Last week IACCM ran an interview with Michael Held, a partner at Deloitte Consulting who had led research on the supply impacts of the Japanese tsunami.
In our conversation, we agreed that an increase in unexpected events is an inevitable consequence of extended supply chains – and therefore, by definition, of low-cost sourcing. Michael set out a thoughtful response to this when he introduced a concept called Risk Adjusted Pricing (RAP), which factors relative risk of supply chain disruption into price comparisons. He illustrated how this could be used to determine a truer sense of competitive cost comparisons and therefore lead to improved buying decisions.
One listener commented: “From the example given in the seminar, the in-country vendor is $11 (approx) more than the Chinese vendor. Assuming the pricing to be FOB Destination (apples to apples comparison), the bottom-line here is that I am out $11 hard cash if I choose the in-country source. Even though the RAP for China is $13 (approx) more. That’s theoretical cash (funny money).
I go with China, I save $11 that goes to support my bonus goal and to my firm’s bottom line.
I go with in-country – I have a tough time coming up with $13 theoretical dollars to apply to my bonus goal and to my firm’s bottom line.
Short sighted, yes, but I think it’s more of a reality for most businesses. It’s easier to blame a force majeure than spend more while your competitor is lucking out with the riskier supplier.”
The truth is that Procurement would prefer to have both a low price and low risk. But the weighting right now is strongly towards the former, at the expense of the latter. And in general, there is no tool or method to establish the value of paying a premium to reduce risks that are often unquantifiable for a single supplier or transaction.
The story may be a little different in a highly regulated industry such as aerospace and defense and this may indicate a re-balancing in other industries where regulatory pressure is increasing – for example, oil and gas, financial services. The cost of actual and reputational damages has to be sufficient to overcome the hunger for front-end savings.
And what about the role of the supplier in all of this? If someone wants to sell at premium prices because they offer superior management of risk, there are two important implications:
- terms and conditions must be adjusted to reflect that readiness to absorb customer risk (an implication that they will be recompensed if it occurs);
- data must be available to show the return on investment (ROI) that will typically be achieved from paying that higher price.
Contracts professionals and lawyers have grasped the concept of agility and flexibility. They all embrace the fact that we need more of it (though mostly from the other side!) But in reality we are stuck in traditional thinking.
We asked IACCM members whether flexibility and greater agility in contracting are important. Almost 90% said yes and that their management is seeking better answers to traditional contracting issues. So what do we then focus on? This Wordle chart is a great representation of the current areas of contention in negotiation and reveals the focus of our thinking. This illustrates why we are stuck having the same unproductive discussions. Unless we break free of considering flexibility only in the traditional areas of contention, we will make no progress.
Tomorrow I will suggest how we might change the conversation – and please share your ideas and experiences.
The wrong contracts and contracting strategies can undermine innovation.
As businesses look more and more to their trading partners as a source of innovation, it is important that we understand how best to encourage the collaboration needed for innovation to flourish. Trust is fundamental, as are the right relationships and forums for discussion and review. You cannot contract for innovation; but you can certainly create a healthy environment through terms and conditions. Or alternatively, you can generate negative behaviors that will defeat efforts to innovate.
At the IACCM Global Forum for Contract and Commercial Excellence, delegates will gain insights to the forms of contract and commercial policies that establish innovative relationships. And of course, in today’s service and solutions based world, the contract terms themselves can be a source of innovation and differentiation as well. For now, here are ten tips to get you started:
| Develop and pursue relationships on collaborative principles and fair allocations of risk |
| Build open, bilateral communication strategies and escalation procedures |
| Create trust and shared responsibility as a foundation for contracting and relationships |
| Foster a “no idea is useless” mentality and ensure the right forums for review of ideas |
| Understand who will own the innovation and how the parties can use it in other relationships |
| Understand the other party – the people, the enterprise – and ensure a cultural fit |
| Build recognition and reward as an integral element of the program |
| Do not discount and prevent ideas that were not viable in prior contracting situations |
| Mitigate fear without encouraging carelessness |
| Recruit and anoint “innovation champions” in both contracting party organizations |
In late October, IACCM will hold its Global Forum for Contacts & Commercial Excellence. I typically write a briefing for speakers, to ensure consistency in the theme of the event. This time, I focused on a number of the key principles that we have been promoting to our members over recent years, to assist organizations to reach ‘best practice’ standards in their contract and commercial capabilities and practices.
I thought that readers of this blog might find this summary of interest – and may wish to add their comments:
What do we mean by contracting?
First, we see contracts as instruments of economic value, in which legal considerations are of fundamental importance, but not their primary purpose. Contracts represent an economic arrangement and should be designed to maximize the probability of a successful outcome.
Second, we see contracting as a life-cycle activity. Businesses must have a contracting strategy (contracts, terms, policies and practices that support the goals and needs of the organization). These are then applied and adjusted during the opportunity or needs evaluation, negotiation and post-award environments. Contracting brings cohesion across these phases of activity and provides a framework for clarity over requirements and goals, roles and responsibilities and on-going relationship governance.
Third, because of this scope, contracting has many stakeholders. Legal, Finance, Operations, Project Management, Sales, Procurement – each has areas of policy or resource interests which make them sensitive to changes. Recent research by IACCM concluded that ‘many negotiations are driven to protect functional positions, sometimes at the expense of business interests’. Good contracting ensures reconciliation of these conflicts and results in creative (as opposed to destructive) contention.
There is soaring interest in contracting.
We believe that contracting is one of ‘the next big things’ in the world of business. That is because the wider view of contracting outlined above is a critical contributor to the management of complexity. Economic conditions are pushing organizations towards new sources of savings; into new and emerging markets; to dealing with unfamiliar cultures and business practices; the growth of Asia is shifting the power of businesses to impose their way of working; companies are dealing with increasingly complex interdependent systems. CEOs are struggling with how to understand, make sense of, and manage ‘interconnections and interdependencies’. The analytical and disciplined approaches that contracting brings are fundamental to supporting this, plus they then provide a firm platform for the management of change (which today is inevitable during the lifetime of every relationship).
Contracting contributes to the organization’s agenda.
In today’s environment, business must become better at managing risk. This is not about risk allocation. It is about building contracts and relationships that are better at reducing the probability of risks occurring, or of managing them to a successful conclusion so that contract outcomes are achieved. Business must become better at eliminating bureaucracy and unnecessary rules. Those in Legal, Procurement and Contract Management have extensive visibility into many of those rules because they are managed through contracts. So instead of protecting and sustaining them, they must increasingly challenge and change. Business must become better at forming and managing relationships. Being a customer or supplier of choice, innovating through collaboration, combining resources to tackle major risks and opportunities, will be key to survival and growth. Bad contracting – unfair or unbalanced terms – will undermine those capabilities and result in adversarial or defensive relationships. Contracts must provide a framework for harmonious relationships that are dedicated to mutual success.
The IACCM conference will illustrate these core values and inspire delegates to return to their organizations as purveyors of ‘best practice’ and as ambassadors of change. These, after all, are the fundamental attributes that underpin the entire concept of being ‘a professional’.
Many companies are reviewing or increasingly engaged in business in emerging markets. For some, the driver remains a need to find lower cost sources of supply. But for many, it is because established markets do not offer the scale of opportunities needed to support business growth. Overall market and economic conditions are forcing increased engagement with new and unfamiliar markets, for business development and sales.
New market entry and new customer or supplier adoption always entail uncertainty and risk. Some organizations have great experience and a replicable assessment and ‘on-boarding process’ to gather necessary information and manage these risks. But many do not. They are driven by either the need for speed, or overall lack of discipline, to undertake high-risk projects and to learn as they go.
There are growing resources to assist companies on their journey to the unknown. IACCM has data in its learning programs and undertakes periodic research, such as its 2010 study of the major risks within the top 50 trading nations. But a resource that I strongly recommend is the Supply Chain Risk blog run by Jan Husdal (see www.husdal.com). It offers the most thorough and thoughtful analysis of risk topics that I have ever encountered, drawing on and referencing many of the major works in this field.
Although Jan’s work is in some ways more related to procurement and logistics, there is much here for those in sales contracting or commercial management. His recent paper on emerging markets is a good example and I commend it as a place to get started.
The IACCM executive forum is designed for leaders or aspiring leaders. A book by Robert Kaplan, Professor of Management Practice at Harvard, may offer some useful insights into the characteristics and requirements for leadership. For example, this comes from a recent interview with Prof. Kaplan:
“You must ask “What is your vision for the business that you run?” A lot of the time, people can tell me, and a lot of times they can’t. Why? Articulating a vision is based on what your distinctive competencies are. As the world is always changing, many people have to think about that. They’re not sure. I try to stop people and ask: What are your distinctive competencies? What’s your aspiration? And then I ask: what are the 3-5 things you must do superbly well to achieve that vision? This is a very simple conversation, but often when a leader is having a problem, invariably they are not clear themselves and priorities, or they are clear but don’t communicate it enough to their people. It’s very hard to be a good coach if you’re not clear with your direct reports and subordinates, as well as lateral relationships. How can you coach them if you don’t really know what you what and where you’re going? Everything you do needs to align around that vision.”
I think this statement offers a useful context for the forum (and our subsequent report). We are working to provide a vision, so that the leaders for contracting and commercial management can give thought to their priority goals and assess the competencies their organization must have or devlop to meet the vision and goals. And from there, they have something clear to communicate.
Our research shows that many professionals in our field do not have clarity over their future, over what they must achieve, over how they will contribute – and that leaves them frustrated. But if they don’t know the answer, imagine how people elsewhere in the business must feel – obviously they see associate a function with an unclear purpose as lacking real value. And certainly they do not associate it with leadership.
Agility is about the ability to adjust to fast-moving market conditions. These might be the result of economic conditions, new competition, unexpected geo-political events …
As always, a company’s ability to survive depends on its ability to adapt. So to the extent that there are pressures for adapting further and faster than in the past, ‘agility’ has become an important concept and characteristic. Being more agile than competition is one factor that contributes to competitive advantage.
Recemtly I was discussing this topic with Professor Rob Handfield of NCSU Supply Chain Management College. We agreed it is a subject we will work on together. Our conversation focused on some of the current constraints upon more agile, more adaptive behavior.
The global networked economy has expanded markets and supply options. It has driven commoditization (in the search for price competitiveness); it has driven compliance (in the urge to simplify, cut costs and drive consistency); and it has driven category management (as a way to address the complexity of global choice).
But ironically, these three actions have in many ways constrained the ability of the business to adjust to changing market conditions. They have often undermined supplier loyalty; they have focused on low cost, often at the expense of long-term relationships; and they have caused a transactional focus that prevents leverage in supply management and the development of ‘collaboration’, internal or external.
On the sell-side, there is a tendency to take a more relational view, but it too is driven by large bonuses for getting the contract signed – not for its successful execution. Therefore Sales often behaves in a way that causes mistrust in Procurement – and among their internal colleagues.
We came up with a few questions on which we will be seeking opinions. Among them are:
What does agility mean to you, in your business or the businesses with which you work?
Does it fundamentally differ between buy-side and sell-side operations?
What actions are you taking to enable agility in your business operations? What areas are you prioritising?
Do you think the need for agility affects old risk management regimes – and they will steadily decline or be repaced by more dynamic approaches?
We would love to have your input and ideas – either through comments, emails, or arranging a call.
Some readers of this blog will recall that acceptance / delivery is the most frequent source of contractual claim or dispute. (Ref: IACCM survey on ‘The Most Negotiated Terms’, June 2011).
Digging into this finding, we discovered four major reasons – and I list them in order of significance:
- Lack of clarity / agreement over the requirements
- Undisciplined change management procedures
- Failure of the supplier to deliver to specification
- Customer changed their mind
Factors 1 and 2 both essentially come down to an inability to ensure clarity on requirements. Both sides have some guilt in this. Many customer organizations are fragmented and do not ensure the right conversations. The supplier may be held at arm’s length from the user community and therefore never has the chance to ask key questions. Requirements are rushed, or distorted by powerful stakeholder interests.
On the supply side, the sales team is often conflicted over the extent to which it wants to be honest about real requirements or real capabilities. They are balancing their need to close business with the extent to which this may be jeopardized if internal groups fully understand needs, or the customer has full insight to capabilities.
On top of this traditional dance, we have a world where the move towards more complex services and solutions is making for greater difficulty in formulating precise requirements, especially where ‘innovation’ is involved. And this is then compounded by the speed of change – new conditions, new technologies, new capabilities etc. – which demand on-going review of the original requirements. Frequently, changes and amendments are agreed informally by project or technical teams, leaving massive room for doubt, confusion and potential disagreement at later points in the project.
As Bill Huber pointed out in an excellent comment on my recent post about Procurement, organizations need to become far more sophisticated in their understanding of contract and relationship types. Specifically, they must organize differently for those things that are ‘strategic’ versus those that are commodity. The capability to define and execute on complicated and volatile requirements demands much greater teaming and collaboration; but it also depends on replicable capability.
I think this issue of segmenting organizations to manage the portfolio of external relationships that they need in order to flourish and adapt is a fascinating topic – and one on which I see growing interest. At its simplest, the idea of ‘first order’ and ‘second order’ activity (ref: Michael Cavanagh) is helpful, though perhaps too simplistic in suggesting there is a black and white divide between ‘the routine’ and ‘complex’.
IACCM has undertaken extensive work in this area and is currently documenting some models which can assist in not only segmenting contracts and relationships, but also understanding the variations in process and resources that are needed to ensure an increased probability of a successful outcome. Getting requirements right – and keeping them properly updated – will be high on the list of objectives.
Something that really strikes me is the readiness of Procurement organizations to meet with each other and share information. With relatively few exceptions, I find most Procurement professionals consider it quite normal to contact others in their industry and exchange ideas and experience. They even work collaboratively to establish common views of ‘best practice’ in areas such as skills or RFX templates or commodity research.
For many in Procurement, ‘the supplier’ is the competitive enemy and true market competitors are often ‘friends’.
The comparison on the sell-side of the business could not be more stark. Competitors are companies which challenge for customers. Companies outside my industry are potential customers. I know who I want to speak with and with whom I will happily share information.
The point of these comments is to question whether Procurement should be re-thinking its readiness to consort with competition. If Procurement today truly is strategic (and I personally believe that it should be), then interaction with competitors should be carefully controlled. Equally, since having the best suppliers is one source of this strategic advantage, increased contact with the supply community should be encouraged.
Essentially, the focus should be on developing strong and differentiated supply chains – and that means beating others in your industry, not sharing with them.
Yesterday I found myself once more in the midst of a conversation about the relationship between Legal and Procurement. It had all the familiar tones about a lack of empowerment and trust resulting in protracted negotiation cycles and limited contract flexibility. The background (in this case for a major international banking group) carried all the usual hallmarks: standard templates that are not appropriate for the nature of the acquisition; rigid, risk averse terms and conditions; limited dialogue between procurement staf and lawyers; frustrated suppliers and an inability to adequately trade on terms and conditions.
As one General Counsel recently observed (having explored a similar situation in his own company): “I realize that we are often fighting for functional positions, rather than negotiating the real business interests”.
All of this is so avoidable. I have written on the subject in the past and IACCM has highlighted some of the success stories in webinars and Ask The Expert interviews. Companies such as P&G, CSC, LG Electronics and Rio Tinto have moved beyond this internal barrier and are reaping the bottom-line rewards.
To assist the development of better practice and process, this will be one of the topics addressed at the next IACCM conference – the Global Forum for Contracting & Commercial Excellence. For now, let me share ‘ten tips’ for improved Procurement and Legal cooperation (these are not in any particular order of priority).
The relationship between Legal and Procurement frequently constrains value as a result of inflexible contracting and negotiation. At the IACCM Global Forum, delegates will gain insight to more effective collaboration between Legal and Procurement:
|
1 |
Develop contract templates applicable to each type of acquisition |
|
2 |
Define pre-approved fall-back terms for frequently negotiated provisions |
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3 |
Agree training / competency levels for delegated authority on contracts |
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4 |
Establish regular senior level reviews between legal and procurement |
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5 |
Monitor contracting cycle times and work together on improvement |
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6 |
Develop joint projects e.g. Innovation, performance-based contracts |
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7 |
Ensure category expertise on legal services and consider placement within Legal |
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8 |
Work with each other to develop contracts expertise within Procurement (don’t hire lawyers to compete with in-house legal) |
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9 |
Partnering on development and use of appropriate software tools to ensure visibility and control |
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10 |
Co-develop contracting strategies and strategic plans |
Commitment Matters 