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

Contracting Excellence Magazine - Jul 2008

 
 

Risk Management: The Uncomfortable Truth - And A Better Way Forward

 
Following the release of our last edition of Contracting Excellence (which focused on risk), complaints from sell-side members about the 'unreasonableness' of Procurement have reached a new pitch. They perceive increased inflexibility and increasingly one-sided terms and conditions - neither characteristic resulting in improved risk management. Yet Procurement executives seem to believe they are performing increasingly well when it comes to the management of risk. What's the truth?
 
 

IACCM research, coupled with a variety of insights from the market, suggest that Procurement is indeed becoming more focused on overall business risks. For example, Justin Fogarty wrote this week in the Supply Excellence blog about a roundtable discussion chaired by Geraint John, editor of the respected magazine CPO Agenda. He highlighted three specific areas:

  • R-E-S-P-E-C-T (and the responsibility that accompanies it) - There was a great deal of talk about the challenges of rising commodity prices. Despite a broad range of industries and products, these CPOs are all feeling the squeeze on their bottom line from fuel costs, steel, copper, etc. But with that cost pressure has come an increased awareness of procurement from the C-suite and an increasing responsibility to produce results that help the bottom line. As a result, rather than rolling up under the CFO or another branch of the company, CPOs are getting a seat at the table in management discussions, where they’re viewed as a strategic business unit rather than paper pushing purchasers.
  • Risk Management - Procurement has taken a leading role in managing risks to their supply chain, in terms of unforeseen cost increases and supply chain continuity. But within leading companies, that responsibility for risk management is expanding into areas like ‘reputational’ risk and Corporate Social Responsibility efforts. Pretty logical changes when you consider that the best way to minimize risks of any kind - from PR to regulatory - is to nip them in the bud.
  • Globalization - I was a little surprised to hear the direction the discussion went around globalization. Obviously everyone there was involved at some level with LCCS (low-cost country sourcing). But their efforts abroad are seen by their companies as a foot in the door of emerging markets. As the middle class grows in an LCC, companies with operations there are well suited to tap into that market.

These comments reflect the point that the areas of focus for risk management are increasing and that of course means extra demands on the time of the more skilled Procurement professionals. Since they are not being given extra headcount, something has to give. And one area of that 'give' appears to be the management of contract terms and negotiations.

Whether driven by Legal or Procurement, there is emerging evidence that many companies are pushing highly risk averse standard terms onto their suppliers. They are also increasingly inclined not to negotiate. Often this is achieved through 'take it or leave it' electronic auctions (see recent IACCM message board discussion about this issue or listen to our Ask The Expert recording with researcher Andrew Moorhouse of Huthwaite International).

Ironically, as so much IACCM literature explains, this approach to risk management is self-defeating. By pushing onerous terms onto suppliers, the buyer has not achieved reduced risk - in fact they have frequently increased the probability of things going wrong. First, the provider may accept the terms, but may be ill-equipped to comply. Second, when suppliers accept risky terms, they introduce risk management techniques that protect their interests. These include contract management procedures that are focused on the ability to recover margins and allocate fault for any non-compliance to the buyer.

So the net effect is a culture of blame and confrontation. And of course, this demands extensive time from the Procurement and Legal groups (plus others) to manage the risks that come from non-compliance, claims and disputes. (And no, I do not actually see more fire-fighting as something that is consistent with a trend towards becoming a 'strategic business unit'.)

So the real pity in contract and relationship risk management today is that time and resources are being expended in needless battles and shoring up untenable positions. What I would have hoped to see emerging from our research and from discussions like the one highlighted above is an awareness of the need for more open and honest contract negotiations that focus on improved relationship governance. Top quality risk management occurs in environments where the parties share information and data and show commitment to risk prevention or mitigation, rather than a bruising battle from which neither side emerges the victor.

IACCM has a working group led by Michel Gahard, a senior counsel at Microsoft, that is exploring mutually agreed buy-side / sell-side term standards. The initiative, agreed by the IACCM Board of Directors earlier this year, involves both buy-side and sell-side representatives from top global corporations and they will endeavor to draft balanced terms and principles that could perhaps offer a reference point for negotiators or contract developers.

Until then, Procurement and Legal groups that truly want to be 'strategic' should step back and consider the impact of their risk averse terms and conditions, in terms of economic costs, relationship costs and contract outcomes.

 
 

 

The Challenges Of Transition

 
In the world of outsourcing and managed services, the term ‘transition’ has become associated with complexity. It is viewed as a distinct phase in the customer – provider relationship – and a phase where things often go wrong. Why has it earned that reputation and how might it be improved?
 
 
Transition occurs immediately after contract signature and before services go fully live. Depending on the nature of the service, it may involve tough and painful actions – for example, the reallocation or elimination of resources, transfer of work and introduction of new technologies and procedures. As with all major change programs, there will be resistance and potential for discord. But these issues could be overcome. Unfortunately, there are other factors – all avoidable – that make such transitions especially painful and prone to failure. This article, based on extensive IACCM research, will explore six of those factors and ways they can be avoided.
 
Leadership
The number one issue identified by customer teams is the lack of consistent and qualified leadership[1]. Executives frequently underestimate the impact and implications of outsourcing or managed services contracts. They fail to appreciate the politics, the emotions and the tough decisions that must be made. Their teams are frequently led by people without the right leadership qualities (they are managers, not leaders) or by executives who simply cannot allocate enough time and oversight. In the opinion of experienced teams, this is the number one weakness in both the pre-award and post-award phase. They need someone who understands and can influence strategy, who is able to create and maintain the vision and goals of the initiative and who has rapid access to senior executives when required. All too often, they get a senior functional manager who understands the existing operations and probably has a sense of the services required – but is emotionally attached to the old ways, the old people and old relationships.
 
Transfer of responsibility 
Weaknesses in the transition team are a frequent source of problems[2]. Research shows that neither side is good at maintaining continuity between the 'deal team' and the 'delivery team'. This is especially true of providers. Very often the transition / delivery personnel are introduced only in the very final stages of the deal set-up. 'Best practice' companies try to ensure that key personnel are involved for at least 6 weeks prior to contract signature. Without this, they are not familiar with the negotiations, they may disagree with some of the commitments made and have had no chance to influence outcomes. Depending on the quality of the records, they may find themselves effectively renegotiating large parts of the deal, or spending time on clarification of requirements, goals and commitments. 
 
Why does this happen? One key reason is that many customers are driving such a hard bargain on price that it is simply unaffordable for the vendor to commit resources before the deal is won. This is a classic example of the price versus value debate; and in this instance, both sides lose out.
 
 
Unclear or contradictory goals / requirements
Many customers are very confused about their goals. They specify that they want one thing (e.g. increased value, innovation), but negotiate another (e.g. cost reduction). Some 25% of customers recognize this weakness; nearly 50% of providers feel it to be the case[3]. Without consensus in the customer organization, it is obviously very hard for the provider to plan or resource effectively. Research shows that outsourcing typically does deliver cost benefits - but frequently disappoints customers longer-term because of failures in quality, added-value or innovation. Glance at the typical measurements or governance system put in place by the transition team and you will find many deals focus on the wrong things.
 
Negotiation focuses on wrong topics
Outsourcing and managed services are in many cases strategic relationships. Treating them as commodities means that the customer must accept far more responsibility for outcomes (yes, you do get what you pay for). Many negotiations are soured by confrontations over pricing and risk[4]. This can be especially true when third parties are involved and not given clear direction - or even worse, are directed to terrorize the provider. Good negotiations will have focused on clear requirements and a robust on-going governance system, rather than getting bogged down by debates over liquidated damages, liabilities and indemnities. Adversarial negotiations sour the relationship and frequently fail to create a relationship framework. This results in a revenge / recovery environment, where neither side trusts the other and each is unwilling to impart information or show flexibility. If you spend too much time planning for failure, guess what you get?
 
Insufficient focus on cultural compatibility
Given the weaknesses outlined above, it is perhaps no surprise that many relationships have not adequately considered the extent to which the organizations are compatible. Do they share similar values and culture? Do they have the necessary complementary skills? Do they have a record of investing in relationships (or do they prefer an environment of blame and dispute)? Too often, the transition teams are the ones to discover that there really is no good relationship fit - and they are then left trying to meld incompatible organizations. Often, the relationship should be rapidly unwound - before it becomes a lose-lose deal. But not many transition teams have the courage or authority to make that decision. Perhaps they should.
 
Too much ‘agree to agree’

Compounding the imprecision of requirements is the scenario of 'agree to agree'. Under pressure to get the deal closed, or because of the time spent on battling over prices and risk terms, many negotiation teams find themselves deferring major aspects of the contract and relationship to be resolved by the transition team. This causes major hold-ups - not least because transition teams may lack the skills and authority to resolve the issues. And of course, this team then runs out of time - so transition planning is compromised. Often such situations result in wide-scale adoption of the old customer process - which leaves both sides exposed to probable failure and disappointment.



[1] IACCM study of skills and organization for outsourcing, June 2007
[2] IACCM study of major outsource and managed service providers, April – August 2007
[3] IACCM / Argea Vendor Performance Monitoring Survey, September 2007
[4] IACCM annual study of the Most Frequently Negotiated Terms, February 2008
 
 

Global 'Communities Of Interest' - The Way Of The Future

 
It has been about 18 months since IACCM introduced its web-based 'communities of interest'. Today, we have more than 50 flourishing groups of practitioners and experts, many of them with more than 2,000 members drawn from organizations around the world. It provides IACCM members with a unique networking and information forum. But are they gaining from it?
 
 

When Jim needed to understand how other organizations were overcoming resistance to the adoption of e-auction software, he turned to IACCM. Via our Automation Community of Interest, he quickly identified eight large, international corporations that had faced similar problems. Within 48 hours, they were on a conference call discussing experiences and exchanging tips on how to succeed.

Ellen had a similar experience when she wanted to check her company's approach to payment terms. By sharing her recommended approach with more than 1,000 members of the Pricing / Financial Terms Community of Interest, she received a mass of advice and benchmark information. Two days later, she was able to attend an internal meeting armed with irrefutable facts, rather than simply personal opinions. Her recommendation was adopted (and her status with the CFO was considerably enhanced).

These two recent examples illustrate the power of our virtual world. This stands in contrast to the ways of traditional associations and professional groups that were formed on a geographic basis. This was largely because of communication issues; physical proximity was essential to allow the meetings at which networking and information exchange took place.

While such physical meetings remain helpful, the benefits are inevitably constrained by the breadth of expertise and experience that happens to be present on a particular day. In general, this approach to knowledge acquisition and management is not especially efficient or effective (even though it may offer social benefits). Many individuals exchange business cards and build a personal contact network, often over many years. Yet this too is constrained and takes continuous investment of effort to be maintained.

Our networked world has brought new opportunities to acquire and share information. They are fast, low cost and borderless. For IACCM, these have been developed through our on-line Communities of Interest. Members can search and identify practitioners and experts around the world. They can form their own on-line contact groups and enage in discussion forums, or ask questions via the IACCM advisory service.

Sound familiar? For some, this may sound similar to social networking sites, such as Facebook or its business equivalents like LinkedIn or Plaxo.

And of course it is. Except that the IACCM communities are rather more focused (areas like Intellectual Property, Outsourcing, Service Levels) and they are 'managed' by a team of experts. That means our members do not simply throw out questions and hope for an answer. Of course they may use the contact group they have personally developed. But often, like Ellen, they will come first to IACCM staff, who will check whether similar questions have recently been answered or researched, and then determine the fastest and most effective way to gain the answers needed.

"Communities of Interest - or what we call CoIs - are proving incredibly powerful," commented Katherine Kawamoto, IACCM's Vice President for Research and Advisory Services. "They allow on-demand research, instant networking and far more targeted information exchange. Members are constantly shocked - and delighted - by the speed and quality of the advice or information they receive."

The Communities have also been important to IACCM in managing its information outputs. No one today needs excess e-mail - yet at the same time, many professionals feel concerned about their ability to stay updated on key issues or trends. The CoIs have been invaluable in helping us know who needs what information. It means IACCM members are among the best innformed anywhere in industry.

Today, the CoIs are increasingly spawning working groups in areas like negotiation, contract standards, risk management and automation (see http://iaccm.com/communities.php). These self-managed, member-led groups offer opportunities to engage with practitioners and experts worldwide, providing insights and knowledge that in the past was almost unobtainable.

For both Jim and Ellen, their experience turned out to be enough to drive their companies to switch from individual memebrships to corporate memebrships. As Ellen's CFO commented: "I want more of this - and I want more of our contracts team having access to this type of information and service."

If you are not yet a member of the IACCM Communities of Interest, find out more about them at http://iaccm.com/communities.php?groups=1

 
 

Contracting As A Competitive Advantage

 
As a clear indicator of the increasing significance of contracting generally - and post-award contract management in particular - , the latest edition of The McKinsey Quarterly features an article that highlights "the importance of first-rate contracting management".
 
 

The article - Managing Capital Projects For Competitive Advantage - focuses on the world of complex contracts - an area that has always been at the heart of the work performed by many IACCM members. In recent months, we have seen not only better understanding that contracting (in)competence lies at the heart of many failed projects, but there has also been growing interest in the role of contracting in addressing supply shortages.

McKinsey summarize their research as follows:

  • Suppliers of energy and energy-intensive commodities are greatly increasing their investments in power stations, chemical plants, oil rigs, steel mills, and other capital projects.
  • By raising the cost of delay and missed opportunities, today’s supercharged environment has elevated the importance of first-rate contracting management.
  • Many asset owners, however, are struggling. Some fail to align the work of their project teams with their long-term capital strategies. Others choose inappropriate contracting models or underestimate the organizational resources they require.
  • Yet a few asset owners are benefiting from better project designs, lower costs, and fewer delays. By standardizing engineering activities, modifying boilerplate contracting models, and ensuring that project teams collaborate across functional boundaries, these leaders are creating a significant source of competitive advantage. An examination of their methods offers lessons for asset-intensive industries of all stripes.

IACCM has a range of services that assist in addressing these challenges - most importantly our Capability Maturity Model and benchmarking service. And we also have a variety of projects and research activities that are contributing to improved contracting competence. These include:

  • a study on 'best practice' post-award contract management methods;
  • an evaluation of negotiation practices and policies, including the terms and conditions necessary to build sustainable 'collaborative' relationships; and
  • a major project that defines a comprehensive commercial contracting process, to support the IACCM Service Delivery Model.

"There is no question that contracts and Legal groups are under real pressure to reevaluate their methods and their performance', observed Tim Cummins, CEO of IACCM. "We have seen a dramatic increase in the number of members seeking advice and assistance in evaluating their current approach to contracts, contract terms and relationship management. They want to know how to organize, how to develop better and more collaborative relationships, how to improve their handling of risk, how to speed up their processes - in the end, executive management senses this process and the way it is managed is impeding the business and failing to deliver optimized business results. In my opinion, they are right."

For more information about IACCM services, research or assistance, contact Katherine Kawamoto (kkawamoto@iaccm.com) or Jim Bergman (jbergman@iaccm.com)