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Is contract management getting complex?

Is contract management getting complex?

Contracts are the lifeblood of every organisation -- they secure key staff, guarantee third-party supply and tie clients into lucrative deals.

But contracts are also a real problem area. The sheer number and complexity of documents can cause headaches across the business because despite finance, sales and procurement -- as well as the relevant business functions -- having a huge vested interest in their content, contract management is typically poor.

Spreadsheets aren't robust enough, despite being the tool of choice for many; and ignoring the issue won't make it go away. A report by Aberdeen Group from 2007 claims that best-in-class companies experience a contract leakage rate of 14 percent, while the rest experience 24 percent. Small companies see a massive 40 percent leakage. Make no mistake, it's a serious problem.

For one, there seems little evidence of a coordinated approach between the interested parties. Procurement or sales often agree complex contracts without the full involvement of finance, meaning that clauses, sub-clauses, milestones or service level agreements (which might have the original aim of securing revenue enhancements or cost reductions) are not honoured.

Second, the majority of organisations have extremely poor visibility of the documents themselves. Centralised contract repositories are non-existent, many documents reside on staff desktops and spreadsheets are the most common method of control.

The reasons for this are both historical and organisational. Historically, contracts have never been so complex as they are today; meaning that in the past their tight management was less of an issue. Organisationally, a general trend towards centralisation - as well as heightened M&A activity - has resulted in operational managers and finance growing further apart. The result? deals being struck without the involvement, or, at worst, knowledge, of finance.

Mark Williams, chief financial officer of technology investment company MMX Group, offers an excellent example of just how desperate contract management can get. He described a situation while working for ERP giant Bahn. The company had leased what he describes as a "horrible office" in South Africa - a contract it was looking to get out of. When he finally tracked down the contract, however, he was shocked to discover that just the week before a clause had been triggered which committed the company to a further 15-years' tenancy.

He says that the common approach is for sales or procurement to "chuck a contract over the wall" with some staff not interested in contracts post signature. All sights are set on putting pen to paper, with the financial implications of the small print often forgotten about as soon as a deal is signed. "No one knows if you buy another can of beans whether it would trigger a 20 percent volume discount on £5 million worth of spend," says Williams.

It's a critical point. While the CFO might have visibility of contracts, often they won't have visibility of volumes. And it's these volumes that trigger the rebates and discounts that will sometimes be the reason why some contracts were signed in the first place.

Talking different languages

Gavin Herman, director of niche supplier-management consultancy Triangulus and a former chief operating officer of sourcing at investment bank Morgan Stanley, offers his own explanation of the situation.

"There are two main components," he says. "First, supplier performance management -- which is about getting what was promised by the supplier in the contract; and second, supplier relationship management -- which is about getting extra value over and above what was promised in the contract, for example, innovation. These activities require different skills. How they're done should be defined as part of the governance that is put in place for each supplier."

Herman, has just spent several months working in the IT function of a global energy giant in an effort to improve just this issue. By bringing the skills and experience of professional supply management and contracting to internal business functions -- such as IT -- suppliers can be better managed and the true value of contracts realised.

Like Williams, he believes that much of the problem has its roots in the disconnect between those whose responsibility it is to get a contract to the point of signature and those who manage the implications of that contract on a day-to-day basis. This is especially true in areas of complex spend, such as IT.

"Procurement, as part of a pre-contract activity, manages the tender process and negotiates the best commercial terms available at the time," he says. "However, once the signed contract is handed over to the business, its management becomes a post-contract activity. Over the contract term, do you absolutely know for sure that you are keeping the benefits you expected to realise or are they bleeding away?"

This "bleeding" effect -- or ensuring that contract obligations are met -- is ubiquitous among large organisations and, as a result, is a huge opportunity for CFOs to improve operating profit and margins. "Obligation management is very badly done almost across the board," argues Williams, giving contract leakage another name.

An ongoing battle

In order to address the problem, finance chiefs need to ask themselves a number of questions. Are the goods the organisations buy linked to a contract price (and potential discount) or are they being bought outside the terms of a current contract or even without a contract being in place? Are volume discounts being applied? Has the relevant contract expired, meaning that full price is being paid? Is the total cost of the contract taken into account? This accounts for only a small proportion of the questions that must be addressed if contracts are to be properly managed.

Consequently, Williams argues that the only way to manage the process is through automation, by using a system which flags up imminent contract events such as volume rebates, service level agreements or milestones. "It needs to be automated -- you need to have a system where you put in reminders of such clauses -- as soon as it's manual, it won't get done," he says, perhaps not surprisingly because his company produces such systems.

But there are few other ways to approach the problem as spreadsheets aren't dynamic enough.

"Sometimes there's a skills and competence gap," says Herman. "Staff in the business, who might be experts in delivery or project management, engage with suppliers day-in, day-out and their drivers and skills tend to be biased towards service and quality.

"Suppliers, while they care about that too, are focused on getting incremental profit and revenue from the contract and have a level of training to achieve that. To avoid this mismatch and enable staff to operate on a par with the supplier to control the day-to-day engagement more effectively requires a higher level of commercial savviness."

According to Williams, however, the problem extends far beyond the failure of organisations to keep track of the minutiae of contract terms and clauses. He claims that another problem is keeping track of the contracts themselves. "A dirty secret is the thousands of contracts that exist in an enterprise that no one knows what they are," he insists.

Williams' company specialises in contract management software, from technology that sniffs out contracts sitting disparately around an organisation, to systems that provide a central repository for the documents and software that manages contract clauses such as service levels and volume discounts. Another increasing trend, he says, is that organisations are looking to contract management software to provide robustness to their audit processes. "One of the Swiss banks was interested in just that," he says.

With the complex nature of today's organisations, it's perhaps no surprise that maintaining strict control over every single commercial engagement is difficult to do. But advances in technology, improvements in processes and greater communication between finance, sales and procurement can reap dividends.

"It's just about starting now," admits Williams. "A proper contract management system will take care of it all - incoming contracts (procurement), outgoing contracts (sales) and human resources."

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