3. Organizational Change Management for Smart Contracts

William Fox

Implementing smart contracts is 10% technology and 90% organizational change management. Institutional inertia opposes all change and smart contracts represent radical change to the status quo. The standard situation is that one area of an organization decides to kick the tires of smart contracting with a pilot. The pilot goes well, the results are briefed up the hierarchy, and then adoption slams to a halt as the organization attempts to understand the magnitude of change. Smart contracting done right costs nowhere near as much as an ERP implementation, but touches every department in a similar way, creating dozens or hundreds of points of friction. Of course, we still think it’s worth the effort in terms of the raw economic benefits achieved through contract automation.

To keep things fun, we present common questions and answers by enterprise department around smart contract implementation.

  1. Operations – objections or issues are almost always tied to use of time and safety rather than monetary savings. Usually, field personnel or first line supervisors are either not responsible for the profit and loss statement or only abstractly related to it.
    1. “Will I have to do more work / fill things out in two places?” – No, fill same or fewer things out / digitize inputs if currently paper.
    2. “Will I have to approve in two places?” – No, proper business logic minimizes manual input.
    3. “Will it improve safety?” – Maybe, depends on the use case. Auto-approving remote deliveries using sensor data may remove the need for as many human visits to remote locations, taking people off the road and reducing TRIR.
    4. “Will it improve quality?” – Maybe, for instance in acquiring long lead items for construction, smart contracts can enforce that required interim parts documentation such as 3rd party inspection, heat treatment certificates, etc are submitted and accepted in exchange for interim payments. In our experience what gets measured gets done, and enforcing the rules results in better quality and time to delivery.
    5. “What about situations that truly require human judgement?” – There will always be edge cases or situations that can’t be pre-coded. For less than 5%, keep a manual option. The rest can be coded.
  2. Supply Chain
    1. “We already trust our vendors; we don’t need a smart contract” Great- the smart contract just eliminates the non-value add work.
    2. “We know there’s some overbilling but it’s too hard to check” The smart contract, especially when operating from sensor data, checks everything every time with no incremental human effort.
    3. “Our contract is a unique snowflake and nothing like any other company’s contract” To the extent the same services and goods are delivered, there is a finite set of ways to measure them, and we’ve probably already coded 80% of what you need.
    4. “The rules are too hard to explain / can’t be coded” – If it’s too hard to explain then 100% guarantee you the rules aren’t being enforced. If it can’t be coded, then it’s not logically consistent or measurable – going to a smart contract is a great way to clean this up.
    5. “There’s no way a smart contract can save that much” You may be right, let’s run a year’s worth of historical data for one of your categories and see what we find.
    6. “OK the results say we overpaid by 5/10/15%, are you saying that’s my fault / my vendor’s fault?” No, in most cases the contract language was vague, overly complicated, or self-contradictory such that no set of people could accurately calculate payments. The savings are the result of clear, actionable logic and decent data.
    7. “This seems like a huge blow to our vendors, they can’t eat these savings” Good points, things to consider:
      1. You will only pay for what’s delivered, however you explicitly agree to pay for what is measured with no additional nonsense or delay. Reducing the time to final invoice and then paying on actual contract terms is worth several percentage points even to the largest vendors.
      2. If paying for accurate quantities results in a negative margin for the vendor, pricing must be adjusted. Consider the spectacular results BP and their alliance partners in the UK North Sea Claire field[1] have achieved by agreeing to transparently sharing real costs and guaranteeing margins plus the ability to share upside between parties.
    8. Legal
      1. “Does this replace the legal contract?” – No, it automates the execution.
      2. “Can this enforce standard clauses?” - Yes, and smart contracts should be reusable, and template-based to improve your contract risk management.
      3. “Will the resulting records on the ledgers be admissible in court?” Depends on jurisdiction but they should be, ledger transactions have been used in prosecutions, but this is an emerging area jurisprudence.
      4. “I love it, can we match every legal clause with code snippets?” For the measurable parts of the contract likely yes, for other elements like indemnification, probably no / not worth the effort.
      5. “Will this result in better contract language?” For complicated contracts the answer is probably yes. In many cases the contract was assembled by different groups of experts or third parties and the legal department doesn’t have the subject matter expertise to know what makes sense. Forcing all parties to agree on black and white logic will have a cleansing and simplifying effect on the total contract language and lower risk. For simple call off contracts, there may be no change in language necessary.
    9. Accounting
      1. “Isn’t this going to cause a SOX issue?” No, let’s walk down the hall to audit together and they’ll love you for this.
      2. “What are all the Accounts Payable Clerks going to do now?” Sensitive topic for sure, especially if this function is not already outsourced or contracted out. There WILL be discrepancies and edge cases, so there is still a requirement for competent AP staff to review the 5% of transactions that either have discrepancies or can’t be automated.
      3. “How are you going to make sure the prices are correct / perform the 3-way match?” We’ll use the purchase orders / sales orders / price books both parties agree, plus the smart contract will calculate the correct quantity, not just match whatever was in the purchase order.
      4. “Doesn’t Ariba/Open Invoice / Coupa already automate this? Why do we need you?” Most of our enterprise clients have one or more platforms on top of their ERP that helps digitize the payment process, but all they have done is digitize a (bad, inefficient) paper process. Providing a workflow and doing some metadata matching is not the same as ensuring the invoiceable quantities are correct. Any high-quality smart contract platform will connect with these systems via API, then it is up to the organization to determine what steps they want to remove from the process.
    10. Audit – I’ll comment here that I have never had a bad conversation with an audit team at any buyer or seller we’ve worked with. Once you walk them through what you are trying to achieve with the smart contract, feedback is usually great:
      1. “OK so this is removing non-value add steps and decrease the opportunity for human error? Put the flow diagram in a PDF and we’ll take it to our auditors.”
      2. “This is great because I can perform an audit on all locations using the same smart contracts right from the office!”
      3. “This is actually going to make SOX compliance easier!”
      4. “So you are using sensor and digital reporting from the field to calculate invoices? It’s like a real-time, onsite audit powered by the Eye of Sauron!”
      5. Lor Lord Of The Rings GIFfrom Lor GIFs
    11. Information Technology (IT)
      1. “Why do I need a smart contract / distributed ledger?”
        1. The problems identified have manifestly not been solved with legacy systems.
        2. Your current solution is using email and excel spreadsheets.
        3. There are probably other ways to solve it, ours is just the best we know about.
        4. One sided solutions aren’t attractive to vendors and partners, you can’t be the referee and the home team at the same time.
        5. Using a 3rd party smart contract network allows you to outsource data standardization.
        6. Distributed ledgers are a somewhat clunky database but are an elegant solution to enforcing metadata standardization across multiple enterprises.
      2. “But muh data!” A key point here is that while the buyer may have some of the data, much of the rest required for smart contracts comes from the vendors and third parties, and in any case the data the smart contract needs is usually data that is already de facto shared with those vendors and 3rd parties – just in a less secure and auditable manner! Customers can set their own requirements around data retention, keeping in mind look back periods for transaction processing as well as financial records retention requirements in their jurisdictions. Enterprise customers may choose to write data security clauses into their Master Services Agreement with their smart contract provider to control the use of their confidential data. A high-quality smart contract solution should support strong customer data separation and storage. One feature of the Data Gumbo approach is that each customer gets their own separate cloud storage account for their copies of ledgers, which they can opt to host themselves if desired.
      3. “What about GDPR?” Regulations provide a shifting target but in general feature common sense rules around data required for legitimate contractual execution. For instance, if a consultant’s time is billed at his or her hourly rate it makes sense that their name appears in an invoice line item. Enterprise grade smart contract providers commit not to use or resell the customer data for any purpose beyond smart contract operation.
      4. “This is a distraction from SAP” – ERP implementations are always a nightmare, however a good smart contracting system should be integrated purely through APIs anyway. The creation of new work instructions for the ERP implementation complements the definition of business logic and APIs for smart contracts, plus the smart contracts will be written and implemented by different personnel. The main concern will be IT project management bandwidth. We’ve been run over by the ERP implementation truck in the past, but a few customers have chosen to go ahead in parallel because the value proposition of “optional” smart contracts exceeds that of “mandatory” ERP upgrades.
      5. “What about all this other software we already bought?” – See 4 D above. To the extent an organization leans into smart contracting, it’s possible some other middleware becomes unnecessary.
      6. “What about Cybersecurity?” High quality smart contracting systems require NIST compliant end to end encryption, all contact with customer systems must be via API or other encrypted means, and the smart contracts must be abstracted from operational systems. Some clients utilize data streams from digital twins to provide a further layer of abstraction from control loops.
      7. “ISO 9001 / 27001 / SOC 1 / SOC 2” – High quality smart contract providers will have ISO / SOC certifications or be in the process of gaining them. These are minimum requirements for connecting to corporate enterprise systems.
      8. “How much is this going to cost me?” Between 1/10th and 1/30th of what you are losing to waste in the system.
    12. Finance
      1. “How much in overpayments? I wish I didn’t know that” – I have personally screwed this one up before. Some finance personnel lean in and realize the bottom-line benefits, others recoil in shock and horror at the ramifications. The most successful approach focuses on efficiency, auditability, and financial metrics improvements from payment accuracy.
      2. “Wow – can we use this for everything?” Probably 80-90% of Capex and Opex actual spend, but probably not everything.
      3. “Great, so I’ll pay my vendors faster, but what about getting us paid faster?” There is no barrier to engaging the customer’s own customers in smart contracts beyond the will to try. While we have worked mostly with oil and gas companies on payments to their service providers, there are dozens of use cases downstream from them – anything from getting paid accurately by the midstream (pipeline) company to lubricants deliveries.
      4. “Can this help with Joint Interest Billing / Joint Venture Management?” Emphatically yes! Smart contracts and ledger security can be designed to provide read only access to JV partners or government entities with audit rights.
    13. Executive Management. Implementing smart contracts potentially upsets or inconveniences every party involved. Only senior executive sponsorship provides the necessary air cover to the project team. Projects without SVP or higher-level sponsorship are extremely unlikely to advance beyond the pilot phase. One way to get this is to charge enough for the implementation of the smart contract that it requires senior sign off. Alternatively, working with one of the management consulting or ISVs already embedded in the organization as part of a broader digitization / Industry 4.0 program can also work. From the Data Gumbo perspective, the ideal situation is that a partner already working for the buyer manages the smart contracting program, while we provide the smart contract platform, smart contract templates to build from and technical support.

What about the other side – the vendors and service providers getting “Smart Contracted”? Each functional area tends to have similar concerns to the buy side, but the key focus areas are:

  1. Will this impact our revenue negatively?
    1. It might. There could be significant overbilling in some cases based on current practice. However, we find that even in a single buyer / seller relationship, there can be areas of both under and over billing in the same contract. The best way to model this is by running a smart contract against a year’s worth of historical data and seeing what comes out. In one example, a drilling contractor chose to leave freight charges off their invoices due to (non-contractual) rules from their customer that each invoice must use only final charges from sub suppliers, and their freight forwarders often took 60 days to submit final invoices. In another, a drilling chemicals provider submitted invoices using the previous year’s pricing and underbilled by hundreds of thousands of dollars. Smart contracts can enforce severability or be applied downwards to sub suppliers to solve the first issue, and always use the latest agreed pricing.
    2. Different personnel also apply rules differently when invoices are prepared manually. In one equipment rental situation we reviewed, the parties used three different methodologies to determine active versus standby days depending on which asset team prepared the invoice. Standardizing across assets results a) better and more consistent data entry b) standardized rules and c) netted out almost all the under and overbilling.
  2. Why should my company participate?
    1. After the initial reflexive pushback on trying something new, almost every service provider working on smart contracts came to embrace the key benefit: reduction of time to final invoice. In especially complicated contracts involving multiple product lines, the construction of a draft or proforma invoice involves multiple people on both sides of the contract. Even in a best-case scenario, emailing the proforma back and forth to get a final agreed invoice adds at least 10 business days to the process. On average, the lag between service delivery and approved invoice is closer to 45 days. When the contract is especially complex or the relationship adversarial, we have seen it take up to 55 days to get the invoice approved and the payment clock started. These working capital delays become material for all but the largest service providers.
    2. The smart contract can work for the service provider as well – for instance one contract we worked on involved around 65 different product lines, some of which combined to provide single service lines for the end invoice. The service provider’s product line managers first combined all their data to make an invoice then broke it back out again for P&L accounting. To the extent a service provider can codify these revenue recognition rules, the smart contract can perform that division automatically. Additionally, the smart contracts model the real-world equipment usage, so individual bits, tools or silos can be tracked for profitability in an automated manner as a side effect of smart contract usage. This can save both time and money for the seller as they make decisions on how to best utilize and deploy their assets.
    3. Smart contracts are sticky – there’s work up front on both sides, but once in place they reduce contract management work by 90-95% and make contract negotiations and renewals a very collaborative affair. Buyers selfishly prefer smart contract ready sellers due to the inherent efficiency gains.

What about scaling? After a successful pilot or initial implementation, companies often go through an extended planning process on how to next deploy smart contracts. Do we expand to other assets? Do we add new contracts? What’s the training plan? Our recommendations:

  1. Plan for success. Assuming for a moment that the pilot goes well, companies must plan to continue the momentum. Time and again an initial smart contract deployment will succeed and then die on the vine as the organization struggles to transition from a siloed, manageable project run by IT or Digitization with minimal operational involvement to a shared service useable by the organization. Leaving aside for a moment the efficiencies lost by delaying the rollout, smart contract vendors will shift their gaze to paying customers and the knowledge built during the initial project will start to erode.
  2. Staged rollout. One effective approach involves using a single business unit or asset for the first smart contract implementation to prove out how they will work for the broader organization. We see companies picking their most forward thinking or highest value / volume units to serve as test pilots. The results of the project provide the playbook for the rest of the organization. The company can then validate that playbook by running it with a few more units before rolling out globally on an accelerated basis.
  3. Contract categories. Another aspect of a scale up is figuring out what contract or contract category is the closest to the pilot and picking the next contracts to automate. For instance, if the first smart contract dealt with trucking, what other contracts or contracting categories in the company could benefit either from the exact same smart contract used in the pilot or a modified version? One customer that standardized service contracts in a category chose to roll that smart contract out globally to all business units prior to taking on the next category, both to achieve the efficiencies faster and to allow the team to focus on a single set of problems before starting the analysis of different contracts such as logistics or fuel. The amount of work and OCM required to get the first few contracts over the finish line means concentrating on 1-2 contracts at a time, especially if they have high overlap, improves the speed of delivery and chances of success.
  4. Shared services. Our view is that smart contract platforms will become ubiquitous and linked to company’s Enterprise Resource Planning (ERP) systems. Trying to scale as a series of individually supported and funded projects across business units becomes unwieldy within the first 2-3 years. To maximize value, companies must map the pathway for smart contracts to become part of a shared service model at the corporate level. Finance, Audit and Supply Chain will all see the benefits of handling the smart contract platform similarly to the ERP, IT will need to take ownership of the platform maintenance and center of excellence.

In summary, while the technological aspect of deploying smart contracts is non-trivial, organizational change management dwarfs the software effort.

 

[1] https://www.kearney.com/industry/energy/article/-/insights/strategic-alliances-a-win-win-for-oil-and-gas-operators-and-suppliers

 
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