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Companies with good contracting processes make more money

October 29, 2014

In a recent exercise, we had groups of business people discuss different aspects and attributes of contracting. They discussed the role and value of the process in managing risk, in establishing reputation and trust, in delivering revenue or profit and in supporting operations and outcomes.

Feedback revealed broad consensus that good contracting delivers benefits in all of these areas – or alternatively, poor or disjointed contracting causes damage and under-performance. Yet despite this realization, it rapidly became evident that few organizations have a well-defined process. For example, participants quickly highlighted major problems with input (unclear or badly defined scope and goals) and with transitions (transfer from pre-award to post-award teams). They mostly felt that contracts are not effective governance tools and often lack the terms needed to manage flexibility or change.

How much does this matter? What is the business case or the economic return from ‘good contracting processes’?

IACCM has approached this challenging question in several ways. The reason it is challenging is that data is limited – not least because so few organizations have a coherent process with regular performance measures. Research in 2012 focused on the scale and reasons for value leakage and identified that on average weaknesses in contracting are resulting in losses equivalent to 9.2% of annual revenue. In companies with the most integrated process, this reduced to as low as 3.4% – an impressive difference.

One finding from this study was that there are substantial differences between industry sectors. Therefore more recent research has compared companies within specific industries, exploring whether there is a link between overall profitability and the maturity of the commercial and contracting process. The answer is clearly yes. For example, in the outsourcing industry, profit margins are highly variable, even for companies offering similar services. In examining their approach to contracting, it was quickly evident that some saw this as a life-cycle process, while others viewed it more narrowly as an activity to oversee compliance or control. A few had little evident control; they delegated authority to business units and operated with many variants in contract terms.

Those who viewed contracts as control instruments or who operated with very few controls showed similar results and struggled with their market reputation. They were viewed either as inflexible or unreliable and failing to meet commitments. Both suffered from a high degree of fire-fighting and their contracts were not useful operational tools. They were also perceived as less creative or innovative – too busy fixing things to have time for added-value conversations.

In one select group of 10 companies, the typical margins of those with poor contracting processes were in the range 2% – 5%. Those with holistic approaches to contracting were recording margins of 14% – 16%.

Conclusive proof that good contracting pays a healthy dividend? Perhaps not; there are of course wider factors to take into account. But there seems little doubt that the quality of contracting is a significant contributor to profitability – or failure to develop competence in this area carries a heavy cost.

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