Those responsible for contract terms often encounter demands for more flexibility. There is frequent conflict between the demands for ‘compliance’ (which most take to mean rigid standards and templates) versus ‘flexibility’ (which seems to mean high levels of custom drafting).
Is there no other way, no middle ground between these positions? That was a question that my friend Craig Guarente and I recently discussed, based upon an article entitled A Strategist’s Guide to Personalized Medicine. Based on this conversation, Craig wrote the following.
The Strategist’s Guide offers an interesting look at the healthcare industry and how pharmaceutical companies are using metrics and market segmentation to drive the business and increase profits. In the article the authors describe how there is a movement in big pharma to create medicines that are more personalized. For example, there are medicines that are designed only to treat cancer in people with a certain gene. In fact, there is an example cited where a medicine was only effective in 25% of the test patients. In the past that medicine would never have come to market but in this case the drug company segmented the cancer patients into smaller groups. This drug was approved based on its effectiveness in that 25% group.
Contracts professionals can draw some parallels from the experience of drug companies developing “personalized medicine.” In fact, I’ll go so far to say that we as contracts professionals need to develop more “personalized contracts.” Okay, okay, maybe I won’t go that far, but there are lessons to be learned.
The authors write that pharmaceutical companies “recognize the competitive advantage that could accrue from a segmented customer base with structures, processes, and capabilities to match. They are just unsure about how to leap ahead into practice.” Does this sound familiar? The IACCM best practices call for contracts personnel to first look at the market when designing processes, tools, and terms. We must understand our customer base (internal and external) to ensure we can meet their demands and provide a quality agreement that is acceptable to both sides. You can’t have a one size fits all approach to contracting if you are buying from or selling into different markets with different competitive forces and pressures.
The challenge for contract professionals, and in particular those in the medical/pharmaceutical space, is how we can guide the business to take advantage of these opportunities rather than following a course that is dictated to us. The IACCM offers a large knowledge base and a host of research topics that can guide us through the process. In fact, I’ve used this research as both an in-house contract practitioner, a functional executive, and now as an outside advisor to other companies. The IACCM’s “Future Of Contracting” research and analysis has provided me with concrete examples and strategies in my work helping companies and organizations advance up the value chain.
Traditional thinking has us believe that we must create one process with one contract to obtain maximum efficiency, lower costs, etc., or alternatively that we must offer custom negotiation in order to be ‘responsive’. In truth we should work on creating one option within a particular segment. If one contract will work for 25% of your customers without negotiation then that is something worth pursuing. This doesn’t mean you ignore the other 75%. Quite the contrary, perhaps there is another contract vehicle that works for other segments. In the end, what would you rather have – a portfolio of contracts that are easily accepted by distinct customer or supplier groups, or one contract that is highly negotiated or creates significant dissatisfaction in a high percentage of your transactions?
Planning is also important. The authors write, “To be successful, they [drug companies] will need to take into account three elements of their current reality: First, the prospects for innovation; second, the right value proposition; and third, the capabilities needed to deliver on that proposition.” The same assessment must occur within your contracting organization, be it in finance, legal, or operations. One area where leaders often stumble is in assessing the organization’s capability to deliver. If you are segmenting your customer base into high value and low value, then one natural outcome will be the need for increased business acumen and contracting skills for those people on your staff handling the high value contracts. Unfortunately, just wanting to deliver a good product/contract is not enough. Your team must be able and willing to produce. If you have an existing organization that might mean undergoing an assessment to analyze how close you are to being able to deliver your goals. You shouldn’t go live with a new contract or process if you won’t be successful.
Another parallel to draw is the connection between data and action. We in contracts often attend to the squeaky wheel first. We find ourselves to be firefighters going from emergency to emergency extinguishing the latest business bonfire. A better approach would be to use hard data and analytics to analyze your market before engaging it.
To be successful, “pharma companies will need to emphasize diagnostics — which, historically, has been a very different business from pharmaceuticals.” Again, does this sound familiar? Contracts personnel are often of the mindset that every contract and every negotiation is different. Every attempt to quantify or qualify is met with resistance. We need to break through this barrier once and for all. There are scores of examples of contract organizations using proper diagnostics before going to market. These must become the norm if we are to continue our climb up the value chain so we are brought in to discussions and not merely informed of decisions.
The IACCM’s research clearly shows the need for the contracting profession to not only use, but also embrace, technology and analytics. It is not that we should use technology for the sake of technology. Rather, technology and analytics enable us to truly analyze our business and offer insight that executives may not have. We can help our companies make better decisions, seize untapped opportunities, and avoid pitfalls. Through years of research, case studies, and practical application, the IACCM had developed a bevy of information that can be used within any industry.
I will leave you with two final quotes, each of which could well be applied to the contracts, legal and procurement community. First “Personalized medicine could also require changing hearts and minds because it affects the character of an enterprise.” And, “many of these innovations must overcome the medical community’s profound resistance to change.” Inertia is a powerful force and the more data you have, the more likely you are to move your organization.
Research shows that good Contract Development and Management could improve profitability by the equivalent of massive 9% of annual revenue*
Research by the independent International Association for Contract & Commercial Management (IACCM) indicates that companies struggling to maintain stakeholder returns and profitability in harsh economic times could well be missing a trick. A massive boost to bottom line figures can well be achieved by focusing on an often neglected discipline: Contract Management.
IACCM notes that without ongoing diligence contracts can ‘leak’ value. Leakage can be directly financial (out of date pricing schedules for example), or indirect (misunderstandings and a breakdown in relationships might lead to poor or late delivery for example).
IACCM identifies the major areas of contract and management weaknesses leading to leakage as:
- Disagreement over contract scope
- Weaknesses in contract change management
- Performance failures due to over-commitment
- Performance issues due to disagreement over what was committed
- Inappropriate contract structures
- Disputes over pricing
- Issues with subcontractors
Of those contracts that leak revenues, the losses commonly manifest themselves in several ways. Indeed these manifestations can be inter-related and impact each other, or lead to consequential loss such as non-renewal or failure to expand the contract through additional business or innovation (and it shoudl be noted that the average 9% losses do not include the effect of these missed opportunities).
In a recent study, almost 77% of IACCM member companies indicated that project delays or cost overrruns represent a regular source of loss; a further 53% highlighted claim and dispute settlements, with 26% experiencing losses and delays from contract cancellation and a similar percentage facing revenue leakage from liquidated damages. Importantly, these issues are predominantly due to non-technical causes – such as those identified above.
IACCM Conclusions
Ultimately, contracting is all about performance. Trading relationships are formed in order to enhance results. It is based upon those contracts that organizations claim savings, revenue or enhanced capabilities.
Yet many contracts do not deliver against forecast or expectations – and it is this under-performance (causing a potential impact on the bottom line equivalent to 9% of annual revenue) that is gaining increased management attention. There will be growing focus on the causes of failure and contract risk analysis will be expanded to better understand why things go wrong and how they can be remedied.
The evidence suggests that two key stages need attention:
A) A solid contractual position: relies heavily on both parties showing a readiness to build alignment that supports performance. Key to this is qulaity of communication and recognition that today’s fast changing environment generates inevitable uncertainty and a need for flexibility. Organizations must also become more creative in their use of external benchmark and performance data. IACCM points to deep concerns that the process to a solid contract can be compromised by the development of the wrong partnerships, driven by incomplete or inappropriate selection criteria. Much of this is a result of functional performance measures that undermine good judgment and decision making – for example, sales compensation paid on deal closure or procurements measured by claimed savings at the point of contract signature.
B) On-going contract management: here IACCM encourages future contract processes to be driven by a better integration of internal management and measurement systems. Given this solid structure Contract Management skills post award will play a key and fundamental part in identifying possible risk of ‘leakage’. Contract Management needs to become not just a functional discipline, but a business competence.
Finally, IACCM observes that many organizations have fallen into the trap of believing that contract and commercial discipline is achieved through rigorous compliance management. In fact, this approach simply serves to blind management to key aspects of business and market intelligence, resulting in terms and processes that accelerate the level of loss. The IACCM research found a direct correlation between the level of loss being experienced and the nature of investment in contract management capability.
* Figures based on independent market research carried out by IACCM in 2011/12. 9% represents an average which varies significantly between companies and industries (contact IACCM at info@iaccm.com for more precise information).
The IACCM Operational Guide to Contract & Commercial Management sets out the underlying body of knowledge for this discipline – see http://www.vanharen.net/9789087536275/contract-and-commercial-management-the-operational-guide?filter_name=6275
In “There is an I in Team”, author Mark de Rond poses an interesting challenge to the current push in business towards greater collaboration, co-working and co-creation.
The point he makes is that today’s focus is on teaming and that this has resulted in a search for people with qualities of likeability, trust and empathy – often at the expense of individual skill. Through analogies with the world of sport, the book suggests that individuals are frequently game-changers and teams can be built around them. By seeking to suppress individuality in the interests of team harmony, managers may in fact be driving out the very success they are attempting to achieve.
“When teams work well, it is because, and not in spite, of individual differences”, de Rond correctly observes. Yet the obverse is also true, so there is clearly a balance that needs to be struck in management oversight. The concern that the book raises is that we could be misled into thinking that team harmony is an end in itself – that all we need to do is create a collaborative working environment and success will automatically follow. That is not true; we need to maintain a degree of tension and real clarity over goals and objectives. In the past, IACCM has observed that all healthy and productive relationships operate with a degree of contention. The question is whether that contention is creative or destructive.
And in another important observation, de Rond observes that ‘a settled and happy team is the result of success rather than its cause’. All of which implies that to be successful, there is a need for clarity, rigor and effective oversight of performance, together with encouragement of individual aspiration to be distinctive and a high-achiever.
In recent weeks I have encountered a growing number of conversations about project financing and the links between funding and contracts.
There is more and more discussion in many industries about new and alternative contracting models. In particular, there is wider acceptance that traditional approaches to negotiation and contract risk allocation are counter-productive and that they undermine outcomes. This leads to the conclusion that greater collaboration and a more appropriate and balanced allocation of risk and reward is needed – and that this must be reflected in how we develop terms and conditions and post-award governance principles.
However, such models fly in the face of long-established principles in which risk consequences are (at least in theory) well-defined and apportioned. The new multi-party arrangements are designed with risk prevention in mind and depend on a readiness by the parties to share information and techniques in pursuit of shared goals and benefits. For the financing community – whether it be banks or some of the other sources of funding – this is unfamiliar territory and they do not know how to assess the relative riskiness of differing contract models. ‘Behavioral impact’ is not a concept with which they are familiar.
At a recent conference, a banker sought o describe ‘what makes a project bankable?’ He made an analogy to a glass of water. If it is clear water, we drink it, but as it shows signs of cloudiness, we become steadily more hesitant. For a project to appear ‘clear and clean’, the technology must appear sound, the contracting parties must appear stable and have good balance sheets, the business plan must be clear, cash flows reliable etc. In many of today’s projects, there are high degrees of ‘murkiness’, in large part due to underlying uncertainties or pressures of change – new technologies, new regulation, new competition, industry consolidation, riskiness of other projects for the balance sheet etc. In this environment an unfamiliar contracting model tends to cause concern.
The conclusion from these discussions is interesting:
- Banks will welcome a growth of contract standardization and also be more prepared to invest when the key participants show evidence that they learn from the lessons of the past
- Banks expect to see commercial intelligence being applied. Specifically, the parties should reflect the uncertainties of change by making appropriate contingencies in their project plan
- Banks understand the concept that complex projects depend on consensus building and collaborative communication, but need evidence to support this contention.
Overall, funding for projects is available, but in today’s risk environment those applying for support must illustrate they have effective understanding and appropriate project controls. Contracts that involve shared responsibility and collaborative approaches to issue and problem resolution sound like a good idea, but time must be taken to educate the financing industry and also to show there has been road-testing of these models that demonstrates success.
For the contracts and commercial community, this raises the question of how well we are coordinating and communicating with the finance community – not just externally, but within our own organization. We need to ensure our senior Finance executives similarly understand this link between project models and terms and the challenges of project financing.
I have spoken recently with a few seasoned negotiators who work on large outsourcing and managed services deals. Their comments regarding the quality of contracts and commercial staff they encounter can be summarized in one word – ‘underwhelming’.
Each of them has observed the trend among major providers to consolidate their Legal and Contract / Commercial Management teams. As a result, they ‘seem to have taken the worst characteristics of lawyers and trained commercial managers to do their job’, was one observation. “Contracts and commercial staff seem to have become cheap surrogates for lawyers,” commented another. ‘They don’t understand the deal, how what they do affects the financials. It is all about checking, wordsmithing, document handling and processing. No real value.”
The concern is that providers have suppressed judgment in favor of compliance. “they have created people who are a counterpart to Procurement. It is a process rather than understanding vlaue. People sell the wrong thing, buy the wrong thing – and then get frustrated by the result.” A compliance mentality blinds organizations to actual risks, their potential impact or probability. Contracting becomes a box-ticking exercise and there is no counter-balance to teh subject-matter experts (or ‘subject idiots’ in the words of one negotiator) who can easily delay or derail deals because of their narrow perspectives.
Organizations seem to have lost sight of their need for people with broader and more rounded skills and understanding, who can coordinate across the stakeholders and manage the inevitable contention that arises in any complex deal. When discussing this concern with several of the major providers, they acknowledged the problem, attributing it in part to the pressures of the regulatory environment and in part to the behavior of buyers and their distorted view of compliance and risk allocation.
Added to these factors, I think there is also the problem that most contracts and commercial groups have failed to make a compelling business case for their independence. In an era of cost reduction and pressure for added-value, they have struggled to explain their precise contribution, or what will be lost without them. The benefits of ‘talented dealmakers’ are typically visible only after they have gone. Groups that are flourishing are those which are working to deliver strategic capability. They are consolidating their learning and understanding to equip the organization with the the right contracting models, updated commercial policies, empowered business units. Their role and purpose is not static, but adaptive to changing business conditions.
The recent IACCM Innovation Award entries reflect this stark contrast between those who are driving change and those who are stuck in a downward spiral. For Commercial Management to survive, it must itself grasp the fundamental of commercialism – and be ready to update itself.
Are you by nature suspicious, incisive, critical, exacting, organized and of high standards?
According to an expert writing in Workforce, these are traits often associated with people who have strong analytical skills. These skills are widely considered to be of increasing importance. In part that is because routine jobs can be automated; and it is in part because automation itself enables more analysis since it generates so much additional data. Those in contract and commercial management are not immune from this trend. Indeed, creative professionals have always needed strong analytical skills in order to resolve problems. That need is growing and the potential we have to analyze contract content, performance, the inhibitors to good relationships, the factors that damage value delivery are all potentially there for the taking.
One of the major distinctions within our community has been between three classes of practitioner:
- the administrator – people who simply follow the process, monitor and report, oversee compliance
- the reviewer – people who are able to check, validate and identify problems for others to take action
- the solution provider – people who examine the problems and identify ways they can be fixed or turned to advantage
It isn’t hard to guess which of these categories is most valued. But a challenge for recruiters is how to identify the people who are either in, or have the potential to join, that class of ‘solution provider’. How do you identify analytical capabilities? The article provides some useful ideas. For example, you might ask:
• Describe a situation when you anticipated a problem. What, if anything, did you do about it?
• Give an example of when your diagnosis of a problem proved to be correct. What approach did you take to diagnose the problem? What was the outcome?
• Describe the most difficult work problem you’ve ever encountered. What made it difficult? What solution was implemented and how successful was it in solving the problem?
• What steps do you take toward developing a solution?
• What factors do you consider in evaluating solutions?
As a more extreme, but perhaps more revealing approach, I recall having dinner with Seth Godin some years ago. He described an interview approach where he asked candidates to tell him how many gas stations there are in the US. Of course he did not expect them to knwo the answer. He was simply interested in their reaction. Most professed to ignorance and would not even venture a guess. A couple were so upset that they either walked out or burst into tears. Just a few sat back and though through an answer. It was those few who wereof course of interest to him; and his next question was to understand the process they had gone through in reaching an answer.
If you want analytical skills, it probably isn’t a bad way to assess them. What do you think?
Yesterday I participated on a panel at the ISG EMEA Sourcing Conference. One of the ISG presenters talked about the advisory firm’s experiences in reviewing supplier bid submissions, highlighting a number of easily avoidable errors. I thought it would be interesting to share the list and to add my opinions on what this means to contract management and legal teams.
- Lack of insight: sales teams often display a limited view of opportunities, which means a consequent lack of planning, failure to understand the real reasons behind client need (instead they sell to stated reasons) – and as a result answer the wrong questions. This will be a familiar syndrome to many contracts and commercial teams, which often sense the sales opportunities that are purely speculative (often cast as ‘strategically important’). If Sales cannot answer basic questions, or refuse to engage in discussions around value-add that goes beyond the scope of the obvious, there should be alarm bells ringing – and generally these ‘opportunities’ are a waste of scarce resources.
- Bringing the wrong sales team; failing to involve the right skills at the right time, in particular excluding subject matter experts until late in the process, failing to ensure alignment between the skills at the table from the customer with those from the supplier. This is one of the biggest complaints by contract management and Legal – ‘if only we had been involved earlier’. Well, the customer-side clearly feels the same; failure to get term and condition issues or contract structure discussed at an early stage frustrates the customer, results in extensive delays and – of course – can often result in the wrong deal.
- Spreading efforts too thin: there is a need to focus on things you can win. Qualify opportunities, don’t chase too many. Match prospects with capabilities. This obviously has some similarities with issue 1 above, but it goes further because it also addresses the point about ‘matching capabilities’. This tendency to over-commit is one of the top reasons for claims and disputes. Customers are becoming more alert to this – and thankfully they often throw out such bids. But once more, it is a waste of supplier resources and it damages reputation.
- Have a robust process – research tools, consultancy-style workshops. The mature and reliable supplier is often obvious because of the nature of the data they possess – and also for the methods they propose. For example, executive alignment sessions, requirement definition workshops, approaches such as IACCM’s ‘relational contracting’ workshop – these are things that distinguish the experienced, mature provider from the also-rans.
- Poorly prepared responses: sloppy, generic or irrelevant material. Failure to grasp and address issues. Often linked to 1 or 2 above. Many companies have a professional proposal management group – and hopefully they eliminate this problem. But in my experience, it often takes the rigor of a contract management or legal team – people who care about words, spelling, precision – to bring real discipline and quality to a proposal document. It is certainly crazy to be losing business just because you can’t produce a professional response.
GOOD PRACTICE
The presentation concluded with this advice for pursuit teams:
Listen to client objectives
Avoid prescriptive solutions
Empowered sales team – ability to make commitments through involvement of experts
Show responsiveness throughout process
Concise response that addresses issues
Getting this right is a collaborative activity. How confident are you that your organization avoids these common sources of failure?
Last week, I participated in a seminar run by the law firm Eversheds at their London offices. The topic was Contract Management and Disputes in the Energy Industry.
Having attracted around 100 attendees, there was clearly interest in the topic and the audience came from a varied functional background. The presentations reinforced IACCM’s conclusions that the importance of contracting is growing. The event had extensive input on ‘collaboration’, in particular the increased use of alliancing. However, it was evident that terms such as ‘alliancing’ and ‘partnering’ actually cover a range of contract structures or models. The real issue is that there is growing consensus about the need for a fairer balance of risk, that traditional turnkey projects are out of favor and that ‘multi-partner’ contracts are becoming the norm.
One presenter summarized alternative forms of contract to address these concerns. These were:
- To incorporate partnering and collaborative working provisions as an overlay to existing forms of contract
- Target cost contracts
- Framework agreements (to address issues of continuity, expanded timeframes for the relationship)
- Individual alliance agreements
- Project alliances, with gain/pain share
- Strategic alliance
There was also discussion about the challenges in moving to one of these models. Organizational culture was often mentioned as a potential inhibitor. Presenters also highlighted the fact that there are no contract models that fully address the industry environment (there is some use of FIDIC, LOGIC, BIMCO and the NEC model – with the NEC approach currently gaining ground due to its perceived flexibility). But whichever model is selected, multi-party contracting creates challenges:
- Dealing with multiple interfaces
- Negotiation and management of contracts
- Maintaining alignment
- Dealing with ‘known unknowns’, such as weather , supply constraints, regulatory changes etc.
- Handling claims
- Marginal project economics
In the end, a key point is that organizations must recognize the need to establish new and different governance and management behaviors if they want to develop truly collaborative relationships – and without these behaviors, collaboration will not work. This includes key issues such as senior management engagement, that both parties must commit interface resources, common methods for communication, accept accountability (eliminate blame) and work together for continuous improvement.
Like many other areas of business, the energy industry is undergoing transformation and has discovered that traditional ways of contracting are not suited to a world of rapid technological innovation, key supply shortages, regulatory uncertainty, challenges over funding and lack of clarity over roles and risk allocations. It was encouraging to see the number of people attending this event, anxious to learn and to share ideas. Given this need for change, it was disappointing to see how few of the audience came from the contracts or commercial management community; they of all people should be anxious to be at the forefront of ideas and innovation in contracting.
Commitment Matters 