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IACCM - International Association for Contract & Commercial Management Contracting Excellence Magazine
 

July/August 2014 Edition

 

Welcome to Contracting Excellence – the essential IACCM member e-zine bringing you news, insights, experience and practical approaches to key issues relevant to our international community of contract and commercial management practitioners.

 

 
Public Sector Corner

Collaborative contracting - and how this organization got it so very right!

 
Better collaboration with customers or suppliers is high on executive agendas - but how many manage to bridge the gap between concept and reality? Many contracts and legal professionals struggle with the practical implications of 'collaborative' contracting, negotiations and relationships. One high profile organization experienced extraordinary results using a new relational contracting model.
 
 

Find out how the Australian Defence Department worked with IACCM to establish a relational contract - a key area of support that IACCM provides1. Details appear in a case study now on the IACCM website.  The study will be of wide interest to those who want to raise their profile as a source of collaborative working.

What they did – case study summarized…

A relational contracting team process seeded by IACCM has achieved spectacular success with the undocking of Royal Australian Navy ship HMAS ANZAC on July 3 following its major upgrade. What did it take to move this massive project across the finish line?

Outstanding commitment of Team ANZAC Alliance (BAE and Saab) was key to completing this 18-month journey with the G3 Group Maintenance Contract with NSM (under the Babcock and UGL joint venture) providing maintenance.  The team will grow in size as the project moves into the test and trials period.

The highly complex and demanding Anti-Ship Missile Defence upgrade saw this lead ship of the ANZAC class frigates fitted with world-class radar and combat system technology and the latest engineering changes. IACCM partnered with the team by providing original blueprint and concepts, three workshops and remote interim coaching.

“The outcome achieved by the ANZAC Alliance and NSM has been truly ground breaking and sets a new standard in project co-operation,” said Captain RAN Wendy Malcolm, Director ANZAC Systems Program Office. “My congratulations to the ANZAC Alliance (BAE and Saab), the extraordinary team at CEA Technologies, Frigate Group and all those who have supported us on this journey – with thanks to Commodore Michael Houghton and Commodore Mead for their ongoing support and leadership despite all the challenges we threw at them along the way!”

At the beginning of the journey, IACCM led the Australian Defence Materiel Organisation (DMO) and the contractor alliance through a two-day kick-off workshop, during which the customer and contractor agreed to implement and measure their Relational Contracting process, focusing on eight Relational Contracting enablers. The DMO/contractor relationship team established eight sub-teams to more clearly define and facilitate each enabler.

IACCM returned to lead the DMO/contractor relationship team through additional one-day workshops - to examine results, share successes and review the opportunities to improve. 

Bruce McLennan, Director, MSS Strategic Supplier Management Cell summarized the effort. “The seeds of the relational journey that IACCM helped to sow remain fertile and healthy, and there are many within Team ANZAC who continue to work hard to ensure that the lessons are not forgotten.”

Achieving good outcomes from contracts is increasingly on the executive agenda. The costs of poor contracting - both financial and reputational - are becoming far too evident.

Development of IACCM's model for relational contracting has been one of its key initiatives.  News of the exceptional success achieved by the DMO - one of the early adopters - is welcome endorsement of its effectiveness.

HMAS ANZAC arriving at Oxley Wharf, Fleet Base West, Garden Island, Western Australia, 3 July 2014

Team ANZAC (from left to right) Able Seaman Elyssia Shearman, Mr Chris Stoll (Commonwealth Representative), Commander Cass Ryan (ASMD Program Manager), Chief Petty Officer Nick Ryan (Ship Agent), and Petty Officer Shane Bannister (Assistant Commonwealth Representative)

 

END NOTES

1 Collaborative Contracting articles on the IACCM website:

 
 

Contract management: could the Bitcoin - with its shady past - show up on your desk?

 
That digital, virtual currency (or commodity) not issued by any government, bank or central organization - commonly known as a Bitcoin - is best known for illegal use. Yet, it's more popular than ever! Is it here to stay? If it appears in your contracting world, what must you know now?
 
 

Author Ashish Chandra put the stethoscope on the Bitcoin and its effect on the global community – and found it alive and finding its feet!  He discovered some interesting implications commercial and contract managers need to know about if and when it becomes a contracting issue.

IMPLICATIONS FOR CONTRACTING

The Bitcoin payment option would pose several head scratchers for contract professionals.  You will need to consider several things, including…

  • Ensure it is actually legal in your jurisdiction
    This is the first question parties must consider before including Bitcoin in the contract.
  • It's legal today – but may not be tomorrow!
    Most countries that have not specifically banned Bitcoins have taken a “wait and watch” approach. A real risk could be that even if it's valid the day you make your Bitcoin exchange or sign your contract agreement, it may not be the day payment is due. So you would need to ensure suitable provisions are included in the contract to ensure future payment obligations of the parties are protected should Bitcoin subsequently be declared illegal.
  • Could a Bitcoin contract end up being taxed twice?
    Because Bitcoins have not been declared “fiat currency” in any country  - and in some they're considered either as “property” or a “payment service” - any commercial contract providing for payment of consideration through Bitcoins could be subject to dual taxation ie the subject matter of the contract could also be liable to taxation:
    • direct tax on the income arising pursuant to the contract and indirect tax (eg VAT/GST etc) on the goods/services sold under the contract) and
    • taxation on the exchange of Bitcoin either as property or as a payment service.
  • Beware of falling foul of money laundering laws
    In jurisdictions where Bitcoins are not specifically banned, you would need to take extra care to comply with “Know Your Customer” (KYC), anti-money laundering and anti-terrorist finance laws. This would become even more important where the contract is being signed by a “paper” company in a tax or other legal-friendly jurisdiction. Necessary due-diligence, information requirements, representations, indemnities and corporate guarantees should also be considered carefully in these cases.
  • Take foreign exchange laws seriously
    In jurisdictions where payments for international trades are controlled through foreign exchange laws (e.g. the Foreign Exchange Management Act 1999 in India), you would need to comply with such laws when agreeing to provide for Bitcoins as a mode of payment of consideration under a contract.
  • Can we protect against highly volatile exchange rates?
    “Hedging” the conversion rate risks may be the best way, depending on the period of holding of Bitcoins. A new form of hedging or derivative contract would be required for each jurisdiction depending upon how that country treats the Bitcoin (i.e. as currency, security, property or as a service). As per the recent news, Tera Group Inc., a New Jersey based company, has created a framework for buying and selling swaps linked to Bitcoins that would let investors hedge risk from trading in digital currency.

Bitcoin - more viable than volatile

The real culprit is misuse, not the currency itself.  True, Bitcoins have generated unprecedented volatility in exchange rates; precipitated the collapse of big Bitcoin exchanges; caused a few promoters to get arrested for several illegal Bitcoin exchanges and spawned other harmful developments. Notwithstanding, the Bitcoin is proving to be a viable substitute for the fiat currency exchanged for trading goods and services in the virtual world.

Few developed countries have fully legitimized Bitcoins. Nevertheless, as Bitcoins gain user acceptability and exchange rates stabilize, they will increasingly gain recognition from governments worldwide, and slowly become an option for payments under commercial contracts.

BITCOIN BASICS - keeping it simple

  • Bitcoin is a digital currency in which transactions can be performed without the need for a central bank.
  • Bitcoins have no physical existence beyond an on-line public “ledger', known as the “Blockchain,” where all transactions are recorded.
  • When you buy a Bitcoin, it is allocated to your digital “wallet.”
  • The Blockchain (online ledger) registers all Bitcoin transactions, including their initial creation such as, which digital user first bought them, who since bought and sold them and who now has them in their digital wallet3 (Bitcoin account). It therefore serves as a public record of the chain of custody of all Bitcoins.

For the technically minded, Bitcoins are based on an open source, math-based protocol existing on an online, peer-to-peer computer network that hosts the Blockchain (Public transaction ledger).2

You may access your Bitcoin digital wallet and use it to receive or send Bitcoins through a digital address together with a public key and private key that are part of the Bitcoin Network's cryptographic security mechanism.

How can you get Bitcoins?

Mining

Using a “goldrush” metaphor, one way of getting Bitcoin in your digital wallet is by “mining” them through cracking algorithms. It's like a reward to the miner for having solved the math-based algorithm, a game of skill, not chance.

The number of Bitcoins in existence will never exceed 21 million.  This controlled supply of 21 million Bitcoins multiplied by its smallest unit can create 21 trillion Bitcoin units…

Trading

You can receive Bitcoin in your digital wallet through peer-to-peer transfer or when a seller of goods or services (virtual or actual) receives Bitcoins from the buyer as sale consideration.

Currency exchange

You can buy Bitcoin through exchange of a fiat currency. The currency denominations are “BTC” or “XBT”.  Currently 1 BTC = ~640 US$. In late 2013, the virtual currency traded for over $1,100 per Bitcoin before dropping precipitously. Bitcoins are easily divisible as the smallest unit of the currency is one-hundred-millionth of a Bitcoin.

Bitcoin growth

The Blockchain reflects usage of Bitcoins within past years to the present. Please click on the links below to view line graphs showing how the Bitcoin has been progressing: 

Bitcoins can benefit the economy

  • Bitcoins can never be counterfeited.
  • Bitcoin Exchanges record all transaction data about all trades of each Bitcoin and this data is publicly available. The creator, transferor or transferee of Bitcoin may remain anonymous but all exchanges of Bitcoins are public information.
  • Bitcoin can be used by people who have access to internet but are not bankable i.e. don't have bank account or credit cards.
  • Bitcoin payment processing is far cheaper than the processing or transaction fees presently charged by the existing payment gateways (or sometimes NIL). This could potentially reduce the price of goods and services which can be traded online.
  • Being a global virtual currency, Bitcoins are immune to exchange rate fluctuation of a typical fiat currency which depends upon the economic status of its sponsored country.
  • Payment for cross border trade can be more hassle free and cheaper, which is a great incentive for global ecommerce … and one can use Bitcoin to buy on eBay / Amazon on Cyber Monday!!

Regulatory issues

Lately, various governments have been attempting to regulate Bitcoins either by…

  1. declaring them specifically as property or service and accordingly issued appropriate tax advisories on taxability for mining and trading in Bitcoins (for example: Australia, US, Canada, Singapore, Brazil, Germany); or
  2. keeping a hands-off approach i.e. neither deliberately banning it nor specifically regulating it but keeping them under watch or observation with risk advisory to its citizens (for example: Hong Kong, India, Taiwan); or
  3. banning the same (for example: China).

Items a. and c. are objective and clear however b. is ambiguous and the Bitcoin industry appears to be skeptical about doing business in those countries, because they are not sure what category Bitcoin will fall into and what would be the tax impact (if at all Bitcoins are specifically made legal) or whether their business could be shut and they could face criminal trials.

Because Bitcoins are positioned as currency for the virtual world, Bitcoin enthusiasts and entrepreneurs could use this regulatory arbitrage in their favor and set up shops in regulatory and tax-friendly jurisdictions.

Regular currency and Bitcoin compared

The recent extreme volatility in the exchange rate of Bitcoins has given shivers to financial and securities regulators the world over. The real Bitcoin damage started when The Silk Route used Bitcoins to trade illegal drugs while hiding the identity of the payer and payee. Hacking into the private keys of Bitcoins (stealing Bitcoins from digital wallets) also occurred.

Some believe regular currency or other commodities are not better, supporting their view with examples like the following, all of which exist in the real world with real currency and other commodities:

  • The uncontrolled surge in oil, gold, property prices and sudden slump in 2008;
  • Billions of dollars exchanged by the underworld and used for terrorist financing;
  • Recent political agendas of various governments to bring unaccounted wealth back home from offshore havens; and
  • Bank account hacking, Nigerian frauds, credit card frauds and phishing scams.

What is the outlook for Bitcoin?

Fraud will always threaten innocent people. Bitcoin is money, and money has always been used both for legal and illegal purposes. The Bitcoin wasn't really developed to replace fiat currency. It is here to stay in the long run and governments need to frame uniform and flexible regulations to enable the Bitcoin to develop as a payment currency for the virtual world. They need to quickly adopt a balancing approach to cater to the payment system needs of this community.  Currency is not the problem: we are - unless we are watchful, aware and operate with integrity. 

Next steps – my further thoughts

  • We must immediately check the volatility, blatant abuse by money launderers and technical compatibility and interoperability for world-wide acceptance.
  • Apart from framing enabling regulations, the international standards-setting body for payment industry and internet should frame and adopt standards for worldwide uniform adaptability of Bitcoin and protocols for mining and running the exchanges.
  • We must find flexible and innovative means to comply with KYC/AML regulations. One way could be to link the IP address under the new IPv6 regime to an individual or organization against proper KYC and such IP address to be recorded at the Blockchain.

END NOTES

1.  Bitcoin - definition (See also Wiki definition of a block chain.)

2.  Blockchain home page

3.  Free Bitcoin wallet

Disclaimer: The views expressed in this article are my personal views and are neither subscribed to nor endorsed by author's present or previous employers. The author doesn't own or trade in any Bitcoin. Comments welcome at ashish1109@gmail.com.

ABOUT THE AUTHOR

Ashish Chandra is Vice President & Head Legal (Media & Technology) with Reliance Industries Limited (a Fortune 200 and India's largest private sector company). Ashish spends most of his time in advising Reliance for the launch of Reliance Jio 4G network and related services in the areas of entertainment, mobile payments, cloud computing and ecommerce. Prior to joining Reliance, Ashish worked with major US multinationals like News Corporation, eBay / Paypal and NCR Corporation. Ashish is a qualified company secretary, law graduate from University of Delhi and specialized diploma holder in Information Technology laws and IPR laws. Ashish is a regular industry speaker at various legal and industry conferences on Media, Broadcasting, Internet, Technology and Telecom.

 
 

Risk management - let's share the risk, not dump it!

 
Risk management by definition is ambiguous and unpredictable, but it doesn't have to be. Picture a highly collaborative approach. It shares the risk instead of pushing it to the other guy and designs unified goals to better manage and reduce risk.
 
 

Organizations too often embrace an “I-win-you-lose” approach to procurement, one that seeks to get the best possible deal today and then moves on to the next negotiation.  This shifts the risk from “your company” toward the “other guy” who often gets stuck with burden and costs associated with the risk.  

There is a new approach and it works.  By using it, corporations like McDonald's, Procter and Gamble (P&G) and Accenture are now seeing more cost savings, better risk management and happier suppliers.. 

Thinking differently is your first step

Shifting risk is literally burying your head in the sand. Just because you can't see the risk and believe it is not your company's responsibility anymore does not mean risk has gone away. In fact, it's actually worse to shift risk to a party that cannot mitigate the risk very efficiently.   Shifting risk to the other guy could backfire in two ways:

  1. If the other party lacks good processes for managing and mitigating the risk or
  2. If the CFO from the other party's firm forces the sales rep to bury a risk premium in the quoted price as “insurance” in case the risk actually happens.  

Attitudes are changing

Almost 50 years ago, researchers began questioning the traditional “risk avoidance” approach to contracting. Not until recently has this started changing 1/2/3.  In 2010, IACCM's research confirmed these findings.4

More recent research now tells us that traditional 'shifting-the-risk' attitudes are under the microscope. In his Harvard Business Review article Creating Shared Value5 Harvard Business School professor Michael Porter talks about an outdated approach to value creation that views value creation narrowly and optimizes short-term financial performance “in a bubble” while missing the most important customer needs and ignoring the broader influences that determine their longer-term success.

Companies are changing.  IACCM's latest findings published in the 2013/2014 Top Negotiated Terms survey6 reports that a growing number of executives want a more collaborative or partnering approach to their supply relationships.  

Holistic approach - sharing risk and reward

What if your company and its supplier assigned your top operational people to execute the agreement and invited the most qualified financial analyst to join the working team? Your new team would then be ready to…

  • identify and quantify the value of all the risks you will jointly face over the life of this contract;
  • figure out the best way to jointly manage these risks to lower the expected impact; and
  • set targets and - if you can mitigate these - risks, share the savings achieved.

Vested® for success – the “five rules”

The University of Tennessee's Vested sourcing business model creates a contractual framework that follows the “five rules" and 10 contractual elements to bring together shared value creation and risk. You can use each element to better mitigate risk. 

Rule 1: Use the outcome vs transaction-based business model

Traditional contracts reflect a transaction-based business model and are arm's length in nature (I'll give you a $1 for a widget or a unit or service).  Instead, the parties must adopt a “what's in it for we”7 mindset, building trust and transparency. Vested agreements shift to an outcome-based business model. The parties work together to map their intentions and objectives for the business at hand, and formulate their desired outcomes. This process, embodied in the 10 contractual elements, guides the parties to jointly understand the commercial and operational risks they are undertaking and how to deal with them. 

Element 1: Business model map

First, understand and document the business model. It is vital to map potential risks and outcomes. The parties will see how well they are aligned and will pinpoint the transactions of value and the risk factors. This element also fashions a culture in which the company and the service provider maximize profits by working together more efficiently, no matter who is doing the activity.

Element 2: Shared vision and statement of intent

The parties then work together on a joint vision that will guide them for the duration of the contract relationship. A cooperative and collaborative mindset opens a conversation: the result is the contracting parties share what is needed, admit to gaps in capability, and address risk concerns, thus allowing a focus on the benefits that the other party can bring to overcome any gaps in capability.

Rule 2: Focus on the what, not the how

Element 3: Statement of objectives/workload allocation

Depending on the scope of the partnership, the company transfers some or all of the activities needed to accomplish agreement goals to the service provider. This where who does what, including risk management, is discussed and determined under a Statement of Objectives focusing on results, not tasks.  

Rule 3: Clearly define and measure outcomes

Element 4: Top-level desired outcomes

This is a centerpiece of the contracting exercise, because without having mutually-defined outcomes in place, the parties will not accurately envision the results they expect and risks they face.

It is imperative to define exactly how you will measure relationship success and monitor risks. And most importantly, end-to-end measures must be defined – not just Service Level Agreements (SLAs).  Having an end-to-end view enables the parties to view the overall impact on the business, not just the impact on a service provider.  This provides a more holistic view of business performance than SLAs can provide.

Element 5: Performance management

At this point the parties must consider how to measure performance to determine if they achieved their targets - including how the parties will institutionalize processes for managing the agreement. Good performance management processes should not just provide a rear view look of performance – but also provide an anticipatory view by reviewing early warning signs of potential issues. 

Rule 4: Optimize the pricing model with incentives

Element 6: Pricing model and incentives

Focusing only on the “lowest price” is a huge inherent risk and would undercut the work the parties have done to establish a collaborative, shared-value mindset.

A Vested approach creates a transparent pricing model with incentives that optimize business outcomes. Service providers are rewarded with incentives when they make investments that reduce – or eliminate - risks. When an uncontrollable risk does happen that causes a financial burden, the pricing model would monitor the profit impact on both parties and use a use a pre-determined margin matching trigger. For example, a rise in inflation rates above a certain target might be a trigger point for resetting inventory carrying cost charges.

Rule 5: Initiate an insight versus oversight governance structure

Element 7: Relationship management

A good relationship management structure creates joint policies that emphasize the importance of building collaborative working relationships, attitudes and behaviors. The parties monitor the agreement within the framework of a flexible governance structure that provides top-to-bottom insights into what is happening, including risks. A “two in a box”, peer-to-peer system creates an environment for more collaborative behaviors.

Element 8: Transformation management

Any improvements or changes – including those that involve managing risk – mean change for employees. Element 8 sets out the protocols for the way the companies will work together to manage major change (transformation efforts), small incremental improvements (continuous improvement), and how to handle contractual and commercial management change due to the dynamic nature of business.

Element 9: Exit management

Sometimes the best plan simply does not work out or is trumped by unexpected events. Business happens, and companies should have a plan for when assumptions change, or events alter outcomes. An exit management plan in your contract should provide a template to handle future unknowns.   

Element 10: Special concerns and external requirements

Governance frameworks handle the unique regulations and specific regulatory or legal risks that parties face in technical or complex strategic relationships.

In the governance framework, you need to consider including additional provisions that address specific market, local, regional and national requirements.  If you ignore or sublimate these factors you put all parties in peril.  For instance, in supplier and supply chain relationships involving information technology and intellectual property, security concerns may require special governance provisions outside the normal manufacturer-supplier relationship. Supply chain finance and transportation management are other areas that often require special handling under the governance framework.

Does a Vested approach really work?

Yes it does. The University of Tennessee research team shared success stories in the book Vested: How P&G, McDonald's and Microsoft are Redefining Winning in Business Relationships.

A flexible, sustainable governance framework is key to the success of McDonald's and its extensive supplier network. The company's famed “System First” philosophy relies on a flexible and highly collaborative approach for working with their suppliers in a proactive approach to manage the business at the operational and executive level.

The supply chain model is based on a set of operating principles that create long-term wealth and competitive advantage for the entire network by mitigating costs, preventing safety issues and producing quality and innovative products. The key is innovation—no matter where it comes from; reducing costs, improving service, creating new products for the menu and yes – reducing and eliminating risk.

For McDonald's and their suppliers - food safety is a key mutually defined desired outcome. “We have twelve non-negotiables of safety, performance standards and animal welfare. It's much easier to maintain our demanding standards when we know and trust our business partners intimately,” said Jerome Lyman, vice president of McDonald's global supply chain. “The supplier has skin in the game and we all share common goals.”

The result of this attention to managing food safety? A 2009 article in USA Today noted that McDonald's beef is “safer than a school kid's lunch.” 7  The article said that McDonald's tests its beef up to ten more than companies selling beef to school programs.

When Microsoft and Accenture formed their ground-breaking “OneFinance” outsourcing alliance on global finance and processes and operations, risk mitigation to comply with the Sarbanes-Oxley Act across global boundaries was a front and center concern. Microsoft found that its global finance and accounting programs included 95 countries ranging from more advanced countries like the UK, Germany, Japan and Australia to rapidly growing markets like the BRIC countries to smaller and less mature countries in Asia and Africa. Prior to outsourcing only 15 countries came within the scope of SOX. With outsourcing and the resulting centralization, all 95 came within scope.

In addition, the outsourcing effort increased the probability of failure because unintended process variability made oversight more difficult. The problem was resolved by embedding boundary-spanning controls in the OneFinance environment. Embedding proper compliance and controls into supplier governance processes, as with OneFinance, reduce risk and ensure internal controls and compliance are integral to the overall outsourcing program, and the focus will not become diluted over the contract's life term.   

“We needed to develop an approach that would reward our business partner for achieving results that created value for our business—not just cost reductions,” said Srini Krishna, Microsoft's director, finance operations – global supplier management, Microsoft Inc. The OneFinance team realized—and avoided—the “unknowns and variability that would increase risks and lead to a 'supernormal' risk premium over and above the 'normal' business risks,” Krishna said.

The Vested business model and governance framework provides a pathway to implement a trusting, collaborative contract relationship that shares risks and rewards – enabling outsourcing parties to align their interest and focus on mitigating risk versus simply shifting risk. 

 

END NOTES

  1. Ian R Macneil, Contracts: Instruments for Social Cooperation (Hackensack, NJ; F.B. Rothman, 1968. Macneil died in February 2010 after devoting his life to advocating that contract law needed to be approached from a collaborative rather than an adversarial approach.
  2. Kate Vitasek was the John Henry Wigmore Professor Emeritus of Law at Northwestern University School of Law. 
  3. Ibid.
  4. See 2013/2014 Top Terms, International Association for Contract & Commercial Management, (May 23, 2014).
  5. Michael E Porter and Mark R Kramer, Creating Shared Value, Harvard Business Review, January 2011.
  6. See Special Edition Top Terms, published by IACCM 2010 http://www.iaccm.com/userfiles/file/CE_April2.pdf
  7. Kate Vitasek, Jeanette Nyden and David Frydlinger, Getting to We: Negotiating Agreements for Highly Collaborative Relationships (New York: Palgrave Macmillan: 2013).
  8. Peter Eisler, Blake Morrison and Anthony DeBarros, Fast-Food Standards for Meat Top Those for School Lunches, USA Today, December 9, 2009.

 

ABOUT THE AUTHOR

Lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce, author, educator and business consultant Kate Vitasek is an international authority for her award-winning research and Vested® business model for highly-collaborative relationships, Her practical and research-based advice for driving transformation and innovation through highly-collaborative and strategic partnerships launched a book series that includes:

  • Vested Outsourcing: Five Rules That Will Transform Outsourcing,
  • Vested: How P&G, McDonald's and Microsoft Are Redefining Winning in Business Relationships and
  • Getting to We: Negotiating Agreements for Highly Collaborative Relationships

Vitasek has been featured on Bloomberg radio multiple times, NPR, and on Fox Business News. She also has been featured in over 300 articles in publications like Forbes, Chief Executive Magazine, CIO Magazine, The Wall Street Journal, Journal of Commerce, World Trade Magazine and Outsource Magazine.

 
 

Time to upgrade your manufacturing outsourcing practices

 
The 2009 recession forced manufacturers to increasingly turn to outsourcing to solve their cost challenges - but this has greatly reduced control over their supply chains and influence over their cost structures. We propose a method for correcting this challenge, one that works.
 
 

The method is designed to help organizations assess the maturity of their processes throughout the contracting lifecycle and figure out how to interact better with suppliers – particularly third party manufacturers. We have titled it, The Contract Manufacturing Stages of Excellence Model.  But first, let's quickly review major challenges.

Outsourcing needs better management control 

Increasing product and process complexity continues to drive up overheads and fixed costs.  So, organizations across all industries are looking again at which competencies are critical to their competiveness. They then use contract manufacturing to outsource non-critical operations - and with them the associated complexity and cost. 

But this increased outsourcing has increased challenges in managing third party manufacturers. For example, at Original Equipment Manufacturers (OEMs) in the Germany automotive industry, vertical integration (where the entire supply chain of a company is owned by that company) has fallen to about 20%, according to VDA, Verband der Automobilindustrie (Association of the German Automotive Industry).  .

As companies dismantle their internal manufacturing operations, they would be wise to maintain control.   The best way to stay in charge very much depends on what, why and how manufacturing operations are outsourced.

Using third parties calls for a stronger supply chain process

People tend to think of contract manufacturing as the straightforward outsourcing of the manufacturing of products that an organization sells under its brand name.  For example, iPads, athletic shoes and private label products in grocery stores are among the best known examples of the involvement of external parties. 

But third-party manufacturing is used in a variety of industries, often even for discrete manufacturing steps such as producing custom raw materials, performing intermediate processing steps or converting semi-finished goods into finished products. 

Typically, the use of third parties is driven by a strategy to lower total delivered cost or by a lack of capital to invest internally.   Increasingly, organizations also use contract manufacturing strategy to reduce risk of product launches or new market entry, increase speed to market, increase supply flexibility, and even for product, process or packaging innovations. 

But regardless of the choice, outsourcing forces organizations to depend on contract manufacturers to deliver strong supply chain performance and satisfy their customers. To achieve these objectives management of every aspect of the contract manufacturing process must be decisive and well planned.

PROPOSED SOLUTION

Contract Manufacturing Stages of Excellence

To help companies figure out how to get better at interacting with and managing their contract manufacturing suppliers, A. T. Kearney has developed a Contract Manufacturing Stages of Excellence model to assess the maturity of practices throughout the entire contract manufacturing lifecycle (see Figure 1).

Seven dimensions of the model's framework (described below) test how the practices of organizations compare with best practices across industries that cover all aspects of contract manufacturing.  Each dimension contains multiple elements that illustrate practices applicable to that dimension. 

Each element describes practices, based on cross-industry input, that fall into four stages, in increasing order of excellence: nascent (just beginning); emerging; robust; and advanced. The chevrons in the top half of Figure 1 show the seven dimensions. The bottom half of the Figure shows the four stages of excellence.


Figure 1: A.T. Kearney's Contract Manufacturing Stages of Excellence model

The aim is for companies to understand where exactly their current contract manufacturing practices are lacking relative to their industry (or cross-industry) benchmarks and therefore be able to develop targeted improvement plans.

The model's dimensions are as follows:

  1. Strategic direction setting tests to what extent outsourcing of manufacturing is an integral part of a company's business strategy and whether both the internal and external asset base is well understood.
  2. Buy vs make tests to what extent the buy-vs-make decision uses a comprehensive set of criteria and a balanced segmentation framework, and considers all internal and external costs, as well as potential synergies with other operations at both the company that outsources as well as the contract manufacturer.
  3. Supplier selection tests whether a comprehensive, consistent and structured process is in place to identify and select the supplier that best fits a holistic set of selection criteria.
  4. Contracting tests whether balanced contracts, with the appropriate performance, intellectual property and core value related elements, are in place for the majority of contract manufacturing relationships.
  5. Transition and integration tests whether a process and cross-functional team is in place to manage start-up, trials & testing and integration, including IT/IS integration if needed.
  6. Supplier Relationship Management tests to what extent processes, key performance indicators, audits, teams etc. are in place across the lifecycle to manage the relationship with the contract manufacturer for maximum, joint value creation.
  7. Organization tests to what extent the organizational model, processes, roles, responsibilities and operating model are aligned, what level of governance is in place and whether appropriate training is available for people in the organization

Please note that the Stages of Excellence model is meant to highlight performance gaps versus leading practice, but it does not advocate reaching the highest level of maturity in ALL dimensions.

You should always base your decision to close performance gaps on the strategy and the overall business objectives you are pursuing. For example, a strategy built on innovating ahead of the competition and being first to market will likely give a lower priority to practices that primarily are helpful in achieving cost reduction objectives.

Stages of Excellence Survey Results

In late 2013, we conducted a survey to test and better understand the maturity of outsourcing practices in six industry groups:

  • Chemicals/oil & gas
  • Electronics
  • Food and beverage
  • Food ingredients
  • Pharmaceuticals/biotechnology 
  • Textiles/garments. 

Representative samples of respondents (Figure 2) from both large and small companies active in these industries completed the survey by selecting the descriptions of practices for each element that most closely resembled their current practices.

We also asked respondents to provide additional qualitative and quantitative insights into their practices. We analyzed their responses to determine the average performance within an industry on each dimension as well as the “leading” performance, defined as the average of the top quartile of performers within the industry.


Figure 2: Contract Manufacturing Stages of Excellence survey demographics

The survey results shown in Figure 3 revealed that across the respondent pool, companies exhibit “robust” performance on average in every dimension.

Figure 3: Survey results across all industries

Most companies seem to get the basics right with more than three out of four reporting “robust” or ”advanced” practices for protecting their intellectual property rights and managing quality.

Companies also seem to recognize the importance of contract manufacturers in overall supply chain performance and are shaping their organizations accordingly.  For instance, 53% of respondents had the organization managing contract manufacturers reside within the supply chain or manufacturing functions, a significantly higher proportion than in past surveys where the function was a part of the procurement organization and contract manufacturing was primarily seen as just another “buy” item.

Despite the relatively good performance on average, the top quartile of performers, labeled the “leaders,” showed significantly better performance, with approximately one stage higher performance on every dimension. The performance of leaders in different industries show interesting differences (see Figure 4), which can be understood based on the industry's history of outsourcing, its outsourcing drivers and prevailing business models.

Figure 4: Leading performance by industry

For example, companies in the electronics industry rely heavily on contract manufacturers for making individual components as well as assembling entire products. As a result, electronics leaders have developed strong practices in every single dimension, and exhibit the most consistently strong performance among leaders of different industries.

The textiles/garments industry, on the other hand, primarily appears to be seeking labor cost arbitrage in its contract manufacturing strategy, moving from one country to another in search of the next low cost location. Accordingly, leaders in this industry have strong outsourcing strategy and supplier selection practices, but do not invest as heavily in managing supplier relationships over the long term. 

The food ingredients leaders exhibit the poorest performance across all dimensions relative to other industry leaders.  It appears that this industry has not quite embraced outsourcing as much as other industries.   Food ingredients companies typically either operate on the small volume-high margin side of the spectrum, where there's little strategic rationale for outsourcing, or they produce huge volumes on the lower margin side of the scale that require such high capital investment that no third party could be convinced to make.  The processes that are occasionally outsourced are typically lower value operations like blending or pure commodity products, neither of which warrants much management attention.

Opportunities for improvement

  • In general, survey respondents self-reported better performance in the upfront contract lifecycle dimensions of developing outsourcing strategy, making buy-vs-make decisions and selecting suppliers.
  • They reported lower levels of maturity in practices on managing supplier relationships, integrating suppliers into their supply chain networks and designing the right organization to manage contract manufacturers.
  • In particular, many survey respondents reported that they do not segment their supplier base effectively, and do not manage supplier relationships in a tailored fashion based on specific outsourcing goals. Supplier segmentation and importance of supplier relationships is often decided based on proxies like size of spend or prompted by recent history of performance issues. Also, the organization managing contract manufacturers is largely designed based on geographical considerations or along legacy organizational lines with personnel typically managing a mix of strategic and non-strategic suppliers in a defined geography.
  • Finally, survey respondents cited challenges in integrating manufacturers into their supply chains with nearly 50% describing their practice in the “emerging” stage.

One-size-fits-all approaches to manage the entire contract manufacturing base are not very successful, especially for global organizations with operations in both developed and emerging markets and with, likely, a history of mergers, acquisitions and divestitures.  Companies with that profile may have a wide variety of contract manufacturing relationships.

Reasons for outsourcing can vary even for the same products in different geographies.  For example, in the developed markets, outsourcing may be driven by cost efficiency goals, while in new markets the outsourcing activity may be motivated by speed-to-market considerations.  As such, different approaches to how the relationship with a contract manufacturer is managed are required.

Successful supplier relationship management hinges on understanding the value each supplier brings to the relationship and the role they play in helping attain the company's strategic goals.  Companies that understand this measure supplier performance not just on the basic deliverables of cost, quality and service, but on tailored metrics designed to evaluate progress towards the specific goals for outsourcing the particular activity.

Suppliers are also segmented into different categories based on their value and each category is managed differently according to its needs. For example, managing highly strategic suppliers may require peer-to-peer relationships at multiple levels in the organization. On the other hand, suppliers with strong planning and quality processes, significant experience in making the required products and a long relationship history with the company may need only a light touch.

Successful companies understand these nuances and manage the contract manufacturers accordingly. These companies also make sure to align contract manufacturers' incentives with the company's goals through well-structured contracts and shared risk-reward incentive structures. They also help manufacturers succeed by providing greater transparency into production forecasts, not overprescribing the requirements and collaborating on performance improvement initiatives.

Supplier segmentation also helps in designing the organization that is responsible for managing contract manufacturers. Requirements for managing different supplier segments provide input into the necessary skills and expertise, laying the groundwork for developing successful staffing models. Designing the organization structure from a requirements perspective helps align the organization with the operating model for managing the contract manufacturing base and enables efficient use of resources.

Room for improvement but moving forward!

Both the survey and our own observations reveal that companies are doing a reasonable job overall in using contract manufacturers to achieve desired business objectives.  However, leading practitioners in most industries exhibit advanced practices on several dimensions. While closing individual performance gaps depends on companies' business strategies, the survey specifically highlights broad opportunity for improving on-going management of supplier relationships and designing effective and efficient organizations to manage contract manufacturers. 

The next frontier is getting the most out of contract manufacturers as well as companies' own resources that manage those third parties, in a way that best aligns with the strategic role that contract manufacturing is expected to play in the business.


ABOUT THE AUTHORS

Patrick Van den Bossche is the Americas Lead Partner of A.T. Kearney's,  Strategic Operations Practice. Patrick has 20+ years of business and consulting experience helping executive teams of companies of all sizes, think and work through challenges and opportunities in the operations area. Patrick has especially deep expertise in global supply chain strategy, contract manufacturing, complexity management, manufacturing and distribution.  A sample of industries served includes specialty chemicals, consumer goods, paper & pulp, pharmaceutical, health care etc.

Before joining A. T. Kearney, Patrick was a senior logistics consultant at Plant Location International, a division of PwC, responsible for coordinating and implementing pan-European supply chain integration projects.

He earned his university degree in electro-mechanical engineering at the University of Ghent (Belgium).  Patrick is based in A. T. Kearney's Washington DC office.

Rajeev Prabhakar is a Manager in the Energy and Process Industries practice at A.T. Kearney. He has more than nine years of experience in industry and consulting, helping chemical and energy companies with challenges in contract manufacturing, procurement, and operations and in developing their business strategy.   Rajeev has a PhD in chemical engineering from the University of Texas at Austin and an MBA from the Wharton school at the University of Pennsylvania.  Rajeev is based in A. T. Kearney's New York office.

 
 
IACCM Insider

IACCM's annual forum - a success in Copenhagen!

 
Over 200 conferees with 54 guest speakers attended the IACCM Europe Forum, June 16-19 2014 in Copenhagen. Many return every year to our forums, because they are inspired by discussions with colleagues and fellow professionals - and they're able to turn forum insights into results at their jobs.
 
 

As Ioana Canescu, EMEA Contract Management Practice Executive at IBM put it: “It was not just a conference; It was a meeting with colleagues and friends”.

Others commented:

“If my company give me permission to attend one  event per year,  it would be an IACCM conference, I always learn so much at each event.” – Gary Crag, ‎General Manager, Contracts at Nexen Energy

And:

“It was an excellent learning opportunity for me and my colleagues from RasGas to meet so many contracts professional and share the Knowledge, ideas, experiences, best practices.” - Ravi Saladi, BEng, MBA, CCME, Specialist (Contracts Engineering), Supply Department-CC&S, RasGas Company Limited

That's why you don't want to miss the Americas Forum on October 14-16 in Chicago.  And don't forget to apply for the third annual IACCM Innovation Awards. It's a global competition with presentation of the awards on October 15 during the forum.

The diagram below provides all the information you need to sign up for the forum and submit your entry for the Innovation Awards. You and your company could be our next winner!  But it won't happen unless you enter.

 
 

IACCM SRM Certification - why people love it

 
We asked several graduates of the IACCM Supplier Relationship Management (SRM) Certification Program what they thought of the program. Here's what they had to say.
 
 

“A perfect next step for me”

Chris Lagoe, Contract Consultant, Kelly Services, Inc., Troy, Michigan

“I was extremely enthusiastic that there was a certification program in supplier relationship management, as several of my years in the staffing industry were heavily focused on managing and maintaining a successful supply base.  I wanted to enhance my skills in SRM and be able to bring that expertise back to my company - and assist with accelerating the contract management process with our supply base. 

So this was a perfect next step in the IACCM certification process for me, after completing the contract management certification.

The modules were succinct and to the point, covered a lot of material in a short amount of time.  The case study at the end of the course gave an opportunity to tie in all of the materials used in a real-life example. IACCM delivered on this course.

My industry is staffing, outsourcing and consulting, so drawing parallels from other industries has been extremely useful.

The networking aspect was excellent. I really enjoyed being able to network and have small scale discussions with peers from other organizations. It was extremely useful for me to be able to interact with peers dealing with similar supplier management issues across multiple industries (for instance oil and gas) and bring back that knowledge and best practices to assist with our supply base management.

The ongoing discussion board postings and resources have been very helpful.”

“The professional SRM accreditation delivers”

James Doran, Director, Apple Procurement Ltd, Croydon, UK

“I chose this course because it was clear the profile of SRM was gaining momentum in terms of interest and job roles within the world of procurement and commercial professionals.

It was important to obtain a better understanding SRM, and crucially obtain an accreditation, to compliment other professional qualifications I already have. IACCM is still one of the few recognized SRM accreditations.

As a career interim, the IACCM SRM professional accreditation differentiates me from other candidates in the market and gives potential clients the added assurance that I can successfully deliver projects. My clients need the assurance that a project implementation, whether contract management or SRM, is not merely a bolt-on, but is developed with a full understanding and appreciation of other areas of the business.

The professional SRM accreditation delivers in fully aligning SRM with the rest of the organization. It has given me a structure to deliver projects and access to a huge library of supporting documents that can be used to develop business case evidence or training modules.

The remote learning also allows me, in my own time, to grow my knowledge as I continue my membership.”

“I give the course a grade of A+”

Monty Boyle, BP, Common Process Deployment Specialist, Houston, TX

“I always had a desire to enhance my capabilities and skills in Supplier Relationship Management (SRM).  When IACCM began offering the SRM course, I did not hesitate one moment to sign-up for it as a result of my career objectives and the excellent past experience I have had with IACCM courses. I give the course a grade of A+.  Thank you IACCM, I would highly recommend the course to anyone.”

To learn more about the IACCM Supplier Relationship Management program, please go to:
http://www.iaccm.com/training/online-learning-programs/programs/#srm

 
 

Procurement's profit motive: getting credit for boosting the bottom line

 
As a procurement organization you know how much you contribute to corporate profitability - but can you prove it? Author Richard Waugh tells why procurement organizations need to become true profit centers, reaching specific, measurable ROI targets if they want to avoid being outsourced to more efficient third parties.
 
 

At a time when savings expectations are increasing but savings opportunities are increasingly hard to find, procurement organizations must work harder to demonstrate their ability to contribute to corporate profitability by achieving world-class ROI from their procurement operations. 

Adopting the “profit center” mindset challenges procurement leadership to think like marketers, focusing on the products they deliver and how they market them to their customer base.  Products in this case are the contracts negotiated by procurement professionals who know how to reap total cost savings.

In the near term, procurement organizations will continue to be challenged to find new savings opportunities.  A June 2014 Hackett Group report How Leading Procurement Organizations Outperform Their Peers shows a marked decline in the ability of world-class performers to reduce spend and avoid purchase costs – down 17.3% in 2014, returning savings levels to only slightly above pre-recessionary benchmarks. 

Nevertheless, World-Class procurement organizations continue to far exceed their counterparts in delivering “Procurement ROI.”  Calculated by dividing spend savings by the cost of the procurement organization -  World Class performers generate nearly an 11x ROI (10.72%) compared to less than 4x (3.89%) for the overall Peer Group in the Hackett benchmarks. Procurement organizations that fail to demonstrate world-class Procurement ROI could be susceptible to a trend towards outsourcing.  For example, a survey by Capgemini Consulting of over 1,000 CPOs indicates that about 10% of organizations have chosen to outsource some form of their procurement operations and another 25% are considering that option.

Gearing up to demonstrate ROI – are you ready?

Procurement organizations will increasingly need better visibility for tracking and reporting savings to justify their organization's ROI contributions and fend off outsourcing inquiries from the C-Suite. 

Although most organizations currently lack the tools to get organizational acknowledgment and financial endorsement of their contribution to corporate profitability, many are recognizing the gap; and are prioritizing investment in tools that clarify the value they are contributing to their organizations. 

In fact, savings tracking, compliance and metrics monitoring tools ranked the third top investment priority in Hackett's 2014 Key Issues Study (trailing behind only sourcing and category management).  It increased significantly over 2013, with 75% of respondents ranking it as either a  “critical” or “high” priority. 

At Zycus, our own Pulse of Procurement 2014 study showed more companies (almost two-thirds) had invested in contract management tools than any procurement application other than spend analytics – with 11% more reporting contract compliance exceeding 60% of spend as compared to the last Pulse study from 2011.

Close collaboration with finance is key

A correlation exists between procurement's performance and the strength of their relationship with finance. For example, if procurement generates cost savings and finance doesn't sign-off, did the savings ever really happen in the first place?

According to the Aberdeen Group's CPO Agenda, CPOs from best-in-class performing procurement organizations rate their collaboration with finance as more consistent and frequent than with any other function - 4.35 on a scale of 1 to 5. All the others rated their interactions with finance at only 3.5. Moreover, 2/3 of these best-in-class organizations had the ability to trace procurement's contribution through to the financial statements (income statement, balance sheet and cash flow statement), while fewer than 50% of all others demonstrated the same capability.

Savings management - a practical approach

Savings management is a full life cycle process that starts with an initial pipeline of identified savings opportunities (savings forecasts), followed by negotiated savings, transitioning to implemented savings, and finally to actual and realized or “bottom-line” savings

While many procurement groups have focused on the first part of the savings management process – the negotiation and contracting phase - most struggle with the transition from the contracting process controlled by procurement, to the actual implementation process where responsibility for compliance with negotiated savings is transferred to individual budget owners.  It is during this critical transition phase that contract management becomes the critical enabler. 

Unless approved, negotiated corporate agreements are visible and accessible to business users at the moment of truth – when placing an order – negotiated “paper” savings will evaporate and never make it to the bottom line.

One of the critical success factors cited by many procurement teams that have been able to extend their influence over various spend categories across the business, is a policy that permits budget owners to “re-invest” procurement generated savings rather than having them removed from the budget by finance.  However, in the latter case, procurement influence may actually diminish due to perceived disincentive to collaborate with procurement-led savings initiatives.

Avoid the “two sets of books” trap

One of the greatest benefits of having a financial savings process, and effective procurement/finance collaboration, is a generally accepted and commonly agreed upon savings calculation methodology.  Whereas more dysfunctional organizations end up keeping essentially two sets of books – procurement's numbers and the actual, finance-reported numbers – top-performing organizations can get on the same page when calculating cost reductions. 

The most common metric is a year-over-year price variance, where the best practice is to normalize volume, currency, and market fluctuations to measure true procurement impact on purchase price as compared to the baseline as follows:

Year-Over-Year Price Variance:

  • Normalize volume (unless demand controlled by procurement) e.g. calculate savings based on historical volume
  • Exclude currency exchange impact
  • Adjust for market fluctuation (CPI or other indices)

Cost avoidance conundrum

What should the calculation methodology be where no historical baseline exists, for instance on a new purchase?  Or in the case of inflationary commodity market pressures where staving off a larger price increase is the most favorable outcome that can be expected?  In both cases, procurement organizations typically calculate a “cost avoidance” benefit, which is often the subject of intense debate with their counterparts in finance, who tend to view cost avoidance with a jaundiced eye due to the lack of verifiable budget impacts. 

Whether acknowledged by finance or not, most procurement groups continue to document cost avoidance as a measure of procurement contribution and activity, even if not widely accepted outside the function.  And there seems to be a strong argument for continuing the practice – according to IBM's 2013 CPO Survey, 91% of “top performing” organizations place a high importance on cost avoidance - just 54% for “emerging performers.”

Among the best practices for cost avoidance savings calculations are these scenarios:

Scenario #1:  Cost avoidance (new purchase – no historical basis)

  • RFP to set baseline
  • Final cost vs average or lowest of original offers or final cost vs budget.

Scenario #2:  Cost avoidance (proposed supplier price increase)

  • Supplier price increase vs commodity market price increase, e.g. plastics market up 8% - negotiated price increase 5% (net cost avoidance 3%).

Current state – savings tools lacking

One of the great ironies of the current situation is that while many procurement organizations have invested in state of the art tools to produce savings – spend analytics, e-sourcing, P2P and the like - most are still in the dark ages when it comes to tracking and reporting savings.  According to a Gartner and Rutgers University 2013 study, titled, Establish a Savings Management Process to Drive Procurement's Financial Performance, a hodgepodge of spreadsheets and/or legacy, in-house developed applications still predominate, with only 43% of respondents using a COTS (commercial, off the shelf) enterprise software platform for this purpose.

Future state – enterprise-level savings lifecycle management

Procurement teams seeking to achieve, and be acknowledged for, their ability to produce world-class profit improvement contributions, need to ensure that their procurement technology infrastructure includes not only the critical enablers to produce the savings, but an enterprise-class capability to report them.  Here then, a summary of the key requirements for the “to be” savings management platform and process for top performing procurement teams:

  1. Enterprise-wide, cross functional adoption – consider the case of a leading, global health and beauty aid company that not only rolled out the financial savings management  solution to 100+ procurement users across various commodities and divisions, but nearly as many finance and budget owners (70 users) as well.
  2. Lifecycle savings tracking – the ability to embed standard calculation formulae and track and report savings projects over multiple stages and reporting periods, including the critical ability to integrate and track actual spend data against negotiated corporate agreements to ensure actual, savings realization.
  3.  Approval workflow savings documentation – automated routing of savings projects for sign-off by cognizant budget owners, category managers, and financial controllers.
  4. Dashboard reporting and analytics – robust tracking and reporting, including ability to trace savings impacts through to company financial statements (income statement, balance sheet and cash flow statement).

About The Author

Richard Waugh, Vice President - Corporate Development, Zycus Inc. leads strategic initiatives in the areas of new product introduction, market development, thought leadership, analyst relations, and strategic partner development programs. Richard has an extensive background in B2B E-Commerce, going back to his early career at GE, where he helped launch GE'S Trading Process Network (TPN), the first on-line Marketplace for Sourcing and Procurement in the mid 1990's. He was Co-founder of B2eMarkets, one of the first SaaS (Software as a Service) Sourcing Suite providers and later covered the Supply Management market as an Industry Analyst for the Aberdeen Group.  Richard has a BA from Wake Forest University and is a graduate of GE's Financial Management Program (FMP) executive training.

About Zycus 

Zycus is committed to positioning procurement at the heart of business performance. With our spirit of innovation and a passion to help procurement create even greater business impact, we have evolved our portfolio to a complete Source-to-Pay suite of procurement performance solutions - Spend Analysis, eSourcing, Contract Management, Supplier Management, eProcurement, eInvoicing and Financial Savings Management. We are proud to have more than 200 solution deployments among Global 1000 clients across verticals like Manufacturing, Automotives, Banking and Finance, Oil and Gas, Food Processing, Electronics, Telecommunications, Chemicals, Health and Pharma, Education and more.

To learn more about the Zycus, address e-mail to information@zycus.comor visit http://www.zycus.com/

 
 

Contract audit - a 'health check' to keep your business up and running

 
Regularly auditing your contracting process not only guards against contractual risk, but also avoids potential penalties for your business. How do you know, for example, whether or not your contract is 'bleeding' value? Could a penalty notice or unforeseen 'sticky' situation be around the corner?
 
 

A compliance check can literally save the bottom line.  This article tells why the many benefits, practicalities and challenges of regularly performing this vital process can protect you from future litigation by ensuring governance is robust. Checking for gaps in existing contracts, undertakings or agreements will avoid potential fines or penalties - or even getting sued.

During this “health check” you will be taking the pulse of questions like these:

  • Does the contract have privacy or data security terms? These topics have constantly evolving laws for businesses that mean all areas of the businesses must stay vigilant.
  • Does the contract have outbound indemnities or IP rights?
    These topics have implications that can far outreach the one statement of work included in the contract.

VITAL SIGNS

Ethical practice – are you really compliant?

All organisations also need to regularly check compliance in the gamut of laws covering and safeguarding the interests of their employees, shareholders, consortium, banks and business. Ethical practice is a key area which often invites penalty and litigation if compliance is not regularly performed.

Contractual audit is a reliable way of ensuring regular compliance in all relevant laws and regulation, safeguarding the company's interest against any untoward incidences. It also takes care of other key areas such going public, amalgamation and merger, revenue recognition and memoranda of understanding (MOU).

Healthy habits – are you gaining?

The richness of an audit can flow these benefits into your business:

  • Keep abreast of relevant legislation, changes and updates and ensure compliance.
  • Ensure proper guidelines and processes are being followed for all functions at all levels within the company - creating value and emphasising great organisational culture.
  • Manage compliance and its applicability for client/vendor contracts, and also for internal processes such as people management, HR and corporate ethics.
  • Ensure corporate social responsibility.
  • Raise awareness of agreed contractual obligation among internal stakeholders, and the importance of risk mitigation and avoiding scope creep.
  • Ensure systematic contract governance.

BIGGEST CHALLENGES

The greater the need is for a proper audit, the greater the challenges you can face in getting started.  These include:

  • lack of information due to the confused state of contractual practice and processes;
  • confidentiality of information - in many cases senior members are reluctant to share information with auditors;
  • “manipulated” data provided to auditors to achieve a zero NCR (non-compliance report) - resulting in wrong audit findings;
  • lack of awareness of the contract and implications of non-compliance among stakeholders; and
  • absence of a governance process.

First steps – checklists and planning

You will need pre- and post-contract signature checklists to ensure all aspects of the contract process are covered. These become very useful tools in the hands of counsel/contract managers, who are juggling multiple tasks, and an easy way for managers to proactively audit their contracts once in a while.

The following are the types of topics a contract checklist should cover, and which contract owners can and should fill out.

  • Does the company want approvals prior to certain critical terms being given?
  • Does the counsel/contract manager need approvals to use certain fall-back positions?
  • Are the documents required as part of the contract process stored as required?
  • If there is a contract checklist requirement and is that process being regularly followed? (Note: processes should only be put in place if they are meant to be followed).

Look ahead - try to avoid reactive audits

Random audits by a formal group will ensure a proactive response if there are issues. They can also identify when processes are not working or need to be updated.

Ultimately, no business is perfect. Reactive audits do happen. If you face a disagreement issue, or a failure of duty or conflict in business direction, you would then need to review the contract. However, if legal counsel or contract managers have tools to follow the contracting process and if internal groups are randomly and proactively auditing to ensure compliance, a reactive audit should rarely be needed.

What the  process includes

  • client and vendor contracts (contractual, legal, operational, technical, performance and financial);
  • registration, licensing, local laws and statutory requirements;
  • application of various company processes and functions, and documentation in place;
  • Companies Act, compliance with labour laws, health insurance, attrition, tax and treasury;
  • disputes, mediation, alternative dispute resolution (ADR) and litigation;
  • customer loyalty index, business continuity plan and employee survey.

How to perform the audit

Start with a questionnaire and check list

Through exhaustive brainstorming, the auditor comes up with an audit checklist and questionnaire – an important first step as it also helps the audit process itself to evolve.  This can be prepared well in advance if the audit is regular or through discussion and understanding if done for a new client / contract / process / system / function. Both audit mechanisms can agree to have a complete and exhaustive check list, to figure out any gaps between agreed and actual in the process.

Identify your goals

In this initial phase the team should identify a clear GOAL, which will depend mainly on the scope of the audit. For example, if the audit is for a bleeding account which has been “floating negative” for the past year due to uneven contractual terms and process, the prime goal would be to bring the account back into even terms. This can be done using similar previous audits, operations drawn in, key interfaces and performance metrics. In most cases the goal of the team will be to keep the system healthy, identify and remedy any “bugs,” and advise on process improvements to boost business and revenues.

Stay interactive, one-to-one

Most contractual gaps are due to lack of process and communication. One-to-one interactions are therefore a key step in the audit to gain in-depth understanding to identify:

  • critical areas which may be the cause of penalty or future litigation;
  • any bottle necks which may be causing non-compliance; and/or
  • checklist items which may have been missed initially due to lack of information or subsequently reviewing them with the key stakeholders.

Company leaders can also provide key information with a significant impact on the audit findings.

Develop a compliance method

Once the checklist and interactions with key stakeholders are complete, the audit team can perform a gap analysis between the checklist and supporting backup documents. This will not only determine the percentage of compliance and health of the process or contract, but will also identify:

  • the cause if the account is bleeding;
  • key risks; and
  • any budding contractual liability which could result in future penalties.

Produce your audit report

The audit report is not limited to operational, technical and contractual issues but also covers various other impacting issues like regulation, process and people, etc. It covers the status of compliance, liability and any errors together with possible solutions. A detailed report catalogues any non-compliance based on the risk percentage, and any repercussions as some may involve scope change or litigation, and there may be few which could attract penalties and loss of client base.

Develop an implementation plan

Based on the audit findings, suggestions and timelines, management should put an implementation plan in place, signed off by key stakeholders. Critical non-compliance needs to be corrected on a primary basis, followed by medium and low. There needs to be a regular follow-up call on the audit findings and its compliance until the system is hundred percent (100%) compliant.

Get the benefits

Regular compliance audits are powerful.  They can…

  • protect your company against penalties, fines, litigation and provides a regular health check on the program/process;
  • raise awareness of the contract among stakeholders and shared responsibility in adhering to contractual requirements;
  • keep the system updated and consistent with industry standards and practices;
  • facilitate good contract and corporate governance;
  • establish and creates trust both internally among stakeholders and functions, and externally among clients and vendors; and
  • significantly improve efficiency of the process and function, and generates additional revenues through creative methods and process.

Feeling great? Your health is worth the effort!

Having an audit team as a standard part of the contract/legal portfolio not only provides regular health checks but also enables businesses to keep a tab on any gaps or lost revenues. Over time, incorporating the guidelines and implementation plans into routine practice improves the overall compliance percentile and reduces overall cost associated with litigation, fines, penalties etc.

ABOUT THE AUTHORS

Anupam Sharan, Director Contract Management for Sutherland Global Services Inc., is a senior attorney managing strategic legal, contractual and commercial programs globally. He has extensive legal and contractual experience in drafting, negotiation, IPR, corporate, commercial including International law, M&A, government affairs, risk, governance, change, compliance and privacy matters. He seeks to channelize business and operational insights to provide thought leadership within the industry and contribute to shape laws, regulations and public policies. He brings experience across multiple industries such as consulting, financial services, telecom, outsourcing, IT, ITES, steel, power and construction.  He is a regular speaker at various conferences, with many articles and white paper published to his name.  He has dual qualification of Bachelor in Mechanical Engineering (B.E.) and Bachelor in Legislative Law (LL.B.) with Masters in Business and IPR Law (LL.M) added with various certifications

Michele Totin  Michele Totin is a Contracts and Negotiations Manager for Intel Corporation.  Accountable for leading the negotiation process with suppliers above $5M of spends per year. Michele's responsibilities include developing the negotiation strategy and ensuring negotiations meet or exceeds Intel positions. Michele also co-chairs Intel's Contract Specialist team and enjoys mentoring and working with others as they develop their own negotiation styles. 

 
 

Potential technology approaches for contract lawyers

 
In many ways, law departments' delivery of contract management services is still like the Wild West - a lawless frontier. Within a single law department, approaches to managing contracts can differ wildly among practices or teams, if not among individual lawyers themselves.
 
 

This article originally appeared in the December 2013 issue of The Metropolitan Corporate Counsel.  It is reprinted by permission.

Some teams or lawyers are straight shooters: very disciplined, requiring structured submission of requests, using pre-approved templates, and capturing data and executed documents at the end of Legal's involvement in the lifecycle of the contract. Most lawyers, however, still take requests by email, look to their personal stash of past contracts with "good" language, and file the latest version of the contract they had (often, not the executed version) within their personal email folder.

Although both strategies may produce an excellent contract that achieves the client's objectives, there is a bigger picture to consider: the risk of variations in negotiated terms across similar contracts and the inefficiency of lawyers spending time inserting key provisions that are regularly missing when the client submits a contract. As a result, law departments of all shapes and sizes are considering technology options to improve the delivery of contract services.

As a former head of technology consulting services to law departments and a professional now charged with instituting efficient contract management services, I am often asked to recommend contract management software.

Although the lifecycle of a contract can be characterized the same way among most law departments, unfortunately, the role that technology plays within that lifecycle for a law department is not one-size-fits-all. I've led clients through the exploration of a variety of approaches and will describe four general approaches to consider.

Repository Approach – This approach is what I have most often seen within law departments. A common mantra is, “Legal is not the owner of the contract.” Here the law department purposely avoids technology and processes that might imply that Legal is doing more than reviewing/drafting a contract and providing legal advice. As such, the law department simply wants a central location to store its templates, the versions of the contract on which the lawyers worked, and the final version of the contract (in the event there are questions or disputes). The best technology to support this approach is a legal document management system that enables storage and profiling of documents.

Piggy-Back Approach – Some teams of lawyers believe in the benefit of having more visibility into the metrics behind legal contract services. Knowing the types and volumes of contracts that clients are requesting, understanding the turnaround time for a contract request, or having insight into how often certain/different types of players are involved can inform how the department should staff and approach contract service delivery. 

To achieve this insight, the department must gather some detail about the contracts on which they work. A database can capture key data points or business terms that describe a contract (the type of contract, date of the request, parties in the contract and value of the contract). However, with Legal as a cost center, purchasing tracking software can be tricky.

Therefore, departments may look to “piggy-back,” leveraging software such as the department's matter management system. Some matter management systems are not ideal for tracking contract terms. A better fit might be systems with contract management functionality, such as those used by Procurement (purchase-to-pay systems) or Finance/Accounting (ERP systems). Undoubtedly, corporate IT groups will thank those who choose to piggy-back on existing technology!

Point Solutions – In some cases, lawyers may seek to improve very specific processes, and there are tools that offer functionality to address a single need. For example, teams of real estate attorneys in the retail sector may spend inordinate amounts of time abstracting large volumes of leases. Why not use an automated abstraction tool to assist with quick and easy documentation of lease business provisions? Another group of lawyers may spend significant time reviewing large volumes of low-risk contracts. Document assembly software provides client self-service templates, along with the security that clients are using company-approved templates without changing the terms. There are a wide variety of point solutions to support document drafting, document comparison, document review, electronic signatures, workflow/request management, automated reminders, OCR and obligation management.

Full Contract Lifecycle Approach – In recent years, the number of law departments seeking full contract lifecycle management solutions has grown, often driven by increasing risk management and compliance remits. Departments now recognize their responsibility may not end once a contract has been executed. Increasing regulation and ever-present litigation risk means that lawyers are more often revisiting contracts after execution.

Furthermore, in the spirit of improving client service, some departments are taking on greater responsibility in the management of terms and obligations. In these cases, full contract lifecycle systems are being considered. While there are well-known enterprise systems, there also have been a number of new entrants to the contract lifecycle management space that cater to law departments. Most of these systems offer software-as-a-service and work well with other law department systems.

It is important for the lawyers in a department to discuss each individual's current approach and decide where the group wants to take their practice in the future. Having identified the requirements, the team can select an approach, narrowing the list of candidate systems to support the future state of contract service delivery.

Rebecca Thorkildsen brings more than 18 years of experience in legal management and technology consulting experience to Pangea3's clients. Ms. Thorkildsen serves as a strategic advisor to legal, operations and procurement teams considering outsourcing as a means to achieve mission critical business objectives such as cost savings, efficiency improvements and legal resource optimization in delivery of legal services.

 

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An IACCM Ask the Expert (ATE) webinar, presented by best-selling author Lisa Earle McLeod, lifts the lid on Hidden reasons why traditional negotiation techniques destroy trust and erode value and reveals why those who “get it right” do so well.

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Originally broadcast live to members in March of 2013 with Tim Cummins, hosting, the webinar has since attracted the attention of about 25,000 visitors – and counting -- on the IACCM website.

As we hear from Lisa, “The key is to re-frame the way you think about negotiation, and to see it as the start of what is going to be an ongoing relationship. This is where so many organizations have found IACCM's support invaluable in helping them to understand why where you're coming from is so important, the benefits of being “creative” as opposed to “adversarial” - and how to make that change.”

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Contract manager role: martyr or hero?

 
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Reprinted by permission

Corporate “martyrs” work so selflessly for their organizations they too often compromise their personal lives, suffering silently when they could perform better with a few metrics and a conscious, proactive approach.

Corporate “heroes” bring heightened value to the table – while maintaining integrity and a sense of balance.

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2013/2014 Editorial Board

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