How to Manage Contract Volatility

There always seems to be a handful of trouble-makers. Going off on a tangent, going against the flow, resisting change or seemingly always needing to be brought back on track.

Some are hard-cases with a long record, regularly needing attention to get sorted. Others are just not equipped to deal with the slings and arrows of outrageous fortune, as Hamlet so aptly put it.

Life can be hard enough with having these sorts of road bumps on the way. Ask any parent, teacher, parole officer, shepherd or lion tamer. Or Contract Manager.

For Contract Managers, this particular road bump comes in the form of contracts exhibiting, or suffering from, high volatility.

What is contract volatility?

Volatility means a tendency to change rapidly and unpredictably. This characteristic is generally forward-looking, in the sense that change could and most probably will occur, but the expectation of such a future is solidly based on past history.

Volatility with respect to contracts has this future aspect, but it is mostly associated with a more retrospective view. It is generally used to indicate a contract that has already undergone rapid and unpredictable change and could still do so, but more often than most other contracts.

If ‘more often than most’ seems to be a fairly imprecise measure, it is, because it’s totally subjective for the Contract Manager, kind of like you know it when you see it.

There’s no hard and fast rule about the number of amendments made to a contract that might suggest volatility. It could almost be declared on a per-contract basis when the Contract Manager first grumbles ‘not that contract again!’ through gritted teeth.

The volatility designation doesn’t necessarily imply that risk is actually increased for a contract just because it has a history of amendments.

By definition, the purpose of each amendment is to decrease risk by addressing shortcomings in the contract.

It’s more like a warning light that has changed from green to orange, giving notice that something is going on that really needs to be understood.

So, what’s the ‘so what?’ about contract volatility?

Volatility is simply a contract risk indicator, increasing the visibility of such a contract. If the cause or causes are not already understood, it is a sign that the deeper and underlying ‘why’ of the contract’s seemingly ongoing need for amendment really ought to be discovered. Otherwise the designation simply indicates that the contract could continue to be problematic at some unpredictable time in the future.

Awareness of contract volatility provides the opportunity to reduce:

• The sensitivity to uncertainty of existing volatile contracts
• The opportunities for volatility creep in important contracts.

What can cause contract volatility?

Many things, singly or in combination, by their presence or absence, can produce a need for a contract to be amended in some fashion, such as:

• Price changes resulting from an annual review of spend levels
• Improvements to the standard ordering process
• Introduction of new regulatory obligations
• Removal of the organisation’s right to use certain 3rd party intellectual property
• Inability of the supplier to comply with service delivery targets due to force majeure
• Failure of either the supplier or the organisation to comply with contractual obligations
• Invalidation of the elemental assumptions the contract is based on
• Changes in perception of the stability of the market fundamentals

Some of these are really just normal happenings. They can occur according to a schedule or randomly.

Other things can occur that the contract doesn’t handle well or at all.

Because contract volatility is distinguished by multiple amendments over time, its main causes can be reduced to any combination of the following:

1. Widespread uncertainty delivering the unexpectedFor years now, the general business environment has become more chaotic, characterised by increasing uncertainty and disruption. Politics, economics, armed conflict, extreme weather and so on are introducing new risks and exacerbating existing risks.
   
   Uncertainty can lead to situations that have not been encountered before or to the current extent. Conversely, it can result in the altering, diminishing or discarding of what might have always been considered standard practice.
   
   There’s no way of knowing exactly what may happen that warrants an amendment to a contract.
   
   The circumstances need to first occur, their implications for the contract then determined, and the contract’s ability to deal with both assessed last. It’s probably the case that an uncertainty-driven situation would result in a contract amendment only relatively infrequently, but given global trends, an increasing amendment frequency could be expected.
   
   
2. A contract unable to deal with the unexpected A contract can prove to be inadequate at some level when it is unable to cope with certain situations, whether actual or hypothetical. This can arise when the contract doesn’t have much allowance for exceptions, is fairly inflexible or not future-ready.
   
   This sort of inadequacy can be a feature of contracts from particular suppliers and industries, or it can result from inexperienced contract drafters and reviewers, rigid and indifferent bureaucracies, or ignorance of the bigger picture and the accelerating rate of change.
   
   More commonly, the contract is well-drafted other than it doesn’t go far enough in generalising a non-specific catch-all response for dealing with all the weird, wonderful and downright strange stuff that can happen. There are two reasons why this might happen:
   
   
   • It can be really hard to craft such a response well
   • It’s likely to be even harder to cater for the inconceivable.
   Bear in mind that any inadequacies a contract may contain could lay dormant and unrecognised for its entire lifetime, if the right combination of circumstances never arises to reveal them.
   
   
3. A contract expected to change often over timeSome contracts are inherently dynamic by design. They may be a small part of a much larger whole, say development of a spacecraft, and need to be flexible to account for upstream changes that are almost certainly going to occur in the contracting ecosystem they’re part of.
   
   They might just be intended for use in a very fluid environment, say a major infrastructure development. Upstream improvements may result in downstream simplification, changing specifications, costs, timing and risks.
   
   Many contract amendments may be needed to keep pace with the upstream changes before the contract in question kicks off, as well as during its lifetime. This dynamic quality doesn’t mean such contracts will be immune to uncertainty-driven events or prove to be free of any inadequacies.
   
   
4. A contract that just doesn’t workSome contracts prove to be ineffective almost immediately or shortly after an initial ramp-up period. Service levels aren’t met. Costs skyrocket. Approaches designed to encourage certain supplier behaviour perversely produce exactly the opposite result. There is no clarity about roles, responsibilities and rights.
   
   A lack of awareness, preparation, understanding or insight by both sides during contract development is often at the heart of an unworkable contract.
   
   This initial fault can be compounded by superficial and repeated contract amendments that only deal with the burning issue at the time, and fail to address the underlying causes of the unworkability of the contract.
   
   The sheer amount of attention these contracts require is a sure sign of their volatility.

What are some possible consequences of contract volatility?

The upward trend of uncertainty has almost certainly resulted in an increase in unexpected situations that many contracts were never designed to accommodate.

It goes without saying but let’s say it anyway: contract risk is following the uncertainty trend line.

No prizes for guessing who’s going to bear the brunt of responsibility for identifying and mitigating the risks. That’s right: your broad-shouldered, can-do, never-say-die Contract Managers and Legal Counsels.

Your typical Contract Manager’s life is already very busy. A lot of the workload can be planned, but some time needs to be reserved for the unexpected. Dealing with volatile contracts is unlikely to be a regularly scheduled activity, unless their existence has already been recognised and regular watching has been planned.

It seems that there’s always something happening that can change priorities in a heart-beat. New contracts can arrive without warning. A supplier can fall over or misbehave. A spot contract compliance audit could be launched by a particularly pedantic supplier. The organisation needs due diligence performed on all the contracts held by a potential acquisition target… by Monday morning.

Volatile contracts that are not volatile by design can be likened to an accident waiting to happen. The more of these contracts that are active, the greater the potential for the ‘accident’ to take place.

The ‘severity’ of the accident potential can increase the stress levels of Contract Managers.

Should a volatility-induced ‘accident’ actually happen, it can be minor, or require a ‘drop everything and all hands to the pumps’ response. It can be hard to tell just how things might pan out. It’s easy to run out of reserved time and encroach on scheduled time.

The nature and treatability of both the issue and the inadequacy will determine whether a quick fix or something more substantial is required.

The need for speed, pressure from within and without, lack of support, fatigue, delays in developing ideas and obtaining approval for proposed corrective treatment, and interruption to the flow of normal activities can all conspire to impede progress towards a solution, with the consequent knock-on effect on other important, possibly time-sensitive work.

Importantly, there may not be an obvious or readily achievable solution to an unexpected contract problem.

The momentum and reach of the exceptional circumstances can deliver a tsunami of pain to those directly involved. The tsunami itself and /or its inevitable aftermath can catch others at several removes who are just as unprepared.

How can contract volatility be detected?

Remember, it’s a contract’s amendment history that determines if it’s volatile or not. The actual designation of volatility depends completely on the organisation’s definition, whether informal and notional, or formal and assigned by measurement.

Contract volatility should be self-evident if the definition is well known and supported by sufficient records of amendments that are centrally accessible to people who need to know.

Failing this, institutional memory may provide a guideline if those with the knowledge can be tracked down and induced to pass it on. Selective amnesia may be rife if these guardians haven’t been treated well in some sense, and rightfully or wrongfully still bear a grudge.

The final recourse is a tedious journey through the records, hopefully electronic, to find and document contracts with an amendment history that suggests volatility, for the benefit of all current and future Contract Managers.

Bear in mind also that a contract’s stakeholders may be painfully aware of its chequered amendment history and be the first to notice something unexpected going on at an operational, relationship or marketplace level, get a sniff of an amendment in the wind and sound a warning.

How can contract volatility be managed?

Any approach to managing contract volatility involves a trade-off because there's no such thing as a free lunch.

The approach laid out below comes at a cost, mainly in time and effort but likely also in the form of delays to other work.

The upside is that adopting the approach should fairly quickly reduce the number of contracts designated as volatile, and recover much of the time that would have been spent making localised spot amendments to deal specifically with whatever caused the need for the amendment.

This follows the truism that there’s a bigger payback from stopping something happening in the first place than in stopping it after it has happened.

The steps in the process are:

1. Assess the current operating environment A clear understanding of how and where the world is changing is essential for actual and potential contract volatility as well as effective contract risk management.
   
   This might sound a bit over the top or alarmist to people who only deal with local suppliers. Such a perception is only valid if it is known for certain, bet-your-job-on-it certain, that none of those local suppliers are dependent on non-local supply chains.
   
   Where local really does mean local from start to finish, assessment of local change is required. The Contract Lifecycle Management function needs to work with organisation management to relate its need for such an assessment and agree on how this can be achieved.
   
   Requirements need to be specified to ensure information relevant to contract risk is delivered by the assessment.
   
   
2. Assess the current risk profile of all volatile and important contractsWith stakeholders in these contracts, develop, discuss and agree on a plan to review the base assumptions used to derive the risk profiles, and determine if the findings of the global or local environment assessment change those assumptions in any material way.
   
   Where this proves to be the case, work with the stakeholders to derive a new risk profile, develop appropriate mitigation approaches and any proposed contract amendments.
   
   Use of appropriate contract management software such as Gatekeeper can make this process a lot more straightforward.
   
   Contract ownership and activity is recorded centrally in an auditable record allowing for easy identification of key stakeholders and the volume of actions taken against a contract over time.
   
   
3. Improve and test the contracting approach Many organisations use a fairly standardised approach to developing new contracts. Certain types of clause might be required in certain types of contracts but not others.
   
   The value of certain clauses settings might vary depending on the contract type. Adjusting the contracting approach to deal with new situations is a simple and controlled way of maintaining contract flexibility and agility. This can be achieved as follows:
   
   
   • Select a handful of volatile and important contracts that cover the provision of different products or services under various legal jurisdictions
   • Working with selected stakeholders in these contracts, hypothesise a number of uncertainty events covering various categories like extreme weather, armed conflict, political instability and so on, and some likely implications of the occurrence of such events
   • Check if each selected contract can accommodate the hypothetical events as-is, and the nature of any amendment that might be needed to minimise the impact of those events
   • Identify the contract constructs that were able to deal as-is with any of the hypothetical events
   • Check if existing contract constructs or proposed amendments can be generalised for more universal applicability
   • Formulate an approach for the development of new contracts that decreases their susceptibility to, and increases their resilience against, the unexpected, by use of the generalised approaches to uncertainty
   • Discuss the proposed new approach with several important suppliers to obtain feedback about its suitability and acceptability
   • Adjust the new approach based on all feedback received, determine which aspects are generally applicable and which need to be tailored for the nature of the contract
   • Finalise the contract development approach, publish the details and train all interested parties in how to use it.
4. Apply the new approach to volatile contracts as soon as possible This is a remedial step aimed at volatile contracts that are not volatile by design.
   
   The intention is to increase their ability to deal with uncertainty to the greatest extent possible, and minimise the likelihood of ongoing random amendments. Follow the procedures agreed with each supplier to produce an executed contract amendment.
   
   
5. Apply the new approach to all important contracts as a priority

   When contracts exhibiting actual volatility have been addressed, the focus moves to minimising the opportunity for volatility in other contracts, particularly those that are important to the organisation. This can be achieved as follows:

   • Identify all important contracts that weren’t involved in trialling the new contracting approach
   • Review each contract to determine if application of the new contracting approach is necessary
   • Prepare a draft plan covering a timeline and sequencing of an amendment of each contract needing to incorporate the new contracting approach, with prioritisation based on risk profile
   • Prepare a draft notice for the suppliers involved with the important contracts, advising of the proposed amendment to their contract, its rationale and proposed timing
   • Issue the draft plan and supplier notice to the relevant contract owners and key stakeholders, and request feedback. Adjust the draft plan and supplier notice to incorporate any feedback
   • Issue the supplier notice and applicable elements of the draft plan to the suppliers involved and request their feedback
   • Work with relevant contract owners and suppliers to deal with any feedback received from the suppliers, and make any mutually agreed adjustments to the plan
   • Publish the final contract amendment plan and implement it

This process needs to repeated regularly, say every 12 or 6 months depending on the general feel of uncertainty in the environment, but certainly more often if the rate of contract amendments due to uncertainty is trending upwards.

Summary

With the general business environment exhibiting increasing uncertainty and disruption, it wouldn’t be at all surprising to find that some number of contracts experience volatility at some time, in some fashion, under some circumstances.

Consequently, it’s important that concrete steps are taken to minimise the effects of uncertainty on existing contracts that have a history of volatility or are important to the organisation, as well as all new contracts.

This remedial work will take time and effort, could involve quite a few people, and is likely impact on planned Contract Management activities.

The payback over time from more robust contracts should be a lowering of general contract risk, the impacts of uncertainty on the organisation at large, and the fire-fighting pressure on Contract Managers.

In this article we’ve introduced the concept of contract volatility and presented an approach to help you to understand its causes and effects, detect it and deal with it.

If you would like more information on how to manage contract volatility and specifically how Gatekeeper can make the process more straightforward then contact us today for a free consultation.