How to Reduce Value Leakage in Complex Contracts

Twitter icon
Facebook icon
LinkedIn icon

According to reports authored by the International Association of Contract and Commercial Management, the Aberdeen Group, and the International Association of Outsourcing Professionals, the average contract loses approximately 17% to 40% of its value from the time of execution through to close-out. Value leakage can range from things like low adoption rates, non-value-added change orders, lack of innovation, poor governance, etc. This blog post will help contract professionals understand how customer-supplier relationships lose value and three best practices to preserve value.

Move Beyond Deal Points

Typically, negotiators think in terms of “getting the best deal”, meaning, financial and legal Terms that are favorable to the negotiator’s organization. Here is the problem: if businesspeople accept this premise, they are negotiating short-term “deals” in a complex, long-term business environment.

Focusing on the “deal” often leads to losing focus on the larger business goal(s) that a customer-supplier relationship seeks to address. For example, an overemphasis on “getting the best deal” often results in failing to fully document costly aspects of the work in the Statement of Work, failing to include adequate inspection, testing and cure processes, and failing to document and control common risk events.

Furthermore, focusing on the “deal” also precludes the inclusion of innovation in the delivery of goods and services. Buying emerging technologies like artificial intelligence, robotic process automation, cloud computing, or cognitive automation is the new norm, yet only 21% of respondents in Deloitte’s 2016 Global Outsourcing Survey reported that innovation was a key part of their contracts.

To align the need for value-adding transactions within one customer/supplier relationship that is part of a complex supply chain, customers and suppliers have to create a long-term relationship first. Then, within the confines of that relationship negotiate all the short-term transactions, while simultaneously managing relationship.

Performance-based contracts are contracts that identify expected deliverables, performance- measures or outcomes, and appropriate techniques to ensure that agreed upon value is received. These techniques may include, but are not limited to, positive and negative incentives to encourage supplier performance. Outcome-based relationships seek to deliver identified outcomes (such as innovation) in addition to performance and value. These are the most interdependent, structurally complex customer/supplier relationships. In many ways, they emulate a non-legal partnership or joint venture.

Best Practices

RISK

The first way a contract professional can attempt to preserve value is to identify risks, and locate where in the contract that risk can be addressed with relevant language. Risk is typically thought of in the “boiler plate” contract Terms such as Limitations of Liability, Indemnification and Warranty protections. When establishing performance- and outcome-based contracts, this view of risk is far too limiting.

The contract professional must broaden the organization’s view of risk to focus on risks associated with non-performance beyond the “standard” legal provisions. Non-performance typically happens when people make mistakes that could have been avoided in a clearly written Statement of Work which is then properly managed, and all risks tracked and controlled.

SCOPES OF WORK

The second way to preserve value is to fully document the work in a technical specification and/or scope of work. When suppliers have an incomplete picture of what is required of them, suppliers can inadvertently fail to fully perform or demand change orders to add scope, work statement or performance levels that were expected by the customer but previously undocumented (or poorly documented). With a comprehensive SOW and actionable SLAs, both buyer and supplier understand what success looks like and can act accordingly.

GOVERNANCE

The third way that contract professionals can preserve value is to document a complete governance mechanism. Business people rely too heavily on the paper agreement to do the work of monitoring, mitigating and control risk and associated loss. This reliance is misplaced trust. To avoid loss associated with risk, someone must personally monitor, measure, and verify that the supplier is performing.

In order to ensure that each organization is meeting regularly and having fulsome discussions that resolve pending issues while also looking ahead to anticipate business changes or challenges requires a documented governance mechanism. The contract lays out a framework, but people actually assure that it comes to fruition. This governance mechanism includes peer-to-peer grouping, documented responsibilities to meet and monitor the work, and an outlined escalation process to move issues quickly to the appropriate level of delegated authority before issues become problems and problems turn into disputes.

By putting these three best practices into place, both the customer and the supplier organizations are better positioned to preserve value, reduce risk, and deliver on the promises for a complex, long-term relationship.

To learn more, register for our upcoming Western Regional SIGnature Event in Bellevue, WA on May 16 where Jeanette and Lawrence will conduct a deep dive training session on this topic. Regional SIGnature Events are powerful one-day meetings in which buy-side practitioners benchmark with other organizations and network with colleagues facing similar issues. For more information about the event, visit our website.

 
Jeanette Nyden and Lawrence Kane

Jeanette Nyden and Lawrence Kane are co-authors of The Contract Professional’s Playbook: The Definitive Guide to Maximizing Value Through Mastery of Performance- and Outcome-Based Contracting and corresponding eLearning program. Lawrence Kane is a SIG Sourcing Supernova 2018 Hall of Fame recipient and author of 17 other books. Jeanette Nyden is the author and co-author of three other books including Getting to We: Negotiating Agreements for Highly Collaborative Relationships.