Category Archives: contract management

Managing Indirect Spend: An In-Depth Review, Part I.2

In Part I.1 we began our review of Managing Indirect Spend, a new book by Joe Payne and William (Bill) Dorn of Source One that is the culmination of everything they have learned while doing nothing but Strategic Sourcing, primarily on Indirect Spend, since 1992 — before it was cool. And as SI noted in its last post, clocking in at 422 pages, this book is an incredible handbook for anyone who wants to get a handle on indirect spend, which has increased in organizations across the board since outsourcing and right-sizing rose to fame in the 1990s. (And if you think otherwise, download SI’s free eBook white-paper on Spend Visibility: An Implementation Guide, dive into your spend, and see just how much of it is indirect.)

Today we’re going to continue our review of Part One — The Process, and dive into the last three parts of Bill and Joe’s excellent adventure into the strategic sourcing process and discuss:

  • Scorecarding
  • Negotiations
  • Contracting

A Balanced Scorecard is a strategic performance management tool that tracks supplier performance against a set of metrics in order to provide a well-rounded picture of the supplier that can be used to monitor and control performance. While most organizations introduce balanced scorecards after a supplier has been selected, scorecards should also be used when determining which suppliers to invite to the table, and everything — pricing, capabilities, past performance, market intelligence, supplier responsiveness, and employee perception — should be built into the scorecard to help insure the most appropriate supplier is selected.

The chapter also makes some great points that are often overlooked:

  • Scorecarding can be a teambuilding activity
    The entire cross-functional team can contribute to the process.
  • Scorecarding fosters buy-in to the awarded supplier.
    As everyone knows that the supplier was selected only after all data and all viewpoints were carefully considered and organizational needs fully balanced.
  • Scorecarding can deliver market insights not otherwise obtainable.
    Especially when supplier references are checked as part of the process.
  • Insights only come when a full history of the relationship is obtained
    Suppliers only give you references they believe will be glowing and cast them in the best light. Thus, it is vital to ask the references what supplier interactions were like from day one, what issues were encountered, and how (effectively) they were resolved. How long before the customer reached its current level of satisfaction?
  • A lot of questions will need to be asked!
    The authors provide a starting list of sixteen on page ninety-seven, and depending on the category and its nature, this might just be the ice-breakers.

Eventually, every process results in negotiations, which are covered extensively in Chapter 6. The authors also make some great points in this chapter that cannot be forgotten:

  • Suppliers have the advantage — ALWAYS!
    Whereas a sourcing team spends 5% of its time, or less, sourcing a specific product or service, especially in an indirect spend category, the [lead] supplier negotiator is 100% focussed on selling that category of products or services every single day. They know everything about it, and the market waters around it, while the sourcing team is struggling just to tread water in the unfamiliar territory.
  • A proper negotiation strategy minimizes the chance a supplier will add extra margin in a first round bid.
    If the negotiation strategy pervades the entire process, and presents a business case to the supplier that your business is something they can’t afford to lose because they will profit immensely by gaining it, the supplier will be much more aggressive with its bidding up-front.
  • It’s Not Getting to Yes, It’s Getting to No!
    If the supplier never says no, then the sourcing team never came close to getting the supplier’s best offer.

The chapter also had some great techniques a buying team can use to improve pricing, as well as some very important things that a sourcing team should never do, which include:

  • no negotiating after a reverse auction
  • no negotiating in contracting
  • no setting artificial targets

and if it’s not clear why, then you should definitely read this chapter.

The last, and final part, of the basic process is contracting — getting it in writing. A contract should balance the need for legal protection with common sense. It should be concise and only address the relevant risks and identified resolutions. It should not be a generic — one size fits all — boilerplate MSA that is 100 pages in length where only 10 pages are really relevant. All that does is add time (for unnecessary review), cost (of the overpriced lawyers), and loss (while savings opportunities go unclaimed) to the process. With the exception of a few basic definitions, the only clauses that should be there besides negotiated terms and resolutions are a balanced force majeure clause, a right to audit clause, and, possibly, a right to first refusal clause. While the supplier should have the right to be late without penalty if an act of nature prevents it from business as usual, the buyer should have the right to seek alternate sources of supplier or terminate the contract if the supplier cannot recover in a certain amount of time and, especially in the case of software (maintenance) contracts, should NOT be required to make payments when the supplier is unable to perform. The right to audit should be for the life of the contract, the audit should be allowed to go all the way back to the start of the contract (even if four and a half years into a five year contract), and the buyer should have the right to recover all monies owed from overcharges, even if they were made four years ago.

The chapter also did a great job of explaining why:

  • legal should be brought in even before the RFP/Q to prevent issues from arising later on,
  • most favoured nations clauses, which symbolize much of what is wrong with government agencies, do nothing but bite you, and everyone else, in the @ss, and
  • continuous innovation clauses all but guarantee that there will be no innovation for the lifetime of the contract.

There’s some great advice in these pages — and more to come in Part I.3 which will discuss how to truly achieve continuous innovation, how to get stakeholder buy-in, and what not to do if the goal is success. Continue to stay tuned!

Boilerplate Blasphemy

A recent article over on the eSide that explained why you need to “Focus on the Fine Print”, while a little simplistic, did a great job of pointing out the most important thing you need to remember when you are in contract negotiations:

The advantage always goes to the drafting party.

Always. Why? Because the drafting party always takes home-court advantage. While it is theoretically possible to prepare a contract to the advantage of the other party, I’ve never seen it happen. Even the fairest contract I’ve ever seen gave home-court advantage to the drafting party in the section on Governing Law.

Thus, if you are given a choice as to whether you should start with your paper or their paper, start with yours. And then remember that:

The fairer the contract is, the faster the negotiations will go.

You should only take the advantage where you absolutely need it. If you try to take it in every clause, the other party will likely be insulted at your lack of willingness to at least offer a few concessions and negotiations will not go well.

Remember that the point of a good contract is to build a framework for a problem-free working relationship. Keep that in mind, and drafting will go easier.

For Good Outsourcing Contracts, Keep Litigation in Mind

A recent article in the Sourcing Interests Group newsletter that described “a litigation perspective on outsourcing relationships” is right when it states that a litigation perspective will improve your results with outsourcing agreements. Given that outsourcing agreements are typically long in duration, it is important to craft the best agreement possible. A litigation perspective will help. Why?

Without a litigation perspective, a typical outsourcing agreement is:

  • general
    Since it is impossible to predict every circumstance that may arise, most drafters of outsourcing agreements stick to general terms, broad service descriptions, and generic service level improvement requirements. This is bad because generality results in uncertainty, uncertainty breeds disagreement, and disagreements threaten the stability of outsourcing relationships.
  • full of vague terms
    Such as material breach; gross negligence; willful misconduct; direct, indirect, consequential damages; best efforts; generally accepted standards; and commercially reasonable efforts which sound very legal but which are typically unclear in case law.
  • sparse (or devoid) of communication protocol
    While most outsourcing agreements will contain clauses for dispute resolution, they will be sparse, or devoid, of clauses describing proper communication protocols for communicating, addressing, and responding to issues as they arise. Disputes only arise when issues are not adequately addressed as they arise.

However, with a litigation perspective, a typical outsourcing agreement is:

  • specific
    While the agreement will still contain general clauses for modifying procedures to deal with unexpected situations, it will contain provisions for dealing with situations that can be anticipated in advance, such as a spike in data processing, the inability for the service provider to handle increased order processing, or a change in regulations that restrict a service provider from performing one or more functions. For example, in the first case, if data processing requirements increase beyond a certain threshold in a given month, the organization will pay overtime rates to get it done. If the service provider can’t handle a rapid spike in customer orders, the organization will have the right to bring on a second service provider to assist. And if an unforeseen change in regulations preclude part, or all, of the functions from being performed by the service provider, the organization may cancel the affected parts, or all, of the agreements, without notice and penalty.
  • built on clearly defined terminology
    Instead of just saying that the service provider is liable for “direct damages”, the agreement will say that the service provider is liable for “direct damages, which include but are not limited to the additional cost of securing an alternative service provider” or instead of just saying the service provider is responsible for damages that result “willful misconduct”, which may or may not include a deliberate breach of contract, the agreement will say the service provider is responsible for damages that result from “willful misconduct, which include but are not limited to intentional tortious acts”.
  • clear on communication protocols
    The agreement will contain a communication protocol where the organization can officially notify the service provider of issues that arise, and response protocols for the service provider to officially respond to the issues.

Communication protocols are important as they provide official communication trails and a way to “shape the record”. If an official dispute arises, and goes to arbitration or court, and the organization does not have a clear record of events, that includes correspondence officially notifying the service provider of a(n impending) breach, then its chances of winning its case (and receiving damages) are not good.

Moreover, if the organization maintains a good “real-time” written record of events, that includes official communications that follow the protocol, it has a better chance of resolving the disputes quickly, cost-effectively, and with minimal disruption as a provider is not going to want to risk an official dispute when the client organization has a strong case.

Considering that termination of the relationship likely will cause both parties serious economic disruption, its important to draft the best agreement possible. The best way to do this is to keep litigation in mind and consider how you would prove the elements of a claim if a dispute were to arise as this will lead to the creation of clear and unambiguous clauses.

Contracts Capture Value (Key NPX Take Away 3)

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.