Work of Commercial Management and Resolving Problems for the Buyer in Project Commercial Exchange - Literature review Example

How does the work of commercial management help resolve possible principal/agent problems for the buyer in project commercial exchange?

Introduction

Commercial management is a phrase that has now been used for some time, and it can trace its origin back to the mid-20th century. However, the last few decades have experienced an increase in the number of people taking on commercial management roles in organisations. In the past, commercial management was a top level management role, but it has transformed to the middle-senior management role in organisations (Lake and Boyce, 2009). In the United Kingdom, there is a clear trend that is detected in all organisations whereby there is an increase in the number of commercial managers. Consequently, commercial managers are today found across a range of companies and industries especially those that are mainly project based.

With the various changes in the way that buyers view sellers and the changes in what sellers of commercial products and services have to do to get and maintain business, the projects and contracts have become more important than ever (Müller and Turner, 2005). Buyers and sellers are always looking for flexibility in terms conditions and creative contractual agreements and easiness of doing business. Effective commercial management bridges the interests of both the buyers and sellers and ensures a balance of rewards and responsibilities. In addition, effective management protects both buyers and sellers from inadvertent commitments and from entering into agreements that cannot be achieved or fulfilled. However, there are possible principal/agent problems for the buyer in project commercial exchange and efficient commercial management help resolve those problems. The essence of this paper is to discuss ways in which commercial management can resolve the problems between buyers and sellers.

Principle/ Agent Relationship

The principal-agent relationship is an arrangement that one party legally appoints another to fulfil some duties on its behalf (Laffont and Martimort, 2009). In a principal-agent relationship, the agent will act on behalf of the principal and ensure that there is no conflict of interest in executing the act. The principal-agent relationship is also known as an agency, and Dostic, Todorovic, and Todorovic, (2013) states that the law of agency forms the principles and guidelines of the principal-agent relationship. The contract or agreement establishes the formal terms of a particular principal-agent relationship. For instance, when an investor purchases shares of an index fund, he becomes the principal whereas the agent is the fund manager (Müller and Turner, 2005). The fund manager is required by the contract to manage the fund that consists of many assets of the principals in a manner that maximises the returns at a given level of risk in respect with the prospectus of the fund.

Principal/Agent Problems

Bond and Gomes (2009) states that principal-agent problem occurs when the principal forms a business environment that the incentives of the agent do not align with that of the principal. Usually, the principal has the responsibility of creating incentives for the agent to ensure that the agent acts in the way that the principal wants (Laffont and Martimort, 2009). It involves everything from avoidance of information asymmetry to financial incentives. Sannikov (2008) argues that problems between principals and agents in the context of commercial exchange are inevitable. The relationship between buyers and sellers is regularly strained because of differences in the actual performance and expectations related to pricing. Efforts to minimise prices of products by commercial managers to support production are termed as necessary to maintain or improve competitiveness in the end market where the products are sold. Price and credit rating are among the problems between buyers and sellers (Bond and Gomes, 2009). Principals and agents rarely agree on prices because each of the parties will try to fight for the price that favours their side. Agents are always looking to make large profits whereas principals are always trying to save so that they can use the extra cash on other projects.

On the same note, principals are always looking for an agreement where the sellers leave a portion of the price on the table. Low credit rating increases the cost of borrowing the organisation; it has an incentive to design its compensation of the rating agency with the intention of making the agency give a higher credit rating than what is deserved. In this case, the agent is less likely to be objective since he fears that he may lose future business if he is too strict. Another principal-agent problem occurs when the principal requests the agent to make a purchase without the agent knowing the preferences of the principal (Hamman, Loewenstein and Weber, 2010). As much as the principal and the agent may have agreed on the pay rate for the purchase and delivery of the products, the lack of details on the preferences will make it hard for an agent to make the right pick resulting in a principal-agent problem. According to Pavlou, Liang, and Xue, (2006) principal-agent problem occurs when the principal seeks the services of the agent in a case where the agent is more knowledgeable than the principal is; thus, the agent has the ability to charge the principal at his own discretion.

Roles of Commercial Management

Commercial management refers to the identification and development of business opportunities as well as the profitable management of contracts and projects from their inception to completion (Boyce, 2007). Commercial management role in an organisation, especially during projects, is highly valued. Commercial managers who are working within different departments take on responsibilities for marketing, sales finance, contract law, negotiations and property management.

Commercial managers are in charge of procurement management, which entails dealing with agents and ensuring that the products are purchased for distribution (Boyce and Lake, 2007). In the capacity of procurement management, consumer managers negotiate for the best possible prices with agents (suppliers), manufacturers and vendors (Bajari, McMillan, and Tadelis, 2009). In addition, they ensure that their respective organisations gain access to high quality products. Apart from the management of procurements, commercial managers also ensure that departmental managers follow procurement procedures and policies.

Commercial managers are responsible for store management whereby they handle the storage, packaging, distribution and sale of products. In the era of technological advancements, commercial managers use storage management software to keep track of the movement of stock from the suppliers, to storage, to packaging, and to the consumers at the point of sale (Boyce, 2007). Store management also involves the management of records such as receipts and making sure that the products are stored in respect to the procurement policies and guidelines of the organisation.

A different role of commercial management is managing the inventory (Boyce and Lake, 2007). Commercial managers monitor the level of stock that is available to the organisation. In this capacity, commercial management ensures that the organisation neither over stocks nor under stocks. By managing the inventories, commercial managers ensure that the financial department creates accurate budgets to ensure they account for costs like inventory, freight, and logistics.

Analysis and strategies that Commercial Management help to resolve the problems

As stated above, commercial management plays a significant in the procurement of different products for the organisation. Consequently, commercial managers will be getting into numerous principal-agent relationships, and they must be well equipped with different strategies of resolving the problems. Commercial managers have the ability to resolve all the problems that may occur during procurements.

Over the years, organisations have had numerous attempts to solve principal-agent problem. Many organisations have opted to hire other people to solve the problems on their behalf. The companies are the principals, and the people they hire are their agents. Companies opted for this strategy because the agents have skills that they never hand, and they required those skills. Nonetheless, the companies continued to face the principal-agent problems because the incentives to the agents were not necessarily going to lead to a change of behaviour that would benefit the companies as the principals. For examples, companies employed lawyers who were being paid by the hour but did things slowly whereas the interest of the companies was to be best served by doing things faster (Yukins, 2010). What is in the best interest of the company is not necessarily the same as what is the best interests of the agents. It is at this point commercial managers come to play because they give an alternative to other agents who incur additional costs for the organisations.

Commercial managers are corporate members of various chartered institutions, which means that they have professional representation and recognition (Boyce and Lake, 2007). Consequently, they are in a better position to disseminate good practice because their competency to resolving procurement problems is certified. Apart from being highly qualified, commercial managers have the interest of the organisation at heart because they are part of the organisation; this puts them in a better position of solving the procurement problems among other principal-agent problems.

Organisations’ management are always working to maintain the business so that they can fulfil their agent responsibilities to their principals, the shareholders. However, business is not just getting into agreements; business is about procuring great products and providing incredible services to the consumers. In addition, business is a network of human relationships that should be well managed. The most pervasive and critical of all is the one between the principal and the agent. Commercial management is in the middle of these relationships, and business efficiency demands that the ideal amounts of resources and efforts are invested in all the transactions (Lake and Boyce, 2009). To resolve procurement problems, commercial managers establish ideal commercial relationships by building steady business foundations with all the agents Sannikov (2008). Commercial management creates a platform where the procurement problems are replaced with the needs for success. Commercial managers look for innovative strategies that can transform the problem to favour the organisation and its shareholders.

As much as principal-agent problems in procurement are inevitable, it does not necessarily mean that they cannot be prevented. Commercial managers prepare strategic plans that create strategies that will help prevent the procurement problems (Krähmer and Strausz, 2011). Commercial managers take on a strategic approach to procurement problems by ensuring that they align it with the general business plan. Commercial management operates on a common understanding that procurement does not exist in isolation. Consequently, after understanding the general objective of the organisation, commercial managers review their procurement strategies to ensure procurement delivers directly against the needs of the organisations.

Müller and Turner (2005) states that most of the procurement problems are caused by poor design of contracts and selection of agents as a result of lack of information. Commercial management controls procurement management thus commercial managers are responsible for developing all the contracts. Therefore, since the commercial managers act in the company’s interest first because they act as their agents, they are in a better position to design contracts that will eliminate standoffs with suppliers. Contract design is a critical process, and commercial managers should be aware of every word used in the contract to ensure that agents cannot use some clauses to their benefit and cause a principal-agent problem. Secondly, commercial managers should seek enough information on the various suppliers whom they seek to supply products to the company. Adequate research on these agents will identify agents who cannot be relied on. In the modern world, the internet has made it easy to research on suppliers because their information is easily accessible. In addition, there websites such as Yelp that provide rating and reviews of the suppliers. With such information, commercial managers can make the right decisions on the right supplier. Such an action will prevent procurement problems and resolve the existing problems.

Commercial managers assess the risks and make recommendations after a thorough evaluation of all factors involved in procurement and other commercial exchanges elements of the company (Lake and Boyce, 2009). To resolve the procurement problems, commercial managers communicate with the relevant parties in the agreement so as to understand all the terms and clauses of the agreement. Communication is the basis of problem solving process, and commercial managers play a significant role in the communication process. Commercial management involves the analysis of all the procurement reports that gives an insight of the procurement problem and determine which party should make adjustments to resolve the problem and improve the performance of the principal-agent relationship. According to Yukins (2010), procurement laws and company’s rules are crucial when resolving principal-agent problem. Consequently, commercial managers should examine the company rules and ensure that they are relevant so that they can be used to resolve the principal-agent problems.

To avoid and resolve procurement problems, commercial managers should coach and train their employees on the best practices for management of contracts and principal-agent relationship. In addition, they should coach on the different contract issues when it comes to procurement agreements to ensure that the agents do not exploit junior employees. According to Hamman, Loewenstein and Weber (2010) delegation is one of the critical element of commercial management; it ensures procurement problems are resolved fast even in the absence of the commercial managers.

Moral hazards go hand in hand with principal-agent problem because one gives rise to the other. Principal-agent problem in procurement will occur when the principal, commercial manager, hires an agent, supplier to supply designated products and services that will benefit the organisation and compete with the best interest of the agent (supplier) contracted to complete the tasks. When this problem arises, moral hazards occur which involves information that has been issued by the commercial manager in place of the principal when entering into contract with Supplier Company who represent the agent is deliberatley altered or skewed in the attempt of making profits on a contract (Jewitt, Kadan, and Swinkels, 2008). Commercial managers should be on the lookout because moral hazards occur anytime a contract is entered and the agents may try to act in a way that alters the agreement. To resolve this problems, commercial managers should keep records of all agreements to ensure that they refer to the original copies of the agreement in case the suppliers try to alter it. In addition, it is important to seek the help of the corporate lawyers who can interpret the contract and highlight areas which suppliers may alter or exploit for their best interests.

Dahlstrom and Ingram (2003) defines the adverse selection problem as rigged trade where buyers and sellers have access to asymmetric information. It is a situation where the supplier, the agent, has more information on some aspect of product quality than the buyer, principal, has or the vice versa (Dahlstrom and Ingram, 2003). The adverse selection problem may occur where the supplier contracted by the commercial manager has some hidden information quality of the products. The supplier may go ahead to supply substandard products and the company may experience losses as a result. Consequently, to prevent this problem, commercial managers should be in position to different quality and sub-standard products and make sure they are scrutinized before the payment is made. When designing the contract, commercial managers should ensure that there is a clause that requires return of any substandard products and the consequences on the part of the supplier.

Conclusion and Recommendation

In summation, effective commercial management can link the interests of both principals and agents in commercial exchanges such as procurement and also balance the rewards and responsibilities. In addition, it can protect principals and agents from any anticipated problems and from making agreements that cannot be satisfied. Commercial managers play a significant role in the success and prosperity of any organisation. Procurement is one of the roles of commercial management; success is procurement depends on the nature of the relationships between the principals (the organisation) and the agents (suppliers). Just like any other relationship, the principal-agent relationship is bound to problems especially when the agents fail to meet some of their responsibilities. Commercial managers protect the principals or the buyers in this case their respective companies from procurement problems.

To prevent principal-agent problems, commercial managers should be cautious during the design of the contracts. Most of the principal-agent problems are as a result of information asymmetry and incentives (Sharma, A., 1997). Consequently, the best way for commercial managers to protect themselves and their organisations against agents who act out of self-interest as opposed to their interests is to be very intentional and cautious about the language used in the contract and the different types of incentives laid out by the contract. It is recommended that commercial managers plan ahead as stated by Krähmer and Strausz (2011) to ensure that they are well prepared for the unplanned procurement problems. Before getting into any agreement, commercial managers should conduct a background search on the agents to identify the right one for the company; this will help avoid unreliable agents who are prone to cause principal-agent problems.