Tim Cummins, CEO of the International Association for Contract & Commercial Management (IACCM), expressed that thought in a recent Commitment Matters blog post about the need for a rebalancing of contract terms, especially in the area of risk allocation.

“The unfairness of risk allocation in contracts is one I have encountered many times during discussions in recent weeks,” he writes. “There is a feeling that large corporations and major public sector bodies have become more risk averse and have used current economic conditions to exert their strength – liabilities, indemnities, IP rights, termination provisions, performance criteria and (in the corporate sector) payment terms have been areas of focus.”

These same organizations “think nothing of using their power to force unilateral renegotiation when conditions change,” Tim continues. “Overall, I think things have become worse.”

There’s a persistent belief that harsh, muscular terms will drive performance. For complicated or long-term relationships, “all the evidence points the other way … unfairness undermines loyalty and commitment, leading to poorer outcomes and therefore added risk.”

Recognition of this problem goes back more than 40 years. In 1968 the legal scholar Ian R. Macneil observed that most contracts are ill-equipped to address the reality of business needs. In Contracts: Instruments for Social Cooperation, he wrote that contracts are rooted in the classical approach to contract law and thus crafted to address transactions and legal protections such as pricing and price changes, service levels, limitation of liability, indemnification and liquidated damages.

Macneil was instrumental in developing a wider view of the contract, called relational contract theory. He contended that business-to-business contracts should be “instruments for social cooperation,” adding that contracts can be “governed efficiently only if the parties adopt a consciously cooperative attitude.” He said that contracts are rooted in relationships and activities that have a large context, rather than as the discrete transactions prescribed in a contract.

Macneil challenged lawyers to rethink their approach to business-to-business agreements and criticized the classic approaches to contract law.

That rethinking really has not occurred in a comprehensive way. An April 2010 study by the IACCM concluded that contract terms remain mired in the classical legal approach of contract law, focusing almost exclusively and hierarchically on pricing, limiting liability, indemnification, service and transaction levels, risk mitigation, and liquidated damages.

Though Tim says things are worse he also sees some light end of the tunnel. “I have the impression that an increasing number of organizations are starting to question their approach. This is leading to a number who have renounced liquidated damages; some who are questioning how they can be more intelligent in protecting (and exploiting IP); others who are looking for shared approaches to governance through better change provisions, escalation procedures and added flexibility through mechanisms such as ‘hardship clauses’. I believe the door is opening for those suppliers who engage early and demonstrate their capabilities and commitment to deliver.”

The Vested Outsourcing Manual addresses this longstanding contracting problem by changing the way companies and service providers interact. Job one is collaboration and a non-adversarial mindset in which the parties sit with each other at the conference table and jointly discuss their intentions, objectives and Desired Outcomes before they think about final contract terms.

I heartily agree with Tim that “relationships that extend beyond a few transactions will always depend on trust and cooperation. Failure to establish and sustain these characteristics will always result in degraded performance and missed opportunities.”

A Vested Outsourcing partnership is based on trust, cooperation and contracts that are real, sustainable and aligned for the long-term win-win.

Copious, onerous and (often) unnecessary T&Cs not only can hit the bottom line, they can contribute to a failed outsourcing deal, especially if they are one-sided and inhibit innovation and trust.

Oliver Kirchner, Senior Legal Counsel, Global Commercial Transactions for Nokia Siemens Networks, illustrated this point last month in a presentation on “Why Outsourcing Deals Turn Sour“ at the Arab Outsourcing Conference.

Outsourcing projects can sour when the various reasons for outsourcing in the first place become blurred by self-interest and a failure to collaborate, or as Oliver says, when the expectations of one of the parties are not met.

Rigid T&Cs reached in a vacuum can’t align expectations between the parties. In a Vested Outsourcing partnership they can because they exist only after the parties’ collaborative efforts on a joint statement of intent to achieve their Desired Outcomes.

Oliver’s chart shows that T&Cs are not just a legal issue. As base costs (including calculable risks) and costs involved with additional requirements (such as estimated risks) mount up the final pricing structure eats away at profit.

Outsourcing practitioners remain stuck in old-school, and I believe, outdated contract principles designed to shift risk, limit liability and focus primarily on price instead of value as the main priority of contract terms. Oliver points this out in his presentation, and The Vested Outsourcing Manual, which will be published by Palgrave Macmillan later this month, also addresses this unfortunate reality, based on research by IACCM.

Rather than contract terms that start with pricing, price protections, indemnification and payment, why not collaborate on terms that begin with scope and goals, change management, and communication before worrying about price?

That’s the outcome-based Vested approach that produces value through the true collaborative win-win.

It is also what Oliver said last month: “Only a win-win deal is a good outsourcing deal.”

While there is obviously no standard cost template for contract negotiation services—contracts can vary from the exceedingly short and simple to the immensely long and complex and you won’t find any BOGO contract specials at your local Best Buy—it is legitimate to consider how much it will cost to produce a contract.

The IACCM’s Tim Cummins addressed that question at some length in a recent Commitment Matters blog post. He dug into IACCM’s extensive benchmark database to extract some estimates.

He relates factors that impact the cost question, including:

• Complexity – Is it a simple purchase order or a major outsourcing agreement?
• What constitutes the actual contract – Does it include SOWs, schedules, SLAs?
• Are Master Service Agreements, which represent core terms and conditions, part of the contracting process?
• Time calculation definitions and whose time is part of the cost calculation. Are the parties using elapsed time (i.e. cycle time) or actual time (the number of hours spent on specific contract production activities)?

With respect to a simple purchase order, he says, “The actual production process in efficient organizations has been driven down to a cost of $10 or less.”

Things ratchet up quickly after that under other contract forms.

There are two key cost considerations, Cummins says. “One is the cost of producing and agreeing the contract; the other is the cost of having the wrong contract (inappropriate terms, poorly drafted SoW, unclear service levels).”

The latter point, it seems to me, is crucial. Wasting time, energy and money on poorly drafted, unclear contract terms accomplishes nothing and puts the entire outsourcing relationship at risk. The Vested Outsourcing Manual, which will be published in June by Palgrave Macmillan, provides a pathway to crafting the best possible Vested agreement and avoiding pitfalls.

Cummins notes that contracts can be put in place very quickly and at very low cost; the downside of that approach is that it can “create major risks and downstream costs in so doing,” for example renewing an expired agreement without review.

Another problem is too much rigidity, where procurement teams impose highly standardized agreement forms that are not adjusted for the nature of the goods or services they are acquiring, “for example, distinguishing between production materials, computer hardware or software licenses.”

Assuming companies are operating with an efficient contracting process, Cummins relates the following contract production cost estimates:

1. Simple contracts (some negotiation and review (internal and / or external), low risk, relatively low value or spend commitment): Average cost $5,000 (lowest cost $3,500)
2. Mid-complexity contracts (significant review, some external negotiation, significant – but not major – risk considerations,): Average cost $19,200 (lowest cost $12,000)
3. High complexity contracts (major review and approval, extensive negotiation, high or unique risk factors and value): Lowest cost $40,000, upper cost may be $200,000+

A wide range of costs, but I would note that the upper end of the cost for a complex deal can well exceed Cummins’ estimate in complex outsourcing deals.  I have seen the cost of a retained advisory firm or legal fees amount to well over $500,000 just on the buyers side!

Companies that have excessive rigidity, no overall process discipline, or high levels of non-compliance  “may well produce contracts at much lower cost, but their actions will result in extensive downstream problems – for example, frequent claims and disputes, extensive cost overruns or project delays,” Cummins writes.

My recommendation? Get it right from the start with a Vested Outsourcing collaborative and flexible mind-set at the front end of the contract negotiation, the correct mix of experienced teams, and a clear vision of intent and Desired Outcomes. Following the Five Rules will get you the most bang for your contracting buck.

But would you rather have a lawyer do it? Really?

Gonzalez does make a point, and in entertaining style, featuring background music and lyrics by the 1980s rock group Depeche Mode.

Gonzalez makes the connection between the band’s “handshake deal” (sans lawyer or economist) for its first record label contract in 1981 and how it might have gone for them if they had “lawyered up” and taken the normal contract negotiation path. Back then they came up with a simple 50-50 agreement that offered flexibility, shared risks, rewards and interests – and all without contract legalese.

Of course that was then and this is a more complicated and legalistic now but perhaps you can see where this is going in the context of Vested Outsourcing. The crucial message that a rock band discovered (and even wrote about in song) back then is that the best and most useful contracts will flow from a vested, relationship-based approach that features mutually agreed upon and beneficial terms rather than me-first terms based on transactions, shifting risk and limiting liability.

I wrote about the vested approach to creating value through contract terms in a recent blog post, spurred by the International Association of Contract & Commercial Management’s 9^th Annual Report on the most frequently negotiated contract terms. What alarmed me then – and still does now—about the IACCM findings is that most contracts remain much too bound by traditional legal exercises in self-interested power plays that set out first to limit liability, avoid risk and set transaction, service level and pricing level provisions, rather than striving from the start to foster collaboration on contract goals and scope with specific understandings on flexibility, communications, reporting and the responsibilities of the parties.

In his post Gonzalez tracks the IACCM report in a similar vein and notes that economists such as Oliver Williamson (whom we have talked about in other posts) “have a more enlightened and scientifically-grounded approach to structuring win-win business relationships than lawyers do.”

Economists understand that “people and organizations are in fact able to grasp the benefits of cooperation and team behavior,” he continues. “The law is struggling to catch up and still appears to believe that the best way to manage risk is to allocate it to someone else and the greatest incentive to perform is via threats of dire punishment for failure.”

Of course the foundation of a vested contract approach is based on the Five Rules because a Vested Outsourcing relationship functions best in a culture where the participants work together to ensure mutual success, or getting to What’s in it for We?

Thanks Adrian for the shout-out to my blog in your post; I figure a turn-about shout-out to yours is apropos.

So lawyer or economist for your next contract? Maybe it’s not that tough a call after all.

As we move to the Vested Outsourcing world of cooperative, mutually-beneficial, performance- and outcomes-based contracts based on the transforming power of the Five Rules I’d suggest that the oft-used term “Contract Management” no longer really fits the bill.

In fact I believe Contract Management is a bad term. At the very least it’s outdated, larded under decades of contract legalities and precedents that struggle to account for what has happened and what may happen in the real world.

In Vested Outsourcing aren’t we really developing a flexible, anticipatory and collaborative framework and governance structure to manage a dynamic business relationship? This is straight out of Rule 5, Governance Structure Should Provide Insight, Not Merely Oversight. The Vested Outsourcing relationship works best in a framework and culture where the participants work together to ensure their mutual success.

Think of it this way: Marriage is a legal agreement, and certainly a marriage can be difficult to manage. But it is much more than a legal enterprise in which each potential event or scenario can be carefully anticipated and managed, or something that’s inherently susceptible to strict management rules. It’s a unique, vested relationship based on mutual trust, cooperation, flexibility, hope and much more.

A contract, especially a vested contract, is like a marriage in many important respects. It should be the basis of a long-term relationship in which the contract parties work, grow and prosper together.

A marriage based totally on transactions doesn’t sound like much fun for the long-haul; neither is a transaction-based contract.

So instead of Contract Management, perhaps it should be called Economic Relationship Management.

And while you’re thinking about managing that economic relationship think of it also as a flexible framework, not a legal weapon.

We all know that the world of business and outsourcing is not static; it changes and evolves over time. Dr. Oliver Williamson, the Transaction Cost Economics guru, argues that organizations that “all complex contracts will be incomplete – there will be gaps, errors, omissions and the like.”

As such, a contract should provide a framework and (I hope) a process for understanding the parties’ relationship. The framework thus must be highly adjustable or adaptable rather than prescriptively outline the detailed working relations.

Flexibility should be embedded in a contract so that potential maladaptations can be resolved or at least lessened by crafting mechanisms that deal with unanticipated disturbances as they arise.

Creating a detailed contract and associated statement of work puts the outsource provider into a box and forces the provider to stay there. Instead of being a prescriptive document, the contract should provide a flexible framework and process for understanding the parties’ relationship. In achieving this “flexible framework” the contract will never accurately or fully indicate real working relations, unless the contracting team has immense psychic talents. Instead of trying to guess about the future, it is better to indicate a rough idea of the work to be done, while providing methods for ultimate appeal.

This means that this framework/process must be highly adjustable or adaptable. And trusting. And cooperative. Like a marriage.

That is where problems almost always emerge, usually sooner rather than later.  The title of a survey report done by the International Association of Contract & Commercial Management is apt in this regard: Contract Negotiations As A Source of Value.

Tim Cummins, the chief executive of IACCM, quotes Ian Macneil, the recently deceased writer and legal academic in the first paragraph of the report to the effect that contracts arise because parties “recognize that there is more to be gained by some level of cooperation than by separation.”    This sounds like Mr. Macneil would have been an advocate of Vested Outsourcing and it’s foundational WIIFWe approach to doing business.

That seems obvious; it’s also easily said but difficult to implement successfully.

“When it comes to the terms on which contract negotiators spend most time, this spirit of cooperation remains notable for its absence,” Cummins says.

Rather, risk allocation and avoidance dominate the interaction between parties during conventional business-to-business negotiations,  he continues in IACCM’s 9^th Annual Report on the Most Frequently Negotiated Terms.

Unfortunately, it appears the recession made matters worse: Cummins says the effect of the recession actually increased the “degree of separation between contracting parties, further threatening the economic value to be achieved from their relationship.” More adversarial attitudes marked the recession and contracts became pieces of paper with limited value as many powerful organizations “simply ignored inconvenient terms and insisted on their renegotiation,” while others made unilateral, non-negotiable changes in areas such as payment terms. The muscular approach to contracting was indeed in play.  In fact, one Fortune 100 we know proudly used their muscle and the economy as an excuse to force their suppliers into what they called “ZeroOI”  - meaning that they mandated that all of their outsource providers were a forced to work for Zero Operating Income!

While it seems obvious that the nature of a contract, along with the time that’s invested in its creation and management, depends on the nature and economic potential of the contract relationship, “too many contracting and legal professionals either fail or feel unable to make this distinction and do not alter their negotiation priorities to reflect the potential value or the extent to which its realization depends on cooperation,” he adds.

The result is that contracts become exercises in me-first, power-play games.  The stark reality of this me-first approach shows up loud and clear in the IACCM study revealing, which reveals the contract terms with the greatest frequency, which include:

• Limitation of Liability
• Indemnification
• Price/Charge/Price Changes
• Intellectual Property
• Confidential Information/Data Protection
• Payment
• Service Levels and Warranties
• Delivery/Acceptance
• Liquidated Damages
• Warranty

As Cummins explains, these terms are “frequently seen as obstacles to value creation.”   I agree.   I don’t see very much room for trust and collaboration in that list. It’s mainly about transactions and risk avoidance.

Cummins also notes that much contract philosophy remains driven by classical legal theory based more on transactions than on relationships, and that classical law assumes selfishness. He states that while economists have come to understand that people and organizations are able to grasp the benefits of cooperation and team behavior, contract law “is struggling to catch up.” The law “still appears to believe that the best way to manage risk is to allocate it to someone else and the greatest incentive to perform is via threats of dire punishment for failure.”

That’s all wrong in my opinion.    Vested Outsourcing’s Five Rules can show a clearer, better way to a successful, collaborative contract relationship, with friendlier, nicer and ultimately more rewarding areas for negotiators to focus upon.

IACCM agrees, suggesting that companies focus on contract terms that would be more productive in supporting successful relationships.  Rounding out the top four suggestions from IACCM are:

• Scope and Goals
• Change Management
• Communications and Reporting
• Responsibilities of the Parties

When you compare the two lists it’s apparent to me that the best and most useful contracts will flow from the vested, relationship-based approach of the second list of more productive mutually created terms rather than the self-interested terms focused on shifting risk in the first list.

Time to lay a foundation for change.