There is a small, but growing, understanding that improving the performance of trading relationships depends not only on a sense of economics, but also greater understanding of psychology.
I have frequently made the point that today’s contracts and relationships would benefit from more effective economic analysis. In particular, I have urged increased use of behavioural assessment. For example, liquidated damages, or onerous indemnity clauses, or unbalanced performance measures are terms which often undermine the results we are seeking. We structure and negotiate agreements without stopping to think what behaviors they will induce.
Further evidence of the importance of psychology in decision-making comes from an article in The Financial Times ((June 1st, ‘Beware the irrational side of your inner self’). While this focuses on investment decisions, many of the observations carry over into the world of contracts – which are, in essence, a form of investment. Apparently there is a growing science of ‘behavioural finance’, led by psychologists who have plenty of evidence that ‘we are far from rational when we invest’. Decisions are distorted by in-built biases and prejudices, which result in limited reflection or analysis.
The psychologists refer to the massive influence of ‘framing’ (which I am pleased to say receives substantial attention in the IACCM learning program). For example, we are innately attracted to high potential gains and tend, when these are on offer, to downplay the potential scale or probability of loss (an observation reflected in ICCPM’s work ‘A Conspiracy of Optimism’). On the other hand, human behaviour is generally risk-averse when there is a high degree of uncertainty. For example, if we are asked to gamble $100 with a 50/50 chance of doubling our money, most will reject the offer. However, our willingness to gamble again soars once we have actually lost $100 (and merely have the hope of recovering it).
Even brief examples such as these illustrate the tensions within organizations when they are considering contracts and the value of trading relationships. We have those who are seeing high potential gains and ‘framing’ accordingly. Groups like Sales inevitably see things this way, since they have bonuses to win, with little if any downside from a poor decision. There is evidence that business executives fall into the same trap, especially for large deals. On the other side, we have groups such as contract management and Legal ‘who assign less weight to opportunities that are merely probable in favour of those where outcomes are certain’. Since every deal has a degree of uncertainty, our inclination is to focus on protection, even though we may be increasing the chances of failure. We are skeptical and resistant to new techniques. For example, ‘relational contracting’ can be used both to improve partner selection – thereby reducing the initial uncertainty – and to increase the quality of governance – leading to a higher probability of success.
A final point of interest is that the behavioural scientists observe how rare it is for organizations and individuals to learn from past experience. This again reflects an issue observed from IACCM research. Few organizations seek to undertake portfolio analysis. They do not look at contract performance in a holistic way, to see what patterns emerge. In fact, there is a tendency to insist that every deal, every relationship is different and therefore offers no meaningful insight to what might happen in future contracts. That way, we maximize on-going uncertainty and continue to justify our in-built prejudices and biases.
So the real challenge seems to be that even when we identify solutions that can lead to better contracts and more productive trading relationships, how do we get anyone to listen?
Francis Maude, head of the UK’s Cabinet Office, recently gave evidence to a Parliamentary Select Committee on the subject of Government Procurement.
While showing some differences in the analysis of causes, the committee has been relatively united in its criticism of public sector procurement. It is of course always easy to focus on highly publicized failures and the media loves nothing more than to point to the waste and incompetence of Government employees and ministers. As I have observed in previous blogs, that analysis is generally unbalanced since private sector shortcomings are not subject to the same external visibility and to some extent poor decision-making is due to aspects of that external scrutiny.
However, Francis Maude was quick to acknowledge the need for further improvement and focused especially on the challenge of improving commercial skills. He rightly highlighted a number of the key challenges – one being the tendency by many Procurement staff to place process before judgment, another being the fact that you cannot centralize all decisions – so commercial judgment must be a quality that is widely dispersed. In this diagnosis, his evidence accorded strongly with that which I (and several other IACCM members) have provided to the same committee in recent weeks. It also aligns with the realization by many private sector executives that ‘raising commercial competence’ is a critical issue in meeting the challenges of today’s markets.
The challenge for Government remains in part where it should start. As the Minister indicated, a fully centralized procurement service is unlikely to work well, given the size and diversity of the organizations it would cover. But he was right to suggest that there are opportunities to consolidate certain types of spend or certain types of project. Consolidating skills does not mean that decisions are automatically divorced from user needs. This Government has also taken steps to introduce commercial understanding at higher levels of the organization, though I have some concerns that this will lead to frustration rather than change (it is certainly a tendency I have observed when private sector companies try this approach). Inserting private sector ‘experts’ is another recent measure which I suspect may assist diagnosis rather more than generating improvements for specific projects.
From my limited insight, I feel that major issues for Government procurement are based on fragmentation of resources and unclear accountability. Without these issues being addressed, it is not surprising that individuals are more concerned with ensuring they do their part of the process rather than worrying about the ultimate outcome. When it comes to commercialism, I think it is critical to remember that public sector employees largely lack insights to ‘the market’. That is because their survival does not depend on selling things. Many times, private sector Procurement staff are also weak on commercial judgement, but they have other forces throughout the business which ensure the wider market is not ignored.
So perhaps a key thought for Francis Maude – and other public sector leaders – is that seeking to emulate private sector procurement is missing the point. Public sector actually needs a different approach to developing the necessary acquisition skills. Perhaps if we started with training in commercial management and then added the techniques of modern procurement we would see different results.
On the Successful Workplace blog, Jaisundar V wrote a thought-provoking piece under the title ‘Your prospects don’t care about your Sales process – maybe you shouldn’t either’.
Jaisundar appears to make the case for greater honesty and integrity in selling, presumably with a view to developing a positive relationship and ensuring future opportunity. But while I agree in principle, it seems to me that there are broader factors at play than just the quality and integrity of the sales person and their underlying process. Among these, of course, is the existence of sales and revenue targets and incentive schemes – a topic that was touched on earlier this week in ‘Motivating Performance’ .
In responding to the blog, I made the following observations:
“Your core point about listening to the customer and discovering needs is certainly critically important. But there are a couple of things that tend to go wrong. One is how well the customer actually understands and can express their own requirement. Especially in a fast-moving field like technology, it can be extremely challenging for customers and users to understand what is possible. Therefore, my requirement definition is often constrained by your inability to explain what I could perhaps achieve, while your ability to describe is constrained by limited knowledge of what my ultimate vision could be. And the definition becomes especially problematic when requirements are actually generated by a whole host of internal stakeholders, most of whom are not even in the room.
Second, you are right that the sales person should be explaining how their product or service aligns with needs. But it is perhaps unlikely that most sales people will be quite so forthcoming with regard to short-comings or areas where the alignment is not so good. And in today’s complex and volatile business environment, they may not even be aware of some of the likely limitations.
At IACCM, we conduct extensive research and one area we have studied is around the most frequent sources of claim and dispute between customers and suppliers. First on the list is ‘disagreement over scope and goals’. So the point you are making is clearly important – and it is also clear we have a long way to go to put it right. There are key questions to be considered about how to get the sales and buying processes better aligned, but also about the skills and knowledge needed on both sides.
Finally, I would make the point that many buyers ask the wrong questions and fail to undertake proper exploration of supplier capabilities, so if they are victims of ‘the sales process’ it is perhaps their own fault!”
What do you think is wrong with today’s sales activity – and why is disappointment so often the result?
I spend some of my time supporting a variety of MBA and executive education programs at international business schools. This support includes discussion and mentoring of project teams.
Recently, I spent a couple of hours talking with a group of senior managers – all at Vice-President level – from the defense industry. They were examining how their companies could improve supplier selection, particularly in the context of choosing suppliers who would assist innovation. Very early in the conversation they made a point of telling me that they had deliberately not included anyone from Supply Management in their team ‘because they seem to us to be the problem’.
I could not dispute this conclusion because it was clearly based on experience. They felt that procurement groups are detached from broader business needs and lack empathy or judgment. So their answer was to look at ways of excluding them from the selection and appointment process.
If this had been a junior group, or perhaps a group consisting largely of people from sales, business development or engineering, I would have understood this approach, even if I did not agree with it. But the group was far from junior and it was very cross-functional. In fact, the leader was head of HR at a major manufacturer.
We had a long – and I think useful – discussion about the wider challenges of supplier selection and motivation, including ways to develop relationships that encourage innovation. But of course I eventually came back to the question of the Supply Management role. I felt that I must point out that the behavior of procurement staff is in large part driven by the messages they receive from senior management – in particular, the way they are measured. So rather than exclude or work around a key business function, would it not be smarter to alter their success criteria and metrics? The group continued to sound dubious. At this point, they raised a variety of objections, most of which related to ‘low skill levels’, ‘poor communication’ and ‘not motivated to be team players’. But perhaps the most telling was the observation that ‘we are not clear what added-value supply managers bring to the table. They seem totally process-driven and have no real ambition to understand what drives a good supplier or a healthy relationship’.
This comment reminded me of work that was done to research inclusion in high-performing project teams. It highlighted that to be considered and welcomed as a core team member, two attributes were essential. First, you needed to bring areas of specific knowledge or techniques that others lacked; second – and more important – was the need to have wider connections to a network that might be useful to the team. In their experience of Supply Management, this group felt those two characteristics were lacking; they could not see what they considered ‘useful’ knowledge and they felt that procurement is generally too insular and limited in its outreach.
Yesterday, I had a feeling of deja-vu when I met with a professor who teaches contract and commercial management at a top business school. He commented on his experience of teaching commercial staff – both buy-side and sell-side – and said ‘They seem to lack interest in expanding their thinking. I try to get them to read your blog, to read and make observations about relevant research – and they just seem to switch off. It takes them out of their comfort zone. They don’t want to expand their ideas or consider new approaches that don’t fit with current practice.’
So next time you hear someone in contract management or procurement complaining about not being included or consulted, have them read this blog and ask them to reflect on whether they meet the characteristics of a team player ……
As part of the on-going debate over bonuses and incentives, McKinsey has re-issued an article from 2009 entitled “Motivating Without Money“.
The article contains research findings that suggest there are alternatives to financial incentives. For example, praise from immediate management actually emerges as the most motivating acknowledgement, with ‘attention from leaders’ and ‘opportunities to lead projects and task forces’ also beating cash bonuses or salary increases.
I don’t know the profile of the people participating in the McKinsey study, but I suspect these findings come as no great surprise to most contracts or procurement professionals. Indeed, as a community I suspect we are rather skeptical about the subject of bonuses. We have too often experienced the negative behaviors and distorted judgments that they create.
In addition, those in contracting and procurement overwhelmingly operate outside the incentive schemes of some business groups. We look quizzically at people who can apparently be motivated only by money. Indeed, our hard work is frequently not even acknowledged with praise, yet still we carry on. And the reason for that is because we know we make a difference and we have true professional pride in our achievements.
Anne Kohler wrote an interesting article on The MPower Group News. In it, she suggests that Purchasing does not gain the acknowledgement it deserves.
Anne makes the following comment: “In a nutshell, Purchasing is the “Glue” that holds the buying function together. They play liaison to internal business partners, suppliers and customers and are the face of whatever you call your “Procurement” function. When Purchasing works, everyone up and down the supply chain is happy.”
In principle, I am sure that Anne may be right in this assertion. But as she states “When it works …” …. and as she also observes, Purchasing seldom receives the respect it deserves. I think these two comments go together. Whether or not is can or should act as ‘the glue’, it is rare that it does so. Why is that?
It seems to me rare that Purchasing has significant liaison with external customers. The resultant lack of awareness of market intelligence is certainly a problem, since it seems tome that many purchasing professionals lose sight of the fact that they exist only because of customers. Without sales, there is no need for Purchasing. But another big problem is the internal image of a group that is associated with rather rigid, rules-driven process and over-focusing on front end savings. Of course it isn’t altogether fair to blame Purchasing for the role that executive management has given it, but I do feel that far too few groups try to break out of the mould. If they want to be seen as ‘the glue’, they need to be far better at understanding and reconciling the divergent viewpoints of the various stakeholders.
For any function to gain the status that Anne describes, they must operate with commercial judgment that balances the multiple forces and interests that compete for attention. They must be capable of making the contention that is present in every organization into a creative force for new ideas and solutions. I’d welcome input from Purchasing groups that are achieving this status. Indeed, they should be among those competing in the 2013 IACCM Innovation Awards.
It is a challenge for many groups or individuals within business to describe the precise value they bring. For some – like Procurement – it is a claim of savings relative to a price that they might otherwise have paid; for groups like Contract Management or Legal it is often an expression of costly risks avoided. But in each of these cases, the baseline of ‘what might have been’ is hard to prove and therefore the claimed benefits have limited credibility.
It is now about a year since IACCM issued its study on ‘The ROI of Contract Management”. Our goal was to gain insight to the cost of poor contracting, based on typical experience today. The resulting report had application for anyone directly involved in the formation or management of trading relationships. It generated a number that was higher than our expectations – a figure of 9.2% of annual revenues. This was the average loss or ‘value erosion’ that businesses were suffering from weaknesses in their contracting process and practices.
Those who are familiar with the study will recall that this was an average. Individual business and industries are operating at significantly different levels. But the causal patterns were similar.
Over the last year, a growing number of IACCM member companies have been using this base data in the way it was intended – as a baseline from which they could undertake their own specific research and generate a benchmark. We do not believe any company will fully eliminate losses associated with contracting, but the report indicated a massive range in current performance, suggesting that many could achieve improvements equivalent to 3 – 10% of their annual revenues.
So how are the case studies turning out? Some have been conducted on the sell-side, some on the buy-side. I am not yet aware of an enterprise-wide analysis covering all contract types. But those that have been conducted are broadly validating the original study. For example, this weekend I was reading a report from a global corporation with a high value of capital projects. It reinforces the point that the biggest exposures apply to companies with significant capital or services relationships, where durations are longer and there is greater room for misunderstanding or disagreement. In these conditions, the role of the contract is critical, ensuring clarity of goals and the framework for on-going governance. This buy-side report exemplified our earlier study. Following an audit of a significant cross-sample of contracts, it found repeated examples of losses that were occurring due to:
– Inappropriate form of contract, or omission of key terms
– Incomplete or non-existent Statements of Work
– Poor controls over change management
– Work commenced without contract in place
– Poorly drafted or managed payment schedules
– Misalignment between contract requirements and supplier capabilities
– Inadequate performance criteria and / or no defined performance management regime
– Absence of warranty management
On the contracts reviewed, the costs of poor contracting at this point represent 26% of original anticipated contract value.
A similar sell-side analysis by a major international technology and services company identified now familiar issues: contract terms that mismatched the project goals; poorly defined scope; weaknesses in change management; obligations that were not actively managed; imprecise and contentious performance metrics. In their case, the combined impact was that anticipated margin was 4.2% below plan.
As we look across the range of companies where analysis has been undertaken, we see a substantial variation in performance based on whether contracting is viewed as a coherent discipline and process. The high performers are those where there is more consistent definition and control. The poor performers have limited insight to who produces key contract documents (for example, statement of work) and generally lack effective tools or training to support the contracting process. Without these, they only discover weaknesses in contracting when disasters occur. They have no insight to the steady drip of lost value that is happening every day.
Stephen Ashcroft posted on Supply Management on the topic of ‘high risk’ procurements.
According to the media, most procurements these days are ‘high risk’. Stephen captured a number of key points, setting out some common weaknesses in many procurements. For example, he starts by highlighting the need for good quality specifications. Our research at IACCM shows that the main cause of disputes is due to poor specifications or scoping. This will only be avoided if Procurement acts as a facilitator of discussions between users and the business, rather than as a barrier. It must also ensure proper documentation of whatever is agreed and recognise that requirements are likely to change – so facilitate that within the contract.
Next he focuses on selection. What are the important characteristics you want from your supplier? If you select on price alone, you will have a relationship that reflects this principle. Don’t expect quality, value, flexibility, innovation because nothing you said or did suggested those were important – and the price does not allow them. If they were important, you should have established different selection criteria.
And as for contracts, another of his areas for focus, a high proportion of the templates used by Procurement have little relationship to the bid or the desired outcome. Many Procurement groups really do not understand contracts or their role. They accept templates provided by Legal that are based on risk allocations, not on outcomes. Far too many Procurement groups consider the contract to be an administrative requirement, rather than a critical tool in performance definition and management. So it is hardly surprising when results are disappointing.
But never mind. Lost savings this time round can be claimed all over again with the next Procurement!
“It Only Takes Seconds To Lose A Customer” is the title of a recent blog on Successful Workplace.
Citing the work of Vivek Ranadive, the article emphasizes the importance of empowering the customer interface to answer questions rapidly and accurately – or risk losing a sale. It is not just a matter of customer impatience; it is also about credibility and perceptions of competence.
I recall research that I encountered some years ago to support this point. It related to Chief Financial Officers and examined factors that made them trust information. When asking for data, they were profoundly influenced by the time it took to provide an answer. I forget the precise statistic, but the tolerance level for delay was low – and the longer it took, the less faith they had in the eventual answer.
This supports Ranadive’s point that “A little bit of the right information just a little bit beforehand … is more valuable than all of the information in the world six months later”. Throughout my career, I have witnessed this point – and the fact that delays not only reduce the value of information, but also typically result in increased demands and expectations.
The application of this ‘need for speed’ is evidently important for the world of contracts and commercial management. Indeed, the principle complaint about Procurement, Legal and Commercial functions is that they slow things down. They are knowledge and information roadblocks.
But in an increasingly complex world, surrounded by a multitude of risks, can we really ’empower’ the sales interface? We all know their propensity to exaggerate, to give false or incomplete information … And with the growth of interactive technologies, the number of people who interface with the customer has grown, so the challenge of empowerment extends far beyond the sales representative.
Commercial and Legal groups are becoming steadily busier as the demands for support grow. Their current model of operation is not sustainable. They must start to work on new and better structured approaches to supporting and enabling the business. This means steps such as codifying information, segmenting the areas of information need, providing remote access via technology, developing apps for mobile devices. To get started, they must begin to analyze the nature of the topics and issues on which information is needed; this means ending the idea that every situation is unique and seeking patterns for sales enquiries and customer issues.
‘The 2 second advantage” is a powerful concept – and it is something we really must take to heart. Today would be a good day to start.
Research shows that a majority of people dislike contracts because they cannot understand them.
When you think about how important a contract can be – the effect it can have on people or their business – this is quite an indictment. Surely it must be in everyone’s interests to produce contracts that are clear and offer a useful source of guidance.
Regular followers of this blog and of IACCM will be aware of the support we are giving to the proactive law movement and its work to encourage more useable contracts. Their campaign continues with an excellent article published by the Cornell University Law School. This sets out much of the background and history related to the use of visualization in contracts and the growing role of Information Designers.
As the article points out: “Lawyers are communication professionals, even though we do not tend to think about ourselves in these terms. Most of us give advice and produce content and documents to deliver a specific message. In many cases a document — such as a piece of legislation or a contract — in itself is not the goal; its successful implementation is. Implementation, in turn, means adoption and action, often a change of behavior, on the part of the intended individuals and organizations.”
With a growing number of examples from which we can draw, there is no good reason why contracts professionals should not be leading the charge to improve the quality of contracts. Indeed, if we could make them easier to understand, many people might start to like contracts – and think what a pleasant knock-on effect that could have for the people who write them!
Commitment Matters 