Out-Law / Your Daily Need-To-Know

The rise of behavioural contracting

Out-Law Analysis | 07 Sep 2020 | 7:25 am | 2 min. read

As businesses plan to rebuild resilient supply chains in the wake of the Covid-19 pandemic this brings about opportunities to think differently about what the contracting model looks like. There are valuable lessons for manufacturers to learn from the recent pandemic. These will help ensure that the shock absorbers are in place for any future disruption – whether that be a similar global event or caused by economic or political pressures.

This is part of a series, find out more about creating a resilient supply chain regime.

Will this be the rise of behavioural contracting?

Behavioural contracting incentivises the supply chain to meet the aims of the project. Ultimately everyone in the supply chains wants to ensure that the product gets to the end customer on time and at the right quality. If this happens, everyone wins. The customer is happy, there is brand loyalty and repeat business. So why do we not incentivise the supply chain to achieve this every time?

Measuring an efficient and effective supply chain can be complex. However, the ultimate measure is whether the customer experience is maintained throughout regardless of any turmoil affecting the supply chain. If this customer satisfaction can be maintained then the supply chain is operating effectively and is truly resilient.

Traditional linear models

Traditionally manufacturing operates on a linear supply chain model. The original equipment manufacturer (OEM) contracts with a tier 1 supply who in turn contracts with a tier 2 supplier, and so on. When all goes well the goods pass up the chain. When things do not go so well the liability passes back down the chain, often by the way of liquidated damages.

This means that if the tier 3 supplier is struggling to meet its commitments it is not incentivised to tell the remainder of the supply chain because there is a risk that it will suffer liquidated damages as a result. Equally the OEM does not have sight that there is an issue until it is too late to do anything about it. This impact can be significant if it leads to the stopping of a production line which OEMs endeavour to avoid at all costs.

How do behavioural contracts differ?

A behavioural contract looks at the supply chain as a whole and focuses on achieving better outcomes. The outputs and objectives of the overall project or supply chain are the end goal and incentivises everyone to achieve these. Once those outputs are achieved everyone in the supply chain benefits. It can help supply chains to flourish.

This change in mindset from transactional to enterprise relationships is what fosters collaboration. Changes to commercial reward promote more collaborative behaviour and assist parties in sharing risk. It incentivises the tier 3 supplier to provide early warning signs to the OEM so that solutions can be considered and issues resolved early enough to solve the problem. This has resulted in some creative solutions being found for the benefit of the whole supply chain.

What are the challenges of behavioural contracting?

A change in mindset is required and businesses can be concerned about sharing intellectual property rights, confidentiality and data. Collaborative contracting can be legal by design, though, and ensure that these issues do not prevent parties from obtaining the benefits of collaborations.

The contract can be designed to meet these outcomes. The default position for many businesses which are developing intellectual property is to hold onto it. However, there are other mechanisms which can ensure you achieve the same outcome through a more nuanced approach which benefits the supply chain, collaboration and ultimately your customers.

You can learn more about the thoughts of a Pinsent Masons team as developed at a Financial Times Innovative Lawyers Global Legal Hackathon.