the financial crisis in 2008, large corporations have been using supplier money to build cash – they deliberately delay payment. Outsourcing of accounts payable appears to be further exaggerating the problem. Finally, recent, highly publicized accusations of supplier fraud further undermine trust and confidence.
Vehicles to protect payment are coming back into use – a resurgence of supplier credit mechanisms such as Letters of Credit, but also some new approaches such as the ICC-backed ‘BPO’. Certainly the contracts community needs to be aware of these. But I believe more is needed and that commercial groups must become better at evaluating payment risk. Measures to achieve this include the need to ask more questions (e.g. has the customer outsourced payables?); development of shared information systems with key customers to allow data accuracy and improved tracking and problem resolution; a greater focus on the customer view of risk and how to reduce it; perhaps improved audit or checking rights to boost confidence – maybe even a penalty clause related to % invoice inaccuracy.
Payment is the issue that lies at the heart of contracting. It is far too important to allow these latest statistics to be ignored. Through IACCM, we will establish a working group to develop a set of ‘best practice’ terms and practices; I hope some of the readers of this blog will volunteer to join us.
Yesterday I wrote about the impact of virtual (technology-based) negotiation on the resulting quality of contracts and business results. My conclusion was that many of the efficiency benefits and savings that are supposed to flow from reduced physical meetings are not achieved – and that any gains are far outweighed by the losses in creativity, understanding and quality of negotiated relationships.
To emphasize this point, it is important to note that virtual negotiation and meetings are in many cases driven by growing geographic distance between suppliers and customers and (with internal teams) the elimination of the office. Technology has not only enabled virtual communication, it has also broken down the barriers of who we communicate with and where they are in the world. So ironically we are using an inferior method of communicating at the very time when communication quality matters most – when we are operating with multi-national teams (in our own organization) and across borders (with our customers or suppliers). We are handling different business cultures, different languages, different legal systems – and eliminating the benefits of physical interaction – all at the same time. No wonder so many contracts prove disappointing in terms of results.
So it is in many cases fair to conclude that the push to such extensive electronic communication has proved destructive of value. But before levelling too much criticism at senior management, I have to ask “Where is the voice of the contract and commercial community in all of this?” We see negotiation as one of our core skills so surely, as professionals, we should be undertaking and reporting analysis to help management understand the true costs of pushing virtual negotiation too far. They cannot be expected to understand the precise blend of physical and virtual meetings that will produce optimum results – that has to be our job.
IACCM research suggests that around 80% of today’s business-to-business contract negotiations are ‘virtual’ – that is, they use technology of some sort, rather than physical meetings. The theory is that this approach cuts costs, increases efficiency and shortens cycle-times. Whether or not any of these benefits have actually occurred, I do not know – but I somehow doubt that the overall balance sheet has seen much improvement.
Researchers and academics are trying to make sense of the move to virtual meetings and when they may (or may not) be appropriate. A recent book by David Pearl suggests that creativity is one notable victim of the virtual world – ideas and brainstorming apparently flourish in a physical environment. Pearl also highlights the need for physical presence ‘when you are making important decisions or working on matters that concern the organization’s core business’.
Professor Richard Arvey adds to the list by pointing to the constraints on communication in a non-virtual environment. Not only are non-verbal cues largely lost, but attention spans waver (who is really listening during those interminable conference calls?). Team spirit and group identity also suffer, potentially undermining a sense of shared goals or objectives (an issue often critical to contract results).
Taken together, these factors suggest that many negotiations would gain from more frequent physical meetings and that many of today’s disappointing results could be improved. Certainly this is likely to apply for negotiations of strategic importance or where team consensus is essential to the outcome.
So when does virtual make sense? It appears to be in three specific types of negotiation scenario:
- Where the deal or contract in question offers little chance of added-value and therefore no need for creative thinking;
- Where the meeting is either ‘non-discursive’ or where information flows are largely one-way – for example, basic fact finding or issuing instructions on tasks to be undertaken, or setting an agenda.
- As a method of follow-up, for progress checks or detailed discussion of very specific points between experts.
A well-planned negotiation would take account of this need for a more nuanced approach and I am sure some experts establish the right mix. But it would be good for all organizations to be more aware of the impact of the virtual / physical choice …. and I will write more on that theme tomorrow.
Many contracts remain unintelligible to anyone who is not a trained professional. Often this appears to be a deliberate strategy – let’s make reading and analysing this so hard that no one will want to do it. In many spheres – such as consumer contracts and on-line ‘click-through’ agreements – it seems to work.
In situations where no one really needs to understand what terms apply, this approach is not important – except to the extent that it sets a norm for standards of design and drafting and impacts overall perceptions of contracts. Research suggests that most normal people (i.e. not lawyers or contract managers) see little value in contracts, except for the purpose of securing against worst-case scenarios and as support for counting revenue. The fact they are difficult to understand is not perceived as a particular problem.
Yet anyone who manages contracts knows this is wrong – and increasingly, that it costs a lot of money. While many high volume agreements may have limited relevance, contracts contain a range of rights and obligations that should be easy to understand and where compliance is essential. Contracts that fail to operate as efficient and effective tools for communication add to the likelihood of expensive mistakes and oversights.
So this brings me to the key concern, which is that there is so little focus or training on the sort of design and drafting skills needed to support contracts that are fit for purpose. Despite the infrequency of litigation, they continue to be driven by theoretical concerns based on historic interpretations of language. This means that they are intelligible to judges and lawyers and unintelligible to most others. Yet while there is evidence that their unintelligibility costs money and causes risks, there is no evidence (that I am aware of) that says judges are unwilling to accept improvements in design and terminology. Indeed, increasingly the sources of judgment are via alternative dispute resolution and there is no requirement that arbitrators or mediators are legally trained. Decisions are based more and more on understanding intent than on the old common law principle of precise wording.
It is time for all those who are involved with drafting contracts to stand back and question why we are doing things the way we are and what negative consequences flow from it. Our documents should be clear, easy to understand, simple to interpret and implement. Sustaining approaches that undermine these principles may be good for job protection, but should not be a source of pride.
Limits of liability is the top negotiated term year after year in IACCM’s annual survey. But will the environment in which these terms are negotiated be steadily upended by technology?
In a thought-provoking blog, Michael Lewin (a firm of solicitors in the UK) asks leading questions about driverless cars. They point out that the use of such vehicles will require major changes to road traffic laws, which all assume a human operator at the controls. But beyond this, where would liability actually reside in the event of an accident? I presume that anyone buying such a car will expect to be indemnified by the manufacturer. After all, if the manufacturer is not confident about the reliability of the vehicle, I am not going to be very interested in sitting inside it. However, you can be sure the manufacturer will in turn be looking for protection by its major suppliers – the producers of the software and computing equipment on which safety relies. Given the places my GPS tries to take me, there are certainly a few improvements to be made there!
And as if this is not enough of a new battleground, what about the transformation created by 3D printing? The future is likely to include giant factories of 3D printers to which clients can download their designs for production. So no longer will we have those battles between customer and supplier over the quality of goods or their fitness for purpose, because control over specification lies entirely with the customer. The machine will simply produce what they transmit … or will it?
Maybe the negotiation of liability clauses will actually become fun … at least for a while.
“Supplier relationship management is about people, not technology” is the title of a short article by Professor Rob Handfield. He was citing a recent presentation by former CPO Lowell Hoffman, which had tracked the various trends impacting procurement over the last 25 years.
While the precise timings may be open to question, the core point being made by Mr Hoffman was that the world of ‘purchasing agents’ has been transformed. They have been on a journey that embraced transaction pricing, supplier segmentation, strategic sourcing, e-procurement and global low-cost markets. Along the way, they have steadily destroyed people-based relationships and become driven by technology and process. Today, having awakened to the issue of supply chain risk management, ‘relationships’ are back on the table. I would add to that the fact that the pit of potential ‘savings’ is not bottomless and suddenly Procurement finds itself facing questions over what exact value or purpose it fulfils. After all, if it is all about technology and process, why does a company need the Procurement function at all?
I think this story offers all of us a salutary lesson. Perhaps more than any other business function, it seems to me that Procurement has been driven by the latest mantra from consultants and analysts. Each new idea has been rapidly grasped and adopted, without real thought to its consequence. Now, many in Procurement find themselves struggling to build good relationships either internally or external. As Mr Hoffman points out, the skill-set simply is not there.
Executive management has been complicit in this development. They have tended to see suppliers as interchangeable and largely dispensable. Such inconsistent behaviour and rapid adoption of trends could never occur on the sales side of the business, because management would understand the cost of alienating customers.
The consequences of innovation are never easy to forecast, but that is why it is important to analyse, to test, to run pilot schemes. And it is also important to seek the views of relevant stakeholders and listen to their reactions and concerns. My feeling is that Procurement embarked on this journey without really caring about supplier opinions or warnings; their input was dismissed as self-serving. Of course, to some extent that was true, but surely a role of leaders is to evaluate advice and extract meaning from it, not just to ignore it and hope for the best.
So what can we expect the next fad to be?
Commitment Matters 