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Contracts matter

Posted by Tim Cummins | Jan 21, 2019 7:48:00 AM

Contracts ‘set the tone for the relationship’, especially in more strategically important interactions. The design of the contract, the way it is worded and negotiated, all have a psychological impact on the parties, influencing the way they perceive the counter-party and subsequently behave.

The research is available

For at least 30 years, academic research has indicated the importance of the contract to subsequent performance. IACCM’s studies, especially those related to ‘The Ten Pitfalls’, have confirmed both the elements and the impacts of poor contracting. In one study, ‘Using Psychological Theories to Shape Partner Relationships through Contracting’, the authors observed: “if a firm can develop specific competencies in the contractual process, particularly in the more complex end of the contract spectrum, then it is possible for it to create a competitive advantage based on these contracting capabilities. This idea is akin to that of alliance capabilities, in which some firms develop competencies in creating and managing alliances that other firms cannot imitate (Kale, Dyer & Singh, 2002). One way for firms to develop a contracting capability is to first identify what type of relationship it desires with the partner,whether arms-length or a trust-based relationship, and then use psychological theories to guide the framing that it uses in the contract. Although this process seems straight-forward and therefore imitable, it is, in fact, difficult to determine the type of relationship that is most appropriate and the best approach to accomplish this end”.

I have highlighted the sentence regarding the type of relationship because it is remarkable how frequently businesses fail to give this adequate consideration. Indeed, a mentality that is based around standard templates and compliance almost inevitably results in a failure to address – or even care about – the psychological impact of the contract. Far too often, behaviors are driven by narrow views of efficiency and risk, rather than the economic or business outcome to be achieved.

Getting things wrong

IACCM’s work regularly confirms the pervasive nature of this issue. For almost 20 years, the annual study of ‘The Most Negotiated Terms’ has indicated the divide between the terms that are most important versus those that receive greatest attention. This in turn explains why many in Sales or within business units consider contracts to be negative or even destructive in the formation of relationships. One result of this is that the type of relationship – and the appropriate contractual framework – is often ignored. Indeed, a common complaint by contracts and legal staff is that they are involved too late, meaning that often they have little or no influence over the contractual framing.

In many cases, technology makes this situation even worse. ERP and P2P Systems in particular typically relegate the contract to a point of little significance, imposing a cookie-cutter standard, almost regardless of its applicability or suitability.

Avoidable costs

All this sums up to the fact that most organizations fail to build robust contracting capability. This results in a whole host of avoidable costs – not only is it intrinsically inefficient, but it generates extensive downstream operational costs, as well as lost revenues, missed opportunities for innovation and damaged reputation.

Unfortunately, the pervasiveness of these failings makes it hard for enlightened organizations to break the mould. Even those who wish to develop sound, productive relationships typically find themselves frustrated by the contracting practices of their counter-parties. This goes a long way towards explaining why the stories of highly successful contracts are so rare and why they are then so hard to replicate.

Achieving change

Although the evidence is compelling, achieving change is not easy. One major factor is education. The facts about contracts and their economic impact are simply not taught. Hence a multitude of stakeholders emerge with little or no understanding of the way that contracts frame their business relationships and as a result, few organizations make the investments needed to build a true contracting capability. Things are improving and new technologies will accelerate the change, but it remains frustratingly slow and sadly is often perpetuated by people who really should know better.

It’s time for all those who care about business results to start shouting the message. If you want successful relationships, contracts matter!

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