Dynamic purchasing or
procurement, driven by IoT-enabled devices, promises a fundamental shift in
manufacturing supply chain relationships. At its simplest, dynamic purchasing
streamlines ordering procedures in existing bilateral supply contracts.
Rather
than providing for regular or occasional orders using manual forms, dynamic
procurement uses IoT-enabled sensors to monitor and transmit in real time
details of raw material, components or stock levels. Existing levels are
checked against orders, with algorithms driving orders on a machine-to-machine
basis to ensure that they are placed on a “just in time” basis.
Commercial
benefits include the ability to maintain stocks at the leanest level consistent
with production or distribution needs, promising substantial savings in
inventory and warehousing.
Dynamic procurement goes even
further. Rather than merely streamlining elements of existing contracts, fully
dynamic procurement would result in the formation of a fresh contract for each
transaction, potentially breaking the link between supplier and purchaser. The
purchaser’s requirement would be transmitted, either directly to a range of
existing suppliers or via an online platform accessible to a much wider range
of potential suppliers.
As well as clear specification of the required goods,
key parameters might include price, current location, guaranteed delivery date.
Relevant data might be gathered from suppliers’ IoT-enabled facilities.
For
example, an IoT-enabled shipping container could draw on GPS data to feed
information about its current location, direction and speed of travel. Sensors
might also gather and transmit data concerning environmental conditions within
the container – potentially very significant if the contents are perishable.
From there, prices might be provided by way of data feeds from each supplier,
with the contract going to the supplier whose data best meets the purchaser’s
requirement.
Each scenario is credible. IoT
is not a future prospect, but a current reality. It is an increasingly valuable
element of supply chain and contract management. It is also a crucial driver
for the development of “smart contracts”.
What is a “smart contract”?
A smart contract is fully
“self-executing”, which means that it is written (or, perhaps more accurately,
coded) using a series of “IF/THEN” statements to describe every relevant state
of the contract. For example:
IF [Advertising Network
#564445] sends [1,000,000 clicks] that [convert to purchases at a rate of 15%
or more] THEN release [[$0.002] for each of those clicks] to User/Account
#899782392
Performance – here defined by
the number of clicks and the sales conversion rate – would be verified by data
feeds respectively generated by the Advertising Network and the User. Where
that data is gathered and transmitted on a machine-to-machine basis there would
be no need for human intervention once the contract has been set up, and it
would be an easy matter to apply a further element to the IF/THEN statement so
that it becomes a recurring/periodic procedure.
The key to “smart contracts”,
then is to break the commercial elements down into a series of IF/THEN
statements and to agree on data feeds that will verify performance.
In the simple example, payment
would be “released” immediately on satisfaction of the conditions contained in
the “IF” element of the provision. That suggests a radical change in the
practice of many businesses – particularly large-scale purchasers – whose
current invoice procedures often impose as long a period as possible before
payment is made. For a fully “smart” contract, payments might be placed in
escrow, or access might be given to the paying account. However, given their
commercial leverage, large-scale purchasers might simply incorporate their
usual payment terms into the “THEN” element of the provision, perpetuating the
imbalance in cashflow terms that often characterises the relationship between
large organisations and their suppliers.
Why is Bitcoin relevant?
The technology underpinning
Bitcoin is often referred to as “blockchain” or “distributed ledger”. An
element of value is identified and given a unique identifier known as a “hash”.
That hash is carried into the next transaction involving transmission of that
element of value. Each subsequent transaction is added to the original “block”,
giving a complete, unalterable and objectively verifiable record in relation to
that element of value. The blockchain is open to inspection, and is the
“public” element. The detailed contents of each “block” or transaction remain
confidential, protected by a private key.
The blockchain provides a full
replicated copy of the data underlying the transactions making up the chain at
each node (account (for these purposes a bank)). Each node will hold a full
copy of the ledger.
Blockchain, as a distributed
ledger, is shared across a broad business network. This means that the blockchain provides the
opportunity to re-engineer business methods. At present, businesses keep lists
of everything they own and then change these lists in a specific way when
ownership of assets changes. Blockchain is a standardised list for all assts.
Smart contracts can be used as transactions for making changes to those lists
of assets.
The
blockchain is visible to all participants in the network. The participants can
see the transactions that other participants in the network have entered into.
Although the identity of the participants is not visible, being able to see
what each participant is doing allows the participants to an educated guess
regarding each other’s identity.
Companies
such as Elliptic use the visibility of the blockchain to:
Flag
suspicious patterns to their FS clients;
and
Help
law enforcement agencies with criminal bitcoin enquiries.
There
is a tension between identity and privacy for blockchain users. You need an
identity to enter into a contract (smart or otherwise). Regulation also
requires participants in transactions to have an identity. Bitcoin is not
anonymous. Users can tell a lot about the organisations transacting by how they
use bitcoin. It is however possible to build a new blockchain which focusses
more on privacy. Blockchain can be adapted for numerous business scenarios.
The
decentralisation of data means that participants in the blockchain should have
more control over their own identity. Various organisations will be able to
validate different aspects of a participant’s identity. The identity of a
participant will not be held with one provider.
Blockchain
also allows participants to view transactions in real time. This provides
opportunities for businesses (and regulators) to collect valuable data and cut
processing times.
The
principles of:
Permission
(the participant setting up the network can determine which parts of the ledger
the other participants can see and give a regulator the right to see everything
if necessary (it is worth noting that the regulator will be able to see all
transactions flowing across the business network inreal time))
Consensus
(all participants in the network must validate the blockchain as correct)
Provenance
(blockchain provides a full transaction chain showing the transactions
participants in the network have entered into)
Immutability
(the record of transactions cannot be altered)
Finality
(participants cannot add to the chain until it has been validated as correct).
This
means that the blockchain has the potential to change the way businesses
operate for the better.
The
participants in the network are the same as they are at present. It is the way
that businesses interact, exchange data and transact that will change as a
result of using the blockchain.
Blockchain
is being incorporated into smart contracts – for example, providing a
verifiable record of transactions affecting a particular asset, such as a
parcel of land. Confidence in the ability of the current owner to transfer
value stems from the blockchain or distributed ledger, rather than from a
record maintained and updated by a central authority or agency. Consequently,
where smart contracts are based on blockchain, the way is open for a radical
shift in the relationship between assets such as land and the role of State
bodies such as Land Registries or (possibly) Revenue authorities.
Are
these developments commercially viable?
Greater
efficiency in transactions bring obvious advantages – not least through reduced
transaction costs. However, the developments discussed in this chapter reach
much further than that, and may require a radical rethink of key commercial
relationships.
It is
worth considering those developments in a broader context, bringing in the
perspective of lenders and potential investors. When deciding whether to
provide banking facilities, ranging from accounts to loans, guarantees and
performance bonds lenders are rightly concerned to assess business prospects
and revenue projections as part of any overall security package. Healthy order
books and multi-year contracts provide good evidence to support lending
decisions. In a world of dynamic purchasing, and even more in a world of
dynamic procurement, those elements are likely to fall away – perhaps even
taking with them contractual protection such as “take or pay” clauses.
That
does not necessarily mean that businesses would lose viability from a lender’s
or investor’s perspective. However, it does require substantial recalibration
of the factors that underpin lending or investment decisions. If every contract
– or even a significant proportion of contracts – becomes “smart” and agile,
assessing business performance will inevitably become more difficult: but then
risk assessment is a fundamental part of lending and investment, and when they
must do so, markets are well-able to adapt to new conditions.
Conditional
contracts?
Many of
the early models of blockchain-based smart contracts assume a single
transaction. That model becomes more complex when a deal involves or requires
coordination of several transactions.
For example, a manufacturer might seek to
order critical components from a supplier. That supplier might in turn have to
order elements from other parts of the supply chain, eventually reaching back
to the extractive industries to source raw materials. If each link in the
supply chain were to seek to operate on a “just in time” basis, then their
ability to meet an order might well depend on dynamic procurement all along the
chain.
One result might be a need for the immediate contract between the
manufacturer and the component supplier forming the next link in the supply
chain to be conditional upon the conclusion of contracts back to the root of
the supply chain.
Alternatively, the contract between the manufacturer and the
component supplier might be concluded, and have legal force, only if the
component supplier’s system can give an assurance (probably supported by a warranty
and/or an indemnity) that it has in place the contractual chain necessary to
meet the order.
There
is nothing insurmountably complicated in that picture. In practice, it would
simply require the smart contract to be formed only when the supplier’s system
can generate a confirmatory message. However, methods for ensuring the validity
of any such message – and providing for the consequences of default – would
have to be an explicit element of any smart contract system.
Dispute
resolution?
A key
selling point in relation to smart contracts is the promise that they can be
“self-executing”. Consistent and comprehensive use of “IF/THEN” statements
should mean that the contract anticipates every possible state, with
performance being verified by previously agreed data feeds.
In that
model, there is little or no room for dispute, leading some promoters of smart
contract platforms to suggest that they offer either a wholly new approach to
dispute resolution, or that they spell the end of any need for dispute
resolution through arbitration or litigation. Such claims might well be met
with scepticism. However, there is no reason in principle to doubt that a
contract could accurately anticipate and cater for at least a high proportion
of issues likely to arise in a commercial relationship.
If smart contracts were
to develop on industry- or sector-wide bases, and with the benefits of the
consensus arising from distributed ledger technology, then it is quite credible
to suggest that smart contracts might materially reduce the scope for dispute.
Certainly, smart contracts have the potential to provide a viable alternative
to current models of arbitration or litigation – but only if (and to the
extent) that they fulfil their own objective of catering for all possible
“states” of the contract.
Any
widespread move towards smart contracts would also have broader implications
for lawyers and legal services. If smart contracts were to be adopted across
sectors, one result might well be a substantial reduction in the volumes of
transactional work requiring legal input. Contractual disputes might also
diminish where contractual performance is verified by objective data feeds.
That is not to say that all deals could easily or cost-effectively be rendered
into smart contract form, or that contractual disputes would become a thing of
the past. It does, however, support the view that an increasing proportion of
the work traditionally carried out by law firms might be commoditised or dealt
with on a “do it yourself” basis by clients. In response, law firms may well
have to re-examine and overhaul their business models – perhaps even making a
long-overdue attempt to close the gap that has opened up between law firms,
largely still locked into a model dominated by specific transactions and
disputes, and the broader advisory practices that have emerged largely
uncontested from the major accountancy practices.
IoT, blockchain and smart
contracts might well compel law firms to reconsider what it means to be a
lawyer, and to focus on areas in which legal input genuinely adds value.
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