Sunday, February 6, 2011

Negotiation - Managing Performance

Once you have completed the negotiation the negotiation stops, right? Actually the negotiation will continue in different activities until all work is done, all commitments are satisfied, and all claims are settled. The negotiations that occur during performance can be broken down into several categories.

  • Some negotiations may be required with Suppliers who are intent on "pushing the envelope" regarding the work to be performed, or disputes in the intent or interpretation of the specification or drawings, or conflicts between drawings and specifications, etc.  
  •  Negotiations may be required regarding performance problems (either theirs or yours).   
  •  Negotiations will always be required regarding changes to the work, the scope of work, the specifications, required processes, or the schedule.   
  •  Negotiations will be required if there are any claims (either theirs or our yours) for failure to perform the obligations of the party as contracted.

The real difference in many of these negotiations is leverage. Before you enter into the contract you may have significant leverage with competition. Once the work has started and you have problems, your leverage may be substantially reduced. Termination of the contract or switching Suppliers mid-stream may not be a reasonable or financially viable solution. Many times you may be left with the protection provided for in the contract and the leverage of additional or future business (if that exists). If you are entering into a contract where termination or switching of Suppliers mid-stream is not a viable solution, it becomes very important to have properly crafted the contract and also properly manage and document the issues.

There are four basic ways to manage performance:
The first is structural.
The structural management of performance requires periodic reporting of various performance indicators - status against schedules, activities performed, staffing and equipment assigned, problems identified and periodic scheduled reviews and meetings to aid in managing performance.
The second is informal. 
The building a relationship with the counterpart on the other team and the informal sharing of information in which you are appraised of performance and  take no formal actions as long as the Supplier is performing within certain parameters.
In the formal approach, every issue is documented and sent by formal notice to the other party. If performance is late, a “cure notice” may be generated. This third approach is generally used to document problems leading up to termination or other legal actions, but may also be used to “shock” a Supplier into performance.
The last way to manage performance is financial. 
Financial performance relies upon the use of items such as performance bonds, liquidated damages provisions, penalties, releases of progress payments or a delivery date based pricing (with bonuses for early delivery, or credits for late delivery).

A good Contract will usually establish the structural, formal and financial methods of managing performance.
What are things you might want in your contract to help in these negotiations?
1) The longer the duration of the contract, or the more the requirements are subject to being revised, the more important a well defined changes provision becomes. A changes provision should define how the cost of the change (add or deduct) will be calculated. This includes: rates and categories for labor; mark-ups for purchased goods or services; pre-agreed overhead and profit percentages that will be applied. It would also include: any formulas for identifying cost; agreed formulas for any waste or scrap; identification of the treatment of any materials or work in process made obsolete by the change.
2) Problems need solutions and contracts need to define what commitments the Supplier will make and what they will do in the event there is a performance problem. For example, if they are late, the contract may require them add at no additional cost additional shifts, night, weekend or holiday work until the problem is corrected or the work is back on schedule. If there are delivery problems it may require the Supplier to carry an inventory or even consign materials to you to pull from as needed. If they can’t delivery and it is available elsewhere, it may require them to pay for your excess costs of buying it from another source. If there are quality problems it may require additional processes on their behalf to verify or check quality or provide additional stock to you at no cost to cover any problems. If there are problems with equipment, it may require that they provide you with a free loaner until it can be repaired or replaced. The commitments should also have a management escalation process where depending upon the severity, impact, frequency or length of the problem it requires increasingly higher levels of the Supplier's management to participate in performance reviews or problem resolution meetings.
3) Contracts should address what the Supplier's commitment is to reimburse you for any additional costs that are incurred as a result of their performance problems. For example, if quality problems require you to add incoming inspection to your activity, do they reimburse you for the cost? If items aren't shipped on time, do they pay the incremental costs for premium shipping? If there are significant reliability problems do they reimburse you for additional costs you incur?
4) Contracts may, in addition to identifying the corrective actions and reimbursement of costs, address the damages the Supplier must pay in the event of certain performance problems. Damages can be things like liquidated damages for things like delays in performance, or they may take the form of reductions to price if the problem continues.
5) Contracts should address what will happen in the event of extraordinary circumstances. For example, what is their commitment in the event of a safety problem with the product? How do the normal repair terms and lead times change if there are a higher than normal incidence of failures? What are their commitments regarding recovery in the event of a disaster?

6) Contracts should always address how the work may be terminated either for cause or for convenience. Having a termination for convenience provision is important for on-going contracts where either business circumstances change or, you find that the Supplier you selected will be an on-going problem or isn't performing to expectations, but isn't failing according to the standards required for a termination for cause. The less they want to be accountable for their product or services by their demand for reduced warranties or inclusion of disclaimers, the more you need to have the ability to walk away from them without penalty.

7) Contracts also need to address what can you require which will insure that you get their complete attention and know that they will feel enough pain to aggressively correct the problem. Sometimes people will only take the necessary steps to correct a problem if they feel real pain. The two best ways to have them feel pain so you get their attention are money claims (such as liquidated damages or reduced pricing for problems),  and elevating the problem within their management structure.

8) Contracts may need to address the administrative aspects of managing the relationship. This is where you define the meetings that will be held, where, their frequency, who will be in attendance, what will take place. This may range from normal meetings, to emergency meetings, to management review meetings, to strategic discussions of future business. It will also be where you define what reports are required, their content, their frequency, etc..

9) Contracts should address the information and data that are the critical tools to manage performance. This can range from progress schedule status, quality information, delivery information, identification of critical issues and problems, etc. If you want to improve performance, the Supplier needs to have a periodic scorecard prepared to understand how they are performing and where they need to improve and where they stand against the performance of others.

10.  To protect against negotiations where Suppliers are intent on "pushing the envelope" regarding the work to be performed, or disputes in the intent or interpretation of the specification or drawings, or conflicts between drawings and specifications, your contract needs to have clear, well written specifications that accurately describe what you want. If those are described in multiple documents you need to have an order of precedence that establishes your desired priority.

11. The final thing is always check to make sure that what you have included in the agreement will drive the behavior that you want. For example, I've seen companies who have as a standard remedy for failing to deliver be: 1) Cancel the order, 2) Require delivery by premium freight, or 3) have all remedies available at law or equity.  Assume that you have single source supplier that is providing you with a custom product or service. Will the right to cancel the order buy you anything if you need them to deliver and have no alternatives? What are the investment a Supplier would need to make to perform and would having to pay premium freight be sufficient to get performance? It won't if the investment required to perform is greater than the premium freight cost. What value is the remedy at law (which would be the right to cover and collect any excess cost of re-procurement), if you need the product or service or would have a significant delay to buy from another source? It provides you little if you are dealing with a single source supplier of a custom product or service?

The key to remember is that if you want real tools available to manage performance you need to negotiate their inclusion in the contract. If you don't you may be left with only the threat of the loss of future business and, for some things which you buy infrequently, that is no real threat. Once you have the tools, you need to manage the contract using those tools to ensure that you get the products, services or performance that was committed. 

In managing Supplier performance and cost, you need a closed loop process. The problems that you identify on your Supplier Scorecard, need to be identified as costs to you. If you had problems and your existing agreement didn't provide you with the tools to manage them or get recovery, if you negotiate a renewal or new business, you should use those costs and performance problems to either get the Supplier committed to change the areas that are causing problems, or reduce their price to offset the problems they have caused. In doing a Supplier Report Card there is always one clear message that you give to the Supplier: If they are doing things that add to your costs

    • They need to change so those costs are eliminated, or
    • They need to reduce their price to offset those costs, or
    • They will get less or no business.

No comments:

Post a Comment