Continuing demands for greater transparency in business operations are matched by questions over how to monitor corporate behavior. This raises issues over the extent of regulation, the quality of audit and the extent to which ‘reputation risk’ might cause self-monitoring.
A precise balance will probably never be struck, but the interest in these topics is unparalleled. Last week, while the US trade regulator announced a settlement with Google over privacy protection, the UK House of Lords was reporting on audit competition (or its fears over the lack thereof). Companies today feel obliged to announce their policies in a whole range of areas – data protection, environment, health and safety, corruption are some examples. On one level, they hope to build their reputations through such policies, yet of course they then face incremental blame if they do not meet their own standards. And they can be sure that the media (both established media and the ‘new media’ of bloggers etc) is watching and waiting for them to fail.
As part of our work at IACCM, these fields of compliance and audit have become steadily more important. It is obvious that they are linked to the whole commitment and contracting process. A big question for the contract negotiator or manager is to what extent they should have personal or professional responsibility to ensure that the commitments they make are a) in line with stated corporate policies and b) that the corporate policies against which they are committing are in fact capable of being followed. To that extent, is the contracts or commercial manager also an auditor?
In my opinion, this is not a new question, but it has reached new levels of importance. Personally, I always felt that it was my job to ‘systems assure’ the commitments I was making when I negotiated a contract, and to be open and honest with the customer when I felt that a commitment was at risk. But I think that integrity has increasingly been challenged by modern sales and procurement practices. It feels as if many relationships are built around what the respective organizations can get away with, rather than caring too much about honorable or honest disclosure. In a sense, the behaviors that used to be associated with street traders appear to have permeated even to the Boardroom, with a consequent loss of trust and increased need for regulation and audit.
The contracts and commercial professional sits in the middle of this. Should they have ethical standards, or should they simply ‘play the game’?
Last week the Financial Times carried an excellent insight into the role of patents in business today (Tech Patent Arms War Reaches New Level Of Intensity). It describes how the registration of patents has become a critical competitive weapon – and how this has become a significant barrier for entry for smaller companies, with the possible frustration of innovation as a result.
The story begins 20 years ago when Nokia found itself on the receiving end of a patent infringement suit by Motorola. As a newcomer to the telecoms market, it lacked enough of its own patents to counter-sue. And thus began a registration battle, so Nokia now has nearly 9,000 US patents in its intellectual property war chest.
This is the ammunition it has used recently against Apple. Having provisionally won one case, it immediately filed a further five complaints. Litigation now covers 46 patents in six courts and four countries.
Converging technologies – for example the personal computer and the smartphone – are leading to new levels of intensity and complexity in this struggle for dominance. Indeed, it appears almost inevitable that any new product will offend someone, so a patent suit has become a ‘business as usual’ risk. Now, with emerging markets such as China jumping in on the act, we can only expect enormous proliferation of such actions.
One question is whether small companies can survive in such an aggressive environment. The answer appears to be yes; enterprising attorneys and law firms have of course found a way to ‘protect; these clients. Companies like IPX and Intellectual Ventures buy or register patents and then act as middle-men for smaller companies. Intellectual Ventures has more than 30,000 patents, attracting companies as large as Blackberry- maker RIM to its list of clients.
As the FT observes, these activities smack of a ‘protection racket’ and certainly the costs associated with settling these disputes add significantly to the price of the product.
Are we getting value?
That is increasingly a question being asked within business and across the public sector. It is especially applicable in the field of service delivery, where comparisons of cost, quality and effectiveness can be especially difficult to measure.
Last week, I had the chance to interview Mike Maiden, Chief Executive of the West Midlands and Staffordshire Probation Trust, a UK public sector body charged with managing a wide variety of offenders within the justice system.
At first glance, Mike might not be an obvious candidate for an interview on the topic of contracts and commercial management. But the harsh realities of public spending cuts, combined with the new rigors of performance management, have driven dramatic changes to accountability and governance standards throughout the public sector – and Mike has been among the first to grasp the critical nature of commercial competence in this new world. Indeed, as one listener commented: “it is people like Mike who truly understand commissioning and recognise that whilst contracts, procurement and commercials are integral, they are an output of the demand analysis and needs assessment. For so long it’s been the (procurement) tail wagging the (commissioner) dog, and now that is changing”.
Mike explained the increased focus on the delivery of successful outcomes and how that demands a far more structured approach to the design and management of relationships. He described an environment where direct, contracted and (non-contracted) collaborative resources must be aligned and their interdependencies understood and managed. He also outlined the critical role that the right software can play in supporting management of this increasingly complex environment, highlighting the role that the ‘PAM‘ platform has played.
To be effective, all these resource options require discipline and definition; they also demand high levels of visibility and communication on a one-to-one and one-to-many basis. This can be achieved only if there is a commercial strategy that offers the right frameworks and systems. These include steps such as determining when to use formal contracts; how to introduce greater discipline to traditional collaborative relationships with partner organizations; the creation of commercial models to enable concepts such as payment by results, or to incorporate teaming arrangements that enable non-traditional sources of funding; and the introduction of web-based tools and systems that support performance oversight, ensure transparency and assist communication across the service delivery ecosystem, or supply network.
Such a dramatic shift in direction and needs should represent an exciting opportunity for commercial and contracts experts. Yet will they step forward and assist in the design of these new capabilities, or sit back and await instructions? How many have grasped the potential that such a change represents? The indications thus far are not especially encouraging. Those trained in traditional Procurement have rarely experienced the broader aspects of commercial management; and those on the provider side, who could be assisting in the design of solutions, are frequently far too focused on individual transactions to contribute at this more strategic level.
No one is immune from the fundamental changes going on around us. To remain relevant and of value, contracts and commercial experts must take the opportunity to provide the strategic and operational framework for the interdependent relationships on which today’s businesses and society rely. As a community, we provide a service. We must answer the question that I asked in the opening to this article – are we giving value? How will we compare when our management starts to assess our cost, quality and effectiveness relative to alternative sources or solutions?
Make sure you can answer that question; and a good start would be to listen to the recording of the webcast with Mike Maiden, which will be available shortly in the IACCM library.
On his Law Department Management blog, Rees Morrison has recently featured several stories that will be of interest to the contracts and commercial community.
One of these is a comment made by Mark Harris, CEO of Axiom, that long-term contracts typically experience 5 – 7% revenue leakage. In my response, I observe that it is interesting that Mark cites 5 – 7% because that aligns exactly with a number IACCM been highlighting for several years. It is indeed common as an average (not a maximum) and it comes from a mix of sources. Among them are the missed revenue opportunities due to poor negotiation practices; the inefficiencies generated through failure to align business terms with economic cost; and the many inefficiencies and missed opportunities in post award contract management.
IACCM has often cited the causes, prime among them the absence of any coherent ownership of the contracting process.
Rees concludes that, if the number is true and if it is indicative of similar losses elsewhere, then “lawyers are letting down their clients. Somehow, better contracts should put fingers in some of those dikes, savvier interpretations of their client’s rights, or better oversight of executed contracts could turn law departments that can claim a portion of the saved money as profit centers. We need to know if revenue leakage from contracts happens at that rate and what the law department can do to apply a tourniquet.”
I welcome converts to our cause, however late in the day! But in general, I see few General Counsel ready to step forward and take responsibility for improvement in contracting process and practices. There are exceptions – CSC, Verizon, LG Electronics and HP come to mind. But overall, as IACCM research regularly reveals, we continue to fight the battles of the past, buy-side and sell-side, with no regard to the economic cost.
According to the old song, ‘Breaking Up Is Hard To Do’. But as I survey the business world today, it seems that ‘getting together’ and making things work harmoniously may be even harder.
Every day, I encounter questions, advertising materials, conferences and more, advocating the benefits of collaboration. It is an interestring commentary on our times that we appear to find it so difficult, especially since collaborative behavior is the underpin to any form of trade. Yet somehow we have managed to make relationships in business today highly adversarial. The collaborative spirit that is inherent to an organization like IACCM still remains the exception.
I am pleased to be involved in a variety of initiatives related to understanding and encouraging increased collaboration. One of these is the new award program introduced by leading group purchasing organization Corporate United. At their Synergy Conference in Chicago May 3rd – 5th, I will join fellow judges Professor Rob Handfield and Jason Busch (of Spend Matters fame) in announcing the winners of the Corporate United Collaboration Awards program, established to honor supply chain, procurement and other related departments that have ‘demonstrated superior collaboration with an internal functional group and/or an external supplier’.
I welcome this and similar initiatives to encourage more collaborative behavior because without collaboration we limit value creation and long-term economic growth. But at the same time, I cannot help but ask why we need such focus on what should be an innate characteristic. Is it not amazing that we need to make awards to people who cooperate with their fellow employees? Is it not remarkable that we see collaboration between a supplier and a customer as something exceptional? What has brought us to this position?
I have a list of factors that I have observed which appear to be the enemies of collaboration. Some are cause, some are effect. I will expand on these in my next blog. For now, I would very much welcome your thoughts on these two key questions:
- In the business world, are we less collaborative today than we used to be?
- If yes, then why has that happened?
For years, Western (democratic) nations argued that collaboration with autocracies and dictatorships would lead to greater distribution of wealth and growing internal pressures for democratic systems.
In reality, the results appear rather more variable. For example, the collapse of Communism has led in many cases to the growth of corruption and an unaccountable elite. The early hopes of democratic reform in countries such as Russia and the Ukraine have been stifled by the emergence of strong leaders who appear selective in their application of the law. Now we see similar turmoil in the Middle East, causing us to question many of the political assumptions that were made regarding the path of progress in the region.
An editorial in The Jordan Times by former Jordanian Foreign Minister Marwan Muasher(now a senior fellow at Yale University) addresses some of the myths and realities exposed by the current unrest. Of particular interest for those in the commercial world is his observation regarding economic liberalization. Mr Muashar says that Western governments (and large international corporations) convinced themselves that ‘economic liberalization should precede political reforms’. This was perhaps a convenient excuse for doing business with unpleasant and repressive regimes; we could convince ourselves that this was morally justified since it would. over time, lead to greater distribution of wealth and thence to growing freedom for the people. Co-incidentally, it also served the short-term exconomic interests of those governments and corporations.
But in reality, says Mr Muashar, the benefits of privatization, economic reform and increased international trade went largely to ‘political and business elites’ because it occurred in an environment where there was no system of checks and balances. As a result, the Arab people ‘have come to view liberalization and globalization negatively’. The article suggests that to be successful and sustainable, economic reform must be accompanied by the creation of institutional mechanisms of accountability. The real sources of public anger are not high prices or unemployment, but rather they are driven by a sense of inadequate governance and fundamental unfairness.
This suggests that governments and international corporations from outside the region face a challenge of building trust with local populations. But they also face a period of sustained uncertainty, because the implosion created by popular unrest has revealed the lack of established institutions for improved governance and hence it is hard to predict what systems may emerge. In some respects, making investments at a time of such uncertainty will be risky, but failing to make them is probably even riskier. We must show the positive aspects of economic liberalism and globalization or otherwise face the prospect of a potentially hostile and alienated world region.
The New York Times carries an interesting article on the subject of transparency. It highlights the extent to which data availability is putting new levels of control into the hands of buyers and consumers, in particular through the growth of computer applications. Examples include the ability to monitor the arrival of buses or trains, the chance to check product performance and – of course – the potential to monitor prices.
The article makes the point that not everyone welcomes this transparency. Airlines in particular appear to hate the idea that anyone might be able to understand or compare their charging practices. But they must surely be standing in the way of progress.
However, are they alone in this skepticism? On one level, business has jumped at the opportunities created by today’s technologies. They monitor markets, they create demand-based pricing models, they welcome web-based selling and procurement programs. Yet they have been reluctant to grasp the opportunities that could flow from more extensive and rapid exchanges of information between buyers and sellers – for example, shared performance management systems, proactive visibility of risk, on-demand financial information.
Over the last 20 years, there has been massive investment in Enterprise Resource Planning (ERP) systems which were focused on internal efficiencies. In some ways, these made relationships between businesses harder to manage. I believe the next 20 years will be dominated by systems that facilitate the management of business interconnections – first among them an increased level of transparency and the enabling of new levels of customization.
Many companies will doubtless be hesitant about these changes, yet they are fundamental to the growth of trust and to the strength of corporate reputation. This is especially significant in the supplier selection process, during negotiation and in post-award contract and relationship management.
In a global market, these attributes of trust and reputation will be critical to success – so it is time to start thinking about transparency, in particular as part of the contracting process.
Supply & Demand Chain this week carries a useful article on transfer pricing, with a warning that Governments are becoming increasingly energized by investigations into tax avoidance.
At a time of recession and public expenditure cuts, it is no wonder that Governments will be looking at every opportunity to raise revenues. Higher taxes will also increase the inclination of international corporations to become creative in their tax minimization techniques. The benefits of effective tax planning are enormous and with so much activity now undertaken offshore, the chances to take advantage of low-tax regimes abound.
Transfer pricing is of course the price or charge that applies when goods or services are transferred between different parts of the same enterprise. Tax authorities fear that such transfers could be manipulated to avoid taxes and therefore generally insist on an ‘arm’s-length’ principle. “The arm’s-length standard requires that the amount charged by one related party to another for a given product or service must be the same as it would be if the parties were not related. An arm’s-length price is the price that independent companies would pay for the same good or service purchased under the same or comparable circumstances.”
This apparently simple principle is in fact very complex, since many factors can be used in determining what is truly ‘the same’. In addition, many companies may embed royalties or other charges into the price, and of course those royalties tend to be payable to a low-tax jurisdiction (for example, most software companies register ownership of their software products in a tax-friendly offshore location).
For companies with multinational operations and clients, there are also interesting opportunities to decide where title to goods will pass, or (in an internet age) where services will be provided. The implications of who takes ownership, where and when, can have significant impact on the eventual price and profitability. That isn’t simply because of taxes on income; the effect of charges such as import or export duties or sales taxes such as VAT are also of major significance. For example, I recall one deal in which I was involved where, by providing goods on consignment to the customer and retaining title until the eventual point of installation, total cost was reduced by more than 30%.
Not all companies have close links between their contract and financial staff, so the commercial opportunities from price and tax optimization are sometimes missed. Equally, this disconnect may result in substantial exposures if the terms of inter-company trade are not fully understood, or if actions by a particular country organization could lead to unexpected tax liabilities.
Knowledge in this area has always been important for a rounded contracts or commercial professional. Today, as the risks increase and Governments become more vigilant, it is essential.
IACCM research has revealed widespread concern about the integrity of the bidding and negotiation process. Contracts and Legal practitioners recognize that this is the phase when foundations are laid for future claims and disputes. A recent survey suggests that failure to properly describe, understand or respond to requirements accounts for 40% of failed or troubled contracts. Other data implies that the percentage may be as high as 65%.
This should come as no surprise. Firstly, as with all mating systems, competition creates an incentive for the parties to maximize their attractiveness. Even if that does not lead to outright misrepresentation, it certainly encourages exaggeration of positive attributes and minimization (or omission) of those that are less attractive and could be the source of higher prices or future problems.
In business, the situation is made worse by a tendency to limit interactions between the parties during the bidding phase and to indulge in a negotiation process that they have been trained to view as some sort of game. This results in buyers defining requirements behind closed doors and often divulging only part of the truth to their potential partners. The supplier similarly prepares a proposal behind closed doors and works out how to obscure weaknesses in their capabilities. Each side then excludes participants who might ask awkward questions or probe for the truth, or delays their involvement until it is too late for them to ‘derail’ the deal.
In theory, partners who have worked together over time should be in a better position to judge the truth, but even that is no guarantee of increased success. Changes in personnel and the constant drive for innovation are two factors that may undermine the integrity or validity of the selection process. It is also often derailed by fundamentally incompatible goals that distort the performance of the parties in the execution of their agreement. Prime among these is the issue of price, though the allocation of risk comes a close second.
Ultimately, price is not in fact the most important thing to a buyer. It is the outcome cost that really matters. By focusing on lowest price, they frequently drive up the cost and force dishonesty by the bidder, who can win only by compromising their performance capabilities, and who then spends the post-award phase attempting to recover margin through highly contentious change procedures.
For the buyer, their belief that the supplier will try to avoid or amend their obligations causes the imposition of onerous risk terms, which divert the negotiations from the terms that might assist in reducing risk probability. These weaknesses are compounded by an attitude that it is the supplier’s job to succeed. This causes the customer to ignore key governance and accountability principles, in particular a failure to share in responsibility and allocate the right resources or mutual review procedures to oversee successful delivery.
In summary, we face a syndrome where bidding and selection processes lack due diligence and open, honest interactions between customer and supplier. This leads to unrealistic requirements and commitments. These in turn lead to a risk-allocating contract that establishes an environment of fault and blame. And from there, the relationship governance process offers little opportunity to keep the deal on track. It may sound complex to fix, but it is not. The situation demands a better planned and more integrated approach, which can best be driven by the customer and will require executive leadership to implement.
Commitment Matters 