Five tables reported back their respective thoughts on the topic “Contracts as Instruments of Innovation.”  The items covered at each table had limited overlap, demonstrating the breadth of the topics that can be considered.

I am grouping the thoughts in a way that hopefully could make them a bit easier to process, rather than table by table.  In general, people reported back some particular immediate innovative ideas; thoughts related to improving the processes leading to ongoing creation of innovation; and reflections on the organizational and attitudinal barriers to innovation.

I.  Immediate Ideas

A.  Some tables adopted the framework about contracts consisting of three circles: (1) the economic exchange relationship, or content of the bargain; (2) the personal relationships that accompany the exchange; and (3) the legal relationship.  These same tables seemed to agree that the legal circle has come to dominate contracting, creating barriers to innovation.

1.  Those who spoke this way brainstormed various ideas for bringing the three relationships back into better balance.  Ideas included the following:

a.  enlarge the exchange and the personal relationship circles, especially if the other circles could grow so as to overlap once again with each other and with the legal circle.

I.  This could occur, for example, by having someone from the legal side participate regularly and early in the exchange negotiations, as part of established teams.  One person reported using this structure, saying it had the effect of helping the lawyers understand the business needs better, as well as building far better internal personal relationships.

ii.  The personal relationship circle could also grow through a systematic personnel exchange, at a middle-management level, between counterparts in strategic contracts.  Two different table suggested this as a way to advance trust and mutual understanding between the contracting parties.  Obstacles to this idea were possible disclosure of internal policies/trade secrets, and the fast turn-over of personnel.  One person reported successful experience with the idea.

b.  another idea was to approach lawyers on their own terms, so as to persuade them to shrink their own domain.  The thought was to tell the lawyers that their desire for a “zero risk” contract was not only a fantasy, but that in addition to raising transaction costs it actually generated a significant new risk: that an otherwise desirable contractual counterpart would ultimately refuse to do business with the lawyer’s company.   If that happened, the company is shrinking its alternative contracting partners, potentially ceding bargaining power to an oligopoly.  A second sort of new risk that ironically grows out of the unrealistic “zero risk” mentality is what happens when an ongoing contract encounters some completely unforeseen occurrence or change in background environment.  Legal departments, it was suggested, must understand that their job is to cope with not only current risks, or “unknowns,” but also those risks which cannot currently even be imagined: the “unknown unknowns.”  Only a contract with some flexibility and discretion built in could handle the unknown unknowns.  And if that flexibility is absent, the parties could experience significant costs that otherwise could have been prevented by the more flexible contract.

c.  putting together thoughts from two tables, a third idea was to have contracting parties always disclose their strategic interests, as well as their immediate transactional interests, in initial negotiation sessions.  Doing this would generate risk profiles for each party.  Contracts could be crafted so as to acknowledge both of these risk profiles, to meet the interests of both parties.  Through presenting the risk profiles to the legal departments, the exchange personnel would be taking a stronger role than simply abdicating issues about risks for the lawyers to resolve on their own.

d.  another idea was to move U.S. business practices, at least with respect to strategic contracts, toward the Japanese model in which top management from both sides to an agreement personally work out the agreement in private meetings.  And then they specify that their agreement should be memorialized and formalized.  This would, clearly, expand the exchange relationship circle and perhaps also the personal relationship circle.

e.  a dramatic fifth idea was to make some contracts, or parts of some contracts, explicitly not legally enforceable.  Hence they would in whole or in part look more like informal letter agreements.  Obviously this would significantly reduce the importance of legal rules, and correspondingly increase the importance of the exchange and personal circles.  When asked what would ensure the dependability of the undertakings, one suggestion was that perhaps both parties could supply insurance bonds–to guarantee performance on one side, payment on the other.  Gradually, the risks of non-performance by a given company would raise insurance rates for that company, thus making it in the best interest of that company to keep its promises.  One person did express skepticism, however, that insurance companies would issue bonds on contracts that were not legally enforceable.

f.  finally, one table suggested that a fourth circle should be added to the existing three that had been identified, because this circle–sales–had significant influence over the other three circles.  By controlling the sales teams more carefully, the legal circle could be diminished.

That was the verdict of an executive with whom I was talking last week. His point was that the claims of savings generated by procurement are overstated. But he went further: “The process model and methods that have been put in place are based on the retail and manufacturing industries. They do not translate to a world of complex services or projects.”

Our conversation had arisen because we were exploring IACCM’s recent research findings on the cost of poor contracting. Like others, this executive was not surprised by the results, but he made the point that it is now essential to demonstrate how those savings or revenue improvements will be tracked. “We simply can’t go to senior management any longer with abstract numbers that may or may not translate to the bottom line.”

The irony of the IACCM results is that a significant proportion of the financial benefits that flow from improved contracting are in fact the theoretical savings already claimed by Procurement. In other words, better contract management ensures disciplined implementation and on-going governance, including change management and performance management, plus ensuring that commited outcomes are in fact achieved. This discipline is especially critical in any services or project environment.

“Bringing an aggressive retail mentality to project-based industries has done a lot of damge,” we concluded. “It has undermined the loyalty and collaboration that are essential to long-term relationships and unpredictable conditions. The truth is, far from achieving savings, we have probably finished up costing the business more as a result of some of the methods and systems we introduced. They simply aren’t appropriate across all areas of spend.”

The results of IACCM’s ‘Return on Investment’ study have pointed to the areas where there is greatest financial opportunity and we are now exploring these with several corporations, to understand how best to implement and measure improved contract management.

Over the years, Ken has single-mindedly continued to develop his expertise in contract language, through his books, articles, blog posts, seminars, webcasts, and his law-school teaching. (Go here for his bio.) And what he has to say has become increasingly in tune with the wishes of many contract managers, to improve the clarity and precision of contract language.

That’s why we’ve arranged with Ken for IACCM members to receive a discount to Ken’s upcoming seminars in Melbourne and Sydney, Australia (go here for information), and in Geneva, Switzerland (go here for information).  And that’s why I thought it time to interview Ken on this blog.

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Tim: What keeps you relentlessly plugging away at your subject, the building blocks of contract language?

Ken: For one thing, it’s been exciting—well, a specialized sort of excitement! Contracts set the rules that govern business transactions, and English is the lingua franca of international transactions, so the world of English-language contract drafting is vast. Yet no one had thought it worthwhile to devote serious scrutiny to the components of contract language. That gives me a lot of room to play in.

Yet that wouldn’t mean much unless something were at stake. By using contracts riddled with archaisms, redundancy, misconceived usages, and other inefficiencies that characterize traditional contract drafting, most companies waste time and money, hurt their competitiveness, and unnecessarily expose themselves to risk.

Tim: Your comments reflect IACCM’s position on making contracts effective as business tools – which means greater focus on the users, rather than the drafters. So can you expand your thoughts on this?

Ken: Most template commercial contracts—even those of companies with the resources to do better—are overlong and nowhere near as clear as they might be. (The “before” and “after” examples I link to in this blog post will give you a sense of what I mean.) The result is delay and confusion at each step of the contract process. And my writings are full of examples of contract parties finding themselves in court fighting over some ostensibly minor drafting glitch.

Furthermore, defective contract language subverts grander schemes. It’s tough to bring to bear on the contract process notions of trust, collaboration, innovation, and the like when your contract are full of sludge.

Tim: Are the problems with traditional contract language a function of the idiosyncrasies of common law and associated custom and use? Won’t we start to swing more towards the principles of civil codes, where intent matters more than specific words and where relationships typically matter more than transactions?

Ken: In this 2006 blog post I discuss the differences between common-law and civil-law drafting, and they’re broadly as you describe them. The thing is, the Anglo-American style of drafting has become increasingly prevalent, perhaps simply as a by-product of use of English as the common language, and I don’t see the tide turning any time soon. But more to the point, there’s no reason why the Anglo-American system has to be so painfully inefficient.

Tim: So what should companies do?

Ken: First, you analyze thoroughly the costs and benefits of overhauling your contract process. If you decide that the benefits of change outweigh the costs, you take the following steps: You adopt a style guide for your contract language, to get away from regurgitation and improvisation. You train your lawyers and your contract-management personnel so they know how to draft and review contracts consistent with the style guide. You redraft your templates so they’re consistent with the style guide. And if you have sufficient contract volume, you automate your templates using document-assembly software, so that drafting a contract becomes a matter of completing an online questionnaire. Taking these steps would make the process so much more efficient for all involved.

Tim: That sounds simple — so what are the obstacles?

Ken: In my experience, the resources required to take those steps isn’t the problem—it’s not that difficult a process. Instead, the issues are cultural.

For one thing, you can’t expect those who oversee a suboptimal set of templates to welcome scrutiny. Don’t be surprised if you encounter defensiveness and bluster—“I’ve been doing this for fifteen years!” Any decision to overhaul your contract process would likely have to come from higher up the food chain.

Even if your company decides to review its contract process, your personnel probably won’t be equipped to retool your templates if all they know is traditional contract language. They may regard themselves as expert drafters, but it’s easy to think you’re something special when you haven’t been required to comply with rigorous drafting standards and your drafting hasn’t been subjected to any real scrutiny.

And drafting by committee can be deadly, with those taking part championing their pet usages. It drags on, and often the result is a mushy compromise. It’s far better to put in charge of the drafting process someone with a legitimate claim to drafting expertise.

Tim: What role might contract-management personnel play in any overhaul?

Ken: I suspect that at many companies, lawyers act as gatekeepers of the templates, with contract-management personnel having little or no say. There’s no reason why that should be the case—as I noted in this blog post, when it comes to doing deals, there’s relatively little that’s best left to lawyers as opposed to reasonably well-informed nonlawyers.

And lawyers are adept at blowing smoke. They’ll routinely trot out misguided conventional wisdom, deflecting questions by saying that a given approach is standard, or is required by law. Or they might say—this is the clincher—“That’s the way we’ve always done it.” Reading my stuff would help you to call them on it.

More generally, I encourage your members to recognize that in contract drafting, usually there’s one most efficient way to accomplish a given goal and a bunch of less-efficient ways, and that life would be simpler if everyone were to stick with the most efficient way. Only through rigorous research, analysis, and writing can you figure out and disseminate what’s most efficient, and that’s what I’m trying to do. Less conducive to enlightenment is trading information, and disinformation, around the online water-cooler, as I noted in this blog post.

Tim: But aren’t you letting lawyers off the hook? Shouldn’t they be responsible mitigating risk, including the risk that arises when you create contracts that are clear as mud? “Legalese” is a source of risk; if I hire a lawyer, I expect them to reduce my risks, not to increase them.

Ken: I share your indignation, but you’re not going to get clear contracts just by asking for them. You have to engage in relentless quality control and make sure that those who are responsible for your contracts, whether they be lawyers or contract-management personnel, aren’t engaged in regurgitating dysfunctional contract language and misconceived conventional wisdom simply because it’s all they know.

And by the way, outside counsel get blamed for clogging up the works and being resistant to change, but I’ve found that in-house personnel can cling to the status quo just as tenaciously.

Tim: How rapidly do you think we can make progress?

Ken: I’ve learned to be realistic. I like to think that I’m helping to change people’s expectations regarding contract language, that we’re moving from chaos to acceptance of a set of standards. Many individuals have already made that leap, and I’m hopeful that institutions will follow suit in due course. After all, what’s great about contract drafting is that the drafter can call the shots. If you think a given approach will offer better results, you can go with it rather than following the herd.

Like many companies, this organization was finding it increasingly hard to sell on their terms. So they had developed a standard check-list of the contract provisions that needed review. The content will come as no surprise to any of us – it had several categories of liability, indemnities, warranty clauses, performance undertakings, IP rights, liquidated damages, governing law …. in other words, all the things that could represent risk when things went wrong.

Not surprisingly, the contracts group was struggling to make much impression. Armed with this list, every negotiation became confrontational and a battle over risk allocations. Contract closures were delayed. There were frequent internal escalations because almost every situation resulted in a risk profile that was outside company standards. Senior management was becoming increasingly frustrated and saw contracts (and by extension the contracts department) as a problem.

The issue in my opinion was that risk was being viewed far too narrowly and the consequence was an overall increase in risk – risks of lost business, of increased chances of failed projects, not to mention risk to internal relationships and the future of the contracts team! So we spent time expanding the risk list and thinking about a range of contract terms that often don’t make it onto the typical risk list. These included things like ‘Requirements definition’ and ‘Documented scope’. We added ‘Client resources’, ‘Sources of funding’, ‘Cash flow’ and ‘Performance reviews’. And within these – and a host of other areas – we wrote down what standards need to be achieved to reduce the risk of contract failure. For example, lack of clear requirements is a massive risk, as is an unwillingness to ensure a properly documented scope, with mutually agreed procedures for change. If the customer is not willing to commit resources for on-going implementation or management, we have another factor that makes a positive outcome unlikely.

These additions have led to new conversations, dealing with value and how each party will contribute to success. They are topics that executives understand and can perceive a new level of value-add from the contracts team.

Ironically, our perspectives towards risky terms today often lead to the sources of risk being ignored. We become so fixated on the downstream consequences of things going wrong that we increase the likelihood that they will. It is rather like worrying about the insurance policy on our car, but never bothering to check its mechanical condition.

How good is your risk assessment? Are you managing risks or are you just dealing with limiting their consequences?

Within the overall Smarter Planet concept, IBM also discusses ‘Smarter Commerce’. A few days ago, the Financial Times ran a quarter page advertisement (which unfortunately I have lost on my travels) which discussed the relative maturity of corporate capabilities at supply management, compared with sales or market management.

The IBM view is that businesses have invested heavily in building integrated supply management (i.e. sourcing) capabilities and that the maturity of these processes has far out-distanced the competence of the sell-side operations. It calls for companies to work on integrating the areas of market management in order to implement ‘smarter commerce’.

I find this perspective interesting. It sounds a bit like consultant-speak to me and perhaps a rather superficial analysis. It is certainly true that many organizations have invested massive sums in standardizing their procurement and logistics process. Much of the investment in ERP focused on integration of these areas with manufacturing and operations. They have also attracted major investments in stand-alone software to oversee compliance, spend management and – more recently – category management.

But in the end, has this actually resulted in ‘smarter commerce’? It seems to me that many investments have actually led to dumber commerce. Rigid standards. Inability to adjust to shifting market conditions. Limited insight to risk. Continuing inability to link to critical financial performance measures. So we continue to see pressure for improved analytics, greater commercial skills, better understanding and management of supply risk …..

So does this mean that IBM has got the assessment completely wrong? I don’t disagree that the sell-side has a long way to go, but I think the challenge is simply different. While buy-side investments were being made in standards and tools, the sell-side was gaining greater investment in skills. The two are fundamentally different. Winning business for the sell-side means needing to be flexible and responsive to customer demands. Much of the software developed over the last 20 years has been designed to disable these characteristics. Sales and commercial efforts have often had to be directed to overcoming the complexity created by such systems.

So my view is that buy-side and sell-side are in quite different positions, but true ‘Smarter Commerce’ demands continuing developments by both – and in each case, it is to find systems and processes that enable more flexible and collaborative relationships, based on stable commercial principles and values.

What do you think?

The lawyer’s client – quite unreasonably, I suppose – wanted to negotiate certain points in the vendor contract. They proposed to do this through red-lining – which for most companies is a well-accepted approach. But not for this particular vendor. They do not welcome amendments, or indeed negotiation in any form. It creates extra risk, extra costs and is counter to the philosophy of their leader. So, next to an outright no, they do their best to make it impossible.

For a while, due to market pressure, they decided to build up a large contract management team. However, its purpose was not to facilitate customer service, but to act as a source of compliance. They monitored the Sales organization to prevent deviation and they acted as a buffer to the customer – essentially saying no a bit faster and with a smile.

But that approach didn’t work. Many of the contracts professionals didn’t much like that job and some even started campaigning on behalf of the customer, because they could see the damage that the approach was doing to market relationships. So the vendor had a fix for that. It decimated the contract management headcount.

Many may find it surprising that a company can still operate this way, though in truth it is just an extreme example of the way that many large corporations behave. There is of course a need for balance; complete flexibility over terms and conditions would not be affordable or sustainable. But I shall watch with interest to see how this particular vendor fares in today’s competitive markets and whether the next step will be to address their contracting process, or perhaps to see a steady erosion of customers.

IBM in the 1980s, Microsoft in the 1990s, Apple today; each is an example of a company where market demand for world-beating products trumped the need for negotiation and commercial flexibility. Until recently, the pharmaceutical industry maintained high margins through product leadership and market controls that made rigor in contract negotiation appear of little importance. In all these cases, investments in contract management focused primarily on the administration of contracts and in the imposition of rules and procedures that prevented deviation from standard terms and conditions.

At the other end of the spectrum, consumer based industries such as retail may also view contracts as largely non-negotiable instruments. The inability of the consumer to dictate terms and conditions means that flexibility is needed only in the context of special promotions or deals; and in general, such industries are dealing with suppliers who also lack power to negotiate. Therefore contracts, to the extent they exist, are mostly standard forms and employees have little empowerment to agree variations to terms.

For these companies, ‘contracting strategy’ means having the ability to operate off standard terms of their choosing and avoiding the costs and risks inherent to negotiation and the management of non-standard agreements.

Between these two environments, the bulk of businesses need a more nuanced approach to the way they do business. However, the challenge for many is that they do not in fact have a contracting strategy, or the strategy they have is no longer aligned with business conditions and needs. This may be because they are still trying to impose standard terms in a market where competitive pressures demand a revised approach; or it may be that they are trying to operate with high levels of deal-based flexibility at a time when technology, regulation and cost pressures have combined to make such an approach unaffordable and vulnerable to unacceptable levels of performance risk. The financial services industry provides an extreme example of a business sector that failed to understand and manage its contracts. Others, in sectors as varied as outsourcing and engineering, are learning the hard way that commercial knowledge, supported by robust and consistent contract management discipline, is a necessity.

Misalignments of this sort result in ‘the contracting process’ being viewed by many as a source of complexity, frustration and delay. It becomes an inhibitor because, as business and market conditions change, contracts and the contracting process typically lag behind. And it is that lagging which results in a burden of excess costs and missed revenue, together with the potential for severe competitive exposure.  Recent IACCM research suggests that, on average, corporations are losing the equivalent of 9.2% of annual revenue through weaknesses in their contracting process, being a combination of missed savings and cost reduction on the one hand, and lost revenue opportunities on the other.

The role of contract management is clear. It is to secure economic value; to provide a framework for the allocation and management of risk; and to oversee the performance of commitments that reflect a positive brand image.

It is within this context that IACCM advocates the need for a fresh approach to contracting, including the need to reconsider the purpose of the contract itself, and to develop a clear strategy that is capable of rapid adjustment to shifts in business and market conditions. In a new paper, ‘The Future of Contracting’, it will lay out the rationale for change and the steps that are required to turn the contracting process into a source of competitive advantage and economic value. Currently in the final stages of production, the paper will be issued in several weeks and discussed at a  variety of forums, including the Ariba LIVE event in Las Vegas and the IACCM EMEA conference in London.