Commercial Special Sauce – Trust

In a recent Commitment Matters article, Tim Cummins said:

My hope for 2022 is that the commercial community raises its voice and promotes the ethical standards and supporting systems that alone can move us along the path to making trust-based collaboration a norm, rather than an exception.

But how do we achieve trust-based collaboration?  When discussing nuclear disarmament discussions with the then Soviet Union, former US President Ronald Regan often quoted the Russian parable, “Trust but verify”, separating trust from faith.  Yet, a different US politician, Lincoln Chafee, is more relevant here who said, “Trust is built with consistency.”  

This led me to consider the notion of trustworthiness in our commercial relationships.  Some of you may be familiar with the work that I have done with the Australian Department of Defence in terms of defining what a “trusted business relationship” is and putting in place a measurement approach to assess whether the standard has been met linked to commercial consequences.

I recently read an article discussing how the last few years of the pandemic has moved trust to the centre of our decision-making process, stating, “Whether it be trust of governments, scientists, newspapers and journalists, or social media, trust, or our perception of trustworthiness, is central to our decision-making process.”  What caught my eye was the following statement:

“One good thing about trustworthiness is that it’s testable. Over time, evidence may confirm or refute the hypothesis that, say, the government is trustworthy about vaccine health advice but untrustworthy about cyber privacy protections in contract tracing apps.”

The key is in developing and applying both a measurement approach (the standard) and a formal governance process and commercial terms (the supporting systems).

Some of you may believe this approach is not very relational or collaborative given the potential linkage to commercial consequences, considering it is more representative of a conventional buyer-seller relationship.  However, in my experience, regardless of whether you are the buyer or seller, we use words like “collaborative business relationship” and “relational contracting” and potentially put in place collaboration or relational charters, but rarely link this to a repeatable measurement process underpinned by formal governance process and commercial terms.  Without an agreed definition of a good relationship, we risk having different interpretations when we get together, leading to friction between buyer and seller.

This result mirrors the World Commerce and Contracting (formerly the International Association of Commercial and Contract Management (IACCM)) reports into Overcoming the 10 Pitfalls in Contracting, indicating that the number 1 factor leading to contract value erosion is a lack of clarity on scope and goals.  Unfortunately, we typically think of contract scope as the “what” needs to be done or delivered rather than the “how” we will work together or behave.  This “how”, as one colleague put it, is the “special sauce” that, like a hamburger, separates the good from the great.  In our case, our special sauce separates merely good contracts from great commercial relationships.  So what does a great commercial relationship look like?

While there is a range of materials available to the reader, my experience since 2013 in materiel management contracts of the Australian Department of Defence, under the banner of a Generation 3 Performance Based Contract (PBC), has routinely included definitions of individual and shared (collective) objectives, specification of attributes of a great commercial relationship, and a formal governance process and supporting commercial terms.  Recently, this approach has been reimagined under a different banner by David Frydlinger, Kate Vitasek, Jim Bergman and Tim Cummins (see Contracting in the New Economy), the “formal relational contract”, but remain identical in approach.

In future articles, I will look at better practices in measuring relationship health and trust, both in terms of how to define and assess it (the standard) and how to look for it as part of choosing the right commercial partner.

Regardless of the label, the facts are clear; by explicitly addressing the number 1 pitfall through defining what a good business relationship looks like (irrespective of whether buyer or seller or even third parties) and ensuring that we discuss and reward it, the chance of having successful business outcomes and an enduring collaborative business relationship is much higher.  And isn’t that we all desire?

Posted in Behavioural Economics, Behaviours, Collaboration, Collaborative Contracting, Formal Relational Contract, Relational Contracting, the What | Tagged , , , , , , , | Leave a comment

Welcome to 2022! (and a belated Happy Holidays)

I am sure many of you (well the 3 people that read this blog!) have noticed that I haven’t posted anything recently and for that I apologise.  2021 was an interesting year for all of us no matter where you were in the world or what job you were in, and as such, it impacted my ability to write.  However, writing is something I love to do and so in 2022 I intend to restart delivering articles, but also restart the podcasts.  Although my family has asked me to apologise in advance for the podcasts, unless of course you need the help getting to sleep!

I would also like to thank my friend and colleague, Dr John Davies, for continuing to contribute articles to our sister site (the Collaborative Contracting blog) to give those interested in this fascinating and adjacent topic something to think about from a practitioner perspective.

Of course, if there is anything that you want me to specifically cover, please don’t hesitate to ask as I am always keen to help people in their Performance Based Contracting journey and add to the wider community of practice.

Finally, despite everything going on, I sincerely wish you all the joys of the season and happiness all throughout the upcoming year.  I think we have all earned it!

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Presenting at 2021 Virtual Academic Symposium on “Relational Contracting: Theory and Practice”

I am excited to announce that I will be speaking at tonight’s 2021 Virtual Academic Symposium on “Relational Contracting: Theory and Practice” which is being jointly conducted by The Center for Corporate Reputation at Said School of Business, University of Oxford, the Stigler Center at the University of Chicago, the Becker-Friedman Institute at the University of Chicago, the Relational Contracts Workshop and World Commerce and Contracting.  You can get more detail here.

Specifically, I have asked to give provide some insight into our (Australian Defence Sector) Generation 3 Performance Based Contracts and how we moved from a contract architecture focused on the delivery of individual, transactional outputs to one that focused on the delivery of collective, strategic outcomes.  That is moving from suppliers to partners.

This links neatly to the first perspective which was developed by Oliver Hart, David Frydlinger and Kate Vitasek who put forth a new type of contract—the formal relational contract—that they view as an effective way to overcome the problems of contractual incompleteness, particularly in complex transactions. This approach highlights the importance of aligning perspectives as well as building trust and understanding during contract negotiation. It also suggests that contracts contain a legally binding obligation to act in accordance with six contracting norms—reciprocity, autonomy, honesty, integrity, loyalty and equity—to induce the parties to respond cooperatively to the inevitable problems arising from contractual incompleteness.

I am honoured to be a part of this discussion which includes recognised global thought leaders Oliver Hart (2016 Winner of the Nobel Prize in Economics with Bengt Holmström for their work on contract theory), David Frydlinger, Kate Vitasek, Douglas Baird and Henrik Lando.

Wish me luck!

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Happy 2020 Holidays to all the Performance Based Contracting (PBC) Blog Readers

To all my readers, I hope that despite the unexpected and hard year we’ve all endured, that each of you have an opportunity to have a break and a bit of downtime over the next few weeks.

So sincerely, here’s wishing you all the joys of the season, and happiness all throughout the upcoming year.  I think we have all earned it!

Happy holidays!

Best Wishes

Andrew Jacopino

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Responding to a Performance Based Contract (PBC)

“See first, think later, then test. But always see first. Otherwise, you will only see what you were expecting. Most scientists forget that.”

Douglas Adams

One area not usually covered in the discussions of developing and operating better practice Performance Based Contracts (PBC) is how to respond to a PBC tender.

In many cases the PBC will be competitive through an open or limited tender.  In this situation, the aim of the seller is how to increase the Probability of Winning, commonly referred to as the Pwin, by balancing:

  • the desire to comply with the buyer’s position of specific PBC requirements (e.g. the performance measures, associated performance levels and commercial consequences; and
  • the commercial risk that this compliance brings (e.g. is the performance level achievable or is there a real risk of a failure to deliver, and what will this mean commercially to the seller?).

Having worked for both buyers and sellers I offer the following 4 points for consideration when responding to a PBC tender:

  1. Understand the Buyer’s Intent. When reading the PBC, and especially the performance measures, think about why the measures are being used.  What outcome(s) is the buyer trying to incentivise; either through positive (incentives) or negative (remedies) consequences? And if they are weighted, which outcome is the most important.  Additionally, but less common, if shared or Enterprise Performance Measures are used, consider the role the buyer’s wants the seller to play in delivering a bigger “enterprise” or collective outcome.  This should give you an insight into the buyer’s intent; what contract success should look like.  This understanding is critical if you want to be the buyer’s commercial partner.
  2. Your Solution Should be Designed to Deliver Green Performance. Once you understand the buyer’s intent your solution should be designed to deliver Green performance (i.e. to deliver the buyer’s Required Level of Performance where 100% payment should be achieved).  This isn’t as simple as it sounds, especially when balancing the desire to minimise cost / price in a competitive situation.  However, it is critical the seller understands both the short and long-term implications if Green performance is not delivered.  Not just in terms of payment, but other non-monetary implications such as reduced contract term, limited or no future work and damage to the company reputation, all of which is critical if the buyer is a repeat customer.
  3. Understand the Probabilistic Nature of Performance. Many PBCs will include a range of monetary and non-monetary consequences tied to seller performance.  However, many sellers will confuse the existence of a consequence in the contract with the likelihood of occurrence.  Given this, many sellers try to remove it through putting in a non-compliance in the tender response.  For example, many PBCs will include the right to terminate for continued poor performance, especially those buyers in the public sector.  Before responding, the seller must understand what is the chance that they will continuously deliver poor performance resulting in termination.  Unfortunately, trying to remove the consequence leads the buyer to believe that the seller doesn’t want to be held accountable for their performance.  While this may not be the case, you can understand from a buyer’s perspective why asking to remove (or minimise) their commercial performance protections may give them concern.
  4. Responding to a PBC is a Team Sport. In helping buyers and sellers I have repeatedly observed that responding to the elements of a PBC can get confusing with no single owner within the bid team.  Unlike the technical requirements or pricing, which have clear leads, given a PBC is multidisciplinary in nature touching commercial, financial, technical and management functions, finding and individual accountable can sometimes be hard.  In my experience, it important to ensure there is a single accountable person within the bid team responsible for aligning all aspects of the PBC response to ensure a coherent and aligned response.  I have seen tenders where the seller’s technical team respond with an alternate performance measure, the finance team put no money at risk (despite the buyer asking), and the commercial / legal team removing termination for poor performance.  Yet the executive summary states how the seller wants to be the buyer’s partner, standing shoulder-to-shoulder, being held accountable for their performance and behaviours.  From a buyer’s perspective this is confusing and may lead to concerns with the true nature of the seller’s intent potentially reducing the Pwin.

In addition to these general points, in some cases as a seller you may be asked to provide your opinion on what performance measures and their associated performance levels should be used, taking into account either existing internal measures or industry standard / better practice.  When considering your response you should be very careful in offering an alternate that is not aligned with the buyer’s intent.  If there is a legitimate reason, such as the cost of collecting the data, this needs to be made clear as otherwise this may be seen as form of negotiation, minimising the commercial risk that the seller is exposed to.  Alternatively, where the proposed alternative performance measures include detailed rationale and statement of benefit to the seller (i.e. the why), it may increase your Pwin.

Before I end this article, I do want to highlight that sellers should not simply comply with everything the buyer wants.  Over the years I have seen completely unrealistic PBCs from buyers which were both unachievable (in terms of performance) and unaffordable (in terms of the buyer’s budget).  In these cases, it is critical that the seller understand their commercial imperative as, at least in my opinion, no contract is too important to win at any cost.  A PBC like this will result in numerous disputes and ultimately not deliver the desired outcome to either party; a loose-loose situation.  One option for the seller is to explain the reasons and offer an alternate Performance Management Framework (PMF) that is both achievable and affordable.  Of course, the seller may conclude that the PMF is too arduous and the cost of tendering too high.  In this case, the seller may simply not bid (tender) for the contract.

So in developing your response to a PBC I hope you consider the points in this article.  Importantly, I hope you consider viewing your response from the perspective of the buyer, and how it delivers their desired outcome(s).  Since, just like in school, the best advice my teachers gave was to simply read and answer the question being asked.

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How Many KPIs Should My Contract Have? – Part 2

In the previous article (see How Many KPIs Should My Contract Have? – Part 1) we examined the benefits and costs of using performance measures.  In this article we are going to examine how to balance the benefits versus the costs of using them .

On method is to use the science of human factors engineering to determine the optimal number of performance measures.  This field examines the cognitive workload on humans describing the optimal amount of activities, including complexity of each activity, allowing humans work at their best.  For example, in the defence and aerospace sector, much of this research and the associated “standards” drive how the various instruments and controls are positioned in aircraft, helicopters and spacecraft.

The famous 1956 paper titled, The Magical Number Seven, Plus or Minus Two: Some Limits on Our Capacity for Processing Information, by George A. Miller observed that through a variety of studies our short-term memory had a capacity of about “seven plus-or-minus twochunks.  These chunks represented a concept or thought as opposed to single value.  However, other research found that this study was sometimes overly optimistic and perhaps the real value was a low as four.

Accordingly, it is possible to apply this thinking to our problem of how many performance measures we should use.

Firstly, if it makes sense for your contract, I recommend you divide (or chuck) the performance measures into different tiers reflecting their utility, potentially using a 3 tiered approach based on Strategic Performance Measures (SPMs) / Enterprise Performance Measures (EPMs), Key Performance Indicators (KPIs) and System Health Indicators (SHIs).  You can learn more about each of these tiers, including their role and responsibility, from previous articles (see When is a KPI not a KPI?).

Secondly, limit the number of performance measures for each of the tiers, especially the SPMs and KPIs which will get the most attention, to between 3 and 5, or perhaps up to 7.  Where the performance measures are simple, intuitive and easily understood, including objective, quantitative or common, industry standard performance measures, it is possible to use the higher band (e.g. between 5 – 7).  However, where the performance measures for more complex and harder to understand performance measures including subjective, qualitative or bespoke performance measures, the lower band is recommended (e.g. between 3 and 5).

Finally, in setting the total number of performance measures avoid combining multiple performance measures into a single measure in an attempt to minimize your total number of performance measures.  For example, KPI1 is made up of KPI1.1 and KPI 1.2 and KPI 1.3, etc.

So when considering how many performance measures you should have in your contract keep in mind the words of the American actress Julie Newmar:

“More is not necessarily better. Better is better.”

It is better to deliberately and consciously consider what is the optimal number of performance measures for your contract, including how they aggregated rather than simply applying a “magic number”.  But which performance should you choose?  That is a question for another time.

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How Many KPIs Should My Contract Have? – Part 1

A colleague of mine sent me the following cartoon that made me laugh.  The very talented cartoonist Tom Fishburne sketches tongue-in-cheek how people tend to view key performance indicators (KPIs).

Figure 1 – “KPI Overload” by Tom Fishburne at http://www.marketoonist.com

As a Performance Based Contracting (PBC) practitioner I cannot remember the number of times I have experienced this exact circumstance.  So why am I bringing it up? For over 15 years people constantly ask me how many KPIs should my contract have?  Unfortunately, there is no single number or magical formula that will make our lives easier. But, more importantly, I think it’s the wrong question.

To be honest, the first question should be what are KPIs and why do we use them?  The Key Performance Indicators Manual: a Practical Guide for the Best Practice Development, Implementation and Use of KPIs by AusIndustry (part of the Australian Department of Industry, Science, Energy and Resources) defines KPIs as:

Key Performance Indicators represent a set of measures focusing on the aspects of organisational performance that are most crucial for the current and future success of the organisation.

KPIs are therefore focused either on the critical aspects of organisational performance that require improvement, or on the aspects that must be kept within a specified level to ensure the continued success of the organisation.

But shouldn’t more KPIs be better?  For example, having more KPIs means the buyer gets additional performance information, including the associated performance drivers and risks, leading to better oversight, control and assurance of seller performance.  However, more KPIs is not without costs, including the increased cost of collecting, analysing, reporting and storing information.  Interestingly, more KPIs can also lead to confusion and loss of control with the buyer distracted from critical performance issues with numerous indicators, some masking true performance.  Alternatively, having too many performance measures may result in the buyer interfering (micro-managing) the seller’s delivery of performance potentially resulting in more disputes and damaging the business relationship.  A summary of these benefits and costs is illustrated in Figure 2.

Figure 2 – Benefits vs. Costs of Using More Performance Measures

Given this, perhaps the next question might be, how do we go about balancing the benefits of using performance measures versus the costs of using them?  We will look at that in the next part of the article.

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Release of PBC Awareness Video

After a lengthy delay I am proud to announce that my first video on Performance Based Contracting (PBC) is now available free for your viewing pleasure; PBC Awareness.  The video provides viewers a 35 minute introduction to PBCs using a presentation format with voiceover explaining each slide.  The intent of the presentation is to provide viewers an insight into the purpose, key features and details of this style of contract.

This will be the first in a series of videos over the next year.  While my family suggested I do not call this series “Phun with PBC”, the videos that follow this one will build on it and cover specific topics in more detail.  If you have any areas that you would like me to cover, please let me know.

Anyway, I hope you enjoy it and forgive my Australian accent!

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Guest Presentation on Managing a Performance Based Contract during Free Online Course from IACCM

While I usually don’t advertise on this Blog, the International Association of Contract and Commercial Management (IACCM) are once again offering a free Massive Open Online Course (MOOC) on Contract Management: Build Relationships in Business.  This free online course is scheduled to run from 25th May 2020 – 14th June 2020 and is designed for anyone who wants to better understand what is involved in commercial business relationships, and the process of managing contractual agreements.

The reason I am mentioning this course on my Performance Based Contracting (PBC) Blog is that I am one of the guest presenters during the event talking about Managing a PBC.  The topic of my short 1 hour presentation covers the following area:

Performance Based Contracts (PBCs) have proven to be an effective tool in reducing overall costs for buyers and providing profitable growth opportunities for sellers making it the contract model of choice across a range of market sectors.  While deceptively simple, PBCs are different to conventional contracts and require a different approach to their development, implementation and management.  The ability for organisations to effectively develop, implement and manage PBCs is critical to business success as failure can often lead to long-term performance, financial and reputational damage.

I hope to see you there.

(Disclosure – I am a Fellow and part of the IACCM Australia and New Zealand Advisory Board.  These are non-financial positions and my guest presentation is being offered for free as part of my vision to create a PBC Community of Practice to help advance this fascinating field).

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Introducing the Power By The Hour Approach

In designing a Performance Management Framework (PMF) for a new Performance Based Contract (PBC) the team asked about using a “Power by the Hour”™ approach and asked my opinion.  Given the general similarity between Power by the Hour and PBC I thought it a good area to discuss.

So what is Power by the Hour?

Firstly, Power by the Hour is a trademarked term used by Rolls-Royce, the global power systems company.  The term was invented in 1962 to support the Viper engine on the de Havilland/Hawker Siddeley 125 business jet.  Unlike previous approach of airlines buying the engine as part of the aircraft and then having a separate maintenance contract to support it, Power by the Hour offered airlines a new option.  That is, a complete engine and accessory replacement service on a fixed-cost-per-flying-hour basis.

While Rolls-Royce’s Power by the Hour approach has become more sophisticated since it’s introduction in 1960’s, from a behavioural perspective a Power by the Hour approach remains simple.  If the engine is working, there is a high chance that the aircraft is flying and generating revenue for the airline.  In this case, a working engine would also be generating revenue for Roll-Royce.  However, if the engine is not working with the aircraft sitting on the ground, there is no revenue for either the airline or Rolls-Royce.  This approach aligns the needs of both buyer and seller; that is, when the engine in working and the aircraft is flying, this makes money for both the airline and Rolls-Royce.

But why are we talking about Power by the Hour approach in a PBC Blog?

In a previous article (see Designing Successful Performance Based Contracts) I suggested that highly successful PBCs had the following characteristics:

  1. drives the right behaviour in the seller by addressing the Seller’s Needs;
  2. provides adequate commercial protections for the buyer by addressing the Buyer’s Needs; and
  3. balances the needs within a usable Commercial Construct (i.e. the contract).

This is achieved by aligning the Seller’s Needs against delivery of the Buyer’s Needs as reflected in the Commercial Construct.

A Power by the Hour approach delivers these three characteristics by aligning Rolls-Royce’s payment (i.e. the Seller’s Needs) with working engines (i.e. the Buyer’s Needs) all within the commercial construct (i.e. the contract).  In doing so, a Power by the Hour approach is an elegant approach to delivering a highly successful PBC.

Given this, can a Power by the Hour approach work in other situations and if so, what are the Critical Success Factors and constraints that must be considered?

In the next article I will look at a Power by the Hour approach in a more generic manner including how this relates to modern “as a Service” approaches to contracting.

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