Contract Management: How to Use "Carrot and Stick" to Motivate Others

Have you ever heard of the “disappointment gap”? This is the term given to the difference between what was promised by a supplier and what was delivered under the contract. And which of us hasn’t experienced that?

This article explores what we can do about an underperforming contractor by using the “carrot and stick” approach, as well as some other useful tips and tricks to get the most out of your suppliers.

What is the “carrot and stick” approach?

Generally, the term “carrot and stick” refers to using a combination of positive and negative incentives to bring about desired behaviour. This approach can be applied to most professions, including contract management.

If you read the terms and conditions of a contract, it’s not too hard to find the “sticks”. Many contracts have clauses that mention negative consequences for the supplier if they fail to do something. An example of this is the damages clause. The supplier will be liable to compensate you if they don't do what they promised to do in their proposal.

The reality is that most contracts have more sticks than carrots. Carrots are the incentives that motivate the supplier to meet the agreed standards or to put right what is not working. The most common example is the contract extension. If the supplier performs well, the contract term may be extended at the discretion of the client.

Why do we need to motivate suppliers?

There is an argument that we are paying suppliers to do the work, so why should we need to motivate them? More than that, they promised to meet certain standards in their proposal.

There are three main reasons you should challenge this thinking:

1. The interest in your account is greatest at the proposal stage. It is perhaps understandable that managerial attention reduces during the contract.

2. Maintaining service standards is hard. No one performs at 100% of their capability all of the time.

3. Suppliers usually have multiple accounts, and however ‘special’ we may like to think we are, we are likely to be one of many. Why should we be treated differently?

How to use the most common incentives (The carrots)

Let’s say that the contract has a primary term of two years, with two potential extensions of one year each. There is no question that the supplier reads this as a four-year contract!

To make a contract extension clause more effective as a motivator, schedule a performance review meeting after 17 months of the contract starting. Make it clear to the supplier that the meeting is a “go or no-go” meeting. The outcome will be a recommendation whether to exercise the option to extend or not.

If the decision is not to extend, there will be six months to complete the re-tendering of the contract. This will focus the supplier on meeting KPIs and also empower you in day to day performance management.

Incentives that are harder to use

Which of us has not heard the phrase “win-win”? In managing a contract, a potential incentive is a bonus that is earned by the supplier if they meet certain defined performance standards. As an example, if a supplier is tasked with maintaining a minimum of 95% uptime and they achieve that, they get paid their normal rate. However, if they achieve 98% uptime, they earn a bonus sum.

Whether this is a “win-win” depends upon a number of things. Is the extra uptime valuable to the client? Is the amount of the bonus likely to be of interest to the supplier? If 98% uptime is valuable, why have we set the minimum at 95%?

Not all contracts lend themselves to “payment by results” clauses. Such clauses are often easier in principle than in practice. “Win-win means the supplier wins twice!” is a cynical interpretation, but to make bonus schemes work in practice requires a lot of time and goodwill from both parties.

How to use the most common disincentives (The sticks)

Most contracts include the following clauses; escalation, damages, insurance, warranty, liability, indemnity and termination clauses. The reality of most of these is that they are relatively difficult to apply in practice. Most are only relevant when performance is a major issue, and require the involvement of colleagues in the legal department.

The clause that is most likely to be in your control is the escalation clause. When do you trigger this clause? One suggestion is that if standards are not met in a period (whether a month or a quarter) let the supplier know that if performance does not meet standard by the end of the next period that you will invoke the escalation clause.

This gives you the chance to involve other managers to address the performance issues and shows that you are actively managing the contract.

“Termination for convenience”: Is it actually convenient?

There is a trend to supplement traditional termination clauses with “termination for convenience” clauses.

In the case of the traditional termination clause, the client has to prove a breach of contract, typically involving a “show cause” process. There is no such requirement with termination for convenience clauses. The clue is in the name.

The challenge with these clauses is that changing suppliers is never convenient. There will be a complex process of migration to a new supplier, and there is no guarantee that other suppliers will perform any better.

Termination is the ultimate sanction, but it is also the last resort.

Other ways to motivate your suppliers

There are some practical behaviours that can help you motivate suppliers. Firstly, agree with the supplier on how performance will be measured and track their performance. The simplest thing that motivates the supplier is the knowledge that you are monitoring their performance.

One tip is to track performance monthly, and review the performance at least quarterly. Look at the trend in performance, rather than monthly results (unless performance drops below the agreed standard).

Giving and receiving feedback is another behaviour that can motivate the supplier. If a supplier meets the required standard 19 times out of 20, what might we say to them? Many clients will ask “what went wrong?”, which is not always the most productive approach.

Instead of doing that, you should ask “What can we do in the next period to get 20/20?” Focusing on the future, rather than the past, helps explore what the supplier plans to do differently. Otherwise, things will fall into defensive explanations of past lapses.

The reality is that commercial opportunities (‘carrots’) are often stronger motivators for suppliers than contractual sanctions like damages clauses or termination clauses (‘sticks’). So if your contract does have an optional extension of term, schedule a formal review process to make this clause meaningful.

The vast majority of optional extensions are granted, but this is arguably because the client has no bandwidth to manage the renewal of the agreement. not a testimony to the performance of the supplier.

Want to learn more about supplier relationship management (also known as vendor relationship management)? Read our article on the best practice tools and methods for FY22.

Solutions that help contract managers do their job

The reality is that the urgent drives out the important. This is easy to identify as a risk, but hard to avoid.

One way to deal with this is to schedule reminders of key contractual milestones, which help a contract manager be more proactive. Many contract management solutions automatically generate reminders of key events.

These reminders prompt the supplier to submit performance data, or the contract manager to schedule a review meeting. Because these are automated, the chance of human error is reduced.

When it comes to analysing performance, a visualisation tool goes a long way. Looking at a row of numbers is not as powerful as graphing the trend. Spreadsheets can do this, but analytic solutions integrate dashboards to allow monitoring of multiple dimensions at once.

Tracking contract variations can be hard without a contract library. “Do you have a copy of the current contract?” is a question that can often result in people rummaging through old emails and filing cabinets.

This can be averted by using a single creation, approval and execution solution. These solutions do more than drive simplicity and lower corporate risk - they also increase productivity and reduce the cost of manual contract management.

To learn more about contract management solutions, read our article: The Ultimate Guide to Contract Management Software.

Looking for a contract management solution?

VendorPanel can help you improve visibility and tracking of your contracts, speed up process times and approvals, and help you manage supplier performance, compliance and risk. Click here to find out more.