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Contracts and Risk—the Big Picture

WHY DO COMPANIES MAKE CONTRACTS?

For traditional thinkers, contracts are legal tools. They are about promises that the law will enforce. Contracts create rights and responsibilities, and the law will provide remedies if contractual promises are broken. For the purposes of this book, such a view is too limited and too legalistic.

Experience and research prove the growing importance of contracts for today's extended and interconnected enterprise. Companies do not make contracts just for the legal department or future litigation; they make contracts to enable business to reach business objectives. Apart from being legal tools, contracts are management tools, not only in terms of risk but also in terms of opportunities for value creation, successful inter-firm collaboration, profitability, and competitive advantage.1 1

See, for example, Siedel, G. and Haapio, H. (2011) Proactive Law for Managers: A

Hidden Source of Competitive Advantage. Farnham: Gower Publishing, and Argyres, N.S. and Mayer, K.J. (2007) Contract design as a firm capability. Academy of Management Review, 32(4), October, 1060-77.

Today's business takes place in an increasingly complex, global and networked environment where contracts play a key role. Major business decisions crystallize into a contract or agreement of some sort. Projects ranging from construction and equipment supply to It acquisition and outsourcing all involve contracts, both on the sell-side and on the buy-side. Collaborative R&D, selling, procurement, finance, invoicing, change control, claims and many other fields operate within the framework of contracts.

In collaborative ventures and large projects with multiple suppliers and subcontractors, the interfaces among the various providers must be managed well. Required actions must be taken at the right time and in the right place by one's own organization and by the other parties. The required coordination, communication and control can be provided by contracts.

When used as managerial tools, contracts can help to coordinate and manage business, projects, and commitments; to create, allocate and protect value, whether tangible or intangible (such as intellectual property rights); to communicate crucial information inside and between organizations; to motivate; and to allocate decision and control rights. Contracts also enable companies to share, minimize and manage risk; to prevent problems; and to keep problems from developing into disputes. Where a dispute is unavoidable, contracts provide evidence of what has been agreed and an effective means to control and resolve the dispute. The main functions of contracts can be summarized as follows:2 [1] [2]

Contracts are tools for:

  • 1. Managing business, projects and commitments
  • 2. Creating, allocating and protecting value
  • 3. Communication, coordination, motivation, and control
  • 4. Sharing, minimizing and managing risk
  • 5. Problem prevention, dispute avoidance and resolution

Good-quality contracts serve as visible scripts for parties working together.

One way to look at contracts is to see them as visible scripts—blueprints, roadmaps or sets of instructions—for collaboration. Contracting processes and documents can help make requirements, roles, and responsibilities—along with related risks—visible. In this way, contracts can serve as tools for articulating and aligning expectations and planning and managing business, projects and relationships. The chapters that follow will show how businesses can use their contracts to actively manage risk and the realization of benefits.

  • [1] 2 Siedel and Haapio 2011, p. 118. originally published in Haapio, H. and Haavisto,
  • [2] (2005) Sopimusosaaminen: tulevaisuuden kilpailutekija ja strateginen voimavara.[Contracting capabilities: Emerging source of competitive advantage and a strategicresource]. Yritystalous—Leader's Magazine, 63(2), 7-15.
 
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