Jeanette Nyden—a commercial contract coach—joins me on this episode of the Negotiations Ninja podcast to discuss how to negotiate performance-based contracts. We discussed what performance-based contracts are, why they’re important, what to think about when putting together performance-based contracts, and some of the rewards systems that can be put in place. Don’t miss it!
Outline of This Episode
- [3:20] Learn more about Jeanette Nyden
- [5:05] Why use performance-based contracts?
- [7:03] The customer’s obligation to the supplier
- [12:30] Negotiating performance-based contracts
- [15:51] You have to change the way you think
- [19:48] The best way to think about risk allocation
- [26:13] The benefits and drawbacks of liquidated damages
- [32:16] Addressing performance versus risk
- [35:32] Rewards for companies that exceed objectives
- [40:20] How to improve performance-based negotiation skills
Why use performance-based contracts?
We don’t always know what we’ve agreed to when we sign the dotted line. Performance-based contracts help you think through the value proposition to the buying organization. What do they really want? When do they want it? Why do they want it? This informs the supplier of the level of performance they need to fulfill the obligation and why it’s important. It also helps identify the appropriate price point. When you’re trying to make these decisions, you need to be able to track the customer’s obligations to the supplier and the supplier’s obligation to the customer.
Why the customer’s obligation to the supplier is important
The customer’s obligation is often implied but rarely explicitly spelled out. If the language says the supplier will do background checks on people with access to confidential information, she has to think through what that means. Is there a gate to the parking lot? Do they need badges to get into the gate? What doors can their badges access? What parts of the computer systems can they access? You have to build those obligations into the contract.
The challenges faced in negotiating performance-based contracts
Jeanette’s biggest concern is people who aren’t comfortable with working with performance-based contracts. Contracting teams need to be prepared to handle these complex contracts. That’s why Jeanette is passionate about helping sales and procurement professionals take their skills to the next level. They need to become comfortable thinking through drafting a statement of work for performance issues, ensuring metrics are appropriate, collecting the right information, etc.
You have to change the way you think about risk
Jeanette was teaching contracting principles and speaking with a woman about risk (regarding a cafeteria in a government building). She asked her what would happen if someone in the cafeteria ate lukewarm food that was supposed to be hot. That person could get sick. So what happens if a tourist in the building gets sick? Those two questions made this woman an evangelist for performance-based contracting.
Jeanette teaches people to look at agreements through a different lens. If someone is buying prepackaged bulk food, the liability is on the manufacturer. But if something is prepared in the cafeteria, the risk falls on the cafeteria—so you must consider the risks. You have to think about potential risks ahead of time and work them into the contracts.
Rewards for companies that exceed objectives
Jeanette believes you should structure incentives that are pure profit to the supplier for exceeding stated performance objectives. However, the customers have to be on board with supporting those initiatives. What are the implicit obligations? You have to state them clearly to know what exceeding performance looks like.
If you want to reduce the consumption of electricity, someone can do an inspection and let you know what can be done to be more efficient from an automated standpoint. But what is within the customer’s control that can decrease consumption? That’s the conversation that leads to goals.
What is the best way to think about risk allocation? What are the benefits and drawbacks of liquidated damages clauses? Listen to the whole episode to learn more!
Resources & People Mentioned
- Getting to We: Negotiating Agreements for Highly Collaborative Relationships
- Vested Outsourcing: Five Rules That Will Transform Outsourcing
- The Vested Outsourcing Manual
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