Delivering Value To The Business
It is a challenge for many groups or individuals within business to describe the precise value they bring. For some – like Procurement – it is a claim of savings relative to a price that they might otherwise have paid; for groups like Contract Management or Legal it is often an expression of costly risks avoided. But in each of these cases, the baseline of ‘what might have been’ is hard to prove and therefore the claimed benefits have limited credibility.
It is now about a year since IACCM issued its study on ‘The ROI of Contract Management”. Our goal was to gain insight to the cost of poor contracting, based on typical experience today. The resulting report had application for anyone directly involved in the formation or management of trading relationships. It generated a number that was higher than our expectations – a figure of 9.2% of annual revenues. This was the average loss or ‘value erosion’ that businesses were suffering from weaknesses in their contracting process and practices.
Those who are familiar with the study will recall that this was an average. Individual business and industries are operating at significantly different levels. But the causal patterns were similar.
Over the last year, a growing number of IACCM member companies have been using this base data in the way it was intended – as a baseline from which they could undertake their own specific research and generate a benchmark. We do not believe any company will fully eliminate losses associated with contracting, but the report indicated a massive range in current performance, suggesting that many could achieve improvements equivalent to 3 – 10% of their annual revenues.
So how are the case studies turning out? Some have been conducted on the sell-side, some on the buy-side. I am not yet aware of an enterprise-wide analysis covering all contract types. But those that have been conducted are broadly validating the original study. For example, this weekend I was reading a report from a global corporation with a high value of capital projects. It reinforces the point that the biggest exposures apply to companies with significant capital or services relationships, where durations are longer and there is greater room for misunderstanding or disagreement. In these conditions, the role of the contract is critical, ensuring clarity of goals and the framework for on-going governance. This buy-side report exemplified our earlier study. Following an audit of a significant cross-sample of contracts, it found repeated examples of losses that were occurring due to:
– Inappropriate form of contract, or omission of key terms
– Incomplete or non-existent Statements of Work
– Poor controls over change management
– Work commenced without contract in place
– Poorly drafted or managed payment schedules
– Misalignment between contract requirements and supplier capabilities
– Inadequate performance criteria and / or no defined performance management regime
– Absence of warranty management
On the contracts reviewed, the costs of poor contracting at this point represent 26% of original anticipated contract value.
A similar sell-side analysis by a major international technology and services company identified now familiar issues: contract terms that mismatched the project goals; poorly defined scope; weaknesses in change management; obligations that were not actively managed; imprecise and contentious performance metrics. In their case, the combined impact was that anticipated margin was 4.2% below plan.
As we look across the range of companies where analysis has been undertaken, we see a substantial variation in performance based on whether contracting is viewed as a coherent discipline and process. The high performers are those where there is more consistent definition and control. The poor performers have limited insight to who produces key contract documents (for example, statement of work) and generally lack effective tools or training to support the contracting process. Without these, they only discover weaknesses in contracting when disasters occur. They have no insight to the steady drip of lost value that is happening every day.