Transparency is coming to B2B commercial contracts
Markets have evolved dramatically over the centuries with the world moving from traditional markets like souks and bazaars to eCommerce. The differences in efficiency between the two are staggering with buyers and sellers now enjoying faster transaction cycle times, lower administrative costs, and, most important, greater value derived from their purchases and sales. A number of factors contribute to this development.
Perhaps most significant is that buyers in traditional markets lacked ready access to critical information. Goods had no prices on them, lacked labels showing their contents, etc. Thus, buyers had to engage in the laborious process of physically visiting the market and attempting to gain information by learning the local practices and customs, assessing sellers’ reputations, and determining what the market price was for an item.
In contrast, today’s electronic marketplaces are just a few clicks of a mouse from one’s home or office, where buyers can find a complete inventory of potentially suitable products and compare just about every aspect of them side-by-side.
Although the amount and quality of information may reduce sellers’ pricing power, it also reduces the likelihood of having to deal with an unsatisfied customer and thus significantly increases the likelihood of customer referrals and low-touch repeat business. eCommerce also tends to shift competition to the thing, or combination of things, that matter most to the individual end-user, such as product features and quality, service levels, return rights, and delivery times.
The role of contracts in markets
Contracts play a key role in the efficiency of markets. If buyers and sellers lack confidence that (a) they know what the terms of the deal are and (b) the terms will be enforced, their willingness and ability to engage in commerce will be compromised significantly.
In modern consumer markets (B2C), buyers have gotten through this issue and are willing to quickly complete transactions either without a contract at all or by click-accepting whatever the vendor is offering.
The world of business-to-business (B2B) transactions operates differently. B2B transactions commonly involve large purchases that may involve products that are less standardized or bespoke, and often have a direct impact on the buyer’s ability to deliver its products, comply with applicable regulations (e.g., data privacy), and run its business effectively. These factors spawned a souk-like marketplace for legal terms and conditions, with the souk being controlled by a guild of legal and procurement professionals. Like a souk, the marketplace for legal terms and conditions historically has been characterized by a lack of transparency, with contract terms often being kept confidential and no easy way to determine what market is on any particular term.
Although this opaque approach to contracting has been profitable for the guild, it has been a real drag on commerce. Data collected in 2017 shows that most companies spent an average of more than 21 days to complete a medium-size commercial contract, incurring a cost of approximately $23,000 just to get the contract done. See Bryan Ball, Contract Management: How the Best-in-Class Maximize Their Potential (Aberdeen Group, July 2017); Tim Cummins, The Cost of a Contract (IACCM, November 20, 2017).
What this data doesn’t show is how many transactions ended up getting aborted due to the difficulty of completing the contract. It also doesn’t show the “value” that the parties derived from haggling over the terms for days. Yet, every general counsel I know who has looked into this has concluded that the vast majority of negotiated changes have no substantive impact whatsoever.
The impact of eCommerce on contracting
The traditional souk-like marketplace for legal terms is in direct conflict with the transparency-driven efficiency of modern electronic marketplaces. This conflict is well known, and both marketplace operators such as Amazon and individual sellers have been making efforts to address this issue. To date, however, no one appears to have cracked the code in a widespread fashion. There have, however, been some significant developments and some signs that transparent and efficient competition on legal terms may be right around the corner.
One significant development is the rise of collective bargaining. By this, I mean the adoption by industries of standard terms and conditions that will govern all contracts. This is most prevalent in situations where parties with equivalent bargaining power have a business necessity to engage in a large volume of transactions in tight time frames. Financial trading is a good example of this, with the financial services industry moving to standard agreements in a number of areas. Where this happens, the parties are effectively opting out of the souk for legal terms.
A third development lies in the recent advances around machine learning and data analytics. The ability for parties to gather and analyze large bodies of data is at an all-time high. Multiple companies are starting to apply these capabilities to assessing commercial contracts, offering buyers and sellers a dizzying array of contract lifecycle management tools (e.g., Apptus, SAP Ariba), contract sifter and analysis tools (e.g., Kira, Seal), contract analysis services (e.g., Knowable, TermScout), that can help provide companies with actionable business intelligence.
These developments indicate that commercial contracting could be teetering on the edge of transformation to a fully functioning modern market.
Is the end of the souk in sight?
In extolling the virtues of free markets, economists invariably assume that all parties have perfect information. As shown by Joseph Stiglitz’s Nobel-prize winning work, the real world is full of information asymmetries that cause the market not to work so efficiently. Recent developments show that the marketplace for contract terms may be on the cusp of a transformational shift toward greater transparency similar to what has occurred in the broader electronic marketplace.
One example of this comes from data recently released by TermScout, a company founded by IFLP graduates that will launch its first commercial products in January 2021. See Post 157 (discussing formation of TermScout and its connection to IFLP). [Full disclosure: I am a TermScout investor and serve part-time as its Chief Product Officer.]
This dataset analyzes the Platform as a Service (PaaS) offerings from ten cloud companies: AWS, Microsoft, VMware, IBM, Oracle, Snowflake, Digital Ocean, AppHarbor, Red Hat, and Google. For each of these contract offerings, TermScout abstracted 600+ data points and scored them using a rating algorithm to generate customer favorability scores for both the overall contract and for individual contract topics (e.g., limits on liability, indemnification). This data set shows signs of evolution toward more robust and transparent competition, but not always in the ways that one might expect.
At the contract level, the companies analyzed showed a broad range of distribution, varying from Extremely Unfavorable to the customer all the way up to Customer Favorable.
This distribution is not surprising in and of itself. What was surprising is which companies fell where. I had expected the smaller companies having less market power to be the ones offering the more favorable terms and the market giants to be closer to the bottom of the pack. In fact, a large percentage of the smaller companies were clustered at the bottom of the stack, and five of the seven biggest companies were ranked as balanced or higher.
Clearly, a company’s size is not a reliable indicator of how customer-favorable its terms are likely to be. Indeed, this small data set indicates that large companies (as a whole) may be making a greater effort to facilitate business transactions by offering terms that are at-market, or better.
This level of competition is healthy for buyers. Unless a buyer is locked into a particular vendor due to other competitive factors (product features, price, availability, etc.), the buyer should easily be able to secure terms that are at least balanced, if not favorable.
The dataset revealed that competition on terms was not uniform across the different topics, with some topics showing near uniformity in the vendors’ positions and others showing high levels of differentiation.
|Largely Undifferentiated with Outlier(s)
Two aspects of this data distribution warrant further comment.
First, in all four of the topics where the vendors offered highly undifferentiated positions and in three of the four topics where vendors offered largely undifferentiated positions, the vendor’s offering was at least balanced. One possible implication of this data is that the market for these terms is reaching equilibrium and that standardization in these areas may have largely occurred.
Second, robust competition on terms exists in 10 of the 17 different topics reviewed by TermScout, with a number of these topics being among the most commonly negotiated contract items. The wide range of positions offered on these topics likely supports the all-too-common scenario where each party to a negotiation asserts with absolute conviction (but no real data) that market is what that party says it is.
Yet, we are finally reaching a point where parties have the ability to instantly point to definitive public data regarding what market actually is. This is likely to cause more aggressive vendors to feel pressure to move to the middle (or more) in order to avoid competitive disadvantage in the market, further driving standardization. Further, this shift should only accelerate if the operators of electronic marketplaces start publishing comparisons of the contract terms offered by their vendors akin to what they do for product features.
In the meantime, astute buyers who aren’t bound to a particular vendor for other reasons should be able to get at least balanced terms on most topics and astute sellers should be able to gain a competitive advantage by publicizing the reasonableness of their terms.
The marketplace for contract terms remains well behind the broader marketplace for goods and services in terms of its adoption of efficiency generating practices. Current commercial contracting practices represent a major drag on overall economic efficiency and are drawing significant attention from buyers, sellers, and third-party data and tool companies.
Despite the broad interest in modernizing the marketplace for legal terms, real change is unlikely to occur unless and until the participants in that marketplace have access to better information. The tools and datasets necessary to generate the information required to generate a base level of transparency as seen in other aspects of the market (feature sets, pricing, etc.) are maturing rapidly.
Whether a party obtains its information by running AI tools against its own data set of contracts or by subscribing to public data sets, they are unlikely to tolerate the market inefficiencies that get obscured by the current lack of available information. The transparency movement now seems to have enough momentum behind it to be unstoppable, portending even greater changes to the way that commercial contracting occurs in the future.