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The Cost of a Contract

April 21, 2011

An IACCM member asked ‘how much does it cost to produce a contract?’

As one of my colleagues observed, this is a ‘How long is a piece of string?’ question, but I thought it would be interesting to try to answer. So I started digging into IACCM’s extensive benchmark data to extract an estimate. I am sharing my findings – and will welcome any additional inputs that might either validate or complement what I discovered.

As you will appreciate, thee are many factors impacting the answer to this. Some key considerations are:
  • The complexity of the contract (at one end of the scale we have a PO, at the other something like a major outsourcing agreement)
  • The view we take of what constitutes ‘the contract’ – for example, does it include things like statement of work, schedules, service level agreements etc.?
  • Whether or not the organization makes use of ‘master agreements’ which represent the core terms and conditions under which transactions will occur
  • Definition of what activities are included in the time calculation (for example, is something like requirements definition viewed as part of the contracting process or not?)
  • Whose time we are including in the cost calculation
  • Whether we are considering elapsed time (ie cycle time) or actual time (the number of hours spent on specific contract production activities)
So I will try to provide some data based on a few assumptions. This data applies to Procurement contracts, since it was someone from Procurement who asked the question. I can produce similar data from a sales contracting perspective, if anyone wants to know!
 
First, with regard to something as simple as a purchase order, the actual production process in efficient organizations has been driven down to a cost of $10 or less.
As you move to other forms of contract, there are in fact two key cost considerations. One is the cost of producing and agreeing the contract; the other is the cost of having the wrong contract (inappropriate terms, poorly drafted SoW, unclear service levels). Contracts can be put in place very quickly and at very low cost; business units often find expedient ways to get to contract fast – and create major risks and downstream costs in so doing (an example would be to renew an expired agreement without review, or to re-use an agreement that was raised for a different purpose). Similarly, some Procurement groups seek to impose highly standardized forms of agreement that are not adjusted for the nature of the goods or services they are acquiring – for example, distinguishing between production materials, computer hardware or software licenses.
 
So let’s assume that a company has instituted an effective contracting process that results in proper review of the proposed acquisition and then preparation or use of a contract that is appropriate to that acquisition. Let us also assume that our view of ‘the contract’ is inclusive of all contractual documents, not just the master terms and conditions. And let us also assume widespread use of ‘master terms’ that eliminate the need for case by case discussion or negotiation of the core terms and conditions.
 
Companies operating with an efficient and highly automated contracting process such as that I describe above typically achieve contracting cycle times that are about one third the duration of inefficient companies. In terms of cost, I would estimate the following (these estimates include the time of all those involved in contract production, since precise roles and responsibilities will vary by company and often even within a company):
 
  1. Simple contracts (some negotiation and review (internal and / or external), low risk, relatively low value or spend commitment): Average cost $5,000 (lowest cost $3,500)
  2. Mid-complexity contracts (significant review, some external negotiation, significant – but not major – risk considerations,): Average cost $19,200 (lowest cost $12,000)
  3. High complexity contracts (major review and approval, extensive negotiation, high or unique risk factors and value): Lowest cost $40,000, upper cost may be $200,000+
Inefficient companies fall into two categories. Those that have a rigorous but inefficient process will experience costs of up to three times the level indicated above. Those that have a) excessive rigidity, or b) no overall process discipline, or c) high levels of non-compliance, may well produce contracts at much lower cost, but their actions will result in extensive downstream problems – for example, frequent claims and disputes, extensive cost overruns or project delays.
3 Comments
  1. Peter permalink

    Interesting article Tim

    $10 seems a tad on the low side?http://www.cips.org/en/resources/tools/procurementfaqs/costsofraisinganorder/

    For a complex agreement, your figures represent 19 days to 4 1/2 months for an associate level lawyer in a London office. This drops to 2 1/2 months for negotiation at partner level.

    • Peter
      We have found ‘best practice’ organizations (using software to facilitate contract use and enabling on-line ‘self service’ or outsourced (low cost) production are achieving elapsed and actual PO production times as low as 4 minutes.

      The complex agreements that I reference have typical cycle times for negotiation of 12 weeks or more and of course involve multiple stakeholders, which include lawyers.

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