While it would be nice to nice to transfer all risks and costs to the Supplier, even it the Supplier would be willing to accept the risks, the potential cost to do that could be prohibitive. There will always be costs and risks that the Buyer needs to accept and manage. The contract is where you provide some of the tools to manage those costs and risks and manage performance. There are six basic ways to manage a performance. Every contract should have three ways of managing performance.
The first way to manage performance is relationship management where you build a strong relationship with the other party’s account team so that they know and understand what you need, want and what will impact them. This does not need to be addressed in the contract.
The second method to manage performance is structural. In the contract you would include all the structural tools you need to manage their performance. The larger or more complex the purchase, the more you need the structural tools as part of the contract requirements that the Supplier must meet.
Whether you are managing a contract for a supplier or buyer here are examples of structural tools that would be used to manage performance:
•Having clear specifications or a statement of work that makes it clear what both partie must deliver.
•Establish a team to manage performance.
•Identify tasks required, responsibility for those tasks.
•Establish schedule, milestones and deliverables.
•Have a clear process by which the work will be tested and accepted.
•Establish a strong program review process
oEstablish a meeting schedule, frequency, and required attendees for progress reviews.
oImplement action item lists to track and manage open items and the timeliness of parties in closing those open items.
oIdentify the content and frequency of required progress reports.
•Have rights to audit any on-site work being performed for quality and performance,
•Establish senior management involvement and periodic reviews.
•Establish formal escalation process for disputes.
•Include ability to back charge costs for significant problems, or delays.
The third method is of managing performance is control.If you have agreed to assume a cost or risk, you simply can’t let the other party do its own thing, so your contract terms need to provide you with the necessary control over what the other party can do over the things that may impact your cost or risk. Control is a way of managing behavior or performance. Examples of control type of provisions would include:
•Control over the Supplier’s team that performs the work and any changes to that team.
•Control over where the work is performed.
•Control over subcontracting of the work.
•Restrictions against assignment of the work.
•Control over changes to the product or service.
•Control over changes to the process.
For example, lets assume that the Supplier will only agree to sell to you on Ex-works delivery terms. What this means is that from a cost and risk perspective you are responsible to pay for all the costs to get it from the Supplier’s dock to your point of use. If further means that you would also be responsible for any loss of damage that occurs while it is in transit. To manage this potential risk you should be able to require them to comply with packing and packaging specification designed to reduce the risk of damage that may occur in transit. You might also specify that you must either select or approve the carrier and shipping lane used, as the potential for loss or damage may vary by carrier and by shipping lane. You could also require the Supplier to ship it with pre-paid insurance that would be reimbursed as a separate line item. If you didn’t have the controls they could take whatever actions were the cheapest for them, which could increase your potential risk of loss or damage.
If you can’t transfer the cost or risk of problems that the Supplier has control over back to the Supplier, then to manage the risk you should require strict control about what the Supplier can or can’t do with all the various factors that may impact risk. For example if the supplier was unwilling to assume the major risks and costs of quality problems they could create, you would require approval of subcontractors, material suppliers, restrict any assignment, not allow them to make any changes to the product or service without your advance approval, etc.
The old axiom is that anything that is left unmanaged will cost more and if the Supplier isn’t going to bear the cost or risk of an item, in most cases they won’t make the investment to manage those risks for you unless you force them to by the contract terms or specifications.
The fourth aspect of managing performance is financial. The four main financial ways that manage performance are:
1.The remedies that you have in the event of a breach of the agreement (the types and amount of damages you may recover).
2.The costs of any remedies the either party is required to provide for failing to meet their specific obligations.
3.Any pre-agreed impacts to price for non-performance such as liquidated damages or price adjustments for being late with deliveries or claims a supplier may make for delays by the buyer.
4.Impact to their payments and cash flow. For example, a terms that would allow the buyer to not make progress or interim payments if the work was behind schedule would be designed have the cash flow impact to try to drive the supplier take necessary actions to get back on schedule.
As I say elsewhere, correcting problems is an investment decision. If the financial approaches that are included in your contract won’t have a significant on the other party, they probably won’t make the investment to correct the problem.
The fifth aspect of managing performance is structure terms to drive the desired performance. A classic example of this is many times a buyer will want the supplier to help reduce the cost of the work. Which approach will work better in meeting that goal?
A.Fixing their overhead and profit amount and sharing in the savings, or
B.Paying them a fixed percentage for both overhead and profit based on the cost of the work?
To me the answer is clear."A" provides the supplier with an incentive to perform, whereas "B" provides a negative incentive. How much help would you expect to get if helping you penalizes them by reducing the amount the supplier gets paid for their overhead and profit?
The sixth aspect of managing performance is making sure that you include and negotiate express conditions for that performance.
1.Make it an express commitment in the Agreement.
2.Use language that establishes it as a firm commitment.
3.Avoid any softening or qualifying language that would reduce the commitment.
Any commitment that includes “efforts” as part of it whether its Best Efforts, Reasonable Efforts or Commercially Reasonable Efforts doesn’t guarantee performance. All it does is require the Supplier to extend that level of effort in trying to perform.
A seventh and last way of managing performance is contract management. Any activity left unmanaged will always cost more. The amount of contract administration you need is dependent upon the risks with the other party and the activity. There are three main focuses to contract administration.
1. Manage the delivery of your deliverables. That is to avoid claims by the other party.
2. Manage the other party’s performance using all the performance management tools listed above. For contract management to be successful you need all the structural management tools to be in place.
3. Document performance in meeting minutes, messages, letters, notices, action item lists etc. and make sure all that is captured and included in the contract file.
In documenting problems with performance always make it clear exactly what the problem is. To provide that clarity I would suggest that you do two things as part of documenting performance problems.
1.Always refer to the specific section of the contract, specification, drawing etc. that established what was required that wasn’t completed, done or performed correctly
2.Make sure that the document identifies the applicable 5W’s & an H.
a)Who was involved?
b)What was the obligation that was not met?
c)Where did it occur?
d)When did it occur?
e)Why did it occur?
f)How were you impacted?
I always share the documentation of any performance problems with the other party so they are aware that we are tracking them and there could be potential claims in the future. What I have also found is that there frequently is two sides to a story and by sharing it, if my company or our people contributed to the problem the other part will be quick to point that out. That helps verify the facts.
Whether you win or lose on a claim or suit will be dependent upon being able to establish who did what and when and what the contract requirements were at a specific point in time. Below are two examples of what I mean.
When I worked in construction I once had a claim by a site work contractor for additional costs to bring in new soil to make the necessary elevation grades that were called for by the drawings and specifications. The first thing I did was to review our on site inspector’s daily reports that included all on site activities including deliveries and things being removed from the site. There was a clear record of the Contractor being delivered all the soil that he claimed. A further review of earlier reports disclosed two things. One was the contractor had previously removed substantially more soil and that was taken off the site. The second was the architect instructed Supplier to not remove broad segments of topsoil and expose the remaining soil to the elements where if it got wet it would need to dry out before use. I was also able to see from the daily reports the weather and their progress and how the rain made some of the remaining soil unusable. Based on my findings I refused to pay any amount toward the claim based on the position that 1) there was an excess of soil on the site and had they not removed it, they would not have needed to bring in new soil. Their actions of uncovering too much soil they created the problem that required new soil.
In another situation we had a situation where a electronic circuit card that was supplied by a Contract Manufacturer had a specific component on it that was failing and costing significant field costs. The Contract Manufacturer argued that because it was a component that we had specified and they had purchased from our approved Supplier they should have no liability. The component supplier was currently approved and the CM was authorized to purchase from them, but we did specific research on what the dates of those purchases were that were failing. We then went back to the agreement to see at what point in time the specific part number was added to our agreement. What we found was that these purchases were made by the Contract Manufacturer before they were ever added to our contract. Under the terms of our contract with the Contract Manufacturer these would be considered as parts they directly sourced for which they assumed full responsibility.
The more you have changes in the personnel that will manage the contract on both sides the more important it is to document and maintain this type of information so it isn’t lost. It also doesn’t hurt to have a running summary of all the problems that the other party caused that cost you extra money.If you represent a supplier you might use that to make claims for those costs during or at the end of the work or to offset against any buyer claims for damages. If you were representing the buyer you might use that to offset any supplier claims or to back-charge the supplier.