Seven wastes of negotiation

What do you get the legal eagle who has everything? A spirited comparison of ISDA negotiation to car manufacturing, of course.

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Now it is well-known that the ISDA negotiation process works basically like the production line at British Leyland in 1978 — see video in panel.

But it needn’t be that way. Just as Toyota revolutionised the car manufacturing world by focusing on waste and not cost, so can the docs team. The metaphor is not perfect, but it is pretty good, as we will see.

For those not steeped in the mythical history of the mass-produced motor car, in the 1950s, Toyota’s chief engineer Taiichi Ohno created the “Toyota Production System”, which revolutionised the car industry. The American firms took years to cotton on, and British firms never did.

Ohno-sensei’s great insight was to focus on eliminating waste, not cost.

Waste is the enemy on any production line: a process that is inherently necessary must add value, even if it is expensive so you should be cool about paying a fair value for it.

Processes which do not add value are inherently wasteful. The job is to eliminate waste, not cost per se. To get rid of waste, you have to know exactly what waste is and where it exists. Ohno-sensei categorised seven types of waste and for each one, suggested reduction strategies.

Even though Ohno-sensei was talking about a physical manufacturing line, “waste reduction” translates directly to the type of intellectual manufacturing needed to make contracts.

This fact seems to have escaped every management consultant who has ever ruminated on contracting process — and a lot of them have — for every single one obsesses with reducing cost, and will do so even when it creates more waste.

Bad idea.

So, in the quixotic hope of nurturing better ideas in the minds of our consulting overlords, here are some thoughts on how to read across the seven wastes to legal contract production.

Summary

The seven wastes, as applied to contract negotiation, are these:

• Overproduction: Negotiating contracts that are never ultimately executed, or which are, but where there is low (or no) order flow. Cars which you can’t sell.
• Waiting: Any point in the negotiation process where you are waiting for continuing the negotiation: drafts to client; questions to sales; escalations to risk.
• Transport: Any unnecessary hand-offs to other departments (or the client) is the equivalent of transporting stock in trade in a physical manufacturing process. Keep it to a minimum by sequencing the production inputs.
• Over-processing: Unnecessary complexity in product design and manufacture that doesn’t have any practical application for the client or utility for your risk management team. Hint: this is the gorilla in the room.
• Inventory: Work in progress that is not finished product on the shop floor. In a negotiation, that is the client agreement for the time between inception and execution. The longer that average period the larger the inventory. You can’t make any money out of a product while it’s still in the factory.
• Motion: The longer and more convoluted a contract is the longer it takes to read, understand, comment on and conclude. All other things being equal, any unnecessary formal complexity will add time and effort to the job. Short, utilitarian, Spartan contracts. Easy to handle. Robust.
• Defects: Products that don’t work as billed and which may require replacement or re-tooling. Consider the factors that lead to defects: complexity in the product design and manufacturing process. Which is more likely to break down, and what would you rather fix: a Range Rover Evoque, or a 1982 Toyota Hilux?

On machines, humans, and the relations between

Here is wisdom, taken directly from Toyota, which well explains the dissatisfaction of mindless automation and outsourcing:

Machines and robots do not think for themselves or evolve on their own. Rather, they evolve as we transfer our skills and craftsmanship to them. In other words, craftsmanship is achieved by learning the basic principles of manufacturing through manual work, then applying them on the factory floor to steadily make improvements. This cycle of improvement in both human skills and technologies is the essence of Toyota's jidoka.

It’s about your people, not the management consultants you hire

Sure, you can sluice the waste out of your Augean stables — there’s nothing more satisfying than a spring clean — but long term, things will revert to how they were unless you commits, through permanent staff, to a continual process of self-improvement. You won’t earn this disposition by dropping a hundred grand on a six-sigma black belt for three months to fix everything for you.

The reasons for this are as obvious as they are routinely ignored: projects, priorities, processes and people change, and the path of least resistance is to layer a new process over an old one. That kind of short-termism is exactly the environment that created the baffling complexity, redundancy and waste in the first place: barnacles accrete unless you are constantly, permanently, committed to removing them. Train your staff to be constant gardeners, and you won’t need periodic visits from McKinsey to dig you out of holes.

Which staff? The ones on the ground. You have people not only with detailed — unparalleled — expertise in the conduct of your contractual negotiations, they are as well-disposed to eliminating crushing tedium from their professional existences as you are, if only you’d let them: your negotiators. Instead of imposing a the fantastical schemes of some glib management consultancy outfit on these poor people, how about offering them some tools to sort it out for themselves?

The seven wastes

Overproduction

Headline: Don’t make what you don’t need.

Don’t make things before they are needed, or if they aren’t needed. Seems obvious, right? In the contract negotiation world, “manufacture” is sales-led and the negotiation process with direct client — you can’t negotiate without one, so there is buyer for every product, right? — so overproduction seems irrelevant. But is it?

• The one that craters: Many contracts get negotiated, but never executed: the client may not be serious, it may change its mind, or it may not accept your fundamental terms. Some times this is foreseeable, but it should be Sales’ job to identify and weed out clients who are highly likely never to executed a contract. Finding out you have a deal-breaker after a nine-month negotiation is a huge waste of time and resources.
• The dud: Even where the contract is executed, the revenue that accrues is not a function of executing the contract, but trading under it. A contract that is concluded but rarely or never traded under is an example of overproduction. Again, Sales should be responsible for identifying good quality potential revenue, and should be incentivised — that is to say, penalised for the costs of overproduction, the same way they are rewarded for revenues that accrue on sensible contracts — not to introduce poor prospects into the onboarding funnel. No financial services firm does this, of course.

Summary: Overproduction is generally a sales problem. It is not easy to fix as it involves predicting the future, but the costs can at least be allocated to sales (in the same way that revenue is!)

Waiting

Headline: Over to you, Chuck
Whenever no-one is actively handling work in progress, in the sense of marking it up, or arguing with someone (internally or externally) about it, it is waiting. In a typical negotiation that is likely to be more than 90% of the time.

How do these waiting periods arise? Well, it’s not hard to understand.

• Waiting on the client: The negotiation process requires client input. waiting on that is largely but not entirely outside your control — if the client doesn't read emails, there’s only a certain number of polite, passive aggressive reminders before you just have to shut up and wait. But let’s say the client is looking at the document: the shorter, easier and less objectionable your document is, the faster the client’s review, all other things being equal,and the faster it will come back and with fewer comments. Each comment requires action and implies more waiting. Right?

So, how to make your client documents easier and less objectionable?

Make it shorter: the fewer words there are to read, the faster the client will read it.

Make it nicer: Don’t include terms you don’t really need. Do you really need that NAV trigger? Before you say yes, ask yourself, “how many times have I ever actually used a NAV trigger?”

Talk, don’t email: You guarantee some waiting time if you email with your comments and questions. If you pick up the phone, you just might clear the questions on the spot.

• Waiting on an internal escalation: Eventually the client replies, and it doesn’t like that NAV trigger. Per policy, you must escalate this to Credit team. This involves composing and sending an email, then waiting for credit to reply. That is a 15 sec decision, but it will take 24 hours (on a good day) to achieve. Reduce this wait time (and improve data control) by:

Standardising terms to pre-approve obvious giveaways empowering negotiators to approve common points of contention; '

Recalibrating standards to reduce the gap between “starting offer” and “walkaway point”;

Standardising the escalation process to capture metadata about variations from the requested terms

• Talk, don’t email: See above. Same principle.

Summary: Most of your negotiation time is dead air. Fix that.

Transport

Headline: Escalations and reporting are the “transport” of a negotiation process: they may be automated, but ideally should be avoided (where possible) by robust redesign of the contract production process.

In physical manufacture, our man Taiichi Ohno recognised that transport product between processes during manufacture incurs cost and adds no value. The answer is to reconfigure the production line to get all the inputs at the right time and sequence. Contract negotiations are no different. The hand-offs may be electronic, but the waiting is inevitable. They arise in:

• Escalation points: Against all expectations, a client challenges credit’s required credit terms. I mean, imagine. Unless there is a playbook with acceptable fallbacks, the negotiator must escalate to the credit/legal risk holder for approval to concede the required term. The very act of this escalation (regardless of how quickly it is actioned) will be costly in terms of Waiting time. Such transport may require some kind of escalation hub through which terms can be systematically captured. This is an additional cost, but may generate useful metadata as to trends, off-market terms, and bottlenecks.
• Post-negotiation approval, execution and storage processes: Once the negotiation is finally agreed there is a lot of time preparing execution agreements, summarising terms and submitting them for final formal approval, obtaining signatures and filing approvals, execution copies and capturing key agreement metadata in the firm’s risk and trading systems. Traditionally this is a labour-intensive, manual task. Technology here (particularly digital execution) offers an enormous capacity for efficiency and digital audit.
• Process maintenance: Maintenance, approval, version control, storage, retrieval and sharing of negotiation templates and knowhow. Again, technology offers significant organisation, time savings and better reporting. Also, product/process design will be important: generally there will be too many templates and they will be too complex. The job or organising them will be overwhelming.Part of this is a by-product of the lack of control of the process (proliferation of different templates to do the same job); part is a function of over-processing (templates imposing requiring terms that are not really needed, though unnecessary caution or ossification through time).

Summary: Transport is a place where technology — if implemented thoughtfully can make a difference to the process and eliminate wastage where transport is necessary. But transport should not be necessary for standardised regular client contracts. They key should be to eliminate the need for transport through removal of over-processing and poor process design.

Over-engineering

Headline: Don’t design your plane to be waterproof in case it falls into the sea. Design it so it doesn’t crash.

In its original physical manufacturing sense, over-processing refers to unnecessary complication in design, whether brought about through carelessness or over-specification. The production cost of features that no-one will ever use is as much a form of wastage as any.

The chief production cost in contract negotiation is time and human resource. The longer a contract takes to read, and the more it invites challenge, the more expensive it is to produce. Any time taken over the bare minimum needed and any client challenge to a term that is not really vital the firm’s risk protection strategy is a waste in the contract negotiation process.

As we have seen, client challenges to credit terms create their own additional wastes (waiting, transport, as well as risking of overproduction and defects).

In contract negotiation, over-processing arises in two chief ways:

Risk controllers are short an option

Risk controllers are short an option. They are incentivised to err on the side of caution: they don't get a bonus if the client generates extra revenue, but they will be regarded as having failed if the client blows up owing the firm money. So no wonder there are overreaches in the terms they require in general client documentation.

While credit teams do not typically monitor or collect data about the frequency with which they invoke specific credit terms, we know for sure that:

• Well over 90 per cent of client contracts never default at all,
• Of those contracts which are closed out, in nearly all cases the cause of default is a failure to pay or insolvency. Counterparties will generally not challenge these two events of default during the negotiation process (how could they? that you will pay what you owe when you owe it, and that, by extension you will be solvent enough to do it, are your counterparty’s most fundamental expectations. If you won’t commit to these, you should get your coat.)

Barnacles and the effluxion of time

“Policy is institutional scar tissue” — Jason Fried

Over time contract templates will inevitably accumulate what I call “barnacles” — ad hoc responses to historic situations, anecdotal reactions to unexpected risks, flannelesque flourishes to placate a truculent, obtuse or just downright stubborn counterparty — no-one likes them, but if your client insists on redundant (or misconceived) terms (“for the avoidance of doubt”; “without limitation”; “because it is our policy to require them” — that kind of thing) for the sort of fellow who prefers a short-term fix over long-term existential satisfaction, the pragmatic response is to agree them and move toward execution.

These barnacles have a habit of finding their way into, and encrusting, negotiation templates. And, as people move on, their original justification — if there even was one — becomes lost to time. The instinct of successive risk controllers, short an option as they are, upon encountering them will be, “I don’t know why that is there, but whoever put it in must have had a reason for doing that, so the safest thing is to leave it there.”

This will lead more complicated templates, longer templates and a proliferation of different templates.
Summary: Over-processing arises through excessive caution in credit terms and through the natural, pragmatic process of getting negotiations across the line. If your counterparty insists on something misconceived, idiotic but basically harmless, then few negotiators will die in a ditch about it. The length and convolution of documents creates significant over-processing wastage and, as a by-product, waiting and transport wastage as well, through unnecessary escalation."

Inventory

Headline: Work in progress. Usually a second-order waste, where there are bottlenecks on your production line and half-processed inventory stacks up waiting for the next step, meaning the real waste here is waiting, rather than inventory per se.

But— time is money, as the old saw has it — so the longer the overall negotiation process takes, the more expensive the inventory.

In the context of contract negotiation, inventory is coterminous with waiting — not being a bearer instrument, a legal contract has no intrinsic value even when completed — it is what you do with it that creates the risk and reward — so having a hopper overflowing with half-completed credit support annexes does not of itself represent a large waste. But the fact that they are stacked up waiting for someone to answer an email — be it the client, trading, risk or credit — it stretches out the production time.

Motion

Headline: With careful document design and a commitment to brevity, you can restrict the amount of necessary movement. The less page flipping you do, the faster you get through it.

On a physical production line, unnecessary motion is bending, stretching, reaching, walking. It all takes time and wears out parts. Motion on a contract is reading, writing, formatting and maintaining the templates. Economy of action is just as important.

If a contract has seventy pages and there are negotiable points on every page, there is a lot of movement back and forth. If you strip the economics away from the boilerplate, set out the economics in a single page term sheet, then the amount of ground the negotiators need to cover to finalise the contract is far less. and another shout out for the good people of plain English and lean, elegant legal prose, but if you can say it in five pages and not fifty, it follows that the possible motion involved is one tenth.

Oh, and learn how to use style sheets and automatic numbering, for heaven’t sake.

Summary: Don’t make it harder than it needs to be. Keep the agreements short, and keep the economic terms away from the boilerplate.

Defects

Headline: If the product doesn’t do what it says on the tin, how it says it will on the tin, you are going to have to waste time and resources fixing it.

Two things to consider here: What factors are most likely to avoid defects in the first place — and if there do have to be defects, what design principles are the key to fixing them as cheaply and quickly — efficiently — as possible?

This won’t come a surprise: the same thing checks both boxes: simplicity of design. The more complex the product is, the more things can go wrong, the more interdependent they are likely to be, and the more of a tangle it will be to sort them out.

Now, it is true: all other things being equal you would prefer the late model Discovery with the electric seat warmers, computer-controlled fuel injection system and keyless entry, but the ’82 Toyota Land Cruiser ... you know?

See also

• Innovation and the innovation paradox
• A faster horse - technology article
• Cost