Poor Contract Management Costs Companies 9% — Bottom Line
Research shows that good Contract Development and Management could improve profitability by the equivalent of massive 9% of annual revenue*
Research by the independent International Association for Contract & Commercial Management (IACCM) indicates that companies struggling to maintain stakeholder returns and profitability in harsh economic times could well be missing a trick. A massive boost to bottom line figures can well be achieved by focusing on an often neglected discipline: Contract Management.
IACCM notes that without ongoing diligence contracts can ‘leak’ value. Leakage can be directly financial (out of date pricing schedules for example), or indirect (misunderstandings and a breakdown in relationships might lead to poor or late delivery for example).
IACCM identifies the major areas of contract and management weaknesses leading to leakage as:
- Disagreement over contract scope
- Weaknesses in contract change management
- Performance failures due to over-commitment
- Performance issues due to disagreement over what was committed
- Inappropriate contract structures
- Disputes over pricing
- Issues with subcontractors
Of those contracts that leak revenues, the losses commonly manifest themselves in several ways. Indeed these manifestations can be inter-related and impact each other, or lead to consequential loss such as non-renewal or failure to expand the contract through additional business or innovation (and it shoudl be noted that the average 9% losses do not include the effect of these missed opportunities).
In a recent study, almost 77% of IACCM member companies indicated that project delays or cost overrruns represent a regular source of loss; a further 53% highlighted claim and dispute settlements, with 26% experiencing losses and delays from contract cancellation and a similar percentage facing revenue leakage from liquidated damages. Importantly, these issues are predominantly due to non-technical causes – such as those identified above.
Ultimately, contracting is all about performance. Trading relationships are formed in order to enhance results. It is based upon those contracts that organizations claim savings, revenue or enhanced capabilities.
Yet many contracts do not deliver against forecast or expectations – and it is this under-performance (causing a potential impact on the bottom line equivalent to 9% of annual revenue) that is gaining increased management attention. There will be growing focus on the causes of failure and contract risk analysis will be expanded to better understand why things go wrong and how they can be remedied.
The evidence suggests that two key stages need attention:
A) A solid contractual position: relies heavily on both parties showing a readiness to build alignment that supports performance. Key to this is qulaity of communication and recognition that today’s fast changing environment generates inevitable uncertainty and a need for flexibility. Organizations must also become more creative in their use of external benchmark and performance data. IACCM points to deep concerns that the process to a solid contract can be compromised by the development of the wrong partnerships, driven by incomplete or inappropriate selection criteria. Much of this is a result of functional performance measures that undermine good judgment and decision making – for example, sales compensation paid on deal closure or procurements measured by claimed savings at the point of contract signature.
B) On-going contract management: here IACCM encourages future contract processes to be driven by a better integration of internal management and measurement systems. Given this solid structure Contract Management skills post award will play a key and fundamental part in identifying possible risk of ‘leakage’. Contract Management needs to become not just a functional discipline, but a business competence.
Finally, IACCM observes that many organizations have fallen into the trap of believing that contract and commercial discipline is achieved through rigorous compliance management. In fact, this approach simply serves to blind management to key aspects of business and market intelligence, resulting in terms and processes that accelerate the level of loss. The IACCM research found a direct correlation between the level of loss being experienced and the nature of investment in contract management capability.
* Figures based on independent market research carried out by IACCM in 2011/12. 9% represents an average which varies significantly between companies and industries (contact IACCM at firstname.lastname@example.org for more precise information).
The IACCM Operational Guide to Contract & Commercial Management sets out the underlying body of knowledge for this discipline – see http://www.vanharen.net/9789087536275/contract-and-commercial-management-the-operational-guide?filter_name=6275