Achieving Value through Contract Terms: It is Possible

If you’re in outsourcing then you know about the importance of the contract. The contract is the essential foundation, but it’s not a document that exists in vacuum. Equally essential is the art, attitudes and techniques that go into achieving the best contract possible, and then proactively managing it over its term.

That is where problems almost always emerge, usually sooner rather than later.  The title of a survey report done by the International Association of Contract & Commercial Management is apt in this regard: Contract Negotiations As A Source of Value.

Tim Cummins, the chief executive of IACCM, quotes Ian Macneil, the recently deceased writer and legal academic in the first paragraph of the report to the effect that contracts arise because parties “recognize that there is more to be gained by some level of cooperation than by separation.”    This sounds like Mr. Macneil would have been an advocate of Vested Outsourcing and it’s foundational WIIFWe approach to doing business.

That seems obvious; it’s also easily said but difficult to implement successfully.

“When it comes to the terms on which contract negotiators spend most time, this spirit of cooperation remains notable for its absence,” Cummins says.

Rather, risk allocation and avoidance dominate the interaction between parties during conventional business-to-business negotiations,  he continues in IACCM’s 9th Annual Report on the Most Frequently Negotiated Terms.

Unfortunately, it appears the recession made matters worse: Cummins says the effect of the recession actually increased the “degree of separation between contracting parties, further threatening the economic value to be achieved from their relationship.” More adversarial attitudes marked the recession and contracts became pieces of paper with limited value as many powerful organizations “simply ignored inconvenient terms and insisted on their renegotiation,” while others made unilateral, non-negotiable changes in areas such as payment terms. The muscular approach to contracting was indeed in play.  In fact, one Fortune 100 we know proudly used their muscle and the economy as an excuse to force their suppliers into what they called “ZeroOI”  – meaning that they mandated that all of their outsource providers were a forced to work for Zero Operating Income!

While it seems obvious that the nature of a contract, along with the time that’s invested in its creation and management, depends on the nature and economic potential of the contract relationship, “too many contracting and legal professionals either fail or feel unable to make this distinction and do not alter their negotiation priorities to reflect the potential value or the extent to which its realization depends on cooperation,” he adds.

The result is that contracts become exercises in me-first, power-play games.  The stark reality of this me-first approach shows up loud and clear in the IACCM study revealing, which reveals the contract terms with the greatest frequency, which include:

  • Limitation of Liability
  • Indemnification
  • Price/Charge/Price Changes
  • Intellectual Property
  • Confidential Information/Data Protection
  • Payment
  • Service Levels and Warranties
  • Delivery/Acceptance
  • Liquidated Damages
  • Warranty

As Cummins explains, these terms are “frequently seen as obstacles to value creation.”   I agree.   I don’t see very much room for trust and collaboration in that list. It’s mainly about transactions and risk avoidance.

Cummins also notes that much contract philosophy remains driven by classical legal theory based more on transactions than on relationships, and that classical law assumes selfishness. He states that while economists have come to understand that people and organizations are able to grasp the benefits of cooperation and team behavior, contract law “is struggling to catch up.” The law “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.”

That’s all wrong in my opinion.    Vested Outsourcing’s Five Rules can show a clearer, better way to a successful, collaborative contract relationship, with friendlier, nicer and ultimately more rewarding areas for negotiators to focus upon.

IACCM agrees, suggesting that companies focus on contract terms that would be more productive in supporting successful relationships.  Rounding out the top four suggestions from IACCM are:

  • Scope and Goals
  • Change Management
  • Communications and Reporting
  • Responsibilities of the Parties

When you compare the two lists it’s apparent to me that the best and most useful contracts will flow from the vested, relationship-based approach of the second list of more productive mutually created terms rather than the self-interested terms focused on shifting risk in the first list.

Time to lay a foundation for change.

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