Contracting Excellence Magazine - Jul 2008
Risk Management: The Uncomfortable Truth - And A Better Way Forward
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
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.
Global 'Communities Of Interest' - The Way Of The Future
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
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."