I was in conversation recently with a partner at one of the largest international law firms. We were discussing ways that contracts can be an obstacle to doing business. As an example, my companion cited one of the largest technology and software companies. “It took seven escalations before we could get hold of an editable version of their contract”.
The lawyer’s client – quite unreasonably, I suppose – wanted to negotiate certain points in the vendor contract. They proposed to do this through red-lining – which for most companies is a well-accepted approach. But not for this particular vendor. They do not welcome amendments, or indeed negotiation in any form. It creates extra risk, extra costs and is counter to the philosophy of their leader. So, next to an outright no, they do their best to make it impossible.
For a while, due to market pressure, they decided to build up a large contract management team. However, its purpose was not to facilitate customer service, but to act as a source of compliance. They monitored the Sales organization to prevent deviation and they acted as a buffer to the customer – essentially saying no a bit faster and with a smile.
But that approach didn’t work. Many of the contracts professionals didn’t much like that job and some even started campaigning on behalf of the customer, because they could see the damage that the approach was doing to market relationships. So the vendor had a fix for that. It decimated the contract management headcount.
Many may find it surprising that a company can still operate this way, though in truth it is just an extreme example of the way that many large corporations behave. There is of course a need for balance; complete flexibility over terms and conditions would not be affordable or sustainable. But I shall watch with interest to see how this particular vendor fares in today’s competitive markets and whether the next step will be to address their contracting process, or perhaps to see a steady erosion of customers.
Many of the world’s most profitable companies invest very little in their contracting process, but that does not mean they lack a contracting strategy. Indeed, they have often chosen to operate with business systems and in markets where flexibility of commercial terms and offerings is not required, or can be managed by non-contractual means.
IBM in the 1980s, Microsoft in the 1990s, Apple today; each is an example of a company where market demand for world-beating products trumped the need for negotiation and commercial flexibility. Until recently, the pharmaceutical industry maintained high margins through product leadership and market controls that made rigor in contract negotiation appear of little importance. In all these cases, investments in contract management focused primarily on the administration of contracts and in the imposition of rules and procedures that prevented deviation from standard terms and conditions.
At the other end of the spectrum, consumer based industries such as retail may also view contracts as largely non-negotiable instruments. The inability of the consumer to dictate terms and conditions means that flexibility is needed only in the context of special promotions or deals; and in general, such industries are dealing with suppliers who also lack power to negotiate. Therefore contracts, to the extent they exist, are mostly standard forms and employees have little empowerment to agree variations to terms.
For these companies, ‘contracting strategy’ means having the ability to operate off standard terms of their choosing and avoiding the costs and risks inherent to negotiation and the management of non-standard agreements.
Between these two environments, the bulk of businesses need a more nuanced approach to the way they do business. However, the challenge for many is that they do not in fact have a contracting strategy, or the strategy they have is no longer aligned with business conditions and needs. This may be because they are still trying to impose standard terms in a market where competitive pressures demand a revised approach; or it may be that they are trying to operate with high levels of deal-based flexibility at a time when technology, regulation and cost pressures have combined to make such an approach unaffordable and vulnerable to unacceptable levels of performance risk. The financial services industry provides an extreme example of a business sector that failed to understand and manage its contracts. Others, in sectors as varied as outsourcing and engineering, are learning the hard way that commercial knowledge, supported by robust and consistent contract management discipline, is a necessity.
Misalignments of this sort result in ‘the contracting process’ being viewed by many as a source of complexity, frustration and delay. It becomes an inhibitor because, as business and market conditions change, contracts and the contracting process typically lag behind. And it is that lagging which results in a burden of excess costs and missed revenue, together with the potential for severe competitive exposure. Recent IACCM research suggests that, on average, corporations are losing the equivalent of 9.2% of annual revenue through weaknesses in their contracting process, being a combination of missed savings and cost reduction on the one hand, and lost revenue opportunities on the other.
The role of contract management is clear. It is to secure economic value; to provide a framework for the allocation and management of risk; and to oversee the performance of commitments that reflect a positive brand image.
It is within this context that IACCM advocates the need for a fresh approach to contracting, including the need to reconsider the purpose of the contract itself, and to develop a clear strategy that is capable of rapid adjustment to shifts in business and market conditions. In a new paper, ‘The Future of Contracting’, it will lay out the rationale for change and the steps that are required to turn the contracting process into a source of competitive advantage and economic value. Currently in the final stages of production, the paper will be issued in several weeks and discussed at a variety of forums, including the Ariba LIVE event in Las Vegas and the IACCM EMEA conference in London.
The most recent Association of Corporate Counsel survey shows that Chief Legal Officers have growing concerns about their ability to maintain business oversight and prevent potential legal exposures.
The 2011 survey confirms growing workload, but also reveals that many law departments have been able to increase hiring. The percentage feeling under pressure to cut budgets has dropped, from 74% to 54%. However, most continue to push for greater value from their external law firms and have introduced new charging models (though it is interesting that these new models appear to represent a low proportion of overall spend).
A majority of law departments (78%) include some number of non-legal staff. The survey does not address specifically the extent to which contract or commercial managers are coming under the wing of the General Counsel, though IACCM benchmarks show that this has increased in recent times and is now the typical situation in the largest corporations. This appears to be a result of the concern that General Counsel have over their ability to have insight to the business, plus the challenge of workload. By consolidating the contracts teams within legal, they tackle three issues:
1) They gain control over one source of potential legal risk which can arise from contracts staff making unauthorized or (legally) unwise commitments;
2) They gain increased visibility to the business deals and trends;
3) They obtain incremental resources that are typically lower cost than hiring lawyers and can offer some relief to growing workload.
On this last point, recent benchmarking by Rees Morrison indicated a fully-loaded hourly rate of $193 for the average in-house lawyer. The equivalent average for an experienced contract manager (not administrator) is approximately half that number (based on the 2011 IACCM salary survey). Since commercial contracts work represents 40- 50% of total workload in many in-house legal groups, there is significant potential to cut costs through more effective use of qualified contract managers. Case studies suggest that law department costs can be reduced by up to 15% through this means.
The benefits and the dangers of this consolidation have been the subject of previous blogs. If the General Counsel appreciates the differences between contract management and the role of the lawyer, it can be an effective partnering. However, if the motivation is primarily to increase legal control or eliminate an alternative source of commercial support, the long-term effects are more likely to damage business results.
Logistics Viewpoints has an article about the value of business intelligence. It features a story about an on-line grocer, FreshDirect, that has survived through its ability to honor commitments and thereby maintain high levels of customer satisfaction.
One example is the way it is using live information to ensure on-time delivery, now running at 99%. This is important to FreshDirect because they know that meeting delivery commitments is key to customer satisfaction – and also to their own financial results, since they offer service credits for delay. Historically, performance was only around 90%, but by monitoring the delivery rate of each truck, their business intelligence system can accurately predict which deliveries will be late. FreshDirect has a small fleet of trucks held in reserve, enabling them to release back-up support when needed.
A second example relates to the delivery of eggs. Customer satisfaction reports showed that deliveries that contain damaged eggs were a particular source of dissatisfaction. Initially, the company explored alternative forms of packaging and this had some effect. But then someone suggested a much simpler technique – to check the eggs before they were despatched from the warehouse! This approach has reduced the breakage rate to one per thousand.
The point of this story is to illustrate the importance and the power of analytics and to advocate its use in the world of contract management. Customer satisfaction with contract terms and contract performance is a source of powerful data that can be used to drive continuous improvement in capabilities and results. But if we don’t collect data, or dismiss it as being outside our field of responsibility, then we learn nothing, we are continually dealing with crises and we miss the opportunity to add value for our business.
What are the repetitive issues where your contracts are broken, or where they fail to meet customer expectations in the terms you offer? Is it perhaps billing accuracy; or delivery reliability; or unwillingness to take on risk? There are many possible areas for improvement, but first we must undertake the analysis to know what they are and second we must take responsibility to ensure something is done to fix them.
Otherwise, we will continue to deliver the equivalent of broken eggs to our customers.
Contracting is one of ‘the next big things’ in the world of business. That is because it is a critical contributor to the management of complexity and risk. Economic conditions are pushing organizations towards new sources of savings, revenue and project funding; into new and emerging markets; to dealing with unfamiliar cultures and business practices; growth in 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’.
In this environment, the analytical and disciplined approaches that a high-performing contracting process brings are fundamental to business management and controls, plus they then provide a firm platform for the management of change (which today is inevitable during the lifetime of every relationship).
More than 60% of organizations see automation of their contract management process as a priority; indeed, it emerges as the number one priority for 2012 in the latest IACCM global benchmarking study. There are several reasons why automation is seen as key to improved performance:
- Management is demanding ‘greater value’ from the contracting process, which includes improved cycle times, improved controls and improved management information
- Resources applied to contract management are stretched; workload is increasing and hiring is generally not an option
- Increasing regulation is imposing growing pressure on compliance, which is frequently achieved through contract management. Without automation, the necessary visibility and controls cannot be achieved
Acquiring the right automation is critical. For example, most Procurement groups have invested heavily in technology in recent years, including in many cases some rudimentary tools for contract management. Yet many are finding that what they acquired is not ‘fit for purpose’. A simple repository and a system that supports transactional management of standard forms of contract are inadequate to deal with today’s volatile, fast-changing market conditions. Far from enabling the business, such systems act as a constraint.
To become effective at managing contract risk, organizations need to focus on business and market intelligence that will help steer them towards improved decision making and will safeguard planned contract outcomes. To do this, we need to be far more thoughtful about the nature of the data needed for analysis and how to combine this with forecasts based on likely market trends and directions. Through this combination, the quality of risk management would improve and result in increased bottom-line contribution.
Some Key Considerations In Selecting Your System
It is critical to remember that contracts are instruments of economic value, in which legal considerations are of fundamental importance, but not their primary purpose. Contracts represent an economic arrangement and the underlying system should be designed and managed to maximize the probability of a successful outcome.
Second, contracting is a life-cycle activity. Businesses must have a system that supports their contracting strategy and allows appropriate flexibility during the opportunity or needs evaluation, negotiation and post-award environments. The contracting process 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 (not to mention the external trading partner). Each has areas of policy or resource interests which make them sensitive to authorities and review and approval processes. Therefore a contract management system must address their needs and be seen to deliver benefits and advantages consistent with their interests.
Together, these factors mean that gathering requirements and building consensus will be key to success. The right vendor will have the experience to assist you in developing a business case and will be able to offer a solution that not only addresses your perceived needs of today, but also has the flexibility to adjust to the fast-emerging needs of the future.
IACCM has started the feedback process from its 2011 surveys on benchmarks and measurements.
On January 10th, there will be two webinars that explore a range of commonly asked questions, including typical reporting line for contracts and commercial groups, the type of measurements used to monitor and report performance, trends in workload, the scope of the role performed, cycle times and sources of knowledge and information. The study compares buy-side and sell-side groups and also reveals variations between geographies and, where relevant, based on the size of the business.
The study is based on input from more than 500 organizations. The last time research was undertaken across such a wide group was in 2004 and the webinar will discuss some of the changes over that period – as well as the areas in which there has been limited progress.
Overall, the study reveals a sense of insecurity for both managers and practitioners. There is a broad awareness of the need to improve the contracting process and demonstrate greater value, especially for sell-side resources. On the buy-side, the input reflects a continued battle to exert greater influence and achieve higher status in the business. In both cases, the webinar will point to some of the key reasons why contract groups are struggling to achieve their goals and suggest a range of changes that must be made.
Registration for the live webinars is at https://www.iaccm.com/events/. Alternatively, a recording will be available in the IACCM Member Library later this week.
“Low margin businesses are particularly vulnerable to disasters beyond their control.” (Financial Times, November 26th)
Given the truth of this statement and the volatility of market conditions, it is critical that any Procurement strategy must be thoughtful about actions which:
– force down prices without adequate understanding of the consequences to the supplier’s margin
– consolidate the supply base to a) increase negotiation strength and b) cut administrative costs, but thereby reduce protection against ‘disasters’
– embrace global markets to a degree that significantly reduces the ability to predict or manage ‘disasters’
I am sure these factors are well understood in many organizations, but word on the street suggests that they do not necessarily translate into action. While Procurement measurements continue to be driven by short-term savings, the incentive to ignore these issues remains strong – and continues to leave many organizations seriously exposed to ‘disasters beyond their control’.
It can be hard to get the right balance between cost and risk. But a start would be through an understanding of the ‘costs of vulnerability’ – that is, the actual cost to a business that occurs as a result of selecting low price supply. This would of course be a cumulative number over a specified period of time and would capture the costs associated with supply disruptions, crisis management etc. that were a direct result of deciding to take the risk of going with a low-cost supply option.
Does anyone collect this data? Even if Procurement do not collect it, if I was a supplier under continuous pressure to cut my margins, I would be interested in establishing this data as part of my rationale for value through quality and reliability.
Corporate Counsel magazine recently interviewed Robert Weber, General Counsel at IBM, on the question of whether non-lawyers should be allowed an ownership stake in law firms. At present, in many countries, they are not – but this principle has been eroded in the UK and Australia and is now under review in the US.
Mr. Weber opposes change to the current rules, which also include the legal profession being self-regulating. He believes that allowing non-lawyers to take a stake in a law firm is just the thin end of the wedge and that this will be to the detriment of client interests.
The argument against change is nicely summarized in Wikipedia: “The rule was created in order to prevent conflicts of interest. In the adversarial system of justice, a lawyer has a duty to be a zealous and loyal advocate on behalf of the client, and also has a duty to not bill the client excessively. Also, as an officer of the court, a lawyer has a duty to be honest and to not file frivolous cases or raise frivolous defenses. A lawyer working as a shareholder-employee of a publicly traded law firm would be strongly tempted to evaluate decisions in terms of their effect on the stock price and the shareholders, which would directly conflict with the lawyer’s duties to the client and to the courts.”
Mr Weber adds to this with the observation that “The very nature of being an attorney is that you’re an agent to someone” and cites this as a reason why lawyers act exclusively in their client’s interests.
This discussion raises some important issues. For example, to what extent can a professional body be self-regulating and still act in the wider public interest? To what extent does the legal profession hide behind its proclaimed role of ‘agent’ in order to avoid accountability for its actions? And even if law firms are somehow ‘special’, should similar principles continue to apply to in-house counsel?
There is no question that many lawyers are people of great principle and high ethical standards. Yet there is also no doubt that many are driven by financial reward (the legal profession is among the world’s highest paid). It is hard to swallow this concept of ‘agency’ when lawyers today are so active in promoting litigation – patent trawling, class-action lawsuits and active encouragement for personal injury claims being obvious examples. And I observe many in-house legal teams seeking either to expand their role, or to crush others who might be seen as a form of competition (contract and commercial management groups being an obvious target).
Skepticism about the legal profession is perhaps partly due to the way it dominates the field of politics. For example, according to the Wall Street Journal, 60% of US Senators are lawyers. The School of Human Rights Research in The Netherlands has explored this issue and finds a similar dominance in many other countries. It comments that lawyers and politicians are among the “least trusted groups of people, as the large number of jokes at their expense will attest, and this may be at the root of some of the public cynicism towards politics in North America and elsewhere. Although ethical conduct is considered central to both professions, they both seem to exhibit a higher than normal rate of professional misconduct and breach of trust, in the public perception if not in reality. For many lawyers and politicians, the point is to win at all costs – in trying to win on behalf of their client, or in trying to get elected, they often seem to push aside their convictions or sense of right and wrong in favour of expediency. Much of the vitriol directed at lawyers and politicians is directed at their rhetorical flair – they are good at selling things and telling people what they want to hear.”
A recent survey published by the Law Society Journal in the UK showed that only 47% of people trust lawyers to tell the truth. I believe this is largely due to the perception that lawyers are more driven by personal rewards than they are by professional principles. The American History blog sums it up well in reminding us of one of the fundamental rules of the Law Society: “When acting as an advocate, a lawyer shall not knowingly assist or permit the client to do anything that the lawyer considers to be dishonest or dishonourable.”
Confidence in the rule of law depends on a system that is transparent and fair. A problem with any profession having a monopoly in its field is that it has a strong incentive to maximize complexity and to increase client dependency. This also extends into the question of how broad the role of lawyers should be. It seems to me that if they want ‘special treatment’ because of the importance of their legal role, they must also be clear about its boundaries and remain removed from broader questions of business judgment and management.
The WordPress.com stats helper monkeys prepared a 2011 annual report for this blog.
Here’s an excerpt:
The concert hall at the Syndey Opera House holds 2,700 people. This blog was viewed about 44,000 times in 2011. If it were a concert at Sydney Opera House, it would take about 16 sold-out performances for that many people to see it.
Commitment Matters 