B-2-B Markets Weeks 8&9

Managing in Business to Business Markets:
Contracts, Negotiation and

Conflict Resolution
Week 7 to 9 Contracts and Contract
Management
CBSP, The University of Birmingham, 2011.
Supporting relationships with contracts - introduction

Assuming the purchase is not a re-buy, managers will need to produce a (hopefully
sensible - see OBB) specification or project brief against which suppliers can bid.
Such a specification/brief (and associated selection criteria) can be issued as part of
an open competition or a more restricted one (although public sector buyers need to
be careful).
Suppliers, usually having gone through a pre-qualification exercise (PQQ), will then
prepare bids in line with the buyer information. This is the RFX or ITT stage.
Depending on the purchase, these bids may be a quote, proposal or, if the
procurement is setting up a framework contract, evidence of capabilities.
Where there is a negotiation / presentation following submission, there could be bid
development or, indeed, changes in the buyer requirement.
The RFQ or RFP process could be prefaced by an RFI process if the buyer is in new
terrain.
Following all this, hopefully the buying organisation will be in a position to select
one or more suppliers.
Supporting relationships with contracts - introduction
If so, there will be a need to develop a contract.

Depending on the purchase (uncertainty) and on the objectives of the
buying organisation (desire for supplier innovation / focus on outcomes),
this will be more or less complete.
However, any formal contract will contain two main parts: terms and
conditions and appendices called schedules.
The terms and conditions (or Ts & Cs) set out the basis on which the buyer
and supplier agree to conduct the relationship.
There will be negotiation over these and managers are usually advised not
to accept the other partys standard Ts & Cs, unless they have no choice.
Some of the Ts & Cs may refer to a schedule. Schedules form the second
main part of the contract, are contained in the appendices and are where
aspects of the agreement are spelt out in greater detail.
Supporting relationships with contracts - Ts and Cs
Parties to the contract
Confidentiality
Background, including purpose
Data protection
Definitions
Compliance with relevant law
Goods / Services (detailed in schedule)
Insurance
Standards (the SLA detailed in schedule)
Exclusions and liability limits
Supplier staff
Term and termination arrangements
Use of premises, equipment and thirdparty contracts and products
Non-solicitation of other partys staff
Waiver and remedy arrangements
Required customer assistance
Severability of invalid clauses
Service charges, payments and liquidated

damages (references SLA)
Currency issues
Change controls
VAT issues
Dispute resolution procedures
Indemnities (e.g. for IP breach)
Sub-contractor rules
Entire agreement and exclusion of past
IPR
Force majeure
Source: Adapted from Supply Management (2010). Not an exhaustive list.

Supporting relationships with contracts - schedules
As mentioned, some of the Ts & Cs will refer to schedules. These are

where clauses in the contract are discussed in more detail.
The schedules are often where much of the negotiation has focused upon
and commonly concern the following:
-
Specification or description of service (statement of work)
Method of manufacture
Pricing schedules
Service level agreement (SLA)
Contract management and dispute arrangements
Equipment schedule
Exit arrangements
IP assignment
Usage rights following termination
Supporting relationships with contracts - beyond the basics
These then are the basic elements of the contract.

However, these basics tell us nothing about how contracts work in
practice. To understand this we need to access the literature on contract
law and economics of contracts.
The literature on contract law tells us how the courts judge managerial
conduct during negotiations and during the contract period notes are
provided, although we shall not be going through them in class.
The literature on contract economics tells us how contracts can be used (in
combination with extra-contractual managerial methods) to deal with
different purchase circumstances and different types of customer or
supplier behaviour.
Fundamentals
Fundamentals
of
of
Contract
Contract Law
Law
Contract law: areas of interest

The following issues are covered:
Establishing a Contract
The Terms of a Contract
Exclusion Clauses
Misrepresentation
Validity of Contracts
Contractual Remedies
The latter is particularly relevant for the session on conflict

management.
Contract law: establishing a contract

There is a range of basic legal terminology relating to the existence of a contract.
Certain actions need to take place for a contract to exist between two parties:
Offer This is defined as a statement of willingness to contract on specific terms,
made with the intention that, if accepted, it shall become a binding contract.
This needs to be distinguished from an Invitation to Treat something that usually
covers advertisements and ITTs. The resulting tender from the supplier, however,
will be deemed an offer.
Acceptance This is defined as unconditional assent, communicated by one to
another, to all the terms of the offer, made with the intention of accepting. The buyer
is not deemed to have accepted if the offer is a framework agreement lacking
detail on quantities.
Consideration There needs to be some element of bargain for a contract to
exist. Something must be exchanged for something, not just a promise made for no
return.
Intention to be Legally Bound Usually assumed in commercial transactions
Formalities For the most part, there is no requirement for a contract to be
written to be binding.
Contract law: the terms of a contract
Contracts consist of various statements, promises and stipulations grouped

together under the word Terms. The terms may be express or implied.
The terms of the contract determine the extent of the two parties rights and
obligations. As shall be seen, the remedies available if any of the terms are
broken is dependent on the importance of those terms.
There are various issues related to the terms of a contract:
Certainty a contract might be declared void if the (written or oral) terms are
not sufficiently clear, although the courts will often try to interpret the terms in
question if there are industry norms or previous relations between the two
companies. The courts may also apply a reasonable persons test.
Parol Evidence Rule Where a contract is written then (in theory) outside (or
parol) evidence is not admissible to add to, subtract from or vary a contract.
However, the courts have created many exceptions, e.g. custom, collateral
contracts (extra-contractual assurances).

Representation and Terms Statements that are made in negotiations can be
classified as either representation or terms. A representation is a statement that
induces the contract, but is not actually part of the contract.
A term is part of the contract. This matters as if there is a disagreement the issue will
be either be with respect to misrepresentation or breach of contract, which attract
different remedies.
Whether a statement is a representation or a term revolves around the issue of
intent. If something is stated a term, then it is a term. Otherwise, classification
depends upon requests for other party verification, time between statement and
contract, the impact on the other partys decision to enter contract and skills of two
parties.
Condition The most important type of contract term. Breach will allow discharge
and damages.
Warranties Less important aspect of the contract and will lead only to damages.
Two cases regarding opera singers in the late 19th century provided guidance for
distinguishing between the two. An opera singer being obliged to attend on
performance nights was considered a condition. An obligation to attend all
rehearsals was considered a warranty.
Innominate Terms Some terms will be classified in terms of the effect of the
breach.
CBSP,
The University of Birmingham, 2011.
Implied Terms The courts may also make assumptions about the agreement
between two parties. This is referred to as implied terms.
Implied terms may be implied by the court (where something is so obvious, it
goes without saying 1889 precedent case of a docking place being safe for
ships to land).
Implied terms may be implied by statute (e.g. Sale of Goods Act 1979).
Implied terms may be implied by custom (local or industry).
Contract law: exclusion clauses
A clause can be put into a contract which seeks to exclude or limit to some
extent one party to an agreements liability for breach of contract,
misrepresentation or negligence.
Clearly, the use of exclusion clauses is a potential area for abuse. As a result,
the courts try to restrict their use. This has taken the form of the following:
Use of the Unfair Contract Terms Act 1977.
Insistence that exclusion clauses be incorporated into the contract,
something that can only happen if the other party knew of the clauses and had
any unusual aspects of them specifically pointed out to them. There is less a
burden if the parties have traded previously.
Insistence that the incorporated exclusion clause be shown beyond doubt to
cover the breach in question construction. The courts take a narrow view of
the wording of any exclusion clause to restrict its coverage.
Exclusion clauses also need to be reasonable.
Contract law: misrepresentation

It was discussed earlier, that a statement made in negotiation can be either a
term or a representation. When it is the latter, if it turns out to be untrue or
misleading it means a case of misrepresentation has occurred.
A misrepresentation is defined as false statement of fact (i.e. one not
substantially correct) that materially induces one party to an agreement into
that agreement. This does not cover opinions or statements of future
intentions.
Telling another party to check is not a way out of this.
There are three types of misrepresentation: fraudulent, negligent (where party
should have foreseen) and wholly innocent.
Remedies depend upon which it is. Rescission, taking things back to where
the two parties were before the contract and giving the plaintiff the option of
rescinding the contract, can be used for all three types often accompanied by
indemnity.
Fraudulent and negligent misrepresentation can lead to damages.
The Fraud Act 2006 has added sins of omission to the sins of commission of
fraudulent misrepresentation and made both a criminal offence.
Contract law: mistake, duress, illegal/void contracts and discharge

Mistake The courts will not require parties to stand by contracts
(rescission), or they will allow their rectification, if there have been genuine
mistakes by both parties: incorrect recording of an agreement; key fact
understood wrongly by both parties; one party successfully claims that what
they signed was fundamentally different from what they thought.
Duress and Undue Influence Was the contract entered into freely? This
is difficult for the courts to untangle from the everyday power relations and
commercial interplay. The courts are interested in whether there is bad faith,
whether the victim had an option but to submit to pressure and whether the
victim protested at the time.
Illegal and Void Contracts Various things can cause this: violates the law
of the land, contravene public policy (e.g. endanger public safety), contract
includes fraudulent activities, contract aims to restrict competition or trade.
Discharge of Contract A contract can be discharged for a number of
reasons: frustration (things (e.g. the law) have changed so much that
contract meaningless); breach, if serious; agreement to discharge (or vary)
the contract; performance (contractual obligations fulfilled).
Contract law: contractual remedies
Remedies Where a party to a contract suffers as a result of the other

party breaching the contract the courts can do a number of things in an
attempt to rectify the situation:
- Damages: which are normally awarded on the basis of putting the aggrieved
party in the same position it would have been in if the contract had been
properly honoured. This is called compensation for loss of bargain or loss of
expectation under the contract.
Award depends on remoteness of damage plaintiff needs to establish
causality and directness of action by defendant and show that it made steps to
mitigate the effect of that action.
The level of award is subject to no fixed rules, although market prices will be
used if applicable. Courts often speculate.
Liquidated damages could be specified in the contract.
Contract law: contractual remedies
- Quantum meruit: translates as much as he or she deserves. If one party is

prevented from completing its performance under the contract then it can be
re-numerated.
- Specific performance: an order of the court compelling one party to fulfil its
obligations under the contract. Can be used instead of, or in addition to,
damages. Often happens in land deals, where damages are inadequate.
- Injunction: an injunction may be granted to restrain a breach of contract.
Already mentioned as remedies:
- Discharge: where contract is seriously breached.
- Rescission: for misrepresentation, duress or mistakes.
- Rectification: for mistakes.
Contract law: sample cases

Fine art logistics:
The logistics supplier lost a piece of fine art. The issue was over whether the standard
Ts and Cs, that limited supplier liability, were part of the contract with the buyer of the
logistics service.
The court ruled that they were not because the buyer did not see them prior to signing
the contract and did not have previous experience of dealing with Ts and Cs in that
sector. The court said that parties must provide a copy of the Ts and Cs to the other
party and bring anything unusual about them to their attention.
Land sale:
The seller suggested a base price that it knew was very high, expecting the buyer to
negotiate it down. The buyer did not, something which then affected whether the buyer
benefited from an index mechanism.
The court did not change the price back to a market level, but did find against the
supplier for deceit. The court said that parties should be careful about exaggerating too
much in negotiations as this may be ruled as dishonest. Not surprisingly, the court also
said that in future the buyer must do proper research.

Commercial property lease:
There were problems with a property. The owner did not rectify them and then, when
the occupier claimed disadvantage, cited the contract which excluded it from liability
for consequential loss and limited its other liabilities.
The court ruled that the clause excluding consequential loss was acceptable, but that
the other clauses limiting liability were not. It said that a contract should not be
developed that provides one party with no remedy for a breach that is central to the
contract. Contracts must be reasonable.
Logistics in the clothing industry:
The buyer claimed that the supplier had not delivered goods on time or to order. The
supplier said it was protected from any claim by the Ts and Cs in the contract. The
buyer said that the suppliers Ts and Cs were not relevant to the contract as the buyer
was never given those Ts and Cs.
The court found with the supplier after it emerged that the supplier had notified the
buyer about the Ts and Cs and made the buyer aware of some unusual conditions. The
buyer had not followed up. The court also ruled that the Ts and Cs were reasonable.
The court said that the buyer needed to take more care in future.
Purchase of oil for manufacturing storage drums:

The supplier changed a plastics ingredient in an oil product which caused the
buyer to experience an increased failure rate (from cracking) in its usage it
used the oil in the manufacture of storage drums. The buyer wanted
compensation from the supplier for the consequent loss of revenue.
The court ruled with the supplier and denied the compensation claim. It said
that the buyer should have tested whether the new oil was suitable for the
product in question and that, in any case, the suppliers actions could not be
proved as the cause of the revenue loss (remoteness).
The court said that suppliers need to have reasonable terms and bear a loss
when the blame is clear. However, the onus is on the buyer to make it clear to
the supplier what its product is to be used for.

Customer relationship software:
The buyer argued that the supplier had made claims during the sales process
about its ability to implement a CRM system. It became clear after the contract
commenced that it did not possess such an ability. As a result, the supplier
sacked the supplier, finished the project itself at a cost of 265 million and then
sued the supplier for fraudulent misrepresentation. The supplier denied the
allegations and argued that the project failure was due to the lack of specific
information on requirements from the buyer.
The court found with the buyer in part of its claim, that part based on the claims
made by one supplier employee about timescales. Other parts of the sales
process were not deemed fraudulent. The result of the finding was that the court
set aside the contractual liability cap (30 million) protecting the supplier, leaving
it open to much greater damages. The supplier has already made an interim
payment to the buyer of 200 million.
Fraudulent misrepresentation is still hard to prove, but this case has shown it is
possible. Buyers should retain details of pre-contract bidder claims and bidders
should be careful about what they promise.
Contract
Contract
Economics
Economics
Contracts and contract management
Where a purchase is a one-off, generic, spot purchase or is recurrent, but still

possesses low asset specificity and switch costs, the main threats to VFM (aside from
poor OBB practice, e.g. not searching the market or over-specification) are:
- market concentration
- adverse selection.
However, where the buyer is entering into a medium or long-term contractual

agreement with a supplier there are also other potential hazards, including:
- A (non-strategic) failure to deliver the product or service as required
- A (non-strategic) cost overrun
- Hold-up
- Moral hazard
Managers want to prevent these potential hazards, thus preventing value from leaking
during the contract period and, hopefully, allowing the contract to stay in the draw.
This, in turn, requires us to consider together the contract and contract management and also OBB and supplier selection (competence and congruence).
Contracts and contract management
Smith and Czerniawska (2010) comment: A good contract defines responsibilities

clearly, is easy to understand and is reasonable and balanced in the eyes of both
parties. As such, it sets the scene for a relationship that may not require much
contractual argument.
In other words, a big part of contracts being largely self-enforcing or kept in the
drawer (because performance is in line with the original agreement) is that they leave
both parties, following the negotiation, satisfied and more or less enthusiastic about
implementation.
While there is much truth in the statement, there are caveats:
-
The concepts reasonable and balanced does not mean equal and need to be seen in
context of power relations.
- Uncertainty can change levels of satisfaction on part of one or both parties

-
Some suppliers will play dirty (opportunism) during the contract period even if the contract
is reasonable
- The notion of a contract being reasonable and balanced will often be understood
subjectively by the two parties, potentially causing conflict
- Sector-specific cultures can be hard to work against, e.g. rail and construction
Contracts and contract management: re-visiting the NS&I case
At this stage in the module, it is useful to look again at the NS&I case we
studied in week 1 as part of a comparative cases exercise.
This case was not an example of perfect best practice, but the NS&I team made
a pretty good fist of a challenging project.
Many of the lessons of contract economics, in particular, the aforementioned
OBB, contract design, supplier selection and contract management, can be
observed in this case and it can help our learning.
So, before we proceed to study the key elements of contract economics, we take
a few minutes to read the case again
Potential
Potential
Contractual
Contractual
Hazards
Hazards
Contracts and contract management hazards in contract period

As mentioned, key hazards that threaten the implementation of a (hopefully
reasonable) medium or long-term deal are:
- A (non-strategic) failure to deliver product or service as required
- A (non-strategic) cost overrun
- Hold-up
- Moral hazard
The first two are self-explanatory. This is except to say that while cost overruns
may be dealt with by the fee structure, in reality there may be practical impediments
to imposing this.
Imposition may damage the relationship with an important supplier or the supplier
may simply be unable to take on the additional costs which could be a problem for
the buyer if there are barriers to switch.
The other two hazards, the concepts of hold-up and moral hazard, require further
explanation.
Contracts and contract management the hold-up problem

Hold-up occurs when one party threatens to halt production or terminate a
relationship altogether. When there is uncertainty (although not risk) the hold-up is
often over variations.
There is a dispute over causes: pre-planned opportunism (contractual traps or
adverse selection); uncertainty; or, unreasonable pre-contract buyer actions. All can
be seen.
In the case of pre-planned opportunism, hold-up can be said to have been
successfully executed when A has been able to force B to accept an unwanted
movement in the commercial relationship because of a lack of alternative solutions
available to B outside of the A-B relation.
Hold-up can be practised by buyers or suppliers we focus on supplier hold-up.
It can occur for a range of reasons, including:
- Asset specificity
- Switch costs
- Time
Contracts and contract management the hold-up problem

Reneging: Hold-up without uncertainty
As has been stated, hold-up tends to be associated with uncertainty and the need for
variations.
However, it does not necessarily have to be that way.
On some occasions, a supplier will just seek to re-negotiate the contract, ex post (in
the bare-faced manner we saw in the case of pre-contractual drift).
There are a range of reasons why this might happen. It may have always been the
intention of the supplier to do this, or it may be that the suppliers commercial
circumstances have changed.
Alternatively, reneging may come in the form of a refusal to provide a certain level of
performance within the current contractual agreement.
Contracts and contract management moral hazard

According to Milgrom and Roberts (1992), moral hazard is an incentive problem
that affects the economic fortunes of one party to a transaction, under any type of
contract.
It occurs because (a) the actions of one party are hidden from the other party and
(b) the incentives in the relationship are misaligned.
It is particularly a problem in buyer-supplier relationships when the suppliers
production processes (and this could be in the development and delivery of
services as well as goods) are characterised by what Achian and Woodward (1988)
called plasticity.
Processes are characterised by plasticity when the supplier has considerable
discretion over how to generate / deliver the end product or service in terms of
quality and effort. This can lead to quality shading and/or shirking.
Some processes are mandated by technology, others can follow various routes.
Moral hazard can also result, however, from plain cheating and lying such as
padding and upgrading the invoice.
Contracts and contract management moral hazard

Examples of moral hazard:
Misrepresentation of the time/cost taken to undertake research and
development project.
Legal firms or quantity surveyors claiming that senior lawyers or surveyors
were responsible for a brief/report, when really it was compiled by junior
partners.
Construction companies using cheaper materials than was stated in the
quotation.
Non-statement of annual or monthly rebates.
Management consultancies developing studies that they say are customerspecific, which in fact are compiled in part from generic material gained
through previous assignments.
Under-performance of services due to lowering of staff levels (number or
quality).
Agencies in the advertising sector claiming that greater input had gone into
developing a creative brief than was in fact the case.
Management
Management
Action
Action
Contracts and contract management management action

When addressing the hazards of opportunism, or strategic behaviour, no methods
are certain to be fully successful. Indeed, there can often be unintended
consequences.
This is why any methods need to be matched by managerial judgement. There is no
best practice template.
Having said that, managers can (1) address the hazards, (2) secure the original deal
(itself influenced by power and pre- contract drift), (3) preferably without rancour
(self-enforcement) through:
- effective OBB,
- development of a clear and reasonable contract (even if stays in drawer, still
needed)
- execution of basic contract management principles, and
- methods of addressing strategic supplier behaviour including supplier selection.
The philosophy here is that effective contract management should start as early as
possible and not be about shutting the stable door ...
Effective management action requires the employment of feasible foresight.
Economic Actors: Bounded rationality but not myopia.

Williamson (1990): Economic actors have the ability to look ahead, discern
problems and prospects, and factor these back into the organisational /
contractual design.
Feasible foresight allows farsighted, if incomplete, contracting.
If the perceived risk is asset specificity, actors will be able to use feasible
foresight to ensure that either the asset-specific investments are shared or
hostages are posted - to ensure contractual balance.
The hope is that the agreement will become self-enforcing as the gains from
opportunism will be less than the loss of the relationship investments, not to
mention potential future dealings.
The Quest for VFM Avoiding non-strategic delivery failure or cost overruns, or hold-up and/or moral hazard
Contracts and contract management a summary

Effective
EffectiveInternal
InternalEngagement
Engagementand
andBehaviours
Behaviours
Specification
Specification
Bargaining Strength
Bargaining Strength
Adverse Selection
Adverse Selection
LOW
LOWRSI
RSI/ /SWITCH
SWITCHCOSTS
COSTS
SIGNIFICANT
SIGNIFICANTRSI
RSI/ /SWITCH
SWITCHCOSTS
COSTS
ORIGINAL
ORIGINALDEAL
DEAL
(CLARITY
/
REASONABLE)
(CLARITY / REASONABLE)
ORIGINAL
ORIGINALDEAL
DEAL
(CLARITY
/
REASONABLE)
(CLARITY / REASONABLE)
REQUIRED
REQUIREDGUIDANCE
GUIDANCE
REQUIRED
REQUIREDGUIDANCE
GUIDANCE
Market
Market
(Sharp
in,
(Sharp in,sharp
sharpout)
out)
Transactional
TransactionalEfficiency
Efficiency
(E-auctions
/
Optimisation)
(E-auctions / Optimisation)
Trust:
Trust:contractual/goodwill
contractual/goodwill
Trust
Trustmaintenance
maintenance
Opportunism:
Opportunism:subtle/blatant
subtle/blatant
(potentially moderating over time)

(potentially moderating over time)
Assiduous
Assiduoussearch,
search,negotiation,
negotiation,
contract,
monitoring
contract, monitoring
Power
Powerand
andSelection
Selection
EU
EURules
RulesProxy
ProxyIndicators
Indicators
Partnering: experience and resources
Partnering: experience and resources
Public sector track record

Public sector track record
Values and behaviours
Values and behaviours
Screening (pricing, gain-share and relationship
Screening (pricing, gain-share and relationship
investment)
investment)
Relationship mechanisms (knowledge sharing, change)
Relationship mechanisms (knowledge sharing, change)
Credible
Crediblecommitments
commitments
Contractual
Contractualdeductions/rewards
deductions/rewards
Reputation
Reputation
Or
Or.
.Alignment
Alignment
Or
Or.
.Integration
Integration

Non-strategic supplier problems can usually be limited by basic contract
design and management and before that effective OBB:
-
Ensure the contract clearly defines the inputs and/or deliverables, something
that requires a clarity of objectives right from the initial need identification
stage
Ensure the contract clearly details the timings of inputs and/or deliverables
Ensure the contract provides necessary guidance on product/service delivery
Ensure that the contract clearly defines the responsibilities/obligations of

both parties
Where necessary, ensure the contract identifies supplier staff to be engaged
Ensure the contract makes the payment details clear (e.g. milestone
payments)
Ensure the payment mechanism is appropriate to the product/service in

question. Certainty / uncertainty and degree of supplier control of outcome
key.

- Ensure that the price has not been forced too low / contract period made too short to the
point that the supplier will find delivery / necessary investment infeasible (this doesnt rule
out stretch targets though)
- Prior to all of the aforementioned, ensure that the supplier selected possesses the
necessary capabilities and capacity
- Ensure that the right people from both organisations are involved. Not too many ensure effective governance. Not too few - ensure that the necessary information is
exchanged and necessary improvement or obstacle-removal actions are taken
- Ensure that demand and technical information is timely and stable and that internal
decision-making is swift
- Ensure that dispute resolution mechanisms are in place so that problems can be dealt
with quickly and effectively
- Ensure that the supplier gets regular feedback and that there are regular progress
reviews that look back and forward
- Where there is uncertainty, ensure that there are clear mechanisms in place to deal with
changes beyond the contractual agreement for orderly negotiation and creep avoidance
However, not all non-delivery and cost overruns are non-strategic.
There can be strategic hold-ups and moral hazard which can also see the contract
out of the drawer.
A range of methods beyond those to address non-strategic hazards have been
suggested as ways of addressing opportunistic behaviour.
Not all will suit all industries and there are costs, but the principles behind them are
generic.
An approach will usually combine methods there is no magic bullet.
Pre-contractual drift, though, can make the task difficult.
Balancing mechanisms (to address hold-up, in particular):
Try to select congruent suppliers, potentially even at some expense of competence
Consider dual sourcing, shifting the balance of demand according to performance
Joint investments or, if not feasible, the posting of hostages
IPR assignment
Stress contingent renewal, if possible
Play upon reputation
Compete clauses on variations and switch arrangements
Buyers can also seek to benchmark supplier demands
Contracts and contract management management action (Klein)
Gains from Acting Exploitatively
Costs of Acting Exploitatively
Quasi-Rents
Future loss
Loss of reputation
A supplier manager is said to act exploitatively where the gains exceed

the costs (This could be added to by adding broader C/B factors)
A buying manager can seek to prevent the gains exceeding the costs by
using the contract in two ways:
Use Contract to Reduce Scope for

Gains through Legal Clauses
Use Contract to Create Private

Enforcement Capital
(Joint Investments, Hostages, Contingent
Renewal)
And Rely on / Play-up Reputation Fears
Creating incentives (to address moral hazard, in particular):

-
Deductions or rewards to address moral hazard - although these can have

unintended consequences, for the same reasons why moral hazard can occur
in the first place, namely plasticity and information asymmetry
No form of payment mechanism (e.g. cost-plus, fixed price, risk-reward) is a

solve-all. They can all affect behaviour in unwelcome ways
Where tried, any system of performance incentives must be based upon the
balanced scorecard principle
Moral hazard can also be addressed by monitoring hands-on or spot-check.
Potential dysfunctional consequences of performance incentives:

-
Tunnel vision: supplier only focuses on measured activities at expense of others
Gaming: supplier alters behaviour to achieve targets
Myopia: supplier focuses on short-term targets at expense of longer-term performance

and improvement
Misrepresentation: supplier commits fraud to hit targets
Risk aversion: supplier doesnt innovate in case of short-term failure
Non-cooperation: supplier ignores wider supply base improvement initiatives
Incentives can be accidental or deliberate many actions can create incentives.

There are many types of incentives, not just deductions and bonuses.
Types include:
-
Retention as a supplier
(Avoiding future loss and/or loss of specific investments. Supplier valuation of retention will vary. Also, fear of
summary dismissal can suppress investment in relationships)
Fixed payments
Bonus payments or gain-shares
Financial deductions
Publication of performance data
Public recognition (reputation): formal awards or informal forums
Autonomy
Intrinsic rewards

Contractual bonuses and deductions need to be set carefully to be effective in creating
desired performance
-
Fundamental to the creation of effective incentives is comprehensive knowledge of the

production process or service.
This links to the need to set stretching not easy targets and / or aim the incentives at valueadding activities. Otherwise, you can just be substantially adding to profit.
It also links to the issue of suppliers pricing-in deductions.
Similarly, it is hard to develop effective incentives when the supplier is not solely
responsible for successful execution of the task, e.g. management consultancy.
Make the KPIs and metrics that govern the incentives clear and cap the incentives.
Carefully consider the cost implications of the incentives: could reduce effort elsewhere or
force the supplier into gaming.
Think about how the incentive might work its way down to the people on the ground.
Think carefully about the thresholds and incentive gradients.
Incorporate increased performance into base assumptions of future contracts.
Remember that some suppliers will have broader motivations.
Consider trying to create contractual balance before elaborate deduction and bonus
schemes.
There is also the issue of getting what you pay for.

With simple production, tasks can be easily defined, measured (across the
tasks that create value) and monitored and short-term performance is all that
matters.
Many business relationships are not characterised by the above, so
- Be careful about creating strong incentives where cheating is hard to observe.

- Be mindful not to incentivise suppliers to ignore what is of great value to you or
focus on what is of little value to you.
-Select a reasonable number of KPIs that, as much as is feasible, cover what is valued.
- Consider mixing objective and subjective assessments.
- Consider the impact of short-term incentives on long-term performance.
- Be mindful that indicators that are the outcome of effective supplier performance can
affect performance negatively if they become subject to incentives, e.g. customer
satisfaction.
Cousins (2007) argues for a balanced scorecard, a la Kaplan and Norton

(1992).
Hughes (2005) agrees and suggests categories that both extend to cover a
suppliers wider business contribution and look forward as well as back.
Clearly, such broadening will not apply to all, or most, relationships thus
the weightings facility.
Outcome Measures
(Ends)
Strategic
StrategicValue
Value(?%)
(?%)
Financial
FinancialValue
Value(?%)
(?%)
Contribution
Contributionto
toproduct
productinnovation,
innovation,
Total
Totalcost,
cost,price
pricestability,
stability,
process
processinnovation
innovationor
orimprovement,
improvement,cost avoidance, asset utilization,
cost avoidance, asset utilization,
supply
supplyrisk
riskmanagement,
management,new
new
incremental
incrementalrevenue
revenue/ /profits
profits
market
marketentry,
entry,CSR
CSRtargets
targetsand
andbrand
brand
generated
generated
development
development
Predictive Measures Operational

OperationalPerformance
Performance(?%)
(?%)
(Means)
Quality,
Quality,delivery,
delivery,flexibility,
flexibility,
service
levels,
administrative
service levels, administrative
efficiency
efficiency
Relationship
RelationshipQuality
Quality(?%)
(?%)
Trust
Trustlevels,
levels,quality
qualityof
of
communication,
strategic
communication, strategic
alignment,
alignment,quality
qualityof
ofjoint
joint
problem-solving
problem-solvingand
andconflict
conflict
resolution
resolutionand
andcommitment
commitment
Adapted from Hughes

(2005)
Any system of incentives needs to be given an unintended consequences

test.

If things have not gone to plan, how do you address opportunism from a weak power
position?
-
Close management (manage the heck out of them make em earn every penny)
Make organisation easy to serve or alignment
Try to develop some degree of obligation to good behaviour even if it is not cast iron trust
Or, ultimately, consideration of vertical integration:

-
In some circumstances, the lack of scale economies obtained from using the market plus
the costs of managing opportunism (and co-ordination across boundaries) make vertical
integration a better option, despite its own shortcomings
Less drastically, buying organisations can lower specific investments, although this is not
always discretionary (i.e. dictated by compatibility issues)
Contracts and contract management management action exercise

Having studied the theory, another look at NS&I .
Targeted
TargetedHazard
Hazard
Adverse
Adverse
Selection
Selection
Pre-Contract
Pre-Contract
Drift
Drift
Post-Contract
Post-Contract
Hold-up
Hold-up
Moral
MoralHazard
Hazard
Contractual
ContractualMechanisms
MechanismsAdopted
Adoptedby
byNS&I
NS&I
This session links forward:

Ideally, buyers develop a good initial deal that self-enforces (i.e. the contract
stays in the drawer), with additional value-added if relevant.
Of course, sometimes this will not happen and there is a conflict that may or
may not result in the initial deal being delivered (i.e. delivery can be achieved
through self-enforcement or following conflict).
This conflict can be in either the public or private arena.
Next week we consider how buyers might address conflict situations, deciding
whether to accept the additional transaction costs of fighting for the initial deal
(or another cause) or whether to accept an alternative outcome.
It will be argued that conflict decisions should be treated as cost-benefit
decisions.

B-2-B Markets Weeks 8&amp;9

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Managing in Business to Business Markets:

Contracts, Negotiation and

CBSP, The University of Birmingham, 2011.

Supporting relationships with contracts - introduction

Supporting relationships with contracts - introduction

If so, there will be a need to develop a contract.

CBSP, The University of Birmingham, 2011.

Supporting relationships with contracts - Ts and Cs

Parties to the contract

Background, including purpose

Compliance with relevant law

Goods / Services (detailed in schedule)

Standards (the SLA detailed in schedule)

Exclusions and liability limits

Term and termination arrangements

Use of premises, equipment and thirdparty contracts and products

Non-solicitation of other partys staff

Waiver and remedy arrangements

Required customer assistance

Severability of invalid clauses

Service charges, payments and liquidated

Dispute resolution procedures

Indemnities (e.g. for IP breach)

Entire agreement and exclusion of past

Source: Adapted from Supply Management (2010). Not an exhaustive list.

Supporting relationships with contracts - schedules

As mentioned, some of the Ts & Cs will refer to schedules. These are

Specification or description of service (statement of work)

Service level agreement (SLA)

Contract management and dispute arrangements

Usage rights following termination

CBSP, The University of Birmingham, 2011.

Supporting relationships with contracts - beyond the basics

These then are the basic elements of the contract.

CBSP, The University of Birmingham, 2011.

CBSP, The University of Birmingham, 2011.

Contract law: areas of interest

The Terms of a Contract

The latter is particularly relevant for the session on conflict

Contract law: establishing a contract

Contract law: the terms of a contract

Contracts consist of various statements, promises and stipulations grouped

CBSP, The University of Birmingham, 2011.

Contract law: the terms of a contract

Contract law: the terms of a contract

CBSP, The University of Birmingham, 2011.

Contract law: exclusion clauses

CBSP, The University of Birmingham, 2011.

Contract law: misrepresentation

Contract law: mistake, duress, illegal/void contracts and discharge

Contract law: contractual remedies

Remedies Where a party to a contract suffers as a result of the other

CBSP, The University of Birmingham, 2011.

Contract law: contractual remedies

- Quantum meruit: translates as much as he or she deserves. If one party is

CBSP, The University of Birmingham, 2011.

Contract law: sample cases

Contract law: sample cases

Contract law: sample cases

Purchase of oil for manufacturing storage drums:

CBSP, The University of Birmingham, 2011.

Contract law: sample cases

CBSP, The University of Birmingham, 2011.

CBSP, The University of Birmingham, 2011.

B-2-B Markets Weeks 8&9

B-2-B Markets Weeks 8&9