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Wednesday, April 23, 2014

Rethinking Contract Language Can Yield Benefits

A recurring theme at last week’s ProcureCon conference in St. Louis was the benefits that can be achieved by developing collaborative relations with suppliers. These range from access to supplier innovation and continuous improvement of product quality to gains in revenue via savings, improved margins, or both.

A big part of a supply relationship is determined by the contracts negotiated between vendor and customer. Tim Cummins, president of the International Association for Contract and Commercial Management (IACCM), said during a presentation that most contracts create and reinforce adversarial relationships. IACCM’s focus, he explained, is not on traditional contracts where a buyer imposes conditions on a vendor. “Our philosophy is to stop treating one side as the enemy,” he said.

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Tim Cummins Credit: IACCM

Cummins argues for a more enlightened approach — one that balances the needs of both buyer and supplier. A contract could achieve this by sharing risks and rewards equitably, being clear and specific about requirements, creating metrics to analyze objectively vendor and customer performance, and downplaying negative incentives in favor of mutually agreed goals.

I will discuss three key points that Cummins made. Today’s focus is on negotiating meaningful contracts and the value they provide. Tomorrow I will look at how much bad contracts cost a company in lost revenue. Finally, I will examine Cummins’ suggestions for improving contracts and attitudes about them.

Cummins says a contract must be the basis of a “holistic relationship” between buyer and vendor. And like any relationship, it “requires variations in level and scope of what is constructed.” In other words, one size does not fit all. “Good relationships are built through balance,” he said.

Cummins told the story of a presentation he made at a bankers’ dinner meeting. Prior to his remarks, one banker went to the podium and inquired of the audience: “How many think suppliers are evil?” A number of hands went up. So much for enlightened thinking.

Credit: Stuart Miles at FreeDigitalPhotos.net

Credit: Stuart Miles at FreeDigitalPhotos.net

“Do we have clarity over the nature of our commitment to each other?” Cummins said. When a buyer imposes stringent conditions on a supplier, chances are an imbalance will be created in the relationship that impedes efforts to resolve problems that may develop.

It could also affect the ability of a supplier to share innovation with a buyer. Cummins says major corporations frequently insert onerous terms in contracts, one of which is that a supplier assumes “unlimited liability” for its products. This affects risk management, which in turn could keep innovative products out of a market. “No company wants to be last to market with a product, but this is what happens” when risk falls solely on a supplier, he remarked.

A 2012 IACCM survey compared contract terms that are negotiated with the greatest frequency by buyers to those that would be more productive in supporting successful relationships.

The five most frequent terms are, in order: limitation of liability, indemnification, price/charge/price changes, scope and goals, and liquidated damages.

In contrast, respondents said the five terms that would promote more successful relations are, in order: scope and goals, entirety of agreement, responsibilities of the parties, change management, and communications and reporting.

In ranking the impact of agreed-upon conditions on contract outcome, the IACCM survey developed a ranking of nine conditions that would improve relations between buyer and supplier. These are, in order: risk allocation, solving problems, a no-blame culture, joint working, communication, gain- and pain-sharing, mutual objectives, performance measurement, and continuous improvement.

“We need to develop a new contract language,” Cummins concluded, “one that will drive innovation and financial benefits.”

Otherwise, buyers will not be able to fully gauge the impact of their contracts on business. Tomorrow, we will see how costly that can be.

 

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