Cats and typewriters or: Resilience through contractual building blocks

The cat case

A cat once fell into a barrel of engine oil to be shipped to an automotive OEM. Many vehicles were filled with this oil during the assembly process. In the final inspection, the engines caused trouble. In the root cause analysis after many chemical tests, it became clear that a feline must have “contaminated” the product. The relationship with the supplier was strained for some time, and this was the final straw: The OEM sued the supplier since the supplier was unwilling to pay for the consequential damages caused. Guess what? The supplier won the case. Why, you and many cat lovers might ask? Because the OEM did define a lot of contaminants in the oil specification that the supplier should check for…but nowhere was written to check…for cats.

This could have been prevented if this particular OEM organisation had used the contractual template of the rest of the corporation with the phrase: “Fit for function”. In essence, the phrase "fit for function" emphasizes the importance of ensuring that the product or service is suitable for its intended purpose as defined in the contract, hence no cats, dogs, fish, or other contaminants that could lead to engine failure.

Now, you might argue that the occurrence of cats or other animal remains is rather seldom in the products you receive. And you are right. But, after nearly 35+ years of working in the supply chain in five industries, we could spend a day going through real-life “fails” that lead to the need for sentences or paragraphs in standard global terms and conditions and supply contracts. 

The intelligent typewriter case

A procurement department was measured on the contractual milestones they passed up to signature during a given time. The department took pride in the massive, often arcane documents they negotiated.  The buyers told stories about their epic negotiations with suppliers to agree on their terms and conditions, and they had metrics to show their “workload”. There were whole departments led by former lawyers that negotiated aspects of work farmed out to suppliers, leading to four different procurement departments dealing with the same supplier.

Buyers spend 20-30% a week on negotiating contractual terms. There was not much time for getting lower cost or better services. This was done by the “grown-ups” in the internal customer departments…people that had pre-selected the suppliers in the first place - often without any market testing - just because: they knew better…

Again, outlandish, you might think, when you are employed in the manufacturing industry - but the alternate reality in many professional service industries - buyers are intelligent typewriters of their internal, commercial customers.

So what?

The alternative to the above, by the way, true cases: A  modern, standardized contract portfolio set-up.  It leads to:

• Risk reduction - in the case of fault by the supplier, your company can rely on the application of standardized, agreed terms - no cats

• Workload reduction - little to no involvement of lawyers and buyers on the commercial documentation front, concentration on the triple bottom line (profit, people, planet) - no type-writers

Sounds simple, right? Still, most companies have a rather loose definition of standards regarding the "buy" side of the enterprise, opening themselves up to litigation, risk and unnecessary waste of resources. 

Just look around: How many different general terms & conditions exist in your company that are sent to suppliers? How many payment terms are accepted? How many statements of work formats are in circulation? How many different Non-disclosure-agreements exist? Are the contractual formats aligned? How about simple things like the accounting addresses on the forms - are they correct? How many different confidentiality phrases exist in your templates? Is there a repository of standard documents for procurement to use? How about templates for internal procurement (one business from the next)? Do you have an online contractual workflow tool? And if yes, does it make work in procurement manageable or more workload intensive since it was designed for the need of lawyers in the firm, not operations?

The Jungle

Many companies work with an unorganised jungle of contractual documents because standardization is more an operation than a legal concept, especially in the Anglo-American case-law trained legal professionals. The issue is that most buyers and salespeople have not studied law (if lucky, they get a one-day course in do’s and don’ts sometimes in their early careers). 

Hence, if a products and service company has an army of lawyers (in- and external) exhausted and frustrated due to all the humdrum, ever-repeating work they have to do for sales and procurement, you have a clear sign of missing standardization, accompanied by people trained in the perception that making hours, means making money…

And in sales and procurement, good people with competence in selling or buying spend their time in long e-mail and conference room battles about singular words in contracts instead of fighting for innovation, lead time, ESG, and margins.

 Standardization is the way.

The solution is quite apparent and alluded to before: Legal documents in a corporate context are to be standardized as much as possible and tailored as little as needed. 

To get there, we recommend a simple, three-step approach:

1. Build legal building blocks: Company lawyers align across the company together with their operations customers (sales, service, procurement), the building blocks of contracts like liability, guarantee, compliance, termination, etc. The art focuses on having as few variations as possible while still achieving legal compliance with all markets they sell, manufacture, or buy. The building blocks can be tailored into three levels: 

1. The strongest statement protecting the company 100% is “preferred”, 

2. “Still acceptable” takes the standard industry-agreed version

3.  “Acceptable after approval” is the less preferable option and should only apply when there is no short-term alternative to a supplier.

2. Assemble: These building blocks are assembled into general terms and conditions and individual contracts. Which contractual building block belongs on which level (general or individual contractual terms) is part of the internal discussions. As a guiding rule: everything the company feels strongly about being accepted across the board belongs to the general terms and conditions. Next is which version (preferred, still acceptable, acceptable after approval) should be used as a standard. Here I recommend going with the industry-standard approach - unless you look only for an extended workbench of suppliers. Some companies also define special terms and conditions that are too special for a general condition document but general enough to apply to a full supply market  (i.e. IT services, chemicals). All general and special terms and conditions must be published on the company’s webpage, with older versions annually still accessible in an archive. Some old-fashioned legislation in countries also requires an individual bilateral agreement between the GTCs and STCs, which, as needed, can be built as a routine in the contract-to-source procurement system.

3. Simplify: Finally, simplify the creation and management of contracts: What constitutes a contract in our firm; Which building blocks are mandatory; what is a release; do we allow a Letter of Intention (LOI); what can be done without an NDA, who approves what, how do we deal with toxic offers (my recommendation: find other suppliers), and - very importantly - what constitutes a good Statement of Work (SOW)?

For the visually inclined readers, picture a Roman temple structure (after the pyramid, probably the most over-used picture on PowerPoint) made out of Lego-like building blocks: 

• The roof constitutes the General Terms & Conditions, 

• The pillars are the different special terms and conditions, and 

• The base is individual contracts gathered under the respective pillars. The crevices are filled with NDAs, LOIs, releases etc. - all assembled from the same ‘Lego’ moulds.

The result:

Every contractual relationship is built as an image of this temple structure, leading to the following:

1. Contractual security 

2. Massive workload reduction in the legal and procurement department - time that can be used on value-add tasks

3. Transparency for suppliers upfront to consider whether or not they want to engage with you

The mirror

So, we now know what the current state of many companies is and what the future state could look like. How about looking into the mirror and assessing where your company is in this continuum of legal excellence?

How many of the below questions/statements can you answer with a resounding, fact-based "yes"?

1. Do you have one set of general terms & conditions for your suppliers (with few variations due, i.e. case-law vs common-law legal systems)? 

2. You have a standard set of payment terms (max 20) generally approved.  

3. The standard template of the Statement of Work (SOW) is owned by procurement. The individual SOW creation and the performance tracking against metrics and KPIs are the responsibility of the internal customers.

4. Only one set of NDAs exists (one-sided, bilateral, three-party etc.), and all buyers know when to use them.

5. Topics like confidentiality, liabilities, quality, and indemnity are clearly defined and require clear approval by procurement & legal before changing.

6. There is a repository of standard documents and building blocks for procurement without involving legal case-by-case.

7. There exists an aligned set of templates for internal procurement (one business procures from the next)

8. Commercial training exists for all buyers on how to use the contractual templates and contractual training for new lawyers coming on board.

9. There is a standard “driver’s licence” training for anyone who wants to buy goods or services…the “Licence to Buy”.

If you answered „yes“ to most questions: Great. You have your corporate contract portfolio under control. Congratulations - well done! Do not read any further. Better to focus on other topics.

Size of the prize

If you answered several questions with a “No” or were unsure, you have an excellent opportunity to make your company more resilient contractually and efficiently.

We established that the benefit of a standard set of contractual documents is reducing your supply chain risk. In a standardized set-up like in the automotive industry, buyers spend as little as 5% of their time on contractual topics. That means internal or external lawyers are less engaged and can rather deal with a quick turn-around of sales contracts and litigations.

We leave with you what this means for you and how much you value risk mitigation and efficiency as a significant part of it. Ask yourself: How would I set it up if I owned the company?

If you established that you have a gap, and want to set up a contract standardisation project, here is a guide:

The guide for implementation

Time plan: 6 months (depending on the lack of current focus)

Board Sponsor: General Counsel

Lead: CPO

Project Lead: Dual leads: one top talent from the procurement manager and one from the legal department

Blueprinting: Benchmark against other industries and your competitors. If documents are in the public domain, copy with pride - accept that you are late to the game.

Project set-up: weekly task force with clear objectives, monthly reporting to board sponsor, at the end to board with clear output KPIs (=# of contractual standards developed & implemented; corporate external website for suppliers established; training set-up; # of employees trained; authority level for changes to templates implemented and communicated in- and externally to supply base)

Sustain success: Regular contract audits by Internal Audit, need for online storage of all contracts, small AI program to assess the alignment of contracts with template standards); annual update, approved by General Counsel

Digitalization/Automation opportunity: None of this should be manual. If you do not have systems that can operationalize this, get something well-established. Ranking lists are available everywhere on the internet. Avoid do-it-yourself solutions, none I have seen in the last decades were worth their salt, and all were more expensive than the external versions. 

Risk: Low for the project, but high if standardisation is foregone. It leads to high costs due to litigation, selecting the wrong suppliers,  and unsuccessful claims due to amateurish contracts and simplified, supplier-friendly indemnification clauses.

Cost: small: either set up an internal task force full time (preferred) or employ external support, but lead internally. 

Watch out for missing adoption rate in procurement departments; the need for differentiation due to different legal systems; the need for translation (with the same meaning), over-simplification, and missing competence coupled with misguided arrogance internally.

The Conclusion

Standardize your contractual environment, it is a matter of corporate hygiene: while cleaning up is not fancy, it is necessary to keep your contractual relationships clean - otherwise, it starts to…smell!

What now…?

Thank you for staying with us so far. Season 1 of “Close the Gap” comes to an end. This season, all articles were linked to one service in our helmig advisory AG toolbox.

Yes, we wanted to show off a little to demonstrate that we know what we are talking about. But as well, we wanted to give you the tools to do it yourself - without us...if you want.

There will be a break for a few weeks in which we work on Season 2 - starting in late summer. 

In the meantime, we continue publishing episodes in the “The Supply Chain Dialogues” podcast every week, where we dive deeper into each blog post not yet covered…and have some fun with it.

Preview of Season 2

In season 2, we will change the format a bit: We will examine topics by asking questions (ten) - challenging assumptions and arriving at solutions through more or less critical thinking. And…in the corresponding podcasts, we invite friends to find solutions with us…

Until then: Stay safe and be bold (and have a great summer)

Daniel

PS: Did you enjoy this blog post? Sign-up for the “Close the Gap” blog and “The Supply Chain Dialogues” podcast on the helmigadvisory.com webpage, or listen in on Apple Podcasts, Spotify or any other major platform).  

Are you interested in having a dialogue about the above, receiving Advisory support on tackling the topic best in your firm, or just having an exploratory call with Daniel? Contact us via e-mail or call +41432000015.

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