Strategic Economic Relationships: Contracts and Production Processes

By Robert D Hughes

It matters to an organisation, whether a buyer or supplier, that appropriate contracts are used. There are specific conditions that determine the appropriate choice of contractual relationship. These conditions include the production processes used by the buyer and supplier. Certain contract types are best suited to specific production p

• Language: English
• Publisher: Hughes Consulting Limited
• Release date: Jul 30, 2021
• ISBN: 9780473577216

Robert D Hughes

Robert Hughes has more than 25 years of experience as a strategic management consultant. He is principal of the consulting firm Hughes Consulting Limited and former partner in the multinational business advisory firm KPMG. Hughes Consulting counsel significant organisations in the private and public sectors. Robert holds a Doctorate and professional credentials as a: Management Consultant, Information Technology Professional, Engineer, and Manager. Robert brings experience in information, communications, logistics and infrastructure networks which contribute to, and in turn are affected by the digital economy.

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Strategic Economic Relationships:

Contracts & production processes

Robert Hughes

A publication in the Creating Business Angles Series.

Strategic Economic Relationships: Contracts & production processes 
by Robert Hughes

Published in 2021 by Hughes Books an imprint of Hughes Consulting Limited NZ Business number 9429038579288 UK Registered number 05067369

www.HughesBooks.info

Alpha Edition © Robert David Hughes 2021

This book is copyright. Apart from fair dealing for the purpose of private study, research, criticism or review, permitted under the Copyright Act 1994, no part may be reproduced by any process without the prior permission of the copyright holders and the publisher.

ISBN 978-0-473-57720-9 (Paperback)

ISBN 978-0-473-57721-6 (ePub)

A catalogue record of this book is available from the National Library of New Zealand Te Puna Matauranga o Aotearoa.

Introduction

Role of contracts

Businesses exist to exploit opportunities for profit from economic exchanges. Contractual agreements are the economic relationships governing exchanges between parties. Contractual relationships exist for all the contributors to a business’s profit. Profit is generated by, first, providing high value-for-money products to purchasers, and the selection of an appropriate contract is important for the sale of products. Second, by selecting a set of inputs to support an efficient production process and economical purchase of inputs using appropriate contracts. Contractual relationships enable a rich variety of business relationships, such as collaborative partnership arrangements. Here, contractual relationships are important to align incentives, and protect and give title to resources. Third, by making valuable scarce resources from a highly productive production process delivering planned outputs. Contractual relationships enable businesses with different core competencies to parlay these by collaborating by pooling their resources to develop new opportunities, which would not otherwise be accessible, through strategic alliances. Fourth, by providing risk mitigants to ensure that business plans are met, and strategic options to provide the resilience for on-going profitability. The use of contracts may be central to achieving these ends, for example, by enabling risk to be passed to a third party. Finally, by enhancing business value through financial management, and contracts are required to realise this value. As a simple example, the use of leases that separate the right to use from the underlying ownership of the freehold create a new financial asset.

Additionally, the existence of contracts and contractual relationships themselves provide business opportunities at all levels of market play, for example: to lawyers and subject matter experts to write specifications, monitor performance, and resolve disagreements. It is also worth pointing out that because some forms of relationship are widely used or even standard in an industry, this provides methods of gaming the established place of contractual relationships. For example, to glean, by inference, information held by other parties, situations can be engineered to force a behavioural response from suppliers to reveal confidential knowledge they possess. Tender processes, and pilot projects are common ways to get suppliers to share proprietary information.

Products and coordination mechanisms

Products are exchanged between parties in the context of the place in the value network, and splice these parties together in a contractual relationship. The nature of this splicing is described by the product form, type and coordination mechanism – which are elements of the product specification and the terms and conditions of the contract. Products take the form of access to a capacity to have some function performed, a capability to perform some function, or a complete product. Complete products are a catchall for all remaining products that includes commodities, other tangible assets, financial assets such as a promise to pay, and other intangible assets such as intellectual property rights.

Products are exchanged according to the coordination mechanisms used between the parties. Many products involve the supplier producing products as a precursor to offering them for sale in the market, this is push/push coordination. This occurs, for example, in the production of perishable produce or freight shipping that is then offloaded to the market, and the coordination problem is solved by price. This is only one of the four ways businesses coordinate exchanges. Push/pull coordination involves the production for inventory, that is subsequently drawn down by buyers. Mass produced products use this form of coordination. Other examples are where capacity or capability are put in place just in case they are required, such as telecommunications restoration capacity, and stand-by electricity generation. Pull/pull relates to customised production when a product is produced to meet a custom order, such as software developed to meet a buyer’s unique specifications. Finally, pull/push production is contract production for a buyer’s inventory, from which the buyer then draws down their requirements. Contract apparel manufacturing uses this coordination.

The coordination mechanism is an integral part of the production process. Contractual relationships echo the rules by which this element of the production process must conform. The important implication from this is that changing the contract type can necessitate significant changes to production processes used by either or both purchaser and supplier.

Exchange, interface, and application products are the three product types. Exchange products provide a high degree of readiness for use (through for example, custom and standardisation of specification) and transfer decision-making rights to consume or use, if not entirely, then at least for a period. A unit of gas or a gas appliance are examples of exchange products. Interface products are associated with the interaction between systems and processes, or channels for delivering exchange products. Frequently, interface products reduce transaction costs and increase access. Interface products are sometimes bundled with an exchange product and may not be offered as a stand-alone product, for example, a connection to a gas distribution network is an interface product, bundled with the purchase of gas. Application products extend the use of the provider’s knowhow, systems and processes to new adjacent workflow processes or value networks by providing extra functionality. The annual certification of appliances connected to a gas network is an example of an application product. Interface products frequently provide access to capacity. Complete products are frequently exchange products. Applications products frequently provide access to capabilities.

Generic contractual relationships

Product exchanges use a range of different contract types. These are categorised into five generic contractual relationships: In-house-provision; preferred-supplier; selected-supplier; and buy-in.

In-house-provision, referred to as a unified contract, has the organisation making the necessary investment and other commitments for In-house production of products. In-house-provision is associated with the creation of scarce