Are your written contract terms fit for purpose? 4 steps to driving better cost savings

By Allan Watton on June 10, 2015

driving costsA significant number of outsourcing relationships appear to have major value for money and efficiency challenges. A phrase clients often use is that they believe their outsourcing relationship is ‘leaking’.

If you perceive this to be the case in your outsourced relationship, every day that passes may create its own small inefficiencies and missed opportunities – which can accumulate until you find yourself metaphorically semi-submerged in a pool of costly lost potential.

This situation has, at times, arisen because the written contract terms – the document that is supposed to drive successful outcomes and protect your actions and interests in your outsourced relationship – may well be misaligned to drive fit-for-purpose behaviours between you all.

Over 20 years of experience, helping public and private sector organisations to make the most of their strategic partnerships, has brought me to one clear understanding on this matter – to prevent the inevitable leakage your written contract terms need to firmly align with the business outcomes your relationship was set up to achieve.

In other words, you need less of a contracting strategy, and more of a business strategy that allows the written contracts to drive the right behaviours in order for your organisation to implement and benefit from that business strategy.

Your written contract is (or should be) your path to a fit-for-purpose solution that drives maximum value

Lou Gerstner, Chairman and CEO of IBM from 1993 to 2002, believed that contracts were far more than simply legal documents – saying that he thought them to be ‘fundamental instruments in the creation and support of brand image’, citing them as marketing tools that in themselves could aid an organisation to win more business. Certainly from our experience in the recovery of complex relationships, it seems that a number of written contracts are operating in ‘legal silos’ rather than being aligned to what the business is actually trying to achieve.

Some 20 years on and another ex-IBM man, current Executive Director of the International Association for Contract and Commercial Management (IACCM), Tim Cummins, agrees. He takes things even further by suggesting that, to a large extent, ‘a contract strategy underpins and impacts [the] economic and financial results’ possible from the relationship it governs.

Cummins has recently written an insightful paper on the subject of contract strategy – so I will refer to some of his words for this article, as they largely reflect my own feelings on the topic.

Complexity of outsourcing

In the 1930s British economist and author Ronald Coase recognised the complexity of outsourcing. Though much of the restrictions that he envisaged around control and management have now been overcome by far more rapid and effective networking and communications, what has remained the same is that outsourcing suffers from a level of complexity quite different from projects handled in-house.

Theorists will wax lyrical about a world now unrestricted by traditional boundaries that has evolved, thanks to a technological and digital revolution, to enable any organisation to source the best talent from anywhere for greater efficiencies and value. They will talk about outsourcing now being able to offer cost savings as specialist firms can offer economies of scale. But, along with all the advantages, outsourcing also comes with baggage, its own complexities that, on occasion, make outsourcing relationships strained and ultimately untenable.

These ‘risks and challenges’, as Tim Cummins refers to them, are what your contract should be designed to tackle from the outset and throughout your relationship.

The written contract’s role in promoting cost savings

Coase was correct in his belief that an organisation’s written contract terms had a greater role to play than simply to dictate or determine recourse in the event of a relationship breakdown. Written contracts are one of the key components that should be used to build strong, trusting relationships with cooperation and innovation at their core. However, currently far too many are confusing, filled with legal jargon, ill-conceived and do not align or drive the right success behaviours. These issues will seriously impact on how wasteful your strategic partnership will ultimately end up being.

Is your contract misaligned to the business outcomes you want to achieve?

From the review of contracts we have undertaken, here are some of the common ways in which we have seen written contracts allow outsourced relationships to ‘leak’ cost saving opportunities. Again, Tim Cummins’ recent essay inspired us to bring this to your attention:

1. Poorly defined service scope, business goals and individual responsibilities

A topic much discussed in our articles is that of gaining a complete and thorough understanding of ‘what good looks like’ in your service delivery options. These are the expectations you wish to achieve, by whom and to what defined levels. This is the starting point for any successful strategic relationship.

Only by involving all appropriate stakeholders and other relevant individuals in the development of a clear plan of action – with established and agreed upon (and business aligned) KPIs and outcomes – can you have a yardstick with which to determine success or failure. Without goals to shoot for, and regular milestones to measure them at, you will have no idea whether there are opportunities for cost savings to be maximised or whether ineffectiveness is running rampant in your relationship.

2. The contract management of your expectations

Your written contract should create the right environment to develop the right behaviours to drive strong service delivery – but at the same time, help you realign services to improve on-going cost savings.

Although your partner is under a ‘duty to warn’ you and ask you the right questions with regard to your requirements, you are responsible, as you would expect, to make sure you give them factually correct information.

If you have a perception that your partner has misunderstood some aspects of your requirements, then you are under a duty to clarify this with them. However, if you genuinely believe that your vendor understands your requirements, then it is for your vendor to have qualified them correctly, based on their expertise.

However, note that even if your vendor has represented itself as a ‘specialist’ in your sector, and despite it being accountable to validate your requirements, if you are not clear on your business outcomes and objectives and have not appropriately quantified these, it is likely that your unquantified expectations will result in confusion and the potential for error, manipulation or dispute. Irrespective of your vendor’s expert responsibilities, this will not help you achieve the right business outcomes that you expect from the relationship.

Creating the right environment to develop the right behaviours is fundamental. If your partner does breach its contractual responsibilities, productivity drops, service levels decrease and, by definition, costs increase significantly. This does not help either of you, irrespective of who is at fault.

How you respond to these circumstances will say a lot about your character to your strategic partner. If you ‘turn the other cheek’ in the ‘spirit of partnership’, you leave the door open for potential abuse from some ‘accountability shy’ providers that will directly impact your ability to recognise and prevent wastefulness in your relationship. Conversely, deal with it too harshly and you risk driving a wedge between you and your outsourced partner. Finding a balanced reaction that is firm but fair is ideal to creating an environment in which increased service delivery and cost savings are much more likely.

3. Contract complexity

Written contract terms are as varied as the organisations that use them, which from a personalisation perspective seems like a good thing. However, this does add a level of complexity that necessitates the use of experienced, and often expensive, legal advisors.

Add to this the fact that there seems to be little consistency in the terminology used in contracts and how people interpret them – which only leads to ambiguity, confusion and the potential for conflict. It would be a shame that after you’ve dedicated yourself to pre-contract due diligence in the development of scope, goals and responsibilities, then determined who needs to do what and how their milestones and outcomes should be measured, if you allowed this clarity to be muddied by ambiguous legalese.

Written contracts should be appropriately detailed documents, but they must also be clear in how they communicate expectations and business outcomes. Plain English contracts, or at least those that speak the language of the business people involved in the relationships, is a good step forward in communication clarity, and it is only through this clarity that the potential for cost savings can be maximised.

Furthermore, drawing up process diagrams of the operational aspects of written contracts saves significant misunderstanding. They also aid the re-shaping process as your business outcomes change over time and need to be updated in the written contract terms.

4. Strength and depth of contract negotiation

When you trust someone, or the organisation they work for, then you are more likely to be comfortable collaborating with them to achieve your business goals. Conversely, a lack of trust is likely to have the opposite effect.

Trust is hard won, through consistently doing what you say you are going to do, when you say you are going to do it. By not acting in this way trust is so easily lost, which is why your contract strategy must have an appropriate trust building process built into it.

It is inevitable that most clients will wish to scrutinise a written contract to ensure that all risks are mitigated and all opportunities for cost efficiencies are maximised. However, how you handle your contract negotiation will set the tone for the relationship. If you are too soft and focus less on the business outcomes to be achieved, then your strategic partner may see this as a sign of weakness and exploit this to abuse your trust in them.

If you are too harsh, labouring over every tiny detail of the legal obligations and liabilities, then you are implying a lack of trust them and they in turn will question their trust in you. A clear focus on the business outcomes and objectives that both sides need to achieve must be struck to minimise risk exposure across the whole relationship, which encourages cooperation, trust and a collaborative approach.

Contracts are becoming ever more important in the development and management of strategic partnerships and, as Tim Cummins states in his essay:

‘it is increasingly the public sector that is recognising the importance of contract and commercial capabilities. The winds of austerity are forcing a fundamental rethink of the way public services are delivered, moving from state-run to increasingly outsourced provision. This cuts costs, increases flexibility, generates innovation – but only if the management skills are there to select, motivate and manage suppliers and only if those suppliers have the integrity and competence to perform on the contracts they win.’

In our experience of improving the performance of large outsourcing relationships, the assertive statement of outsourcing – ‘cutting costs, increasing flexibility and generating innovation’ – is somewhat patchy at the beginning. If you develop the right environment to encourage supplier performance, in the form of service re-shaping and innovation, this can often result in cost savings and minimises the opportunity for leakage in your outsourced relationships through the contracts you structure. They’re more than just legal documents, they should be structured as relationship enhancement tools.

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