Today’s business environment has increased concerns about disaster recovery. The growing dependence on remote suppliers, often linked via fragile technologies, has combined with a growth in regulatory requirements and broader reputational risk to push this topic up the list of ‘most negotiated terms’.
I am pleased to see that several US regulatory authorities combined forces to develop guidance on business continuity and disaster recovery. They have just issued their report which covers a wide range of areas that an organization should consider in order to protect itself from unexpected disruption. The guidance is aimed at those responsible for compliance and may therefore assist contract specialists as they consider the nature of the commitments they wish to seek or offer to trading partners.
It is early to hail a trend in the attitude and role of regulators and auditors, but I see encouraging signs that they are emerging from a world where they simply made judgments on poor performance, to a growing recognition that their insights and observations can be used to assist in prevention.
A recent article in The Economist is just the latest to illustrate the extent of job erosion for ‘skilled labor’, with growth occurring for executive and professional management and for low-end service and support tasks.
Time and again I hear from top management and academics about the need for increased commercial competence and judgment and the ‘skill deficit’ they face in coping with today’s challenging markets. They see groups like Procurement and Contract Management as transactionally-oriented, coping with work at an operational level, but contributing little to strategic or market capability. In that sense, they are ‘skilled labor’ – and their role is therefore under threat of being steadily squeezed.
“People, people, people – those are the big problems,” observed one academic yesterday. “We need to re-skill existing staff”. He was speaking in the context of Procurement and brushed aside any suggestion that the issue is due to the narrow scope of Procurement role or the constraints imposed by the current focus on savings. This view was reinforced during another conversation, with the head of HR at one of the largest aerospace and defense manufacturers: “It isn’t the role or measurements that constrain them – it is their unwillingness to expand their thinking and contribution”.
Fundamental to the survival of any skill group is its readiness to adapt and change. The transactional and operational work performed by purchasing and contract management groups is steadily being replaced by automation or by service and support centers. The value work is moving up the scale, to people who can think strategically, who are excited by the power of analytics, of concepts such as holism, who want to drive and influence policies, practices and process and to empower the organization through their depth of knowledge. This demands fresh thinking and a readiness to challenge existing knowledge and methods (characteristics which, based on IACCM data, are possessed by no more than 15 – 20% of the existing expert community).
The role being demanded by top management is very different and many find it threatening. Indeed, as I commented to the academic, why would he expect that many people can make this transition in skills? They chose a job that requires different competencies from the requirements of today, so perhaps it is a case of the wrong people with the wrong aptitudes – and therefore in many cases unable to escape ‘the squeeze’.
The debate goes on and on. What role should Legal have in the negotiation and drafting of contracts? When they insist on transactional review and approval, do they finish up managing risk, or creating risk?
This issue arose yet again in an email from an IACCM member, frustrated by the delays, the difficulty of meeting business objectives, the risk aversion (in her opinion) of the Legal department. So what should the role of the lawyers be, she asked.
I do not know her company so my reply was generalized. Here is what I said. What would you suggest?
“I understand why you are asking these questions and yes, many organizations face similar problems, though many have also resolved them.
In the end, Legal (and any other specialist stakeholder) should be seeking to enable good business decisions and to meet business goals regarding flexibility, achieving value, being responsive to the market. The situation you describe does not satisfy those goals because it imposes a control mechanism that gets in the way of good judgment and delays processing. This creates counter-risks in the name of Legal’s view of ‘good risk management’.
I do not know whether Legal has legitimate concerns about the competence of the Contracts team, but if that is the case they should work to train them better. They should also be offering support for a ‘negotiation playbook’ that would include approved term alternates and the circumstances in which they can (or cannot) be used. They should be thinking about the nature of the reporting they require to understand the use of such alternates and also the terms of delegated authority. For example, one Law Department agreed delegation to staff who had achieved IACCM Certification.
Yes, you should also be looking at overall process performance. We have benchmarks on many things, including cycle times for different contract types. So how do you compare? If you are not doing well, why is that? Where are the major delays and what is causing them? I could give you opinions on the likely problems, but in the end you need a proper process analysis and commitment to reengineering.
All of this can be achieved, but you will most likely need a very senior executive sponsor, because (as your note indicates) there are many stakeholders and they are often reluctant to give up their power. They fear for their jobs and the ‘mystery’ that surrounds their expertise. They may also have genuine and valid concerns about the competence of those who will make decisions, or whether those decisions are driven by inappropriate success criteria (ie that terms are given away in return for price reductions).
It sounds as if you really need to pursue a significant project on this. And the success of that will depend on whether you can gain strong management support for the potential benefits it brings. Perhaps you can tell me what are some of the top management goals right now? What are they saying is important to the business and how would improvements in the contracting process assist in achieving those goals?”
I just read an article by Larry Lapide, “The Promise and Pitfalls of Big Data”. In it, he observes that making effective use of data is nothing new, but the digital age has transformed the volume and speed with which information can be accessed. In this environment, ‘Picking the right data streams is extremely important, since not all data is information. Information supports improved decision-mak- ing, and not all data is useful for that.’
In the world of contract and commercial management, a typical start point is of very little data and almost no information. The extensive work that IACCM undertakes on benchmarks has illustrated just how little information is gathered on a regular or consistent basis. We have lists of the measures that are or can be used, but there is no consistency across organizations in those they select – or indeed, whether they collect data at all.
Among the most common measures are things like expense to revenue ratios, or numbers of contracts handled per employee. These seem to me of little merit, because in isolation they tell us nothing about relative value. Data on things like cycle times has more meaning, so long as there is accompanying analysis of where and how time is spent, allowing deeper analysis and potential for improvement. But all of the easy and most frequently used data tends to relate to efficiency and if I were leading a contracts or commercial group, I would be far more interested in measures of effectiveness. That is the stuff the executives really want to hear about, the information that drives improved business results through enhanced competitiveness.
In this category come measures such as the level of market push-back on terms and conditions, the frequency (and type) of claims or disputes, the percentage of contracts that are performing in accordance with expectations (and reasons why they are not), the sources of actual (versus theoretical) risk and the extent to which classical risk theory actually causes risks to occur. This type of information directly supports decision-making. It influences internal policies and practices; it highlights areas where capabilities are misaligned with market needs; it generates insight into opportunities for cost-saving or revenue improvement.
Ultimately, it seems to me that those who grasp the potential of better data extraction will rise to the top in terms of the value they bring and the influence they exert. Contracts are a little like shale gas – a largely unexploited source of energy. In this case, that energy could be powering a massive improvement in business performance – but it needs someone with enthusiasm and imagination to exploit it.
It is interesting that despite record low interest rates and robust stock-turn rates, there is continued pressure to extend the payment period. A couple of years ago, the average was 57 days; now (according to data being assembled by IACCM) it is just over 60.
One possible reason could be the difficulty companies are having in obtaining short-term funds from the banks. However, this does not stand up to examination since the drive is being led by larger corporations, which are sitting on record cash piles.
Another possibility could be that this is a strategic move, designed to take advantage of the lower resistance that suppliers may show because of the low cost of money.
IACCM research will shortly explore this topic in more depth, to discover what is going on.
Meantime, the issue facing suppliers is not only the contracted period for payment, but also the actual time it takes to get paid. An article in CFO magazine suggests that this is not entirely due to poor levels of compliance by customers, but actually has more to do with invoicing errors by suppliers. While this is certainly an explanation, investigations by IACCM suggest that many of those ‘errors’ are due to either unclear or altered processes by customers. For example, many have tortuous internal approval processes which are frequently not understood by the group that placed the order. Another common ‘trick’ is to change the invoicing address, but not alert suppliers to that change until they chase for payment.
The issues with getting paid seem to be more pronounced in companies that have outsourced their accounts payable, which raises questions over how much they know or control the behavior of their outsourced provider.
Getting paid is fundamental to doing business. Customers that value supplier loyalty should focus on the fairness and integrity of this key process and contract term.
Guy Strafford recently wrote a blog that asked whether the word ‘Procurement’ is toxic. He asked readers to suggest an alternative name that might assist an image make-over – and offered a bottle of champagne to the winning idea.
The blog attracted lively input, a majority agreeing that Procurement tends to be viewed in a relatively negative light. The underlying sense appears to be that the role is seen as narrow in its contribution and that it has never achieved the respect associated with established professions. Those who made comments overwhelmingly agreed that a change of name would be beneficial, though there was no apparent consensus over what that should be (perhaps because of the desire to win the champagne). However, the term ‘Commercial Management’ arose several times because of the need to reflect both a broader role and also a more holistic basis for the selection and management of supply relationships.
In many ways, Contract Management faces a similar challenge. The role and status of Contract Managers varies widely, resulting in confusion in both scope and contribution. As with Procurement, for many it remains a largely tactical, administrative role, supporting ‘true professionals’ such as lawyers or project managers.
The image will not be fixed just by changing the name; it requires a genuine and sustained shift in business value and contribution. The opportunity for such a shift exists and those who identified the potential in Commercial Management are correct. ‘Commercial capability’ is a big deal right now because senior management is increasingly conscious of the need for improved decision-making and commitment processes, achieving a balance between control and creativity in external trading relationships. This has resulted in a surge of membership and training for IACCM, from both buy-side and sell-side personnel.
The IACCM vision has long been that those responsible for creating and managing trading relationships should represent a single profession because they require similar knowledge, tools and techniques. But we know that it is often hard to change management attitudes and images; and indeed, many of the incumbents in Procurement and Contract Management may not have the internal drive or desire to move to a higher level of contribution and ‘professionalism’.
So perhaps the real point behind a change of name is to establish a division between those who are content with their largely administrative, operational role and those who have the enthusiasm to rise to new challenges and grasp the opportunities that come with professional status. However, it has been pointed out to me in the past that ‘true professions’ all have a singular noun to describe them and do not use the word ‘manager’ – for example, lawyer, accountant, engineer, even ‘marketeer’. And in that case, is Commercial Manager the right name?
Continuing my theme of the role of contracts in the management of change, another example is in the field of supplier selection and ensuring that a trading relationship does not result in reputational or regulatory exposures.
Many organizations are struggling with how best to include this risk in their overall processes. The challenges they face include how best to identify risk severity, how to then incorporate identified risks into supplier selection and the process for on-going governance and oversight.
McKinsey illustrated this growing need in a recent article that discusses supplier risk and suggests a six-step plan for its management. They use the Financial Services sector as an example since the need there is especially extreme. Interestingly, I find the McKinsey view rather inward-looking. It makes no mention of how the trading relationship itself might be impacted, except in the most generic terms, and it does not discuss the extent to which implementation requires fundamental changes to the contracting process and terms (surely, if nothing else, making this a seven-step plan). Nor does the article consider the responsibilities – or opportunities – that today’s regulatory environment offers to suppliers and the fact that the best of them will be competing on their superior compliance capabilities.
In the end, improved supply risk has to be tackled through the contracting process. For example, having identified sources of potential exposure and their severity, they need to be incorporated into business requirements and supplier selection. The weighted factors for choosing a supplier must change dramatically – price becomes far less important than reliability and capability to avoid reputational or regulatory exposure. These criteria then flow through into contract terms. Whereas the finance industry cannot absolve itself from risk, it will certainly expect suppliers to make commitments in at least two key areas:
1) through terms that enable high levels of transparency on operational quality. These will include things like rights of audit, communication and reporting procedures, revised KPIs, shared approaches to problem resolution – in fact, many of the factors we use at IACCM to define ‘relational contracting’. Most of these are measures to reduce risk probability.
2) increased allocation of risk consequence. Inevitably, the customer will want suppliers to feel the pain if their actions – or inactions – cause an exposure. This drives towards tougher negotiations on the traditional areas of liability, indemnities, liquidated damages etc.
What does this mean for broader contracting strategies? One thing we are observing is that customers are becoming better at segmenting their supply relationships. They need to ensure greater rigor for those suppliers who represent the highest risk. On the other hand, they cannot afford to spend so much time on negotiating with the low-risk suppliers. So the smart approach is to relax some of the onerous risk terms at the low end (and reduce the need to negotiate) and to focus efforts on the high end.
For suppliers, the opportunity is to differentiate through superior performance capabilities. In general, these customer concerns tend to favour the bigger suppliers because they share an obvious interest in avoiding reputational damage and they have the resources to build capabilities. But in a sense, big companies also face greater problems. Their very size can make it difficult to maintain full oversight and ensure integrity throughout their operations. Overall, suppliers must design operational quality into every step of their procedures and those who pro-actively offer superior reliability and governance can win new business. That superior reliability and governance is primarily evident in one place – the contract.
Yesterday I wrote about using the contracting process to drive alignment with business goals. I highlighted how contracts are often seen as an impediment to getting business done, but in truth that is because of mismatches within the organization.
An example of this is the attitude to risk, especially within the Finance community. Over the years, I have encountered many situations where Finance imposes rules that directly inhibit the business and resists the need for change. Examples range from topics such as tax and inter-company to approaches to pricing and discounting. Within Finance, the aversion to losses can often prevent the realization of gains.
A recent example of this is the dislike of the Finance community for contracts that are not clear about allocations of risk. They have a strong preference for contracts that either impose risk on the supplier (when they are buying) or place responsibility for performance on the buyer (when they are selling). They see any ‘shared risk’ approach as inherently risky, even though there is no data to support this view. Apparently this attitude has been a key factor in undermining the use of more collaborative contracting models.
In my earlier article, I highlighted the choice that faces the contracts function or experts. They can of course sustain this view by Finance and simply impose this preference for risk allocation. Alternatively, they can take the view that it is their responsibility to understand the impacts that different contract and risk models have on performance and to educate Finance accordingly. There is extensive evidence that the approach preferred by Finance regularly damages financial results, in terms of both costs and profits, yet their position is rarely challenged.
Few would disagree that business undergoes continual change and that we have been experiencing an environment of particular turbulence.
It is inevitable that business structures struggle to keep pace with the changes going on around them. Many of these cannot be anticipated and their effect is often cumulative. As a result, wherever we turn – skills, processes, systems, policies, practices – we find gaps and shortfalls in capability. The ambitions of our business leaders are typically far ahead of the ability of their organization to execute.
Within this environment, contracts and their management are increasingly seen by many as contributing to the problem. The process through which contracts are produced or negotiated is perceived as inflexible, bureaucratic and therefore a symbol of all that is wrong. And indeed, it is frequently true that the contracting process becomes an impediment to doing what we need and the contract itself becomes misaligned with business strategy or market requirements.
In truth, the contracting process can never be more than the sum of the component parts of the business. Contracts reflect capabilities, they don’t create them. Those who are charged with establishing and documenting business commitments cannot alter the realities of existing skills, processes and systems. Their job is in many ways to protect the business from its natural over-optimism and in performing that task, they will rarely be popular.
But in a well-run organization, those who are charged with contracting can and should be at the forefront when it comes to identifying and challenging lack of capability. The contracting life-cycle offers potential for invaluable insights to the mismatches that occur in an era of rapid change. To that extent, the people responsible for contracts do indeed have a choice – they can defend the status-quo, or promote change.
In coming days, I will highlight a few examples of the types of issues that analysis of contract experience can offer and thereby become a source of strategic capability.
For most organizations, the process of developing terms and conditions and deciding related policies is largely an internal activity. There may be some reference to industry norms, comparison with competitor standards, advice from outside counsel or influence from an external consultant. But mostly, contract terms just tend to evolve based upon discussion between internal stakeholders.
Recently an IACCM member approached me to seek help with developing a customer forum which they titled “Achieving Value from Improved Contracting”. Intrigued by the data IACCM has produced on the costs of poor contracting (costs which negatively impact both customer and supplier), they decided that the best way to develop an improvement to standard terms might be through an open discussion rather than through individual negotiation and they asked whether I would act as moderator.
There were about 40 participants at the event, a mix of Procurement, Finance and Legal staff from some of their largest customers. The agenda covered a number of specific clauses as well as several contract-related themes. For example, one topic was ‘Payment terms and Invoicing’, in which trends and impacts were discussed. This session included IACCM research into the standard approach at the participating companies – with data anonymity, of course. This offered delegates a different perspective; most had not realized the extent of the divergence in their own practices or considered how their term and condition demands can impact things like invoice accuracy.
Not surprisingly, the topic of risk allocation generated lively debate. The extent of IACCM data on this topic, together with evidence from a top consultancy, helped participants to grasp the benefits of a more nuanced approach to risk terms, based on what they are trying to achieve. This led to sessions in which delegates explored some of the terms that help cause or avoid value loss in contracts and a round-up presentation that sought opinions on potential new offerings – for example, greater use of digital technologies in contract formation and distribution, as well as the potential for performance or benefits-based contract models.
Before the event, there was some nervousness about bringing customers together in this forum. Would they start complaining or making adverse comparisons with competition? Might they ‘gang up’ either at the event or afterwards to push for new approaches? In the end, none of these fears were realized. Instead, the customers had a new appreciation of the impacts of term choices; they felt their voice was being heard; and overall, contract terms were suddenly no longer a taboo subject, but instead a recognized source of added value.
For the forum organizer, the benefits were many. They included invaluable market insight, a stronger customer relationship, future reductions in negotiation and contract cycle time, improved cooperation with sales and account management and an enhanced understanding by top management of the role that contracts can play in the business. Not surprisingly, plans for the next two forums are already under way.
Commitment Matters 