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?
Spend Matters has reviewed a book by Professor Andrew Cox in which he challenges whether win-win is a useful or achievable concept for negotiators. Without being specific as to why they take this view, the Spend Matters’ author concludes that ‘win-win is possible in some situations’ and then makes a call for planning, compromise and ‘mutually advantageous concessions’.
The perspective of negotiation and its purpose shown by this debate seems to me far too narrow – and is perhaps more a commentary on the value perspectives of the Procurement function than a useful analysis of the benefits that come from effective negotiation. I have personally experienced many ‘win-win’ negotiations, but they are not based on the narrow parameters of price and risk allocation. They concentrate on business goals and objectives and how, together, the parties can generate a creative solution that may ultimately surpass the initial expectations that either had.
Of course every organization struggles with consistent win-win relationships and much depends on the ability to be creative. This is impacted by issues such as culture, the inclusiveness of the negotiation team, the timing of engagement and readiness to be open-minded. In the feed-back I receive, much of the win-win problem results from the narrow perspectives and objectives of Sales and Procurement – one driven by closing the deal as fast as possible, the other by being able to claim ‘savings’. Of course in this environment compromise and concessions become the only real currency and win-win is an illusion.
As many commercial experts will tell you, if you want to achieve high value from negotiation, it is often best to make sure that Sales and Procurement are kept out of the discussion. So maybe Professor Cox’s real point is that the measures and objectives used by many Procurement organizations are the antithesis of win-win – and on this I would agree. They need to change.
Why should anyone employ you? What difference will you make to the business?
Two weeks ago, IACCM ran a webinar with the results of its most recent salary surveys. It also discussed industry estimates of job opportunities for those in Procurement, Legal and Contract Management. The picture was mixed, but for Procurement in particular it was generally negative. More companies plan to reduce the size of their Procurement function than plan to expand it.
But hold on. Don’t we keep hearing about the importance of cost reduction and improved supplier management? Surely the prospects for procurement professionals should be good. And with all the new regulation and fears over reputation risk, the outlook for lawyers must similarly be promising.
The answer seems to be no. While these issues are important, top management does not necessarily see the answer lying in more staff. They see opportunities for more automation, more outsourcing and more up-skilling of other functions. And a big reason for this is the failure of most Procurement and Legal functions to develop a compelling case for their value-add.
Last week I was talking with Mark Rosen, from Corporate United, who told me that the ROI (return on investment) of procurement staff is falling quite rapidly. So if I am the CFO, why would I support further recruitment? Instead I would be looking to cut the costs of the function.
Right now, Contract Management seems to be relatively immune from the cuts and indeed is seeing net growth. But that is from a low base, in a discipline that is seen as increasingly important in delivering results. But already the pressure is growing to develop specific measures of value. Theoretical savings and cost avoidance are not enough. If you don’t find a way to define your ROI, you are at risk
IACCM has developed a number of insights to the ROI of contract and commercial management and work on this continues.
Commitment Matters 