Embracing Relational Contracting for Business Success - With Jerry Silber, Hal Bretan, & Lita Bollimpalli

Made with speech-to-text software, so a few words may be off.

0:00You're listening to the Contract Heroes Podcast, your one-stop shop for all things contract management. And now here are your hosts, Marc and Pepe. Hi, everyone, and welcome to another episode of the Contract Heroes. Now we are at the World Commerce and Contracting America Summit at Atlanta, Georgia. This is our third time, actually, we're doing podcasting live here. We're really, really e-excited to have three really cool people for our first episode: Jerry Silver, Hal Brittain, and Lida Bolling Pali. They work together in this really cool project about con- the relational contracting principles. And let's start Jerry with what's all about with the relational contracting principle. Let's start with that, and then we can just start on some use cases on, on how companies can start using them. Sounds like a plan. Happy to see you guys again also, by the way.

1:06Let me start with why we should think about relational contracting as a alternative to the traditional way that we contract. All right? Traditional contracting is not working very well in many cases. All right? At World CC, we see these numbers a lot. Parties underperform by twenty-seven percent. Wow. All right? Value leakage in most contracts, around eight point six percent. Extrapolate that out to a million-dollar deal, right? That's a lot of money. And frankly, contracts simply are not aligned with how business people work. Right? Business people resolve issues business person to business person based on the relationship that they have. That's the experience that I've had. It's pretty rare that one party has to sue another party under the contract. So re-relational contracting says, "Let's focus on what's important. Let's focus on the relationship building between the two parties." Right?

2:11Now, look, there are gonna be some types of deals where the traditional contracting works better. If I'm going to sell my home to a buyer, I don't need a long-lasting relationship, right? I need one and done. But for a long-term arrangement where the relationship is more important than the individual deal, that's when we're thinking that going the relational route really is preferable. But you've got to be willing to invest in the long-term relationship. You need to agree to cooperate with each other, loyalty, mutual trust, a lot of things that are simply not thought of in the traditional adversarial agreement. Relational contracts are enforceable. Courts will look at them. They may not review it with the same view that they would a traditional contract. They're gonna look to make sure that the parties are performing based on good faith.

3:14That's really what this is all about, mutual goals, establishing good faith. And they want to be sure that the parties aren't going to yell breach every time something goes wrong, right? The relationship is more important than that. Let's move forward notwithstanding the fact that, that there are gonna be issues betw-be-between the two parties, right? But just because there are issues between the parties doesn't mean that there needs to be a, uh, a call for a breach of contract each time something goes wrong. Relationship-- A relational contract doesn't have to be a standalone agreement. You can incorporate parts of the relational concept into a traditional agreement, or it could be standalone as well. But the key is to make sure that the personnel involved buy into the value of cooperation over communication and buy into the principles of relational contracting that World CC has set, set out, promulgated a couple of weeks ago. And that really is the segue to the, the star of the show, which are the, the main principles here.

4:35I'm not gonna go through them all. Others can do that. I'm gonna focus on three. All right? No blame culture, right? As I said, just because something goes wrong, don't start to point fingers. Stuff happens, we'll fix it and move on with an eye on the goal of the contract, right? Mutual objectives. Both parties have the same objectives. That's very different than a traditional adversarial contract where each party wants to beat up the other party. And continuous improvement, right? This is gonna be an evolving process, not a one and done. These are the nine principles. L-Lida has some ideas, I think, on some of the, the companies that actually have been able to successfully implement these principles. And so hand it over to Lida now. Yeah, for sure. So thanks, Lida. And this is a really good introduction because, I mean, I, I used to work at the big law firm, and usually when we were negotiating contract, that was something we didn't do, right? Right.

5:45It's, like, always, like, trying, like, how really risk adverse and trying to look to our customers, you know, how, how we can draft a contract so it's, like, just one way without thinking about the future of this contract relationship, right? It's not like putting the finger what's going to happen when some-something goes happen. So I'm really curious, Lida, like- How have s- companies implemented this, and especially, like, when they work with outside counsels, when they're more aggressive? Yeah, and actually, what you just said is a really good example of what economists call the contracting paradox. It's the idea, or I guess the delusion, that we can write contracts to cover every single contingency, but the problem is we can't plan for every contingency. So by trying to write that 200-plus page contract that covers every what if or maybe, what we end up doing is having gaps, omissions, ambiguities, which when they arise, are even much worse because you don't have the framework to resolve them in.

6:49So, I mean, what I did is I went and looked at some different companies that have invoked relational contracting. Probably the most pertinent to this conversation is Dell and FedEx. Harvard Business U- Review has done a few case studies on this. Dell hired FedEx to basically be its exclusive shipping provider. It was $100 million plus contract. And so the agreement itself was over 300 pages. It had tons of supplier shall do this, supplier shall do that, and it had over, I think, over 100 different measurements for Dell to say whether FedEx was performing or not. So they worked into this agreement for close to 10 years, but throughout it all, although FedEx was meeting its base obligations, it wasn't meeting what Dell expected from them, which was innovation and collaboration. And to be honest, because the contract was so incredibly tight, FedEx really had no margin to perform above and beyond so that it basically could blow away Dell's expectations.

7:55So in the eighth year of this contract, they both had pretty much had it, but like all good married couples, they could not separate. So what they did is they went to a relational contracting model, and what they found from that relational contracting model where they could skinny the contract down, get rid of the dozens of the shalls, and actually put out their goals, namely that FedEx have continuous improvement, have collaboration, et cetera, they were able to realize more gains on both sides. There was a few problems that were solved by that, one, what the economists called a holdup problem. And the holdup problem basically occurs when each party thinks the other one is going to stick it to the other. So that's what they were operating under for the first eight to 10 years, was just an area of distrust at not saying, "You are my partner in this," but saying, "You are my enemy, and I will hold you to this contract." So when they were able to switch to relational contracting and say, "You are my partner. We will work together. We will make this vision come true for both of us," it went much smoother for them.

9:02The other problem that they had is what economists call shading, and that happens in a lot of transactional agreements, where one party starts to implement retaliatory behavior to make up for maybe lost profits, what they didn't... The expectations that they wanted from the deal did not come to fruition. So they start trying to minimize their efforts. They start, like, cutting corners. They start doing smaller outputs, and the other party gets upset, and again, that leads to disagreement. So when Dell and FedEx were able to move to relational contracting, they were able to shrink costs. They were able to get great outcomes, and there are lots of cases out there like this. The Australian Navy is a really good example. They've implemented relational contracting into all of their supplier models. I think they've seen something like a 40% decrease in cost from those relationships. Yeah. And another good one is Toyota versus GM, actually. Toyota, there's a philosophy in Japan called, I think it's called Karits, and basically, that is that your agreement is built on the fundamentals of relationship versus adversarial. So Toyota has implemented that with all of its suppliers.

10:18While other auto manufacturers had supply shortages, Toyota was able to leverage that relationship and make sure it got the parts it needed so that it could keep delivering its cars. GM used transactional contracting, and it did not fare quite as well. A final one is the franchising type relationship. McDonald's is amazing at relational contracting. Ray Kroc, the founder of McDonald's, actually built his system based on three stools. One was the supplier, one was the owner, and one was the franchisor. And his belief was that unless those three legs of the stool worked in combination and in strong relationship with each other, the system would fail. And I mean, McDonald's is the number one franchise out there still, so you can see that it's worked. And with that, I will pass it on to Hal, who will tell us how to get to relational contracting. Hi. Thanks, Lena. Th- thanks, Jerry. There's one thing I want to mention right from the start, and that is that you don't have to move 100% from relational to, from traditional to relational contracting.

11:28Interestingly enough, many traditional contracts have pieces of relational contracting built into it already. For example, if you have a dispute resolution clause where you escalate up to executives when there's a problem, that is the beginnings of relational contracting. The same thing when you have, your contract calls for periodic monthly reviews of, uh, how the service is being provided, how, uh, things are working or not working in the relationship. Those periodic meetings are indeed, uh, the beginnings of relational contracting. So it's not a question of moving from zero to 100. You probably have some elements already built into your contract without really recognizing that they are relational in nature. The whole idea here, though, is to move the needle further along, to add more and more elements, and to move away from the concept that I will rely on the limitation of liability clause, and the more damages I could claim, the more I could hit you over the head with them if you do something wrong.

12:36And that is not the way to create long-term friendship relationships. And indeed, I say friendship intelligent-- intentionally because you need to be partners in the relationship. It can't be a, a relationship where I'm gonna hit you over the head more than you're gonna hit me over the head. It just doesn't work in the long term. To help this process along and to give you a guide on how to follow the path toward World CC has made available to its members a relational contracting and governance guide. And what this guide does is first goes over in detail the concepts that Jerry alluded to. It goes through some of the theories. It goes through the principles that he mentioned. But it goes a few steps further, and that's what I want to emphasize right now, is once you understand the reasons why, and once you understand why it's important and the value it brings to relationships and to your top and bottom lines, then you need to start down a path of moving in the right direction.

13:45And the guide gives you those steps along the paths. The first step is, uh, going through a checklist which looks at the principles and asks what, uh, what about these principles are important to the relationship that's on the table right now? What would be of maximum help to you in this relationship? Where are the anticipated pitfalls? What could go wrong? Where are the risks? And then where are those areas where you need to do something to avoid the constant pressures of threatened litigation? Where can you have a better relationship that avoids problems before they mature into the fighting stage? And so that's the first step, just going through the checklist of picking out which elements may be of value to you, given the relationship, given what needs to be done, given the potential risks associated with it, the length of the relationship.

14:47And once you have those selected, then you go to the next step, which is, given those pieces that you've selected, what clauses are, uh, can be affected by those particular desires to change the, the way the contract works? Which specific clauses are involved? Is it limitation of liability? Is it dispute resolution? Is it establishing greater communications between the parties? Is it the way executives can deal with each other? Are there safeguards that could be put in place? For example, amending the SLA so that you're not just looking backwards in time for what went wrong in the prior month, but you can get data real time when something appears to be problematic. The next step, and the last step to all of this, is how do you change the conduct of the impacted organizations?

15:48So w- the guide goes through organization by organization of how these changes in your contract affect changes in conduct. What are the additional responsibilities that organizations take on, whether it's in terms of communication, in reporting, in constant reviews of innovations, as was mentioned before? Where are the linkages between organizations on one side and organ-- comparable organizations on the other side? So these practical guides of how it affects, in real time, organizational structures, organizational sizes, because sometimes it does take more resources to implement some of these changes, in terms of mindset, in terms of culture. All these are laid out in the guide so that you understand the implications of what happens with relational contracting. The bottom line to all of this is that if you're looking for long-term, profitable relationships that impact the bottom and top lines of your company, then we have tools available through World CC that give you guidance in terms of how to go down that road and recognize and realize the importance of implementing these really dynamic and important changes in how we contract today in a business-to-business basis.

17:23Wow. I mean, it really sounds like the team has, has, has done your homework here. This is extremely well thought out, a-and I think we're excited to, to hear more about this in the session later today when the team is gonna be talking about this. I guess one question I had around maybe the types of agreements that organizations are working with, w-where do you see... Right, I know we started-- We talked about a process, right, that folks can put in place, but are there specific types of agreements where organizations are seeing the fastest return on value if, if they decide to implement this type of strategy? Uh, yeah, definitely. I mean, transactional agreements definitely have their place. If you're a manufacturer selling a hundred widgets, and it's a one-and-done type transaction, a transactional agreement is great for it. But relation agreements, relational agreements are really better for anything that's more complex and strategic, so franchising agreements, unionized labor type agreements, any kind of strategic partnership or commercial agreement, anything that's going to ebb and flow. And as I said before, anything that's going to be akin to a marriage or a long relationship really does deserve the relational contracting approach. Right. One addition there that may be of interest to everybody, when COVID hit, we all remember COVID, right? When COVID hit, Pfizer and Moderna, I- I'm sorry, Pfizer and Bi- BioNTech got together to manufacture a vaccine. Moderna was the other.

18:56Uh, they knew that to do a traditional contract would take months and months and months and months, and they knew that the American people, people around the world, could not wait months and months and months. They did a relational contract in a matter of weeks for s- for a large distribution of vaccine, how we're going to cooperate and how we're going to work together, recognizing there will be bumps along the road, and how we're going to resolve that, layers of escalation, as Hal was mentioning ear- earlier, all with the understanding that we, that we've got a mutual goal here, right? To get the vaccine out to the public as quickly as possible. I think that's a great example of where this can work. There's one other category or bucket of contracts that I wanted to mention as well, and that is where you expect that technology and changes in technology will have a major impact on the relationship down the road.

19:59And, and Jerry mentioned strategic relationships where you need to be at the front of the marketplace, wherever that marketplace leads. And with the change of, of technology at such a rapid pace, you never know exactly and can't predict exactly where that road will lead to. But you wanna be prepared to work in partnership with your vendors to make sure that whatever happens, you're able to move quickly and decisively in the dir- right direction and in changing direction, perhaps even 180 degrees, if necessary, to accommodate those changes. And relational contracting is, is ideal for that situation because you don't wanna s- have to stop in your tracks and start negotiating a whole new agreement, because that's gonna delay you by six months. A- and so that, that speed of, of being flexible to adapt is ideal for relational contracting.

20:59So this is very impressive, and one of the things that I like the most is that this is something that is applicable to any kind of companies of either any, any, any kind of industry. And I just can think about the massive amount of work that was invested here. So one last questions, and I wanna take you to, like, the backstage of the relational contracting principles. How do you work? Like, how, how was it? Like, how did you started to talk about it? And, and we were actually th- talking about if it's li- li- like book or handbook or a, or a guidelines, but can you tell us a little bit how this process started when you started working on, on this project? Honestly, I think I'll leave this one to Hal, because he was definitely the taskmaster on this one. He did a great job at it, actually. Yeah. The key for me was members o- of the association, and probably everybody, needs to be able to translate high-level principles into actions. Exactly. And, and you need to take that extra step to bring it down to ground level. And here's...

22:08And what we did was look at what are the practical pieces of advice we could offer to everybody in terms of taking high-level principles and come up with s- a step-by-step approach. And so we did it by steps. A- and as I outlined, the three steps, as I outlined before, was taking it step by step, lower and lower, to down all the way to an organization by organizational level. And it was a journey we took along, in terms of creating that guide, moving down those steps, and it, it turned out to be quite useful, and we're quite proud of the product that came out of it. The guide is, I, I'm biased, of course, but it, it's a phenomenal product in terms of follow the steps, and that's, that was our goal, and we ended up achieving it. I'd add one thing to it, 'cause I think we'd be remiss. We learned a lot from Tim and Sally, the founder and CEO of WCC, from the different relational contracting exercises, that they've gone into different companies that are having a dispute, and they actually help those companies figure out how to have this kind of methodology.

23:18So we took a lot of their teachings, and one quote comes to mind. Sally had had someone tell her that they thought this was a love-in, and after they had got in and done the entire relational contracting exercise with them and proved the value of it, those same people came to her and said, "Okay, we understand it's not a love-in, and it's actually extremely valuable." No, I, I think it really sounds like the team has, has obviously done a, a large amount of research here and really gone above and beyond to provide something that I think is going to have a ton of value, like we said, for all different industries and organizations and, and of all different shapes and sizes. So we really appreciate the team taking some time to chat with us. And if folks do want to be able to, to leverage this and use this, where is that available, and how can they access it? It's available through World Commerce and Contracting, the wcc.com. As we said, you need to be a member of the organization. If you are, then you have free access to it.

24:15If you're not, it may be a good reason to join and to become a member, and because it's one of many practical guides that the association offers its membership, and it's worth the price of admission. Great. Well, Hal, Jerry, Lita, thanks so much for joining us. Good luck on stage later today, and thanks everybody for listening to another episode of Contract Heroes. This episode of the Contract Heroes is sponsored by Koho Consulting. Koho helps organizations of all shapes and sizes find, implement and manage their chosen CLM tool. Whether your project is buy or sell side led, Koho can help you navigate the waters of the CLM space to make sure that you're getting a product that's going to fit like a glove years to come. If you'd like to learn more about Koho, visit their website at cohoconsulting.com.