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Contracts – inhibitor or enabler

April 27, 2015

Contracts are written to reflect a wide variety of business policies and practices, as well as product or service capabilities. At a time of rapid change, it is inevitable that terms need continuous review and update.

Examples of change come in the form of regulation – for example, the European Union and payment terms, the US and revised revenue recognition, China and software code. It may be driven by market volatility – for example $50 oil, turmoil in the Middle East, the emergence of the AIIB – or the challenges created by growing social transparency and reducing trust – for example, the recent initiatives by Microsoft and Amazon regarding labor practices, or the more general trend towards supplier responsibility for outcomes.

Existing contract models are often not appropriate; traditional templates and terms are too rigid; perceptions and evaluations of risk are too narrow. Contracting processes are struggling to catch up with the trends towards empowerment and self-help. These factors cause contracts to be viewed as inhibitors to getting business done. For many organizations, this results either in lengthening cycle times for negotiation and drafting (as demonstrated by IACCM’s recent benchmark study) or in contracts that are simply not suited to the purpose for which they are used.

Overall, this means that the incidence of financial loss from poor contracting is increasing.

Driving improvement is difficult because in most organizations there is no clear owner of the contracting process. In those organizations where leadership does exist, several areas of improvement are starting to emerge:

– shifting appreciation of risk, focusing more on analyzing the likelihood of risks occurring

– greater use of relational and performance based contracts (which IACCM research suggests cut failure rates by up to 50%)

– growing sophistication in the use of agile contracting models, with work to reconcile budgeting and forecasting systems

– user-based contract models and tools, to ensure fast and accurate dissemination to those who are responsible for implementation and performance

– analysis of contracts for business intelligence – in particular insight gathered from across the contract portfolio, not just individual transactions

For those leading these changes, contracts do indeed become a business enabler and a source of competitive difference. They reflect businesses that are adept at change – and therefore far more reliable trading partners.

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