Data suggests that many organizations have seen the volume of service and solution contracts more than double over the last 10 years. This surge has placed tremendous pressure on tradtional resources and management systems, many of which have not adjusted to the needs of managing such relationships.
Services and solutions contracts demand far more intelligence and support than traditonal product agreements. That’s because requirements must be better defined, commitments more clearly aligned and outcomes / outputs more actively managed. The probability of performance issues or the need for renegotiation is also higher.
These factors place pressure on resources and create stress on procedures. Very few organizations – buy-side or sell-side – have invested in planned development of their contracting capabilities. Research shows that this has resulted in lengthening cycle times and an increased percentage of contracts resulting in claims and disputes. Of course, in some high-profile cases, there have been enormous failures and a high volume of outsourcing and managed services contracts (estimates suggest up to 70%) do not achieve expected goals – for either party.
A few organizations have mastered this challenge and built the contracting and commercial capablities needed to flourish in an outome-based world. They have restructured to address the complexities of a global economy. They have developed processes and systems that enable flexibility and adaptability in the face of continuous change.
It is around these themes that IACCM has built its 2011 conference series, with its three regional conferences this year focussing on the world of services and outsourcing. It has assembled speakers from many of the companies that are showing leadership in this field and are ready to describe how the global networked economy and the transformation to a service-based model has impacted their operations, their contract standards, their commercial organization and their contribution to business results.
The agenda – and registration details – for the first of these events, to be held in Orlando on March 1st – 3rd, can be seen at www.iaccm.com/americas.
Many of us use the term ‘negotiating’ in a generic form, giving little thought to the variations in approach that are demanded by different circumstances.
In recent days, a couple of excellent examples have come my way and seem worth sharing. The first is from an in-house lawyer, making reference to IACCM’s annual study of the most negotiated terms.
“Proving value as in-house counsel and as a law department is a constant grind. Should we negotiate clauses that we’ll never litigate? Do we ever litigate contracts? Or, as we say at my company, do we just “manage the suppliers to death” when they are in breach? To wit: we rarely litigate, but we’ll negotiate firmly because (our customer) expects us to do so in order to protect the prime contract performance or security interests (export control, classified material, FCPA terms, etc.). Sometimes that makes sense, sometimes it does not. Are we “disrupting commerce” by negotiating fiercely on clauses that are never litigated or that provide very low risk margin, under the risk formula: B>P*L (does the Benefit of doing the deal outweigh the Probability times the Loss)? Relationship dynamics are key. We deal with the same customers on prime contracts over and again, and we deal with largely the same pool of subcontractors across several prime contracts. Consistency in dealing should be paramount to sustain those relationships but in a big company, our various lines of business and programs often treat both the customer and supplier vastly different. Adding value may be getting to yes, it may be in mitigating risk, and it may be in getting it just right through balanced risk.”
Adding to this set of challenging questions, IACCM member DC Toedt alerted me to an excellent (and unfortunately anonymous) blog that does a great job distinguishing between ‘a deal, or transaction’ and ‘a relationship’. Here is an extract:
“A transaction is a quick, short-lived exchange. It’s about this deal, these terms. Get a signature, and you’re done. Negotiating relationships is a process with no clear beginning or end. Your goal is to build sufficient understanding, comfort and trust between parties that you can work together now and in the future, under conditions that enable both sides to prosper.
There are other critical differences:
- In a deal, the party you are negotiating with is, to a large extent, your opponent. In a relationship, the other party is your preferred partner.
- Deals are about getting as much of what you want as you can carry away. Relationships are based on fair division and joint burden-sharing.
- In a deal, you hold yourself aloof from the other party: hiding information, guarding your responses, pressing your position. In a relationship, you are more relaxed, open, and natural: sharing information and truly seeking to understand and resolve differences.
- In a deal, you may exaggerate the strength of your position or try to trick the other side into giving in. Successful relationships are based on honesty, reliability, and follow-through.
- Deals are static, inflexible, with exhaustive contracts intended to guarantee that every term and condition will remain “carved in stone” until the transaction is completed. Relationships are also based on fundamental agreements, but they are more accommodating, less rigidly detailed. Because relationships take place over time, change needs to be anticipated and managed constructively rather than ignored because it falls outside of the scope of the initial agreement. Relationships are dynamic, not carved in stone.”
As the blog rightly points out, not all deals require relationships in order to succeed. But often negotiators fail to distinguish their focus and behavior based on whether the desired outcome is a transaction or a relationship – and that goes to the heart of the initial quote from the in-house attorney.
This brings to mind a third quote which came to me several years ago, when researching the differences in approach to negotiation between the East and West. One of those we interviewed made the comment: “Westerners negotiate transactions from which relationships might follow; Easterners negotiate relationships, from which transactions will follow.”
That difference is quite fundamental in the style and approach it induces. In the West, we have tended to let legal risk perspectives cause us to be adversarial and ‘transactional’ in the way we approach our trading partners. Collaboration occurs in spite of the contract, not because of it.
There is no absolute of right and wrong in the way we negotiate, but I hope this blog will give all negotiators pause for thought and to ask themselves the question of how best they deliver the right value and the right outcomes for their business.
I recall some years ago, when researching for a presentation, I discovered the origin of the word ‘mystery’. It was a mediaeval term, used to describe the craft guilds and their hidden practices and methods.
Those craft guilds were the fore-runners of today’s professions. Now, as then, there is a tension between the obvious merits of specialization and the maintenance of high standards of practice, versus the inclination to create barriers to entry and to resist change.
This conflict is especially evident in the legal profession and, by association, it affects many contract and commercial managers. As an article in The Economist points out (‘Offshoring Your Lawyer’), there is widespread belief that lawyers are inefficient and overpaid. In large part, this is because they often fail to distinguish high value work from routine and low value tasks. Respect for the judgment of a good lawyer can be undermined by frustration over the profession’s reluctance to innovate and its insistence that repetitive activities require the intervention of high-paid professionals.
The practice of law definitely demands thoroughness and sound investigative techniques. But so do fields such as medicine, scientific research and engineering. In each of these, there are many lower level (and lower salaried) positions to undertake supporting or peripheral roles. In addition, technology has made major inroads, enabled by a readiness to record experience and define patterns that enable the application of consistent methods to generate rapid results.
Many legal jobs are routine and could be conducted far faster and far more cheaply than they are today. The same applies to contract management. Work could be automated; it could be outsourced; it could be transferred to the client.
At present, the focus for change appears to be on the external law firm, where costs have risen and billing practices are widely regarded as unsustainable. The Economist forecasts a surge in outsourcing and a consequent ‘squeeze’ on the profession, especially in the United States (where the number of lawyers has continued to increase). This will drive many to look at careers in related areas – such as contract and commercial management. Hence we already see a growing inclination by in-house legal groups to assert territorial rights over all contract-related activity.
Lou Gerstner, when he was CEO of IBM, made the observation that ‘contract management is far too important to be left to the lawyers’. He is right. Many lawyers can excel at contract management and some General Counsel are visionary leaders. But contract management is a business discipline, requiring wider knowledge and talents than those taught to the law graduate. It demands judgments that take account of the legal issues, but are not subjugated to them. Mr. Gerstner understood this. He felt that contract management was all about brand image – that is, supporting the brand’s reputation and demonstrating its quality and trustworthiness.
Does all of this really matter? I think it does. As another Economist article (‘The Tyranny Of Choice’) points out, we are increasingly overwhelmed by the volume and variety of products and services at our disposal. Research shows that increased choice creates confusion and delays decisions. This plays into the hands of those who focus on their brand image. “Brands simplify choices. They are a guarantee of quality or consistency in a confusing market, and a badge of trust.”
So as we enter a new year, the need to improve the quality and value of legal and contract management services is pressing. And so is the importance of distinguishing between them and ensuring that each, in its own way, is contributing to external perceptions of trust and quality.
A high proportion of people think that life today is more confusing than it was 10 years ago. An overwhelming majority of contract and commercial staff feel they have to deal with ever-greater complexity. Over 40% lie awake at night trying to resolve problems.
Increased choice appears to lie at the root of these 21st century challenges. “Expectations have been inflated to such an extent that people think the perfect choice exists.” A consequence is growing indecision, confusion and expectation that every acquisition can be customized to our precise needs.
These trends have had substantial impact on trading relationships and those in functions such as Procurement and Contract Management. The management of choice has become a far more important discipline, with growing executive expectations of the benefits to be achieved – and frustration when their aspirations are not met. As a result, we have seen increased pressure on suppliers and heavy investment in the tools and resources to support their selection and management.
Yet has the explosion of choice actually led to improvement? In general, the answer appears to be yes. Overall global wealth has increased at an unparalleled rate, driven by rapid improvements in productivity and reductions in prices. Suppliers have been forced to differentiate through more creative solutions, better quality, higher levels of customer service.
As we enter 2011, far from a reduction in the volume of choice, it appears the trend will gather pace. The continued emergence of new competitors from emerging markets, plus reducing barriers to market entry, suggest that the Procurement and Contracts community will face growing complexity. As we are already seeing, this is likely to be handled through increased segmentation of relationships, with the sale and acquisition of commodities, solutions and strategic products or services demanding major variations in approach and resources. It is this evolution on which we should be focussing our plans for the year ahead.
A few years ago, I wrote a definition of Commercial Management for Wikipedia. It was:
‘Commercial management is a term used to describe the non-technical business disciplines within a company or organization, particularly the administration of revenue and expenses to generate a financial return. Commercial management within an organization is applied at both policy and transactional levels. Commercial policies relate to the rules or practices that define how business will be conducted and the standard terms under which external relationships will be formed and governed. Many of these policies are reflected in the terms of any contract in which the organization engages. At a transactional level, commercial management is applied through the oversight of trading relationships to ensure their compliance with business goals or policies and to understand or manage the financial and risk implications of any variations.’
As this definition makes clear, the primary purpose of commercial management is to ensure healthy financial returns. The contract is a mechanism through which these returns are enabled and safeguarded.
There is growing evidence that the academic world has grasped this connection. But in business and the public sector, integrated commercial and contract skills remain rare. Capability is typically spread across multiple areas of the business, with no clear point of coordination or accountability for results. In those organizations where there is a dedicated contract or commercial resource, it is often focused either on overseeing broad compliance with the policies and practices mandated by others, or it manages transactional exceptions. The examples where commercial management teams are truly engaged with the strategic development of the business are relatively rare.
In a simple world of relatively consistent rules and long-term trading relationships, this absence of dedicated commercial skill would not much matter. But our world is not simple; it challenges us with speed, diversity, innovation and unpredictable events. Therefore the ability to view opportunities and relationships through the prism of a cross-functional lens has become essential. Organizations that treat contracting as an administrative sub-element of procurement, project management, legal or finance fail to grasp the risks and the opportunities presented by today’s market conditions.
There is a growing wealth of academic and business texts that reinforce not only the importance of commercial and contract competence, but also set out the framework for methodologies and techniques. As we enter 2011, the ingredients and the recipe for success are ready. What we now lack is a robust community and leadership that is prepared to promote its own cause and demonstrate to executive management its readiness to provide the cross-functional glue that represents commercial excellence.
My parents always taught me that if there is nothing to hide, then there is no need for secrecy.
And in fact, the great thing about the Wikileaks grand exposee of the United States is that … there really isn’t much to hide! No great conspiracy. No sustantive double-talk. In fact, it seems the US – and in particular its foreign policy – is run by a fairly high-principled set of people.
It is therefore somewhat ironic that so many US citizens would like the Wikileaks founder to be caught and punished. For what? For showing that their country is one they should be proud of? Are they perhaps disappointed that there is no double-talk and double-dealing by their top politicians? Should Mr Assange be jailed because he has confirmed that most of the resst of the world does not live up to similar high standards of honesty and integrity?
But there is a broader message in all of this – and one that is especially pertinent to the contracts, legal and procurement community. Each day, we are working across the borders between companies and organizations. Each day, we are in a position where we have to make judgments over the honesty and integrity of others – sometimes our internal colleagues, who may be motivated by personal gain, and sometimes our external partners, who may be misrepresenting or overstating their needs or their capabilities.
Our task would be far easier if there was greater openness and transparency of data and information. And in truth, Wikileaks is just an early indicator of our future because the dissemination of information is increasingly hard to control. Think about the impacts of social networking, or the growing ‘data integration’ services that consolidate global information about organizations and companies. Secrets are more and more difficult to keep. And in general, that is a good thing, because most secrets involve duplicity, dishonesty or bad faith.
The contracts community is in many ways the front line for reputation management and judgment. As professionals, I hope that we are always making true and honest commitments; and I imagine we expect that from those with whom we choose to trade. So the advent of new tools and methods to confirm the inegrity of our trading partners is something that we should master and welcome.
In the end, there is a certain irony that the country that arguably leads on openness and honesty is the one that Mr Assange has targettted for exposure. Where is Wikileaks China, Russia or Iran? The US should emerge from Wikileaks with a great sense of pride. Far from seeking to punish Mr Assange, the US public should thank him.
The real question each of us should now be asking is whether our country, or the organization we work for, could withstand similar scrutiny?
According to a report for the World Economic Forum, levels of trust have fallen by 44% in the last 10 years.
Whether or not we can rely on the precise statistic, the underlying message is important for anyone engaged in the world of contracting and relationship management. Trust is commonly understood to be fundamental to the health and sustainability of relationships. Its erosion therefore has significant consequences, many of which are in fact already evident in our daily work.
Globalization has been the key factor in the decline of trust. I suggest there are several reasons for this.
- As we work increasingly with new and unfamiliar companies and trading partners, often spanning jurisdictional, cultural and linguistic barriers, a sense of caution is inevitable and trust is a casualty.
- The networked world has disrupted traditional methods of doing business – in particular, face-to-face meetings are far less common. Many relationships are ‘virtual’ and lack the forms of bonding that are essential to establishing trust.
- It is widely understood that different cultures operate at different levels of innate trust. For example, Scandinavia is a high-trust region; the United States and Latin America are not. The dominance of US corporations and contractual models in driving international trade has undermined more trusting, relationship based models. ‘The transaction’ has replaced ‘the relationship’.
- Within business, a core reason for the explosion of international commerce has been the incessant hunt for the lowest price. Relational loyalties have been sacrificed in the search for perceived savings.
Among the consequences of this loss of trust has been the rise of the importance of the contract and formalized contract and performance management. During these 10 years, we have witnessed a drive for more and more precision over commitments and their measurement, accompanied by a steady increase in focus on ‘penalty terms’ – or the consequences of failure. Negotiations have become dominated by the allocation of liabilities and indemnities; battles over intellectual property rights, data protection and confidentiality. All principles of ‘my word is my bond’ appear to have been abandoned in the interests of low prices and the destruction of loyalty.
It is right to believe that many traditional relationships were too comfortable and had become inefficient. But it is also very clear that this pursuit of low prices has brought with it enormous additional costs and overheads. We see it in the need for prolonged validation of suppliers; longer lead-times in selection and negotiation; increased claims and disputes; more bad debt; longer payment cycles; growing focus on reputation risks – in fact, all the many costs that accompany more governance and administration.
Finance executives are typically sceptical about the extent to which ‘negotiated savings’ translate to the bottom line. They are of course right to be so – because self-evidently, they do not. Yet those executives remain addicted to cutting input prices far more than they seem ready to tackle the consequences this has on output costs. And while they sustain this behaviour, calls from other senior executives for ‘more collaboration’ and ‘improved relationships’ will continue to be frustrated.
The erosion of trust is not inevitable; it is a corporate choice whether or not to build sustainable relationships with its key customers and suppliers. But so far as I know, we do not have the economic data to demonstrate the relative value of trusting versus untrusting trading relationships. Isn’t it time for commercial experts to explore these impacts and to provide insights to the best performing contract and relationship models?
Recent research among senior in-house lawyers has resulted in three areas of major interest for 2011. These are:
- Global compliance
- Contracting and contract management automation
- Corporate governance and crisis management
These do not necessarily represent the areas of peak workload or required expertise for in-house counsel. The research was exploring the topics on which the legal community would most value more information, in order to grow their competence and capabilities.
These results therefore point to areas where many in-house groups today feel exposed. In some areas, such as contracting, this sense of exposure is in some respects caused by the challenges of rapidly increasing workload and inadequate staffing levels. Legal is in danger of becoming a roadblock unless it can find new and more efficient methods to deal with the complexities of today’s business.
There are many aspects to these problems. In part, it is the traditional approach to legal training, still largely based on jurisdictional knowledge and with limited acknowledgement of the needs of a lawyer in the world of business. This failing was recently highlighted in The Economist, in an article that was especially critical of the US law schools.
In part, it is due to the nature of lawyering. By and large, it is not a profession for risk-takers. Sometimes, this can lead to over-cautious attitudes and in particular a resistance to change. There is a tendency to create a centralized ‘command and control’ culture, rather than think about ways to empower better decision-making. In the words of Mark Chandler, General Counsel at Cisco, lawyers often want to be gatekeepers, rather than to build gateways.
This conservatism can reflect in some narrowness of vision. The global networked economy that has given rise to many of the new challenges confronting lawyers also potentially offers the solutions. The growth of new, on-demand information sources is one example. Process-based business applications are another.
Lawyers used to stand aside from the business, offering independent judgment on the legality and enforceability of specific policies or actions. Today, their increased accountability places them right at the heart of decision-taking by the business. Yet they cannot be involved in every decision. Therefore they need better and faster understanding of the implications surrounding proposed actions; and they need to increase their tentacles out to the business, both in terms of influencing decisions and in having visibility into what is going on (and specifically, whether it is compliant).
It is this new business reality that is driving the three areas of interest highlighted by the research. But having identified the problems, the real secret of success will depend on how in-house groups approach their resolution. If they try to remain a traditional ‘fount of knowledge’ around which the rest of the business must revolve, they will fail. Lawyers must become far more integrated into the fabric of the organization and its related business processes.
The pressure on procurement and supply chain groups seems certain to grow as more and more reports identify the embedded inefficiencies of today’s performance. But suppliers will also need to adjust to the changes this implies – many of which impact contracts and contract manaagement practices.
The most recent report to highlight supply chain failings comes from Sir Roy McNulty, who was investigating the UK rail industry. He found poor coordination across the range of companies and stakeholders involved in delivering services. He called for ‘much closer working and alignment of incentives’ across the industry and the adoption of ‘good supply chain practices’, which he estimates will save at least £1bn (US$1.6bn) a year, as well as delivering service improvements.
Among the specific failings, the report highlights:
- poor demand management
- failure to challenge requirements, plans or costs at an early enough stage
- inadequate focus on ‘value for money’
- absence of trust and collaboration with suppliers
Although the situation on which Sir Roy reports may be more extreme than many, the symptoms are found in many places. To be fair, a key reason for this is the obsession of many CFOs with purchase price savings and their refusal to allow ‘value for money’ judgments. Yet Procurement increasingly has evidence – through reports like this – that uni-focused, adversarial behavior does not deliver the best finaincial results. Procurement leadership must step forward to push this issue and illustrate that today’s more complex, outcome-based supply networks demand a new approach.
Suppliers must assist in this change. They should ensure that sales teams are far better equipped with the economic data to enable a shift in the way that relationships are established and managed. They will also have to learn ways to collaborate across a supply network, where necessary with competitors. As Sir Roy concludes, there are those who “appear to have been more successful at developing mechanisms to encourage partnership with suppliers while retaining the advantages of competition.” Those companies will be the ones to flourish in our networked world.
This week, the head of Corporate Governance at one of the major international audit firms told me that he was amazed by how many companies still cannot produce or describe a formal process for managing supply chain risk.
Of course, almost everyone uses one of the assessment agencies, such as Dun and Bradstreet, to assess financial risk. But when it comes to areas of business conduct risk – the sort of things that damage reputation and cause regulatory breaches – very few have a formal and comprehensive approach.
I spoke with one company this week that has attempted to build more rigorous risk assessment into their bid and contract process; the consequence has apparently been that cycle times have extended by several weeks. That doesn’t sound much like a sustainable approach; and of course it simply means one set of risks has been replaced by another (delayed revenues, loss of competitiveness, increased risk of internal process avoidance etc.).
So is there a better answer? In my opinion, yes. There are definitely ways that we can start to tackle these risk assessment challenges and I interviewed the CEO of one such solution today.
Richard Cellini is an attorney by background, but has spent many years in the field of corporate governance and compliance. His new company – Briefcase Analytics – offers a fast, practical and low cost solution to checking the integrity and performance of suppliers and customers. As the interview revealed, it is important that we undertake such checks not only at the outset of a relationship, but on an on-going basis. Indeed, regulatory requirements increasingly demand evidence of a robust and continuing evaluation process. Richard’s examples included some fascinating illustrations where major corporations have failed to act, even after there have been highly publicized cases involving key suppliers.
Briefcase Analytics is just one of a growing number of organizations using web-based data to provide creative new corporate services. In their case, they focus on seven major areas of business conduct:
Their services are global, so if you are Chinese and want to check out your potential US trading partners, or a North American company doing business in India, you can access the data.
I see so many organizations struggling with how to manage risk. But increasingly the answers to their problems are readily accessible, if only they would look beyond their traditional approaches. Far from managing risk, we seem far too often to create risk though an unwillingness to explore new ideas.
A recording of the webinar with Richard Cellini, which includes insights to the ‘most risky’ industries and some of the best and worst performing companies, is available in the IACCM member library – or send a note to info@iaccm.com for a copy.
Commitment Matters 