In the final instalment of my ‘moral dilemma’ series (see immediately previous blogs for other examples), our contract manager faces a not unfamiliar challenge – how to deal with deliberate over-billing.
Some of those who have made comments on these situations are perhaps missing the point. In every case, the ethical position is clear. My question is what role or responsibility does a contract or commercial manager have when faced with such situations. The easy answer is always ‘I was only following orders’, or perhaps ‘It’s industry practice’. But of course, neither excuse is morally correct.
My original blog in this series on ethics made the point that established professions operate with a code of conduct that includes an expectation of high ethical standards. It therefore raised the question of what standards should be observed by those in contract management or procurement, who have oversight and insight to the integrity of trading relationships. Each situation I have posed is based on real examples. And in each case, those who were overseeing the contract remained silent. Was that the correct thing to do and, if not, what should have been done?
Here is the last case study. Although this situation was probably extreme, it is also common.
You were involved in the negotiation and implementation of a large Government contract. Charging under this agreement is use-based. During implementation, you become conscious that the mechanisms for monitoring use are unreliable and may result in significant over-counting. Some time later, you hear that questions are being asked about possible over-charging. The business unit executives deny that this is – or could be – happening, but you know different. So what would you do?
We often hear about the problems dealing with overseas markets. China has come in for extensive criticism regarding its business practices, especially with regard to intellectual property, but also in terms of the overall respect for ‘the rule of law’.
But as this case study shows, it may not all be one-way traffic when it comes to issues of ethics and trust. This example is a situation that was referred to us at IACCM by a member. What would you do in these circumstances?
Pressure to terminate the contract without cause Your purchasing department is under constant pressure to deliver savings. Over recent years, more and more business has been sourced to low-cost countries. Several months ago, you awarded a large supply contract to a manufacturer in a remote region of China. It resulted in substantial savings and included a minimum monthly call-off and a committed two-year term. You have been told that this contract was a major boost to the local community and resulted in significant hiring by your supplier.
However, due to a temporary drop in demand, your monthly shipments have actually been lower than forecast and you know the supplier has a stock build-up. Now, the category director tells you she has received a lower price offer from another Chinese supplier and she wants to terminate the original contract. When you explain there is no cause for termination, she simply demands that you switch supplier since the chances of the original contractor taking legal action against you are almost nil. You agree with this risk assessment, not least because this action will probably put your current supplier out of business and they are unlikely to have the funds to pursue an action.
In the ‘real life’ situation, the contract manager accepted the business pressure for savings and switched to a new supplier.
What would you do?
Most organizations are struggling to improve their contract and commercial processes at the speed they would like. There are many issues – for example, the timing of engagement, who to involve in review, authorities to negotiate and oversight of performance and change. Overall, those responsible for contracts fear that risks are ‘just waiting to happen’.
Yet despite those fears, for most of us, change and improvement are at best incremental. Until something goes badly wrong, it is hard to gain executive attention and even harder to generate the investment needed to make substantive progress.
However, this is not the case everywhere. A few organizations are achieving a new vision for their contracts and commercial process and teams. This is being achieved because they look beyond today’s process, rather than at it. They have grasped the need to illustrate and describe the purpose of contracting excellence and the many benefits that improvements can deliver. This requires selling the vision to executive management in terms that appeal to them.
These conversations do not focus on how to better control or mitigate risks (not a subject that gains lasting attention from most C-level executives). Instead, it concentrates on achieving business value through improved bottom-line performance. A small but growing number of contracts and commercial groups are projecting beyond mere process improvement and calculating the scale of financial benefit that can be achieved. Examples are through accelerated decision-making, avoidance of repetitive errors, improved recovery from claims or change management, enhanced performance oversight and improved definition of scope or service levels. Together, initiatives such as these can generate many millions of dollars in savings or revenue improvements. Right now, there are IACCM member companies where investment in contract and commercial management is quite simply not an issue – because these groups are delivering measurable bottom-line contributions of several hundred million dollars a year.
Could you be one of those? Without doubt, the answer is yes. But the only route to success is to think ‘beyond contract management’ and to grasp the scale of added-value that could be achieved in your business. A number of those at the leading edge will be recognized at this year’s IACCM Innovation Awards. Others will be presenting their stories during plenary sessions at the IACCM Americas conference. Many more will be there to discover, learn and carry these ideas back to their business.
Since inception, IACCM’s mission has been to assist organizations in building better and more successful trading relationships. We do that by tackling not only the practical, day-to-day issues that our members face, but by providing strategic vision, a clear sense of how the future will look. The next step of the journey will be in Phoenix, Arizona, from October 8th – 10th, when our Innovation Award winners, our academic research partners and our change leaders will come together and share their wealth of insights and ideas that take us ‘beyond contract management’.
(If you cannot join us in Phoenix, we will be bringing the message and methods to Singapore in November, to Sydney and Mumbai in December, to Abu Dhabi in February and to locations in Europe early next year. See the IACCM Events calendar fro details and dates)
Yesterday I asked whether contract and commercial managers have an ethical responsibility to raise issues and challenge unethical behavior. I promised a series of brief case studies, posing the question ‘what would you do?’ Here is the second example:
Supply commitments will not be met You are managing an extremely high profile contract with a government body. It involves supplying trained personnel to support a major international event. Since the dates of this event are fixed, there is no flexibility over timing. You become aware that targets are slipping and that supply commitments will not be met. However, senior management refuses to acknowledge this and, in meetings with the customer, continues to assert that the contract will be fulfilled. As a result, the customer is not being given an opportunity to mitigate risk and you are very well aware of the reputational damage this failure will cause.
Underlying this series there is a bigger question, which relates to whether ‘professionalism’ demands a clear code of conduct and sets ethical standards for practitioners; and whether a condition of being ‘licensed to practice’ depends on adherence to this code.
Please share your thoughts and suggestions for action!
This month’s edition of Contracting Excellence focuses on ethics and their impact on contract and commercial management. it features a wide range of articles and case studies that illustrate the ethical and moral dimension of our work – for example, the highly-publicized scandals at Satyam and Siemens, the impact of the Snowden affair on outsourcing contracts, and the cost of lying in negotiation.
In the editorial, IACCM asks about the role that contract and commercial staff should have in the application of ethical standards. It makes the point that contract managers may have visibility into broader acts of contract performance that raise ethical questions. An obvious example is of deliberate overcharging – perhaps expanding the hours worked, or claiming the rate for a top consultant when activities were conducted by a trainee.
Actions like this are often justified as ‘industry practices’. Just like minor acts of bribery, everyone knows they happen, so they are acceptable so long as they stay within limits. Increasingly, such attitudes are not accepted and it is perhaps time for the contract management community to consider its role in the management and application of ethical standards.
The article then offers four brief examples of ethical dilemmas faced by contract or commercial managers. Each is based on a real situation and the reader is asked “What would you do in these circumstances?” This week, i will reproduce each of the scenarios in this blog and ask you to give your reaction.
Dilemma #1: We might not meet customer requirements
You work within an industry business unit in your corporation. The unit head is ambitious and sometimes overbearing. You are involved in the negotiation of a multi-million contract and other members of the team are expressing concerns over the ability to meet customer requirements. The terms demanded by the customer offer no room for maneuver and you feel that either a) the customer should be told that the current scope may not be achievable or b) senior management should be alerted to the risk. Your unit head dismisses these recommendations and insists on pushing ahead with contract signature. Other team members disagree with this position, but simply shrug their shoulders and stay silent.
Proxima, a consultancy and outsource service provider, recently published a report “A global study of cost externalization and its implications on profitability”; or put more simply, ‘how much do organizations spend with external suppliers and how should we manage them better?’
According to the report, some 7o% of an organization’s revenues today flow to its external suppliers. To those who ever studied the writing of Ronald Coase (see my blog from last week), this should come as no surprise. Coase’s work demonstrated the point that operational cost is the main determinant of ‘make or buy’ decisions – and network technologies, coupled with their falling cost, therefore makes the move to outsourced supply inevitable. Indeed, I was a bit surprised that the Proxima report suggests that the growth of external spend to this level is ‘new news’.
For most executives, the big question remains ‘What must I retain as an internal competency? What capabilities represent competitive advantage?’ One area that will never disappear is commercial judgment – the ability to make the right decisions at the right time. It is a topic on which we observe growing focus. And another, quite obviously, is the ability to select, structure and manage the right trading relationships.
In this regard, I depart from the views expressed in the Proxima paper, because they express this business challenge in narrow terms of ‘procurement’. What all those engaged in the promotion of supply management appear to miss is the fact that procurement only matters if you sell things (I appreciate the position is a little different in public sector, though even there, procurement only matters to the extent that services remain relevant and affordable). For corporations, the pressing issue is how to drive better integration between their trading relationships. The 2011 IBM CEO study expressed this as a need to better understand and manage ‘interdependencies and interrelationships’.
I strongly believe that organizations must develop a more integrated capability in their management of trading relationships. Increasingly, they must also understand and oversee how those relationships interact with each other. The fragmentation between buy side and sell side activity, the inability to manage interdependencies in the supply network, the absence of consistent management of the same customer or supplier in different parts of the business …. these remain fundamental issues for many organizations and generate substantial value-leakage.
Establishing coherence demands an integrated contracting process in which business goals are reflected in selecting the right suppliers and market opportunities. Selection will increasingly be based on criteria such as culture, ability to perform, value delivery and management of risk. Greater rigor in selection and performance management enables far more collaboration in the overall relationship.
Looking back over the last 10 or 15 years, many proclaimed the birth and maturing of the ‘procurement profession’ and predicted a steady rise to ‘the top table’.
But in truth, how much progress has been made? Does an assessment of procurement practices over this period point to sustained improvement, or does it reveal that opportunities were missed and value was destroyed? Indeed, in a recent blog, Guy Strafford asked whether the word procurement had become ‘toxic’, perhaps reflecting his own anxiety over the future of the function. The volume of replies suggests that a large number of practitioners share that concern.
In my view, many procurement functions have indeed been led down a blind alley. An unrelenting focus on short-term savings destroyed valuable relationships, introduced hidden costs and complexity and has done little to develop sustainable business practices. Procurement associations and major consultancies have conspired in promoting the latest fad – commoditization, compliance, category management, low-cost sourcing – to drive the next wave of nominal savings, without apparent analysis of business impact. And now, when many of the claimed benefits are shown to be bogus, we head in the opposite direction and pursue value-based procurement, on-shoring and supplier relationship management.
The economist John Kay offers an excellent example of the effect of recent wisdom in an article in the Financial Times. “Sometimes a spot of collusion can be a very good thing” is a marvelous expose of how the drive to lower prices has increased complexity and costs. He points to the fact that the buyer’s judgment has been driven to focus on the headline price, which may disguise the reality of true cost and quality. It has driven suppliers to hide extra fees, to fight for compensation on every change and to skimp on quality because it has no apparent value. Loyalty also has no value, because it was discarded in the scramble for savings, and therefore long-term customers pay a premium to subsidize the special discounts offered to the new arrival. “The company that offers a fair price loses business to the company that provides the misleading tariff,” is John Kay’s conclusion.
For many Procurement groups, what happened after they claim their savings became of little relevance. And Sales organizations adapted to this new world because short-term relationships demand far less in terms of honesty and on-going support.
Sustained, long-term relationships do have value, They create organizations that work in synergy, with shared interests and benefits. Yes, they require discipline and oversight, just like every other form of human relationship. But the wisdom that drove Procurement down the path of short-term cost-cutting has much to answer for and much to recover from.
What is your view? Has Procurement been steered in the wrong direction? Where should it go next?
“Beware standard contracts!” That was the exhortation from John Jorgensen in his response to one of my recent blogs. The comment reflects an on-going tension in the ‘should we, shouldn’t we’ debate over standard forms of contract.
In my opinion, standard forms should generally be welcomed. It is the way they are used that tends to be the problem. For example, this note of frustration came to me recently from a member of the IACCM management team: “We have spent hours discussing the terms, then right at the 11th hour someone from Procurement has appeared with a standard agreement that reflects none of our conversation. I would understand if Procurement had been excluded, but the conversations have actually been led by a senior person from that function”.
What this reflects is a use of standards without communication; indeed, you sometimes wonder whether large organizations impose standard forms as a safeguard against ineffective internal process. In this case, they can reflect a mentality of controlling disaster even at the expense of frequently undermining possibility.
Why have standards? Certainly in most organizations the driving issue is control. Standard agreements deliver efficiency; they safeguard against the inevitable gaps in knowledge and business judgment; they reflect established capability, policies and practices; and without them, ‘deviation’ becomes the norm so we do not readily know when we are deviating or what the implications might be.
However, those who oppose standards point to a variety of counter-arguments. For example, standards often cause laziness, a lack of judgment; they undermine the potential that could have been achieved from a well-managed negotiation; when they are used blindly, they obscure risks. And since it is mostly large and powerful organizations that are able to impose standards, they typically reflect an unbalanced allocation of risk and responsibility.
But of course, these disadvantages are not inevitable, any more than the benefits are automatically achieved. To work well, standards must operate within an intelligent management system which ensures they are appropriate to business goals. This means those who set the standards need a continuous monitoring mechanism, internal and external, to grasp when a standard needs to change or when new or alternative forms of standard are required. This may mean adjusting specific terms or providing new term alternates; or it can mean introducing a completely new offering. The real test is whether the system delivers the right standards on a timely basis and also whether it then trains the right people in their use.
Ou rallying cry needs to be ‘Standards that enable, rather than standards that suppress’. Well, I’m not sure we’ll get too many votes for that particular rallying cry, but I am sure you get the point!
Just this week, I was talking to a colleague about Professor Ronald Coase and my respect for his work. His death on Monday will probably not be noticed by most contract, commercial and procurement professionals – but it should be. Ronald Coase’s work as an economist and legal academic had a substantial effect upon the ideas that underlie our discipline and business role.
Back in 1937, Coase wrote a paper entitled ‘The Nature of the Firm’. In this he argued that in a pure world, there would be no firms or corporations. From an economic perspective, hiring full time labor made little sense – it would be far better to outsource work and maintain full flexibility over the amount and skills of resources. However, in reality, the operational costs associated with discovering and transacting with this outsourced labor would exceed the costs associated with longer term hiring.
These ideas were contentious and it was not until the 1950s that they gained wide acceptance in the academic community. Until then, no one had considered the impact of organization and operational costs on business decision-making, but steadily it became understood that this lies at the heart of ‘make or buy’ decisions. And it is of course those decisions that lie at the heart of the need for ‘trading relationships’ between businesses – and which keep contracts and procurement professionals in a job!
As soon as one grasps the significance of Ronald Coase’s work, we begin to see how our world is impacted by shifts in the underlying transactional costs that he identified. Back in 1930, technology was very limited. Conducting a search for sources of supply was expensive; hence either hiring people to do the job, or contracting with a nearby provider, was the obvious way to go. But as communications technology has developed, cost structures undergo dramatic change. The idea of large-sale outsourcing is no longer considered an expensive and unmanageable proposition. Nor is trading across borders.
The work that originated with Ronald Coase has inspired others, among them fellow Nobel prize-winning economist Oliver Williamson. Much of this work looks specifically at issues that affect how we view and use contracts – though only now are we truly refining our understanding of the economic impacts of contracting practices and policies.
At IACCM, we owe a debt of gratitude to Professor Coase for key theories that underlie our purpose and existence. Hence this acknowledgement and brief memorial to him.
Back in 1963, legal academic Stewart Macaulay asked business leaders what purpose contracts have – and the answer he received was ‘not much’. At that time, most business was done without a contract and for those where a contract existed, it rarely came out of the drawer.
In previous blogs, I have reflected on the fact that my early experience of contracts was similar, although the situation varied by industry and also by geography (US firms were much earlier to adopt widespread use of contracts, but they had more lawyers and more litigious society). But now Professor Gillian Hadfield has resurrected Macaulay’s work and is seeking to update his findings. In an excellent article, she sets out some early research findings, which are (she acknowledges) based on a very limited sample of interviews.
Professor Hadfield discovered similar reactions with regard to standard business transactions. Where she found a big difference is in situations or industries where there is a high degree of innovation. In that case, even though there is no expectation of litigation, the investment in writing contracts is substantial and they are used in the normal course of business.
I would add to these observations with the comment that there are many factors that have elevated the use and importance of contracts in the last 20 years, even though senior executives may be unaware of them. Among these factors are issues such as IP, regulatory compliance, relationship volatility, frequency of change, increased international trade and the growth of long-term performance relationships (essentially the shift from product sales to services and solutions). Each of these drives a need for increased clarity and relevant safeguards which are achieved through some form of documentation – most typically ‘a contract’.
To illustrate this change, I think of the story one member told me. He was driving a project to standardize contracts for his company in all operational locations. They had large facilities in Germany. He met with the German management team. They listened politely and then said “It is a very interesting project, but not relevant here”. When he asked why, they explained “We don’t use contracts. Almost all our suppliers are local and we have done business with them for 30 years or more. To introduce contracts now would imply a loss of trust and would be very offensive”.
That was 5 years ago. Since then, the centralization of Corporate Procurement and resulting consolidation of suppliers, more aggressive approaches to cost-cutting through competitive bidding, and a strong focus on compliance have resulted in more than half of those ‘traditional suppliers’ no longer working with the company – and Germany is using the standard contract for more than 80% of its business.
However, all of this perhaps illustrates that CONTRACTS are useful business instruments, but CONTRACT LAW may remain a rather incidental element. The two are not the same. The nature of these changes goes far beyond the world of law and they indicate the degree to which ‘contracts’ and ‘lawyers’ are no longer (perhaps never were) synonymous. I welcome Professor Hadfield’s work in this area and hope her research will continue. Indeed, I will be offering the IACCM member network as a way to expand the findings and develop a truly authoritative answer to the question ‘What good is contract law?’
Commitment Matters 