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

Contracting Excellence Magazine - May 2010



Contracts & Commercial Management: An Era Of Change Is Upon Us

With President Obama once more demanding an end to 'cozy relationships', it is clear that the world of contracting and relationship governance will continue to move center-stage. Obama is not alone in these demands; politicians and executives worldwide are recognizing the need for new approaches to their trading relationships - approaches that deliver transparency and control, but which do not stifle innovation and creativity.

There are many reasons why change is difficult and risky. There are many good excuses why now is not quite the right time to question the status quo. And there are many contracts and commercial groups which wait until it is too late and find that change is thrust upon them.

Today we see a strong growth of executive interest in the areas of commercial policy, contract practices and relationship management. Volatile economic conditions have made speed and flexibility of much greater importance. Innovation remains a buzz word because it is important to establish areas of competitive difference. And trading relationships are becoming more complex and inter-twined, as recent incidents such as Goldman Sachs and the Gulf oil spill so clearly illustrate.

At times like this we face a remarkable opportunity to demonstrate our value to the business. Innovation is driven by a culture of continuous improvement. It is quite evidently not a characteristic of those who simply maintain the status quo. Nor is it a characteristic of those who focus only on operational deal-making. We may indeed be innovating in the context of a specific contract - but is it replicable, sustainable, visible?

The contracts community - lawyers, commercial staff, procurement - is commonly perceived as providing a worthy service, but we are rarely accused of being radical change agents or risk-takers. In fact, we are too busy doing the same things time and time again to become more strategically involved with the business. And if you don't believe me, just look at the most recent Top Negotiated Terms study - and you will find a list largely unchanged for the ninth successive year. Creative? Innovative? Or stuck in a rut?

Procurement has made great strides in bringing discipline to spend management. Contract Management groups have overseen similar improvements in corporate standards and discipline. But where next? Control and compliance provide a platform for managed change - they are not in themselves radical or sustainable sources of competitive advantage.

Our conversations with IACCM members and with their executives, plus the findings from our research programs, clearly show that we face an unparalleled opportunity to make a real difference. Terms and conditions, contract structures, and commercial policy and process have moved to the core of the change agenda. IACCM is the only organization that has applied relentless focus in this area for the last ten years - building data, understanding best practice, creating assessment and benchmarking tools and models, delivering education and certification. 

There are many reasons why change is difficult and risky. But there are many more reasons why failure to change is even more risky. If you are serious about a change agenda, IACCM can help you get started and support your journey.  


IACCM Excellence Awards

At the recent IACCM conference in Orlando, the Association acknowledged achievement by two of its leading Corporate Members. The Awards Ceremony took place at a Gala Dinner generously hosted by Upside Software and introduced by Upside CEO Ashif Mawji.

In 2008 and 2009, IACCM undertook global member surveys to identify the companies 'Most Admired' for their performance in Contract Management and Negotiation. The objective process that was followed truly represented a peer review system in which thousands of contracts, legal and procurement professionals participated, nominating many hundreds of companies with which they have interfaced.

Our study resulted in publication of the companies 'most admired' in post-award contract management (2008) and negotiation (2009). The tables distinguished whether the achievement was for buy-side or sell-side performance. IACCM also undertook in-depth interviews with the high performers and published reports to explain why these companies had fared so well.

Earlier this year, all the results - from both surveys, and covering both buy and sell perspectives - were consolidated to produce a chart of the highest performing organizations. IBM Corporation emerged as the overall winner of our first Global Excellence Award. Accepting the award on behalf of IBM, Vice-President of Global Services M.C. McNeill paid tribute to the work of her colleagues in making this achievement possible and especially the contribution of the team led by IACCM Board Member Melinda Wilkins, who unfortunately could not be at the ceremony. She highlighted the underlying work of bringing discipline to the contracting process and the commitment to continuous improvement that is fundamental to IBM's commitment as a 'learning organization'.

This issue of continuous learning lay behind our second award of the evening and this was to Chevron Corporation for their 5 years of partnership with IACCM in training and development. During that time, almost 500 Chevron procurement and contract management employees have successfully completed the IACCM skills assessment and Managed Learning program, emerging with certification standards. However, as IACCM Vice-President Paul Mallory pointed out, this learning program has proven to be a two-way process. The creative ideas generated through our work with Chevron Global Learning and Development Manager Tom Crimi have resulted in continuous improvement in the learning concepts and methods. As a result, program participants worldwide - and from more than 150 top corporations - have benefited from a program that truly represents 'best practice' and generates learning at individual, team and corporate levels, plus providing continuous feed-back to the experts and developers at IACCM.

Tom Crimi and Ken Riley, General Manager of Supply Chain Management at Chevron Global Upstream & Gas, accepted the award and acknowledged the role that the IACCM learning program has played in raising Chevron's contract management competencies to the top of the petro-skills charts. Tom expressed his appreciation of the spirit of partnership between the two organizations and commented on the many enhancements that have emerged during our years of working together.


Have an Economist Negotiate Your Next Contract

Adrian Gonzalez makes a compelling case for new thinking in the way we structure and negotiate our contracts. Adrian Gonzalez, ARC Advisory Group

I’ve been on a Depeche Mode kick the past few days. This happens to me at least twice a year, where I just can’t get enough (pun intended) of their songs. One of my favorites is “Everything Counts,” a song I’ve lost my voice singing countless times at their concerts. The song begins with these lyrics:

The handshake sells the contract
From the contract, there’s no turning back
The turning point of a career…

Since 1981, Depeche Mode has sold over 100 million albums and singles worldwide, a career that began with a simple handshake agreement. As detailed in the book Stripped: The True Story of Depeche Mode (Jonathan Miller, Omnibus Press, 2003), the band turned down lucrative offers from large record labels and went with Daniel Miller at Mute Records, a relatively new and small label. Here is an excerpt from the book:

"To give Daniel Miller credit, the initial one-off deal he offered Depeche Mode was very fair indeed—all the more so since it was consummated with a simple handshake; no written details; no formal contracts. “It’s basically a 50-50 deal, so Mute put up half the cost for the recording, manufacturing, and everything else,” Vince Clarke [a founding member of the band who is no longer with them] openly clarified. “Then the record is put on sale, and, after paying off all the expenses, whatever’s left—the profit—is split 50-50…”

The big record labels offered the band lots of money, but with a price: bureaucracy and limited control. Daniel Miller offered something different: a flexible relationship where both parties shared risks, rewards, and interests. I wonder where Depeche Mode would be today if it had “lawyered up” and taken the traditional contract negotiation path?

The International Association for Contract and Commercial Management (IACCM) conducts an annual study each year of the contract terms most frequently negotiated in business-to-business transactions. Its 9th Annual Report indicates that “risk allocation and avoidance continue to dominate interactions during the negotiation of formal business-to-business agreements.” Some of these terms include Limitation of Liability, Indemnification, and Liquidated Damages.

According to a recent IACCM report, Contract Negotiations as a Source of Value: "Much of our negotiation appears driven by classical legal theory that is based more on transactions than it is on relationships. Classical law assumes selfishness and that economic interest is “best served by looking after yourself, at the expense of other parties.” This assumption encourages an attitude that approaches negotiation deal by deal, rather than seeking or observing patterns or examining the potential management of risks across relationship portfolios".

Economists have move moved beyond this point, with their understanding that people and organizations are in fact able to grasp the benefits of cooperation and team behavior. The law is struggling to catch up and still appears to believe that the best way to manage risk is to allocate it to someone else and the greatest incentive to perform is via threats of dire punishment for failure.

As Steve Banker highlighted in “Winner of Nobel Prize in Economics On Outsourcing and Supply Chain,” economists like Oliver Williamson have a more enlightened and scientifically-grounded approach to structuring win-win business relationships than lawyers do. Economists understand vested outsourcing (aka performance-based outsourcing), while lawyers get paid to make sure the other side always has more to lose.

It might take more than an handshake to sell a business contract these days, but the more should be focused on defining a shared vision statement, on developing a joint business plan, and on creating an economic model that benefits both parties rather than spending valuable time drafting pages and pages of “cover my ass” terms.

The ironic thing is that the people sitting at the negotiation table already know this, yet they lack the will, power, and incentive to go against tradition, to go and knock on their boss’s door and make the case for change.

The grabbing hands grab all they can
All for themselves – after all
It’s a competitive world

So continues the rest of the Depeche Mode song, and so continues the negotiating philosophy most companies still subscribe to.

It’s time to listen to a new song.

This article is taken from Logistics Viewpoints (http://logisticsviewpoints.com/) and reproduced with the permission of its author.  Adrian Gonzalez is Director of Logistics Viewpoints and part of the Supply Chain and Logistics consulting team at ARC Advisory Group (www.arcweb.com). Adrian has authored many market research and strategy reports and has managed consulting projects for manufacturers, logistics service providers, and other clients.



Pricing In Partnership and Innovation

I want to share with you a pricing model which will hard-wire partnership and innovation into your outsourcing deal, but to do so I first need to build the foundations by putting a couple of pegs in the ground and so a couple of questions to start with... Ian Deeks, Director, Ten Squared Limited
The Foundations
I want to share with you a pricing model which will hard-wire partnership and innovation into your outsourcing deal, but to do so I first need to build the foundations by putting a couple of pegs in the ground and so a couple of questions to start with.
Would you enter into an outsourcing arrangement if the service provider could not deliver some incremental value, be it in terms of cost, efficiency, access to skills, transfer of risk, etc.? Clearly not. You would only enter into a deal if the service provider could offer some incremental value, although that value may come in many different forms.
Would a service provider enter into an outsourcing deal if the pricing covered only its costs, that is, it didn’t deliver an anticipated profit? Again clearly not. The service provider will seek to make a financial or other profit, albeit that that profit may be back-ended.
What drives people and corporate behaviour? Economic incentives. As Steven D. Levett and Stephen J. Dubner say in their highly acclaimed book, Freakonomics:
“Morality ........... represents the way that people would like the world to work – whereas economics represents how it actually does work.”
So we need economic incentives which drive a service provider and a client to work in partnership in an innovative way.
Should the service provider be paid dependent upon the value of the business benefit which he undertakes to deliver to the client? Clearly so. This is a ‘no brainer’.
In a business service outsourcing, is it the service provider which delivers 100% of the business benefit? Clearly not – the client needs to integrate the service provider’s output into the client’s business in order that the benefits are achieved. Take the simple example, which I’ll use throughout this document, of a service provider committing to deliver an automated payroll service to a client which had until now self-operated a manual payroll system: the benefits of the new service would only be realised if the client changed its business processes to accommodate the service.
So, if it is down to both the client and the service provider to deliver the business benefit, how much of the net overall business benefit (i.e. gross business benefit less the parties’ costs to deliver it) should the service provider receive as its reward, that is the price? Clearly the supplier should only receive reward in line with how much of the business benefit it was ‘responsible’ for. In commercial parlance, ‘responsibility’ is ‘risk’. And so the answer to the question is that the service provider’s share of the overall business benefit should be tied to the proportion of the overall risk that the service provider bears.
What if the overall business benefit is less than the aggregate of the costs of the client and the service provider in delivering that benefit? Clearly the parties would not wish to proceed if this were the case. There needs to be net incremental business benefit to be shared for the trouble of managing the risks in delivering it.
Distilling the above points, the basis becomes clear for determining the price the service provider should be paid for its contribution to the generation of incremental business benefit for a client. It clearly needs to recover its costs and to make a profit. The question is ‘how much profit’. From the above it is clear that this profit should equate to that percentage of the net overall business benefit which it took the risk to deliver.
If I am right in this assertion, how much of the overall business benefit is left for the client to enjoy? Doing the maths, it’s clear to see that the residual business benefit, after deducting the supplier’s price, equates to the amount of the client’s costs plus that percentage of the net overall business benefit which it took the risk to deliver.
One further point: in order for the parties to mutually decide whether to go ahead with the initiative, they need some certainty as to their rewards if things go as anticipated. Accordingly, the thinking above determines the fixed price which the service provider will be paid for delivering its side of the bargain, if of course the parties agree to proceed on this basis. This price, and consequently the client’s residual business benefit, is therefore based upon anticipated, not realised, business benefit. Having said that, there is no reason why the parties could not continue to work together in the same way during the delivery phase to drive out further business benefit via opportunity management, and to share the rewards in a similar way. But this is the subject of a further document.
I suggest that the symmetrical nature of the parties’ respective rewards proves the commercial equilibrium of the thinking and thus its validity.   The approach also aligns with common sense. This thinking is proposed on the basis that either party should be entitled to withdraw without penalty at any stage prior to the fixed price being agreed.
So the thinking leads us to a formula for setting the fixed price for an initiative. It is:
Fixed Price = Service Provider cost recovery + (Service Provider %age Risk x Net Business Benefit)
And for completeness, the client’s residual reward is:
Residual Reward = Client cost recovery + (Client %age Risk x Net Business Benefit)
The Dynamics and Outcomes
Clearly neither party is in business to make a cost recovery. And so, if this approach is adopted then both parties are incentivised to:
·        Identify as much incremental client business benefit as possible; and
·        Take as much risk as will deliver a positive result.
These dynamics drive many positive outcomes, including the following:
·        Partnership: With both parties being incentivised to identify as much incremental client business benefit as possible, there arises a true partnership between the client and the service provider, that relationship being based upon cold commercial fact.
·        Innovation: In order for the supplier to be able to identify additional business benefit for the client, it will need to be innovative. This is contrary to the traditional outsourcing models which encourage stabilisation and commoditisation.
·        Business Understanding: If the service provider is to identify business benefit for the client, it needs to understand the client’s business intimately. 
·        Trust: If the service provider is to understand the client’s business and if both parties are to understand how much risk each is to take, then there needs to be lots of very open conversation. This in itself will foster trust which will strengthen the partnership.
·        Business Level Focus: The traditional outsourcing model focuses upon the function being outsourced, for example IT which typically represents 2% of turnover. Because this approach is ‘business benefit’ focused, 100% of turnover is the scope of the focus. The potential rewards are consequently considerably higher.
·        Optimum Risk Sharing: Both parties are rewarded directly dependent upon how much risk they agree to bear. Consequently, both parties will want to take as much risk as will deliver a beneficial outcome. The parties therefore will only seek to transfer risk if the other party is able to manage that risk more cheaply than they can. This results in an optimal risk sharing position and thus a lowest overall cost of risk, which in turn maximises the net overall business benefit.
Implementation - the Difficult Bit!
As outlined above, the benefits to be had from successfully implementing the model are huge and to-date unachievable. There are however high, albeit not insurmountable, hurdles to be overcome, because the approach to working together in the way suggested is counter-intuitive to some of the stakeholders on both sides of the fence. What is required is a high level of executive leadership to lead both organisations by example and to whip into line those endangering the open working relationship required.
Even given executive leadership, implementation will not be easy, because the approach requires a rigid and (surprisingly) novel approach to developing business cases for individual initiatives. These business cases however provide the input to the formula for determining the service provider’s fixed price (and by corollary, the client’s residual business benefit).
The approach itself is very simple and, because of its simplicity, is very transparent, thereby making it very easy to understand how a particular outcome was reached. This facilitates simple re-work and ‘what if’ modelling to be undertaken.
The approach consists of simple logical steps, as outlined below. Progression to the next step only occurs if or when the parties agree the outcomes of the current step.  This means that if the parties cannot agree on a step, then the initiative is dropped. The logic behind this is that the parties will come to agreement if they both foresee good net business benefit in which they will share, but will conversely not agree if either one or both of them do not believe that the initiative will deliver net business benefit: in summary, common sense will prevail.
In diagrammatic form the approach looks thus:

Looking now at the individual steps of the model:
·        The first step is for the parties to agree the nature of the additional benefit which will be generated if the customer’s request or the supplier’s proposal is implemented. Using the payroll example quoted earlier, the benefit may be in the form of cost savings and staff satisfaction, for example. If agreement cannot be reached on this, then it is clear that the initiative should be dropped: this rule similarly applies at each of the stages of the model, the basis being that a lack of agreement indicates that one party is not convinced that the initiative will deliver benefit, or enough of it.
·        The next step is the acid test: what is the financial value of this benefit? The tangible benefits, such as cost savings, are easy to value, but the intangible benefits are less so. However, if the intangible benefits are real, then they should be capable of valuation. For example, increased staff satisfaction would manifest itself in lower staff attrition and therefore lower recruitment and training costs. Note though that business benefit is not only cost saving: it could also be additional profit earning potential. Some may argue that the supplier is likely to ‘over-egg’ the value of the benefits, whilst the customer is likely to do the opposite: both run the risk of killing off the initiative by so doing and therefore forfeiting all potential benefit if they take polarised and unreasonable views and so commonsense should prevail.
·        At this stage the parties should jointly specify the requirements for the overall project, including its integration into the customer’s business. This should be done in sufficient detail for contract purposes so as to avoid scope or interpretation issues in the future.
·        The next step is relatively easy if the preceding step has been properly undertaken. It entails allocation of responsibility for each element of the specification between the two parties.
·        The allocation of responsibilities lends itself to the parties undertaking a holistic risk review of the project, which should result in the determination of the overall cost of risk (impact x probability) and each party’s share of the cost of risk. The individual parties’ cost of risk is also an input to the next stage.
·        The allocation of responsibilities likewise prepares the way for the parties costing their responsibilities. Once again it could be argued that the parties are likely to over-state their costs: so doing jeopardises the initiative, because it will potentially result in a negative net benefit and/or it could potentially result in the parties failing to agree on the costs and thus the initiative being shelved. Arguably, therefore, there are the right incentives for the parties to take a reasonable stance if they perceive that there is real benefit to be had from the initiative.
·        The final step in creating the inputs to the reward formula is a purely mathematical one, namely calculating the net benefit by subtracting from the value of the overall benefit the parties’ overall costs of delivering it.
Following this approach we now have the input to the formula which it was earlier proposed be used as the basis for setting the service provider’s fixed price for the initiative, namely:
Fixed Price = Service Provider cost recovery + (Service Provider %age Risk x Net Business Benefit)
There is nothing to lose from experimenting with the model suggested. If successfully implanted, it will genuinely deliver a partnership-type relationship, as well as innovation. It additionally provides a transparent, pure-play risk / reward model and various other benefits, as outlined earlier. To reject it outright would be fool-hardy.
The model proposed is a basic one. It would be perfectly acceptable for those implementing it to add ‘bells and whistles’, such as setting upper and lower thresholds on net business benefit. However, the underlying concept of allocating reward based upon risk taken should not be compromised.
The model will not be accepted by every customer and supplier, because, for it to be accepted, there needs to be an element of trust between the parties or at least an absence of mistrust. This will not always be the case unfortunately. However, if the initial hurdle of accepting the model can be overcome, the prospects of growing the trust will increase dramatically.
Good luck!
Ian Deeks
Director, Ten Squared Limited
Copyright Ten Square Limited 2010

Selecting The Best Supplier: The Use Of Discriminant Analysis in the Contracting & Procurement Function

The recession has caused many organizations to look carefully at their credit scoring and supplier evluation processes. Alejandro Salazar, who is with Shell Engineering & Production, shares a method to better assess the risk of insolvency. Alejandro Salazar, CP Systems and RtP Representative, Shell Exploration and Production (SEPCo)

Every day, and particularly in times of recession, markets are becoming increasingly competitive. This is an important reason for buyers or category managers to make sure that they select the best suppliers - not only in terms of total cost , but also in terms of on-time performance and quality.

Contract risks exist in practically all economic sectors; although only a few contracting and procurement (CP) organizations generate plans or perform rigorous evaluations to minimize risk. One of the main challenges in CP is to avoid interruptions in the services performed by their suppliers. Therefore, the CP professional needs to evaluate each potential company that might form some kind of contractual agreement with them. From a technical point of view, there are several elements - certifications, tangible evidence, site visits, etc - that can help the contracting organization to minimize a potential breach of contract. This is not the case when we consider the financial side.

Despite many organizations including an evaluation of the bidder’s financial statements and financial ratios as part of the technical evaluation in a tender process (so that they can evaluate the bidder's financial health), there is no standard methodology to help quantify or evaluate the bankruptcy or insolvency risk those bidders might have and, furthermore, what the odds are that, once initiated, a contract relationship with that specific bidder may result in a failure to execute.

Discriminant Analysis (about which you can readily discover more on the internet) allows us to build functions (based on information from historic financial statements) that classify companies in predefined clusters. This function calculates a score for each company that is compared with a predictive value (also provided for the Discriminant Analysis), and depending on where that specific score falls, that particular company can be assigned to one of the predefined groups – i.e. a group with risk of insolvency or a group with no risk of insolvency. The score from this function is calculated using the financial ratios (independent variables) that contribute to the classification of the aforementioned clusters. The following function is an example of how this tool can be used.

For market XYZ the Discriminant Analysis was applied obtaining the following results:
S = Score for the “n” Bidder                           S7 = Operating Cycle
S3 = Acid Test Ratio                                        S8 = Total Leverage
S6 = Working Capital Turnover                      0,14 = Constant
Predictive Value: 19.4
Then, if the score for a particular company is below 19.4, this organization will be classified within the insolvency risk group. On the other hand, scores above the predictive value will categorize companies within the non-risk group. The function and the predictive value are valid only for market XYZ and should be updated with new historic data periodically to guarantee accuracy in the categorization. 
The category manager may use this valuable information in a pre or post award contract phase:
a) Using the bidder scores as part of the evaluation analysis in a tender process (i.e. assign weights depending on the value each bidder obtained) or;
b) Use it as a monitoring system for current suppliers for which the company already has contracts in place, so that the contracting company can anticipate any risk situation with that particular supplier and take preventive actions to avoid or minimize a potential service disruption.

No matter how the tool is used, it will provide consistent and accurate information of a company financial health at any point of the procurement process, providing the CP function professional with an additional and statistically correct option to evaluate or monitor their suppliers.

Going forward, the same analysis could be applied to other areas of the CP function, building predictive models that categorize, for example, on-time delivery suppliers vs. suppliers with recurrent delivery delays. The possibilities are countless and the tool is already there to be used.

Information about discriminant analysis can be found in any advanced statistics book. The process itself or calculations can be done using most of the statistical software available in the market (i.e. SPSS, Statistics for windows, SAS, etc).

Alejandro Salazar is an engineer and MSc in Business Admin by background. He is currently working as CP Systems and RtP Representative, Shell Exploration and Production (SEPCo). He can be contacted at salazaraea1@hotmail.com


IT Procurement Returns To The Front Line

IACCM has observed growing focus on IT Procurement skills and organization. This article explores the factors that are driving renewed interest. and highlights the topics that are of greatest concern to the IACCM IT Procurement community.

Several years ago, the hot issue for IT Procurement was whether or not it should be consolidated within the general procurement organization. The development of category management resulted in many specialist IT Procurement groups being swallowed up. While CIOs may not have been enthusiastic about losing their dedicated resources, most understood the business logic.

Today, we are seeing counter-arguments and a growing number of CIOs are appointing dedicated procurement and commercial staff within their organization. Sometimes they are fighting to reclaim the relevant category management teams; in other cases, they are looking to supplement these resources. In all cases, the driver seems to be a recognition that IT service delivery depends less on technical know-how and more and more on commercial competence. A CIOs success is increasingly measured by their ability to select and manage the right supply base.

Contract management, performance management and relationship management are critical issues in this new IT delivery environment. CIOs have regularly been exposed to the challenges of managing outsourced providers, so they know from experience how important it is to ensure accurate scope and goals, to respond to changing user needs and to ensure stringent performance oversight. Now, with the advent of cloud and mobile computing, there is every likelihood that the residue of technical and facility management will move to external providers - and hence the CIOs success will depend on their ability to select the right partners and manage their performance, while also retaining the ability to manage change through versatile terms and relationships.

IACCM has written about this trend several times over the last year, but a couple of months ago we decided that it was time for action. Our IT Procurement 'community of interest' has almost 2,500 members, so we recruited Bill Huber (former IACCM Chairman and today Director of CPO Services at TPI) to lead group discussions on some of the key issues. We started by running a survey that asked our community members to rank their priorities.

As the graph shows, Cloud Computing is the number one issue, but closely followed by the challenges of relationship and performance management and the question of skills and training. Illustrating the point that software is very much the issue of the future, interest in 'the cloud' was supplemented by the broader question of software asset management.



IACCM has of course undertaken extensive work on the skills profile for IT Procurement and its assessment tools are in strong demand. Our Managed Learning tools are also very relevant to the training needed by groups that increasingly need contracts, commercial and relationship knowledge in order to oversee supplier negotiations and performance.

Whether or not the trend towards organizational change continues, it is very clear that the need for skilled contract and relationship professionals in the IT and services procurement field will continue to increase. This represents a strong area of opportunity - and one that is increasingly urgent.

IACCM members can join the IT Procurement community of interest as part of their membership selections at www.iaccm.com. Participation in the community conference calls, webcasts and surveys is free to IACCM members.


Moving From Spend Management to Value Management

To start this discussion, we need to differentiate these two phrases – Spend Management and Value Management. We can look at a very common example - local shopping for groceries. Around our neighborhood, we have several grocery stores. One is at the low end with – generally – the lowest prices on most items. When I shop there, though, I have to check expiration dates and there’s nobody in the aisles to help me. Every time I shop there, I’ve had to stand in long checkout lines and watch the price register to make sure the marked prices are correct. Overall, I spend less at this store than any other store. Sharon Horton, PMP, Senior Consultant, Ariba
To start this discussion, we need to differentiate these two phrases – Spend Management and Value Management. We can look at a very common example - local shopping for groceries. Around our neighborhood, we have several grocery stores. One is at the low end with – generally – the lowest prices on most items. When I shop there, though, I have to check expiration dates and there’s nobody in the aisles to help me. Every time I shop there, I’ve had to stand in long checkout lines and watch the price register to make sure the marked prices are correct. Overall, I spend less at this store than any other store.
At the top end grocery store in the area, the prices are – generally – higher, but their sales are better. If I plan a little for my shopping according to sales, I can actually come close to matching my low-end store spend. There are always people in the aisle restocking during the day, but they’re also available to help me with questions.  If there are more than two people in the checkout line, they open another line. If they need another bagger, a manager will step in. They will cut my meat to order and help me to my car. In ten years of buying groceries here, I’ve paid a little more, but I’ve never had an expired product and if I find a bad price, which doesn’t happen often, I get the product for free.
So, if I kept my eye on the Spend only, I would shop at the low end grocery store and save every week at the register. However, customer service, product management and pricing accuracy create Value for me in my shopping experience. Needless to say, I shop at the top-end store – with my coupons and my sales fliers in order to close the gap in Spend.
What does this mean to us in the business world? So often, the relationship between buyer and seller is managing Spend - the buyer negotiates to get the lowest price and the supplier negotiates to get the highest possible. Does this foster good relationships? Unlikely. More often than not, the relationship that evolves is one of constant battles where the buyer negotiates the contract in a hostile environment and then must watch every transaction to make sure that there is no savings leakage. Would it surprise anyone that these are relationships where there are quality and service problems? And, in defense of the supplier, how can they provide the lowest price and apply the resources for good customer service and quality?
So, although there still is a role for spend management, the New Normal goal is to optimize for Value – control spending, but include quality and service.
Relationship segmentation
How do we get to this Value Management? Should we make this a priority with all our thousands of suppliers? Of course not - there’s probably not enough time in the year for that. So, some sort of relationship segmentation is required. 
One approach is to create a Relationship Matrix. And, this Relationship Matrix can be quite simple, as in Volume of Spend plotted against Criticality of the Product or Service. 
Volume of Spend is usually simpler to figure out. If you took your invoices from suppliers last year, you’d be pretty close to being able to plot this axis. Sometimes Volume of Spend needs work and clean-up because suppliers have subsidiaries, they have different names and vendor numbers in your ERP. However, if you looked at your top twenty percent of spend, you’d probably find most of the suppliers that you wanted to manage by spend.
Criticality of Product or Service is where you would need to some subjective assessments. Several different items might go into this dimension. Here are some suggestions:
-       How critical is this product to our business?
-       Does this product span multiple business units?
-       How long would it take to replace this product?
-       How long is our contractual relationship with this supplier?
-       How many products and services does this supplier provide?

Having determined each vector, suppliers can then be placed in the appropriate sector. The majority of the effort will then be spent in the Value Management sector.

What is the Changing Role of Procurement?
What role can Procurement serve in ensuring that Value is the top priority? One of the most important changes is to change the goals and measures set for Procurement success. If savings and speed to contract remain the only measures of Procurement success, it will be hard to alter the Spend Management philosophy. However, Procurement can take the lead in establishing its new role, one in which Value Management is at the forefront. 
The first step is to define the desired characteristics. What would be most helpful in the relationship with our suppliers? Here are some suggestions:
-       Flexibility in the relationship
-       Cooperative and responsive to requests of all types
-       Available for meetings or other requests
-       Access to new ideas, new products, new services
-       Top notch account representatives assigned to our account
-       Access to innovations, whether in a product, service or new ways to do business
-       An open and honest relationship where both parties bring ideas and cooperation to the table
Having established the “what”, the next step is to make sure that the relationships are built into the sourcing process, meaning that we select the right suppliers, negotiate the right deals and that the right values are built into the relationship from the start. 
Finally, we need to make sure that the value doesn’t slip away during the term of the relationship. Both sides need to be measured on how well they live up to their relationship. Suppliers will continue to be measured on their relationship commitments, but we need to make sure that we enable that relationship and don’t fall back into our Spend Management ways.
The New Normal says we just can’t afford to do business the way we have for the last hundred years. Our relationships need to be cooperative, not adversarial. We need to be flexible and responsive and we need to have relationships with our suppliers that are equally as flexible and responsive to a rapidly changing business environment. Let’s have a customer-supplier relationship that is like that top notch grocery store described in the introduction – let’s have a Value based relationship.
Sharon Horton, PMP, is a Senior Consultant with Ariba’s Best Practice Center with over twenty five years experience in procurement and supplier relationship management. Sharon has worked with many Fortune 100 companies establishing procurement and contracting goals and practices.


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