Risk Management, Cost Reduction and Corporate Governance: An Undiscovered Opportunity?

"The new focus on corporate governance (Sarbanes-Oxley; NYSE; Dey Committee in Canada; Turnbull in UK; KonTRag in Germany; etc.) calls for corporations to undertake a serious program of risk assessment and to summarize risk and responses to boards. Risks are our measures of the probabilities of unexpected outcomes, both positive as well as negative, arising from our decisions and acts. Contracts are techniques for risk sharing: we join with a counter-party to share both benefits and harms".¹

Ask the average corporate executive about the risks contained in their sales contracts and they will either shrug or point you to the Law department. Chances are there is no one in the corporation who actually has a consolidated view of the potential exposures hidden away in negotiated customer contracts. And most have yet to realize the overall positive impact they can gain from standardization and control over this business process. Indeed, many do not even see ‘contracting’ as a process. Yet giants like IBM and EDS discovered the opportunity some time ago – and have reaped the benefits ever since.

Research² suggests that corporations tend to veer wildly between ‘control’ (limiting authority to negotiate, implementing an onerous approval process) and ‘empowerment’ (we must win the business – contracts can’t stand in the way). Such reactions are inevitable when knowledge and information are limited and underlying processes are weak.

Standard arguments against greater control of ‘terms and conditions’ are that it will reduce sales flexibility and responsiveness, or is simply impossible in competitive markets. Wrong. Weak controls are the enemy of flexibility, especially in today’s service-led environment. Lack of discipline – which in some organizations can amount almost to anarchy – actually disables deal-making, pretty much guarantees that products become commodities and, when it comes to contract implementation, is a recipe for failure. Risk flourishes in an environment of uncertainty.

But, the argument goes, this is the wrong time for change. The state of the economy means negotiation power has moved to the buyer. ³ It is scarcely the moment to be imposing central control on our negotiators. Wrong again. A thorough process appraisal and creation of planned and thoughtful standards could not be more timely or appropriate.

The key words here are ‘planned’ and ‘thoughtful’. In such times of uncertainty there is the temptation in some corporations to impose rigid controls and standards and ‘rein in the cowboys in Sales’. This reaction is understandable and will certainly improve control; on the other hand, it will also result in lost business and an open door for more imaginative competitors.

So the message here is not just about standardization and control; it is about how to implement and move to a more predictable, risk-managed environment.

What IBM and EDS discovered was that planned standardization yielded many more benefits than just cost savings (though they alone ran into several hundred millions of dollars). While the driver might have been control, the reality was that it allowed much greater flexibility. For example:

• Risk management and risk acceptance became much faster, more automated. It is much easier to quantify when you are moving from a known base. And rather than focus on issue identification, staff begin to work on solutions and mitigation.
• International customers want consistent global deals. If you don’t know your baseline and capabilities are not defined, you can’t confidently commit or implement.
• It’s true that lawyers handle some key risk terms, protecting your worst case exposure, but more than 80% of contract content typically falls outside their preserve or interest. Rather than just focus on what happens when things go wrong, doesn’t it make sense to plan the commitments that might make the deal go right? Without clear ownership, no one knows where to go or how to handle requirements for non-standard (customized) terms. So what do they do? They either give up, or they guess.
• Clarity of ownership saves time and raises sales force morale. Far from constraining sales, a process-based view and defined ownership are welcomed and often lead to increased revenue commitments, both for new and existing business.⁴
• Customer confidence, satisfaction and spend all increase. Customers may want negotiated terms (their terms) – but they especially want trouble-free implementation. Contract issues – failure to execute in the way that was promised, constant invoice errors, dispute over terms and milestones – bedevil far too many relationships.

Partners to a contract should enter into it having taken the time to understand all the risks. Trouble is, if you don’t have standards, every deal is risky and getting it quantified takes too much time and resource. By having many of the basics established, efforts can instead be focused on what are the potential favorable outcomes, including those that are unexpectedly outlandish? What are the potentially harmful outcomes? How do we share the first? How do we prepare for the second and, most importantly, how do we respond to them?

As if these potential benefits from control weren’t enough, along came revenue recognition and Corporate Governance. These external drivers are sending a wake-up call for many executives who realize they had better get a handle on the commitments being negotiated in their corporation’s name. Yet even now, many are turning to the General Counsel in the expectation this will fix the problem and provide instant answers. In some cases, it probably will; but in many it is going to lead to frustration. There is a world of difference between ‘contracts’ and ‘contracting’ – one is a document, the other is an end-to-end business process. Lawyers may be pretty good at producing legally sound documents and managing risk avoidance through boilerplate terms; not many are experts at process reengineering and overall business risk assurance.⁵

As many major US corporation shave discovered, they lack adequate control or knowledge of the deals being done by their business units. Most cannot even tell you what proportion of their business is transacted under non-standard terms, or what non-standards have been negotiated. For example, in our recent benchmark survey, more than 50% lack any central system or repository for contracts and over 70% have no formal definition of global standards (both quite fundamental to understanding or analyzing potential risks and exposures).

Without knowledge, there is no real control – and without control, the recent past has shown the weakness of Corporate Governance.

Sales contracting is long overdue for some sustained executive focus. Recognizing it is a process and making someone accountable for its effectiveness is the place to begin. Put in some targets and measures that reflect strategic priorities and corporate culture. In the context of risk, build a process that (1) makes sure that both partners understand the risks (potential benefits and harms). (2) work out how each and both will respond in the event that unexpected events occur, (3) Accept mutual responsibility: that's what stakeholders (especially customers and the public) expect and that's what protects and preserves reputations.

A proactive risk assessment should be a part of any contract analysis, along with a shared idea of what to do when something goes wrong. The fewer lawyers that we have in this equation, the better off we will be!

Measures might include:

• Percentage of terms varying from standard
• Percentage of contracts varying from standard, by business area
• Cycle times for different contract types / business units
• Sales force satisfaction with contracting (simplicity, flexibility, responsiveness)
• Process cost savings (reduced time, eliminated steps, headcount reduction)
• Percentage of ‘troubled projects’ that can be traced to poor negotiation or implementation
• Percentage of contracts staff or negotiators certified as competent

Chances are your results will be limited unless you introduce some level of automation. This is a field that is ripe for knowledge management and information capture. Investment in contract management software is essential. It could be in-house, but nowadays there are so many scaleable solutions that it makes little sense to develop your own.

Without changes such as these, contracts will continue to reflect a simplistic view of a relationship: risk shuffling, not risk sharing; most for me and little for you, where possible using corporate weight or market advantage to impose otherwise onerous terms on the other party; many of these terms being rote legal reactions that do more to destroy than build a budding relationship.

What can you expect in return from this investment? Well, as IBM, EDS and a growing range of other corporations have discovered, the benefits are not just in cost savings and better risk management. They can equally be measured in terms of greater flexibility in designing new or higher value offerings, in pro-active risk sharing with customers and in focus on revenue generation and relationship management.

And if that’s not enough, you certainly should avoid a few nights of missed sleep and irate calls from disgruntled customers.

Tim Cummins is Executive Director of the International Association of Contract and Commercial Managers (www.iaccm.com), a global not for profit association for contracts and sourcing professionals. With members from more than 300 major international corporations, IACCM undertakes extensive surveys and benchmark studies to further its aim of improving corporate performance and competency in contracting and negotiation.