Governance - What Governance?

Top Ten Most Frequently Negotiated Terms Reveal Continued Focus On Failure

Each year, IACCM collects data from more than 500 international companies and organizations, representing several thousand contract negotiators. We ask them which terms and conditions they negotiate most frequently. The data tells us where time is spent; it reflects changing issues and concerns; and it also reveals much about the ways companies behave and the value they place on their trading relationships.

Once again, the results for 2006 indicate many opportunities for rethinking the role of contracting in shaping relationships, supporting brand image and as tools for sophisticated risk management - as opposed to blunt instruments for risk allocation. This report highlights the results and suggests new approaches that could result in significant business benefits.

It is argued that the internet and today's networked economy have brought new dimensions to the management of risk. They provide a global medium through which reputations and brand image can be rapidly built or destroyed. As companies have discovered, failures to behave ethically, to honor their commitments, to meet market expectations can have dire consequences.

Leading consultants and business gurus have emphasized the growing importance of the 'quality of interactions' in determining a company's market image and reputation.¹ Over the last year, we have seen signs that corporate executives understand the direct link between commitment management and business success; how a company negotiates, the commitment terms it offers and market perceptions of how easy (and 'fair') they are to do business with.

In such an environment, we might expect new approaches to commitment and risk management. As buyers, why spend so much time on traditional methods of risk allocation when suppliers can be held to account through the potential for damage to their brand image? Why focus negotiation on contentious issues that address the consequences of failure, when efforts could be directed towards greater collaboration and incentives and methods to achieve success? And as sellers, why provoke negative buyer reaction to terms we know they will not accept; why not consciously seek to move discussion to areas that build consensus and trust?

For all the talk about a changing environment, this year's Top Ten Negotiated Terms shows no sign that it has affected the behavior or attitudes of those charged with responsibility for setting policy or leading negotiations. These groups or individuals clearly have not been party to the executive discussions about a new, more collaborative approach to business dealings. Or if they were part of those discussions, they either could not interpret what it might mean to the contracting process, decided that they were not 'the custodians of the rules' and had no power to change them, or they chose to ignore it. Recent CEO surveys² show nearly 50% of executives believe their company is 'not very good at collaborating'. The survey results suggest the percentage may be much higher.

What Is Holding Us Back?

In truth, most corporations continue to issue very mixed messages. They declare a strategic intent to differentiate, to partner, to add value. But at the same time, they send internal messages about control, cost reduction, standardization and risk avoidance. They highlight the need to be flexible, adaptive and agile, yet they introduce software tools and measurement systems that enforce compliance and inhibit change. And in their trading relationships, they offer the promise of a match made in heaven - until they introduce the pre-nuptial agreement and its administrators.

And so we end another year with value-reduction terms heading the list - limitations of liability, levels of indemnity, control of Intellectual Property, rights to terminate, liquidated damages for performance failure ..... We call them ‘value reduction’ terms because they contribute little or nothing to the quality of the relationship, nor the likelihood of its success. They distract from value-add relationship or offering discussions. And they tackle risk in only a very narrow sense – most of these terms are about allocating the consequences of failure. By undermining the framework for collaboration, they often increase the probability that failure will occur.

To suggest that today’s ‘Frequently Negotiated Terms’ represent good governance is misleading.

At present, there are few signs of change. Companies continue to invest in resources and software systems that focus on control and compliance. Internal measurements are either insufficient or lacking when it comes to the quality or outputs of the contracting process; they do not encourage or prompt change or improvement. They do not require the custodians of terms and conditions to become more innovative or creative in their thinking, or to focus on wider issues of company performance and risk.

The Keys To Collaboration And Value Realization

What changes might we have hoped for? How would the list change if we were indeed moving towards a more collaborative framework for business relationships?

I am not among those who believe that the intrinsic nature of contracts and the legal process make this an insurmountable problem and the growing influence of the Proactive & Preventive Law movement suggests that others share this view. The issue to my mind is that either no one has accountability and control – or control has been yielded to groups of specialists who have a narrow focus and limited accountability. Their expertise, environment or education has somehow absolved them from the need to collaborate effectively with colleagues and to behave as part of an integrated enterprise culture. Hence the negotiation agenda has become an elaborate game based on relative power, rather than a valuable tool for mutually defining, maintaining, monitoring and managing successful relationships.

With the right focus, measurements and incentives, I believe that the discussion would switch to ensuring the methods and mechanisms for building and measuring success. Certainly this would involve topics like service levels (relatively static at #11) because these set agreed parameters for performance. But it should also focus attention on governance topics such as change management (not in the Top 30), business continuity (down from #19 to #22) and project / relationship reviews (also not in the Top 30). The only clause that is arguably part of the 'good governance' portfolio to have made significant progress (from #35 last year to #17 this year) is dispute resolution.

I would also expect that those charged with better governance (or those seeking a route to higher value and status within the organization) might spare a few minutes to question their traditional adherence to the methods by which contracts and disputes are managed. For example, as international trade mushrooms, we all know that the legal system is ill equipped to manage trading relationships. Arguments over governing law and jurisdiction are common. Recen t US research has shown that even in a sophisticated and well-developed market like the United States, the courts are weighted against foreign litigants.³ So why would any right-thinking business person want to lose the advantage of home turf? To reduce the contentious debate, one may move to alternative dispute resolution (ADR) mechanisms such as arbitration or mediation - and institute different (non-judicial) forms of incentives for proper performance and sanctions for specific failures.

Another example where we waste so much time is in the area of liquidated damages. Recent IACCM research⁴ illustrated the frequency with which we negotiate such terms - and then either have no mechanism to monitor performance or consistently elect not to enforce the term because 'it would damage our relationship'.

Superior companies that truly focus on customer value will also peruse the list and identify ways that terms and conditions might offer differentiation. Performance Undertakings, Security, Most Favored Customer clauses, Disaster Recovery and Benchmarking are among the examples where creative thinking and innovative approaches can add value through reducing customer risk and increasing relationship loyalty.

Achieving Efficiency AND Effectiveness

In the end, we apply extensive resources to battles over the terms for allocation of blame and failure. We devote yet more resources to fighting over claims or disputes. In most companies, those resources far exceed the heads that are focused on building a foundation for success, resolving problems quickly as they occur, overseeing commitment integrity ('business assurance') or proactively monitoring commitment and relationship performance. The disparity in focus means that many companies create the framework for contract and relationship failure. For them, 'goodness' means having a contract that protects against the consequences, rather than having a negotiation and contract management discipline that raises the probability of success.

Ironically, more companies measure compliance with achieving 'standard' terms (whether or not these are in fact beneficial) than those which monitor whether or not contract objectives were met. It seems a strange disparity - but it certainly explains why we remain stuck with the unchanging grind of today's Top Ten.

Most executives still view contracting as an unfortunate, but unavoidable, administrative and regulatory burden. They imagine they have entrusted it to their law department. But in truth, the contract is a repository for many rules, procedures and practices, most of which are not legally driven. The contract and its terms are tools for marketing, communication and coordination, for corporate image and for business efficiency. Contracts are also core assets (try to sell your business if you don't have any). Those who understand this will find they can shift the focus of negotiation and use the process to build and maintain productive and lasting business relationships. (In this field, IACCM has initiated cross-professional research and collaboration with a worldwide academic network to identify innovative methods and practices).

A Roadmap To Lean Contracting And Improved Governance

Start this way:

• Negotiation is a quality issue; each time we negotiate is potentially an indication of failure (it means we do not align).
• Therefore we must discover what we negotiate today and with what frequency?
• We must ask ourselves how we could avoid that negotiation and what results it would have (positive and negative)?
• Are there things we do not negotiate that should be negotiated (positive impact)?

If you would like more complete insights to the methods and approach, IACCM has recorded a one hour webcast on this topic - and it is also the feature of our next IACCM Americas conference in April 2007.

Analysis of this type requires in-depth thought about individual terms and term elements. It requires creative solutions to identify alternatives, off-sets and value propositions. Terms become strategic and therefore require senior management commitment to drive change and to make significant risk and value decisions. And the process is not 'one-time'; in fast-changing markets, new threats and opportunities must be monitored to ensure terms remain competitive and relationships are managed in ways that optimize their value.

This report on the Top Ten Negotiated Terms is the first in a 2-part series. The second report will focus on the extent of variations between buy-side and sell-side contracts, as well as geographic differences (caused by legal system or culture) and also variations between offering types (for example, products compared with services or solutions).