Due to its emphasis on fostering trust between the parties involved, a new approach to formal contracts has taken the spotlight; relational contracts.

Traditional contractual agreements typically include very restrictive terms that can stifle communication between parties and lead to conflict as each side seeks to maximise their own benefits, sometimes at the expense of the contracting party.

They frequently have a very black and white position to the commitment and do not prepare the parties on how to handle unprecedented circumstances. A relational contract prioritises good faith procedures, aligns goals, eliminates contractual conflict and establishes mutual benefit between the parties.

WHY USE A RELATIONAL CONTRACT?

Relational contracts are a desirable alternative due to the core component of trust and are incentivised by mutual goals and cost savings. They encourage a flexible framework in order to work cooperatively and maintain transparency over the long term for mutual benefit while discouraging independent and self-serving opportunistic actions.

A relational contract would be most advantageous for companies with long-term objectives that depend on suppliers that directly affect the critical path of their business operations.

Industries that often change can frighten parties into terminating their contract if unanticipated difficulties arise. A relational contract puts the preservation of the business relationship first and adapts flexibly to keep both parties on track with their original contractual objectives. This efficiency and capacity to deal with unforeseen challenges preserves the contract and strengthens the relationship, enabling the parties to continue working together to share the benefits.

CONTRACT EXAMPLE

A large-scale example of a relational contract is the agreement between Dell and FedEx. Dell entered an agreement with FedEx in 2005 to manage their hardware return and repairing process. The agreement specified Dell’s commitments to track success as well as FedEx’s supplier obligations. FedEx met their obligations, but neither party was happy in this agreement and both could not afford to terminate the contract. Because of the complexity of their relationship, neither party’s requirements were being met by a conventional contract. As a result, the original contract between Dell and FedEx was terminated, and a relational contract was put in its place. The relationship improved under the new agreement and a 42 per cent cost reduction was achieved by Dell and FedEx. Both businesses back this relational contract initiative and have since implemented it in their other businesses.

CONSTRUCTION INDUSTRY

Due to the heavy need for collaborative behaviour within the construction industry with procurement, project management, joint ventures and the supply chain, relational contracts become the ideal option. In a typical process of property development, the developer wants the cheapest price and the constructor wants the highest price. In a conventional contract, each side would become self-serving in order to maximise their own interests rather than cooperating for the benefit of the other.

Here, a relational contract resolves the contractual conflict. Through process optimisation, operating with openness, no margins, and a fixed fee for managing a project risk is reduced for all parties and efficiency increases.

Establishing long-term relationships with regular consultants, subcontractors and suppliers enables group buying savings that are then passed on directly to the client. Through these relationships the developer is able to secure critical components required for the building process, and in exchange the buying scale provides the supplier with a consistent stream of business.

The mutually advantageous relationship that has been built leads to the desired outcomes and lower expenses.

IS THIS RIGHT FOR YOU?

Not all business endeavours are best served by being covered by a conventional contract. Fixed terms frequently go against a contracting party’s interests, inhibit innovation, and can waste resources and money.

Fluctuating industries and the complexity of business relationships have demonstrated benefits from a more collaborative and flexible approach.

When the partnership is fostered in good faith and open communication, and is motivated by shared goals, the structure of a relational contract becomes beneficial for everyone involved.