Technique 1: Innovation and efficiency in contracting management
How a procurement group approaches contracting management sets the stage for managing risk intelligently.
As an example, the firm I work for often assists leading companies in revising or creating strategic portfolios of pro-forma contract templates. Contract streamlining is an emerging trend and is the outcome of better understanding the significant cost of creating and negotiating old-style “legalese” contracts. Many of these are unnecessarily onerous—written in legal prose, lengthy, difficult to understand, one-sided protections and the like. But newer styles of contract design and wording enable procurement teams to have a dramatically-higher success rate of executing well-drafted agreements. Procurement contract portfolios are a great example of how legal risk can outweigh business balance, extending the contracting cycle time and procurement efficiency. Instead, many legal and procurement groups find that it is better to rely on concise and well-balanced contract documents that result in easier acceptance by suppliers.
Optimized processes and technology tools used in Contracting Lifecycle Management (CLM) also fit here. My team frequently performs reviews of how large enterprises manage their contracting processes and portfolios. They also sometimes find stunning gaps in the approaches that have evolved over time within company cultures.
One corporate example involved master agreements put in place by one company group. Then, another company group executed separate Statements of Work (SOW). But as our research showed, many of the SOWs expanded the list of services beyond those ever addressed by the master agreement, and thus lacked proper protection from the governing terms.
In one of these findings, the original master agreement only covered traditional delivery by ground trucking services. But a new SOW called for the use of a helicopter for the delivery and installation of capital equipment. The lack of aircraft liability insurance in the master agreement exposed the company to very significant risk.
During another engagement with one of the globe’s ten largest privately owned enterprises, with more than 50 subsidiary companies, our team found sizeable gaps in process that frequently exposed the firm to legal risk. Simple to fix, but only when the firm’s management understood the gaps and methods of fixing.
Technique 2: Strategic requirements for supplier insurance and limitations of liability
Use of any external supplier of products or services, either upstream or downstream, requires an evaluation of potential liability exposure. Every contract must address the three-legged stool of protections: limitation of liability, indemnification and supplier insurance. The last requires special administrative attention, but is frequently under-managed.
Suppliers should carry insurance for two reasons. First, it protects them from legal and financial exposure that could limit their ability to support contractual commitments. Second, it provides a buffer of protection to the procurement organization against direct or indirect claims from suppliers or other third parties that may be affected by contracted suppliers’ actions or inactions. If a contracted supplier is allowed to utilize key subcontractors in the performance of services, those firms must also be required to provide insurance coverage compliance.
All too frequently, procurement groups fail to demand a properly executed and endorsed certificate of insurance (COI) from each contracted supplier before contracted actions occur. I’ll admit, it’s a pain to collect and properly review COIs from every contracted supplier. But studies performed by leaders in risk management groups indicate that 80% or more of initial COI submissions do not conform to the language in the customer’s contract.
An even more frequent failure point is one of timing. Quite simply, a supplier’s multiple policies of insurance will never expire on the same date as the contract itself. Failure to proactively ensure that each policy is renewed and continues in effect through contract expiration means that buffer of protection can disappear without the procurement organization’s knowledge. Special risk occurs if the supplier switches policy types or insurance carriers when a policy expires, and the properly-worded endorsement of an organization as an “additional insured” fails to be implemented in the new policy.
Any procurement team that is proactively managing the three-legged stool of risk protection must have resources in place to proactively collect and knowledgeably review COIs. Fortunately, there is at least one new no-cost supplier risk mitigation resource that can do this at your supplier’s expense. This model effectively outsources these reviews to a highly skilled team of professionals without any budgetary impact. The use of that type of outsourced service is dramatically better than trusting internal staff groups to perform this type of task, and provides superior visibility to this important area of supply chain risk.
Technique 3: Provider optimization and redundancy
As part of initial strategic sourcing and supplier selection, ERM principles should be employed to ensure that excessive consolidation of the supplier community does not occur. Too often, aggressive sourcing groups will push to award a contract to a single-source award contractor. That works fine until a disaster occurs, such as financial failure of the supplier or a plant shutdown.
Proper strategic sourcing works much better with a balanced supplier portfolio with either of two requirements. One is multiple plant or data center redundancy by the provider. This enables the provider to manufacture or perform services in multiple locations. The other approach is to segment the provider relationship across multiple suppliers in a primary and secondary contractual manner. This ensures sustainable supply chain operations even in the event of a failure in one production location.
Technique 4: Supplier financial stability visibility
In 2016, Han Jin Shipping, one of the seven largest maritime shipping companies in the world, announced bankruptcy and stopped operations that same day. Thousands of containers were literally locked aboard ships anchored in harbors or tied up at docks around the world. The impact was substantial. Han Jin processed nearly 10% of Asia-American container shipments. Furthermore, countless other shipments with other trade locations between other national trade partners were affected. The mess took months to sort out.
Most companies fail to have adequate visibility into the financial stability of their entire supplier community much less their key suppliers. Some companies do acquire financial reports from a leading provider on a case-by-case basis. However, the largest provider of these reports relies on data voluntarily submitted by the supplier company themselves, calling into question the accuracy of the data. They also charge a fee for their services, which is often beyond the budgets of most procurement teams.
The good news is that a new model for managing supplier financial stability has now emerged. It relies on predictive financial stability reporting that is provided by a major credit rating agency on thousands of potential suppliers. Much like the insurance COI collection services mentioned earlier, the availability of predictive financial stability data for a firm’s entire supplier community can be outsourced without cost. The information is available in a Cloud information tool that warns procurement leadership of potential supply chain failure, providing highly positive ERM visibility to a firm’s management team for free.
Technique 5: Proper diligence in operational supplier assessment reviews
When you were in school, you received report cards. There were three reasons for them.
First, report cards provided students with feedback on their educational accomplishment. Second, they provided parents with visibility into their child’s performance. And third, report cards provided a useful reference tool for conversations between the teacher, parents and student about areas of potential improvement. And it worked. I’ll be the first to say I would not personally have tried nearly as hard in school (all the way through college) if those report cards didn’t keep showing up.
Far too many companies fail to provide their suppliers with any report card feedback on how they are performing. For most companies, the exceptional few suppliers that do receive any scorecard are a small fraction of those that don’t. That is a problem. Any supplier that does not receive frequent feedback will probably assume that their performance is just fine even if it’s not. And why shouldn’t they?
Top companies are now separating their supplier portfolio companies into categories based on financial spend or assigned risk using techniques like the Pareto Principle.
It breaks out like this: