The central element of most nations’ COVID-19 response has been isolation of their population in order to flatten the infection rate curve, save their health systems and thus the lives of their citizens.
To date, the economic effect has been enormous, with levels of unemployment not seen since the 1930s occurring almost overnight. Just as quickly, many governments have committed unprecedented levels of financial aid to support businesses and the workforce.
Couple these commitments with a global economy that hasn’t been in great shape for many years, and the long-predicted recession is now looking more imminent.
In this article, we explore the potential business impact of the recession and how contract managers should respond. Specifically, we’ll look at:
- How a recession causes cost-cutting cycles for businesses
- Three ways businesses can prepare for a recession
- Why failure to plan is planning for failure
- The Contract Manager’s brief for recession planning
How a recession causes cost-cutting cycles for businesses
Either prior to an expected recession or during a recession, organisations order fewer or lower-spec goods and services, or stop buying them altogether. They cancel submitted orders and return goods no longer needed.
They ask suppliers for discounts, extended payment terms and longer delivery periods. They delay payments for as long as they can, or don’t pay at all.
At the same time, organisations explore every avenue for reducing costs.
They look at reducing the number of suppliers used in order to get better pricing through larger orders, while simultaneously considering alternative sources of supply to minimise the risk from failure of a key supplier.
Some employees may be let go, the remainder might have their salaries reduced and bonuses suspended. Outsourcing of common business functions might be considered. As many discretionary costs as possible will be minimised or curtailed.
Contracts are closely scrutinised to ensure obligations compliance and delivery of entitlements, to check for relevance, suitability for the current environment and its trends, flexibility for dealing with change, and termination rights.
Contract disputes and litigation increase. Cost savings are heavily targeted. Demand aggregation will be investigated.
Once this cycle starts, everybody jumps on the bandwagon because they have no choice.
The cycle becomes self-reinforcing, lasting until some kind of circuit-breaker acts to increasingly limit the severity of the situation and an up-cycle takes over.
Three ways businesses can prepare for a recession
Depending on the particular definition used, there have been four to six global recessions in the last 50 years. Extensive research has been conducted about various aspects of these recessions, producing insight into ways to limit the damage at the organisation level.
It turns out that a very straightforward approach delivered the best outcomes: be prepared.'
The only way to face a recession is head-on, with forethought, agility and a hard nose:
- Plan ahead. Consider what could happen and how to deal with it quickly, simply, effectively and cost-effectively. Preemptively implement any measures that make sense, recession or not. Have a solid plan A to deal with other matters that might arise but also alternatives in a plan B. Ad hoc is not a strategy for survival.
- Be adaptable. Some things in your plan A just won’t pan out as expected. With luck, plan B might be able to deal with whatever plan A can’t. Be ready to switch over quickly, or prepare a new plan C on the fly, but don’t leave it too late. Ad hoc can be a tactic for survival.
- Be flexible. Self-imposed limits on what the organisation is prepared to do might seem like a death-wish if the recession exhibits a typical ‘take-no-prisoners’ tendency. Do what needs to be done for long-term survival. Research has found that organisations with a solid plan flourished during the course of a recession and even more so following its conclusion.
Why failure to plan is planning for failure
Those that were less well-prepared had a much less pleasant experience, often as a result of responding haphazardly with too little consideration of the consequences and way past the time when any positive effect was possible.
Many don’t make it through the recession or last long once it is over.
Drastic cuts made in a downturn can cause severe harm to the organisation, and no amount of overspending on recovery efforts in an upturn is guaranteed to work.'
‘Full speed ahead and damn the torpedoes’ and ‘Grab a bottle, hunker down and pray for daylight’ are two great lines from history and comedy respectively.
Neither is or ever has been a workable approach to a recession or a realistic defence against it.
The prudent organisation will involve all its constituent parts in recession planning and preparation.
An organisation-wide approach is ideally prepared by the aggregation and consolidation of smaller, functional-level approaches developed using specialist functional expertise.
Discussion between Contract Management, Procurement and Legal functions is useful for achieving consistency in planning and preparation, especially if they work collaboratively.'
Below, we’ll take a look at how Contract Managers can make a valuable contribution to recession planning. The brief we outline is based on the assumption that the business has followed a number of best practices for contract management.
- The organisation has to-date followed an approach to dealing with the issues presented by COVID-19 similar to that described in our COVID-19 eBook, focussing on key contracts.
- The organisation has established a sensible high-level approach for dealing with an impending recession.
- Every functional unit in the organisation owns a set of contracts that acquire goods and services needed by the unit, or provide goods and services to the unit’s customers and clients.
- The Contract Management team uses a Contract Management System of some kind to manage the organisation’s contract inventory.
The Contract Manager’s brief for recession planning
Contract Managers can contribute to recession planning and preparation using the following approach. It’s an extension of the approach described in the COVID-19 eBook, with a focus on important contracts rather than just the key ones, and on a recession more than a pandemic.
This approach is a guideline, not a guarantee. It can be adopted and adapted as necessary to suit the organisation’s particular concerns, needs, operating characteristics and industry-specific issues.
Inform functional unit heads
All functional units in an organisation will no doubt be kept informed of the organisation’s planning and preparation for a recession at the highest levels, and the part they need to play in those activities.
They will be made aware of the need for close interaction and cooperation with the other functional units in order to achieve a thoroughly coordinated organisation-wide approach.
Contract Managers can expect to have to deal with just about every functional unit in the organisation, given the dispersed nature of contract ownership.
The units may have a high-level understanding that their contracts need to be able to cope with a recession, but not have any real notion of what that might entail. That’s fair enough, it’s why there are Contract Managers.'
Preparation of a plan with a likely timetable is needed to inform the functional units about what they need to do, and when, to help the Contract Managers support the business make its contracts as recession-ready as possible, as quickly as it can be done.
Describe areas of concern
Some of the issues the Contract Manager needs to prepare for in planning for a recession can be categorised as follows:
General issues which may affect the operation of contracts: things that might represent unrecognised or uncategorised risk in the approach to and during a recession.'
Below is a short list of potential areas that those responsible for managing contracts should consider.
- Concentration: few choices of suppliers for certain goods and services, few countries used to source certain goods and services. Even smaller issues can have large knock-on effects.
- Demand: rapid drop in requirements due to workforce reductions can lead to massive overcapacity in areas such as software licences, mobile phone connections, office equipment, subscriptions to various online and offline services, standardised consumables order quantities, floor space and so on.
- Insurance: adequacy of the nature, scope and level of cover in place, given the potential for increasing contract-related risk.
- Relationships: quality of interactions with important suppliers and customers may help determine their recession responses in a negative way. Fence-mending may be required by either or both sides. Litigation may be a distinct possibility.
- Supply chain: independent and trustworthy local sources of knowledge needed to help minimise supplier surprises.
- Targets: certain spend categories are most likely to receive most of the attention when it comes to curtailing spending.
Contract risk areas by absence. Things whose absence from a contract represents latent risk, such as:
- No business downturn rights: for times when less is likely to be needed.
- No late payment approach: for encouraging timely payment.
- No dispute resolution process: for addressing disputes by mediation, not litigation.
- No early termination options: for when continuation is not a viable option.
- No flexibility: for quickly adapting to uncertainty.
- No Force Majeure clause: for dealing with circumstances outside a party’s control.
- No pricing review mechanism: for dealing with spend rise and fall.
- No benchmarking provision: for checking supplier competitiveness.
- No service level agreement: for setting of service delivery performance targets.
Contract risk areas by presence. Things whose presence in a contract represents latent risk, such as:
- Automatic renewal or termination: possibly undesirable outcomes if no notice is given.
- Awkward processes: problematic compliance if workforce reduced.
- Minimum commitments: more pain than gain if compliance unsustainable.
- Obligations compliance: possibly uncertain outcomes if workforce reduced.
- Outdated assumptions: unhelpful if circumstances markedly different now.
- Supplier exclusivity: unsustainable in difficult times.
- Volume drivers: unsustainable if based on revenues or employee numbers.
Potential contract risk mitigation options. Things that should be done, should be done better, could be done differently or not at all, such as:
- Alternative sources of supply: spread the risk of supplier failure.
- Annual benchmarking exercise: check if pricing or service levels should be varied to be competitive in the market. May have limited value for money if conducted during a recession.
- Better use of available technologies: minimise the effects of workforce reductions on contract development, search and discovery; supplier qualification and risk assessment; supply chain visibility; obligations compliance efforts.
- Business continuity plan review: provide evidence of a supplier plan, its validity, currency and exercising with respect to the contract, on a regular basis.
- Consolidation of suppliers: obtain better deals by increasing business with fewer suppliers of the same goods and services.
- Contract renegotiation: eliminate as many obvious flaws and negative potentialities as possible.
- Contract termination: elimination of the need or chronic poor supplier performance.
- Demand aggregation: trigger bulk order discounts by centralising order capture and submitting a single large order to a supplier.
- Deferral of projects: conserve cash when there’s no point in starting or continuing with a project for the foreseeable future.
- Dilution of risk concentration: spread the risk across countries and suppliers.
- Discount options: for early invoice payment, bulk orders, or use of standardised equipment models.
- Discussion with suppliers: share recession concerns, look for mutually acceptable ways of helping each other.
- Extend delivery period: request more time to use previously received goods when demand is reducing.
- Early contract renewal: reset assumptions, requirements, the deal, the term and so on to better deal with the foreseeable future.
- Exchange rate hedging: lock-in favourable exchange rates for a fixed period to counter currency volatility.
- Extend lease term at reduced rates: defer equipment replacement when the price premium often payable for the latest technology has little payback in productivity terms.
- Extend payment period for non-critical items: request more time to collect cash from customers.
- Focus on complying with critical obligations: minimise non-compliance that can have serious consequences.
- Form or join a buyers’ group: collaborate with a supplier’s other customers to improve availability of supply and pricing for all group members.
- Lease vs buy: preserve cash flow by spreading payments over a 12-36 month term.
- Litigation for breach of contract: establish criteria for proactively moving from dispute to lawsuit.
- Longer contract terms: commit to a longer term than usual to gain favoured customer status and help ensure at least priority if not complete continuity of supply for critical goods and services.
- Pay on time for all critical goods and services: to get good customer service, be a good customer, even pay earlier if incentives to do so are provided.
- Payment plan: spread a large order cost over many payments for a specific term to preserve cash flow.
- Relax supplier KPIs and SLAs: realign capabilities and requirements to account for current circumstances, obtain better pricing and conditions.
- Revise contract assumptions: revisit organisational growth and consumption rates to resize the deal, terms and conditions.
- Temporary contract changes: put contracts into standby or minimal-ops mode for a period, say by reducing requirements or deferring orders, to save time and money and see if the situation improves enough to warrant a restart.
- Total spend with a supplier must count: seek keen pricing for each individual contract, say at each contract anniversary, when there are multiple contracts active with the same supplier.
Identify specific contracts that may be susceptible to any of the areas of concern
Provide every functional unit in the organisation with a list of its contracts, plus details of the expected areas of concern and the most likely mitigation approaches to be used.
Request each functional unit, by way of the contract owner, to promptly identify the contracts that are:
- Important to the unit, and
- Susceptible to one or more areas of concern, and
- Urgent, i.e. beyond the cutoff date for avoiding auto-renewal but not yet renewed, or
- Within 30 days of the cutoff date where both renewal is intended and the contract is approaching the end of at least its second year of operation.
As each contract is identified, the contract owner should propose their preferred option(s) for mitigating the areas of concern. These options should not be limited to those suggested above.
In general, discussions with the other party are advisable in the spirit of collaboration and cooperation, to explain the situation the organisation is facing, the issues with the contract, and proposed actions for dealing with those issues.
Talks may lead to other mutually acceptable options, unhappy acceptance or active resistance. It’s better to determine this sooner than later.'
Where the relationship with the other party is all but dysfunctional, there may be only one mitigation option acceptable to the contract owner, and no point in discussing that option with the other party.
As soon as they are ready, details of each urgent important contract, any mitigation options agreed with the other party or not, plus any other guidance should be submitted to the Contract Manager.
Of course, discussions can be held with the Contract Manager at any time during this process for advice, ideas and general guidance.
Once all urgent important contracts have been identified, this identification and proposal process needs to be repeated for any remaining non-urgent important contracts that contain susceptibilities.'
When all this work is done, details of mitigation proposals can be submitted in bulk to the Contract Manager.
Any other less important contracts that might prove to need attention during the course of a recession can be dealt with at the time.
Prepare a response for each issue discovered in a contract
When guidance is received that a contract should be terminated, the Contract Manager can prepare a formal termination notice and send it to the other party on the contract owner’s behalf, in accordance with the contract's specified notification process.
In all other cases, based on the guidance received about a contract, the Contract Manager should check if that contract also needs updating to address any other areas of concern. If so, the nature of those changes should be noted and discussed with the contract owner.
With all required changes identified, the Contract Manager can then prepare a formal contract amendment, listing the contract owner’s preferred mitigation option plus any other updates deemed necessary.
This should be sent to the other party on the contract owner’s behalf, in accordance with the contract’s agreed variation process.
Assist contract owners in negotiations with contracted third parties
If the contract owner and the other party have already agreed on the changes to be made to the contract, the other party may wish to negotiate any other changes made by the Contract Manager to address other areas of concern.
This may also happen if the amendment or termination notice is a surprise to the third party.
Discussions about these other changes may include various stakeholders like the contract owner and a member of the Legal team.
Hopefully the rationale for the changes will be readily understood and accepted by the third party, possibly with some give-and-take on both sides, and lead to a successfully executed contract amendment.
If not, some negotiation on the sticking points will be necessary and a completely different outcome than expected or hoped for might be the best that can be delivered.'
A compromised global economy, clearly where we are today as a result of COVID-19, is much like a compromised human immune system: it leaves the host susceptible to the mildest infection.
Government efforts to manage the human cost might turn out to be the metaphorical straw that broke the camel’s back, the trigger for that infection: global recession.
The smell of recession is in the air, no doubt about it. Prudent organisations, from sovereign states to one-man bands, should now be adopting the key approach to surviving a recession: preparation.
Nobody can really accurately predict the length, depth or course of a recession, and there are no guarantees of surviving it even for the best-prepared.
Counting on good preparation to get through a crisis is infinitely more sensible than depending on good luck.
Since contracts form the foundation for commerce, Contract Managers have a small but important part to play in helping organisations increase their readiness for the issues a recession will bring.
In fact, Contract Managers or Legal Teams (or whoever is responsible in a given organisation for managing contracts) should have already started on that work, through their efforts in mitigating the effects of COVID-19 on their organisations’ key contracts.
Continuation of those efforts on the larger number of important contracts is critical, with recession issues as the focus in place of pandemic issues.
Will there be contract-related shocks and missteps? Almost certainly. Will some things fall through the cracks? Undoubtedly. Will there be casualties? Too many to contemplate, but for sure, less than there could be without solid preparation.'
The upside, the silver lining for organisations surviving a recession will come in the form of increased knowledge. For Contract Managers, this will include:
- How to make contracts more fit-for-purpose, standardised, robust and flexible.
- The nature of additional information about supply chains that needs to be identified, captured, reported and kept updated.
- The type of technological, system, service and process improvements that might be adopted to assist in Contract Lifecycle Management activities, whether conducted onsite or remotely.
- How to better identify, mitigate and manage contract-related risk.
- How to better identify contract-related obligations, assign ownership, measure and report on compliance levels.
So, if you haven’t yet started or made any real headway with your recession planning and preparation, you’d better get a wriggle on.
If you have started, maybe this article can help you flesh out your approach or fill in some gaps.
If you would like more information about approaches to recession planning and preparation by Contract Managers, or specifically how Gatekeeper can help in managing contract risk, then contact us today.