The Importance of Contract Negotiation in 2013

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1 Win-win negotiation: becoming a reality? Business is at last awakening to the need for a more positive approach to contract negotiation. That is the encouraging news from IACCM s review of market trends in During the last year, the approach to negotiation has visibly started to change, with a growing number of executives pushing a more collaborative or partnering approach to their supply relationships. This is beginning to edge out the tendency to practice negotiation as a zero sum game, with success for one party happening at the expense of the other. A variety of factors are driving this shift, but the important point is that negotiators are focusing more on performance and governance criteria that drive positive results and outcomes. This means that contracts and negotiations have the potential to become more effective at tackling risks at source and generating improved financial results, rather than dealing primarily with the consequences when things go wrong. Behind this shift in attitude there is a steady awakening in some industries to the fact that many of today s agreements must be more sustainable and also more flexible. The influences of a caveat-emptor world are diminishing, as the balance of contracts swings away from the purchase of direct materials and products and moves towards a growing volume of services and solutions. (See chart below). These service and solution contracts require far more cooperation between the parties because value can only be gauged over time. Success is not defined at the point of signature, but is determined by the eventual output or outcome that is achieved.

2 In other sectors, the shift may be more pragmatic. It reflects a change in the balance of power. After a decade in which buyer-power has dominated, industries such as oil and gas, automotive, mining and utilities are confronting suppliers whose relative strength has been increased by new technologies and shortages in skilled labor. Customers in these industries are being forced to re-think their approach to negotiation as part of a wider need to become a customer of choice. A growing focus on collaboration In this environment, negative incentives to perform must be balanced by more positive attributes that encourage shared responsibility and collaboration and which create opportunities for innovation, continuous improvement and shared benefits. Defensive, risk-averse, compliance-based contracts undermine results. Therefore the agreements now emerging are far more likely to establish principles for improved governance and to recognize the need for greater flexibility. This also releases the potential to discover hidden values that the parties lost in previous negotiation approaches. There have of course always been negotiators who appreciated the need for balance and achieved winwin agreements. But they have tended to be the exception rather than the norm and in many cases their success proved difficult to replicate. Too often, these high value relationships occurred in spite of the underlying organization and culture, rather than because of it. The changes we see emerging are more fundamental and offer the possibility of a substantive shift in attitudes and capability. The importance of judgment Another factor influencing change is the need for greater efficiency, speed and improved business judgment. The cost of getting contracts wrong is increasing, not only because of the traditional measures of cost, time or quality, but also due to more specific concerns over regulatory compliance, reputation risk and sustainability. The growing range of issues confronting today s negotiators is resulting in a spiraling number of stakeholders whose view must be considered. This has introduced greater complexity and, as shown in the chart below, has resulted in longer lead-times to reach agreement. It runs directly counter to executive pressure for more speed and flexibility. In addition, many contracts today require on-going negotiation to deal with rapid change; relationships in non- commodity business tend to be more than just one off business deals. Average Negotiation Cycle Times (weeks) appears in the chart below: Average Negotiation Cycle Time (weeks)

3 These are early days in the transformation needed to address the emerging challenges. It is interesting to note that much of the leadership for change is coming not from Procurement or Contract Management groups, but from lawyers. In part this is driven by their increasing workload and the need to change focus from repetitive, low-value negotiation to tackle the much bigger issues of regulation, corporate governance and enterprise risk. But it goes further, with more business-savvy lawyers wishing not only to cut time spent on traditional confrontation, but wanting to shift the focus of negotiation to terms that drive and manage performance. A growing number are pushing for industry standards that could dramatically reduce the frequency with which terms such as liability, indemnity, intellectual property and data security would need to be individually negotiated. Starting from a more generally accepted set of core templates or principles is one way that negotiation can be made more effective. Another is perhaps the role of negotiators themselves. Increasingly, talented negotiators are not those who seek to gain advantage over the other side, but are in fact excellent communicators and facilitators of an extended negotiation team. The lead negotiators from each party work collaboratively to build and test consensus, rather than seeking to score points or redistribute value. The negotiation becomes an important element in building trust between trading partners and ensuring their compatibility and shared objectives. This is also leading many organizations to invest in more scientific negotiation skills, to ensure they have the skills needed to support strategic relationships and partnering. That is the encouraging news at a strategic level, but to what extent is this reflected in the latest IACCM study of the Most Frequently Negotiated Terms? This year s Most Frequently Negotiated Terms This is the 12th year that IACCM has undertaken its worldwide research and each year we have discovered that most business-to-business negotiations are dominated by discussions over financial issues (price and payment) and risk allocation (liabilities, indemnities, data security, performance undertakings and liquidated damages). While these issues are important, they do not contribute to the win-win approach that negotiators claim they prefer. In past surveys, almost 80% of participants acknowledge that the focus of their negotiations does not result in the best outcome for either party. Each blames the other for failing to shift the agenda onto topics that might contribute to greater value. This shows little change in the most recent survey.

4 What has changed this time is the extent of understanding of the terms that are most likely to lead to a successful outcome. Only five of today s most negotiated terms survive into the list of the most important terms. Most negotiated term Most important term 1 Limitation of liability Scope and Goals 2 Indemnities Responsibilities of the parties 3 Price / Charge Price / Charge 4 Intellectual Property Delivery / Acceptance 5 Service levels Service levels 6 Warranties Payment 7 Performance guarantees / Undertakings Performance guarantees / Undertakings 8 Service withdrawal / termination Communications & Reporting 9 Liquidated damages Change management 10 Delivery / Acceptance Limitation of liabilities The environment in which negotiations take place is changing fast. Businesses need to be far more adaptive. The dependence on strong and well-defined supply relationships is growing. The pressure for greater honesty, transparency and integrity is growing. Taken together, executive management is exhibiting far greater interest in commercial and contract management skills. Tackling the negotiation agenda gap is clearly one way to illustrate value and force adaptive change. A poorly disciplined approach to contracting results in agreements that offer little guidance or support to implementation teams or to delivery of anticipated value. The gap is closing There have been a number of changes in this year s list of top negotiated terms, but of greater note is the closing of the gap in relative importance. In other words, negotiators are becoming more balanced in their focus. In past years, the traditional risk terms not only led the list they dominated it. The gap between the top five or six terms and the rest of the list was wide; today, the areas that receive focus are much more extensive. Another feature of the current list is the growing focus on outcomes. This is reflected in the big movers service withdrawal or termination (up from number 20); performance guarantees or undertakings (up from number 17); delivery and acceptance (up from number 13). However, in a rather surprising result, scope and goals has fallen from 4th place to 11th, even though it retains its number one spot on the most important terms and is generally agreed to be the primary source of claims or disputes.

5 Summary Overall, trends in business-to-business negotiation are encouraging. Those who are responsible for negotiating show growing awareness that the focus needs to change. Progress varies by company and by industry, but the leaders are increasing their efforts to negotiate contracts that provide a more robust platform for on-going performance management. This is achieved through a shift in the negotiation agenda, away from risk allocation and onto commitments to governance and problem resolution that will safeguard business goals and improve bottom-line performance. Smart negotiators those who care more about results than about narrow measures of compliance are therefore concentrating their efforts on the most important terms, rather than the more traditional most negotiated terms. This enables them to ensure that their negotiating partner has the right capabilities and culture and that together they will deliver successful results.