Many times I am asked by contract management and procurement practitioners how they can gain more influence. They know that they could address some of the weaknesses in current business practice and process, but the timing of their involvement and the lack of consultation and authority prevent them from doing so.
These individuals believe they deserve some form of executive mandate that would expand their powers and ensure oversight of the actions and decisions being taken elsewhere in the business. Essentially, when it comes to dealing with suppliers or customers, they question the knowledge, competence and motivation of their colleagues in other business groups or functions.
Even if this view has validity, it is scarcely likely to win friends or to encourage inclusiveness. Indeed, it is the attitude of many contracts and procurement groups that limits their influence. A value proposition that appears to be based on controls and compliance is rarely attractive to senior management because they are concerned it may impede wider business success.
Status and authority flow from value. Successful procurement and contract management groups are those which work on assisting the business to achieve its goals and can demonstrate how their contribution is adding measurable value. Rather than seek power based on weaknesses in knowledge or controls, they work to understand the causes of such issues and to remedy them. As a result, they regularly lead changes in process, contracting models, systems or knowledge transfer. They are a source of insight, not oversight.
Managing growth in an environment of uncertainty is the overall concern that emerges from a recent survey of business executives. They fear regulation, the potential for market volatility, the possibility of disruptive innovation and the inability of their organization to adapt sufficiently fast.
The top risks all have impact upon contracting and commercial practices. For example, the fear of regulatory changes and increased regulatory scrutiny clearly drives the need to ensure oversight of commitments, market practices and supplier integrity. On the other hand, risks such as economic uncertainty restricting growth, difficulty acquiring new customers and volatility in global financial markets call for new or adaptive commercial offerings and contract terms that enhance competitiveness and improve controls. Specific terms and conditions are also likely to face renewed attention – for example, those related to data security / privacy and managing exposure to cyber threats.
Overall, this should represent a busy time for anyone working on contract strategy and policy, with the evident need to balance creativity and control. Businesses need new commercial models and offerings in order to compete, yet at the same time must improve oversight of compliance and enable greater agility in their contract relationships. Approaches to financing, to currency hedging, to systems for contract and performance management appear critical in the environment executives describe. At the same time, research into the contract terms that will support winning in the market, enabling new business models, may prove critical. Regulatory and reputational concerns are likely to translate into growing interest in the development of industry standard terms and practices, to raise confidence in levels of compliance and as a defense against charges of failure.
I have been reading an excellent research paper (see reference below) based on a study of the US automotive industry and in particular how General Motors went from a dominant market position to bankruptcy in less than 30 years.
The research paper challenges the long-held view that US manufacturers lost share due to an uncompetitive cost base and suggests instead that it was their inability to develop high performing relationships – a capability that was integral to the management style of their Japanese competitors.
The study says: “GM’s (practices) were predicated on a view of workers, suppliers and even white collar employees as commodities whose work could be fully controlled by experts through the use of careful specifications and the spot market, while Toyota’s practices were critically dependent on joint problem solving across boundaries of all kinds, and thus on the existence of strong relational contracts”.
It observes that US industry focused strongly on process and very narrowly defined ‘division of labor’. Employees had little sense of what came before or after; this was a model driven by rigorous cost control over individual steps in the process. It created a ‘blame for problems’ culture versus an ‘accountability for success’ culture. (As someone who worked in the auto industry during this period, I can relate to these findings, having colleagues who moved into the US industry and promptly left when they encountered working practices).
The researchers cite examples where US management concentrated on methods – such as Just In Time manufacturing – rather than understanding the management practices that enabled them. Thus they could not replicate these methods because much was intangible. For example, GM management sent teams to take photos so they could copy Japanese working methods; but how do you take photos of a good and collaborative relationship?
Throughout this era, design of new vehicles in the US took double the number of hours. The percentage of faulty parts massively exceeded those of Japanese competition and improvement rates were only half as good. It was factors such as these that undermined quality. Japanese firms were focused on constructive approaches to problem solving; their US counterparts were not.
Many of these findings resonate today. Procurement practices in many companies have not adjusted to delivering and sustaining high-performing relationships. IACCM’s work on value-based contracting methods addresses these issues, but management must set the scene for collaborative working practices.
For those who claim that contracts and contracting practices do not matter, this report should make sobering reading. Today especially, with increasingly complicated supply networks and global trading relationships, the right contracting strategies can result in sustainable competitive advantage.
MANAGEMENT PRACTICES, RELATIONAL CONTRACTS, AND THE DECLINE OF GENERAL MOTORS by
Susan Helper and Rebecca Henderson, published by the National Bureau of Economic Research
That research also explored the role of contracts and found – perhaps not surprisingly – that the contracting process and contract terms are of very real importance in creating trust within new relationships, but less so in environments where there is a history of working together. It highlighted the difference between environments that benefit from ‘contractual safeguards’, compared to those where there is an established ‘clan culture’.
So does that mean we can forget about the contract in situations where there is past history of success? And to what extent should good negotiators be thinking about contractual safeguards that contribute to the creation of a clan culture?
Traditional contractual safeguards tend to be those of negative incentive (i.e. bad things will happen to me if this fails), together with ‘intrusive’ performance oversight. And while this may in some percent of cases be effective, in others it will create an environment of secrecy and blame. In fact, the whole idea of negative incentives and performance oversight sends a message that ‘this partner cannot be trusted’ and discourages collaboration. This innate lack of trust seems to be present in many corporations; indeed, there is a strange phenomenon I am encountering where people seem to associate collaboration with a threat to their jobs.
So contracts that focus instead on creating an environment of positive interaction are much more likely to breed success. And even if the parties are familiar with each other, this investment in contractual mechanisms probably remains worthwhile. The reasons for this are a) even though we worked well in the past does not guarantee the future: needs and circumstances change, business strategies alter – so continued alignment cannot be taken for granted; and b) the fact we work well with one group or on one contract does not mean it replicated: other research indicates the point that working with the same company in different locations may generate major variations in performance – what works in one place may not be replicated in another, so it is risky to assume that ‘clan culture’ is pervasive in its effect.
This article is based in part on research published in the Strategic Management Journal, 2013: SOURCES OF ALLIANCE PARTNER TRUSTWORTHINESS: INTEGRATING CALCULATIVE AND RELATIONAL PERSPECTIVES by Oliver Schilke and Karen S Cook
I read recently some research on the role of contracting in organizational learning. It confirmed the importance of an effective contracting process in driving successful relationships. In particular, it emphasized how the process informs not only internal decision-making, but also improved understanding between the negotiating parties.
It seems to me that a core value of contracting is in the context of communication. Healthy and successful relationships appear to depend upon the quality of communication. “Good” contracting provides substance and structure to that communication, not only to support formation of the specific relationship, but also for its on-going evolution. It ensures a depth of mutual understanding that reduces the subsequent likelihood of unpleasant surprises.
The contracting process must encourage and enable communication; the contract must accurately capture and reflect what was discussed and agreed.
Communication for contracting may be physical or virtual; it may also be mutual or unilateral. For example, I might receive a contract as a click-through screen and have no opportunity to negotiate, but this contract potentially tells me what to expect from my counter-party and the process creates no illusions with regard to the relative power of the contracting parties.
On the other hand, “bad” contracting is ineffective at communicating anything. It may be incomplete (often deliberately so) or it may be obscure (e.g. the resulting contract is written in language that is hard to understand). It may also be “bad” because either the contract or the contracting process is not designed or used as a basis for further communication. For example, in my experience many of the most complex relationships result in long negotiation and development of a contract, which is then neither distributed nor explained to those who are involved in its execution or delivery.
A key piece of the problem may be the fragmentation of discussions. “Contracting” often involves a multitude of stakeholders and there are many conversations taking place. Those who are responsible for creating “the contract” are frequently not present at many of those discussions. Therefore, they either rely on partial records or individual memory; or alternatively they produce a contract designed to protect against these uncertainties and which actually seeks to exclude many of the conversations that led to, or will in future affect, the relationship.
Since it is unrealistic to expect the physical presence of a contract writer during every relevant discussion, organizations instead need to focus on how to design a less porous contracting process. Part of this is education; but surely another key part of the answer must be more effective use of technology to ensure that “learning” is not lost.
However, a critical start point in most organizations would be to recognize the need to think of contracting as a process. In other words, much of the fragmented discussion and loss of learning is due to the fact that no one has responsibility for designing an integrated approach. As a result, contracts are rarely a good reflection of business intent and learning; they are mostly instruments of business control and frequently reflect an absence of knowledge.
Last week, I wrote an article on the role of contract management in today’s business. I highlighted its increasing strategic contribution, being driven by the need for increased compliance and the growth of longer term, outcome-based trading relationships.
In the article, I also mentioned that this change has implications to the skills and measurements of those who are in contract management roles. Taking the counter-side of this observation, a failure to adjust current skills represents a source of risk – and I recently observed a great example of this problem.
Many businesses face rapid change in the way that services are delivered and a reducing cost of entry for new competition. Together, these forces demand creative commercial strategies and speedy implementation. I had the opportunity recently to sit through a review of such a situation by a team of senior staff from Contract Management and Legal. The situation they faced was of fast-growing market demand, increasing diversity in customer preferences, limited capacity by their business to scale a response, and new competitors emerging. These competitors are at this point relatively fragmented and localized, but they clearly represent a threat.
Business management knew that it could not grow the business fast enough to respond to global market demand, so it had developed a channel strategy through which they would leverage these local competitors by turning them into remarketers or, in some cases, developing strategic partnerships. Through this approach, they could ensure global brand awareness and they would achieve rapid income growth to fund the new product developments that sustain competitive advantage.
I observed the contracts and legal reviewers rapidly lose sight of the major risk (loss of markets) and focus instead on the general complexity of channel management. Their only specific concern seemed to be around the possible threat to brand image that can result from working with third parties, but rather than explore ways this might be tackled, they concluded that a small and relatively unimportant pilot program should be run and that any major decision should be deferred.
This failure to grasp the bigger picture is sadly symptomatic of many current contract managers. They are of course correct in highlighting possible risks, but they must put these into the wider business context and they must propose ways in which the risks can be eliminated or mitigated. If they fail to do this, they are condemned to being no more than a review function that everyone would prefer to avoid.
The recent comments by UK Government CPO Bill Crothers reflect sentiments felt by many customers towards their suppliers – that they are exploitative and cannot be trusted.
Mr Crothers was commenting in the wake of some highly publicized incidents in the UK of extensive over-charging and poor contract performance. He was careful to limit his remarks to ‘some’ suppliers and not industry as a whole.
Buyers in many organizations have an innate distrust of suppliers. I recall speaking to a group of supplier relationship managers at a major international bank who universally took the view ‘all suppliers are evil’. There is no question that customers and suppliers often go through rituals that ultimately detract from the value both could achieve – and that certainly includes a tendency by some suppliers to over-commit or deliberately under-price.
A significant part of the problem is that many buying organizations simply have not adjusted their business model to deal with the changing nature of what they buy. Most of the problems seem to arise in relatively long-term service or solution contracts, where success is determined by an output or an outcome. Many buyers appear still to be using selection criteria and negotiation approaches that are suited to commodity purchases. They fail to undertake fundamental research regarding supplier organization, measurement systems or performance capabilities that are key indicators of underlying management culture. They do not alter the weightings for evaluation or consider the contract terms that are needed to drive performance. Instead, they rely on tough price negotiation and risk allocations that impose negative incentives.
Further, in many cases the oversight of performance is passed to business groups with few qualifications to undertake the task. Even honest suppliers often struggle to perform when the quality of interaction and management is poor – and for the less scrupulous supplier, there is a strong temptation to take advantage and to make up margin.
My observation – as yet untested by research – is that one warning sign for buyers may be the strength of the Finance function within a supplier. It seems to me that this is often related to weak ethical standards, especially if the Legal function is weak or subordinated to Finance. Another indicator may be the reporting line of the contracts or commercial staff. These organizations can place such strong emphasis on financial targets and goals that they overwhelm good judgment and result in the sort of ‘appalling behavior’ that Mr Crothers highlights.
I know that the UK Government has been taking steps to address these problems and organizational weaknesses. Other governments are pursuing a similar path. But businesses generally seem to struggle with adjusting their organizational design and capabilities to deal with new commercial and relationship models. And meantime, there are some unscrupulous suppliers who will take advantage and thereby damage the supply environment for everyone.
It is now almost 6 years since I wrote a blog ‘The Role of a Contract Manager’. It has attracted more than 100,000 views and, in that sense, seems to be the authoritative description of a contract management job.
In 2009, I prepared an update, which explained how the role was changing in the face of tough economic conditions and the growing importance of contract management in securing business performance.
It seems to me that it is once more time to review the contribution of contract management and how the practitioner community and its role are evolving.
The business environment continues to change at a rapid pace and many of those changes are of direct and immediate relevance to contracting and commercial management. For example:
- Since the financial collapse of 2008, there have been wild swings in relative prosperity and trading patterns within the global economy. This has led to substantial shifts in where trade is undertaken and there is no sign that this volatility will end soon.
- Outsourcing appeared unstoppable several years ago, yet increasingly is being questioned and the size, duration and location of outsourcing arrangements continue to alter. This has impact not only on the outsourcing agreements themselves, but also on underlying procurement policies and attitudes.
- The power of the buyer was taken for granted back in 2008, resulting in sharp focus on price and risk allocation onto the supplier. Today, there is far more understanding of the destructive nature of such an approach. Supplier power has returned in many industries and increasingly there is recognition that success depends on greater collaboration and a sharing of risk.
- The continued growth of regulation is forcing organizations to face up to the issues created by inappropriate or poorly managed trading relationships. Regulatory and reputational risks are pushing management to ensure greater transparency and visibility into organizational behavior both internally and within their suppliers and customers.
- Automation increasingly replaces people in the performance o f mundane or administrative contract management tasks. It also supports a growing wave of improved management and performance data, enabling contracts professionals to anticipate problems and manage, rather than administer, contracts.
- Executive management has awoken to the costs associated with poor contracting, especially in failure to secure the anticipated benefits or, as highlighted above, through failure to ensure appropriate forms of governance and performance management.
Taken together, these and other factors are transforming the role of contract and commercial management. Today, it is not simply an operational function overseeing transactional negotiation, implementation and management of contracts. Increasingly it is a critical vehicle for high value management information that supports strategic decision-making.
A result of this is the steady emergence of two types of contract or commercial manager. A majority still performs a role that has changed little from that set out in the original blog, though it is important to note that the required knowledge, measurements and skills required to perform that role have evolved at a rapid pace (I will write more on this is a future blog).
The second contract management role is far more strategic and is about business enablement rather than tactical operations. In this role, the contract manager is both an adviser to executives and a vehicle for implementing organizational goals. Essentially, the strategic contract manager ensures that contracts and contracting procedures are used to execute business strategies – for example, with regard to desired levels of risk, or through the creation of market competitive commitment capabilities, or via more relational or collaborative forms of agreement with trading partners. But this strategic role also informs management about trends or issues that are observed as a result of more thorough analysis of the contracts and their performance. For example, what are the types and severities of different risks and where are they occurring? What are the market trends with regard to the sort of commitments expected by customers or resisted by suppliers? How can the business overall be empowered to exercise better commercial judgment and to reduce regulatory, reputational or margin risks?
Today’s trends suggest that the role of contract management is secure and will become increasingly pervasive. It will be recognized as a life-cycle discipline, with measurements reflecting its impact on revenues and the bottom line. In leading organizations, it will also be an integrated discipline, quite probably part of a shared services unit, that oversees contracting for all trading relationships – buy, sell and distribution channel (even though operational resources may remain embedded within business units).
With this transition, contract management will offer an interesting and fulfilling career path, increasingly supported by structured education and training from university level upward. But with growing sophistication and an increasingly strategic role, the volume of the more administrative, operational tasks will reduce and in many cases will be performed via automation or through greater competence in other groups, such as Sales, Project Management and Procurement.
Therefore, while the job itself will become more highly valued, the numbers bearing the title may over time start to reduce. Those that remain will be more highly paid, have greater status and – of course – will be endowed with skills and knowledge that go beyond the traditional role of a contract manager.
The International Association for Contract & Commercial Management undertakes extensive cross-industry, international research to monitor trends and needs in the field of contracting. It identifies best practices and undertakes extensive benchmarking, as well as offering thought leadership in training and assessment services.
In my blog yesterday, I suggested that the owner of contracting in any business must be prepared to take accountability for the quality and effectiveness of the overall process. That means acquiring an understanding of the impact that contracting has on business performance and optimizing the balance of multiple stakeholder views to ensure that it is driving the best possible results.
This means, among other things, an appreciation of the market and bottom-line effect of the way contracts are structured, negotiated and managed.
Several in-house lawyers responded to my blog, suggesting that it is not reasonable to expect lawyers to take on such a broad role – a point on which I neither agree nor disagree. This is not about what is reasonable, it is about what is necessary. Some lawyers are anxious to develop their business role and contribution – contracting represents perhaps their biggest opportunity to show bottom-line impact. But not all of them want to do this; they prefer their more traditional advisory role. Either position, in my opinion, is easily defended. The one that I do not find defensible is when in-house teams reject the wider role that contracting demands, but also stand in the way of others performing it. This latter group takes the position that contract terms are themselves risky and that no one outside the law department has (or could ever have) the competence to make sound judgment on them. They therefore either mandate standard terms or they insist on situational review and approval. Either way, they stand in the path of both efficient and effective contract management.
I have seen some great examples of legal groups showing initiative and leadership in overseeing the contracting process and being able to explain the business value they have delivered. I observe many others who lack the courage to let go of control and the imagination to see how they could empower others to make better decisions. The irony is that these controllers are creating risk for their business, because their lack of holistic understanding generally results in higher frequency of downstream claims and disputes and inferior economic performance from their contracts. In fact, early IACCM research suggests that these ‘business impediment teams’ may be responsible for around 30% higher levels of claims than the average and a negative impact of up to 5% on profit margin. That is a big price to pay for little or no demonstrable benefit.
This research data is something I will expand upon next week.
I spent yesterday chairing a conference on Advanced Contract Risk Management.
There were some excellent presentations and much lively discussion – but many of the exchanges involved heated discussion over the organizational reporting line and whether contract managers should be lawyers.
These days, it seems many lawyers are becoming more assertive about not only the ‘right of ownership’ they have over anything contractual, but also suggesting that legal skills are somehow uniquely suited to the role.
But what role? Here is where we have the problem. Such debates between the lawyer and non-lawyer fundamentally miss the point over the role of contract managers, the purpose of a contract and the value contribution from a contracting process. These questions must be answered in advance of a decision on the necessary skills or the best organizational reporting line. What value can be achieved from contracts and what value do executives want to achieve? I find that those who claim ownership rarely have answers to these fundamental points.
For those who wish to own contract management, my question is whether they are ready to accept accountability for the quality and outcomes of the overall contracting process. If they are not, then they are not a suitable owner.
Commitment Matters 