Buyer/Supplier Performance Based Contracts Maximizing Success and Sharing Risk
Lorrie K. Mitchell
Lorrie K. Mitchell, Relationship Manager, BellSouth Telecommunications, Inc. Atlanta, GA 30375, 404/420-6068.
82nd Annual International Conference Proceedings - 1997
In the past, contracts were negotiated solely with a set fee structure. Occasionally, a penalty clause would be negotiated into the arrangement, and less seldom an incentive clause was included. A Performance Based Contract (PBC) is the true Win/Win scenario of the perfect union of these concepts. Topics that warrant discussion include: Is a Performance Based Contract beneficial, can/should all contracts be performance based, what type of relationship should exist/be developed with the supplier and how does a customer/end-user participate in this process, what type of environment is conducive to making this type of relationship work, what do you base performance on, what characteristics should the buyer and supplier possess, and how do you implement this type of program?
Is A Performance Based Contract Beneficial? Buyers are seeking to maximize value in purchases. Buyers are demanding high quality, innovation, and excellent service at fair and reasonable prices. Quality suppliers want to provide the best product/service and they expect to be rewarded for exceeding expectations. A PBC provides an opportunity for Buyers and Suppliers to win. Additionally, a PBC provides an opportunity for shared risk while maximizing the opportunity for mutual success. Buyers and Suppliers alike will require flexibility, versatility, and a commitment to lifelong change and learning.
Can/Should All Contracts Be Performance Based? Developing a PBC is NOT about writing a clause. A PBC cannot be negotiated and put on a shelf. It forces both parties to talk and become involved in their business. So, if you're making a one (1) time purchase, you probably will not want to expend the time and commitment necessary to develop and implement a PBC. If no further communication is planned with the supplier, a PBC would hold no payback for you. On the other hand, if you are interested in developing a relationship with a supplier AND both parties are willing to make the necessary time commitment, then a PBC would be an excellent alternative. As a result, the quality, process, and planning benefits not to mention mutual cost savings are endless. The benefits will only be limited by your own imaginations.
What Type Of Relationship Should Exist/Be Developed With The Supplier And How Does A Client/End-User Participate In This Process? A PBC IS about developing a strong mutually beneficial arrangement where both parties have something to gain and something to lose if their "partner" is experiencing a problem. When both sides go through a strength and weakness identification process, a certain alignment and synergy are established. Buyers now realize this is necessary to achieve and maintain a competitive advantage in today's marketplace. Additionally, this type of contract fosters a long term relationship with the supplier whereby both the Buyer and Supplier focus on their long range financial and value-added benefits.
What Type Of Environment Is Conducive To Making This Type Of Relationship Work? There are many factors to consider in this new environment. Is there a strong communication and sharing of information between the supplier and buyer? Between the supplier and the customer/end-user? A good specifications/capabilities document is critical. Communication and buy-in of the customer/end-user is critical since ultimately, they will be implementing the PBC. Will these individuals possess the ability to solve deviations from the specifications/capabilities document in an amicable/win-win manner or are they going to contact their Procurement Manager (to act as a policeman) every time there is a deviation from the agreed upon document? This could make a big difference in the success of the PBC. Both parties need to know that the other will go beyond the agreed upon terms and conditions to make this a successful and profitable relationship. Both parties need to have that security in the relationship.
What Do You Base Performance On? The identification and establishment of performance indicators and the associated outcome criteria are a must. Although Performance Measurements will vary depending on the product/service, customer satisfaction, product/service quality, support process performance, end-user satisfaction, efficiency, supplier performance, and/or measurement methods, each relationship needs to determine exactly what will it will take to make it a success. These are the items that need to be measured.
Pertinent and up-to-date performance data should be available and provided to the appropriate individuals. Neither party should have the impression that the other is "holding all the cards". Format of this data should be agreed upon by both parties early on. Appropriate analysis of this information on an ongoing basis must occur. Clear specifications, measures, and procedures for these processes must be agreed upon. Specifications must be based on customer requirements. Measures must permit the continuous assessment of process performance and the identification of peculiar situations, while procedures should include actions to be taken in these peculiar situations (or as many as can be identified at the onset of the relationship). The agreed upon specifications, measures, and procedures need to be followed consistently.
What Characteristics Should The Buyer and Supplier possess? Interpersonal communication skills are paramount. Being able to clearly express what you need and being able to listen and comprehend what you will receive are extremely important. Effective problem/conflict resolution, analytical ability with an innate good business sense, creative negotiation strategies, innovative ideas, all with a strong customer focus will make this PBC relationship a success. Occasionally both sides will not see things the same way. At that time, a resolution that both parties can live by must be negotiated. A strong focus on the needs of the other party will make both parties successful.
Suppliers who maintain a safe and healthy work environment are usually more successful in motivating its employees. A compensation and recognition system for individuals and teams who support the business and performance objectives must be in place. The supplier must have a vision, mission, or purpose of overall direction that clarifies its commitment to quality and customer focus that is clearly understood by all of its employees. All of a supplier's employees across the company must work together to effectively support the goals and business direction of the company.
How Do You Implement This Type Of Program? Implementation will certainly flush out any concerns not initially addressed by both sides. As mentioned earlier, clear and timely communication is the key. Internal audits/review sessions to assess compliance to process control requirements, to determine the effectiveness of its process control methods, and to identify opportunities for improvement are important to a program's success. Such review sessions should be performed with scheduled regularity. Action must be taken to correct any deficiencies found in these review sessions. The customer/end- user needs to periodically review supplier performance and to plan at the overall company or department levels to assess the success of the program and identify areas of deficiency where action needs to be taken. Implementation should be monitored to ensure that the action taken indeed resolves the problem.
As mentioned earlier, the use of a PBC is more than just the inclusion of a clause in a contract. It's a cooperative relationship that has to be established in order for all parties to be successful. The establishment of a PBC is a "good business" approach to successfully working with a supplier. In this world of Win/Win negotiations and contracts, all Procurement Managers are interested in working with a supplier that REALLY wants to work with them, i.e., establish a true "give and take" relationship. A PBC allows both parties to focus on their strengths and assist the other in eliminating their weaknesses. Both parties may then mutually establish their critical success factors.
Developing a PBC has the potential of increasing the value of the products/services provided by raising standards. Procurement Professionals should be focused on every aspect of adding value in contract development. PBCs create win/win opportunities and REAL partnerships.
The author: Lorrie K. Mitchell is a Relationship Manager in the Supply Chain Management Department of BellSouth Telecommunications, Inc. (BST) She is a full-time faculty member of the Keller Graduate School of Management (KGSM) where she teaches Contracts and Procurement Management as well as Mathematics. Lorrie has a B.A. in Mathematics from the University of Miami and a Master of Science in Technology Management from the Stetson School of Management of Mercer University. Prior to her work at BST and KGSM, Lorrie was a Buyer for Burdines and taught Mathematics at the Secondary Level.