Notwithstanding that there is about as much activity in the sourcing market as at a sloth exercise class, as we approach the end of the big meltdown year, it is timely to reflect on two features: first, Irish sourcing practice to date, which largely refers to the Celtic Tiger years, and, secondly, whether and to what extent that practice can be improved on in the future. In particular, this article examines the Irish sourcing experience, in both the public and private sector, based on the premise that, just as in other areas of economic activity, the sourcing area if not actually broken then was at least operating below par, requiring revision to cater for the financial, not to mention economic and political, realities of the emerging world order. General reference is made to the ‘Business’ meaning public sector administrative or quasi-commercial functions, together with private sector business functions.
It is the contention of this article that what is needed in relation to deal contracting and project/programme management, which are of a strategic or critical nature to the Business, is deal flexibility not variability. All contracts are variable, that is what contract change control procedures are there for – and all project/programme management procedures allow for variability. However, historically, the underlying basis upon which the parties’ legal, commercial and technical agreement was based was fixed, not building-in flexibility as an inherent requirement to support the Business. If the world was previously flat, it is now well and truly round. This article looks at practice in the past and makes some suggestions for the future.
I also assess the supplier and customer side of the sourcing equation, look at recent developments (which essentially means 2009), and attempt to draw some conclusions. Some of the statements relating to customer and supplier experience admittedly shoot from the hip but, in my defence, the statements are looking sector-wide (which leads to flattening out of differences), every exaggeration does contain a grain of truth and it is hoped they improve the article overall.
The Supplier Side
Looking at the supplier side, as a class (if there is such a thing) they can generally be accused of a failure to empathise with the customer. This was primarily seen in the failure to adequately match solutions to requirements, primarily in the commercial and commercial/technical, as opposed to purely technical, areas. In particular, the much mentioned concept of partnership was abused. All too often the uninitiated customer went to the market looking for a trusted partner, only to end up with a self-interested supplier. However, to what extent the resulting deal structure and perception of extent of deal success resulted from supplier self-interest or customer naivety is a moot point. It is difficult to criticise a supplier for keen self-interest, which might be compared to a perch from which the customer bears the onus of doing the knocking. Supplier and customer interests are not naturally aligned. While it is accepted that the customer bears the primary responsibility for knocking the supplier from its perch of self-interest and moving it to something resembling identification with customer interests, the supplier too has a role to play in this equation. To date the interests have not generally been well aligned.
The more dependent the customer is on the supplier post-contract, the more keenly is this divergence of interest felt. Thus, the outsourcing market, given its high levels of dependency, displayed some of the worst examples in this area. While customers are surely not without blame (see below), after a fairly early stage in the procurement process, the pendulum of leverage swings in favour of the supplier. It largely stays there thereafter during the contract term, until the spectre arises of early contract termination or term expiry, with possible in-sourcing or re-sourcing, when it tends to shift back to the customer. Suppliers have generally maximised this position, resulting in contracts which are more or less biased in favour of the supplier.
In the current environment this historical situation poses particular difficulties, primarily for the customer, but also for the supplier. The single biggest business risk posed by this situation is the lack of, or absence of, flexibility in the arrangement. Without flexibility the customer either cannot, or can only to a limited extent, respond to changes in and challenges to its Business. Thus, contract relationships intended to support the customer Business either fail to do so adequately or on a worst case actually threaten the Business. Once a ‘steady-state’ environment has gone, the level of customer dissatisfaction with the supplier, previously manageable in a ‘steady state’ environment, greatly increases.
The supplier, in preferring the security of fixed scope and fixed price, with possible upward only supply of additional services, is observing the requirements of financial certainty and relevant revenue recognition rules. It is contended that, following the biggest economic and social shock in living memory, this supplier need for certainty and security will need to be tempered by the inherent uncertainty and lack of security of catering to the Business needs of the customer, where those needs display high levels of variability.
It should be noted that both public and private sector customers have, during the course of 2009, revisited almost all suppliers, with the request that costs be reduced in more or less specific terms. In most cases, with one or two notable exceptions in the software market, the response has been positive, albeit to varying degrees. However, in general, these discussions took place outside the terms of the parties’ agreement, generally resulting in bilateral supplier reduction in charges or waiver of charge increase, as opposed to formal contract-based variation or use of contract change management procedures. On that basis, they do not point to the type of baked-in contract flexibility discussed in this article.
The Customer Side
Customers can generally be accused of being somewhere between being cushioned by money to being asleep at the wheel. The Celtic Tiger afforded a financial cushion to absorb any number of price increases, poor contracting decisions, and failed projects. That cushion is now well and truly gone, both in the public and private sector.
As a class (again if there is such a thing), customers were generally more interested in getting the deal done than the contents of the deal in a number of key respects. Some of the more complex aspects of contract negotiation, for example, around break option structure and exit arrangements, tended to try the patience of the busy customer representative, with the supplier hardly welcoming their introduction. In particular, the attention of the Business customer to the drudgery of good project and programme management were limited. These are areas which even during the course of 2009 are, I believe, increasing in perceived importance, which should impact positively on the robustness and longevity of future deals.
In the public sector, the establishment of the peer-review process, together with the more recent establishment of the National Public Procurement Operations Unit (NPPOU) is a welcome development. While the peer-review process had built-in limitations and a restricted scope in terms of resources and brief, the NPPOU hold out more hope for evolution in public sector contracting. Exactly how the NPPOU will operate in practice remains to be seen, including, in particular, the extent to which it will directly assist procuring public sector bodies in the management of the procurement and conclusion of resulting contracts, never mind subsequent project review and facilitation of public sector/supplier sector policy and model contract type interfacing. At this stage it seems that the NPPOU will not emerge fully formed as the Irish version of the UK Office of Government Commerce, a large beast many years into its evolution. Its establishment is, however, a welcome development in the evolution public sector contracting.
Recent Experience
We have recently seen an increase in disputes between suppliers and customers, together with contract renegotiation and termination. These are all well and good but frequently point to the original deal lacking the inherent flexibility to cater for eventualities. While recent times have been extraordinary in terms of challenging the likely suppositions upon which original deals were concluded, a well structured contract and project should contain the tools and structures to cater for (generally) customer driven change, giving the parties some chance of responding to the high levels of Business variability assumed in this article. Of course, there are limits on the scope of possible responsiveness to events, with recent events truly extraordinary. As a general principle, the greater the scope of possible deal response to events the better.
In contracting, the motto ‘a moment on the lips a lifetime on the hips’ holds true. We do sense a general customer side shift towards concentrating on the terms of the deal, including the future proofing of the deal. A difficult challenge to be sure and one without guarantee of success, but even limited success is no mean feat. On the supplier side, we also sense a general willingness to look at more complex contract and project structures. Structures which are generally negative in terms of guaranteed revenue, but positive in terms of increasing the chances of sticking to the customer through thick and thin.
Going forward, it is hoped that the Irish customer, both public and private sector, takes the time to consider the procurement, the contract and the project/programme structure. A well structured engagement with the supplier should contain the tools and structures to adapt and change as the requirements of the customer change, whether due to the broader economy or circumstances unique to the customer.
Conclusion
This article makes admitted sweeping statements in relation to the Celtic Tiger behaviour of both customer and supplier. Within every exaggeration there is a grain of truth and, in general, while suppliers were guilty of defensive contracting, the customers were guilty of at least rushed if not naive contracting. It is hoped that, going forward, economic realities will, firstly, force customers into good practice project planning, execution and delivery and will, secondly, force the suppliers into increased interest in the requirements of their customers, including, in particular, potential change in requirements as a matter of principle, rather than as an exceptional item.
The general contracting message for the new world order should, I believe, be ‘flexibility not variability’. All contracts are variable to a greater or lesser degree, hence the inclusion of the well established and necessary principles of contract variation and change control contract terms. What is needed, I believe, is not flexibility as an exceptional item but rather built-in flexibility as a foundation stone upon which the contract and project are based. This is not without challenge for all of us -customer, supplier, legal advisor and even the supposedly all-knowing deal consultant.
Pearse Ryan is a partner in the Technology and Life Sciences group in Arthur Cox, Dublin Office, specialising in IT, outsourcing and strategic sourcing, available at www.arthurcox.com
