Governance - What Governance?
By
Tim Cummins
Top Ten Most Frequently Negotiated Terms Reveal Continued Focus On Failure
Each year, IACCM collects data from more than 500 international companies and organizations, representing several thousand contract negotiators. We ask them to tell us which terms and conditions they negotiate most frequently. The data tells us where time is spent; it reflects changing issues and concerns; and it also reveals much about the ways companies behave and the value they place on their trading relationships.
Once again, the results for 2006 indicate many opportunities for rethinking the role of contracting in shaping relationships, supporting brand image and as tools for sophisticated risk management – as opposed to blunt instruments for risk allocation. This report highlights the results and suggests new approaches that could result in significant business benefits.
It is argued that the internet and today's networked economy have brought new dimensions to the management of risk. They provide a global medium through which reputations and brand image can be rapidly built or destroyed. As companies have discovered, failures to behave ethically, to honor their commitments, to meet market expectations can have dire consequences.
Leading consultants and business gurus have emphasized the growing importanceof the 'quality of interactions'in determining a company's market image and reputation.[1] Over the last year, we have seen signs that corporate executivesunderstand the direct link between how a company negotiates, the commitment terms it offers and market perceptions of how easy they are to do business with.
In such an environment, we might expect to see new approaches to risk management. Why spend so much time on traditional methods of risk allocation when suppliers can potentially be held to account through the potential for damage to their brand image?
Why focus negotiation on contentious issues that address the consequences of failure when efforts could be directed towards greater collaboration and incentives and methods to achieve success?
For all the talk about a changing environment, this year's Top Ten Negotiated Terms shows no sign that it has affected the behavior or attitudes of the lower ranks of corporate organization. Whoever drives policy or negotiation practice has clearly not been party to the executive discussionsabout a new, more collaborative approach to business dealings. Or if they were part of those discussions, they either could not interpret what it might mean to the contracting process, or they chose to ignore it. Recent CEO surveys[2] show nearly 50% of executives believe their company is 'not very good at collaborating'. The survey results suggest the percentage may be much higher.
IACCM "TOP 10" Negotiated terms 2006Term / 2005 / 2004 / 2003 / 2002
1 / Limitation of Liability / 1 / 1 / 1 / 1
2 / Indemnification / 2 / 4 / 10 / 3
3 / Intellectual Property / 3 / 5 / 3 / 2
4 / Price / Charge / Price Changes / 6 / 3 / 5 / 7
5 / Termination (cause / convenience) / 7 / 7 / 7 / 5
6 / Warranty / 5 / 2 / 2 / 6
7 / Confidential Information / Data Protection / 8 / 10 / 14 / 15
8 / Delivery / Acceptance / 9 / 8 / 12 / 13
9 / Payment / 4 / 6 / 4 / 11
10 / Liquidated Damages / 12 / 9 / 13 / 19
11 / Service Levels / 10 / 13
12 / Insurance / 15 / 11
13 / Performance Bonds / Guarantees / Undertakings / 13 / 23
14 / Applicable law / Jurisdiction / 14 / 12
15 / Rights of Use / - / 16
16 / Assignment / Transfer / 16 / 17
17 / Dispute Resolution / - / -
18 / Audits / Benchmarking / 17 / 18
19 / Invoices / Late Payment / -
20 / Most Favored Client / 18
21 / Freight / Shipping / 22 / 19
22 / Business Continuity / Disaster Recovery / 19
23 / Entirety of Agreement / 21
24 / Security / 24
25 / Enterprise Definition / Future Acquisitions / Divestiture / 11
26 / Non-Solicitation of Employees / -
27 / Force Majeure / 20 / 24
28 / Export / Import Regulations / 23
29 / Product Substitution
30 / Escrow / 25
What Is Holding Us Back?
In truth, most corporations continue to issue very mixed messages. They declare a strategic intent to differentiate, to partner, to add value. But at the same time, they send internal messages about control, cost reduction, standardization and risk avoidance. They highlight the need to be flexible, adaptive and agile, yet they introduce software tools and measurement systems that enforce compliance and inhibit change. And in their trading relationships, they offer the promise of a match made in heaven - until they introduce the pre-nuptial agreement and its administrators.
And so we end another year with value-reduction terms heading the list - limitations of liability, levels of indemnity, control of Intellectual Property, rights to terminate, liquidated damages for performance failure …..
The Keys To Collaboration And Value Realization
What changes might we have hoped for? How would the list change if we were indeed moving towards a more collaborative framework for business relationships?
I believe that the discussion would switch to ensuring the methods and mechanisms for building and measuring success. Certainly this would involve topics like service levels (relatively static at #11) because these set agreed parameters for performance. But it should also focus attention on governance topics such as change management (not in the Top 30),business continuity (down from #19 to #22) and project / relationship reviews (also not in the Top 30). The only clause to have made significant progress (from #35 last year to #17 this year) that is arguably part of the 'good governance' portfolio is dispute resolution.
I would also expect that those charged with better governance might spare a few minutes to question their traditional adherence to the methods by which contracts and disputes are managed. For example, as international trade mushrooms, we all know that the legal system has become increasingly anachronistic and ill-equipped to manage trading relationships. It is no wonder that arguments over governing law and jurisdiction are common. Recent US research has shown that even in a sophisticated and well-developed market like the United States, the courts are weighted against foreign litigants.[3] So why would any right-thinking business person want to lose the advantage of home turf? Surely the only way to reduce the contentious debate is to move to more balanced forms of arbitration or mediation - or perhaps become truly revolutionary and institute different (non-judicial) forms of penalty for specific failures.
Another example where we waste so much time is in the area of liquidated damages. Recent IACCM research[4] illustrated the frequency with which we negotiate such terms - and then either have no mechanism to monitor performance or consistently elect not to enforce the term because 'it would damage our relationship'.
Superior companies that truly focus on customer value will also peruse the list and identify ways that terms and conditions might offer differentiation. Most Favored Customer clauses, Performance Undertakings, Security, Disaster Recovery and Benchmarking are among the examples where creative thinking and innovative approaches can add value through reducing customer risk and increasing relationship loyalty.
Achieving Efficiency AND Effectiveness
In the end, we apply extensive resources to battles over the terms for allocation of blame and failure. We devote yet more resources to fighting over claims or disputes. In most companies, those resources far exceed the heads that are focused on overseeing commitment integrity ('business assurance') or proactively monitoring commitment and relationship performance. The disparity in focus means that many companies create the framework for contract and relationship failure. For them, 'goodness' means having a contract that protects against the consequences, rather than having a negotiation and contract management discipline that raises the probability of success.
Ironically, more companies measure compliance with achieving 'standard' terms (whether or not these are in fact beneficial) than those which monitor whether or not contract objectives were met. It seems a strange disparity - but it certainly explains why we remain stuck with the unchanging grind of today's Top Ten.
Most executives still view contracting as an unfortunate, but unavoidable, administrative and regulatory burden. They imagine they have entrusted it to their law department. But in truth, the contract is a repository for many rules, procedures and practices, most of which are not legally driven.The contract and its termsare tools for marketing, for corporate image and for business efficiency. Contracts are also core assets (try to sell your businessif you don't haveany). Those who understand this willfind they can shift the focus of negotiation anduse the process to build and maintain productive and lasting business relationships.
A Roadmap To Lean Contracting
Start this way:
- Negotiation is a quality issue; each time we negotiate is potentially an indication of failure (it means we do not align).
- Therefore we must discover whatwe negotiate today and with what frequency?
- We must ask ourselves how we couldavoid that negotiation and what results it wouldhave (positive and negative)?
- Are there things we do not negotiate that should be negotiated (positive impact)?
Analysis of this type requires in-depth thought about individual terms and term elements. It requires creative solutions to identify alternatives, off-sets and value propositions. Terms become strategic and therefore require senior management commitment to drive change and to make significant risk and value decisions.And the process is not 'one-time'; in fast-changing markets, new threats and opportunities must be monitored to ensure terms remain competitive and relationships are managed in ways that optimize their value.
This report on the Top Ten Negotiated Terms is the first in a 2-part series. The second report will focus on the extent of variations between buy-side and sell-side contracts, as well as geographic differences (caused by legal system or culture) and also variations between offering types (for example, products compared with services or solutions).
1. For example, McKinsey "Competitive Advantage From Better Interactions" (McKinsey Quarterly, Volume 4, 2005)
2. Chief Executive magazine, December 2006
3. "The Home Court Advantage in International Corporate Litigation", Journal of Law & Economics 2006
4. "Contract Performance Incentives", IACCM May 2006
Copyright © 2007 Tim Cummins
[1] For example, McKinsey “Competitive Advantage From Better Interactions” (McKinsey Quarterly, Volume 4, 2005)
[2] Chief Executive magazine, December 2006
[3] “The Home Court Advantage in International Corporate Litigation”, Journal of Law & Economics 2006
[4] “Contract Performance Incentives”, IACCM May 2006