How to Structure Your Contracts to Drive Innovation

By Allan Watton on

Keyboard answers Credit-Murat Göçmen iStock-843260624.jpg

In some circumstances, the reality of strategic relationships can be far removed from the academic ideology of partnership perfection. There are many agenda, personality, and behavioural-led reasons why such relationships don’t always achieve everyone’s expectations.

When we look for the reasoning behind such relationship breakdowns, they are many and varied and are usually specific to the individuals within the organisations that govern them. However, one of the common traits we see that often does not help with governing or driving the right behaviours between individuals in these relationships, is the legal contractual documents that govern (or rather, constrain) them.

Having examined many thousands of contracts over the years, rather than driving the ‘right’ behaviours in a strategic partnership, we have found that the contracts organisations draw up to guide their relationships are all too often responsible for hindering progress. Most worryingly, they often drive the wrong behaviours in the most important area of any strategic outsourcing relationship: innovation.

The collaborative effort of all parties in these relationships should be to promote best value and value-added practices at every stage in a relationship. This is vital to the perceived and actual success of the business outcomes and objectives both organisations are trying to achieve.

Contracts should be ‘implementation plans’ to achieve business outcomes, not just legal ‘sledgehammers’ to use when things go wrong

The complexity of the laws that govern contractual etiquette, in-house legal manpower issues, and an inherent paranoia (sometimes justified, sometimes not, but certainly fuelled by media frenzies over high-profile law suits and strategic partnership breakups) that the other side will exploit any legal weakness, has led to a culture which believes that contracts exist to eliminate risks, rather than to promote collaborative innovation.

Having been involved in the realignment and recovery of hundreds of strategic programmes, projects and outsourcing relationships, we often see the following scenarios;

  • Scenario #1 – unclear expectations: The service definitions and objectives have often been outlined, but they aren’t clear, little has been quantified, and the KPIs to measure performance so that both organisations achieve their business outcomes are often misaligned and do not drive the right behaviour between everyone. In turn, the written contract(s) is drawn up with little relevance to the business outcomes that need to be achieved.
  • Scenario #2 – the enemy: Contracts are drawn up with the help of a crack team of solicitors who look to plug every conceivable loophole that could be potentially be exploited by the client or supplier (the ‘enemy’). Result – excessive time and money spent on building a fortress of a contract which screams a lack of trust in the other side. This puts everyone on edge, and usually results in constraining any hope of innovative activities actually being pursued as they are considered too risky given the contractual parameters everyone is working under.
  • Scenario #3 – abusing trust: Assuming that the other side will attempt to ‘screw you over’ any opportunity they get, you use your crack, very expensive, legal team to look for loopholes that you can exploit to squeeze every possible penny of value from the other side, then go a little further. Result – a strategic partner that feels that their trust in you has been abused, and thanks to an ever-dwindling profit margin, less interest in investing their best talent in activities that look to optimise productivity and drive innovation.
  • Scenario #4 – boilerplate contract terms: Contracts are standardised to save on the cost of that crack legal team, requiring everyone to shoehorn their round peg into a potentially square hole. Result – money on legal fees saved indeed, but a lack of alignment to your business outcomes in the contract will led to ambiguity creeping in and a greater opportunity for both abuse, misinterpretation and disagreement.
  • Scenario #5 – waxwork contracts: Your contracts are drafted, agreed to, signed, then consigned to a dusty filing cabinet in a basement somewhere never to be seen again. Then a legal issue arises and they are shown the light of day and pored over by that expensive legal team again. It’s what we call a ‘waxwork contract’: it never changes. Result – leaving your contractual documentation to slowly gather cobwebs ensures that it will be all too easy for you to allow the other side to deviate from their responsibilities to you, or you to them, and opportunities to evolve and adapt that contract to encourage greater innovation will be lost.

The prime purpose of your written contract is not to (or should not) be used as a focal mechanism purely for defensive action, or to secure a pre-emptive attack. If it is structured in this way, then, not surprisingly, that is the behaviour you will receive.

Written contracts are not a necessary evil to be laboured over once and then never seen again. Your contract should be the heart and soul of your working relationship; it is the structured governance around a successful implementation plan for you and your strategic partner to achieve your business outcomes in a fair, equitable and innovative manner.

If it is structured correctly, it should be placed front and centre in the governing behaviours around your relationship, and not hidden away. Everyone’s focus needs to be completely realigned to start structuring contracts as documents for driving successful behaviours, viewing contracts in a positive light, as embodiments of the values, ideals and aspirations of a relationship, not the shackles by which two legal entities are chained to one another for a specified period of time, trying to run, but with leg irons attached.

There are five core considerations that in our experience work well for driving superior innovation through the way you develop and work with your written contracts:

1. Build innovation into your contract’s core values

The International Association for Contract and Commercial Management (IACCM) have written on this subject and I will refer to this on occasion throughout this article.

“For many, the purpose of contracts and negotiation has been more about avoiding risk than creating value.” A study from the IACCM into the most frequently negotiated terms shines a spotlight on what businesses consider most important when they draw up their relationship documentation – how to “deal with the consequences of default or failure”. While it is of course important to protect your organisation from the possibility of negative outcomes from a relationship, this obsession with “liabilities, indemnities, [and] liquidated damages” clauses implies too much weighting on the side of relationship pessimism and not enough on the ways contracts can be used for fostering the positive environment that encourages fairness, cooperation and innovation.

Maintain a sensible level of vigilance when drafting your contracts, but make them more about collaborative working, communication and clarity. Make the ‘relationship’ central in your contract strategy, building in opportunities for innovation wherever possible.

2. Don’t let your contract worries become self-fulfilling prophesies

As mentioned above many people focus on the potential for disaster in their contractual strategies, shoring up their legal documents against the possibility of abuse from the other side. But, the more you insist on defensive measures within the contract, the more likely you are to damage the trust you have an opportunity to be building, increasing the likelihood of your strategic partner considering you as an onerous claim risk. The more strained your relationship becomes, the less inclined your strategic partner will be to take risks for you. In these circumstances, innovation can suffer.

Naturally, you have to have a level of diligence and certainty that if matters are not working out between you, you need mechanisms that provide for appropriate escalation. Ultimately, if matters cannot be resolved, then you need a clear process by which the relationship can be exited and transitioned to something different – or to someone else. But these are ‘catch-alls’ for when matters cannot be resolved. The first focus of your contract should be to drive the right innovative behaviours to encourage the right business outcomes for all involved.

3. Keeping it simple

Contracts can be complex entities, often so full of legalese and internal referencing that the average person who deals with having to manage the provider, would be hard pushed to make it work to drive the right behaviours.

For your contract to be a document central to all parties’ understanding of the task ahead of them, it needs to be, well, understood. With greater understanding comes more confidence, greater awareness of when expectations are being met, and, therefore, when it is appropriate, possible or expedient to invest time and talent in innovative activities to drive even greater results.

Simpler contracts are the way forward, and we often find that written contracts that use more business-orientated language and other mediums such as process diagrams, graphics and even video, to ensure that everyone clearly understands what is expected of them, leaves less to be misinterpreted. This in turn ensures that all parties’ expectations of how the contract should operate and the business outcomes that everyone anticipates they will achieve are mutually aligned.

4. Commercial trust is key to encouraging innovation in others

I cannot say this strongly enough, commercial trust is one of the most important elements in any successful working relationship. It should be fostered, nurtured and protected. IACCM state that: “Management has failed to appreciate the role that contracting strategies and negotiation practices play in tackling these issues. Interconnections and interdependencies are defined and managed by contracts. Global differences and cultural gaps are bridged by negotiation. Trust is created by contract terms and our performance against those terms.”

Our own experience clearly evidences that greater commercial trust between parties encourages greater collaboration and an invested perspective that is more likely to lead to the volunteering of innovative activities to better the business outcomes.

5. Contracts must evolve to take advantage of value-adding opportunities

Contracts seem to be seen by most people involved as set in stone, inflexible and simply mechanisms for legal recourse when something goes wrong. This is entirely the wrong focus if it is the primary emphasis of the written contract. A contract that embodies the values and aspirations of a collaborative effort to achieve best results is a contract with built-in flexibility, a contract that grows and evolves with the relationship of its signed parties.

Almost all outsourced partnership contracts should have review and revision periods locked into them. It’s important that at least every six months everyone has an opportunity to review the evidence of performance over the previous six months, and use that evidence to drive better results and innovation and then realign/reshape the contract terms and KPIs to add value to the relationship.

Contracts need to be more capable of driving the right behaviours at the right times in the relationship, and to achieve this they need to take on a more aligned approach, one that recognises that as time goes by you will gain a better understanding of the needs of the business and the capabilities of your strategic partner.

IACCM captures the essence of a poor contract strategy: “Our recent studies have proved that the failure of contracting practices to keep pace with the business environment is eroding value, creating conflict and causing loss.”

So, if you wish to drive better results from your next strategic partnership consider the importance of a flexible, evolving contract that is created with fairness for all in mind, that builds commercial trust, is fully understood by all parties, and most importantly, is primarily focused around collaboration – not just risk aversion.

Photo Credit- iStock, Murat Göçmen