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Presenters and Moderator

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Tim Cummins, London
\nProfessor, University of Leeds, School of Law
\nFounder & President, International Association for Contract & Commercial Management
\nCareer includes commercial, financial and executive roles in banking, automotive, aerospace, technology and business services in UK, US and France

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Svetlana Lobanova, Sydney
\nLead Project Contract Manager, Nokia

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Career includes leading in-house legal  and contract management roles in telecommunications, engineering, oil&gas industries in Russia and Australia     

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Gleb Krokhmalyuk, Moscow
\nLecturer of English law, Higher School of Economics
\nPracticing lawyer qualified in Russian and English law, career includes international consulting and dispute resolution

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The following article originally appeared on the website of Tech Contracts Academy, LLC. It is reprinted here by permission from the author.

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Contract drafters regularly confuse cloud services with traditional products and services. They approach software-as-a-service and other cloud services as if they were either software products or old-style services, like professional services. That leads to perplexing negotiations and contracts full of errors.

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Much of the trouble stems from the IT industry’s vocabulary. In the 20^th Century, words like ‘product,’ ‘service,’ and ‘software’ had simple, singular meanings – but no longer. Fortunately, once you recognize the confusion created by language, the underlying concepts start to look pretty simple.

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The key point is this: software-as-a-service and other cloud services are neither products nor services, as those terms have been used for centuries. They’re in between: something new in the world.

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To many, the differences among the three offerings seem subtle. But for anyone writing a contract, structuring a business relationship, or maximizing revenue recognition, they are crucial.

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Traditional Definitions: Products and Services

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For most of history, most business deals involved either a product or a service (or an animal, but the beast-trade doesn’t concern us here). A ‘product’ is “a thing produced by labor,” according to Dictionary.com. You can either buy one or rent it. A product might be a plow, spoon, shirt, car, or computer. Software is a product too.

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A ‘service,’ on the other hand, is “an act of helpful activity,” again according to Dictionary.com. Services include help building a barn, treating an illness, writing a will, or cooking a meal. Services also include tech support and software programming, among many others common to the IT industry.

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What Dictionary.com does not point out, because it’s obvious, is that human beings provide services. Nor does Dictionary.com point out that products are things you get. You get your hands on them, whether you rent or buy. Again, that’s obvious.

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Except it’s not so obvious anymore.

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The New Thing: Cloud Services

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Shortly before the turn of the 21^st Century, the IT industry created a new type of offering. Tech companies began putting computers and software online, and they allowed customers to access and use them remotely. These customers did not have to install, run, or manage the software or computers they got from the vendor. They could just access and operate them, generally using their own desktops to connect via the Internet. The customers didn’t possess or copy the vendor’s software or computers, so they weren’t receiving a product. But at the same time, no human being got directly involved in the vendor’s offering. So it wasn’t a service either.

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Today, we call this new thing ‘cloud services.’

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Salesforce.com provides a well-known cloud service: its customer relationship management (CRM) system. The customer gets to use Salesforce’s CRM software, but it doesn’t get to copy it or even to possess a copy. The customer just accesses and uses the software remotely. (That’s software-as-a-service or ‘SaaS,’ a type of cloud services.)

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Amazon Web Services (AWS) provides another well-known cloud service: use of its server computers and other hardware, as well as security software. The customer accesses AWS’s computers, loads them with its own software, and uses them and the rest of the AWS infrastructure – again, remotely, without getting possession. (That’s another type of cloud services: infrastructure-as-a-service, or IaaS.)

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Cloud services share features with both products and traditional services, but they differ from each, a lot. They stand in between.

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Cloud Services vs. Products

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To many users, cloud services look like traditional products. They involve software and computers – both products. But though IT products and cloud services have a lot in common, they call for very different deals and contracts.

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Prime Clauses

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In a product contract, the vendor’s key promise – which I call its ‘prime clause’ – involves delivering the product. The vendor also grants a copyright license if the product is software, giving the customer the right to make copies. But in SaaS and other cloud services deals, the vendor does neither. Its computers and software remain with the vendor. So it doesn’t deliver a product or grant a copyright license – at least, it doesn’t grant a license if it knows what it’s doing. (See my article, “Don’t Use License Agreements for Software-as-a-Service”.) The vendor’s prime clause simply promises to let the customer access and use the cloud services via the Internet (often called a ‘subscription’).

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Also in product contracts, the vendor’s prime obligation ends once it’s delivered the product and/or granted the license. (FYI, maintenance obligations don’t play a role in the product sale; rather, they’re separate professional services offerings, though often in the same contract.) Yes, the contract might give the vendor side-jobs, like addressing malfunctions or IP claims about the product. But those are secondary provisions, only relevant if a problem arises.

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In a cloud services deal on the other hand, the vendor’s primary job is continuous. It hosts and runs the technology for the customer. Instead of the software product vendor’s one-and-done prime clause, the cloud vendor has to perform throughout the term – like a traditional services vendor.

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Revenue Recognition

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Product and cloud services deal-types also involve different revenue recognition rules. Those are accounting standards that determine when a company’s financial statements can take credit for money expected or received. In general, a company has to earn fees to recognize them. After the one-and-done sale in a software product contract, the vendor has earned its fees. So it usually can recognize revenue almost immediately.

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Not so in cloud services. There, the vendor hasn’t finished its job until it’s finished delivering the cloud service. So it doesn’t really earn its fees until then. That means the vendor often can’t recognize all the revenues from cloud services until months or years after signing the contract – again, like a traditional services vendor.

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Cloud/Product Confusion

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Despite all these differences, industry terms like ‘software-as-a-service’ suggest that cloud services call for terms about products, like software. In other words, the vocabulary misleads contract-drafters. What happens then?

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Often, the cloud services negotiation reaches an impasse when one party requests product-related terms, like software copies and copyright licenses – and the other refuses, because those terms don’t belong in a cloud services contract. But that’s actually better than the alternative, which is that the parties agree on the misplaced terms, since both misunderstand. Then they’ll write a baffling contract. And that leads to greater chances of dispute and litigation down the road, as well as revenue recognition problems.

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So you don’t want product terms in your cloud services contract. What about traditional services terms?

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Cloud Services vs. Traditional Services

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Like cloud services, traditional services involve ongoing help from the vendor. The two offerings also have similar revenue recognition rules. But there the similarities end.

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Service Level Agreements

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In a services deal, the vendor provides people, while in a cloud services deal, it provides technology, with no people directly involved. So cloud services contracts include service performance requirements that would make no sense for traditional services. They require automatic backups of data, for instance, often hourly or even every few minutes. Or they require compliance with software specifications, or system uptime of 99.9% or more, or electronic communications free of issues like ‘jitter’ and ‘latency.’

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These are tech-related requirements – clauses better suited to tech products – usually found in the contract’s service level agreement (SLA). And they make no sense for human services. (I guess a human could avoid jitter by limiting caffeine, but how would you or I perform according to software specifications or remain “up” 99.9% of the time?)

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Training, Professionalism, and Other Human Requirements

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The problem cuts the other way too. In traditional services deals, vendors often promise that their staff will receive certain training and credentials. They also promise that they won’t subcontract the services. And they warrant that their people will perform in a professional and workmanlike manner. None of that makes sense for services provided through software and computers. (How does a remote-hosted software program behave like a professional or avoid subcontracting?) Nor do the many other human restrictions common to traditional services contracts.

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Cloud/Human Services Confusion

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Once again, the IT industry’s choice of vocabulary creates confusion. Names like ‘software-as-a-service‘ and ‘cloud services‘ suggest that cloud deals should use services terms, despite the issues discussed above. As with misuse of product-related terms, this error leads to impasses and confusion during negotiations. The customer asks for traditional services terms, like restrictions on subcontracting and warranties of professionalism, and the vendor refuses. Or worse, the vendor agrees. And if the vendor agrees to terms only appropriate for human services, it may not add cloud-appropriate terms, like service level agreements. Once again, the parties end up with a baffling contract and a high chance of dispute.

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The new thing, then, looks like services in some ways and products in others, but it needs terms distinct from each. Again, it stands in between.

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Combination Contracts: Just a Side-Note

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You may be thinking: “Wait! SaaS contracts and other cloud agreements do sometimes involve services by people, like tech support. And they do sometimes involve at least some vendor software products installed on the customer’s computers.”

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You’re right, but think of those as combination contracts. A contract can involve two or three types of offerings: products and services, as traditionally defined, and cloud services. But the fact that one deal could address several offerings doesn’t solve the confusion among them. It doesn’t solve the problems generated by mistaking the new thing, cloud services, for the old ones: products and services.

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Simplicity Restored: The Middle Offering and a Little More Vocabulary

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Contract work gets simpler when you recognize that cloud services are neither products nor services. They stand in between.

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Fortunately, the IT industry has at least some helpful vocabulary to offer. The industry has two new(ish) terms for its traditional products and services, and they help draw lines between those offerings and cloud services.

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First, instead of just ‘software’ for traditional software products, the IT industry has started using ‘on-premise software.’ That distinguishes this traditional product, which the customer gets on its premises, from the new thing, cloud services, which the customer only accesses remotely.

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Second, the industry frequently uses ‘professional services’ for traditional (human) services. That tells us those services come from people – ‘professionals’ in IT-speak – not from computers, like cloud services.

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Better Negotiations and Contracts

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If you banish the old product/service dichotomy from your thinking, your job will get easier. Once you adopt the new three-offering vocabulary, the industry will look simpler, and so will your negotiations and contracts.

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ABOUT THE AUTHOR

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David Tollen is the author of The Tech Contracts Handbook, the American Bar Association’s bestselling manual on IT agreements. He is the founder of Tech Contracts Academy and the company’s primary trainer.  David is also an attorney and expert witness and the founder of Sycamore Legal, P.C., a boutique IT, IP, and privacy law firm in San Francisco. His practice focuses on software licenses, cloud computing agreements, and other IT transactions. David also serves as a lecturer at U.C. Berkeley Law School.

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In his role as a law school lecturer and trainer, David has taught the subject-matter of this article to attorneys, law students, contract managers, procurement officers, and IT staff. And he has testified about it in court, as an expert witness.

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© 2020 by Tech Contracts Academy, LLC. All rights reserved.

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Thank you to Pixabay.com for great, free stock images!

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NOTE: IACCM produced a guide to ‘as-a-Service’ contracting in April 2019. This highlights the clauses that are most frequently negotiated when transacting for Cloud or IT Services, and provides a set of ‘norms’ or principles to guide negotiators. It can be accessed at https://s3.eu-central-1.amazonaws.com/iaccmportal/resources/files/10613_iaccm-aas-summary.pdf

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As a matter of good practice, a payment clause should at a minimum specify:

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• The event(s) that will trigger an obligation to pay, either in whole or in part
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• The period within which that payment will be made

Other terms in the contract may contain provisions related to payment – for example, obligations in the event of the cancellation of an order or termination of the agreement, or rights to withhold payment in the event of defects or quality of performance.

Currently, it is unusual for the payment clause to include any provision for 'changed conditions', setting out either rights or a process to agree an alteration to the payment obligations. In practice, changes tend to be unilaterally declared by the buyer. 

For a supplier, non-payment is one of the most significant risks in any contract and there are various ways in which that risk can be reduced. A recent Hackathon explored ideas relating to differing levels of payment security with the underlying thought that suppliers, in particular, could use this framework to be better informed and therefore able to make a risk decision during the negotiation process.

As a recommendation, there could also be benefit in the development of industry contracting standards, even if only as principles, and perhaps the development of expert panels that would express non-binding opinions in the event of performance disputes.

Do we urge parties to negotiate \"changed conditions\"-payment terms, or should they be stable from the outset - and then subject to negotiation (and not unilateral change) in case of changed circumstances?

Looking across a spectrum of possible positions on payment terms (and reflecting variations in the balance of supplier / customer risk, here is an indicative range:

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1. Encouraging full payment: this can be achieved through mechanisms such as payment in full with order, or through payment guarantees, such as bonds or letters of credit. 'Smart contracts' using blockchain technology may represent a lower cost and less bureaucratic alternative. This option represents the lowest risk for a supplier and the highest risk for the buyer.
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2. Encouraging partial payments: as above, but with payments staged or phased, typically reflecting a level of cost recovery or coverage for the supplier.
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3. Promoting receivables factoring: this option provides added security for the supplier and may accelerate receipt of funds, though with some level of discount. This method depends on the financial strength of the buyer and overall market liquidity; if either of these is weak, it may prove impossible to factor the debt, or result in a large discount.
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4. Opportunities for third-party offset. Offset comes in several forms:\t
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   1. Contractual offset would allow the seller to offset unpaid receivables against amounts owed to the buyer.  This will likely have limited application in the cases that concern us (e.g., Bangladeshi supplier holds non-performing receivable from U.S. customer).
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   2. Governmental offset typically involves exporters selling to foreign governments.  These governments often require the exporters to buy goods from supplier's in the government's jurisdiction (countertrade), or to license, manufacture or assemble in the government's jurisdiction.  In this particular case, a purchasing government might require an exporting foreigner to buy non-performing receivables.  So, for example, if Boeing wants to sell planes to Bangladesh, the Bangladeshi government might require Boeing to buy non-performing receivables of Bangladeshi firms owed by U.S. customers.  This arrangement basically forces Boeing to factor the receivables.  Boeing's advantage is that it has consolidated the receivables and can more efficiently pursue them in the United States.
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   3. A final form of offset would be a foreign manufacturer assigning its receivable from a U.S. customer to some other party that owes the customer money in exchange for a cash payment.  The offset would likely involve the holder of the receivable to offer a discount to the party owing the payable.
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5. Buyer enhancing supplier's credit. A supplier holding non-performing receivable is effectively the customer's financier.  The debt is typically an unsecured general obligation, with late-payment interest charged per the contract.  The debtor will typically reserve defences and counterclaims, such as non-conformance of the goods to the contract.

The supplier can seek some form of credit-enhancement from the customer that will enable the seller to factor the receivable closer to face value.  This might include acknowledgement by the customer that the goods have been delivered and accepted, and so the amount owed is not subject to defences or counterclaims, some form of pledge securing the obligation, or some form of corporate-parent or bank guarantee to pay the amount by a date definite.

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1. Buyer extending or expanding supplier's contract. This represents more of a 'future benefit' as an off-set to the current negative impact of delayed or cancelled payment. In itself, it provides no immediate relief in terms of cash flow, unless perhaps it improves the supplier's borrowing ability. However, if the customer is now deemed as being 'at risk', lenders may see the extension as having little value.
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2. Ways for suppliers to aggregate and pursue claims against defaulting buyers. This would depend on the jurisdiction in which debts are occurring and the extent to which the suppliers can realistically connect and agree joint action.
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3. Way to aggregate and publish verified data on defaulting buyers (name and shame). Such methods are most likely to occur within an industry, particularly if the industry operates with some form of 'private law'. There may also be government-sponsored initiatives to highlight or penalize corporations that operate with unfair payment terms (e.g. the EU). Within an industry, one option that is sometimes used is reference to an expert panel, which may only be recommending a resolution, but this is typically followed because of the reputational impact of not doing so.

 

The Impact of COVID-19

An article in Global Treasurer dated Jul 1^st 2020 (see below) offers interesting data and insights, especially on the use of trade instruments such as Letters of Credit, and also on the progress of digitization. For example, many countries have until now insisted on paper copies and physical signatures of many trade documents. The pandemic forced a change to these practices, though often on an unofficial basis. It will now be interesting to see whether there will be fresh momentum for simplification and whether this could spread to pressure for a broader improvement in efficiency, speed and cost reduction.

Pandemic spells change for trade finance

Author

Deepan Dagur

Date published July 1, 2020

The pandemic has been a health and humanitarian crisis of historic proportions. Our understanding of the full extent of its impact continues to develop. As we went into a global lockdown to control the spread of the virus, international supply chains have had severe disruptions, on an unprecedented scale. With these disruptions, there has been a material impact to corporates involved in global trade, as well as to banks who support them with trade finance arrangements.

Trade continues, and volumes should recover swiftly

People movements may have been restricted during the various lockdowns, but imports and exports continued. Trade in essentials has even increased, with a deeper appreciation for necessities required to endure the pandemic – food supplies, staples, medical equipment, PPE (Personal Protective Equipment) and even consumer electronics as more people work from home. Trade volumes have dropped as expected, as non-essential or larger trade transactions were deferred.  This is similar to what was observed during the global financial crisis, when WTO data showed global trade volume declining by around 12 percent. However, the post GFC rebound in global trade volumes was swift. We expect a similar rebound with a return to normalcy once the pandemic eases.

Implications for risk mitigation, working capital financing and digitalisation

According to Bank for International Settlements estimates, trade finance directly supports about one-third of global trade. The key instrument is the letter of credit (LC), which continues to play a material role in enabling trade with developing economies. Over the years, trade finance has provided clients with benefits such as risk mitigation and working capital financing. Digitalisation is one area where trade finance has lagged, though that may be set to change.

The evolving nature of risk mitigation

Risk mitigation is a commonly cited benefit of trade finance – for example the role of an LC to ensure that a seller / exporter will eventually be paid for a product shipped to another country.  LCs are typically used for exports to developing countries – as the risks of non-payment from a developing country are statistically higher. Analysing SWIFT data on LCs issued globally, the top 15 countries include Bangladesh, Pakistan, Vietnam, Sri Lanka and Nepal.  Despite this – International Chamber of Commerce (ICC) data from 2008 to 2018 shows extremely low default rates for LCs – 0.37 percent for import LCs and 0.05 percent for export LCs.

Against this backdrop, we've noticed some changes since the start of pandemic – both to global supply chains, as well as usage of LCs. LCs are also often used by exporters with first time customers or new trading relationships, where the risks of non payments are higher than a historic trading partner. Furthermore, we have experienced tremendous innovation in supply chains – for example auto companies repurposing assembly lines to produce ventilators, or a broad range of industries now adapting to produce PPE.

LC based trade vs open account: Over the past several years – while global trade has increased annually, the number of LCs issued globally has tended to decline. As counterparties become more familiar with each other, a higher percentage of trade was occurring on open account basis. The immediate impact of the coronavirus has been a short-term reversal in this trend. Several exporting corporates now require a higher portion of sales to be covered by an LC, to guarantee payment from their buyers. Coronavirus induced supply chain disruptions are forcing new trading partnerships, as buyers seek alternative sellers. Exporters will typically require LCs from new buyers, especially in developing markets. We will need to wait until the return to normalcy in a post-pandemic environment to determine whether this effect is long lived, or the extent to which these drivers of incremental LC demand will outweigh lower trade volumes.

New LC markets for risk mitigation: Given the increased need for risk mitigation, several corporates have implemented policies requiring a higher percentage of exports to be protected by LCs.  We have also seen increased requests to confirm LCs issued by banks in relatively developed market in the EU and Asia – including Italy, Poland, Malaysia and even South Korea. It's possible with further sovereign downgrades, the role of trade finance in providing risk mitigation expands to a broader range of countries.

Trade as a source of working capital finance: Trade finance is also commonly used as an instrument for short-tenor working capital finance– financing the gap between input costs and getting paid for sales.  This is clearly an area that the recent pandemic has put under strain.

A broader range of trade finance instruments can be used for such short tenor financing – LC discounting, electronic bankers draft discounting (E-BAD) in China, invoice financing (with recourse), trade receivables purchase and payables finance solutions. We have seen a number of corporates that previously only used trade finance for risk mitigation, now also using trade finance for working capital finance, for example by asking us to confirm and discount an LC. Across financing instruments, the self-liquidating nature of trade has lead to continued demand as corporates have sought to raise cash to weather the storm, and in many cases utilise trade instruments to support strategic supplier relationships in the supply chain.

Digitalisation: The trade catch-up game

Trade is an extremely paper-heavy activity with a wide array of required documentation, such as bills of lading, LCs, certificates of origin, customs papers, invoices and many more. Trade finance transactions often rely on hard-copy paper documentation to process payments and ultimately clear the release of goods to buyers. In many countries, electronic trade documents are either prohibited or their legal status is unclear. There has been a trend towards digitalisation of trade finance, though given certain complexities, this has lagged other parts of banking such retail or financial markets.

The recent pandemic has created certain challenges for market participants as sales and operations staff have been required to work from home, reliability issues in courier services have slowed the movement of documents, which has in turn risked delays in shipment.

A broad list of participants of trade, such as exporters, importers, logistics companies, customs authorities and banks, have been evaluating digital solutions for some time. The disruptions from the pandemic have underlined that traditional trade finance techniques and practices are ripe for reform. As such, the pandemic may have actually accelerated this trend. In the short term, this has already increased acceptance of electronic signatures. In the medium to longer term, we may an further usage of digital trade platforms.

It is encouraging to see the ICC show a strong desire to accelerate digitalisation to ensure trade continues. For example, the ICC provided guidance to market participants, regulators and governments alike to temporarily void legal requirements for paper-based documentation. As the trade finance community recovers from the pandemic, it's possible that many countries will continue to accept electronic documentation. This would also be a huge step toward digitalising trade finance.

The pandemic has been unprecedented in its scale, changing our approach to many aspects of our lives and how we conduct business. Exports, imports and the trade finance required to support these activities are no exception. The global sourcing patterns continue to shift, with underlying principles of diversification and agility in supply chains remaining as important today as ever before. Similarly, the pandemic has shown the criticality of trade finance towards facilitating the movement of goods around the planet.  It is in times of stress and dislocation that that this role becomes even more important.

","AuthorId":-1,"PublishDate":"2020-07-08T00:00:00","ExpiryDate":null,"FeaturedImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","ThumbnailImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","PublishedBy":null,"FriendlyUrl":"Payment-Terms-Practices-Alternatives","TemplateUrl":null,"Gated":false,"TeaserContent":null,"Metadata":"{\"Keywords\":\"\",\"Description\":\"\"}","InstanceName":"Content Hub","InstanceDescription":"Resources for members including articles, webinars, podcasts, case studies, presentations, abstracts and templates.","CreatedOnDate":"2023-08-10T10:24:56.01","Author":"Anonymous","AuthorImage":"/images/no_avatar.gif","Categories":[],"Tags":[],"CustomFields":[{"CustomFieldId":1,"ArticleFieldId":2201,"ArticleVersionId":783,"FieldName":"Written by","FieldType":"Text","FieldValue":"Tim Cummins, Deepan Dagur"},{"CustomFieldId":2,"ArticleFieldId":2202,"ArticleVersionId":783,"FieldName":"Description","FieldType":"Text","FieldValue":"This is a consolidation of thoughts and ideas from our recent Hackathon discussions regarding payment terms. Also included is an article published by Global Treasurer, offering some interesting insights to trade finance and the impact of COVID-19."},{"CustomFieldId":3,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":4,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":5,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":6,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":7,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":8,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":9,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":10,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":11,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 5","FieldType":"Text","FieldValue":null},{"CustomFieldId":12,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 5","FieldType":"Text","FieldValue":null}],"DetailsPage":"/Resources/Content-Hub/details/Payment-Terms-Practices-Alternatives"},{"ArticleId":784,"InstanceId":1,"IsPublished":true,"LatestVersion":784,"Deleted":false,"Featured":false,"Views":437,"ArticleVersionId":784,"Version":1,"ContentItemId":31809,"Active":false,"Published":true,"Draft":false,"Title":"7 pitfalls of Logistic contract management","Content":"

\"Complex logistics contracts should be managed closely,” is an often-heard message at logistics seminars. One would expect companies nowadays to have collectively adopted this approach and at least review monthly KPIs with suppliers in order to increase logistics performance. But do they really?

We notice in practice that logistics contract management focused on value optimization is a difficult process for many companies. The contract management process contains a number of common pitfalls. These pitfalls prevent you from getting the most out of the relationship with your logistics service provider (LSP).

In this article, we will look at logistics contract management from both sides of the table. We will explain where the most common pitfalls lie in managing the client-LSP relationship, how they can be identified and, more importantly, how to avoid them.

1. Choosing a supplier focusing on cost alone: “How low can you go?”

Costs are the single most important aspect during contract negotiations. Sometimes, however, opportunities are overlooked for bringing in additional aspects that can generate a lot more value rather than minimizing the core service costs. For example, creating a joint planning process between the logistics service provider and the shipper could potentially yield superior value than a 5% discount on storage. It is wise to develop a number of concepts where extended services will add direct value to your logistics operation and consider introducing them during contract negotiation. LSP's are often more open to discussing an extension of the activities than negotiating rock-bottom tariffs. Think in terms of methods of value creation and include these in the contract. “Price is what you pay, value is what you get,” as Warren Buffett said – let yourself be guided by what you will receive!

2. Negotiating contract terms and KPIs out of line with the daily operation: “Things turned out to be quite different in practice”

It often becomes clear, as soon as the contract management phase has started, that the framework has been based on how the negotiators supposed the operation was going to run at the time of contract negotiation, instead of the actual daily operation. In many cases, the defined KPIs are irrelevant or are impossible to measure in daily practice and, as a consequence, the quality of the performance cannot be measured or is perceived as bad. It is good practice to agree to review and revise the cost base and standardization after a certain time, e.g. 6 months into the contract, to align the initial plan with the reality. During this initial contract period, a combined team should be responsible for evaluating the performance quality, terms, conditions and assumptions agreed upon during contract negotiations. Building on the experience gained in this first part of the cooperation will strengthen the contract and boost mutual trust.

3. Strategy mismatch: “We lost each other along the way”

Strategy is an often-used term, but in a supply chain context the logistics strategy defines a company's approach to ensuring the logistics process contributes to the distinctiveness of its offering. In short: How do we differentiate ourselves, or outperform our competitors, by optimally using our (or our LSP's') logistics capabilities? An LSP that has no match with your own logistics strategy will at best fulfil its operational obligations at the start of the contract. Soon, however, the discrepancy on where you want to go and the 'opposing' strategic direction of the LSP will develop into a serious obstacle for the overall competitiveness and distinctiveness of the entire company. Consider aspects such as the LSP's long-term plans and investment into areas such as IT landscape, visibility, industry-specific solutions, footprint and product development. Request details of the supplier's strategy; ask for a thorough explanation by one of the board members and translate this into a specific logistics strategy. Know which standards are needed for the processes in order to outperform the competition. These standards can subsequently be translated into the logistics contract.

4. Multiple contracts for warehousing and distribution: “Now I have two Single Points of Contact”

Obviously there are instances in which it makes sense to split the warehousing part and the distribution part. From a contract management perspective, however, this type of set-up will add complexity. Apart from perpetual 'whodunnit' investigations into whether the address was wrong or the order was picked too late for dispatch, planning and reviewing is shared among various parties, with the shipper being responsible for orchestrating the flow between the providers. This set-up does not suit all, and one should have a clear business case in favour of separate contracts. The renewal frequency of distribution contracts should be seen as separate and can be renegotiated on an annual basis.

5. The buyer is not the user:  “Well, I didn't agree to that!”

Many buyers, in their role as a Logistics Manager, are not in charge of the budget and therefore are not allowed to make the final decision. Instead, the final responsibility for approving supplier contracts often lies with purchasing departments, who sometimes negotiate unsuitable or different contract terms and specifications. These will only become apparent in the implementation phase, by which point the relationship will already be under stress as additional aspects in the owner's interest need to be included in the contract. The end user is best positioned to assess the actual performance in the contract management phase, but he is not fully informed about the contracted service levels. Even if the end user is involved in the specification phase of the purchasing process, he is usually unable to affect the final arrangement of the contract. That control then once again lies in the hands of purchasers and lawyers. The transfer of the contract (meaning: the translation of the operational paragraphs into daily practice) plays a significant role during the contract management phase. So don't get caught out! Create a team that is responsible for the complete process from start to finish and that is knowledgeable about the specifications which are connected to actual daily practice. All decisions are made by the team, throughout the entire process. This is much more effective and prevents conflicts of interests and communicative misunderstandings arising.

6. Overselling“We deliver anything, anytime, anywhere – or your money back!”

Changes in the supply chain are usually heavily scrutinised by the client's commercial organisation. These changes will often be justified in terms of substantial savings or quality improvements. The exact service level of the new logistics contract is often interpreted differently or its scope and limitations are not clearly communicated, resulting in the commercial organisation of the client overselling to its end customers. We have seen examples of 'On Time In Full' (OTIF) commitments including bonus-malus agreements and liability acceptance at order level. It is very important that the commercial organisation knows what it can – and more importantly what it cannot – sell to its clients. It is vital that the logistics team on the client side proactively communicates the limitations of the logistics operation and Service Level Agreements internally.

7. The lock-in: “You can check out anytime you like…”

The final pitfall is in fact the most common one. There is often an unclear barrier for shippers to terminate a contract and change suppliers. This can be caused by a variety of reasons, such as reluctance to enter into a demanding move project, social relations with the provider, or the fear of service disruption for example. The incumbent logistics provider is familiar with the procedures and methods used by the shipper, and the people involved on both sides know each other well. The more long-standing the relationship, the more disappointing the service needs to become before that relationship is ended. In such a case, it should be clear how the existing contract can be terminated effectively when a fruitful long-term collaboration is no longer viable. Include the exit criteria in the contract. Furthermore, create a stepwise build-up of the relationship. Let the provider first prove that it can meet the standards that have been set before further integrating the processes and systems.

Contracts are usually regarded as lengthy, bulky and complex legal documents. When contracts are well-structured so that their contents are clearly visible, they become great control instruments. Logistics contract managers from both the shipper and the provider should not need to frequently refer to the legal text and small print, since the basis for daily operation should flow from within the well-defined boundaries of the contract.

About the author:

Jan Runge Petersen has been active in the logistics industry for 40 years, during which time he has held various management positions within logistics and freight forwarding globally. He has spent the last 18 years at DSV. He started out as a Division Manager with DSV Road, later as Managing Director DSV Solutions in Sweden and currently holds the position Senior Director Business Development Nordics at DSV Solutions, based in DSV's Headoffice in Hedehusene.

","AuthorId":-1,"PublishDate":"2020-07-08T00:00:00","ExpiryDate":null,"FeaturedImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","ThumbnailImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","PublishedBy":null,"FriendlyUrl":"7-pitfalls-of-Logistic-contract-management","TemplateUrl":null,"Gated":false,"TeaserContent":null,"Metadata":"{\"Keywords\":\"\",\"Description\":\"\"}","InstanceName":"Content Hub","InstanceDescription":"Resources for members including articles, webinars, podcasts, case studies, presentations, abstracts and templates.","CreatedOnDate":"2023-08-10T10:24:56.113","Author":"Anonymous","AuthorImage":"/images/no_avatar.gif","Categories":[],"Tags":[],"CustomFields":[{"CustomFieldId":1,"ArticleFieldId":2203,"ArticleVersionId":784,"FieldName":"Written by","FieldType":"Text","FieldValue":"Jan Runge Petersen"},{"CustomFieldId":2,"ArticleFieldId":2204,"ArticleVersionId":784,"FieldName":"Description","FieldType":"Text","FieldValue":"In this article, we will look at logistics contract management from both sides of the table. We will explain where the most common pitfalls lie in managing the client-LSP relationship, how they can be identified and, more importantly, how to avoid them."},{"CustomFieldId":3,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":4,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":5,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":6,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":7,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":8,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":9,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":10,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":11,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 5","FieldType":"Text","FieldValue":null},{"CustomFieldId":12,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 5","FieldType":"Text","FieldValue":null}],"DetailsPage":"/Resources/Content-Hub/details/7-pitfalls-of-Logistic-contract-management"},{"ArticleId":785,"InstanceId":1,"IsPublished":true,"LatestVersion":785,"Deleted":false,"Featured":false,"Views":278,"ArticleVersionId":785,"Version":1,"ContentItemId":31810,"Active":false,"Published":true,"Draft":false,"Title":"Supply Chain Financing: Liquid Inventory That Keeps Things Moving","Content":"

• https://scm.ncsu.edu/scm-articles/article/supply-chain-financing-liquid-inventory-that-keeps-things-moving

","AuthorId":-1,"PublishDate":"2020-07-08T00:00:00","ExpiryDate":null,"FeaturedImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","ThumbnailImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","PublishedBy":null,"FriendlyUrl":"Supply-Chain-Financing-Liquid-Inventory-That-Keeps-Things-Moving","TemplateUrl":null,"Gated":false,"TeaserContent":null,"Metadata":"{\"Keywords\":\"\",\"Description\":\"\"}","InstanceName":"Content Hub","InstanceDescription":"Resources for members including articles, webinars, podcasts, case studies, presentations, abstracts and templates.","CreatedOnDate":"2023-08-10T10:24:56.21","Author":"Anonymous","AuthorImage":"/images/no_avatar.gif","Categories":[],"Tags":[],"CustomFields":[{"CustomFieldId":1,"ArticleFieldId":2205,"ArticleVersionId":785,"FieldName":"Written by","FieldType":"Text","FieldValue":"Robert Handfield Ph.D."},{"CustomFieldId":2,"ArticleFieldId":2206,"ArticleVersionId":785,"FieldName":"Description","FieldType":"Text","FieldValue":"I had an opportunity to interview Craig Weeks, one of our faculty advisors for the Supply Chain Resource Cooperative this week, at the NC State Football Stadium recording studio. Craig is a wealth of information on this topic, and we will be presenting the insights from this video soon. I thought it would be useful to present some interesting insights for those who are new to the term 'Supply Chain Financing'."},{"CustomFieldId":3,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":4,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":5,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":6,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":7,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":8,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":9,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":10,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":11,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 5","FieldType":"Text","FieldValue":null},{"CustomFieldId":12,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 5","FieldType":"Text","FieldValue":null}],"DetailsPage":"/Resources/Content-Hub/details/Supply-Chain-Financing-Liquid-Inventory-That-Keeps-Things-Moving"},{"ArticleId":786,"InstanceId":1,"IsPublished":true,"LatestVersion":786,"Deleted":false,"Featured":false,"Views":258,"ArticleVersionId":786,"Version":1,"ContentItemId":31811,"Active":false,"Published":true,"Draft":false,"Title":"TRG UK LAW UPDATE - July 2020","Content":"\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t

\t\t\t Suspension of termination rights on insolvency \t\t\t Following public consultation and the UK Government's response published in August 2018, on 20 May 2020, the Government published the Corporate Insolvency and Governance Bill (“CIGB” or the “Bill”). This Bill, as well as having broader corporate implications, also has significant impacts on commercial contracts ... More>>> \t\t\t \t\t\t \t\t\t

\t\t\t Cabinet Office Guidance on responsible contractual behaviour \t\t\t Cabinet Office Guidance on responsible contractual behaviour in the performance and enforcement of contracts impacted by the Covid-19 emergency was published on the 7th May and will be reviewed again before 30th June. It suggests that contracting parties should act 'responsibly and fairly' in their responses to issues caused by the virus. This phrase appears multiple times in the Guidance (ten times over only five pages) but there is very little detail as to what exactly that would entail. The Guidance does however ... More>>> \t\t\t \t\t\t \t\t\t

\t\t\t Don't delay if relying upon an indemnity \t\t\t Towergate v Hopkinson (High Court) [2020] \t\t\t A recent case in the Court of Appeal has highlighted the importance of strictly adhering to express contractual conditions when seeking to rely on an indemnity clause ... More>>> \t\t\t \t\t\t \t\t\t

\t\t\t Failures by procuring body render public sector contract void. \t\t\t School Facility Management v Christ the King College ( High Court) [2020] \t\t\t This case raises potentially very significant concerns for suppliers and service providers to the public sector (and beyond) ... More>>> \t\t\t \t\t\t \t\t\t

\t\t\t   \t\t\t This email is intended as general information only and not as legal advice. If you require any advice, please contact us. \t\t\t

\t\t\t © TRG Law Limited 2020 \t\t\t Home | Contact us | Subscribe to TRG Update | Subscribe to TRG BRIEFing | Archive \t\t\t TRG Updates contain practical summaries of important legal developments in commercial contract law, including information technology and related areas. \t\t\t TRG BRIEFings are brief 'alerts' to key contract, technology and intellectual property related legal issues and developments. \t\t\t TRG law specialises exclusively in the drafting, negotiation and interpretation of technology, outsourcing and commercial contracts. \t\t\t Compromise on cost not quality \t\t\tWe operate a competitive pricing structure, keeping our charges low but without compromising on quality. We act for companies both large and small, public authorities and charities and also provide tailored in-house training. \t\t\t Authorised and regulated by the Solicitors Regulatory Authority. Registration number 567420. \t\t\t

","AuthorId":-1,"PublishDate":"2020-07-08T00:00:00","ExpiryDate":null,"FeaturedImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","ThumbnailImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","PublishedBy":null,"FriendlyUrl":"TRG-UK-LAW-UPDATE-July-2020","TemplateUrl":null,"Gated":false,"TeaserContent":null,"Metadata":"{\"Keywords\":\"\",\"Description\":\"\"}","InstanceName":"Content Hub","InstanceDescription":"Resources for members including articles, webinars, podcasts, case studies, presentations, abstracts and templates.","CreatedOnDate":"2023-08-10T10:24:56.283","Author":"Anonymous","AuthorImage":"/images/no_avatar.gif","Categories":[],"Tags":[],"CustomFields":[{"CustomFieldId":1,"ArticleFieldId":2207,"ArticleVersionId":786,"FieldName":"Written by","FieldType":"Text","FieldValue":"TRG Law"},{"CustomFieldId":2,"ArticleFieldId":2208,"ArticleVersionId":786,"FieldName":"Description","FieldType":"Text","FieldValue":"In this edition we feature: \\r
• Suspension of termination rights on insolvency\\r
• Cabinet Office Guidance on responsible contractual behaviour \\r
• Don't delay if relying upon an indemnity\\r
• Failures by procuring body render public sector contract void."},{"CustomFieldId":3,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":4,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 1","FieldType":"Text","FieldValue":null},{"CustomFieldId":5,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":6,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 2","FieldType":"Text","FieldValue":null},{"CustomFieldId":7,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":8,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 3","FieldType":"Text","FieldValue":null},{"CustomFieldId":9,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":10,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 4","FieldType":"Text","FieldValue":null},{"CustomFieldId":11,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File Title 5","FieldType":"Text","FieldValue":null},{"CustomFieldId":12,"ArticleFieldId":0,"ArticleVersionId":0,"FieldName":"File URL 5","FieldType":"Text","FieldValue":null}],"DetailsPage":"/Resources/Content-Hub/details/TRG-UK-LAW-UPDATE-July-2020"},{"ArticleId":787,"InstanceId":1,"IsPublished":true,"LatestVersion":787,"Deleted":false,"Featured":false,"Views":290,"ArticleVersionId":787,"Version":1,"ContentItemId":31812,"Active":false,"Published":true,"Draft":false,"Title":"How Many KPIs Should My Contract Have? - Part 1","Content":"

\n
• https://performancebasedcontracting.com/2020/06/21/how-many-kpis-should-my-contract-have-part-1/
\n

","AuthorId":-1,"PublishDate":"2020-07-08T00:00:00","ExpiryDate":null,"FeaturedImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","ThumbnailImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","PublishedBy":null,"FriendlyUrl":"How-Many-KPIs-Should-My-Contract-Have-Part-1","TemplateUrl":null,"Gated":false,"TeaserContent":null,"Metadata":"{\"Keywords\":\"\",\"Description\":\"\"}","InstanceName":"Content Hub","InstanceDescription":"Resources for members including articles, webinars, podcasts, case studies, presentations, abstracts and templates.","CreatedOnDate":"2023-08-10T10:24:56.377","Author":"Anonymous","AuthorImage":"/images/no_avatar.gif","Categories":[],"Tags":[],"CustomFields":[{"CustomFieldId":1,"ArticleFieldId":2209,"ArticleVersionId":787,"FieldName":"Written by","FieldType":"Text","FieldValue":"Dr Andrew \"Jacko\" Jacopino"},{"CustomFieldId":2,"ArticleFieldId":2210,"ArticleVersionId":787,"FieldName":"Description","FieldType":"Text","FieldValue":"

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).

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\n
• https://performancebasedcontracting.com/2020/07/04/how-many-kpis-should-my-contract-have-part-2/
\n

","AuthorId":-1,"PublishDate":"2020-07-08T00:00:00","ExpiryDate":null,"FeaturedImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","ThumbnailImage":"/Portals/IACCM/AssetUploads/Plain image icon.jpg?ver=Mtq2EgsMr-tyyxDqnwIxYA%3d%3d","PublishedBy":null,"FriendlyUrl":"How-Many-KPIs-Should-My-Contract-Have-Part-2","TemplateUrl":null,"Gated":false,"TeaserContent":null,"Metadata":"{\"Keywords\":\"\",\"Description\":\"\"}","InstanceName":"Content Hub","InstanceDescription":"Resources for members including articles, webinars, podcasts, case studies, presentations, abstracts and templates.","CreatedOnDate":"2023-08-10T10:24:56.453","Author":"Anonymous","AuthorImage":"/images/no_avatar.gif","Categories":[],"Tags":[],"CustomFields":[{"CustomFieldId":1,"ArticleFieldId":2211,"ArticleVersionId":788,"FieldName":"Written by","FieldType":"Text","FieldValue":"Dr Andrew \"Jacko\" Jacopino"},{"CustomFieldId":2,"ArticleFieldId":2212,"ArticleVersionId":788,"FieldName":"Description","FieldType":"Text","FieldValue":"

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.

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• http://psychclassics.yorku.ca/Miller/

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