How do you create a contract that suits both parties, creates commercial value and mitigates risk? Procurement expert and consultant Michael Hallinan explains how
In simple terms, a contract is an enforceable set of agreements/ promises between two or more parties with each agreeing to do something in return for something else. It can be oral but most often it’s in the written word to avoid confusion, have an agreed reference point and is usually enforceable by law.
At the very least this is what a contract represents, but there are many ways to build commercial value into the contract that will be beneficial to both parties. This normally relates to potential changes in the commercial relationship over time and brings in the idea of agreed variables such as volume, quality, delivery time, specification, balance of risk and price. Note that the variables must be agreed between the parties and therefore must be identified up front and given commercial consideration. This is not always an easy task, after all, nobody can see into the future. A skilled procurement professional with enough experience should certainly make this task easier and working with a lawyer can bring in contractual clauses that give negotiating room for commercial movement.
This brings us onto the next challenge of managing compliance to the contracted terms and working with the supplier over the course of the contract to address required changes and improvements. This is called ‘contract management’ and is defined by ‘The Chartered Institute of Procurement and Supply’ (CIPS) as “a continuous procurement process that ensures suppliers adhere to their agreed contractual obligations along with negotiating any future changes that need to take place”.
In order to measure the performance of a contract, tools such as Key Performance Indicators (KPI’s) and Service Levels (SL’s) will need to be employed and tracked so that progress and compliance can be reported. Failure to meet these performance targets would normally result in a review meeting to understand and try and correct the issues but can also result in a penalty (financial or otherwise) for the supplier if that was agreed. Further actions would normally be agreed to take the service to the agreed levels over a specified time scale but, if this is not likely to happen or the supplier fundamentally cannot meet the agreed performance, it may result in the termination of the contract under agreed notice terms. This of course would not be a desirable outcome and can expose the client to even more risk (supply chain, reputational, litigation etc) which is why significant thought, care and attention should be given to the drafting of performance metrics in the first place.
Contract management can be hugely beneficial in terms of service, supply chain efficiency, cost and managing supplier relationships. It’s not appropriate in its entirety for all supplier contracts as it would be an inefficient use of resources and, as such, a strategic review of the supply base should be carried out to identify suitable supplier contracts before such work is started. In most instances, this work is done as part of a full departmental review with a view to formulating policy, process, toolkits and training etc.
The relationship management aspect of contract management is worthy of its own separate focus and is often segmented away and managed as an individual workstream. Supplier Relationship Management (SRM) as it’s known can be a key part of building a much-improved future state with both suppliers and the industry. It’s a strategic tool and must form part of an ethos rather than a plug and play approach but again it’s not appropriate in all relationships.
It’s likely that, under such circumstances, far more information will be shared from both parties about their business, their plans and future goals.
Collaboration and innovation are the key buzzwords here and it should be a symbiotic relationship more akin to employer and employee when successfully executed. The tools of SRM are usually based on a pillar approach which may include, but is not limited to, any of the following; quality, service, value, innovation, process, systems, people, governance and CSR.
The benefits sought should include improved quality and service, reduced cost, improved balance of risk, better understanding of lifecycle costs, innovation wherever it can be found, deep supplier relationships that can offer true competitive advantage, an improved perception of procurement in your business and better internal stakeholder relationships.
This all sounds wonderful and it really can be, but a note of caution if I may; Rome was not built in a day and neither is an SRM platform. The foundations of good practise need to be laid, adopted and be fully utilised before rushing into an area such as SRM; when managed badly it can create serious issues. A clear procurement policy, sound strategic sourcing, risk management methodology and successful contract management strategy will pave the way to develop the enhanced levels of trust required to utilise an effective SRM approach.
This article was originally published in the Marine Trader, IMPA’s official journal for maritime procurement and supply chain management, in issue 06 of 2018. Head over to www.impa.net to find out more or simply read new issues on the go with the MT Journal app.
