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Have you heard of “smart contracts” yet?

Talking about a Procurement Vision 2030

Today integrated Demand-to-Contract solutions, such as provided by numerous suppliers, have an advanced contract management feature that contains contract standard clause libraries and online approval workflows. When e.g. a contractual termination date is met, the user is able to re-negotiate the terms and set them accordingly. Afterwards the contract can be archived in the tool. So far though, little has been achieved in contract automation, although we are convinced that this is the way forward for procurement operations.

Fig. 1: Procurement Vison 2030

One of Detecon’s main hypothesis when debating about a long-term vision for the Procurement department states that Procurement Operations will be fully automated by 2030. Considering all the current technological development, there is one innovation that could revolutionize the Demand-to-Contract process: smart contracts.

What are smart contracts?
A smart contract is an application that helps to define, validate, automate, and keep record of any action and process. It is one of the main uses of blockchain technology (which became famous with bitcoins) and enables the technical enforcement of rules, which are traditionally rather enforced through laws or courts of arbitration. They follow a simple “if, then” function including a record keeping function and have the potential to serve as elementary building blocks for demand-to-Contract processes.

Smart contracts are written in code and have self-acting characteristics, they are non-manipulative and the history of actions and transactions is written and stored in a digital ledger. In consequence, this could not only lower paperwork and transactions costs of today´s contracting, but once installed, also speeds up and automates processes connected to contracting and increases transparency and hence blind trust.

The idea is not new, but only now, we are able to put theory into action.
The cryptographer Nick Szabo came up with the concept in 1994 already. However, it has remained unused since the required technological infrastructure did not exist back then.

Fig. 2 Source: https://twitter.com/NickSzabo4, 21.October, 2016

Since trust is pre-coded in its origin and part of the blockchain database, contracts can now be signed and executed at very low costs. Smart contracts are furthermore computer protocols based on the conditions, such as payment conditions, of a contract and its terms. The source code, which is the smart contract part readable by human beings, inhibits the executable computer code that runs on a network. Thus, many of the contractual clauses can be partially or fully self-enforced or self-executed which makes them smart in contrast to paper based contracts “smart contracts don’t have to be dumb” as said by Niko Szabo – (see Fig. 2 above). 

What are the benefits of using smart contracts?
Smart contracts are an alternative for companies facing frequent transactions between different parties, which contain manual or even duplicative tasks. Using blockchain as a shared database that provides a single source and a secured environment in which contracts can be self-executed, e.g. adjusted and approved automatically, numerous benefits emerge. The automated and real-time update of contracts speeds up business processes and saves transaction time. Concurrently, it is less susceptible to manual errors. Additionally, these processes require less human intervention and therefore reduce the payroll costs immensely. Due to the decentralized nature of the execution process, risks – such as nonperformance or manipulation – are reduced as well. Overall, it is a viable solution with low transaction costs and risks.

In a nutshell
The blockchain is a secure and decentralized database which stores and records each transaction that prolapses within a network. It became popular since Satoshi Nakamoto´s technological theory about bitcoins in 2008. The source code that forms the smart contract can be added to this blockchain infrastructure without problems. Following Nakamoto, a smart contract is:

"A piece of code (the smart contract), deployed to the shared, replicated ledger, which can maintain its own state, control its own assets and which responds to the arrival of external information or the receipt of assets"

(Bitcoin: A Peer-to-Peer Electronic Cash System; https://bitcoin.org/bitcoin.pdf).

 Smart contracts and Procurement

In a traditional Demand-to-Contract process, the contract preparations and finalization with the supplier usually takes time and is very expensive in regards of transaction costs.  Smart contracts cannot only streamline different contract management processes but they can also adapt such contract parameters as e.g. commodity prices.

One possible scenario for smart contracts usage in the procurement department could be price adaptions in a contract as a reaction to price changes of the world market price. Entire processes such as contract renegotiations could be depicted based on self-executional codes, according to e.g. updated price indices. Furthermore, old paper-based processes rely on multiple parties across different locations, and consume lots of transfer time. The blockchain technology provides a secure and reliable solution, which in turn enables smart contracts to realize the conditions - such as price adaptions in the contract- in real-time.

Prospect 
Back to the starting point: “Procurement operations will become fully automated”. Yes, it is definitely a possible scenario, and the blockchain technology has become widespread. According to Gartner’s “Emerging Technology Hype Cycle” it is “on the peak of inflated expectations”. There is definitely the need to tailor the technological feasibilities to the specific needs of business areas and industries in order for them to be able to take advantage of it. Many startups have risen in this area and have even managed to link IoT devices with smart contracts. However, there is still a lack of use cases. Additionally, one of the main pain points will be to adapt the legislation to these technological developments. Finally, the responsible CXOs have to trigger the technology evaluation in their different departments and mastermind how smart contracts can boost their efficiency and build new digital business processes.

In conclusion, smart contracts are a first viable step towards the automation of contracting, making procurement smarter, faster and more transparent. The greatest advantage will be the cost saving potential, once smart contacts are up and running. As first tests in this field are running, we expect user-friendly solutions within the next five years.