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Law360 (July 20, 2020, 2:59 PM EDT) --
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| Reece Clark |
Initially, a brief discussion involving the scope of transaction cost is warranted to evaluate the benefits of investing in frictionless contracting through terms of service agreements. These costs may be divided into three general categories.
First, transaction costs may be arrived at by calculated means using fixed proportions relative to trade.[1] For example, assume you have x amount of material you wish to exchange for y amount of value. In the process of exchange, z amount of material may disappear for a variety of reasons (e.g., scrap, expiration). Here, z represents a direct transaction cost (perhaps one of many incurred in the process) that is ultimately a cost of production.[2]
Second, transaction costs may be imbued in each step of the transaction itself, such as costs for information gathering, bargaining, decision-making and enforcement.[3] Here, classification of transaction costs is possible at each phase of a deal.
For example, two parties willing to contract must first find each other, which requires time and effort.[4] Once the parties decide to transact, they must convey enough information to one another such that each can arrive at a reasonably agreeable bargain.[5] This often takes time where the parties are sophisticated, and may involve external resources for information gathering. Assuming the parties are able to transact, they may also have post-transaction compliance costs.[6] Viewing transaction costs this way helps cost modeling to create a per-deal estimate of the work that may be required to complete a deal.
Finally, and more generally, transaction costs may be built into the transaction as a setup or overhead cost.[7] This holds that a trade will require resources to carry out; namely, costs that are independent of the trade itself or the amount to be exchanged — in other words, overhead costs.[8]
Overheads are expenditures not readily quantified with any particular cost unit.[9] Overhead costs are expressible as support costs, borne indirectly from business operations that enhance the efficiency or ease involved in the process of profit-making activities.[10] This view of transaction costs allows for macro estimations of overall profit making, rather than a per-deal estimation of cost. The overhead cost most relevant for this article is the legal fees involved in the profit-making process.
Reducing Transaction Costs at Scale
Consolidating the views above into a framework, a few considerations emerge regarding legal spend as an overhead.
First, if each contract a company enters involves x amount of legal fees to negotiate to optimal outcome y, a company should find ways to reduce x while maintaining y as a constant.[11] In other words, for every dollar a company saves in x without decreasing y, it has successfully reduced its transaction cost (expressed either individually at the deal level or as an overhead).[12]
This is not a precise equation as companies are constantly weighing the risk involved in a slightly suboptimal contract against the additional legal spend necessary to achieve an optimal outcome. There is also a lower bound of suboptimal outcome that inverts the value proposition of the contract itself.[13] At that point, the best alternative to a negotiated agreement is no agreement at all.
Generally, reducing legal spend in business-to-business contracting is difficult because of a variety of factors, including the variability of business-to-business contracts, relative parity businesses have to one another in negotiating market positions, and perceived importance of achieving near-optimal contracting outcomes.[14] However, the same is not necessarily true for business-to-customer agreements. Here, the company is never presented with customer paper and customers rarely (if ever) attempt to negotiate the terms of service.[15]
Likewise, a company has obvious advantages in size, information and leverage, and perceives comparatively little risk from a suboptimal customer contract. Because of these disparities, companies desirous of extracting additional value out of their legal spend may rationally choose to focus on gaining efficiencies in customer contracting (so long as they maintain reasonably optimal outcomes in the process).
The clear solution to gain efficiency is to apply principles of scale and standardization in customer contract administration. When the customer accepts the terms of service without negotiation, the customer acquisition process is relieved from involvement with the legal aspects of the arrangement.
More importantly, since the overhead of legal fees has already been priced into the market value of the services, the company experiences no incremental transaction cost. This creates economies of scale as the overhead legal cost involved in customer acquisition decreases relative to the volume of customers acquired.
The result, ultimately, is an amortization of the upfront legal cost involved in establishing the contracting ecosystem (including the cost of developing the terms of service) among an ever-expanding user base. In addition, of course, the company benefits from optimal contracting positions each time at a per-customer level.
Nevertheless, a company cannot realize a reduction in legal fees by publishing terms of service agreements alone. This approach has been repeatedly tried with browsewrap agreements, and has proven to present too much risk of invalidation by a court and alienation of customer base.
Yet, customer acquisition costs would balloon, for example, if each customer were individually offered a chance to negotiate the terms of service. The solution, of course, is the clickwrap agreement, discussed in part one of this article, which offers a balanced solution endorsed by courts and is an effective, efficient and relatively low-cost way to deploy the terms of service agreement to customers.
In sum, companies looking to make informed decisions respecting their legal spend in a COVID-19 economy would do well to focus on the customer contracting process. As shown above, companies likely can realize the greatest return on investment by pricing in (and ultimately diffusing) legal spend over a growing customer base.
In particular, a well-drafted terms of service agreement combined with a clickwrap and other smooth customer workflows offers a company an advantage when it comes to attracting and onboarding customers in a COVID-19 economy. As an expansion of that thinking, this article now discusses technologies and methods designed to further expedite the customer onboarding process and complement the benefits offered by the terms of service agreement.
Expanding Frictionless Contracting
The U.S. Court of Appeals for the Seventh Circuit, in its 1996 decision in ProCD Inc. v. Zeidenberg, observed that "money now, terms later" types of agreements that "[o]ne could arrange things so that [customers sign these] promise[s] before forking over the money, but that cumbersome way of doing things not only would lengthen queues and raise prices but also would scotch [sales] by phone or electronic data service."[16]
With software increasingly delivered via the internet, the court reasoned, a prohibition on sales where terms of service agreements were delivered after the sale would "return transactions to the horse-and-buggy age."[17] What the court divined in ProCD (despite the somewhat ironic antiquated verbiage) was that novel ways of contracting would be necessary in an age where software and services are delivered virtually.[18]
This observation turned out to be quite prescient. In the nearly 30 years since ProCD, companies delivering software and services over the internet have readily adopted the terms of service model in light of the ease of deployment (via website or app) and contract administration process (clickwrap, no paper necessary). And just four years after ProCD, the federal Electronic Signatures in Global and National Commerce Act was enacted, which confirmed electronic signatures for contracts between parties,[19] and authorized the retention of contracts in electronic form.[20]
Having both statutory and case law authority supporting the use of terms of service agreements in combination with electronic signatures, the adoption rate of terms of service agreements as a primary customer-facing contracting vehicle quickly accelerated.[21]
What was less foreseeable in 1996, however, was just how ubiquitous online software and services would eventually become. Indeed, with the rise of cloud computing and software-as-a-service, or SaaS, delivery models, customers today have rare occasion to procure licenses to on-premises software.[22] Companies offering SaaS products do so primarily on a subscription-based model, which clearly differs from the old-school method involving a one-time sale.[23]
Under a subscription fee model, the importance of gaining and retaining customers cannot be overstated, which is especially true in the COVID-19 economy. Indeed, expansion of subscription revenue (and a commensurate reduction in customer "churn") will be critical for companies looking to restart their businesses.[24]
Fortunately, new industries have sprung up over the last two decades that have focused thinking on ways to increase efficiency in the customer acquisition process while reducing the overall transaction cost. These companies consult in all manner of customer identification, acquisition and retention.[25] IBM, for example, emphasizes that a company should make interactions with potential customers "smooth" and "seamless" from "initial contact through to final sale, and beyond to post-sales support."[26]
On the surface, such guidance illuminates the value of a digestible user experience that simultaneously eases customer concerns, moves a customer toward payment, and then ensures retention. Unspoken, however, are the sunk costs involved in moving a potential customer through each stage of the customer acquisition process, and the commensurate importance of closing the sale.[27]
Because there is clear downside to a company from late-stage customer abandonment, all elements of the customer acquisition process are worthy of examination — including the contracting process. This is doubly true in the COVID-19 economy, where consumers will be extra careful about how they spend their money.[28]
Companies must delicately balance several competing issues in customer onboarding in order to close the sale. For example, a customer may be dissuaded from completing a transaction if the legal risks in doing so are made too obvious or clear.[29] Or, a customer may pass on a product that requires the customer to download the terms of service, sign, mail back, and then wait for approval. Likewise, poorly designed digital workflows presenting clickwrap agreements may be absently ignored by a customer, believing it to be an advertisement instead.
These are just a few examples of what could go wrong in customer contracting, and reflect a range of issues that frictionless contracting is intended to treat in whole or in part. Companies need to design their customer acquisition process — including the point of contracting — in a way that balances several needs at once. These include giving notice to a customer about the terms of service, a meaningful opportunity to review, an easy and efficient method for signature, and the ability to subsequently review the terms of service at the customer's discretion.
Meanwhile, a company should ensure it has prepared a correct, accurate and complete terms of service agreement that works for the company's business, and it should confirm that it has recorded a user's assent to the terms through a time stamp. A company should also properly file and index the assent along with the applicable version of the terms of service, and be ready to produce the same when necessary for inspection.
While the need for expert legal services in preparing a terms of service agreement does not change,[30] companies may take advantage of new technologies on the horizon to further reduce their transaction cost and aid in customer acquisition in the contract review and execution process.
For example, OpenLaw is developing a blockchain offering that serves as an intermediary layer between transactional lawyers and their clients to help clients expedite the execution of legal agreements with their customers.[31] Using an Ethereum blockchain[32] application, OpenLaw is positioning this tool to serve "as a common infrastructure to manage and execute legal agreements in a trusted manner." Blockchain is also being positioned as a way for companies to reduce costs in contract enforcement post-execution via smart contracts.[33]
Another example involves reimagining the terms of service as a user-friendly document. For example, the terms of service for 500px, an online network for photographers, divides the document into two columns: legal language on the left and a simple user explanation on the right.[34] When done right, this approach can help customers better understand the terms of service agreement, thereby engendering more trust at the point of execution.
The image sharing website Pinterest accomplishes this as well by indicating to a user that it intends to explain a particular concept in more simple terms using a subtext annotation that says "more simply put."[35] This approach essentially provides an executive summary of the terms of service.[36] However, companies should involve their counsel in any type of translations or explanations involving the terms of service.
A final example involves embedding third-party tools directly into the customer acquisition workflow to take advantage of outside expertise in clickwrap acceptance.
PactSafe, for example, offers a platform of contract management tools, including a library, application programming interface and software development kit that allows companies to embed in their website or mobile application a streamlined user experience in the contract execution process.[37] On the back end, PactSafe tracks electronic signatures, contract audit capabilities, and dashboard visualization of customer acceptance.[38]
These types of integrated platforms can reduce a company's overall costs in contract delivery, execution and administration while keeping drafting and revision of the terms of service with counsel.
The above examples reflect generally different approaches companies could explore to further support in customer acquisition and contract execution. Each approach offers a different type of solution, and some are naturally more cost-effective than others relative to scale.
Regardless of method, companies need to be sure that their efforts to reduce friction in customer acquisition simultaneously maintain their desired level of legal protection, while also delivering greater value than the marginal costs to develop and employ. This is especially true in a COVID-19 economy where companies need to be selective in their spend decisions. Cost-benefit decisions should be weighed carefully by company management in concert with trusted counsel.
Conclusion
In the wake of COVID-19, cross-cutting thought leadership is necessary to help guide companies and consumers back to a transactional relationship. Inevitably, cash-starved companies will be tempted to bring back customers by compromising on legal protections in order to smooth customer acquisition. However, this article shows there is a better way — frictionless contracting. As the economy emerges from COVID-19, companies that make effective use of frictionless contracting strategies are likely to reestablish themselves in the market and expand their customer base along the way.
Reece Clark is an associate at Polsinelli PC.
Disclosure: IBM, mentioned in this article, is a Polsinelli client.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Carl J. Dahlman, The Problem of Externality, 22J. L. & Econ.141, 144 (1979).
[2] See id at 144.
[3] See id. at 145 – 146.
[4] Id. See also The Transactional Friction Problem, Zeex Protocol, https://medium.com/the-zeex-protocol/the-transactional-friction-problem-3a3bad7272e2 (last visited April 8, 2020).
[5] Dahlman, supra note 26.
[6] Id. at 148.
[7] Id. at 147.
[8] Id. at 148.
[9] See PMO and Project Management Dictionary, PMI.org, https://project-management.com/pmo-and-project-management-dictionary/ (last visited April 4, 2020).
[10] See Overhead, AccountingTools, (Dec. 15, 2018) https://www.accountingtools.com/articles/what-is-overhead.html (last visited April 4, 2020).
[11] Driesen & Ghosh, The Functions of Transaction Costs: Rethinking Transaction Cost Minimization in A World of Friction, 47 Ariz. L. Rev. 61, 68 (2005) ("Transaction cost minimization has played a major role in the legal theory of private law."). See also Lisa Bernstein, The Silicon Valley Lawyer as Transaction Cost Engineer?, 74 Or. L. Rev. 239, 241-42 (1995). Driesen and Ghosh summarize Bernstein's writing as a discussion about how "Silicon Valley lawyers minimize transaction costs associated with the identification and acquisition of intellectual property assets in conjunction with the disposition of venture capital."
[12] See generally id.
[13] Driesen & Ghosh, supra, note 34 ("We argue that people and institutions paying lawyers' fees or other transaction costs obtain something of value. They often pay transaction costs to purchase information that will help them evaluate a proposed transaction.").
[14] See generally Thomas C. Keiser, Negotiating with a Customer You Can't Afford to Lose Harv. Bus. Rev. (November 1988) https://hbr.org/1988/11/negotiating-with-a-customer-you-cant-afford-to-lose (last visited April 20, 2020). Other factors can play a roll as well, including the "spirit of the deal". See Fortgang et. al. Negotiating the Spirit of the Deal, Harv. Bus. Rev. Feb. 2003, https://hbr.org/2003/02/negotiating-the-spirit-of-the-deal (last visited April 4, 2020). See also infra Note 50 and accompanying text discussing typical "cost" in contracting.
[15] See supra notes 16 – 18 and accompanying text.
[16] See ProCD Inc. v. Zeidenberg
, 86 F.3d 1447, 1451 (7th Cir. 1996).[17] Id. at 1452 (7th Cir. 1996).
[18] See Id. at 1451-52 ("Only a minority of sales take place over the counter, where there are boxes to peruse. ... Much software is ordered over the Internet by purchasers who have never seen a box. Increasingly software arrives by wire. There is no box; there is only a stream of electrons, a collection of information that includes data, an application program, instructions, many limitations. ... The user purchases a serial number, which activates the software's features.").
[19] 15 U.S.C. § 7001 et. seq.
[20] Id.
[21] And with adoption came litigation. See supra note 4.
[22] Most laptops do not even come with a CD port any more. As discussed in Digital Trends, the answer is "yes" to whether you can download anything. See Matthew S. Smith, Discs are dying! How to live without a CD or DVD drive in your laptop, Digital Trends, (April 24, 2013), https://www.digitaltrends.com/computing/discs-are-dying-how-to-live-without-a-laptop-optical-drive/ (last visited April 4, 2020).
[23] While this creates interesting implications under copyright's first sale doctrine,[23] the important point for this article is how this model bears on customer acquisition and retention. For an excellent analysis on first sale doctrinal issues, see Ariel Katz, The First Sale Doctrine and the Economics of Post-Sale Restraints, 2014 B.Y.U. L. Rev. 55, 55 (2014).
[24] See Patrick Campbell, Expansion Revenue: How Much Do You Need to Be Successful? ProfitWell (Jan. 16, 2020), https://www.profitwell.com/blog/how-much-expansion-revenue-to-be-successful (last visited April 4, 2020).
[25] A quick internet search revealed the following non-exhaustive sample: Customer Acquisition & Retention, SandCherry, http://www.sandcherryassociates.com/resources/customer-acquisition-and-retention/ (last visited April 20, 2020); Allie Decker, The Ultimate Guide to Customer Acquisition for 2020, HubSpot, https://blog.hubspot.com/service/customer-acquisition (last visited April 20, 2020); Customer Acquisition, Beyond Philosophy, https://beyondphilosophy.com/customer-experience/customer-acquisition/ (last visited April 20, 2020); New Customer Acquisition, Holy Grail of Marketing, http://theholygrailofmarketing.com/new-customer-acquisition/ (last visited April 20, 2020); The Art of Office Thinking, Accenture, https://www.accenture.com/us-en/services/business-process-services/intelligent-sales-customer-operations (last visited April 20, 2020); Matt Gilbert, Is Affiliate Important to Customer Acquisition and Revenue? PepperJam, https://www.pepperjam.com/affiliate-marketing-research-commissioned-by-forrester (last visited April 20, 2020). The tools and knowledge proffered by these companies is not limited to use involving customer acquisition in the private sector. For further reading involving the use of profiles, trend analysis, and data mining in the public sector in an effort to identify and target specific individuals, see Bryan Reece Clark, Kafkaesque Dangers: Iperia, Do Not Pay, and the Government's New Fight Against Improper Payments, 102 Iowa L. Rev. 1719 (2017).
[26] Emily Winchurch, Why Businesses Must Follow Customers to a Frictionless Future, IBM, (March 12, 2018) https://www.ibm.com/blogs/watson/2018/03/why-businesses-must-follow-customers-to-a-frictionless-future/ (last visited April 4, 2020).
[27] What are costs of a new contract typically incurred by a company? Here is a proposed breakdown: 2.5 hours of legal time ($500); 18 hours of contract manager/procurement time ($2,700); 12 hours of operations, engineering, or project management time ($1800); two hours in finance ($300); six hours with compliance, risk or regulatory functions ($1,000) and $600 ("other" types of review or resource). See Tim Cummins, The Cost of a Contract, IACCM, (Nov. 2, 2017), https://blog.iaccm.com/commitment-matters-tim-cummins-blog/the-cost-of-a-contract (last visited April 4, 2020). See also Neil Patel, Customer Acquisition Cost: The One Metric That Can Determine Your Company's Fate, Neil Patel, https://neilpatel.com/blog/customer-acquisition-cost/ (last visited April 4, 2020).
[28] American consumers experienced unprecedented unemployment in the wake of COVID-19, which in turn drastically depressed disposable income. U.S. Department of Labor statistics show, for example, that "in the week ending April 11, the advance figure for seasonally adjusted initial claims was 5,245,000, a decrease of 1,370,000 from the previous week's revised level. The previous week's level was revised up by 9,000 from 6,606,000 to 6,615,000. The 4-week moving average was 5,508,500, an increase of 1,240,750 from the previous week's revised average. The previous week's average was revised up by 2,250 from 4,265,500 to 4,267,750." See News Release, Seasonally Adjust Data, Dept. of Labor, April 16, 2020, 8:30 a.m. available at https://www.dol.gov/ui/data.pdf (last visited April 20, 2020).
[29] Indeed, some companies (such as phone carriers) now actively market their services under a "no contract" plan in order to persuade users that they are free from burdensome legal terms. See Kate Tully Ellsworth, How Do No-Contract Phone Plans Work? Reviewed, (Nov. 7, 2019), https://www.reviewed.com/smartphones/features/how-do-no-contract-phone-plans-work (last visited April 4, 2020).
[30] Companies should not rely on third party "form builder" type services for preparing their terms of service agreement because these services cannot give legal advice and the risks of inaccurate terms outweigh the marginal cost savings. For example, Section 5.4 of the FormSwift Terms of Use clearly and unambiguously states: "We are not licensed attorneys or a law firm, nor do we claim to be. By using this Site, you acknowledge that FormSwift and its affiliates are not providing you with legal advice or acting as your attorney, and you assume full responsibility for any outcomes or costs associated with your use of this Site. FormSwift does not claim that forms and Documents are complete and suitable for use in all situations and jurisdictions." Terms of Use, FormSwift, https://formswift.com/terms (last visited April 8, 2020).
[31] See Wright & Roon, Blockchain + Frictionless Legal Contracting, OpenLaw (Feb. 28, 2018) https://www.artificiallawyer.com/2018/02/28/openlaw-blockchain-offers-frictionless-contracting-to-lawyers/ (last visited April 8, 2020).
[32] See Ethereum, https://ethereum.org (last visited April 8, 2020).
[33] Matthew Blycha, Smart Contracts in the Construction Industry, Lexology (Sept. 13, 2018) https://www.lexology.com/library/detail.aspx?g=78d1740e-bb52-4c67-9135-3d0193a2b2b7 (last visited April 8, 2020).
[34] Terms of Service, 500px (Dec. 2, 2018), https://web.500px.com/terms (last visited April 8, 2020).
[35] Terms of Service, Pinterest, (May 1, 2018), https://policy.pinterest.com/en/terms-of-service (last visited April 20, 2020).
[36] Id.
[37] See Manage All the Contracts Accepted Within Your Self-Service Experiences PactSafe, https://www.pactsafe.com/embedded-signing (last visited April 8, 2020)
[38] Id.
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