Good contracts

When negotiating a contract with the buyer you should take particular effort with risk transfer and downstream innovation. Both areas can materially affect the success and profitability of a contract. Another common feature is that business decision makers, not just procurement specialists, should take part in discussions about them. 

Risk transfer

It’s best to place risk with the organisation most able to manage it, it sounds easy but there are plenty of temptations to behave differently. For example, buyers are often best placed to manage the risk of not achieving benefits particularly where they depend on staff reductions, but it’s tempting to make a suppliers reward depend on achieving them. The practical consequence is that the buyer will have an additional reason for avoiding the unpleasantness of making staff redundant as if they do so their contractual payments to the supplier will also increase. If on the other hand the contract had separated out the ability to reduce staff from its achievement both organisations would be able to manage their risks.

The Risks that can, and should, be transferred to you are those where you have control of the factors governing their achievement, for example, equipment availability which depends on the quality of the equipment and the maintenance and repair regimes.

I’ve seen a contract where the risk that a call centre would not be used was placed on a supplier, and whilst use can be influenced by the quality of service provided, that isn’t going to attract completely new users. Responsibility for advertising the existence of the call centre, and why one should call it, was left with the buyer so that when budgets came under pressure advertising was cut and usage of the call centre fell.

Good contracts are built on a shared understanding of the risks and agreement on who takes and manages those risks based on placing the management of risks with the organisation best able to do so.

Downstream Innovation

It’s often said that what’s not in the contract won’t happen, and this is particularly true where change costs money and the supplier doesn’t share in the benefits. The benefits from downstream innovation are normally enjoyed by the buyer whereas the cost and risk of achieving them are met by the supplier. Where the supplier is made responsible for innovation, without defining it or providing any incentive for action, the contract will create stress rather than achieve benefits.

You can take a defensive position and pay lip service to innovation or alternatively you can use it to legitimately grow the value of the contract. A useful approach is to create a mechanism where you can recoup the costs of:

  • building a business case for innovative changes, and
  • implementing the changes,

plus a bonus when measurable business benefits are achieved. Alternatively you may find the buyer is prepared to partially fund the investigative work. In which case you could offer to charge only for your costs, without any profit, and agree a success bonus to be paid if and when benefits are achieved. This is particularly appropriate where you aren’t in control of all the factors affecting the achievement of benefits.

In reality innovation should be a team effort, so in addition to showing how both parties will be rewarded by success the contract should also include some thoughts on how they will work together to achieve it.