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

Contracting Excellence Magazine - Mar 2010

 
 

 

Contracts As Commitments

 
In this brief article, IACCM President Tim Cummins highlights the work of Chilean entrepreneur, politician and innovator Fernando Flores and its lessons for the world of contracting.  
 
 
“A business is a network that allows us to make offers”, according to Fernando Flores, entrepreneur, politician and innovator.
Mr. Flores has led a fascinating life, including at the age of 27 a brief period as Finance Minister in the government of Savador Allende. Following several years of imprisonment by the Chilean military junta, he was able to start a new life in the United States, where he quickly started to apply his fascination with computers to innovative business process and management systems. Today he is once more a politician and Senator in his homeland of Chile.
Out of these interests and experiences, he developed ideas that are highly relevant to all those involved in contracting and business relationships. This quote, taken from a recent edition of Strategy+Business, illustrates my point:
“Spend any time with Fernando Flores and he will assess you. He may make an offer, which you are free to accept or decline. If you accept, he will make a commitment to fulfill his promise. These simple words, or “speech acts,” form the vocabulary of a set of practices that he has deployed across three continents. Their purpose is to help organisations realise improvements in productivity, coordination, and culture — by codifying and making effective the directives and agreements at the core of business conversation.”
One of the terms that Mr. Flores uses to describe his philosophy is ‘commitment-based management’. At its core is the principle that words are cheap; generalisations are easy; value is introduced when commitments are specific and measurable. ”Most communication between individuals consists not of pure information, but of prompts for action”, he observes. But of course we have a choice as to how we respond to that prompt – for example, do we say we will ‘make best efforts’ or do we promise that functionality will be delivered? Do we say that delivery will be ‘as soon as possible’ or that we will have the project complete by Friday?
Underlying this work is the point that organisations exist to produce value, but that value is undermined if the organisation cannot make and honour commitments. It is through commitments that we generate trust and loyalty.
Turning to the world of contracts and negotiations, we can immediately see how they influence these critical characteristics.
  1. Through the initial phases of the contracting process (the selling / supplier selection phase), we should be generating the discussions that are required to establish needs, their alignment (or misalignment) with capabilities, and the sort of commitments required (by both organisations) to support success. A key danger here is that the parties exaggerate their capabilities and create expectations that cannot be met.
  2. During the contract formation and negotiation process, we should be documenting the results of this first phase and turning generalised offers into specific commitments. Where things often start to go wrong are that either the commitments are left vague, or that the negotiators actually seek to limit the implied commitments that were offered. This may be because the promises made in the bidding process simply were not true, or because the standard practices, policies and risk appetite of contracts staff are not aligned with those of their colleagues in Sales or the business unit.
  3. Assuming that a contract is established, the critical test is whether commitments are then met. In the post-award phase, we have not only the challenge of meeting what was offered, but also of managing changes to business conditions, capabilities or requirements. IN the real world, nothing remains static, so organisations must have the ability to reassess and re-open their commitments. The critical issue – if we are to retain trust and cooperation – is to do this overtly and to avoid surprises.
Emphasising this point about managing change, Flores believes that individuals and organisations are never fully trapped in any situation, even one as drastic as imprisonment — if they remain willing to change the way they think and talk about it. “We human beings are linguistic, social, emotional animals that co-invent a world through language,” he says. “That means that reality is not formed by objects. That opens a different world of possibilities.”
Flores argues that the obligations people create for themselves are stronger and more psychologically binding than the directions they are given by someone else. Hence we can assume that contracts, by capturing and recording ’speech acts’ and embodying commitments, fulfill a critical purpose in binding organisations together. For those who question whether contracts have value, Flores’ work has led to an interesting statistic. When companies assess the percentage of the time that promises are met:  “In the best companies in the world, they say about 60 percent will be fulfilled. In normal companies, it’s around 30 percent”. So just imagine if we improved the process of ‘commitment management’ to a point where, as a matter of course, all those involved with delivery felt bound by their promise. And in that world, a contract would become the charter of commitments, rather than a charter of aspirations, surrounded by caveats and exclusion clauses.
 
 

 


 

 

The Economics of Outsourcing

 
Kate Vitasek, Karl Manrodt and Bill DiBenedetto summarize what the work of six Nobel prize-winners can teach us about better outsourcing.
 
 
In many ways outsourcing is as old as commerce itself. But what drives the decision to outsource – and more importantly how to outsource properly?
 
One might be surprised that much of the evolution of modern outsourcing can be tied to the study of economics. In fact, economic research stretching for more than 80 years is woven into the fabric of modern outsourcing.
 
The big thinkers focused on growth theory, transaction costs, game theory, property rights, deregulation and the nature of the firm. At least six Nobel Prizes have been awarded to economists that have something to teach us about outsourcing. 
 
But what does this mean for the average practitioner in charge of outsourcing today? It means that the theories, lessons and wisdom of the brilliant economists can serve as validation and guideposts for outsourcing in the real world. 
 
This article examines some of the best-known economists and how some of their findings can be applied to modern outsourcing. We’ve tried to take the essence of their work and distill it into a few sentences that can help you the next time you find yourself trying to develop your outsourcing strategy or structuring a deal.
 
Ronald Coase, Coase Theorem: or Business is a Math Problem
 
The groundbreaking work of Ronald Coase, which stretched back to the 1930s, shed light on a concept known as transaction cost economics.

Coase advocated that it was not enough to include only production and transportation costs as the main costs of doing business; businesses needed to also consider the cost of entering into and executing contracts. This boils down to a mathematical analysis, and his breakthrough thinking was even given a mathematical name, the Coase Theorem.
 
That all seems obvious today but Coase’s inclusion of contracting and contracting costs into the mix of a firm’s organizational structure and accounting helped him win the Nobel Prize in Economics in 1991 and created the conditions for outsourcing to become a normal and major part of a firm’s strategy. Coase was probably scratching his head laughing at companies who rushed to offshore in the late 1990’s only to find that the $1 they saved in manufacturing was offset by other costs. 
 
Lesson for today’s outsourcing firms: When outsourcing, think about the TOTAL COST – not just the price/budget of the work that is being outsourced. If you make your decisions solely on the price of the scope of work and not the total costs you will have a myopic and highly inaccurate view.
 
John Nash, Game Theory: or Playing Nice is Good for Everyone
 
Is it a wild stretch then to move from the Coase Theorem and business as a math calculation to the famed bar scene in the movie A Beautiful Mind? Possibly, but let’s do it anyway.
 
In the movie the mathematician John F. Nash, as played by Russell Crowe, has a revelatory moment in a campus watering hole as he and his mates ponder the best ways to produce optimum results as they consider how to approach a beautiful blonde and her friends.
 
Nash’s moment of inspiration and clarity was that Adam Smith’s principle that the “best result comes from everyone in a group doing what’s best for themselves” was incomplete and needed revision: The best result comes from everyone in a group doing what’s best for themselves and the group.
 
Nash’s pursuit and proof of that conclusion led to what is called the Nash Equilibrium. He demonstrated that companies that work together will discover that the sum of the parts can be better when combined effectively than if they work at cross-purposes.
 
Nash went on to win a Nobel Prize in 1994 for his work and the related work of two others that he shared the Nobel Prize with, John C. Harsanyi and Reinhard Selten. Their work spurred an entire branch of economics now known as Game Theory, or Behavioral Economics.
 
Game theorists have been studying the economics of playing non-zero sum games (aka win-win) games for more than 50 years to show that playing nice is indeed good for you.    Since Nash’s Nobel Prize – there have been seven more Nobel Prizes awarded to Game Theorists.
 
Lesson for today’s outsourcing firms: It’s pretty easy to observe the seminal importance of game theory development in reaching equilibrium, or win-win solutions and outcomes, in outsourcing contracts.
 
Robert Solow, Technical Change: or Brains are Better than Brawn
 
More than 50 years ago Robert Solow showed that technology was the real driver of economic growth.
 
Solow’s growth model was first presented in a 1956 article. His premise: Without “technological progress” growth rates for capital, labor and total production would all be about the same. In fact, he found that about four-fifths of the growth in U.S. output per worker was attributable to technological progress. In short, brains matter more than brawn if you want to spur economic growth.
 
Solow won a Nobel Prize for his work in 1987.
 
Lesson for today’s outsourcing firms: Today most outsourcing agreements are transaction-based, meaning that a service provider gets paid for every activity – be it a rear-end in a seat to answer a call, two hands for packaging, or fingers for filing. This approach focuses on brawn, not brains. If economic growth is achieved from “technical change” then companies that outsource should focus their efforts around paying suppliers for their brainpower and not their brawn (or simply to perform an outsourced activity). 
 
Oliver Williamson and TCE: or Not Playing Nice Can Really, Really Cost You
 
Oliver Williamson, professor emeritus of business, economics and law at the University of California, Berkeley, is taking transaction cost analysis to a new level that he calls ‘transaction cost economics’ (TCE).
 
He applied TCE directly to outsourcing and the supply chain in an April 2008 article in the Journal of Supply Chain Management ("Outsourcing: Transaction Cost Economics and Supply Chain Management").
 
Williamson warns about potential “maladaptations” in the contract process that can develop if companies don’t start by thinking cooperatively and proactively about “unanticipated disturbances” in order to preserve contract continuity.
 
His analysis of the three styles of contracting -- muscular, benign and credible -- is particularly insightful. We are particularly fond of his quote, “Muscular buyers not only use their suppliers, but they often ‘use up’ their suppliers and discard them. The muscular approach to outsourcing of goods and services is myopic and inefficient.”   
 
Oliver Williamson is the most recent economist to win a Nobel Prize. He shared the 2009 award with Elinor Ostrom, who received recognition for her work on how user associations can effectively manage common property.
 
Lesson for today’s outsourcing company: Companies should think cooperatively upfront – because switching costs of vendors is very expensive. If your strategy is to “bid and transition” you are likely losing at the game of TCE. And for all those companies that have pitbull procurement professionals still on their staff – it is not only old school it is “myopic and inefficient.” If you aren’t convinced by game theory, Williamson’s work is the icing on the cake on why not playing nice can really, really cost you.
 

Steven D. Levitt, Freakonomics and Superfreakonomics: or It’s All About Incentives
 
Steven D. Levitt and his sidekick, the journalist Stephen J. Dubner, are the modern day rebels in economics with their work exploring “the hidden side of everything.” Levitt points out, “One of the most powerful laws of the universe is the law of unintended consequences.”  
 
While Levitt tells lively stories of how unattended consequences drive the behaviors of schoolteachers, realtors, crack dealers, and expectant mothers, we contend this law also greatly affects outsourcing deals as well. In fact, an outsourcing deal that is not well thought out will likely suffer from one or more of the 10 Ailments of Outsourcing spelled out in the book Vested Outsourcing: Five Rules that will Transform Outsourcing.
 
Levitt has not won a Nobel Prize yet – but he does have two New York Times best sellers and his lessons are well worth the read (and much easier to read than his peers).
 
Lesson for today’s outsourcing company: In outsourcing, it’s important to take Levitt’s advice: “Morality is what people should do. Economics is what people do.” For all those out there structuring an outsourcing deal – you always get what you pay for. So if you want more than a simple butt in a seat to do your work you need to consider an outsourcing business model that pays outsource providers for their brainpower to add value and solve your real problems and help you achieve your desired outcomes. We think Steven Levitt would be a supporter of the Vested Outsourcing concept that promotes aligning interest through the use of carefully crafted incentives.
 
Thomas Friedman, The World is Flat: or why outsourcing is here is to stay
 
Thanks to Coase, Solow and their colleagues, outsourcing is now an intrinsic part of the business landscape. However, it has been popularized, debated and indeed lionized in the mainstream press by Thomas Friedman.
 
Friedman’s big bestseller, The World is Flat: A Brief History of the Twenty-First Century (first released in 2005 and updated twice since then) stresses the importance of technology and outsourcing as major elements of the global economic structure.
 
The book describes 10 “flatteners” that have leveled the global playing field. The rise of outsourcing and related activities such as off-shoring and supply chain networks figures prominently on the list.
 
Friedman says outsourcing has allowed companies to split service and manufacturing activities into components that are subcontracted and performed efficiently on a global scale.  
 
The ease of offshoring today – if contracted correctly! – means that a company can locate manufacturing and other processes to a foreign locale to take advantage of less-costly labor and operations.
 
The emergence of sophisticated supply chain networks and the role of technology is another flattener, according to Friedman, because companies can now use the Internet, sophisticated software (including workflow programs and open source software) to coordinate and streamline items such as sales, distribution, shipping and risk management in real time.
 
Lesson for today’s outsourcing company: The world is getting flatter all the time, and if you have not heard, outsourcing can be good for your company’s health. Management guru Peter Drucker sums it up best with his advice in 2004: “Do what you do best, and outsource the rest.”
 
We add one caveat: Do it right, because if you simply outsource and don’t follow the economic lessens of outsourcing you will not maximize your results. For a primer on how to do outsourcing right, pick up a copy of Vested Outsourcing: Five Rules that will Transform Outsourcing.
 
 
Conclusion
 
We’ve come a long way thanks to thought leaders such as Coase, Nash, Solow and Williamson. But the outsourcing phenomenon is really just getting started.
Outsourcing is poised to achieve new levels of sophistication and efficiency, especially if it becomes the cooperative exercise benefiting all parties that it should be and companies play by the rules.
 
 
Kate Vitasek is the lead researcher and faculty on the topic of Vested Outsourcing for the University of Tennessee’s Center for Executive Education. She is also the founder of Supply Chain Visions and is the author of Vested Outsourcing.
 
 
Karl Manrodt is an Associate Professor of Logistics at Georgia Southern University. He is a co-author of Vested Outsourcing.
 
 
Bill DiBenedetto is a freelance writer-editor and managing director of wrdforwrd.
 

 

References/Links:
 
Robert M. Solow Prize Lecture, December 8, 1987
http://nobelprize.org/nobel_prizes/economics/laureates/1987/solow-lecture.html
 
Ronald H. Coase Prize Lecture, Dec. 9, 1991:
http://nobelprize.org/nobel_prizes/economics/laureates/1991/coase-lecture.html
 
1994 Nobel Prize Laureates: Nash, Selten, Harsanyi
http://nobelprize.org/nobel_prizes/economics/laureates/1994/press.html
 
2009 Nobel Prize Laureates: Williamson, Ostrom
http://nobelprize.org/nobel_prizes/economics/laureates/2009/press.html
 
Oliver Williamson:
Prize Lecture (video) - http://nobelprize.org/nobel_prizes/economics/laureates/2009/williamson-lecture.html
Slides: http://nobelprize.org/nobel_prizes/economics/laureates/2009/williamson-lecture-slides.pdf
“Outsourcing: Transaction Cost Economics and Supply Chain Management,” Journal of Supply Chain Management, Volume 44, Issue 2 (p 5-16) 
http://www3.interscience.wiley.com/cgi-bin/fulltext/119422182/PDFSTART?CRETRY=1&SRETRY=0
 
 
Thomas L. Friedman, The World is Flat: A Brief History of the Twenty-First Century 2005 ISBN 0-374-29288-4
 
Steven D. Levitt and Stephen J. Dubner, Freakonomics: A Rogue Economist Explores the Hidden Side of Everything, (2005)
 
Vested Outsourcing: http://www.vestedoutsourcing.com/
eBook: http://www.VestedOutsourcing.com/pdfs/Vested_Outsourcing_eBook.pdf
 
University of Tennessee Center for Executive Education http://www.thecenter.utk.edu
 
Supply Chain Visions: www.scvisions.com
 
wrdforwrd: www.wrdforwrd.com
 
Bar scene from “A Beautiful Mind”: http://www.youtube.com/watch?v=l0ywiYboCLk
 
 
 

Contracting As A Corporate Competence

 
Registrations for this year's IACCM Conference series reflect the growing economic recovery - and also the increased focus on contracts and commercial management at many organizations.
 
 

Our theme this year - Contracting As A Corporate Competence - reflects the demands being placed on many groups to raise their performance and value. The frequency of re-organization and re-engineering of the contract process has gathered speed, in part because of the needs that became evident during the recession.

IACCM is uniquely positioned to help individuals and functional leaders as they wrestle with the changes going on around them - and how best to respond. Because of its global insights, benchmarks and research, IACCM has been able to assemble senior managers from the world's best performing contracts, legal and procurement groups to share their experiences and approach. Through presentations, panels, workshops and network roundtables, we offer our members the chance to ensure that they are ready to respond to management demands and to promote 'contracting competence' in their organization.

IACCM Americas is in Orlando, March 23rd - 25th (www.iaccm.com/americas) and IACCM EMEA is in Edinburgh, May 25th - 27th (www.iaccm.com/emea). The Asia-Pacific event is still in planning, but will be held in Singapore during the week of September 20th.

 

 

 

 
 

 


 

 

 

Compete or Cooperate in Supply Chains

 
UK-based author and practitioner Stuart Emmett highlights one of today's key questions - the extent to which Procurement will occupy the growing field of Relationship Management. He raises in particular whether this requires professionals become better at using 'their emotional side'.  
 
 
Much has been said about how suppliers should be managed by procurement. Indeed one view (Supply Management January 2007) was that the Procurement Manager will become re-titled as the Relationship Manager in future years. This would then mean considering cooperative management styles and perhaps stepping back from any adversarial “them and us” competing power based styles.

With such a change, then what needs to be done?

The competitive way

Most buying and selling organisations have to compete, not only in their local markets but also in a global market. Interestingly this competition is not just for customers' demand, but also for suppliers, as many are becoming selective in their choice of customers. When organisations compete, this is a rational and sound business practice. This rational and logical way creates a sense of what is “right and wrong” and has norms, that are clear and objective; for example, “this is how I should behave” or, in its extreme, “this is how I must behave.” This rational view is, however, only one of the two options available. 

Compete or cooperate

A competing process fosters the protection of “my” interests and a tendency for “I win, you lose” styles of negotiations and methods of business. Competing can also become a fiercely fought business discipline, not just between organisations and with external suppliers, but also internally between departments and between the people within organisations.

Indeed as has been noted by Professor Alan Waller, “we have been taught to compete and not cooperate.”  What has happened here is that competition has taken over from cooperation and rules and procedures have majored over relationships. This subduing of suppliers and competitors by competitive power-plays involves minimising the risk “for me.” This can mean in the longer term, suppliers have to survive on limited margins as they may be continually expected to meet the demands placed on them for lower prices and higher productivity. This in turn leads for some having to survive on extended cash flows and credit, (that one day will have to be re-paid). Indeed one may wonder how long such continual searches for lower prices and increased performance will continue to give increased quality and more added value.

It has been comprehensively proved, by those organisations practicing TQM, that low prices and high levels of quality are incompatible goals; however dominant buyers choose to believe they can maintain their position because they are easily able to switch suppliers and markets.

Market forces at play here, yes, but at what cost? Is there not a better way to use the market?
 
The joining of needs, values and norms

Whilst dominant buyers may choose to believe their needs will continue to be met by forcing external competition driven by rules and procedures; what they are really ignoring here, is that any power to influence others, is also determined by the perceptions of these others as to how, their own needs will be met.

This duality of meeting needs is going to be largely ignored in the power based rationale and norms of for “me” approach. Additionally, ignored will be the desire to find common ground and the use of cooperating “we” views and values.

This incompatibility and conflict between values and norms, means, that unless a newer form of mutuality of interest in working emerges, disintegration is the only ultimate and eventual result. For those who cannot see any relationship between values and norms, then witness the colossal changes made in East Europe in the 1980’s and 1990’s. Here, eventually people values on society, became at odds with the norms from the political society and a major change in political systems followed.

The rational and emotional best way view

Most western organisations lean more towards a rational scientific view.  Whilst emotional and subjective views are often subordinated in Western cultures, they are not in Eastern cultures. Here, the role of buyers and suppliers in practicing continuous improvement with a fuller involvement of suppliers in buyers’ organisations. This is in turn, connected to the dominance of Japan in certain sectors. 

What are needed therefore are norms and values of “rational-emotionality for us.” However, it seems to be difficult for many pre-conditioned “rational only” Western managers to make such a change. This for example, was one of the reasons for the 1980/1990’s failure of TQM methods to impact many organisations. TQM was then being seen, as the source for future success of “UK Limited” and whilst TQM has been successful for a few, most UK companies who tried, failed. Here the already existing superficial attitudes and short term views drove behaviour and the needed fundamental changes were not made “deeper inside.” Organisations wanted the quick fix tools and not the thinking that went behind them.

Changing our views

It seems therefore that Western managers must individually determine how they look at things, and then to be prepared to change their view to incorporate emotional values. After all, they have such emotional values, they were born with them and use them regularly away from work; but Western organisational socialisation and methods have often subdued them and bred competition as, “the one best way”.

Changing however can be a most difficult form of learning for many managers as they have their own "fixed" perception, which can, in effect, block the view. Therefore, if we want to see things differently, we need to change our perception. Remember that perception is reality. The way we see, leads to what we do and what we do, leads to the results we get. So to change the results, we really do need to change the way we see. As an American colleague of mine says, a crazy person is defined as someone who keeps doing the same things but expects better results.

The choice today is change or die

It is my belief that business is, at its roots, an emotional experience. Trying to pretend people’s emotions don't exist in business relationships is dangerous, as building and developing good relationships involves more than just following rational rules and procedures. 

To have effective procurement and supply chain management, then we must fully consider how cooperative relationships are to be handled so we can achieve the greater benefits that will only occur when sharing and mutuality happens. 

By retaining the current dominance of competition and rules, this means subduing the place of cooperation and relationships.
Cooperation and relationships must take a stronger place and find a better balance with traditional rational competition and rules found in most UK supply chains.

For some organisations therefore, the future will mean demise and possibly death, for others, a re-birth and growth. Growth is the better option and needs a conscious choice to learn new ways and in so doing, to change.
 
 
Stuart Emmett
MSc. (Cranfield). BA (Hons) (OU).
FCIT .FCILT. FIFP. FCMI.
MCIPS. MCIPD. M.Inst.LM. MIMC. M.Inst.Ex
 
Stuart Emmett is a freelance independent trainer and consultant who trades under the name of Learn and Change – Stuart believes that in times of change, it is only those who consciously learn, that will inherit, a successful future
 
 

 


 

 

IACCM Board Elects Officers For 2010

 
At its annual strategy and planning meeting, the IACCM Board of Directors elected the officers for 2010. Diane Homolak, from Hewlett-Packard, is the new chair of the association, replacing UK-based General Counsel Tim Cowen, who has served for the last two years.
 
 

Commenting on her new role, Diane said: “I am looking forward to working with IACCM’s talented staff and its diverse and enthusiastic Board of Directors, continuing to provide our membership with new direction and resources to face the emerging challenges from entering economic recovery - and continued market volatility - this coming year.”

Three Board members were elected to fill the regional vice-chair roles - for the Americas, Tim McCarthy (Rockwell Automation) was re-elected, as was Monu Iyappa (Mahindra Satyam) for Asia -Pacific. Paul Henham (Shell) was newly elected to represent EMEA.

Rick Wingate (LG Electronics) was appointed the chair of the IACCM Ethics & Audit committee.

The full Board and Officer roster for 2010 is:

Chair

Diane Homolak, Global Legal Operations Quality and Strategy Manager

 

Board of Directors (Officers)

Jacqui Crawford - Secretary/Treasurer, Commercial Director, Swissport

Paul Henham - Vice Chair EMEA, VP Strategy and Performance C&P, Shell

KB (Monu) Iyappa - Vice Chair APAC, Sr. Vice president, Satyam

Tim McCarthy - Vice Chair Americas, Director of Contracting and Negotiations, Rockwell Automation

 

Board of Directors

David A. Barton, Director of Contracts, Agilent Technologies, Inc.

David Connor, VP Procurement and Supply Chain, BP

Adrian Furner, Commercial Director - BAE Systems Strategic Capability Systems

Michel Gahard, General Manager of LCA's CPE program, Microsoft

Nancy Nelson, Global Contracts Director - CSC

Ken Riley, General Manager, Supply Chain Management - Chevron

Margaret Smith, Executive Director Contract Management - Accenture

Melinda Wilkins, Vice President, Contracts and Negotiations, Global Business Development, Americas, IBM Global Services

Richard C. Wingate, General Counsel, LG Electronics U.S.A, Inc.

 

Academic Advisors / Ex-Officio Board Members

Gerlinde Berger-Walliser, Associate Professor, ICN Business School

Robert Handfield, Professor Supply Chain Management, North Carolina State University

René Franz Henschel, Associate Professor, Ph.D., Master of Laws, Aarhus School of Business

Henrik Lando, Professor of Law and Economics, Copenhagen Business School

David Lowe, Senior Lecturer in Commercial Project Management, University of Manchester

 

 
 

Facilities Management - A Growing Market

 
This article by Pearse Ryan, a partner in law firm Arthur Cox, offers an insight to market conditions in Ireland - and also an excellent overview of considerations in contracting for facilities management.
 
 
With the current economic climate generally either forcing or incentivising customers to keep their hands in their pockets, the IT&T and business process based outsourcing markets are far from bustling. Add to this the draconian cutback in expenditure by the public purse and the picture looks grim. Whether there will be any light at the end of the tunnel by early 2010 remains to be seen. In general customers are currently unwilling to spend to save, which is a necessary ingredient of most medium to large service or technology based outsourcings. 

However, there is one area within the outsourcing spectrum where we have seen an increase in deal volume, together with complexity and scale, in recent times, which is the facilities management (“FM”) sector. By FM we refer here to personnel based services, differing, on the one hand, from technology based managed type services, such as web hosting and application-on-demand type services, and, on the other hand, from business process type services, such as financial administration or site organisation back-office function. FM services tend to be personnel based, organisational facility based and require a certain scale of organisation to permit outsourcing. Typically what is outsourced is a bundle of services in the facilities sector including:

>          building external infrastructure maintenance (physical maintenance)
>          building internal plant operations (electrical maintenance)
>          building environmental (cleaning) and amenity services (catering)

FM has always been a part of the repertoire of any outsourcing lawyer, but in the last year or so, the volume, scale and complexity of deals has increased. This article discusses features unique to the FM model, with comparisons made with the IT&T and business process based outsourcing models.
 
The Marketplace
 
FM is seen generally in the multi-national manufacturing sector, with particular reference to the pharmaceutical/medical device and IT sectors. Of these, the pharmaceutical/medical device sector is the most active. Recent times have seen a real increase in deal volume, possibly reflecting a general sector-wide maturity threshold. Unusually in the multinational outsourcing sector the deals tend to be local in origin, as opposed to the type of group-wide IT and back-office type outsourcings which were a feature of the last decade. The deals tend to be site specific as opposed to covering a number of sites. This applies, largely due to per-site sourcing policies and drivers and despite the fact that most of the large pharmaceutical/medical device companies in Ireland operating a number of manufacturing plants, typically between two and five, given that plants tend to be product specific, reflecting the complexity and scale of manufacturing activity.
 
The marketplace hosts a reasonable supply of service providers, reflecting the fact that the barriers to entry are not overly high, with the notable exception of energy related FM, which can involve construction. The barriers are not particularly high, given that the deals are personnel as opposed to technology/infrastructure based. Examples of suppliers include Dalkiá, Serco and Johnson Control. While barriers to entry may not be high, the deals tend to be medium to high value, given that labour costs are a major component of deal costs, and customers, as well as tending to prefer suppliers with previous experience within their group, tend to prefer suppliers with strong balance sheets. Unlike the IT outsourcing sector, for example, performance and financial instruments, such as performance bonds and parent company guarantees, are a feature of the FM sector. One, upshot of these factors is that the sector is dominated by large overseas suppliers with Irish operations.
 
The Scope of Services
 
The term FM includes a broad range of services, which might be distinguished by direct relationship with plant manufacturing activities. The closer the proximity to manufacturing the more unusual the deal, although we have dealt in recent months with a number of utility service projects, which directly support manufacturing. Manufacturers are naturally cautious in outsourcing activities which go directly to manufacturing, given the obvious direct risk to core business activity.
 
The bulk of FM deals share the following characteristics:
 
>          unlike many IT&T and business process based outsourcings the FM deals tend not to be attention grabbing, which has the beneficial side-effect of allowing the customer negotiation team broad autonomy and timetable control;
>          no or limited direct relationship to manufacturing activity;
>          indirect relationship, which could in certain extreme circumstances prevent manufacturing, with environmental incidents being the most obvious example;
>          supplier stall cost is primary cost factor;
>          flexibility in charging model, with a large number of models available;
>          TUPE present in deals, both at commencement and second generation changeover;
>          redundancy of supplier staff a real factor;
>          constant review of supplier cost-effectiveness, tied to reductions in supplier staffing levels;
>          typical supplier management of number of third party suppliers – either because customer cannot break contracts or wishes to retain direct contract relationship;
>          output based service measurement;
>          profit sharing on supplier cost saving initiatives – ties into cost reduction pressures and staff reduction points above. This is recognised by both customers and suppliers as complex to manage;
>          large liability management pools and insurance of both parties are key issues – a negotiation point;
>          general customer awareness of the cyclical nature of manufacturing, meaning that the service can be larger, smaller or materially different in scope over a given period. IN addition, the possibility of taking the services back in house is generally a manageable prospect given the nature of certain of the outsourced services, where skilled personnel are available for direct employment;
>          general customer awareness of the need to adequately manage the supplier going forward, which is a feature not always seen in IT outsourcings – this may be partly due to the ingrained (including statute based) absolute responsibility for manufacturing activities, especially in the pharmaceutical/life science sector. Retaining high levels of service knowledge in-house does facilitate customer control of supplier as well as increasing the possibility of successfully managing a transition to a new supplier or taking services in-house; and
>          overall deal flexibility is key feature.
 
Comparison with other forms of Outsourcing
 
Of the above a number of features are common with IT&T and business process type outsourcings, but what primarily distinguishes FM is:
 
>          the extend of deal flexibility in financial area – customer review, and price pressure is a regular feature;
>          the extent of deal flexibility in personnel area – personnel are key cost component and service review typically results in headcount reduction;
>          the prominence of TUPE and redundancy – the above financial flexibility and personnel flexibility result in an expectation of headcount changes, typically meaning downwards and typically dealt with by supplier redundancy as opposed to internal redeployment;
>          the importance of supplier use of IT in driving service efficiency – this is a key cost reduction tool in optimising staff efficiencies;
>          the short term of the deals – sometimes as low as one year and rarely more than five – again reflecting the customer requirement to maintain flexibility; and
>          the general supplier willingness to recognise revenue on an ongoing basis over contract term, as opposed to recognising much upfront – tends towards supplier enjoying a degree of flexibility in deal structuring not seen in the IT&T/business process sectors, where generally supplier corporate requirements are to recognise as much revenue as possible upfront. Once recognised the relevant area of the deal is not easily changed.
 
Conclusion
 
The FM market in Ireland is growing, particularly within the pharmaceutical/life science sector. There are a number of reasons for this, which include the drivers to:
 
>          reduce operating costs;
>          streamline the contracting process – a one-stop-shop approach; and
>          focus on core manufacturing activity;
 
The level of activity is greater in non-unionised plants and within one customer different plants may display differing levels of unionisation. 
 
As sites in Ireland move out of start-up phase, which can be a lengthy phase in the pharmaceutical/life science sector, they can concentrate more on cost and operation issues. The FM sector has a number of unique features, typically relating to the importance of factors seen in general outsourcing activities and the extent to which flexibility is a key component of the deal. While administration based back-office and IT/technology based managed services can be forecast into the future, the world of manufacturing is inherently unstable, with change a given. To support these changes with well structured FM deals is a challenge for customer, supplier and lawyer alike.
 
The extent to which the current economic climate will lead to a tendency to either, firstly, take existing outsourced services in-house or, secondly, delay project outsourcing project commencement is not known at present and, as mentioned, the marketplace has evolved quickly over a short period. The generally sophisticated nature of the customer operational management and sourcing management, coupled with certain inherent features of the services, does allow for deal flexibility, resulting in a number of deals displaying higher levels of deal flexibility and complexity of structure than typically seen in the IT&T and business process based outsourcing deals.
 
Pearse Ryan is a partner in the Technology and Life Sciences group in Arthur Cox, Dublin Office, specialising in IT, outsourcing and strategic sourcing, available at www.arthurcox.com.
 
 

Essay Competition

 
DPSS has announced details of its annual essay-writing competition, which this year focuses on 'Sustainable Cost Reduction'. IACCM members are encouraged to enter and demonstrate our qualities for innovative ideas.
 
 

The theme of this year's essay will be “Sustainable Cost Reduction”. The competition is designed to stimulate thought, debate, discussion and innovation in relation to topics which are both important and topical. The winning entry will be published on the DPSS website and in IACCM's Contracting Excellence.

The closing date for entries is October 18th. The winner will also receive a prize of £500. The competition is open to all countries and nationalities.

"Sustainability is a big issue right now," commented IACCM President Tim Cummins. "There is skepticism over the traditional Procurement approach to savings and this was further undermined by the experiences of the recession. It appears inevitable that thoughts must turn to ways to build better and more collaborative relationships."

"I am sure that there will be many from the field of procurement and supply chain who will submit their ideas - but what I really hope is that entrants from the supplier side will set out innovative ideas on how things could be changed."

For more information on the competition and details of how to enter, please see http://www.dpss.co.uk/events/essay-competition.php

 
 

 


 

 
 
 

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