Contracting Excellence Magazine - Feb 2010
Contracts And The Roots Of Trade
Trading relationships lie at the heart of human progress. Whether we look at economic or social advancement, it is our readiness to trade that drives innovation, communication and organizational design. How significant are contracts - and the skills of contract and legal professionals - in supporting the trading relationships of today and the future?
Given this fundamental role, it is strange that so little attention has been paid to the factors that influence the success of trading relationships. While approaches to the production and distribution of goods and services has grown steadily more sophisticated, the question of how inter-organizational trading relationships should best be managed has not been a subject for extensive study. In particular, what role do contracts, procurement and commercial staff have in driving successful relationships and what difference does 'the contract' make in their outcome?
Today, there is growing awareness among executives that 'relationship management' is increasingly important. There is some understanding that growing business complexity demands new approaches and greater discipline to support highly inter-dependent trading networks. Not only must we become better at communicating requirements and expectations, but it is also essential that we become adept at overseeing performance and managing change.
In a generous commentary about IACCM, leading blogger Jason Busch (www.spendmatters.com) recently observed: "Tim Cummins, IACCM’s president ......, in a matter of minutes, will convince you that the contracting practice is one of the most important elements of human society. Or, after a G&T or two, he might even convince you to become an evangelist for IACCM's cause. But Tim -- and his colleagues -- support their philosophical musings with fascinating research and speakers that examine all sides of the contracting process, interjecting much needed legal and sales voices into the process as well. If you’re open-minded about sourcing strategies -- and are looking to expose yourself to new thinking about the best ways of structuring "trading relationships," as Tim likes to call them -- IACCM may be just your ticket to a mind-expanding couple of days." (Jason was referring specifically to our annual conferences).
Why do we see contracting in this way (and here I emphasize that I am talking about contracting as a process, rather than simply 'the contract' as an output of that process)?
Trade certainly pre-dated contracts and both pre-date the emergence of contract or procurement specialists. But as we know, the earliest contracts go back thousands of years because, as trade became more complex (and in particular, as it advanced from simple spot-trades with immediate exchange), it became essential to 'memorialize' the agreement. Over time, each society developed a set of rules that has generally become enshrined in law to govern principles of fairness and to establish recourse for failed commitments.
Each advance in human communications has driven greater complexity in trade. Today, the development of global trading networks has revealed many challenges which are proving to be beyond our immediate comprehension and control. They have revealed the inadequacy of existing legal and other risk management structures. The sophistication of the instruments we use to sustain trade must improve, as must the organizational structure, skills and capabilities for its management.
Trade depends upon trust. And trust is underpinned by confidence in the institutions and methods through which interactions are governed. To take a simple example, 20 years ago it would have been very unusual for individuals to trade across national borders. It was costly, time-consuming and fraught with risk. Today, millions of people operate through trusted intermediaries, such as eBay, and rely for recourse not on the law, but on service providers such as Paypal. Commercial inventiveness finds its way through complexity - and that must be the mission of those within commercial functions such as contract management, procurement and legal.
Few would debate that contracts and the specialists involved in their formation and management must be material to this future definition. IACCM has been alone in bringing together the academics, service providers and practitioners who can define and develop the steps needed for improved relationship governance and performance management - including the future form and purpose of 'the contract'.
Playing to Win
It is much easier to say win-win than to execute win-win. People play to win. From grade school on we are conditioned to believe that there is a winner and a loser. To have two winners on different teams must require some new math or letting someone win. For the truly competitive, giving in or sharing does not come easy. After all, there is only so much pie to go around.
While many organizations tout they have "partnerships," our experience and research found that most organizations have an internal desire to optimize their own self interests. This is often known as a "What's in it for Me" approach (WIIFMe). How could they not when we are ingrained with "winning" from early childhood and most business schools and law schools focus on "winning." Procurement and sales professionals are trained in the art of negations to help them "win."
In our experience, only those organizations that truly challenge the WIIFMe mentality are able to achieve true Vested Outsourcing partnerships that deliver outstanding results. In our opinion, adopting anything less than a WIIFWe philosophy will result in less-than-optimal results.
Deeply wedded to the WIIFWe philosophy are the following five major rules.
- Outcome-based versus transaction-based business model
- Focuses on the "what" not the "how"
- Clearly defined and measurable desired outcomes
- Pricing model incentives optimized for cost/service tradeoffs
- Insight, versus oversight governance structure
The five major rules of the "What's in it for We" philosophy.
In Vested Outsourcing, the organizations work together upon a foundation of trust, with mutual accountability for achieving the outcomes. Through the careful alignment of performance objectives, accountability and control, the service provider, while absorbing additional risk, is empowered to pursue improvements that will deliver improved performance, higher profits and lower total cost of ownership. Vested Outsourcing uses the power of free market innovation to improve the outsourcing relationship. This can be challenging to achieve, but the Vested Outsourcing journey should always strive to arrive at this idealized end state to achieve the performance pyramid where both the company outsourcing and the outsource provider are consistently applying a WIIFWe foundation and applying all five of the Vested Outsourcing rules.
For the service providers, Vested Outsourcing is an opportunity to exercise greater flexibility in deciding how support is provided, to ensure cash flow stability through long-term contracts, and to increase revenue by rewarding the service provider's investment in improving processes. For the company that is outsourcing, it is a chance to obtain improved performance while decreasing costs and assets by partnering with a highly competent and properly motivated firm.
To say that Vested Outsourcing represents a departure from conventional outsourcing practice would be to seriously understate the case. Vested Outsourcing changes the fundamental business constructs of the typical outsourcing approach.
Companies wanting to embark on a Vested Outsourcing partnership will need to deeply understand both the central core of the WIIFWe approach and the five rules. They will need to treat them as rules to live by. In our opinion, a Vested Outsourcing partnership that does not strictly adhere to the entire WIIFWe core and all of the five rules can easily fall victim to one or more of the outsourcing ailments that we have identified in our research. We like to think of a Vested Outsourcing partnership that does not adhere to the rules as a pig with lipstick. You can't simply pretty up something that is essentially ugly!
While the ailments afflicting many outsourcing arrangements occur as frequently as the common cold, they share a common cure: Vested Outsourcing can and does create an outsourced business model where both the company outsourcing and the service provider make every effort to achieve the elusive win-win. And the risk of catching one of these ailments through outsourcing is more than made up for by the achievement, through a productive Vested Outsourcing partnership, of lower costs by the outsourcing company and higher profits by the service provider, neither of which can be attained by each organization working alone.
Our upcoming book, Vested Outsourcing: Five Rules that will Transform Outsourcing is published by Palgrave Macmillan and offers a comprehensive guide for developing successful Vested Outsourcing partnerships. It is designed to help all companies begin their effort to take their outsourcing relationships to the next level. For those wishing to explore Vested Outsourcing further today, we offer four resources:
- The University of Tennessee offers a three-day open enrollment class at its Center for Executive Education, "Vested Outsourcing: Buying Results, Not Activities!" (See http://VO.utk.edu) You can contact Bric Wheeler at the University of Tennessee to learn more BWheeler@utk.edu
- Visit our blog at www.vestedoutsourcing.com and receive additional resources, success stories and insights offered by the authors. The book is available at Amazon
- Contact the authors at the e-mail addresses with their bios below.
About the Authors: Kate Vitasek is a thought-leader in the area of Supply Chain Management and is a well-recognized authority on performance management and performance-based approaches for business. She is the lead researcher and faculty for the University of Tennessee's Center for Executive Education work in the area of outsourcing and performance-based approaches. She is also the Founder of Supply Chain Visions, a Top 10 supply chain management boutique consulting firm. She can be reached at firstname.lastname@example.org
Mike Ledyard is a veteran of international sourcing, manufacture and importation of product and tooling, especially from China and Eastern Asia. He is an author and frequent speaker on process measurement and improvement, and was selected as one of the Top 20 Logistics & Supply Chain Executives of 2001-2002. Mike is also a co-founder of Supply Chain Visions. He can be reached at Mike@VestedOutsourcing.com.
Legal And Contract Management: Should They Be Outsourced?
Can contracting be outsourced? That was the topic I discussed this weekend with Henrik Lando, Professor of Law & Economics at Copenhagen Business School and David Karabinos, co-founder of EquaTerra and a leading expert in outsourcing.
David made the following observation about corporate outsourcing strategy: “Imagine a two-by-two matrix with core and non-core activities on one axis and Do-Well and Don’t-Do-Well on the other. If you do a true and accurate analysis of what your company does, and plot them in the matrix, then you have a better feel for what you should outsource.”
Our discussion was driven by my response that, if you believe outside observers (The Economist, miscellaneous governments etc.), most organizations don’t do contracting very well. So on that count, it should be a candidate for outsourcing. Yet if you believe academics like Leslie Willcocks, Kate Vitasek and Oliver Williamson, then the growing uncertainties of a global economy mean that contracting is fast becoming a critical area of ‘core competence’. So that would imply it should be kept in-house.
In reality, relatively few companies have undertaken extensive outsourcing of their contracting process. And one reason for this is that very few have grasped that it is a process. In most places, it remains a relatively disjointed set of activities – which is of course why it is done so badly. Roles and responsibilities are frequently not well defined; stakeholders work to different agendas and objectives. Risk is not well communicated or managed. And things that are not understood make very poor candidates for outsourcing, because no one has any real idea of the underlying cost and it is almost impossible for the outsourcer to deliver services when there is no clear point of internal ownership.
Henrik Lando recently had the chance to discuss the role of contracting with Nobel prize-winning economist Oliver Williamson. Their conversation confirmed Prof. Williamson’s view that a ‘well-governed contract’ may do more to deliver results than a hierarchical relationship – hence supporting the idea that contracting competence is increasingly ‘core’. So does that mean we should not consider this a candidate for outsourcing?
David, Henrik and I all agreed that some areas of contracting can be outsourced. David cited the extent to which it is already happening with the Legal role, but admitted that other areas have been slow to follow. “Elements of complex contracting can certainly be outsourced (legal, financial monitoring, performance monitoring, contract administration). We tried to sell this as something third-parties could do for our clients at both TPI and EquaTerra. However, only legal is something that our clients (buyers) really accepted as legitimate to give to a third-party.”
In my opinion, the reason for this is largely due to the poor definition of process and the fact that this leaves affected resources hard to identify. ”Because virtually no one sees it as a process, there is no definition of activities that allows intelligent division between what should be retained and what could be outsourced. And it is this lack of definition that results in the fact that companies are generally ‘not very good at contracting’.”
Companies incur heavy costs because of this failure to develop robust contracting procedures. For contracts and legal professionals, it means we remain overwhelmed with tactical support and cannot readily drive strategic change because of poor visibility into data and because we lack the time. Selective outsourcing is the right way forward. Leading the changes needed to make it happen is a great way for contracts and legal professionals to be seen in a new and more strategic role by executive management.
A winning approach to Executive Education from Manchester Business School
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the nature of the transaction
supplier and client capabilities
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Commercial and Contracting Strategies and Tactics
Law & Ethics in International Contracting
Delegates achieve an MSc from one of the world’s leading business schools without interrupting their career
The course is recognised by the International Association of Contract and Commercial Management (IAACM)
Delegates gain immediate practical benefits which they’ll be able to pass on to the sponsoring company
A self-driven, self-selected dissertation provides the opportunity to undertake a research project on a practical commercial management issue, while also providing a return on investment to their employer.
Face-to-face workshops provide the opportunity to network with academics and fellow delegates from different industry backgrounds.
Risk Management: Things About Which You Should Be Aware
A recent report by Mactavish, a UK-based research and consulting organization, provided fascinating insight to the problems created by the recession. Desperate to cut costs and project short-term revenues, executive management has embarked on a range of high risk measures that impact contract commitments, liabilities and supply chain security.
Mactavish CEO Bruce Hepburn, in an interview with IACCM (recording available in the member library) expanded on the potential consequences of these risk decisions and what they tell us about the ability of business to anticipate and manage their consequences. In particular, he highlighted that many companies will have invalidated their insurance cover (which they and their trading partner may be relying upon to mitigate risk); and he observed that companies in general tend to ignore 'new' forms of risk - they focus almost exclusively on things that they or others have experienced in the past.
Among the major risks that were identified, many have direct connection to commercial or procurement activities:
- Moving into unfamiliar product areas and territories (including taking on new and untested contractual commitments or trading / distribution partners)
- Speeding up product launches (creating unknown quality or liability issues, internally and with suppliers)
- Weakening supply chains and increasing vulnerability in order to reduce costs (for example by cutting the number of suppliers and distribution centers, or by relying on lowest cost suppliers regardless of their reliability or capability to sustain claims)
- Increased outsourcing to unknown or high risk locations (pushing down unit cost at the probable expense of quality and reliability)
- Acceptance of extra contract liabilities in sales bids and negotiations (warranties, recall costs, indemnities etc.)
- Reducing supervision in key areas such as health and safety or contract oversight (driven by ’suicidal’ bidding practices)
Over on gtnews, an excellent article drew attention to seven supply chain risks and various regulatory trends and initiatives about which our community should be aware. Many will increase commercial obligations and frequently could result in the need for additional terms and conditions, depending on which countries are involved.
- Security. "The fight against terrorism will remain a priority worldwide. Security changes and requirements will continue to affect international trade for the foreseeable future, with an emphasis on advance data and self-reporting," according to the article. It goes on to list a number of the major initiatives being implemented by governments worldwide and highlights how 'the onus for their enforcement will continue to fall onto the trade community."
- Importer filings. With effect from January 26th, the US has imposed new security requirements for imported goods. "To help avoid liquidated damage penalties, the trade community has dedicated resources to implement the processes and procedures necessary to comply and will require their supply base to do the same. Evidence to this effect will be necessary when being considered for current and future product procurement."
- Food safety. Another US initiative that will shortly be implemented is PREDICT, a system by which customs authorities will undertake random sampling that may cause delays to imports and which will also apply 'risk categorizations' that will have greater impact on some exporters than others.
- Trade Enforcement. Yet again a US initiative that is likely to become law this year and which rewards companies that enter into voluntary controls over supply chain integrity. There are some industry concerns over data security.
- Sustainability. Somewhat at variance with the findings of the Mactavish survey mentioned above, the authors of this article see a shift in larger companies away from simple cost reduction to more sustainable supply chain policies. "Decisions made previously based solely on cost will be held accountable to a whole new set of additional questions by executives, board of directors and shareholders. The conversation and questions will shift from: "Can we?" to: "Should we?" and "How long can this last?"
- Entering new markets. In accord with the Mactavish findings, the likelihood of management pushing into new and higher risk markets is rated high. The authors question whether companies have built the systems and resources necessary to assess and manage the risk involved.
- Flexibility. As with many other commentators, the article highlights the need for flexibility, but makes the point that this itself creates potential problems. As sourcing switches between low cost providers, the need to maintain integration between different parts of the supply chain will prove increasingly demanding.
Congratulations to Dave Sadler
Completing the Fastnet Race 2009
On Sunday 9th August the world's A-List sailors from around the world in the strongest international line up of 300 grand prix race yachts hovered in Cowes waters, waiting for the horn to start one of the toughest events in the international yacht racing calendar, the biennial Fastnet Race. The competitors (from the UK and across Europe, USA, Hong Kong, Chile and Australia) faced brutal weather, complexity, foul tides and at times calm, during their 608 mile ordeal out through the Solent, negotiating numerous tidal gates past the Needles, Anvil Point, Portland Bill, Start Point, and Lands End, as well as the open ocean as they crossed the Celtic Sea to round the famous Fastnet Rock 10.8 nautical miles off the coast of southwest Ireland, before returning round the west (open sea) side of Scilly Isles and the home run in to Plymouth.
Contract Management Community of Interest
CM Organization and Management COI
Sourcing Community of Interest
Supplier Relationship Management COI