Manufacturers Should Aim for Integrated Contract Management
B2Bs can operate under the assumption that their business is a simple matter of exchange. What goods they can make, they MAKE; what services they can provide, they DO; everything else, they BUY. But reality has become far more complicated. Data is increasingly important in deal negotiation; competition around speed to product launch, quality, and efficiency is forcing businesses to make difficult tradeoffs, choosing to BUY more frequently and then manage the risk.
As a result, contract management is evolving along the exact lines that Tim Cummins pointed out in 2014.
“In leading organizations, it [contact management] will also be an integrated discipline, quite probably part of a shared services unit, that oversees contracting for all trading relationships – buy, sell and distribution channel...”
- Tim Cummins
Before we look at how to achieve more integrated contract management, let’s take a look at what an evolved process can achieve. Three years ago, GE Global Research started to find new, richer ways to connect with its suppliers, and buying products was only a starting point. Additionally, GE looked for opportunities to transfer proprietary technology for the supplier to commercialize, sharing IP with the supplier in exchange for promises to produce. Another type of agreement involved collaboration on new product launches, shared capabilities creating new product opportunities, new opportunities that did not require significant upfront investment but only an advanced contract (Ayensu, 2014).
It is indisputable that these agreements enhance the MAKE/BUY decision with a richer palette of strategic options. In GE’s case, the extra options can satisfy customer demands better than competitors and without taking on the risk of purchasing assets for production. These agreements, the contracts GE is making with its middle market suppliers, are helping the firm meet the demands of the information age while retaining the maximum level of control over supply.
Can the middle market follow the same path?
Framework for Envisioning New Supplier Relationships and Enriching the MAKE or BUY Decision
Now that we know where we want to go, it will be easier to envision how to get there. But before we can make the journey, we need to understand why GE’s contract management must be integrated, and why any middle market manufacturer will need to integrate contract management processes before it can execute strategic contracts.
The MAKE or BUY decision is simple in theory. Philosophically, the decision forms the boundary of what a firm considers its essential activities. When an activity is considered non-essential, then the firm should choose BUY. When an activity is essential to the core value proposition, the answer is to MAKE. Simple, right?
This way of looking at the decision is reductive, but it is also indicates the need for a permanent choice. But particularly in a volatile world where the very definition of essential can change in one day, there is no such thing as permanent. We need to be more flexible. Sometimes, we need to hedge our bets, relying on cooperation between buyers and sellers rather than choosing self-reliance. Sometimes, we cannot afford the upfront investment needed to create the supplier’s resources. GE is one prominent source of these new type of contracts, but there are also more traditional examples.
Under asset specificity, a supplier will purchase a resource with the guarantee that the buyer will purchase items created with the resource. Both sides are locked into a long-term trade: the buyer will typically pay a premium in exchange for the flexibility to cancel the contract, whereas for as long as the contract persists, the supplier gains security and loses flexibility.
The problem with these in-between-the-cracks cases is that sales can be ill-equipped to handle them. Sales would love to see a buyer request a long-term deal structure because of the revenues and the profitability. Unfortunately, the sales POV would also tend to neglect the risk that at some time, the buyer will choose to cancel, leaving the supplier in a lurch. The additional risk is the opportunity cost. What happens if another buyer comes in and makes a better offer? Does the contract correctly account for this possibility too?
Sales must be able to negotiate these deals effectively, and the business needs to be able to appraise its risk exposure and influence sales processes to incentivize or disincent contract types. A sale is not always a good sale. Effective, integrated communication is required to take the corporate strategy into consideration.
The MAKE option is almost as complicated. Internally managed suppliers might also sell to external buyers when the parent firm does not demand 100% of production capacity, but what guarantees can the subsidiary give - either to its parent or to additional buyers? The parent company might have the appearance of control when reality could be more like a bank that has the first lien position. When something bad happens, the first lien position is only slightly better off: everyone, even the parent company, needs a backup plan.
With smarter contracts, B2Bs can fulfill more strategic needs, whether MAKING or BUYING.
GE and other large manufacturers are showing us exactly what contract management excellence can do with third-parties to simplify production, expand networks, and mitigate risk. And only integrated contract management can achieve the kind of flexible execution required by the current business environment.
Business functions must work together to carefully construct a comprehensive contract management process, one that aligns customer demand with supply, demand not only including need for products but also features, quality, and consistency. Following in GE’s footsteps will require improved cross-functional coordination at each stage in the contract lifecycle and a rigorous revision of business process.
Ayensu, Nana. “When Microscopes Meet the Middle Market.” GE Global Research: January 4, 2014. http://www.geglobalresearch.com/blog/microscopes-meet-middle-market
Cummins, Tim. “The Role of a Contract Manager: 2014 update.” Commitment Matters: January 28, 2014. https://commitmentmatters.com/2014/01/28/the-role-of-a-contract-manager-2014-update/