Contract Economics 101: Transforming Your Contracts into Opportunities
by Dermot Whittaker on November 11, 2014
In discussions of the ROI of a contract management system, the distinction is often made between efficiency and effectiveness. Getting more work done in less time, or at lower cost, is efficiency. When a contract management system reduces search time for contracts, allows standard language to be reviewed once instead of multiple times, and allows contract professionals to handle work that used to go to more skilled (and more costly) attorneys – that’s efficiency.
Effectiveness, on the other hand, can be defined as perceiving the value a contract offers, including the opportunities for business growth, and consistently acting to realize that value. In a positive sense, this means keeping the organization aware of the buying terms agreed to in a contract and, where possible, making purchasing decisions conform to those terms at their most beneficial. In negative terms, it could mean recognizing the risks that the contract presents – for example, risks of non-delivery by your organization or the counterparty’s – and acting to reduce the risks or using the contract terms to mitigate them.
Efficiency and effectiveness usually work hand in hand. For example, a contract management system that allows managers to extract obligations from the contract text and create tasks and workflows around them is a giant leap forward in efficiency that also helps these professionals reach high levels of effectiveness by giving them access to contract information and alerting them when attention is particularly needed.
When contract managers are aware of the terms of the contract and the realities of the business dealings post execution, they are in a position to recognize and seize opportunities – that is, they can realize, even maximize, the benefits promised in the contract. When they do this consistently – a challenge when managers are few and contracts are many – they show effectiveness.
Paths to Effectiveness
The premise of a contract is that both parties to agree to the business terms and goals and to the contractual terms to reduce or mitigate the risks associated with those goals. Once a contract is signed, it falls to the contract manager to see if the conditions are being met and, if not, that the risk mitigation steps are being followed. This post-execution obligation tracking is one of the most important roles the contract manager has.
Some areas where contract managers can show effectiveness:
Price Discounts – Supplier contracts may offer a discount in return for volume purchases, for prompt payment, or for reciprocal benefits named in the contract. Where contract managers can track spending under the contract, they can determine if the prices paid were the lowest the circumstances allowed. Managers can then adopt new purchasing strategies or approval processes to insure that future purchases are made in accordance with these discounts. In some cases, the managers may be able to recover the overcharges. In the case of rebates, the contract manager can identify these and see that they are applied for and claimed.
CM System Impact – Where possible, integration of a contract management system with the ERP or accounting system can make it easier for a contract manager to access data of spend under the contract or more broadly with a particular vendor.
Price Adjustments – Supplier contracts may allow prices to change based on market conditions over the life of the contract – provided the purchaser does the homework to invoke these changes. If a product is widely available at a lower cost from other suppliers, a contract manager may use the supplier contract to request a reduction in price.
CM System Impact – Where the supplier contract contains terms allowing price reductions based on the lowest market price, a contract management system can be used to create a reminder to review the market prices periodically to determine whether a price reduction should be requested.
Tracking Obligations – This means your obligations as well as the counterparty’s. Your own organization may have the best of intentions where your own obligations are concerned, but these obligations can go unfulfilled if they do not have owners and the owners are not made aware and reminded of these obligations. Reporting requirements are prime candidates for neglect unless they are identified and assigned. As for the counterparty, identifying their obligations and tracking them before the due date has many benefits. For example, in a multistage, cooperative venture, the contract manager becomes aware of counterparty deliverables, assesses the risk of these turning into stumbling blocks, and addresses them in an ongoing manner so that business proceeds as smoothly as possible.
CM System Impact – Managing dozens or hundreds of obligations associated with a contract by listing them in a spreadsheet is a common practice. The spreadsheet method has limits. How much of its organization and follow up logic remains in the head of the spreadsheet owner? How are reminders and workflow produced, if not manually? Most importantly, how are failures to meet obligations escalated when problems are not remedied on a first attempt? A contract management system with obligation extraction and tracking capabilities minimizes the work involved in capturing and monitoring the obligations, permitting more expertise to be expended in intelligently assessing the status of the obligations.
Mitigating Failure to Deliver – Suppliers and subcontractors are not always able to deliver goods and services on time or as specified. Contracts are made to insure that remedies are available in these circumstances. When contract managers tracking deliverables discover one that is late, defective, out of spec, or unfulfilled, they can make sure that that the best available remedy is invoked – whether this is a price reduction, refund, servicing option, or rushed delivery. Simply making these options known within the organization or in discussions with the supplier can insure that follow up to the failure occurs as the parties agreed.
CM System Impact – Setting up conditional alerts – tasks and reminders that only occur where a condition is met – is a way to bring follow-up attention to unfulfilled obligations. In a contract management system, if a deliverable, milestone or fulfillment percentage is not reached by the agreed date, a task tied to the remedy clause of the contract can be assigned, automatically alerting a designated contract manager to invoke the most appropriate remedy, and escalating as needed.
Renegotiation – Organizations sometimes find themselves renewing contracts without renegotiating or even effectively reviewing them. For long-term contracts or contracts for goods and services in rapidly changing industries like high tech or telecommunication services, this is a scenario to avoid. Renegotiation renews familiarity with the market, and usually reduces costs while obtaining better service. Contract managers can enable their negotiating team to get the best possible terms by alerting them to a contract’s expiration early, ideally with 1 to 3 months’ notice. There may even be price discounts or locking in of lower rates if a contract is renewed x amount of time before expiration.
CM System Impact – Knowing when all of their contracts are due to expire or renew is often the first benefit contract managers look for in a contract management system. In addition to reporting on contract expiration dates, a contract management system can assign review tasks to contract owners months in advance so they can prepare for renegotiation. Conditional alerts can provide greater notice for higher value contracts, or for more complex, long-term contracts.
Extending Value Beyond the Contract
Beyond the successful management of any one contract, contract professionals can demonstrate effectiveness in two other ways. First, by staying aware of which contract terms are being met and which are at risk, contract managers can address these promptly with the external party (whether a supplier or a customer) minimizing damage to the business relationship through informed communication, often informal. A supplier or client who realizes that they have an observant partner on the other end of the contract is motivated to treat the contractual agreement as the basis of an ongoing business relationship. Furthermore, addressing any failure or risk of failure sooner rather than later avoids the stresses of late stage failure when larger goals or the entire project is at stake.
Second, by tracking and recording performance of terms, clauses, payment plans, service credit systems, etc., the contract manager can suggest improvements to future contracts, backed by documented business experience. Users of contract management systems can track the instances of disagreement over terms, conflicts and their resolutions, cost of service, and many other aspects of a contract that go beyond purely commercial considerations. Having access to this information in a reportable, organized way makes the contract manager a valuable voice at the table when business decisions involving supply chains and subcontractors need to be made.
In short, contract managers can identify opportunities for savings, anticipate or mitigate risks, and monitor performance of contracts across a portfolio. Contract management systems can help them do this by making the information reportable and actionable through clear tagging of obligations as well as the assignment of tasks associated with these obligations. Obligations that are not met receive appropriate responses and escalations. The combination of trained professionals and up-to-date contract management technology can raise the performance of contract managers from one of simple efficiency to recognized and valued effectiveness.
This is the last of our four-part blog series “Contract Economics." The entire blog series is referenced below.
Contract Economics Blog Series
- Part 1 Focusing the Right Human Resources on the Right Business Problem
- Part 2 Leveraging Process and Automation
- Part 3 Building a Business Case for a Contract Management System
- Part 4 Transforming Contracts into Opportunities