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The cost of a contract

October 30, 2017

I was recently asked by LawGeex, an AI technology and analytics provider, to update an article I wrote in 2011, estimating the typical cost of producing a contract. Here is the result.

Here we are in 2017, with businesses focusing on automation and agility. So surely operational costs in areas such as contracting must have reduced.

In fact, the average cost to businesses of processing and reviewing a basic everyday contract where some level of negotiation is required is only rising. Drawing from IACCM studies, based on analysis of more than 700 organizations, it appears that business spend on a low risk contract from draft, negotiation, to signature, has increased 38% in the past six years, to an average of $6,900. Costs for a mid-complexity contract stands at $21,300 and high complexity contracts run into hundreds of thousands of dollars.

This calculation takes into account data from large companies and enterprises in North America and Europe with annual revenues of $1billion or more, comparing current costs with a similar analysis undertaken in 2011.

The true cost of contract review and approval 

The true cost of a contract reflects the extensive (and growing) time of departments in getting a deal through their organization.

The contract stages include contract creation, processing, review and negotiation of the contract. Costs are incurred due to the involvement of the multiple individuals in an organization required to iron out the contract details. This may include negotiations setting out statements of work, price or charge schedules and ever-growing issues around security and regulatory complaince.

The breakdown of costs in a typical contract involves 2.5 hours of legal time (costing the average business an estimated $500, assuming the use of iin-house resources); around 18 hours of contract manager/procurement time (at a cost of $2700); around 12 hours of operations, engineering, or project management time ($1800); two hours in Finance (c$300); up to six hours with compliance / risk / or regulatory functions (c$1000) and $600 (‘other’ types of review or resource).

Cost data influencing these findings are extracted from the 2017 IACCM salary survey, based on our 40,000 members.

What is driving rising contract costs?

One of the main factors causing an increase in contract costs is the steady increase in domestic and international regulation, such as anti-bribery legislation, data protection and cybersecurity rules. The imminent GDPR legislation is poised to make things even more expensive.

Perhaps as important is the fact that services now represent 58% of business-to business-spend. Contracts for tangible goods (the main source of contracts in the past) are much easier to test, define and specify, while intangible services contracts require increased diligence, such as validating supplier capabilities through service delivery undertakings, drafting service levels and outlining key performance indicators. The growing importance of complex services is mirrored in growing focus (and length) of contracts.

The gap between the most efficient and contract “laggards” is rising 

The gap between average and best has grown due primarily to variability in the levels and sophistication of automation in handling basic contracts. While the average cost of a simple contract has risen by $1900 (38%) in six years, for the most efficient organizations this price has risen by only $300 (9%). Smart companies are moving away from templates and into standard term databases, generating less contention, and saving time and money. This is also where Artificial Intelligence is starting to kick in and where digitization offers potential for major savings.

How to follow the contract cost-cutters? 

The world’s most efficient businesses have cut around one-third of the cost on contracts when compared to the average corporation. The most efficient companies adopt contract “playbooks”, codifying contract policies and empowering the organization. In addition, solutions such as AI and NLP are raising business intelligence and the quality of analytics, which can steadily eliminate the need for case by case discussion of clauses. The lowest costs for an individual contract in “top quartile” companies is $3,800 for simple contracts, $14,000 for mid complexity contracts, and $49,000 for high risk or unique contracts.

What this means for your business 

Management in many companies is awakening to the inherent inefficiencies of today’s contracting processes. The extent of manual intervention, outdated methods of production, individualistic approaches to legal drafting and error-prone production of key documents such as statements of work impose unacceptable delays and costs – not only during production, but even more significantly in performance.

Emerging technologies should eliminate many of these problems. Intelligent systems, together with the steady development of global standard terms, will revolutionize the way that contracts are produced and managed – only then confirming the overall scale of cost that is associated with today’s methods.

 

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