This post continues our discussion of the key take aways from The Mpower Group‘s Next Practices Xchange and its discussion of what is required to get to the next level of supply management. On monday, we started with a discussion of value and how the views of Supply Management are not always aligned with that of the internal customer and stakeholders. Yesterday, we discussed how to align those views and get to value. This post will discuss how an appropriately drafted contract will capture soft, and hard, value in the eyese of all parties and how such value can be communicated.

In many organizations, contracts are viewed as roadblocks. However, as Brad Peterson from Mayer Brown points out, this is a viewpoint that Supply Management needs to overcome because good contract terms create value by improving business outcomes. Supply Management needs to learn how to communicate this value because many companies don’t often recognize the value of contract terms in decsion making. Having a quick out clause with little or no penalty in the case of a major disruptive event that will prevent the supplier from insuring a continuity of supply can often save the organization millions of dollars. For example, if war breaks out in the country that your supplier’s production facilities are located in and roadblocks are put up, you will need to shift orders quickly in order to be sure of supply continuity. Not having the right to do this will put the organization at serious risk.

Well designed contracts create value and reduce risk as they will

• bind suppliers to commitments to provide specified products & services at firm prices (and eliminate price risks for the contract term)
• give the buyer options to flex, change, or terminate under conditions that the buyer knows would require flexing, changing, or termination to insure organizational profitability
• provide the supplier with incentives to perform in ways that increase value or reduce risk
• specify how alignment will be achieved (through governance and IP rights that will prevent problems later)
• define when, where, and how the products and services will be provided and address logistics concerns in advance

But, most importantly, failing to recognize the value of good contract terms is wht leads to poor business outcomes in most organizations as

• projected savings get eaten up by change orders
• service levels stay green even though the customer is red (and stuck in an unhappy relationship for a long time)
• the promised innovation never materializes
• the contract turns out to be unexpectedly costly to govern
• the supplier makes unilateral changes that don’t violate the poor contract terms

That’s why Supply Management has to work on communicating the value of good contracts (that include key clauses that are identified well before negotiations begin) which address the customer’s value points, the key risks, and the overall business strategy. Specifically, Supply Management needs to point out that, with a good contract,

• suppliers work to keep their promises
• suppliers do whatever they can to get their incentives
• options allow the organization to steer to better outcomes
• alignment allows both parties to work together efficiently
• removal of uncertainties saves soft and hard dollars

And the value of each benefit can be estimated using expected value, actuarial calculations, economic calculations, and/or monte carlo simulation even when a fixed price is not included. So focus on better terms, and realize better outcomes.