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  • CONTRACT RENEGOTIATIONS

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    Contract Renegotiations

     

     
     
    The Neglected Phase of the Process
    © International Trade Centre, International Trade Forum - Issue 1/2001 
     

    Today's business executives are finding it more and more difficult to negotiate "static" agreements that withstand the pressure of change. As a result, renegotiations are a growing trend in international business. Here are tips for keeping renegotiations to a minimum, and managing them successfully.

    Every day, business executives operating in the global arena sign agreements meant to be mutually beneficial and long lasting. Despite good intentions and iron-clad contracts, unexpected difficulties do arise once contracts are underway. With an emphasis on just-in-time delivery and total quality management at world competitive prices, as well as rapidly changing market conditions, executives are likely to renegotiate contract agreements.

    Integrate renegotiation in your strategy 

    Experienced global executives recognize that negotiation is a continuous process, not a one-time event that ends with the signing of an agreement. Successful managers treat negotiations in their entirety, from planning to full implementation of the contract. Proper follow-up during the implementation phase by all parties is the crucial test that determines whether or not a negotiation was successful. Unless the agreement is considered profitable and mutually beneficial by both sides, one party is likely to face charges of non-compliance. Implementation is likely to be smoother if both parties negotiate in a spirit of cooperation, with a "win-win" outcome in mind.

    Consider the agreement as an outline of commitments 

    Doing business on a global scale requires agreements that are attainable and workable. The agreement should be seen as an outline of commitments, detailing major responsibilities of each party as specified in the contract. When a party is no longer in a position to service the contract due to unforeseen conditions, that party should communicate and share with the other side its difficulty.

    In international business, where many parties may be involved in carrying out a transaction, numerous problems could arise that call for immediate action. In many cases, a simple modification such as rescheduling shipments or extending payments could be enough to ensure implementation without major renegotiations.

    Monitor continuously 

    Too often, at the time of closure parties assume that the negotiations are over and both sides can look forward to a successful outcome. In reality, negotiations are only beginning. A negotiation is not completed until the agreement is fully implemented. With so many unexpected changes occurring in the global marketplace, smooth implementation is the exception rather than the rule.

    Continuous monitoring of the agreement is essential. Although the main purpose of entering into a business deal is to make a profit, frequently contracts turn out to be unprofitable. The parties may also have different interpretations about their respective responsi-bilities.

    Account for cultural differences 

    Doing business across diverse cultures requires extra care in ensuring full understanding of the agreement's content. For instance, in countries where contracts are lengthy and detailed, little or no flexibility is allowed. In such cases, all possible events that could affect the deal over the period of the contract are identified and appropriate clauses included in the agreement. To avoid deviations, penalties for non-compliance are built-in from the start to ensure strict adherence.

    Some cultures are more apt than others to consider the contract as the beginning of a business relationship. In these cultures, the possibility of reopening the discussions is rather high. As interpretations can be different due to cultural ways of viewing the negotiation process, negotiators doing business across diverse cultures seriously consider the follow-up phase and eventual post-negotiation discussions.

    A question most experienced international negotiators ask themselves at the time of closing is "What does the contract mean to the other party?" In other words, is it the beginning or conclusion of the negotiations? Another key question to be raised toward closure is "how much is the other party committed to the agreement?" Answers to these and other questions should alert the negotiator to potential problems likely to arise during the life of the contract (see box, left).

    Overcoming fear to reopen negotiations 

    More often than not, companies underestimate potential problems which call for renegotiating specific terms contained in the agreement.

    When something goes wrong, it is only natural that parties get together to resolve the problem. Surprisingly, the party at the source of the problem is generally reluctant to seek changes or revisions. Often the persons in charge of implementation are afraid to address the issue for fear of rejection.

    When a business deal is developed in a spirit of cooperation, one side may consider it inappropriate to ask the other party for special conditions that may be interpreted as taking advantage of the relationship. Fear of receiving a negative answer can lead to missed opportunities to improve the business relationship and fulfil the agreed terms.

    In some cultures, fear of embarrassment is so great that indirect "signals" are sent to indicate the needs for revisions. For instance, a sudden lack of communication, vague answers or inability to

    contact the other side including periods of prolonged silence could suggest a problem.

    As soon as one party sees a problem - for example, production of inferior quality, or inability to meet delivery dates - it should take the initiative to contact the other side. It is much easier to take corrective action from the outset by recognizing the problem and suggesting ways of resolving it. Sometimes, lack of international business experience or insufficient knowledge of stringent market specifications may mean that suppliers are not fully aware of what is required to produce top quality products.

    Strict adherence to delivery is another sensitive issue, with firms relying on just-in-time inventory. Concerns with delivery are likely to increase in the years ahead, as more and more enterprises outsource parts of their production and/or services. To minimize problems, maintain open communication lines, make contacts early and be willing to discuss problems openly should they arise.

    A real-life example is the case of a furniture importer, who received in the month of December a large shipment that exceeded the contract agreement. This unexpected shipment resulted in extra storage costs, handling charges and other indirect expenses. Instead of lodging a complaint or sending back the extra goods, the importer contacted the supplier immediately. It turned out that this huge shipment was initiated by the export managers' expectations of a large Christmas bonus. After hearing the views of the supplier, the importer explained the economic hardship caused by this shipment and requested compensation on future orders. By doing so, the importer did not antagonize or criticize the other party, but tried to find a workable solution, while expressing a commitment to continue the business relationship over the long term.

    When to renegotiate 

    Contracts may be renegotiated either during the life of the agreement or after its termination.

    Intra-deal 

    The most common type of renegotiation occurs within the life of the contract, due to the failure of one side to fulfil its obligations. In such cases, known as intra-deal, one party seeks relief of its commitments. Another example of intra-deal negotiation is when one side wishes to extract itself from the agreement due to the inability to meet its commitments. This type of renegotiation is often found in small- and medium-sized firms entering foreign markets for the first time. Their limited capacity to meet high-quality standards, produce large quantities and meet strict delivery dates forces them to renegotiate the contracts or to request cancellation.

    Intra-deal renegotiations are smoother if the initial agreement contains a clause that permits them. Acceptance at the outset that specific clauses may need to be renegotiated due to unforeseen events will go a long way towards reducing tensions and misunderstandings.

    Scheduled reviews 

    The opportunity to renegotiate may also arise when both parties establish specific dates or time frames to review an agreement. For example, when a long-term agreement is put in place, both parties may decide to meet regularly, at specific times. To avoid unpleasant situations, consider meeting at regular intervals to review experience gained so far. These meetings should also identify potential issues that may arise from new market conditions.

    After the contract expires 

    Renegotiations can also take place after the agreement expires. There are instances when one or both parties may decide to wait for the expiration of the contract before re-entering into new negotiations. Post-deal negotiations may reflect a change in existing business strategies or may indicate that one party is no longer convinced of the benefits in continuing the business relationship.

    In any of the three types of renegotiations, open communications and continuous monitoring are critical to success. Flexibility, commitment and recognition that renegotiations may be necessary should be part and parcel of a negotiator's strategy.

    It is unrealistic to assume stability of the contract in a rapidly changing global setting. Business executives negotiating international contracts realize that on-going discussions and consultations are necessary ingredients to successful outcomes.

    Reducing the need to renegotiate 

    In today's dynamic global market, it is difficult to avoid renegotiating business agreements. It is possible, however, to reduce the frequency and extent of renegotiations. Clarify all the major issues, introduce penalties for non-compliance, insist on regular meetings to monitor implementation and explain the negative impact problems can have on future business opportunities when negotiating. This should alert both sides to their responsibilities and risks.

    Doing business in different parts of the world requires alternative negotiating approaches. In some cultures, negotiations don't end with the signing of an agreement, but continue throughout the duration of the relationship. To do business in these environments, the contract should include built-in early warning signals to detect the presence of problems. Instead of insisting on a detailed, lengthy contract leaving nothing to chance, a shorter agreement acknowledging the possibility of eventual amendments may be more appropriate. Penalties or similar deterrents hould be included, however, to avoid potential abuses in critical areas of the agreement.

    For instance, when a manufacturer requests an order of spare parts that is larger than the supplier expects, the supplier should consider it as a warning signal. Perhaps the equipment is not used properly, or maintenance is inadequate. In this example, the supplier could review clauses concerning warranty, responsibility for repairs, supplying spare parts and other matters relating to equipment breakdown. The manufacturer could offer to train operators on proper use of the equipment, adapt the operations manual to local conditions, translate the manual into the language of the user or agree to participate in the maintenance of the equipment during the initial installation phase. By taking these additional precautions, both sides can look forward to the execution of the contract with minimum difficulty.

    Build in renegotiation costs 

    Experienced international business executives include potential renegotiation costs in their final offer. As renegotiations can be costly in time and money, there are ways to build in additional costs in the original offer to absorb such future expenses.

    One possibility is to separate implementation into several stages, with payment after successful execution of each stage. This type of agreement is appropriate for lengthy and complex contracts, such as initiating a joint venture.

    The most effective preparation requires access to accurate information of all past transactions. This helps parties reduce a substantial amount of time in blaming each other for deviating from the agreed terms.

    The introduction of penalties for non-compliance is another way to discourage the other party from deviating from the initial agreement. Excessive attention given to penalties by one party, however, may indicate a lack of confidence in the other party and could lead to mistrust and resentment. This is hardly the basis for developing a stable business relationship in an ever-changing competitive environment.

    Renegotiation as the norm 

    With intense competition, greater outsourcing and the increase of electronic commerce, renegotiating business contracts is likely to become the norm rather than the rule. Instead of looking at the implementation stage as a separate entity, successful business executives consider the follow-up phase as an integral part of negotiating strategies.

    Renegotiating business deals may be necessary and could prove to be more profitable in the longer term even if it offers some temporary disadvantages. Global managers know that relying on the contract alone is unlikely to resolve pending issues. Personal relationships and mutual trust are essential to build a solid foundation for repeat business in a highly competitive global environment. Both parties should keep in mind the long-term benefits of a business relationship when renegotiating existing agreements.

    Experienced negotiators keep negotiating even after reaching agreement. In the end, satisfying and retaining current customers - by working together in solving problems through renegotiations - is less expensive and time consuming than seeking new partners or entering into costly litigation procedures. Skilled executives have concluded that it is not the agreement alone that will keep the business going, but the strength of the relationship.

    Claude Cellich, Vice-President of the International University of Geneva, formerly served as ITC's Chief of Human Resource Development. He can be contacted at info@iun.ch 

    Reducing the need to renegotiate 

    A checklist for international business agreements 

    If you can safely answer "yes" to nearly all the questions below, you are close to entering into an agreement that is unlikely to require serious renegotiation. For those questions where the answer is "no", however, you need to conduct additional discussions. When you can answer all the questions with a "yes", you are ready to conclude the discussions.

    • Does the agreement fit the overall long-term business strategies of both parties?

    • Will both parties benefit from the agreement? (Is it a win-win business deal?)

    • Are you convinced that the other party is fully committed to implementing the agreement?

    • Will your management support you unconditionally in executing the contract?

    • Are you sure that the other party has the capacity (managerial, technical and financial) to fulfil its obligations?

    • Have you built in additional costs to cover eventual renegotiations in your final offer?

    • Have all major potential problems been identified, discussed and resolved?

    • Do you consider the agreement fully enforceable?

    • Are the penalties for non-compliance sufficient to ensure full adherence to the contractual terms?

    • Has a feedback mechanism been put into place to monitor the agreement's execution?

    Renegotiations 

    Key points to remember 

    Before the contract begins

    • Consider negotiations as a dynamic process, requiring constant monitoring of the agreement.

    • Build extra costs into the contract to cover future expenses related to renegotiations.

    • Make the implementation phase an integral part of your overall negotiation strategy.

    • Encourage a healthy relationship between the parties, as it is the best guarantee for a lasting agreement.

    During the contract 

    • Prepare for the possibility of renegotiations - maintain records of all transactions, from initial discussions to the actual execution of the agreement.

    • Remember that agreements mean different things to different cultures, requiring flexibility, understanding and patience.

    • Don't blame the other party of any wrongdoing until you know all the facts.

    • Don't wait for problems to develop into major ones before considering renegotiations.

    If renegotiations appear possible 

    • Before beginning renegotiations, consult everyone involved in the original negotiation, as well as those responsible for implementation.

    • Be sure you clearly understand the factors which trigger the reopening of negotiations.

    • Foster constructive discussions between concerned parties, which is preferable to legal recourse.

    • Keep long-term business objectives in mind when renegotiating.

    • Encourage steps that ensure all parties are satisfied, even if it means renegotiations. Higher profits come from satisfied parties through repeat business and referrals.