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

Contracting Excellence Magazine - Jan 2011

 
 

 

A New Year ... And Some Outstanding Challenges

 
There are some issues and challenges that simply do not go away. Unless market volatility reduces dramatically, a number of them seem set to dominate discussion in 2011. For this edition of Contracting Excellence, we have decided to highlight the ten articles from the IACCM blog, Commitment Matters, that were most read in 2010. They represent topics and themes that remain at the forefront of debate and planning for our community - and in many cases, for executive management.
 
 

In fact, by far the most read article remains 'The Role Of Contract Management', a two-part blog which was written in 2008 and 2009. Since then, it has attracted over 20,000 viewers, with some 6,500 last year. This reflects the continued interest in the precise position and contribution of a contracts or commercial function.

Given the numbers who have already read these two core articles, they have not been included in the selection for this newsletter. However, both remain accessible at tcummins.wordpress.com/2008/08/11/the-role-of-a-contract-manager/ and http://tcummins.wordpress.com/2009/04/14/the-role-of-a-contract-manager-revisited/.

Many of the 'most read' articles build on the themes related to organizational role. They cover topics such as reporting line, performance measurements and empowerment. But there is also wide interest in the extent to which practitioners should influence corporate or organizational policy and whether the role of the contract itself is changing.

These debates show no sign of lessening in 2011. Indeed, with the immediate operational challenges of the recession hopefully behind us, there is reason to believe that many of these more fundamental questions of role and value - and how best to achieve them - will rise even higher on the executive agenda.

Therefore this edition of Contracting Excellence seeks to provide ideas and answers, as well as stimulating debate. The Commitment Matters blog offers chat forums for the exchange of ideas; and the IACCM website forums are the perfect place to pose your questions and generate both feedback and discussion.

At a time of change, it is critical that the professional community unites to share its experiences and to undertake the type of research that enables it be proactive in the face of executive and business needs. These forums - together with member meetings and conferences - can equip the leaders of today and the future. I hope you will invest a few minutes to read this content - and perhaps contribute your own thoughts and ideas.

The Commitment Matters blog (which contains around 400 short articles on topical issues) can be accessed at http://tcummins.wordpress.com. The IACCM community forums are at www.iaccm.com, in the section Forums & Networking.

 
 

Who Owns Contract Management?

 
With almost 2,000 readers, this blog (posted in March 2010) sought to answer the question 'Should the contracts group report to Legal?' In 2010, we saw continuing uncertainty over reporting line reflected in a significant number of switches - some to Legal, some to Finance and some to stand-alone functions. In the end, does reporting line make a big difference?
 
 

Over on the IACCM message board, a member has asked the question: “I am an attorney in the legal department who supports the Contracts Management Group who report to a business/procurement manager. I am trying to find out if most companies have the contracts group separate from the legal group, or if the contracts group is a part of the legal group. And, if the contracts group does not report up through the legal management chain, how do you handle contract negotiations, administration and management with the group?”

Of course, this is not a new question – but it does seem to be rearing its head with greater frequency right now. As I have observed in various articles recently, business conditions are placing real strains on the contracting process in most organizations. On the one hand, there is pressure for greater control and compliance; on the other, there is the need for increasing agility and the ability to remain flexible. And of course, there is the vivid memory of the recession and the scramble to renegotiate contracts, which bruised many and left others feeling exposed when they discovered the types of agreements they had in place (assuming, of course, that they could even find the relevant contracts!)

These factors have alerted executives to the weaknesses in their contracting process. It has caused internal frictions over control and ‘who is the blame?’ There is debate over the reasonableness of terms and conditions and about the time it takes to make decisions or reach agreement (internally and externally). None of these characteristics is acceptable in fast-moving market conditions.

But what change is wise? The problem is that contracts require balance. They must enable internal business goals and objectives while at the same time responding to the needs and expectations of customers and suppliers. They are instruments of governance that are designed to secure economic benefit. With so many stakeholders having a legitimate interest, they can rapidly become a battle-ground for control, with the most powerful function simply seeking to impose its will. On the other hand, few stakeholders are in fact equipped to represent the holistic needs of all affected parties – so often they turn to legal because no one else wants to carry the baby.

So how should an organization decide where contract management ought to belong? Here are a few ideas – and I will welcome additional comments:

  1. Give thought to the nature of your business and the scope of the contract management role. For example, contract management in a commodity business is very different from the role in a high value project business. Maybe your company has a mix of contract types – in which case it may need a mix of organizational answers.
  2. Who is willing to take accountability for the quality of the contracting process? Make sure that you have assembled the criteria that represent ‘success’ and then determine who is willing and able to commit to its delivery. For example, is the aim to be ‘easier to do business with’?. Is it about increasing the quality and outcome from negotiation? Is it about shorter cycle times? I s it about greater business control? Is it about increased competitiveness? Without broad agreement about what you want to achieve, there will be continued arguments and failure.
  3. Who has the right skills today, or is prepared to invest in their development (and associated tools and systems)? Contracting is complex and in today’s markets it must remain a focus area. If the prospective owner wants to grab control because they think they will have a quieter life, or can suppress workload, they should think again. Contracting is set to remain a dynamic discipline, as more and more deals and relationships require active life-cycle management. 

In my experience, world-class contracting depends far more on the integrity and quality of the process than it does on who owns it. So my recommendation is to first focus on ensuring the process supports the goals and relationship needs of the business. Then from this process, the primary skill and knowledge requirements will become evident and potential organizational alignment more obvious. At the very least, whoever steps forward for ownership then has a clear understanding of what they are taking on.

Finally, just because someone owns the resources does not mean they should necessarily own the process. Today’s best performing contract processes operate with a degree of shared ownership where the ‘owner’ is really the first among equals and consults widely and regularly with other key business groups and functions to ensure that contract management continues to meet the needs of the business.

 
 

Contract & Procurement Metrics

 
Close behind reporting line is the contentious topic of metrics. In general, the contract sand legal communities have resisted extensive measurements of their performance, claiming that most aspects are outside their direct control. Such an argument misses the real point - and the opportunity to become more influential within the business.
 
 

The subject of cycle times is – quite rightly – a source of regular debate for our community. After all, one of the most common user complaints is that we are too slow, that the process takes too long.

“Ah yes”, is the regular response, “but the cycle time is out of our control”. A recent IACCM member question gave a couple of excellent examples: “Naturally there are numerous factors to be considered during the process, including but not limited to, should long periods of inactivity from the Supplier be included within the measurement, should scope changes reset the clock”.

Similar comments come from sales contracting groups, with the customer of course depicted as the culprit.

These attitudes miss the point of benchmarking – and represent a lost opportunity for contracts and procurement groups to show their value to the business. The issue here is that time equals lost opportunity and increased risk. As I observed in my reply: “In the end, the factors you mention are part of the process and like other steps, they must be open to improvement. But of course they will not be improved unless they are measured, so I strongly recommend that you treat these ‘exception areas’ as the red herring that they are. The cycle time is the cycle time. If it turns out that supplier delays are making you uncompetitive or unresponsive to business need, you should be thinking how to fix this quality problem, not to use it as an excuse for poor performance. For example, what is to stop you adding a ‘speed of response’ metric into your bid criteria? This is, after all, an important issue; if suppliers really don’t care to be responsive when they are trying to win your business, what will they be like once the contract is signed?”

The issue of scope changes is also very interesting. Who controls scope? In my experience, it is not usually the contracts or procurement groups. So if it regularly changes (and we all agree that is not a good thing), then why is that happening? Our role should be to force an investigation into the causes of poorly defined scope and to promote improvement. We should be assisting the real culprits to improve – or otherwise highlighting the issue to executive management.

If we fail to grasp opportunities to take ownership and responsibility for business improvement, our value will always be open to question. We will always be the victims of claims by others that WE are the cause of avoidable delay – and no matter how loud our protestations, the mud will often stick.

Other blogs on Commitment Matters (and content in the IACCM Member Library) tackle the question of the broader metrics that can be used within contracts and commercial teams. IACCM is also currently updating data on performance levels as part of its benchmarking survey series. See the news section at www.iaccm.com for details.

 
 

 

Partnering for Performance: the key to our success

Join us for insights into innovation and best practice in contracting, negotiation and relationship management at the 8th annual IACCM Americas Conference.
This year our event focuses on outsourcing and services contracts, and evolving organizational capability. Please note that IACCM will be separately staging its first Global Forum for Contracts and Commercial Management in Arizona, in October 2011, which will be a worldwide, cross-industry event.

Why join us in Orlando?

Engage with experts from the highest performing companies in the world, and discuss the biggest and most current issues that you face every day.
Don't miss the opportunity to network with the creme de la creme of the contracts, procurement and outsourcing world. Collaboration, networking and commitment to professional excellence are the keys to success, so join us as we partner for performance.


 

Contracts & Procurement Experts Beware!

 
This article highlighted the need for contracts and procurement staff to intervene and advise on commercial policy and practice. If our role is indeed to protect company interests and assist the management of risk, we must ensure executives are made aware of the implications of policy and practice changes. The blog highlighted a number of trends being driven by Finance.
 
 

An article in GT News offers valuable insights into the world of accounts payable – and should alert those engaged in contracts to several issues that need our input.

The article discusses the latest trends in e-invoicing and highlights its rapid growth. In the US, there are forecasts that the number of e-invoices will overtake paper invoices in 2011. Many will welcome this development since it clearly represents a source of increased efficiency – for example, it leads to fewer errors and shortens approval times (industry estimates suggest these fall from an average of around 25 days in the paper-based system to just 10 – 15 days).

So suppliers may be excited by the prospect of earlier payments – but they would be wrong. As most know, large corporations have used the recession as a further excuse to prolong the payment term – now running at an average of 56 days, versus 53 days a year ago. So approvals are getting faster while payment is getting slower. And the large corporates are simply piling up the cash.

This is where the story becomes really interesting. The article tells us: “Large companies have emerged from the financial crisis with record levels of cash: the S&P 500 industrial companies increased their holdings of cash and marketable securities to US$820bn, up 27% from a year earlier. What is more, an analysis of the 500 largest non-financial US companies by the Wall Street Journal reveals that the cash to assets ratio has reached 9.8%, up from values between 4% and 6% in the 1990s (a similar study by Goldman Sachs reports a jump from 6% in 2002 to more than 10% today).”

But this windfall for the largest companies is at the expense of many of their suppliers. The SME market has seen a reverse trend. Their cash reserves have fallen and “small businesses are having to pay more to borrow relative to the Federal Reserve’s benchmark rate than at any time in at least a quarter of a century, according to official data from the central bank. Moreover, often credit is not readily available, forcing many SMEs to factor their receivables, frequently at interest rates of 10-20% annually. The worldwide factoring market in 2009 was a stunning US$1.8 trillion.”

So we have a picture in which the largest companies have used the recession to build their war-chests, in part at the expense of their suppliers. And now, armed with this data and all the insights that they are gaining from their new e-invoicing systems, Finance managers see a new opportunity to turn the screw. Rather than thinking about supplier liquidity as a problem, they see it as an opportunity. They are preparing either to offer factoring services, or to increase their use of early payment discounts.

Their new electronic systems offer a far more efficient way to manage such programs, including the ability for selective application or to turn the system on or off depending on cash needs. “The cumulative amount of business-to-business (B2B) invoices approved but awaiting payment has never been higher. These invoices can be used to improve working capital or profits. Upon approval, the buyer can either guarantee payment of an invoice (reverse factoring/supply chain finance (SCF)), or pay the invoice early against attractive additional discounts (dynamic discounting).”

Should those of us in the world of contracting and procurement care about this? Well, as suppliers, many of us will obviously not be happy about this trend and its impact on our business. But those in Procurement should also be asking questions, rather than allowing this financially driven shift to take place by default. In my response to the article, I made the following observation:

“This analysis is typical of that used within the finance community, but ignores the broader economic cost of such policies. First, companies pay a premium when they delay. Suppliers are not stupid – they mark up their price to take account of the delay or to cover the early payment discount. Second, such behavior by large corporates jeopardises the performance (and sometimes survival) of their suppliers. This can have significant downstream consequences as suppliers struggle to cut corners and cut costs. Smart finance experts also examine the broader business consequences of their behavior.”

Just because we can do something does not necessarily make it right or make it wise. If you work in a large corporation, be sure that you are involved in this debate. And if you work in an SME, be prepared; decide now what policies you will put in place to protect yourself from the impacts of this financial engineering.

 
 

Legal & Contract Management Outsourcing

 
Outsourcing is a big issue for many business functions. Legal and Contract Management have been relatively immune from this trend - in part because their processes are so poorly defined. Yet far from being a threat, outsourcing can in fact prove extremely liberating for those groups that welcome the opportunity it brings to become less tactical and more strategic in their operations.
 
 

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.

 
 

The Purpose Of A Contract

 
The diversity of views about the purpose of contracts helps to explain many of the uncertainties over the importance of contracting resources, process and organizational position. This article - and the comments it induced - illustrates the various roles that a contract can play. It suggests that business leaders should be clear about the purpose they wish their contracts to fulfill, since lack of clarity inevitably leads to a lack of quality in this key aspect of business performance.
 
 

Today I attended a presentation on 'quality by design', delivered by Rebecca Vangenechten of Siemens Life Sciences.

The session got me thinking about how we would embed quality by design principles into contracting. And I realized that there is no consensus on what 'quality' means in terms of a contract. Is it to do with design and layout? Completeness? Legibility and clarity? Its effectiveness in protecting the drafter? The extent to which it generates successful results? And without knowing quite why we are doing it, how can we be sure that what we are doing is of real value and quality?

So I have a challenge for you. Without any sense of what is 'good', we cannot determine whether a contract – or the contracting process – is 'fit for purpose'. And that seems to me a serious omission. It also explains why we struggle to demonstrate and describe the value of the contracting process. I need your help in fixing this problem.

It is time for the contracts community – contract managers. lawyers, sourcing professionals – to define what 'quality by design' means when it is applied to contracts. To get us started, I posed the following question to some of IACCM’s senior members:

"I am listening to a presentation on quality by design and it strikes me that it would be very helpful to apply that concept to contracts.

However, to do so we must define what we mean by 'quality' in the context of a contract. In most cases, quality is determined in the context of outcomes or outputs. What do you think these are in respect of a contract; for example, the avoidance of unpleasant consequences? The enablement of a successful trading relationship? ...

If we can agree quality indicators, we will be able to determine appropriate measurements that in turn could drive benchmarks and improvement.

So what are the quality indicators for a contract, in your mind?"

I received a couple of answers and they illustrate why this should be a key issue for us. I share these inputs with you – but please add your comments so that we can consolidate the thoughts of our community and develop an answer to the very important question 'What is the purpose of a contract?'

"Quality contracting results in no surprises for either party.  The customer requirements and vendor commitments are fully aligned and both parties have one and same expectation of what contract compliance or fulfillment looks like.  The outcomes or deliverables for the contract (flowing both ways) are objective and measurable.  There is no gray area or white space to be debated at a later time.  New players coming into the engagement mid-stream can read the contract and understand clearly what the obligations and expectations of the parties were at signing and are going forward.

Well over 80% of the disputes and disconnects I see are due to poor scope language.  And that is not just referring to the SOW, for scope requirements can be in any number of documents.  The standard I use is a six sigma concept (at least that is where I was introduced to it) of goals or deliverables being SMART.  SMART stands for deliverables that are

  • Specific criteria for success or compliance — not vague, but focused and clear
  • Measurable — measures that result in any 3rd party, not familiar or close to the deal, can determine objectively whether a requirement has been met or not
  • Aggressive but achievable
  • Relevant to the strategy or goal
  • Time-bounded (there is a due date)

Certainly, most contracts have these characteristics imbedded.  The biggest issues, in my experience, are around S and M of the acronym."

And a member in Italy suggested that: "Thought it is really difficult and it is even down to how we do measure the success of a negotiation.
 
I’ve been pondering what could be an objective criteria of a good quality, though I couldn’t find any applicable world-wide. For instance, let’s consider the number of disputes once a contract has been signed. I’ve been engaged to negotiate a 3-yrs agreement of ca 7$75M USD ending up with terrible Ts&Cs (anyone on earth would have considered of poor quality) though we didn’t have any issue w/ the customer for more than 5 yrs. At the other extent we had a smaller value agreement (ca 25M over 2 years) that was almost including standard T&C for my ex-company: after few months we were close to go to court. In fact the attitude to use contract and to be litigious it really varies from culture to culture….
 
So if anyone has some bright ideas, I will be happy to implement them in my team."

Please add your thoughts. And thanks, Rebecca, for inspiring the question!

 
 


 

Good Contracts Come From Empowerment

 
Most professions struggle with the idea of empowering their clients. The world of legal and contracts is no exception. Yet the availability of on-demand information and training tools and the potential for more automated workflows leaves us with few excuses. And for those who make the leap, the rewards are significant - not least, the opportunity to become engaged earlier in the process and to undertake more valued and more rewarding work.
 
 

A note from IACCM member Leslie Marell reminds me of one of the key characteristics of high-performing legal and contracts groups – their focus on enabling others.

Leslie wrote: “Early on (in my time as an in-house counsel), I recognized that my clients didn’t understand what we were trying to accomplish and that there was great frustration on both sides. I found that if I went to the various company branches/ divisions and explained the underlying concepts and rationales for the clauses – in plain English, and by using real world examples –many of the sales and purchasing people “got it”, (and) … would raise these issues early on with their customers/ suppliers, realizing that doing so often expedited the closing of the contract/ business.”

Helping others to help themselves remains the exception rather than the rule. In many organizations, IACCM research shows that there is a lack of trust and respect between functional groups. The result of this is that cycle times are longer, negotiations less well planned, win rates are lower.

Of course, meaningful empowerment is about more than simply visiting the business units, but good communications is an essential component in building contracting capability. Far too many organizations operate with a culture of blame, rather than a sense of shared responsibility.

If you ever hear (or perhaps utter) sentiments like ‘Those idiots in Sales’, or ‘They always involve us too late’, or ‘If only they had asked me …’, then the chances are you are part of an organization that has failed to reach out and help others become more effective. My experience is that the more we work to empower good decisions, the earlier we are involved and the more productive our work becomes.

And I agree fully with Leslie’s sentiment: “I frankly don’t understand why more of us lawyers/ contracting professionals don’t “reach out” to our clients and help them understand these issues. A basic tenet of any good relationship is communication and taking the time to explain ourselves to the other guy. When that happens, the relationship always improves. ”

Are you doing enough to enable good contracting?

Just as important, I also learned that people were very receptive and eager for this information since they were frequently in the dark about the why and meaning of the clauses. Few, if any, of their legal/ contracts people had taken the time to explain these concepts to them. Once they understood the concepts/ rationales, I found that the lawyer/ contracts / business person relationship greatly improved.

 
 

Why Is Communication So Important?

 
With so many tools now at our disposal, communication should have become easier. In fact, it has in many ways become more challenging - and this is especially evident in a field such as contracting and commercial management, where so many stakeholders are involved. Mastering this challenge is key to our ability to deliver value. This article describes the factors that we must address in order to become better communicators.
 
 

In the old world, it seemed that most people could get by just by doing their appointed job. Indeed, in many organizations, those who pushed at the boundaries of their appointed task by proposing improvements in areas outside their immediate job role were seen as ‘trouble-makers’.

Today, it seems that working hard and efficiently is no longer enough. The big question is “What value have you added?” In other words, we are expected to contribute to the wider development of business process, practice or offerings through our ideas and insights, through our readiness ‘to go the extra mile’.

In order to do this, we have to spend time understanding the perspectives and motivators of the different stakeholders involved in our process area. In the case of internal executives or users, that most likely means responding to their needs. In the case of other internal functions or external providers, it may mean managing their behaviors to ensure they do not prevent or damage desired outcomes. This cannot be achieved without effective communication – both listening and sharing information.

In itself, this does not sound especially difficult to achieve. But the irony of our information age is that it has made communication more important, yet at the same time made it more challenging. There are four major factors that I observe many professionals struggling to manage:

  • The volume of information is often overwhelming. It is increasingly hard to determine which communications really matter, so it becomes tempting to ignore all of them, or to enter a state of inertia and just do things as we always did them.
  • The methods of communication are alien and hard to manage. Most of today’s senior professionals were raised in an era of physical communication. The extent of those communications and the rules under which they were conducted were widely understood. The networked world has disrupted those patterns and we do not really know how to operate. For example, who has been on a training program on virtual negotiation?
  • The audiences with which we communicate are increasingly diverse. This means we are often unfamiliar with their values or perspectives, their cultural practices or norms. In such environments, the opportunities for miscommunication or misunderstanding are manifest.
  • Finally, we face the challenge of time. Today’s pressures on doing everything faster often conflict with the need for more inclusive (or carefully considered) communications and behavior. Communication and time are often seen as directly opposed to each other – and hence we must continually compromise.  This pressure for immediate answers also threatens good judgment – we are often forced to respond faster than we would like and left later to regret how we replied.

In combination, these factors mean that the opportunities for misunderstanding have perhaps become greater than ever. We are in a world where there is far more communication, but of much lower quality. Broadcasting to a wide audience is not the same as communicating – and often leaves us struggling to recover from the perceptions or reactions that were created. Similarly, we struggle to know which groups or networks to join, which sources will provide new ideas and opportunities to learn.  

For a community involved in establishing and performing against business commitments, the ability to coordinate across varied perspectives and reconcile differences is fundamental to our success. Our readiness to share learning and experiences and to be open to the knowledge and ideas of others is also fundamental to our personal and organizational progress. These are tasks we simply cannot perform without good communication skills. That is why we must re-learn how to undertake effective communications in today’s networked world. It is not optional; it is a dependency for answering that fundamental question: “What value have you added?”

 
 

The Global Economy - Considerations For Negotiators

 
This blog summarized one of IACCM's periodic reports on the state of the global economy and the resultant impact on contracts and negotiations. Although the article was among the most read (and its findings remain very pertinent as we enter 2011), overall interest and support for this type of analysis remains low. And it is this point that is perhaps most important. For those in contracts and commercial to become more secure and achieve higher status, we must collect and interpret data that contributes to business strategy and policy.
 
 

IACCM has just issued its quarterly report on the state of the global economy. It noted continued volatility in market conditions and the emergence of significant trends that are impacting negotiations, in particular the focus on methods to reduce costs and a growing focus on pricing mechanisms. IACCM also commented on the impacts of public procurement and policy shifts, both in terms of economic activity and in respect of the impacts of new governance and oversight initiatives.

The survey is unique in bringing together both buyer and seller perspectives (which it will be no surprise, are often not aligned!). It discovered a continued battle over terms and conditions, especially price-related, but increasingly those complaints come from both sides, suggesting that the imbalance in negotiation power that was created by the recession is fast receding. However, circumstances vary considerably between regions and within industries.

Asia-Pacific continues to show the greatest buoyancy in market sentiment, with net positive index of 42% (up from 22% in the previous quarter). The Americas are now close behind, with +38% (previously +16) and Europe / Middle East / Africa continuing to lag, with +13% positive sentiment, up from +4% last time. The frequency of renegotiation has continued to decline, with primary focus now on new contracts or extension / expansion of existing relationships. This suggests a change of pressure in negotiation.

Most negotiators remain concerned about price-related pressures – though in both directions. While sellers report continued ‘unilateral actions’ by their customers to force reductions (or to leverage other cost-related terms), there is now evidence that many suppliers are using the recovery – and supply shortages – to push up margins. While some are doing this through direct increases, others appear to be improving their P&L through cut-backs in service or support or more draconian attention to change management.

There are substantial variations in the fortunes of different industries, and sometimes within industries. Automotive is a good example, with a substantial fall in those reporting positive conditions in the last 2 months, though a similar number reporting improvements – clear evidence that bad news for some suppliers is good news for others. The strongest industries – in terms of recovery – are Electronics, Retail, Manufacturing / Processing and Transportation / Logistics. Those showing greatest weakness and uncertainty are Aerospace and Defense, Automotive, Engineering and Construction and Public Sector.

In their webcast accompanying the report, IACCM highlighted a number of trends for negotiators to consider. These included the weakness of the Euro and associated actions within a number of EU countries to cut public debt; the fragility of supply chains, which has been exacerbated by the cost-cutting actions of the recession; the steady increase in regulation and oversight, which is increasing nervousness in trading relationships and may lead to large-scale reconsideration of bonus and incentive schemes (a welcome development for many negotiators); the wider impacts of public procurement cut-backs and delays, especially in areas like IT, defense and construction. The summary also touched on the switch of market focus to the Far East and the impact this may have on negotiation practices and terms, plus the recent collapse of the traditional annual agreements in the metals industry and the extent to which ‘spot pricing’ may become more prevalent. IACCM believes that pricing mechanisms and indices will be a major area for focus in contract negotiations over the coming year.

In advice to contract negotiators, IACCM observed that they must be flexible in their approach and do their market and competitive research before entering the negotiation (the latest IACCM report represents a good starting point). Negotiating power and positions will be significantly impacted by the state of conditions in the negotiator’s industry and that of their trading partner. The survey shows that many suppliers felt unfairly treated during the recession and that unilateral action by buyers has tested supplier loyalty. As these established suppliers now start to push back in an attempt to recover lost margin, some buyers will be more inclined to consider switching their source of supply, providing competitive opportunities.

Competitive intelligence is therefore more important than ever in negotiation planning, with terms and conditions increasingly a factor in winning or losing. Among the areas to research when preparing to negotiate are whether companies are engaged in major cost-cutting; whether they are changing their service and support model; whether major customers are imposing price cuts, changing volumes or amending payment terms.

IACCM also commented on the erosion of trust that has accompanied the recession and the rapid shift in confidence over supplier and customer financial stability. A recent report from the International Chamber of Commerce noted a sharp up-lift in requirements for Letters of Credit or bank guarantees, as well as growth in requests for Performance Bonds or guarantees. With the banking industry itself in a risk-averse state, it is proving both hard and expensive for many firms to obtain the required support. Once again, an important area for negotiators to consider and prepare.

All these factors suggest extreme variability in the flexibility that negotiators will encounter. They may also offer increased opportunities for value trades and perhaps, in some instances, a greater understanding that partner loyalty and collaboration is often more important than the superficial transaction cost. As we recover from recession, it may indeed become evident that the world of negotiation will never be quite the same again.

A recording of the IACCM webcast introducing this report and discussing its findings is available to IACCM members at www.iaccm.com

 
 


 

Unlimited Liability

 
Liabilities remain at the top of the list for frequent negotiation. Sometimes it appears that contracts and legal specialists have become so accustomed to the debate that they have lost sight of its purpose.
 
 

Whether right or wrong, there seems to be broad consensus that the risks we face in business today are increasingly hard to predict. There is a sense also that the financial consequences of many risks are potentially very large and difficult to estimate. One result of this appears to be an attempt by buyers to simply allocate the risks of failure to their suppliers through broad-brush application of ‘burdensome’ terms, such as onerous liability and indemnity provisions.

To the extent that trade has globalized (taking us to less familiar and perhaps more vulnerable markets) and also the degree to which ‘interdependencies’ have grown, these feelings of greater risk may be valid. Certainly, organizations (both public and private) today often rely on a wide portfolio of trading partners to enable or deliver their business capabilities. A growing number of relationships are based on the delivery of outputs or outcomes, moving away from the time when most acquisitions were product (or input) based.

Suppliers have of course encouraged this trend towards services and solutions, in order to avoid the commodity pricing trap. But with that move comes increased responsibility for performance – and suppliers are generally not so keen on the increased liabilities this implies.

One area of growing friction is around unlimited liabilities (with consequential loss also sometimes thrown into the mix). As recent lively debates on the IACCM contract management forum have shown, buyers and sellers see this topic very differently (even though within each company it is the same Law department driving this rather schizophrenic debate).  It seems to me valid that a supplier should be asked to ‘put their money where their mouth is’. If I promise an outcome – and charge a premium for delivering it – then there should be pain for failure. But how much pain? And at what level of ‘premium’?

The problem with unlimited liability is that (at least in some jurisdictions) it may be precisely that – i.e. unlimited. Unlimited liability is not in general insurable, so the value of such a term of course depends on the size and assets of the company bearing the risk of loss. But more broadly, any unthinking attempt to apply such clauses is intellectually lazy and should be avoided.

The legal theory is that a ‘penalty’ clause will act as a negative incentive to perform. There is limited evidence that this works especially well and plenty of evidence to suggest there is a law of diminishing returns. Indeed, some would argue that there is a point at which such terms become counter-productive. In addition, the value of such a clause varies dramatically. For example, when dealing with overseas markets, it will vary in its enforceability and, depending on the jurisdiction of the contract, it will also vary widely in its value and application.  Regardless of jurisdiction, the actual realizable value will always depend on the underlying assets of the company providing the undertaking.

How often are such clauses exercized? How frequently are they upheld? What is the economic value realized from them, versus the economic costs of including them (extended negotiation time, strained relationships, more cautious suppliers, less delivery of innovation, higher prices to cover the risk etc.)? Is the party agreeing to the term capable of fulfilling it? When an organization or its lawyers prescribe these onerous terms, to what extent do they consider these wider questions? Far too often, the answer appears to be ‘not enough’; so long as there is compliance, the quality of that compliance doesn’t really matter.

IACCM professionals – buy side and sell side – should not accept such positions. We must insist that the terms we are negotiating make sense, are proportional and that they drive the successful results that caused us to form a contract in the first place

 
 

What Does A Good Contracting Strategy Look Like?

 
This final selection poses some of the big questions that face those responsible for contracting, both buy-side and sell-side. It suggests that we must engage in deeper analysis of the connection between contract and negotiation strategies and the outcome of trading relationships.
 
 

Phil Pavitt, CIO at the UK’s Revenue & Customs, wants to ‘kill’ big IT contracts, according to an article on Silicon.com. He apparently believes the mega-deals that were so in vogue a few years ago are unmanageable and should be divided into contracts worth a maximum of £100m each.

Phil is not alone. The last year has seen a growing wave of questions, especially from the IT community, about the way that relationships are structured and managed. Many CIOs today feel that they should take direct control of more relationships (for example, with sub-contractors) - and that they must build contract and commercial skills within their own team in order to manage them.

This trend flies in the face of sourcing strategies adopted just a few years ago, when common wisdom was that the number of relationships must be reduced, often through the creation of prime contractors. This strategy was of course accompanied by the emergence of more rigorous supplier segmentation, resulting in highly differentiated levels of investment in supplier relationships – an approach that is also proving contentious in many places (those non-strategic relationships have a nasty habit of being the ones that bite you).

Relationships are complicated. To work well, they require some investment of time and effort. It is wrong to assume that the closest relationships always offer the best results. For example, recent research in the networked world has revealed that “the more distant members of people’s networks are often the best source of new job leads”. The global networked economy has made things so much more difficult – it dangles the prospect of infinite relationships, each apparently better than the last, yet no established mechanisms to evaluate or manage them.

This is why so much academic work is starting to focus on relationship management – the difference it makes to results, the hidden costs, the factors that make it fail or succeed. But at present, beyond general observations that it is important, there are no firm guidelines on how best to evaluate or develop successful relationships. IACCM has been focusing on the role that contracts play in this – for example, ensuring contract structure and terms are appropriate to the nature of the required relationship; understanding the impact of specific terms on the way that organizations behave; designing contracts to provide a framework for superior relationship governance.

It is clear that the quality of trading relationships has a big impact on organizational performance. It is also clear that the traditional localized model for partner selection has broken down (though in places it may start to re-emerge). But it is not clear what the next model will look like – how many relationships, how they should be managed, how close they should be, whether they should be local, regional, global …. And should relationship strategy drive contracting strategy, or should the experience with contracts be driving relationship strategy?

These are among the biggest questions for today’s business leaders. Our community of contracts, sourcing and legal experts must become more active in exploring and delivering answers.

 
 

Partnering for Performance: the key to our success

Join us for insights into innovation and best practice in contracting, negotiation and relationship management at the 8th annual IACCM Americas Conference.
This year our event focuses on outsourcing and services contracts, and evolving organizational capability. Please note that IACCM will be separately staging its first Global Forum for Contracts and Commercial Management in Arizona, in October 2011, which will be a worldwide, cross-industry event.

Why join us in Orlando?

Engage with experts from the highest performing companies in the world, and discuss the biggest and most current issues that you face every day.
Don't miss the opportunity to network with the creme de la creme of the contracts, procurement and outsourcing world. Collaboration, networking and commitment to professional excellence are the keys to success, so join us as we partner for performance.


 
 

Q & A

 
 
 

Origin of Performance based contracting (PBC)

In today’s market, more and more companies are buying functions rather than capital goods; this seems to have complicated the issue of contracting. Many capital intensive industries are buying the complete solutions rather than just a product in order to finally satisfy the customers. This change in organization’s behavior leads people to make risky deals. It seems that the companies make promises they cannot keep, sign contracts without reading them, agree to terms that they do not understand, make risky assumptions, make unreasonable demands, assume that the terms of one market are acceptable in another and do not recognize culture differences. There are some broad agreements in international contract laws, but there are also fundamental differences in its applications. Among these differences, the major difference arises when the buyer is outsourcing non-core activities to the developing countries. There seems to be an argument upon this difference which is who is responsible in case problems arise. Often it is seen that the supplier is considered as a victim of the failure of the delivery. Such uncertainty encourages companies to be proactive and spend more time on initial contracting stages so that they understand clearly the responsibility shared by each party. Many lawyers are trying to understand the core of the business deal and then recommend the type of contracting suitable for it. In general, designing of the contracts are difficult. It is the responsibility of the procurement officer or a lawyer to ensure that all the agreements are met. This makes the lawyer or the corporate legal advisor to be precise in the types of questions to be asked while recommending the type of contracting. Contract must state the performance measurement method to be used by the company. Most companies focus on measuring the performances of the supplier by indicating the clear and concise benchmarks and the KPI’s. Once the targets are met, the suppliers are awarded for it but if they are not met then they are penalized. This creates conflicts between the parties as the supplier starts arguing on the specifications which were created initially. These specifications could have been understood differently by the parties involved and so on. This originated the need of contracting in a way that makes the suppliers to deliver the tasks based upon the outcome, quality and throughput and not only on the output.

In year 1990, there was seen a drastic action on the performances of the tasks delivered by the supplier which initiated the performance based contracting as the inventive contracting. Many authors have used performance based contracting based upon the need of the industry. For instance, the Performance-based contracting in the health services is defined as a form of contracting that explicitly includes three characteristics:

• Clear definition of a series of objectives and indicators by which to measure contractor performance

• Collection of data on the performance indicators to assess the extent to which the contractors are successfully implementing the defined services.

• Performance leading to consequences for the contractor, such as provision of rewards or impositions of sanctions. Rewards can include continuation of the contract in situations in which there is a credible threat of termination, provision of performance bonuses, or public recognition. Sanctions can include termination of the contract, financial penalties, public criticism, and debarment from receiving future contracts.

Similarly, performance based contracting in human services has been defined as, “ A performance-based contract is one that “focuses on the outputs, quality and outcomes of service provision and may tie at least a portion of a contractor’s payment as well as any contract extension or renewal to their achievement” (Martin, 1999:8).” In this industry, the performance based contracting was used to study the human service relationship. The focus was made on how to improve the desired end goal without affecting the relationship. Some human resource managers are reluctant to use such a type of contracting as they avoid the chances of conflicts between the employee and the employers. But some are widely using it in order to improve the efficiency in their work place. However, It is still unknown how many human services are making a use of it and are able to achieve the desired end goals.

Dilemma regarding usage of performance based contracting (PBC)

Now I am in a dilemma of whether the companies are making good use of the performance based contracting. Is the buyer aware of the main motive behind the performance based contracting. What actions do the buyer takes while using PBC such as does the buyer creates the rules and regulations based upon the needs of the two parties involved. Does the buyer know that there is a need to take a back seat while the supplier is working on creating its benchmarks and KPI’s?

There are few industries which I have come across who are making use of performance based contracting such as health services, human services, social services in some parts of the world. Apparently, each industry is using performance based contracting in its own way. For instance, Health services have created a step by step process to follow performance based contracting where it indicates the KPI’s upon which the suppliers have to perform. Similarly, human services have created their own KPI’s to be achieved by the suppliers. It seems that generally the buyer is working hard enough to specify the requirements and then creating the benchmarks and KPI’s for the suppliers to work on. My question is, should the KPI’s be created by the buyer in the performance based contracting or should they be informed by the suppliers to the buyers. Shouldn’t there be a paradigm shift towards the supplier while using the performance based contracting. Also, there is a gap in the understanding of how the Performance based contracting provides innovation while buying services?

Some anonymous examples for the industries using PBC

Let’s take an example of an industry that thinks that performance based contracting can provide innovation if used properly. An anonymous manufacturing company had a deal with one of the large scale supplier to supply product x. Both the buyer and the supplier took many months to specify the requirements of the buyer and the process to implement those tasks. All the KPI’s were created and were agreed by both the parties to the best of their knowledge. In the contract it was clearly indicated the time when the penalties will be levied. During the delivery of the time, there was noticed the failure in the deliverables and the meeting was held between the two parties. In the meeting, the supplier disagreed to the failure and there was a conflict. In this case, both the parties involved had to undergo many problems. There was not a good relationship between the parties. This made the buyer to be innovative in contracting then decided to shift the penalty contracts to the performance based contracting. This means that the buyer needed to discuss with the supplier, the steps that will be taken to achieve the desired end goal. It was the task of the supplier to create the benchmarks and show the history which stated its previous pitfalls and the parameters taken to improve the pitfalls. The anonymous buying organization states that shift to the performance based contracting have helped the company to earn the maximum profits and achieve the end goal.

Similarly, some energy companies are outsourcing their IT department through performance based contracting. This has helped them to be relieved of the IT sector and focus on their core-activities. The energy company chose the PBC’s after undergoing some problems explaining the core needs to the supplier. The reason to shift from the traditional contracting to performance based contracting is that they were tired of chasing the suppliers for delivering the results on time and specifying their requirements repeatedly. The energy company’s stated that the supplier relationship improves with the use of performance based contracting and the supplier tries its level best to solve the problems when needed. According to them the suppliers have started to work out of the box and have become innovative.

The above two examples which I have come across states that the performance based contracts are been recently used in the buying organizations and the organizations are reaping benefits from it, which in turn are bringing innovations. So far, there is still a gap in the knowledge of how exactly, when performance based contracting used, brings the innovations in the industries. It will be nice to read some more research projects if there are any who have tried to study on this project. It will be interesting to know how many more companies or lawyers are using such a type of contracting in the market. I am very keen to do a research project on it. Do let me know if someone is keen to get a research done on this subject.

Roopali Khurana, lecturing on Purchasing and Supply Chain Management.
Email address: roopalikhurana19@gmail.com
Designation: Lecturer of Purchasing and Supply Chain Management at Fontys, University of Applied sciences.
 


 
 

Forum

 
Are you using the IACCM Forum to get answers to the some of the tough questions that face our community every day? The IACCM Forum is an on-line message facility, exclusive to IACCM members, where you can benefit from the strength and knowledge of our worldwide professional network. Pose questions, contribute answers or simply read and learn.  Visit the Forum at http://www.iaccm.com/network/forum/ This month, we highlight a recent discussion on the age-old favorite of Unlimited Liability ….
 
 

In a recent discussion on the IACCM forum, a member requested help in establishing the unlimited liability of a supplier:

As a supplier to a large Aerospace OEM, the company is being asked to accept "Unlimited Liability" within the terms and conditions of the contract. As a prudent step, the company is attempting to limit its liability at a reasonable amount but is being told by the OEM that the clause is non-negotiable. Has anybody experience of (i) unlimited liability being non-negotiable, (ii) accepting unlimited liability, (iii) insuring for unlimited liability and (iv) insisting on a limit and therefore failing to contract with an intransigent OEM? The governing law for this Contract is Quebec law.’

We received a variety of responses with some really valuable input.

Tim Cummins (CEO, IACCM) stated that the member is dealing with civil code rather than common law and therefore the implications of the requested provision are not as onerous. Interestingly, in Quebec, the principle of unlimited liability applies to business owners, so it is a widely expected concept. Previously, Tim was with a large multinational that did a significant amount of business with aircraft OEMs through a number of divisions. This company never accepted unlimited liability. In their dealings they limited their liability to replacement of any defective goods or services only. No claims for rework time, overtime, part expediting, service charges etc. were accepted.

Furthermore, Tim explained that unlimited liability is not a realistic request, even more so when you consider that typically you are providing goods or services to a company where they have designed the parts, and they are responsible for testing (or set the test standards you must meet), and they as the OEM are the final manufacturer of an extremely complex piece of equipment - and should there be a failure and subsequent claim it is virtually impossible to determine where or how your part falls into the failure. If anything, this OEM should be asked to indemnify you as supplier from any liability and not the other way around.

The answer here is simply, no, do not accept unlimited liability. This is not "non negotiable" ask the customer if they will be willing to pay the premium surcharge required to get insurance for such a liability (if you could!) and watch how fast that non negotiable item comes off of the table.

Another member suggested that ‘The Crown (Canada) in their standard acquisition contract clauses has unlimited liability as their baseline and only in very rare circumstances will they concede to a defined limit of liability. Invariably the prime accepts the risk if they want the business on the basis that a claim from the Crown could be considered unlikely, or it is possible to manage the crown and therefore costs if a claim occurs.

Consequently prime contractors with crown contracts will want to flow these terms down to their suppliers. As the crown will not move on their position someone will always have to bear the risk of unlimited liability which is by its nature uninsurable. The prime often takes this risk as subcontractors naturally will not accept this situation. They prime will typically mitigate its risk by separating the liability into individual risk components. For example typically IPR infringement, damage to property and persons, negligence will be defined as unlimited something most sub contractors accept as may compliance to specifications be defined as unlimited. All other risks would then be capped to a limit greater than 100% of the contract value or a combined cap such as $2m per event or 150% contract value whichever is the greater. This, unfortunately is the nature of doing business with the crown or related to crown contracts’

These thoughts were confirmed by another member ‘If the aerospace OEM has a contract with the Government of Canada, the unlimited liability may be a flow-down of that Prime Contract. The Government of Canada almost always insists on Unlimited Liability. Therefore the OEM may feel it has no choice but to impose this clause on their subcontractors in order to mitigate its own risks.’

In this member's experience of contracts with the Crown and major defence contractors, limits of liability are always negotiable for direct liability to the customer. Sometimes this will be in terms of multiples of the contract value or in terms of a fixed amount that may or may not bear any relation to the value of the contract (e.g. $1 million, $5 million, $10 million). In some, but by no means all, cases these limits do not apply to IP claims or third party claims.

Tim Cummins responded that probably there is significant context behind this question that would need to be understood to give a robust answer. However he explained that ‘Whether in Canada or elsewhere, no supplier accepts unlimited liability and I have never seen a buyer/customer who would insist on unlimited liability. It is clearly a negotiated item and one where the supplier needs to know what liability limits are reasonable for its business, given financial capability and insurance availability. This liability limit is then proposed to the buyer/customer and negotiations continue from there.’

 
 
 
 

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