Author Archives: John Davies

About John Davies

John is a recognised authority in collaborative contracts, relational contracts, and novel procurement options. John has conducted extensive research into alliance contracts and governance frameworks from both the buy side and sell side. John has authored collaborative contract better practice guides, performance-based contract evaluation guides, and tender evaluation guidelines for major programs. You can find his CV at LinkedIn.

Creating a Collaborative Environment – Focussing on Value Creation

“Aquila non capit muscas – The eagle does not hunt for flies” Queen Christina of Sweden (1626 –1689)

M.M.Hassan “Eagle, rabbit, hunt, wildlife” Creative Commons

Introduction

The Pareto Principle (or 80/20 rule) “asserts that a minority of causes, inputs or effort usually lead to a majority of the results, outputs or rewards.”[1]  In the commercial space, this means we should focus our efforts on the top twenty percent of items that drive value to our organisation.  Therefore, contract negotiations, meeting agenda, commercial terms, and all other contract matters should focus on these top issues, but is this case in practice?

Successful collaboration requires all parties to focus on common goals, seek win-win outcomes, and champion continuous improvement.  Sadly, many collaborative relationships falter because they get bogged down in trivial issues that ultimately have little or no impact on the joint objectives.  The adage “don’t sweat the small stuff”[2] should be at the forefront of everyone’s thinking so we are not distracted by issues or risks that are inconsequential.   In this month’s blog, we explore strategies that allow us to focus on value creation and not get side-tracked by meaningless issues.

Focus on the Purpose

In our previous blogs, we emphasised the need for a clear and shared vision of success.  Our vision should be our North Star that steers us to success.  With a common purpose, we should be far less distracted by trivial issues and matters.  This is precisely the point Malnight, Buche and Dhanaraj make in their paper; Put Purpose at the Core of Your Strategy, where the authors identify that high performing companies “let purpose be their guide”.[3] All decisions and interactions must keep this principle in mind so that we focus on value creation and do not waste time on administrivia.  Where issues do arise then parties should simply ask the question ‘so what’?  If an issue has no tangible impact on the delivery of the purpose or vision, then we should not be expending resources on this issue. 

Adopt a Collaborative Attitude

Quite often disputes and issues arise because of a lack of trust, a lack of understanding of counterparties’ views, and cultural momentum whereby we are locked into out traditional black letter law way of doing business.  For successful collaborative ventures we need to be open-minded and recognise that all parties want mutual success.

This is the theme of Gino’s paper, Cracking the Code of Sustained Collaboration, where she observes that:

In successful collaborations, each person assumes that everyone else involved, regardless of background or title, is smart, caring, and fully invested. That mindset makes participants want to understand why others have differing views, which allows them to have constructive conversations.[4]

With such an attitude, we are far less likely to be suspicious and cynical of each other’s motives.  This means that trivial issues will not become the focus of discussions and we can devote our energies to more productive endeavours.  Of course, this approach will only work if we have the right team who are committed to collaboration. This means we must be very careful in our selection process from both the buy side and sell side.

Craft an Effective Commercial Framework

Many commercial frameworks introduce unnecessary checks and balances that add no value.  Countless boilerplate contracts demand detailed reports, plans, and weekly meetings that are often unnecessary.  These should be avoided for the following reasons:

  1. The cost of reporting can be high. It is the customer that ultimately pays this cost;
  2. Reporting diverts critical resources away from the core objective of delivering outcomes; and
  3. Where errors occur in reports, reports are delivered late, or they omit contractually agreed content then corrective action must occur.  Contract managers must intervene, otherwise they may waive rights under the contract.  This is a catalyst for disputes and adversarial relationships.

We should therefore craft a commercial model that minimises the reporting effort, encourages shared systems (with a single source of truth), and embrace a disputes and issues resolution process that encourages resolution at the lowest level possible.  Similarly, we need a remuneration model that does not allow cash flow to be jeopardised to suppliers for inconsequential acts or omissions.

This does not mean we abandon all reporting under our contracts. Accurate and timely reporting is essential for many items, especially where we use Performance Based Contracts with Key Performance Indices linked to profit.  Rather we need be very careful we do not ask for information that will never be used.  An effective strategy here is to specify a minimum level or reporting (preferably with real time access using shared systems) and then identify desirable information.

In addition to ensuring only the essential information is required in our contracts, we also need to make sure our contracts are:

  1. Simple and unambiguous so we do not waste resources with interpretation issues;
  2. Under tight configuration management so there is no confusion on what the contact baseline is;
  3. Outcomes based, and do not specify how the work needs to be done; and
  4. Flexible so that change can be implemented quickly and fairly.[5]

Conclusions

Consistent with the Pareto Principle, we need to focus our efforts on the value drivers.  Associated with this, we need to filter out the noise in our contract relationships by ensuring; all parties share a common vision of success, we approach the relationship with the right attitude, and we have a commercial framework that eliminates noise or mitigates distractions. 


[1] R. Koch, The 80/20 Principle: The Secret of Achieving More with Less (1997) p 4.

[2]Richard Carlson, ‘Don’t Sweat The Small Stuff – and it’s all small stuff’ (1997).

[3] Thomas W. Malnight, Ivy Buche, and Charles Dhanaraj “Put Purpose at the Core of Your Strategy” Harvard Business Review (September – October 2019).

[4] Francesca Gino “Cracking the Code of Sustained Collaboration: Six new tools for training people to work together better” Harvard Business Review (November–December 2019)

[5] World Commerce and Commercial “Ten Pitfalls to Avoid in Contracting” (2015).

Delivering Enterprise Outcomes Through Collaboration

The world is full of gizmos and gadgets that people don’t want, don’t need, and certainly don’t want to pay for.”  – Kimberly Wiefling ‘Scrappy Project Management’ (2007).

Benefits Realisation Map – New HR System[1]

‘Benefits maps provide a visual description that illustrates the links between outputs and objectives. Benefit maps allow us to create a shared vision of success, craft effective Enterprise Performance Measures, and ensure Performance Management Frameworks are fit for purpose’

Introduction

Successful projects or programmes focus on benefits realisation and the delivery of enterprise objectives.  Traditional contract approaches attempt to ‘compartmentalise’ contract scope and allocate liabilities to suppliers in an arms-length manner. In such circumstances, suppliers can deliver 100 percent on time, on cost and to A1 specification[2] yet the customer may fail to realise any expected benefits despite the supplier’s success.  In Andrew Jacopino’s blog on performance based contracting, he highlights the problem with the watermelon effect. This arises where all suppliers can report their performance as fully compliant or ‘green’, yet the customer is not being provided with any tangible value and hence, the customer score is in the ‘red’. A reaction to this problem was the introduction of third generation performance-based contracts. These contracts incorporate Enterprise Performance Measures (EPMs) to drive all parties to a ‘shared destiny’.[3] Implementing EPMs to achieve a shared destiny though is a significant challenge.  In this blog, I explore how we can use the Managing Successful Programmes benefits realisation mapping process to effectively integrate third generation, performance based contract frameworks. This will ensure all parties work collaboratively towards delivering enterprise outcomes.

Benefits, Objectives, and Outcomes

A benefit is defined as a “measurable improvement resulting from an outcome perceived as an advantage by one or more stakeholders, which contributes towards one or more organisational objective(s)”.[4]  Benefits contribute to corporate objectives as illustrated in Figure 1 below:

Figure 1: Mapping of Outputs, Capabilities, Outcomes, Benefits and Objectives[5]

As we have mentioned in previous blogs, it is rare that suppliers would be solely responsible for delivering the actual benefits or corporate objectives to a customer.  In most Performance Based Contracts, it is the outcomes that are often within the remit of suppliers.  The Australian Department of Defence Productivity and Performance Based Contracting Guide for ASDEFCON (Support) makes this point clear

“KPIs are Performance Measures that measure the contribution of the Contract in achieving  outcomes”[6]

KPIs by themselves may not deliver any benefits or objectives.  For example, we could have KPI’s that are linked to fleet availability, or repairable item turnaround time.  Achieving all these outcomes with 100 percent compliance may not result in any capabilities being available if the customer does not have people trained in the system, essential infrastructure, or other enabling systems necessary to realise benefits. In this situation, corporate objectives will not be achieved.  We must therefore ensure that there is a clear picture of what outcomes need to be delivered collectively to ensure benefits and objectives are achieved. An effective tool to achieve this is through benefits mapping.

Benefits Mapping

Benefits mapping illustrates the relationships between outputs, capabilities, outcomes, benefits and objectives.[7] Benefit maps allow us to clearly identify project or program interdependencies and identify the relevant importance of each output. When we craft a benefits map, we start at the right (objectives) and work towards the left (outputs). This ensures that all activities are focussed on delivering the organisations’ objectives.  In Peppard’s paper ‘A Tool to Map Your Next Digital Initiative’, he provides a useful illustration of a benefits dependency map, reproduced below:

J. Peppard ‘A Tool to Map Your Next Digital Initiative’ Harvard Business Review (June 2016).

Benefits maps such as the above, provide us with substantial value, including:

  1. Visibility of all activities needed to achieve corporate objectives;
  2. Assurance that all projects/outputs deliver ‘fit for purpose’ outcomes,
  3. Identification of the relative importance of each output in the program (for example, where a single output can contribute to more than one benefit);
  4. A clear picture of interdependencies of outcomes;
  5. A means to clearly identify ‘Enterprise Performance Measures’; and
  6. A process for providing defensible business cases, whereby every project can be shown to contribute to corporate objectives.

Crafting a benefits map, such as the above, requires a holistic view of all the outcomes required to deliver objectives.  There is a temptation to simply focus on technological outputs or ‘mission systems’ but this ignores the many other critical outputs, capability, and outcomes necessary to delivery objectives.  The Australian Department of Defence uses the term, Fundamental Inputs to Capability (FIC) to refer to all the additional outputs necessary to deliver capabilities. These include[8]

  1. Organisation,
  2. Command and Management,
  3. Personnel,
  4. Collective Training,
  5. Major Systems,
  6. Facilities and Training Areas,
  7. Supplies,
  8. Support, and
  9. Industry.

In summary, a benefits map needs to clearly identify all interdependent outputs and capabilities needed to deliver benefits and objectives.

Industry Engagement

The benefits map should be crafted as early as possible and well before we engage with industry. Nonetheless, as the benefits map matures (and we move from solution independent to solution dependent needs), the benefit map needs input from key stakeholders.[9] Industry engagement is therefore of critical importance in ensuring our benefits map is optimised for the following reasons:

  1. Validation of outputs. Industry is far more likely to have a grasp on what outputs can be delivered in their core business areas. This includes realistic estimates on performance outcomes, cost, and schedule.
  2. Efficiency. Several outputs can be bundled together and allocated to a single contractor in the interests of efficiency. Industry input is required to explore these opportunities.
  3. Crafting a Shared Vision. With co-development of the benefits map, buyers and suppliers are far more likely to buy into a shared vision of success.
  4. Developing Effective Key Performance Indices. Where we have full visibility of all outputs, capabilities, and outcomes required to deliver benefits and objectives, then our performance management framework will be far more robust.
  5. Enterprise Performance Measures.  Where customers and suppliers have an agreed and transparent benefits map, then all parties can progress to developing effective enterprise performance measures and work towards delivering the enterprise outcomes.

Industry engagement in this process will of course introduce some challenges with ‘contamination’ of solution independent needs with proprietary solutions and associated probity risks.  Likewise, with multiple industry participants, challenges may arise with how bundling outputs will be managed as there is an inherent motivation for suppliers to grab as much work as possible.  Nonetheless, where we engage with suppliers who have an affinity to collaboration, such issues should be manageable.

Conclusions

Benefit maps are powerful tools that clearly show what output and capabilities are required to deliver enterprise outcomes.  Benefit mapping will be more effective if we engage a wide variety of key stakeholders, including industry.  The benefit map will ensure we have a clear understanding of what success looks like, will inform our enterprise performance measures, and ensure the broader performance management framework is fit for purpose.


[1] Axelos “Managing Successful Programmes” 4th Ed (2011) Fig 7-7.

[2] T. Lendrum “Building High Performance Business Relationships” (2011) p81.

[3] A. Jacopino ‘Mastering Performance Based Contracts: From Why to What to How’ (2018).

[4] Axelos “Managing Successful Programmes” 4th Ed (2011) p75

[5] Ibid, p83.

[6] Australian Department of Defence ‘Productivity and Performance Based Contracting Guide for ASDEFCON (Support)’ V4.0, p1

[7] Axelos opcit, p83.

[8] Australian Department of Defence “Capability Life Cycle Manual’ v2.1 (2020), p2.

[9] Axelos, opcit [7.4.1]

Early Supplier Engagement

“When you talk, you are only repeating what you already know. But if you listen, you may learn something new.”- 14th Dalai Llama.

Group Collection by Justin Blake (Creative Commons)

Introduction

In the procurement lifecycle many organisations engage with their suppliers to seek information on the supplier’s ability to deliver and at what cost.  This is normally achieved with the release of a request for tender or request for quote.  Such strategies may be suitable where the customer has a very clear idea of what is needed, what market conditions are like, and where procurement risks are modest. When we move to more complex and riskier procurement activities, early supplier engagement is vital. This month’s blog explores why we need to engage early with industry and how to do so.

Smart Buyer Perspectives

A ‘smart buyer’ recognises that they will not always have all the answers. Vann’s framework explores the following questions that should always be asked from a smart buyer:

  • Why buy,
  • What to buy,
  • When is it needed,
  • How much should we pay,
  • How to buy,
  • Who to buy from, and
  • What was bought?[1]

Even for the most mature organisations with substantial internal capability and capacity, these critical questions cannot be effectively answered without engaging with the market.  At what stage though should we engage with industry? The Canadian Government Smart Buyer Procurement framework lists early engagement as one of their four essential pillars or procurement and recognises that early engagement ‘should begin as early as the needs identification stage.’[2] A smart buyer recognises that early engagement can reap benefits but what are these benefits?

Benefits of Early Engagement

Early engagement offers immense opportunities to explore the art of possible, ensure expectations are realistic, motivate[3] and prepare suppliers, and ensure business cases are credible.  The following list (though not exhaustive) explores these themes:

  1. Reduce asymmetry of Information.  Customers are not omnipotent and do not have a complete understanding of what the market can or cannot provide.  Early engagement allows for industry to inform requirements, identify opportunities, and validate critical assumptions.
  2. Promote realistic expectations. Optimism bias is rife in complex projects.[4] Unless we engage early with our suppliers then our initial business cases will be devoid of realistic cost, schedule and performance estimates.
  3. Reduce Bid Preparation Effort.  Transactional approaches to procurement often involve the release of a request for tender (typically the week before Christmas) that invariable comes as a complete surprise to industry.  Early engagement allows industry to inform the customer, prepare and respond faster to the RFT, and with more credibility.
  4. Reduced negotiation effort. Where contract requirements and conditions are developed unilaterally, with no industry engagement, expect negotiations to be protracted and adversarial.  Ensuring industry can provide feedback on requirements and commercial terms will take a substantial amount of pain out of negotiations.

Pursuing early engagement with industry also sets the tone of the future relationship. In such circumstances, the customer is highlighting that they value industry input, are seeking reciprocity, and are focused on delivering value rather than seeking the lowest price.  This is far more likely to promote the collaborative behaviours we need for successful delivery.

Strategies for Early Engagement

The Canadian government offers some useful examples of early engagement, including:

  1. Requests For information (RFIs);
  2. industry days;
  3. informal discussions;
  4. online questionnaires;
  5. online collaboration tools;
  6. focus groups; and
  7. one-on-one supplier consultations.[5]

More resource intensive and interactive strategies include:

  1. Design Competitions,
  2. Exploring and trading off requirements through Cost as an Independent Variable (CAIV),
  3. Funding rapid prototypes, and
  4. Engaging in collaborative project definition studies

These latter approaches normally require engagement with industry through some form of contract prior to entry into a head contract once requirements, budgets and schedules have been set. There are no limitations on who can be engaged here and funding multiple suppliers in a competitive early development phase may be valid.  

We are not limited to just selecting one of the above strategies.  We can choose more than one to help us converge on a solution. We need to remind ourselves that the solution is not just based on requirements but also the, “terms and conditions, pricing structure, performance metrics, evaluation criteria, and contract administration matters”. [6]  For example, we may exploit design competitions, CAIV, and rapid prototypes to define requirements, then use one-on-one discussions, questionnaires and industry days to refine commercial terms. 

Challenges with Early Engagement

Early engagement can introduce probity risks, resource challenges, and competition risks.  Probity risks arise where we are dealing with multiple suppliers and there is a great risk of ‘bid contamination’.  Similarly, customers need to be wary of adopting proprietary solutions that can hinder future competition.  Resource challenges arise as funds need to be available very early in the procurement lifecycle. The UK Government makes this point clear, “with early engagement though comes the requirement for early investment.”[7] There must be a compelling argument for engaging resources early in a program.  Competition issues may arise where we need to focus our efforts on a small cadre of suppliers rather than every participant in the market.  Where we are investing in rapid prototypes, CAIV approaches, or project definition studies a decision must be made as to who will be invited to participate. This will likely involve selection on ‘non-price’ criteria which opens the selection process up to criticism. 

Conclusions

Early engagement will pay substantial dividends if managed correctly.  Suppliers are far more likely to have a thorough understanding of business practices, technologies, and market trends in their core business when compared to customers.  Early engagement allows for early adoption of innovative solutions and value creation.  Developing a suite of contracts, commercial models, specifications, and requirements in isolation to your strategic suppliers will only erode value.


[1] Vann ‘Institutional Dimensions of the Government’s “Smart Buyer” Problem: Pillars, Carriers, and Organizational Structure in Federal Acquisition Management’ (2011).

[2] Canadian Government, Public Services and Procurement Canada ‘Smart Procurement’  https://buyandsell.gc.ca/initiatives-and-programs/smart-procurement/about-smart-procurement#Engagement

[3] UK Defence Procurement Policy Research paper 03/78 (2003).

[4] Bent Flyvbjerg, Nils Bruzelius, and Werner Rothengatter “Megaprojects and Risk: An Anatomy of Ambition” (2003).

[5] Canadian Government Opcit.

[6] Cohee, et al ‘Early Supplier Integration in the US Defense Industry’ Journal of Defense Analytics and Logistics Vol. 3 No. 1, (2019).

[7] Gansler et al ‘UMD FINAL Report LMCO An Analysis of Through-Life Support – Capability Management at the UK’s Ministry of Defense’ June 2012.

My Strategic Supplier is Making Abnormal Profits – So What?

Your profits reflect the success of your customers.” – Ron Kaufman

Money Bag – Creative Commons licence v4.0

Introduction

In many transactional, fixed price contracts, customers are often oblivious to their supplier’s actual profit margins. However; with many collaborative contracts, we often use open book financial reporting. In these circumstances, we can see where the money goes and how much profit is being made.  Commercial managers may be alarmed when they see suppliers make abnormal profits, but we should never over-react to such revelations.   On the contrary, abnormal, or high profits may be a symptom of a high performing team that is driving innovation for the benefit of the customer.  This blog explores these themes where we focus on value rather than price.

Are Profits Really Abnormal?

Effective commercial managers on the buy side possess the commercial acumen to understand the supplier’s business. Effective relationships demand mutual understanding as described in the Automotive Industry by Liker and Choi

“Unlike most companies we know, Toyota and Honda take the trouble to learn all they can about their suppliers. They believe they can create the foundations for partnerships only if they know as much about their vendors as the vendors know about themselves.”[1]

Not all industries are equal and profit margins are highly variable.  The Australia Department of Defence in their Profit Principles recognise three elements of the contract profit rate, comprising:

  • Return for Contractual Risk. For example, firm fixed price contracts are far riskier to suppliers than cost reimbursement contracts.  A higher profit margin would therefore be expected in fixed price arrangements.
  • Return for Activity Risk. Complex, developmental activities carry far greater risk than simple, commercial off the shelf activities.  Suppliers will factor in additional profit for the risky developmental tasks.
  • Return for General Business Risk.  Profit is to be expected on shareholder returns, general and administrative activities, managing sub-contractors, and general resource management.[2]

Included in the contractual risk profit provisions will inevitably be a supplier’s factor for relationships.  With a proven track record of positive relationships with their customer, a supplier may abate their profit margins, knowing that their commercial partner will act reasonably and fairly if things go wrong.  Conversely, if a supplier is dealing with a difficult customer, then they may load up their profit margin (or add contingency) to cater for the drama of working with a troublesome counterparty (or even worse, refuse to do business with that customer).  The following examples illustrate this point:

“In my opinion, [Ford] seems to send its people to ‘hate school’ so that they learn how to hate suppliers. The company is extremely confrontational.”[3]   – Supplier Executive Manager

“Starve before doing business with the damned Navy. They don’t know what the hell they want and will drive you up a wall before they break either your heart or a more exposed part of your anatomy.” – Kelly Johnson, Vice President at Lockheed Martin[4]

Even if you consider yourself a ‘perfect customer’ and suspect supplier profits are high (taking into account contract risk, activity risk, and business risk), there may be no real cause for alarm. The next step is to ask yourself, why are profits are high?

Cause and Effect

All highly competent people continually search for ways to keep learning, growing, and improving. They do that by asking WHY” – Benjamin Franklin

Perceptions of price can be important as the price itself.[5]  A cynical manager who is exploring high supplier profits would immediately assume that the supplier is acting opportunistically and gouging the customer.  This is a very dangerous starting point to adopt (even if the premise could be true). A useful starting point is to explore why profits are high by asking the following questions:

  • Are the profits high in the long term or are they cyclical? Depending on the project or business lifecycle, profit margins can vary widely over the medium to long term.
  • Is the supplier reinvesting profits into their business?  Where a supplier is investing in the relationship, seeking innovative ways of doing business, and adding future value then this should be encouraged.
  • Are you, as the customer, gaining ‘abnormal value’ from the relationship? So long as the customer’s strategic needs are being met and value is being delivered then we should not be too fussed about supplier profits.

If, after the exploring the issues above, it is revealed that value is not being delivered and suppliers are not investing in the relationship then a recalibration of the relationship may be required.  This does not mean that price becomes the only consideration. Do not let the pendulum swing too far in the other direction.

Driving value

The collaborative commercial model should be designed so that all parties win, or all parties lose.  There are a myriad of remuneration and non-price mechanisms we can use to achieve this. In addition to the commercial model, we also need to foster a collaborative culture and operate as one team.  Kanara goes further to state that customers should “treat your vendors like employees.”[6] If we are truly engaged in a collaborative model then customers should “learn to love their supplier’s profits”[7].  The caveat of course is to ensure the relationship continues to deliver value to both parties.  In addition to the remuneration strategy, we can also look at other ways to enhance the profit pool for both buyers and suppliers such as:

  • Initiate a continuous improvement and innovation fund where some of the savings can be distributed to each parties’ profit pool and the remainder used to fund additional continuous improvement and efficiency initiatives (thus creating future savings).
  • Encourage suppliers to reinvest in their business by increasing their scope of work within the customer’s organisation and offer longer term contracts.

Conclusion

High supplier profits may not necessarily be a bad thing.  So long as customers are provided with value then it may be a very positive sign to see high supplier profits, especially where customers and suppliers work together collaboratively to jointly create value.  Ideally, we should craft a commercial model where parties seek to continuously innovate and pursue excellence.  Nevertheless, there is also an important message for suppliers in this discussion. Never turn up to a customer meeting or contract negotiations driving a Maserati.[8]


[1] Jeffrey Liker and Thomas Y. Choi “Building Deep Supplier Relationships” Harvard Business Review (December 2004).

[2] CASG Profit Principles v1.0 (2017) p2.

[3] Liker et al, opcit. 

[4] Rich & Janos “Skunk Works: A Personal Memoir of My Years of Lockheed” (2013).

[5] Sandeep Heda, Stephen Mewborn and Stephen Caine “How Customers Perceive a Price Is as Important as the Price Itself” Harvard Business Review (January 2017).

[6] Ken Kanara “Rethink Your Relationship with Your Vendors” Harvard Business Review (March 2020).

[7] Anon.

[8] Quote attributed to Andrew Pyke https://www.linkedin.com/in/andrewpyke/

Collaboration and Chaos

Chaos is found in greatest abundance wherever order is being sought.  It always defeats order, because it is better organised.” – Terry Pratchett

M. Grandjean, Social Network Analysis Visualisation (2014)

Introduction

Ashby’s law of requisite variety tells us that if we want to control a system, then we must control at least as many states as the system we wish to control. In other words, ‘variety can destroy variety’.[1]  In the contracting domain, Ashby’s law creates significant challenges. We often look to the contract as a tool for formalising and implementing control but how effective are such tools in complex environments?  For simple, short term procurement activities there may be little variety or states of the system for us to manage or influence. In such circumstances, simple transactional contracts may offer sufficient input variety to deal with modest change and emergence.  When we move to more complex, long term arrangements with multiple, influential stakeholders then the quantum of variety in the system can increase exponentially. In such cases, crafting a contract with a repertoire of responses to deal with all these possible states or variety becomes a Herculean task.  This is where we need to look towards collaboration and new ways of delivering outcomes.

The Illusion of Contractual Protection

We like to think of our contracts as ‘iron clad’ mechanisms to protect our commercial positions, limit (or eliminate) liability, and clinically transfer risks to other parties.  Such notions though are illusory for many reasons.  Flydlinger, Hart, and Vitasek observe that contracts often create economic ‘hold-up’ behaviours where parties are unwilling to optimise outcomes:

The fact that virtually all contracts contain gaps, omissions, and ambiguities—despite companies’ best efforts to anticipate every scenario—only exacerbates hold-up behaviour.[2]

Such gaps and omissions will only increase in complex environments where we must deal with long term horizons, and multiple parties.  The variety associated with complex programs makes the so called ‘iron clad’ contract a myth. This is precisely what Ashby was talking about in the following statement (emphasis added):

               When the variety or complexity of the environment exceeds the capacity of a system                (natural or artificial) the environment will dominate and ultimately destroy that system.[3]

Whilst we would not allow circumstances to completely ‘destroy our systems’, we often destroy commercial value through:

  1. Excessive and inefficient contract change proposals,
  2. Wasted time in negotiations,
  3. Increased disputes and issues management,
  4. Sub-optimal delivery mechanisms,
  5. Increased and unnecessary contract contingency fees, and
  6. Under and over-insurance.

We also need to recognise there are very long preparation times and high development costs for these complex contracts. Many of these complex contracts are unfit for purpose.  Attempting to deal with all possible end-states or variety is not the answer. What we can do though is attack the problem from two perspectives. Firstly, we can limit variety within the system and secondly, we can increase our repertoire of responses (input variety).

Limiting Variety in the System

There are many ways we can limit variety in the systems we are attempting to control. In the commercial space we can do this by changing jurisdictions, removing the influence of stakeholders, and limiting the scope (and risk) of what we are trying to achieve.  In our previous blog on agile procurement, we also explored how we can aim for incremental delivery rather than a ‘big bang approach’.  Keeping our options open and not getting locked into a specific solution also helps us keep variety in check.  This includes the promotion of open architectures[4] and avoiding proprietary systems. 

Collaborative approaches also constrains variety in our systems. Where buyers and suppliers work collaboratively towards common goals then diverging interests are far less likely to create challenges.  In other words, where the parties focus on the question “what is in it for we”[5] then the focus is on fixing the problem and not the blame.  This means there is far less ‘noise’ in the system that would normally create unnecessary distractions. By default, we are limiting variety in the system or limiting the influence of that variety.

Increasing Our Span of Control

Maslow’s observation that, “if all you have is a hammer, everything looks like a nail” [6] is an axiom that regularly applies to contract lawyers.  The lawyer’s toolbox of responses is typically to claim that a breach has occurred and enforce damages. Black letter lawyers may also claim that the other party has repudiated the contract, they may threaten or seek termination, or pursue other similar legal sanctions to control that other party.  These control levers are limited in their application, are often ineffective, and carry great risks should they be used.  Contrast this approach to collaborative contracts that bring buyers, suppliers, and critical stakeholders inside the tent. In such circumstances, we have a far great range of responses that include working together to deliver mutually beneficial outcomes.  No longer do we need to rely on the sticks of control[7]  as all parties are working cooperatively towards common goals. We now have a combined range of responses that is far greater than that of any one individual organisation.  Implementing such approaches though requires leaders to possess the necessary mental agility and flexibility to deal with variety in our complex systems, as observed by Goss et al:

Applying the law of requisite variety to leadership in the implementation of change implies that leadership sources must have a repertoire of responses that can successfully deal with the variety of situations they encounter during implementation.[8]

Conclusions

We often rely on contracts to control outcomes but in complex environments, ‘black letter law’ control systems are often ineffective and are often constrained by Ashby’s law of requisite variety. Furthermore, control kills invention, learning, and commitment.[9]  To deal with complexity, collaborative approaches can both constrain variety in our systems and offer us a far greater range of responses when compared to transactional, arms-length contracts.


[1] Ashby, W.R. An Introduction to Cybernetics (1956), p 206.

[2] David Frydlinger, Oliver Hart, and Kate Vitasek ‘A New Approach to Contracts How to build better long-term strategic partnerships’ Harvard Business Review (Sep–Oct 2019).

[3] Ashby, opcit.

[4] Santiago J ‘Applicability of the Law of Requisite variety in Major Military System Acquisition’ (2017) p 60,76 at https://apps.dtic.mil/dtic/tr/fulltext/u2/1046519.pdf

[5] David Frydlinger, Oliver Hart, and Kate Vitasek ‘A New Approach to Contracts How to build better long-term strategic partnerships’ Harvard Business Review (Sep–Oct 2019).

[6] A Maslow, Psychology of Science (1966).

[7] I Ayers, Carrots and Sticks (2010).

[8] Tracy Goss, Richard T. Pascale, and Anthony Athos ‘The Reinvention Roller Coaster: Risking the Present for a Powerful Future’ Harvard Business Review (1993).

[9] Ibid.

Ethics and Collaboration

Relativity applies to physics, not ethics” – Albert Einstein

Image Courtesy of Nick Youngson (creative commons)[1]

Introduction

When we embark on collaborative ventures, there are inherent features that drive us towards more ethical behaviours.  For example, when we collaborate, we are more likely to empathise with out counterparts, power may be diffused with joint decision-making, and our ways of thinking and doing business may be more diverse.  All of these features help us avoid ethical lapses, but we must be alert to some of the risks associated with collaboration.  In this blog we explore some of the temptations that can arise in collaborative ventures and offer strategies to ensure all parties work together ethically to achieve enterprise outcomes.

Winning at Any Cost?

In Ron Carucci’s paper, ‘Why Ethical People Make Unethical Choices’, he makes the following observation:

“organizations set themselves up for ethical catastrophes by creating environments in which people feel forced to make choices they could never have imagined.”[2]

The literature is clear that unrealistic goal setting will encourage people to make compromising choices and as Carucci observes, this pushes people to breach ethical standards in two ways.  First, they may compromise and cut corners to reach goals and secondly, they will under-report or lie about what progress has actually being achieved.[3] Similarly, if we create a reward system that is too enticing, we can encourage ‘justifed neglect[4] whereby the temptation to cheat is too great (especially if the risks of getting caught are low).

When we set up collaborative frameworks, we must be sensitive to setting realistic goals and ensure no one is set up to fail.  Similarly, where failures can occur, then we must ensure that the consequences of such failures are not catastrophic. If the cost of failure is too high for an individual, then there is a clear invitation to deceive and mislead. Setting realistic goals will solve one key part of the puzzle to help use drive ethical behaviours but what else can we do to drive an ethical, collaborative culture?

Ethics at the Forefront

If we fail to discuss or place a value on ethical behaviours, then we are less likely to see such ethical behaviours. That is, we must put ethics at the forefront of our ways of doing business. Simply relying on value statements, code of conducts, and the obligatory online, annual ethical training programs though is not enough.  Incentivising ethical behaviour is far more effective, as observed by Epley and Kumar:

“It is a boring truism that people do what they’re incentivized to do, meaning that aligning rewards with ethical outcomes is an obvious solution to many ethical problems.”[5]

The challenge of course, it to balance commercial incentives with ethical incentives. An organisation that is haemorrhaging money but is working at the pinnacle of ethical standards would not be a successful organisation. The converse is also true (for example; Enron, Volkswagon, and the News of the World to mention but a few), but we are not faced with a binary choice here. We can be both commercially successful and behave ethically. If we craft our commercial model right, drive the right culture, and ensure leadership is committed then all these elements will self- reinforce to drive us towards a high performing ethical team, delivering enterprise outcomes.

Language and Framing

The language we use and how we frame our agreements is also of paramount importance. If we focus people’s thinking towards enterprise outcomes and not just personal self-interest, then we are less likely to see unethical behaviours.  We therefore need to craft our approach to market, commercial agreements, and ways of doing business in terms of joint or collaborative approaches. Language such as “we will work together collaboratively”, or “the team will operate jointly to deliver the joint objectives” should be used. This is in stark contrast to traditional or adversarial contract language such as “the contractor shall…” or “the principal shall…”. Epley and Kumar illustrate the importance of language and framing in the following case study (emphasis added).

70% of participants playing an economic game with a partner cooperated for mutual gain when it was called the Community Game, but only 30% cooperated when it was called the Wall Street Game. This dramatic effect occurred even though the financial incentives were identical.[6]

Substance though is far more important than form, hence we must make sure that our actual commercial models and leadership approaches are aligned to our desired collaborative outcomes. This then leads us to a very important aspect of our blog, ‘leadership’. In our previous blog on leadership we observed that leaders set the tone at the top and are instrumental to reinforcing the organisations’ culture (good or bad).  No amount of goal alignment, balanced incentive structures, correctly framed collaborative relationships, and well crafted, equitable commercial models will drive ethical behaviours if our leaders are setting a bad example.

Conclusions

Collaboration can inherently reduce some of the risks associated with ethical lapses by incorporating joint decision making, transparency and a culture where everyone is incentivised to achieve mutual, enterprise goals.  Nonetheless, we need to be careful we do not set unrealistic targets. More importantly, we must ensure that individuals or teams never face catastrophic consequences where they fail to meet targets or goals. In such circumstances the temptation to cross ethical lines may be too great. Consistent with collaborative contract principles, we should always focus on ‘fixing the problem and not the blame’.


[1] https://www.thebluediamondgallery.com/wooden-tile/e/ethics.html

[2] Ron Carucci ‘Why Ethical People Make Unethical Choices’ Harvard Business Review (Dec 2016).

[3] ibid.

[4] Merete Wedell-Wedellsborg  ‘The Psychology Behind Unethical Behavior’ Harvard Business Review ( April 2019).

[5] Nicholas Epley and Amit Kumar ‘How to Design an Ethical Organization: A behavioral approach’  Harvard Business Review (May 2019).

[6] ibid.

Intra-Organisational Collaboration

ISO44001 – Collaborative Business Relationships Figure 1

Introduction

We have spent a lot of time in previous blogs discussing the value of collaboration between organisations to achieve superior outcomes, but we also need to recognise that intra-organisational collaboration can also deliver substantial benefits to organisations. ISO 44001 Collaborative Business Relationships illustrates this point noting that the standard exists to, “…improve business relationships in and between organizations of all sizes.”[1] More and more organisations are realising that stovepipe approaches to delivery erode value through unnecessary duplication, conflicting goals, and inefficient allocation of resources. By improving internal collaboration we are more likely to get; higher profitability, greater resilience to external shocks, and greater flexibility.[2] We are now seeing more organisations placing a greater focus on internal collaboration to reap organisational benefits.

A Duty to Collaborate and Cooperate?

In the contract law domain, we know that there is an implied duty to cooperate in commercial dealings[3], but what duties drive us to collaborate internally? Some public sector jurisdictions mandate collaboration and cooperation. For example:

  1. Under the United Kingdom Health Act, there is a duty to collaborate with other entities;[4]
  2. The United Kingdom police, fire and rescue and emergency ambulance services now have a duty to collaborate under the Policing and Crime Act;[5]  and
  3. In Australia, Commonwealth entities must encourage officials of the entity to cooperate with others to achieve common objectives, where practicable.[6]

Collaborative behaviours are also finding themselves being introduced into organisational values and behaviours. For example, the recently released Australian Defence Values emphasises the following behaviour:

Collaborate and be team-focused[7]

We also see this theme manifest itself in private sector ‘values’ that demand teamwork.[8] Coca cola, for example, specifically include collaboration as a core values as follows, “Collaboration: Leverage collective genius.”[9]

Putting collaboration at the forefront of an organisation’s mission, values, and behaviours will go a long way to help realise the full raft of collaborative benefits internally but this will only be successful if everyone in the organisation knows what collaboration means and what the common purpose is.

Turning Strategy into Tactics

Having Collaboration embedded in your mission and values will only go so far. Everyone in the organisation must understand what collaboration means to the way they work, think, and behave.  Word pictures such as the following will help embed a collaborative culture:

‘I will actively engage with others inside and outside Defence, and work to create a high- performing team environment that is always seeking to improve our enterprise.’[10]

‘To fully embrace collaboration, we must:

  1. embrace opinions and diversity of thought in order to avoid group-think or narrow perspectives
  2. proactively collaborate, and in a time-conscious manner, in order to ensure a meaningful result
  3. ensure that decisions or advice being progressed have been genuinely reviewed, and all comments have been captured and documented as appropriate to inform                          decision-makers, rather than as a ‘tick in the box’
  4. embed and embrace exemplary practices for communication, media management and advice to government at all times.’[11]

Collaborative principles may also be embedded in employee position descriptions such as the following which appear in the ‘work level standards’ for the Australian Public Service:

“Engage and collaborate with key stakeholders to identify opportunities, achieve outcomes and facilitate cooperation.”[12]

“Drive, manage and coordinate cross-agency collaboration initiatives, activities and relationships”[13]

Even with behavioural standards and values focussing on collaboration, an organisation must have a clear and unified strategy that is understood by everyone in the organisation.  Similarly, leaders must clearly demonstrate and reinforce collaborative behaviours.

Tips for Leaders

Gardner and Matviak offer the following tips to promote collaboration within an organisation:

Connect with the front lines. Make direct contact with people down the hierarchy so you have unfiltered information about people’s actions and states of mind.

Champion collaborative leaders. While recognizing individual effort, also acknowledge the team that helped make the person a hero by calling out the specific actions it took to provide support and the ways all of its members accomplished a goal together.

Reinforce the business’s purpose and goals frequently. A belief that their work fulfills a higher purpose motivates people to think and act in a more collective fashion.’[14]

In summary, leaders need to ‘sell the benefits’ of collaboration to achieve a common purpose and be seen as a role model in collaboration.

Conclusion

The benefits for collaboration are legion, not just between organisations but within organisations as well.  We are seeing more organisations recognise teamwork and collaboration as part of their values and behaviours.  As leaders, we need to ensure our ways of working, thinking, and leading are aligned to realise these collaborative values. 


[1] ISO 44001 p vii

[2] Heidi K. Gardner and Ivan Matviak “7 Strategies for Promoting Collaboration in a Crisis”, Harvard Business review July 2020.

[3] Mackay v Dick (1881) 6 App Cas 251, 263

[4] Health Act 1999 (UK) [26] [27].

[5] Policing and Crime Act 2017 (UK) [1]

[6] Public Governance Performance Act 2013 (Cth) [17].

[7] https://www1.defence.gov.au/about/values

[8] Rio Tinto values https://www.riotinto.com/en/sustainability/people#:~:text=Our%20five%20values%20%E2%80%93%20safety%2C%20teamwork,we%20work%20with%20our%20partners.

[9] Coca Cola values https://www.coca-cola.com.sg/our-company/mission-vision-values

[10] Defence Transformational Strategy (2020) p 29. https://www1.defence.gov.au/sites/default/files/2020-11/Defence-Transformation-Strategy.pdf

[11] ibid., p73.

[12] Work level standards for the Australian Public Service (March 2018) https://www.apsc.gov.au/work-level-standard-executive-level-1

[13] Work level standards for the Australian Public Service (March 2018) https://www.apsc.gov.au/work-level-standard-executive-level-2

[14] Gardner and Mitnik, opcit.

Collaboration – Measuring and Maintaining Success

Figure 1: ‘Staying Together’ ISO 44001 (2017) Collaborative Business Relationships

Introduction

In previous blogs, we explored the importance of selecting the right commercial models, selecting the right partners, jointly managing risks and opportunity, and other key features to reap the benefits of collaborative ventures.  Once the relationship is afoot though, we also need to ensure that collaboration remains at the heart of the relationship throughout the complete lifecycle. Once the euphoria of establishing a high performing, collaborating venture is over, there may be a temptation to revert to transactional management practices with a failure to maintain and sustain effective collaborative outcomes.  This blog explores strategies to measure the effectiveness of collaboration once a contract is afoot and identify opportunities to realign behaviours when required.

Best/Better Practice

ISO44001 Collaborative Business Relationships recognises ‘staying together’ as a critical part of the collaboration lifecycle.   Within this stage, there is a requirement to:

  1. Describe how relationship health will be monitored and reported,[1]
  2. Implementing processes to monitor behavioural and trust indicators, and[2]
  3. Review relationship metrics and take corrective actions where necessary.[3]

The key issue here is to ensure all relationship metrics are jointly managed and reviewed.  More specifically, relationship health needs to be considered in the context of delivering the joint objectives of the collaborative venture. 

Relationship Metrics

There are no hard and fast rules relating to what metrics should be used to measure relationship health.  There may be a mix of subjective and objective metrics, as well as lead and lag indicators. There is also opportunity to incorporate the relationship measurement framework with the broader commercial performance management framework. Generally, we would rarely align remuneration or payment to a relationship health metric rather, relationship health may be used as an ‘Enterprise Performance Measure’ or ‘System Health Indicator’ as described in Dr Andrew Jacopino’s excellent podcast on Third Generation Performance Based Contracts. As with all performance measurement metrics, there should not be too many, and those that are used must be relevant.

Some of the more common relationship metrics we can use include:

  1. Leadership participation. Are key leaders engaged and meeting regularly[4];
  2. Disputes and Issues. Are disputes and issues dealt with promptly and equitably;
  3. Transparency and No Surprises. Are there any communication failures, bottlenecks, or unnecessary incidences of surprises in the relationship;
  4. Collaborative Culture. Do buyers and suppliers work together collaboratively ensuring that all parties ‘fix the problem and not the blame’; and
  5. Continuous Improvement. Are the parties working toward a common goal to maximise value in a joint environment?

Some of the above metrics can overlap and some of the metrics may be sub divided into additional criteria. What is needed though is that there are agreed processes to measure relationship health so that corrective action can be taken and more importantly, positive behaviours are reinforced and acknowledged. 

Managing Relationship Challenges and Corrective Action

Relationship Management is a continuing activity that demands attention from all parties.  In long-term relationships we must anticipate the risks associated with complacency and challenges associated with key staff turnover.  Even the most diligent, high performing teams will encounter relationship ‘challenges.  Consistent with collaborative contracting principles, issues need to be dealt with considering the following principles:

  1. Deal with issues at the lowest level possible, quickly, and fairly;[5]
  2. Focus on fixing the problem, not the blame;
  3. Attempt to turn issues and challenges into opportunities (embrace continuous improvement opportunities)
  4. Do not be afraid to make big changes or change tack to better achieve joint objectives. 

The key objective in ‘staying together’ is focussing on delivering joint objectives. In some cases, uncertainty, risks, and environmental changes may mean that the joint objectives cannot be delivered, and the relationship may need to end.  Consistent with ISO 44001, an exit strategy should be pre-agreed to ensure future business opportunities are not jeopardised.[6]

Conclusions

Measuring and managing relationship health is of paramount importance in a collaborative venture.  This is of particular importance in long term relationships and where repeat business is expected.  Several metrics are available to assist in measuring relationship health though the real test of relationship health is reflected in how the joint team members interact, as observed in the Australian Government Guide to Alliance Contracting (emphasis added):

The desired culture should align to the behaviours required to enable the key alliancing features such as good faith and ‘no disputes’ to operate. Often the desired behaviours are described through establishing an Alliance Charter which documents the alliance values. However, the real culture of a team is demonstrated in how the team behaves and interacts.[7]


[1] ISO 44001 Collaborative Business Relationships [2.8].

[2] ibid [8.8.4].

[3] ibid [8.8.7].

[4] See e.g., Association of Strategic Alliance Partners ‘Alliance & Collaboration Assessment Tools’ at https://www.strategic-alliances.org/page/collaboration_tools

[5] ISO 44001 Collaborative Business Relationships [8.8.8].

[6] ibid [8.9.5].

[7] Australian Government – Department of Infrastructure and Transport, ‘National Alliance Contracting Guidelines – Guide to Alliance Contracting’ (2015), p 35 at https://www.infrastructure.gov.au/infrastructure/ngpd/files/National_Guide_to_Alliance_Contracting.pdf

Managing Uncertainty through Collaboration

           “We demand rigidly defined areas of doubt and uncertainty!”    – Vroomfondle the Philosopher, in Douglas Adams The Hitchhiker’s Guide to The Galaxy (1979).

Introduction

In our previous blog, we explored how collaborative management of risks and opportunities can lead to superior outcomes. Whilst issues (known knowns) and risks (known unknowns) can be relatively easy to manage, a more critical challenge arises with uncertainty. Uncertainty can manifest itself as either:

  1. Unknown knowns. Things we know about, but we may have incomplete information about their likelihood or consequence.
  2. Unknown unknowns. These are simply things that are not contemplated (sometimes referred to as unfathomable uncertainty).[1]

We previously mentioned that a contract is a tool that is used to allocate risk but how can we manage uncertainty where the risk is simply not contemplated, or risk likelihood or consequence cannot be reliably quantified?  This blog explores strategies on how we can effectively craft a commercial model that better deals with uncertainty. 

When to Focus on Uncertainty?

Whilst uncertainty is relevant to all commercial dealings, the impact of uncertainty is more likely to arise within certain environments. Remington and Pollack offer a useful framework to help us gauge the level of complexity in a project, and hence where we need to focus our efforts in dealing with uncertainty.

  1. Structural Complexity. Many interdependent systems or components
  2. Technical Complexity. New technologies or new ways of business
  3. Directional Complexity. Many diverse and influential stakeholders with competing needs.
  4. Temporal Complexity. Unanticipated changes in regulations, law, and environment.[2]

In summary, high complexity often creates an environment where uncertainty is more likely to have an impact of the delivery of outcomes. How then do we create a commercial model to effectively deal with uncertainty?

Crafting a Commercial Model to Deal with Uncertainty.

Traditional arms-length contracts are often underpinned by waterfall development life cycles whereby the principal provides the contractor with a specification, statement of work, and conditions of contract to deliver the contract works.  In complex environments, such approaches are often unsuitable as uncertainty introduces change and emergence that is often not contemplated in the contractual risk allocation framework and procurement documentation.  We may therefore need to adopt a more exploratory procurement model where we ‘probe, sense, respond’ rather than the traditional ‘sense, categorise, respond’ approach we see in simple procurement activities.[3] There are several ways to achieve this including:

  1. Contracting for incremental outcomes and exploiting prototypes. An evolutionary approach mitigates many of the challenges associated with uncertainty by allowing us to ‘probe’ the environment, explore the art of the possible, and create ‘early wins’. Incremental approaches also provide natural ‘off-ramps’;
  2. Maximise tradespace.  Providing maximum flexibility and agility to trade off cost, schedule, and performance parameters. This approach allows a collaborative means to realise benefits even when new, significant risks and issues emerge; and
  3. Create an adaptable organisation and culture that can cope with change. Traditional approaches rely on stable requirements, certainty, and linearity. To effectively deal with uncertainty we need to create an environment where all key stakeholders understand that change is a natural part of the process and we have the right leaders to communicate how change can be an effective tool to achieve the project ‘vision’.

Recognising that there is no pre-ordained path to delivering outcomes will go a long way to helping us deal with uncertainty, but we still need to get into the contractual ‘nitty gritty’ of managing change, implementing suitable risk and reward mechanisms, and dealing with the prospect of cancelling the contract if uncertainty jeopardises the business case. 

Change Management Processes 

Uncertainty can create significant challenges including increased costs, delays, and force change in delivery methods.  Anticipating all possible permutations that may occur throughout the contract lifecycle is a fool’s errand so we must implement robust and fair change management processes.  We need to remind ourselves that there is no price competition associated with variations in a contract so we must ensure any change management process balances fairness, timeliness, and value. This is where a culture of collaboration will reap dividends. Where parties work on a best for project basis with shared goals, and shared information; change management will be far more effective.   Collaboration also allows opportunities to be recognised and exploited when circumstances change.

Risk and Reward

Traditional fixed price, arms-length contracts are unsuitable for contracts involving high uncertainty. A commercial model is therefore required to encourage parties to fix the problem and not the blame when new risks emerge.  A firm fixed price contract where suppliers face unlimited liability for all risks and with no recourse to force majeure will drive the wrong commercial behaviours. Similarly, a cost reimbursement contract where the buyer assumes all risks will unlikely deliver value for money. As we have stated in many previous blogs, a commercial model is needed where buyers and suppliers both have ‘skin in the game’ and are incentivised to work collaboratively to proactively manage new risks and exploit new opportunities. 

Termination

Where a magnitude of change arising from uncertainty is significant, then this could jeopardise the procurement business case or value proposition. In such circumstances, termination or significant rescope of the project must be considered.  Collaboration is necessary to ensure a seamless closure of the project, reduce disputes, and capture lessons learned.  Preservation of business relationship is also of critical importance. By adopting collaborative contract principles, we are more likely to effectively manage radical changes in scope.  We need to make sure that the commercial framework supports timely exchange of information so that there are ‘no surprises’ for either buyers or suppliers.  Termination clauses must also be reasonable, fair and therefore contemplate ‘reasonable de-mobilisation costs[4]

Conclusions

Dealing with uncertainty is something that is often overlooked in contract management as this is a very hard topic to deal with.  Collaboration is a key tool when dealing with complex projects where we anticipate uncertainty. We need to make sure we manage stakeholders effectively, implement robust and fair change management processes and establish a commercial framework where all parties share in risks and rewards.


[1] Kim, S. D. ‘Characterizing unknown unknowns’ (2012) PMI Global Congress 2012—North America.

[2] Remington, K., & Pollack, J. Tools for Complex Projects (2007)

[3] David J. Snowden and Mary E. Boone ‘A Leader’s Framework for Decision Making’ Harvard Business Review (November 2007).

[4] Gray A. ‘Unfair Contract Terms: Termination for Convenience’ [2013] University of Western Australia Law Review 12 (2013) 37(1) 229 at 250.

Benefits Realisation Through Joint Management of Risk and Opportunity

Small opportunities are often the beginning of great enterprises.” – Demosthenes (384 – 322 BC).

Introduction

The overwhelming majority of commercial arrangements are underpinned by contracts.  The contract is largely used as a tool to allocate risk but the way we often use contracts to manage risk is ineffective for many reasons.  First, there is asymmetry of information where parties are unaware of what risks actually exist, what the likelihood of risks are, and their consequences. Secondly, the risk allocation process is often controlled by the buyer and this often results in unfair risk allocation. Thirdly, we become so obsessed by managing risks that we fail to explore opportunities and value creation.   In other words, we end up leaving substantial value on the table during negotiations and beyond.  This blog explores strategies to improve the way we manage risk and opportunities through collaboration.

Risk and Opportunities Identification

It would be remarkable if a buyer fully comprehends all relevant risks associated with the goods and services they are procuring.  It is highly likely an asymmetry of information[1] exists whereby the supplier has a more comprehensive and accurate understanding of the risks associated with their deliverables.  Similarly, suppliers may not have a full appreciation of the customer’s environment, constraints, and motivations.  Typical commercial negotiations are underpinned by this bilateral asymmetry of information and this results in suboptimal outcomes.  There are some strategies that are often used to counteract an imbalance of information such as:

  1. Contracting for an ‘outcome’ rather than a ‘thing’,
  2. Relying on price competition to ensure price (not necessarily value) is fair,
  3. Performing due diligence such as referee checks, customer testimonials, exploring defect rates etc.

Whilst the above strategies may provide some confidence that the goods and services provided are fit for purpose, there are significant limitations where competition is constrained, there is a selection bias in referees/testimonials, and with the failure explore value creation. 

Rather than adopt an arms-length commercial approach, a collaborative approach with early engagement is far more likely to capture all relevant risks associated with the contracting function but more importantly, identify opportunities to create value. This can be achieved with buyers and suppliers working together in a joint risk and opportunities workshop to gain a better understanding of the risks and opportunities upfront. 

The two stage Early Contractor Involvement (ECI) contract is a very good example of collaborative risk and opportunities management. Under the ECI process, the buyer and suppliers work together early in a preliminary stage to jointly identify risks and opportunities in a collaborative fashion.[2]  All options can be explored in this stage, there should be no unnecessary constraints.  Once complete, the parties further work together to explore who is best placed to manage the identified risks. This may involve risk transfer or even risk sharing. Insurance brokers may also be invited to participate in these workshops where risks can be allocated to third parties.  We need to recognise that this preliminary stage does not have a default risk allocation strategy, a default contract template, or pre-defined remuneration strategy. It is up to buyers and suppliers to jointly work together to determine the most suitable commercial framework well before the head contract is signed.  Working together collaboratively eliminates most of the challenges associated with asymmetry of information and ensures the final cost estimates and schedules are realistic.[3] 

Fairness in Risk Allocation

Joint management of risk and opportunities will inherently support fairness in the commercial relationship. We mention previously in collaborative contracting blogs that unfair risk allocation can severely erode value:

Inappropriate allocation of risk resulted in a 14 percent increase in costs to projects. Of this amount, the customer was liable for 78 percent of the cost increase.[4]

We discussed the downsides of unfair risk allocation in our blog on commercial models  but what are the benefits of fair risk allocation?  Fair risk allocation eliminates many unwarranted contingency fees or management reserve being added to the supplier’s contract prices.  More importantly though, a fair and equitable commercial framework encourages parties to share information, explore continuous improvement and innovation, and focus efforts on pursuing opportunities.    A focus on risk transfer does the exact opposite.

Consider a firm fixed-price arms-length contract where the customer allocates as much risk as possible to the supplier.  In this situation, the key motivation of the supplier is to spend all their efforts on risk abatement, deliver outcomes only within the strict boundary of the contract, and ignore any deviations from the contractually delivered ‘plan’.  If we are serious about benefits realisation, a more considered approach is needed that;

  1. Encourages joint risk and opportunities management;
  2. Ensures a risk and reward structure is implemented that is fair and reasonable;
  3. Encourages parties to work towards delivering enterprise goals (which also includes a vibrant, sustainable, and profitable supply base);
  4. Focusses efforts on fixing the problem and not the blame; and
  5. Tolerating prudent risk taking, consistent with the approach of fail fast, fail cheap, fail often, fail safe, and fail smart.[5]

A joint approach to managing risk and opportunity registers with a single of truth is far more likely to foster innovation and value creation. A single source of truth that represents a holistic picture of project risk is also far more valuable to all stakeholders.  This can be achieved via a joint liability risk assessment or risk log that explore risk as a probability distribution.  The quality of this risk assessment will also be far superior as both buyers and suppliers are involved.  A probabilistic analysis can be undertaken to explore most likely, worst case, and best-case scenarios for delivering outcomes. Buyers and suppliers can then adopt a mutually informed negotiation process to reach a commercial agreement but more importantly, all parties can work collaboratively to mitigate risks. 

For those that want to explore probabilistic risk assessments further, I have developed a creative commons (free for commercial use) liability risk assessment template which converts three-point estimates for any number of risks into a probability curve and cumulative probability distribution. This tool is based on a PERT Beta distribution[6] using a 10,000 point Monte-Carlo simulation.  The tool allows users to derive expected value (p50) and best case/worst case estimates for known risks. This tool provides an understanding of the spread of risks on a project and informs the best commercial model for both buyers and suppliers and can be downloaded from the below link.

Monte Carlo Risk Analysis Tool

Dealing with Uncertainty and Estimation

Managing the known risks is arguably the easy part. Crafting a commercial framework that effectively deals with uncertainty (the unknown unknowns and known unknowns)[7] is far more challenging. The traditional approach of dealing with uncertainty with indemnities and managing change through variations rarely delivers value. The topic of our next blog will explore strategies to craft a commercial relationship that does effectively deal with uncertainty. 

Conclusions

Managing risks and opportunities jointly through early industry engagement is far more likely to create value. A shift to collaborative risk and opportunities management though does require a move away from traditional boilerplate contracts and tender evaluation processes. What is needed is a commercial model that explores risks and opportunities at the enterprise level and drive parties to proactively explore these opportunities to realise joint benefits.


[1] George A. Akerlof ‘The Market for “Lemons”: Quality Uncertainty and the Market Mechanism’ The Quarterly Journal of Economics Vol. 84, No. 3 (1970).

[2] Roger Quick, ‘Queensland ECI Contract’ ICLR [2007].

[3] Queensland Government Chief Procurement Office Procurement Guidance Series “Relational Procurement Options – Alliance and Early Contractor Involvement Contracts” (2007) at http://alliancecontractingelectroniclawjournal.com/wp-content/uploads/2017/06/Queensland-Government-Chief-Procurement-Officer-ND-Relational-Procurement-Options-Alliance-and-Early-Conractor-Involvement-Contracts.pdf

[4] CII Research Report RR210-11 “Contracting to Appropriately Allocate Risk” (2007) summarised in Altman R., Cruz J., Halls, P “One-sided Contracts: Do They Pay Off?” ACCL Vol 11 1 (2017) p 169.

[5] US Government “Innovative Contract case Studies” (2014), p20.

[6] Vose D., Risk Analysis: A Quantitative Guide 3rd ed (2008) pp 672-4.

[7] Respectively referred to as ontological and epistemic uncertainty.