When Dell originally selected FedEx, in 2005, to handle all aspects of its hardware return-and-repair process, the companies drew up a traditional supplier contract. The 100-page-plus document was filled with “supplier shall” statements that detailed FedEx’s obligations and outlined dozens of metrics for how Dell would measure success. For nearly a decade, FedEx met all its contractual obligations—but neither party was happy in the relationship.
…We argue that the remedy is to adopt a totally different kind of arrangement: a formal relational contract that specifies mutual goals and establishes governance structures to keep the parties’ expectations and interests aligned over the long term…
When Dell and FedEx reached their breaking point, they chose to abandon their existing contracting process and create a formal relational contract that specified desired outcomes and defined relationship-management processes at the operational, management, and executive levels. In the first two years, Dell and FedEx were able to reduce costs by 42%, scrap by 67%, and defective parts per million to record-low levels. Both companies now consider the contracting approach a best practice and have applied it in other relationships.
That was from “A New Approach to Contracts: How to build better long-term strategic partnerships” in HBR by David Frydlinger, Oliver Hart [2016 Nobel prize in economics], and Kate Vitasek.
The authors stress how formal relational contracts are still legally enforceable in courts, and should be used for organizations with long-term/complex relationships rather than for commodity products and services that are transactional in nature.
Certainly defense leaders have something to learn from these commercial developments, which in many ways reflect an older way of doing business. One of the problems, however, is that DoD has its own contract with the Congress in the form of program budgets. Long lists of requirements must be approved internally and by Congress before funds are released. That constrains the ability for DoD to create formal relational contracts with industry.
One thing that struck me from the article was how commercial firms often became locked into their relationships due to switching costs and otherwise. An example they used was a monopoly/monopsony situation with Vancouver hospital authority and the local hospitalists.
DoD, however, is large enough that it has overlapping offices that could create a multi-buyer organization. In that construct, I wonder to what degree modularizing contracts and using competition can further simply the contracting process.
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