04 January 2001
Several recent events have underlined the importance of getting the spread of risk right when drawing up contracts. David Arminas reports
Railtrack's problems in recent months have been well documented and the fallout will continue for some time yet as companies add up the damage to their supply chain relationships.
English Welsh and Scottish Railway (EWS) has estimated that the number of deliveries it gets to customers on time has fallen by half. Some aggregates producers have reported delays in one-third of deliveries made by EWS. Philip Mengel, EWS's chief executive, is afraid it will be hard to persuade customers lost to the roads to return. It may take months, even though Railtrack has said services should be back to normal by 31 March.
Disruptions on the scale of October's fatal Hatfield rail crash and the rain and gales that followed have driven home the importance of risk management in contracts. Railtrack has said that compensation terms are written into contracts with freight carriers.
Purchasers are often at the frontline of contract negotiations, and need to get the risk management right. This is not new. Military contracts are heavily risk orientated, as seen in the Ministry of Defence's decision to name BAE Systems as prime contractor for the Navy's Type 42 destroyer. BAE is to choose subcontractors "according to affordable price and acceptable risk".
So has anything changed in risk management thinking?
Procurement staff are moving away from adversarial negotiating. Once, buyers had done their job if they loaded as much risk as possible on to the seller. Sellers would then raise prices to cover their exposure to risks. Unacceptable risks were an option if the seller really needed the business. But this might backfire if problems arose that jeopardised the supplier and so the buyer's company.
That's old-school thinking, according to Neill Irwin, director of Partnership Sourcing, an initiative by the Confederation of British Industry and the Department of Trade and Industry to foster improved business-to-business relationships.
The latest concept is to let the risks fall among buyers and contractors, and see which firm can best handle the risks for the least cost. If risk-sharing begins then, it becomes part of the partnership, says Irwin.
Risk management is becoming more important for procurement professionals in any business, said Michael Ensor, former procurement director at the Millennium Dome and London Transport.
In high-risk environments, such as Railtrack and the London Underground, contract negotiators have traditionally focused on risk. But this focus is spreading from those environments, believes Ensor, who's currently interim European procurement director for telecommunications firm Global Crossing.
The techniques of risk management can be applied to any business and assessing penalties for things that go wrong is standard. Negotiators should think about what information they need to create a risk register of things that could go wrong, he added.
Buyers don't want a fat contract covering every conceivable possibility, but neither do they wish to be wide open to claims should things not progress smoothly. It is a matter of sensible discussion and balance, according to Jan Middleton, procurement solicitor at City law firm Denton Wilde Sapte.
She cautions for negotiators to be aware of documents where risks can be hidden in archaic legal references that lay people cannot understand.
It is easiest to associate risks with uncertainties that we are familiar with, said Ralph Seeley, a procurement specialist with consultant Cambashi. "There's no way that all the possible maintenance problems could have be anticipated [at Railtrack], although it's easy enough to be wise after the event. In my opinion, we'd be better diverting some of the money now paid to lawyers into providing better profit margins for contractors."