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Total Contract Value (TCV): price paid or value derived?

Every business relationship is a contract and every contract has a value. Generally speaking, this value is understood to be the final price negotiated/proposed for a contract over the Contract Term. So, everyone in the Legal, Sourcing and Business community see it as some financial figure $ XYZ paid to the Supplier. Even majority of the Commercial Contract Managers, who are entrusted with the task of deriving a value out of the contracts they manage, think it as price paid. They have also lost the forest for the trees in the pursuit of tactical operational requirements rather than organizational strategic imperatives. All supplier governance initiatives tend to revolve around cost centres and spend values. Most people do not see anything wrong with the approach for they are fine with SLA controls for Performance Management and collecting few artefacts from the Supplier for the sake of Risk Compliance.

Then the legendary Harvard Business School marketing Professor Theodore Levitt words echoes in the ever-shrinking Global village, "People don't want to buy a quarter-inch drill. They want a quarter-inch hole!” Almost 20 years ago, Rolls Royce transformed its support and maintenance contracting model for engines used in commercial jets. Instead of charging customers for repairs, maintenance and the provision of spare parts, customers paid a fee per hour based on the number of hours of flying time for an engine. The company recognized that by focusing the contractual arrangement on the real underlying need of the customer – keeping a jet in the air – it could deliver greater satisfaction to the customer whilst at the same time reduce inefficiencies and increase its own revenue. This contractual structure has since become the industry standard in commercial aviation.

As a result, few of the forward-looking members of Contracting Fraternity started challenging the status-quo a long time ago and some of the developed world govt. procurement frameworks have reaped dividends of this approach. After all, contracts are just vehicles and they are successful to the extent they have been able to deliver the business outcomes, which they were entrusted to deliver. Nevertheless, in the private sector still lot of time is spent on ‘how’ rather than ‘what’. During the pre-execution stage so much time is spent on agreeing to ‘how’ of Goods/Services to be delivered. Lack of trust impels both the parties to embed so much actionable intelligence into it for post-execution governance that it sets the navigational compass in the wrong direction altogether. This adversial approach wherein focus is just about attributing control and risks leaves little time to think about the holistic ‘what’. Even in cases, where contracts are outcome-based and lot of time was spent on clearly defining the business outcomes and linking the payment terms with the same; there tend to be post-execution governance issues because the conventional contracting inertia rampant everywhere refuses to move.

I think time has come when we start focusing on collaboration, co-creating and deriving the value i.e. the business outcome out of the pieces of papers called contracts rather than getting entangled in financial transactional monitoring. The distrust between Supplier and Customers needs to pave way to greater transparency into each other’s day to day affairs rather than periodic report submissions to monitor risk. In these times, when there are so many disruptive technologies at play, a clear focus on achieving the business outcomes in partnerships with Suppliers has significant advantage to stand out of the crowd.

To summarize, we need to re-define and re-think about Total Contract Value every time we think of a Contract. It is more intangible than we think!

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