The Cost Of Silence: Friction In Commercial Relationships

Friction in commercial relationships is a common problem. It can arise from the nature of the contract itself, the quality of resources committed, or from the way the parties interact with each other.

This article will explore some of the major causes of friction in  commercial relationships and how it can be managed successfully by both parties.

Decision maker priorities

Outsourcing and contracting remains the business strategy of choice for many companies. In 2021, the Australian Commonwealth Government contracted out more than 78,150 contracts valued at over AU$64.5 billion.

In the Deloitte Global CPO survey 2016-2020, cost reduction remains the top goal for Chief Procurement Officers, with their general slogan being, “If the cost case doesn’t fly, neither does the outsourcing initiative.” Furthermore, they sought to deliver value to the business by focusing on Cost reduction, TCO improvement and Increased supplier engagement.

We can see that since 2020, organisations are negotiating harder with suppliers and seeking ways to improve contract efficiency. Tenders are being released into the market, where innovation for cost effectiveness and value are prominent, common place and higher up on the evaluation criteria order. We can draw a line and state  that reducing friction and its effect on management costs of commercial relationships is  now a priority.

The Cost Of Silence

Friction compromises the efficiency and performance of machines, whether it’s caused by their quality of components, their assembly, maintenance, or the resources used.

Similarly, all commercial agreements are affected by friction to some extent. The higher the friction levels, the more resources that must be consumed to manage the contract.

A World Commerce and Contracting benchmark report published in 2021 states that the cost to manage commercial agreements ranges from 1.5% to 16% of their contract value. Additional research has corroborated this, revealing that the average expenditure to manage a commercial agreement was around 6.3% of contract value, irrespective of the size or complexity, for both the Buyer or Supplier in the deal.

For example, a $10 million service agreement on average will cost an organisation 6.3% of the contract value or, $63,000 to manage it. Much of that $63,000 is influenced by friction generated by the contract documents, the organisation’s capabilities, and the relationship. How much? is still being researched, however early cases are showing that up to one quarter of the cost to manage contracts, is attributed to  friction. This is generated from a combination of; misalignment of business  strategy with contract terms and specifications, appropriateness of resources committed to agreement,  and the quality of the relationship and  level of trust between the parties managing the deal.

What does Friction look like

Friction is inherent in all commercial agreements and can be classified as either perceptible or imperceptible.

• Perceptible friction is noisy and noticeable, with regular clashes occurring between the parties accompanied by a great deal of service instability. It is present in up to 20% of complex, high value deals and when its effect is significant and persistent, stakeholders usually label the commercial relationship as ‘dysfunctional’. The only way forward is to terminate or conduct major surgery on the deal.
• Imperceptible friction is a murmur that melds into background, and becomes normalised into operations, manifesting as minor performance instabilities. Most non-toxic commercial relationships have some amount of imperceptible friction. If allowed to continue, a significant amount [of] value erosion will occur over the long term. These relationships require a tune-up.

Factors Contributing To Contract Friction

There are three main generators of friction in commercial agreements: Contract instruments, Capability of organisations, and Relationship of parties to the deal.

1. Contract instruments

Contracts are the cornerstone of all commercial relationships and contract documents are essential instruments for shaping relationships and defining expectations. However, even the most carefully drafted contracts can lead to friction between parties if there is a lack of alignment between expectations and behaviours. Furthermore, they may be incomplete, inflexible, and/or strategically misaligned.

To reduce friction, it is important to ensure that the terms and conditions of your commercial agreements, as well as their scope, key performance indicators and incentives, are aligned with and will drive desired behaviours and outcomes

2. Capability (and Commitment)

The capability of the organisations who are party to a deal is another key factor that generates friction.

Capability refers to the ability of one party to perform its obligations under the contract. It could be physical or technological capability, or human resource capability (for example, underqualified staff). The more capable the organisations are, the less friction there will be between them.

Commitment refers to the degree of care and effort that a party puts into achieving successful performance under a contract. If the parties have superior commitment to each other and the deal, they will be more likely to resolve any problems that arise, and so reduce friction.

Organisations should ensure that the personnel tasked with managing and delivering contract outcomes have the qualifications, skills, and experience needed for their roles. Best practices in contract lifecycle management should be in place. Organisations may benchmark the performance of similar services or projects.

3. Relationship

Businesses generally focus on improving the contract instruments, and the capabilities of their organisations. They do so because it is the practical option that is relatively easy, and well supported by the market and its enablers.

Unfortunately, we see that relationships are often ignored because they are perceived as “soft” therefore difficult to measure and improve in a cost effective, sustainable manner. However, relationship friction has arguably the biggest impact of all three causes of friction. Not only because its improvement directly reduces contract friction, but also because it acts as a lubricant, and directly reduces the impact of contract and capability friction.

A healthy relationship is, for a contract, exactly what oil is for an engine It helps maintain functionality while supporting efficiency and performance. An engine with insufficient oil becomes noisy, burns more fuel, and generates less power to the vehicle.

To improve a relationship between the parties to a contract, you should first obtain a baseline of where the relationship currently stands. Using Contact Harmonics ™, an online relational contract management tool, – you can assess your commercial relationships and profile their relational qualities. From this analysis, you can plan and implement specific activities that address the shortcomings and opportunities for improvement.

Summary

Friction undermines the value of commercial agreements. It is a force that blends into the background and is often barely noticeable, yet it steadily erodes the value of the deal.  We can continue to engage commercial contract lawyers and business consultants to improve our deals’ contract documents and capabilities, or we can follow the innovative organisations who are turning their attention to improving their relationships, reducing friction, and maintaining competitive advantage.

In the second part of this article, we will discuss ways to reduce friction by improving business relationships and developing high trust.