Risk is about uncertainty – and good risk management is about distinguishing the uncertainties that matter from those that don’t.
This was just one of many valuable insights offered by Dr. David Hillson in an IACCM ‘Ask the Expert’ interview on ‘Bringing a risk perspective to Contract Management’. He was explaining that those who assess risk often focus on future uncertain events and fail to consider factors such as variability and ambiguity.
David made these useful distinctions:
– uncertainty of an event is based on the question will it or will it not happen?
– variability occurs when we can be sure the event will happen, that the goal can be achieved, but key parameters are uncertain – for example, how much it will cost or how long it will take
– ambiguity occurs when we are not quite sure what it is to be done, or what capabilities or competence it may require
These characteristics of risk demand different contractual terms or approaches. They should affect how a deal or relationship is structured, the pricing model, the termination rights etc.
Dr. Hillson also challenged use of the term ‘risk probability’ because, as he pointed out, probability relates to how likely it is that something will or will not occur. It does not take account of frequency. Therefore he suggested that we should think in terms of ‘risk likelihood’, which embraces both probability and frequency.
With these background concepts in place, the discussion moved to their application in the world of contracts – but I will write more about that tomorrow.
Recording of this webinar is available in the IACCM Member Library
Yesterday I ran a feedback session to an organization that had completed the IAACM capability maturity assessment. It illustrated the scale of opportunity facing those in contract and commercial management.
The company strategy is strongly focused on alignment with markets and customers, as part of which ‘ease of doing business’ is seen by executives as key. This has resulted in their sponsorship of an integrated, consistent approach to contracting, including the creation of a worldwide contract management function. For the first time, the company will have a standard process, with simplified contract frameworks and templates and the implementation of supporting systems and software.
This is of course encouraging. But an assessment of the overall business strategy reveals so many other areas where improved contracting and commercial management can assist in achieving goals – and it is interesting (from the assessment) how little the executives understand that potential. For example, as they move towards becoming a ‘trusted adviser’ to customers; as they develop strategic account strategies; as they shift towards providing measurable customer benefit; as they consider enabling an on-demand customer experience – all of these and more demand and can be enabled through improved contracting process and practice.
So a critical step in achieving world class maturity is for those who lead contracts and commercial groups to help executives understand the major contribution that contract management can offer in realizing their goals.
What is the purpose of contracts and to what extent does a good contracting process contribute to business results and outcomes?
According to a recent IACCM survey, weaknesses in contract terms and negotiation have a major impact.
- 63% report that they are frequently a cause of cost overruns
- 59% report that they are frequently a cause of project delay
- 28% report that they are frequently a cause of reduced future business opportunities
So what should you be doing differently? The IACCM ‘Attitudes to Contracting’ study provides a useful contribution in answering this question, as well as indicating what purpose contracts should be serving.
- It confirms that the quality of contracting – both process and document – has a material impact on project outcomes.
- It highlights the practices that frequently contribute to avoidable project failures and under-performance.
- It offers insight to the areas and approaches that, if improved, would generate better business results.
The study is unusual in that it combines views from a variety of functions, industries and geographies, offering perhaps the most objective view of the role of contracting yet undertaken. There are clear messages for industry and public sector bodies, especially with regard to project contracting. Among them are:
- Failure to establish and / or communicate clear objectives is a major issue in subsequent contract negotiation and contract management.
- This issue, together with late engagement of commercial resources or the imposition of industry standards, frequently contributes to use of risk-averse contract terms that distract from establishing key performance criteria and processes.
- Problems with defining project scope cause subsequent disputes and disagreements over change management, charges and payment.
- The use of traditional, legally-driven forms and documents renders most contracts of little practical use to delivery teams and project managers, thereby undermining their primary value as instruments of communication and understanding.
- Few organizations appear to make effective use of past contracts as a source of learning. Procurement contracting is especially weak in this regard.
- Only 16% of respondents feel that their contracting process ‘always’ achieves a positive impact on the relationship between the parties – suggesting there is major opportunity for improvement.
Can projects succeed in spite of poor contracting? The answer is yes, of course they may. But the study confirms there are many ways that the likelihood of success is undermined in the absence of an effective process.
The IACCM study ‘Attitudes to Contracting’ is available in the member library at http://www.iaccm.com
- Growing use – and potential misuse – of e-procurement, including electronic reverse auctions
- A more inclusive assessment of price, attempting to look at overall ‘cost of ownership’
- The use of non-price factors in evaluation, especially qualitative value judgments
- Framework agreements – and in particular, who gets the business when there are multiple suppliers under a single framework?
- Complaint mechanisms for vendors – are they effective, do they inspire trust?
- Process for exclusion of bidders – on what grounds and how discretionary?
- Negotiations with vendors – how extensive can and should these be; what constitutes ‘negotiation’?
- Domestic preferences and preferences for (domestic) SMEs – the extent and economic desirability of such policies
Data security is a big issue for business today. The risks of non-compliance are substantial, both in terms of regulatory exposure and reputational damage. This has resulted in data-related topics being among the most important and the most contentious in contract negotiations.
In this context, the findings of a recent survey published by In-house Counsel magazine are interesting. The study reveals that IT professionals do not understand how to handle data compliance and therefore prefer to outsource to Managed Service Providers. Of course, in some cases it may be less an issue of understanding and more a desire to get out of the line of fire if something goes wrong.
It is entirely logical to hire a specialist to do something when underlying complexity demands specialist skills or knowledge. It seems that the uncertainties of today’s data protection rules, plus the innate risks associated with systems vulnerability, have moved data security into this category. Obviously a buyer of such services will place heavy pressure on its supplier to validate their capabilities. Part of this pressure is in the form of onerous liabilities for failure.
Contention is perhaps inevitable in such a sensitive area. But it seems to me that buyers also increase the risk of failure when they demand highly customized terms. The more variations that a supplier must manage, the greater the risk that something will go wrong. Smart buyers are those who allow their supplier (being chosen for their expertise) to guide them on the optimum terms and conditions. Or to put it another way, if your potential supplier shows a readiness to be highly flexible on data protection services, that should be seen as an indication of riskiness.
You may be familiar with IACCM’s annual study of the ‘most frequently negotiated terms’. This year’s research will soon be closing (you can participate and receive a copy of the results by clicking here).
As part of the survey, IACCM asks participants not only to select the terms they negotiate most often, but also to identify those that they consider most important. This is asked in the context that the items on which we focus are not always the same as those which may deliver the best business results.
This year’s study is once again confirming that divide. In fact, it appears to be getting worse, in the sense that the list of ‘most important terms’ is increasingly divergent from those which gain most attention during negotiation.
But this may not be the entire story …. share your experiences with us by completing the survey and you will receive the initial research report within the next 2 weeks.
According to Jeanmarie Meyer of the Millennium Challenge Corporation, economists cannot identify any significant value associated with today’s Procurement function.
The Millennium Challenge Corporation is an off-shoot of the US State Department with substantial funds to support international development projects. To gain funding, a project must “help alleviate poverty through economic growth”.
As Jeanmarie explained at this week’s World Bank conference, she felt confident that a program to build public procurement capability in an emerging market would rapidly gain support. But she was wrong, because when the economists demanded evidence of benefit, she could not discover any research to validate that Procurement contributes to economic growth.
Modern Procurement has largely been measured on savings at the point of contract. To some extent, we know these can be illusory, but many would argue that such savings force greater supply efficiency and allow spending to be diverted to other purposes, hence driving productivity and growth. To some extent this must be true, though in many cases those savings have been achieved through moving to lower cost countries or supply sources, to the detriment of the national economy. And there is widespread debate over whether large-scale outsourcing led to value creation or value destruction.
There is perhaps a very real difference between Procurement as a function and purchasing as a policy. For example, executives may develop business strategies that use purchasing to achieve their goals – forming specific partnerships, creating a specific brand image etc. This makes Procurement an instrument of strategy, not an influencer. What Jeanmarie sought was evidence that Procurement could itself formulate and propose strategies that would drive benefit – in this case national economic growth.
Certainly there are some who seek to move down this path and I will feature a few of them in future blogs (share your story with me if you would like it to be included). But in general, it seems Procurement is still talking about its strategic role rather than being able to illustrate it. This section from a recent OECD report perhaps help us to understand why:
1. The lack of professionalisation remains the greatest weakness in many countries. Procurement is not recognised as a specific profession in a third of OECD countries.
2. Procurement is not approached as a cycle of measures to ensure efficiency and integrity, from the design of the project throughout the tender until contract management. Only half of OECD countries indicated that their procurement reforms have addressed the whole public procurement cycle in the last three years.
3. Performance-based monitoring of procurement systems is the exception to the rule. When reporting on progress made, very few countries indicated that they monitor the performance of procurement systems and processes based on data and benchmarks.
4. Risks and opportunity costs are rarely assessed when using procurement as a policy lever to support socio-economic and environmental objectives. In half of OECD countries there is no prior assessment to verify that public procurement is an effective tool to achieve these objectives.
5. Access to international procurement markets is still a major challenge. Even in an
integrated market such as the European Union, less than 4% of the value of contracts in the EU is awarded to firms from another member state.
The dilemma is simple. Without being able to show clear evidence of value, Procurement will not be regarded as a strategic function; and without being able to operate strategically, Procurement will struggle to show value. A break-through therefore depends on a leap of faith by executive management; but to sustain its status, any Procurement function that gains this support must then re-evaluate the way it performs and measures its value contribution.
The delivery of outcomes has been a recurrent topic at IACCM for a number of years, since it poses major questions and challenges for the Procurement community. Yesterday I participated at an excellent conference organized by the World Bank at its Washington D.C. headquarters where the theme was ‘Delivering Outcomes’.
“Should the measures on Procurement relate to transactional compliance or contract results?” was one of the questions posed by Jeffrey Gutman, a former World Bank executive and now with the Brookings Institute. He illustrated his point by highlighting the types of measures Procurement uses today related to ‘process compliance’ – number of bidders, objective selection criteria, adherence to policy – and contrasted this with measures that might relate to the effectiveness of the procurement in delivering the right results.
Mr Gutman rightly pointed to the fundamental difference in business role and value between these two positions. He went on to point out that this is not an abstract or theoretical choice, but a reflection of fundamental change in business need. Organizations today are procuring far more, from more diverse sources, under substantially different levels of regulation, expectation and overall transparency. As examples, he highlighted the growing array of instruments (contract and relationship types), the explosion of stakeholders and their influence, the broadening of ‘success’ objectives (harmonization, green, governance, accountability), global reform programs and the persistent concern over fraud and corruption.
“In this environment, there is need to exercise greater discretion in the use of professional judgment. But in reality, we have become more fearful, more compliance oriented, which has the opposite effect. An excessive focus on compliance results in a risk averse culture.”
These observations led Mr Gutman to conclude that if Procurement is to flourish, it must make fundamental changes:
- If the focus is to be on achieving final outcomes, then Procurement measures must be related to the whole procurement lifecycle;
- If a key factor is to exercise the credible use of discretion, then Procurement must focus on the development of a new breed of specialists who will be far better integrated with technical staff and far more aligned with the different types of procurement needed by the business;
- If deliveries are to be successful, Procurement must become better at defining and communicating objectives and their relative priority;
- If organizations are going to function effectively, Procurement must make far more effort to educate others in procurement;
- If Procurement wishes to be seen as valuable, it must continually re-evaluate and challenge policies in the context of a rapidly changing environment.
As later presentations (including my own) emphasized, there is no certainty that Procurement can or will successfully occupy this much bigger space in the business. Indeed, if it waits to be asked, that certainly indicates it does not have the capability. But it seems to me that the alternative is terminal decline, because oversight of transactional compliance is the sort of task that will steadily be automated.
Over the next few days, I will summarize some of the other presentations from this event.
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.
Commitment Matters 