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.
At last week’s IACCM Americas conference, many delegates were stunned by what they learnt about GDPR, the data privacy regulations that the European Union plans to impose from May next year. One observed that this is ‘another example of the law operating contrary to reality’.
It isn’t just the scale of fines that matter (up to 4% of annual revenue), but the extent of what will be deemed ‘private data’. As Apple’s head of litigation observed at a conference this week: “The challenge is that it applies to all personal data, meaning any data that can be used, ultimately, to identify who you are. So it’s far beyond your name, your Social Security, your bank account. It’s your IP address, or your device ID, or a reference number to a customer, or a complaint or question that you brought in. For any organization, beyond tech, it just covers just about anything.”
This legislation is costly; it is questionable how companies will comply; and there is no real evidence that anyone (beyond the ivory tower of the European Commission) actually wants it. When they discover the impact of this legislation, there is every chance that consumers will complain because it means more checks, more clicks, more validations and more focus on giving specific authorizations regarding use of data.
For corporations (and government) GDPR places a heavy burden on processing costs, which will inevitably fall back onto consumers in the form of higher prices or taxes. The level of technology investment required to protect data continues to spiral; the sophistication of nations interested in hacking continues to grow. Adding these further layers of required protection challenges European competitiveness in international markets.
Ultimately, as with too many regulatory initiatives, the rationale and benefits are unclear. Cynics might suggest that the real purpose behind this is that it is another way to fill the EU’s coffers with money from fines. When the consequences – as in the case of GDPR – are so profound, there surely should be a much greater engagement with the wider population to obtain their support.
At the end of each IACCM conference, we like to summarize key themes. Today, I am featuring the observations of Sally Hughes, IACCM’s Chief Operating Officer.
CHANGE
Change is a constant enigma to us all. While one executive presenter told us to embrace change, to “make change your best friend”, another observed that in reality change is reacted to by one of two things – complacency or terror!
We are all facing change – in our organisations, in technology, in the projects that we are managing – so don’t we all have a duty to react to change in a very different way – to focus on it as an opportunity? And in the context of contracting, we need to design our contracts as an instrument for managing change. Our organisations are demanding us all to be more agile, more adaptive; to remain relevant – we have to contribute to this agenda.
RISK
We heard a lot about risk throughout the conference. Again, I would like to quote the speaker who commented that risk is always owned by a customer in every case; customers can lend that risk or share it – but customers always own it. So, we need to have the courage to talk about risk and focus on appropriate risk allocation, on risk management and risk mitigation – to focus on minimising risk. It was noticeable how everyone ran out of the conference room following a presentation on GDPR, terrified of the potential impact of a regulatory fine – 4% of annual revenue. But we seem to concern ourselves so much with what needs to go into the contract to protect us and not the practical solutions to avoid the risk becoming a reality in the first place! It took on of our Leaders of the Future to observe – “…why are we so worried about 4% of annual revenue when it might not happen? Why don’t we worry about the 9.2% value erosion that is already happening as a result of weaknesses in contracting…!”
INTEGRATION
My final theme came as a result of the output from the Great Debate. The audience, by a very small margin, voted that procurement should become a sub-element of Contract Management. However, I think the real output was in fact the need to focus on integration. And that brings me back full circle to our opening remarks on Wednesday where we talked about the inclusiveness and diversity of the IACCM Membership, one of the great strengths of IACCM. The Chief Compliance Officer from 3M talked in her presentation about the “15% Culture”, the need to spend 15% of your working day focused on activities beyond your role because this is the source of innovation, of value. This is the thinking and the opportunity that IACCM provides – extensive networks, the ability to outreach, a commitment to research – beyond your organisation, beyond your industry and beyond your geography – to gain those outsights. So, don’t let this be the end – one of our Leaders of the Future talked about how she was excited to have found “applicable solutions” to challenges that she can take away from these three days. That is the purpose of this conference, to give you tangible takeaways so that rather than just saying – “…it was an OK conference…” – you can say it was an “outstanding” conference and start putting into action the things that you have learnt when you get back to your desks on Monday morning. And key to that learning is to think and operate as integrators of ideas, approaches and people.
Trading relationships often involve multiple parties whose support and alignment is critical to success. Achieving that support and alignment depends on empathy – an understanding and appreciation of their point of view (whether or not we agree with it).
Last week, IACCM held its 16th annual Americas conference, bringing together groups that represent four of the key stakeholders in every significant trading relationship – lawyers, project managers, contracts and commercial and procurement professionals. The spirit of collaboration was palpable. Newcomers especially were amazed at the openness and inclusive behaviors, commenting on the positive, ‘can-do’ atmosphere.
So what makes it different?
For an event to succeed, it requires a shared sense of purpose that goes beyond simple networking. The IACCM conference enables conversations between people who would not normally meet each other outside a negotiation. With its focus on ‘trading relationships’, they rapidly find a uniting topic, something that all of them care about and consider important.
I am going to highlight three of my observations from the event – three factors that helped build this spirit of togetherness.
- Each of the functional groups is facing similar pressure to increase delivery of measurable value. This means a need to expand their role and thinking – and to achieve this, building bridges between each other is an obvious way to generate more creative, more successful solutions and outcomes.
- At this event, even more strongly than in the past, there was a clear consensus that the approach to formation and management of trading relationships is changing. The integration of ‘the contract’ and ‘the relationship’ lay at the heart of many presentations and case studies, with focus shifting to the terms that support improved governance, greater adaptability and proactive performance management.
- There is a new enthusiasm and belief in the opportunities that lie ahead of us – in particular from new and emerging technologies. With ContractTech a major feature of the event, delegates were given multiple insights to an exciting future, where the quality of data will enable a shift of role and business influence.
For several years, IACCM research has pointed to the scale of value erosion that comes from weaknesses in the way we form and manage contracts. While a few organizations have picked up on this and driven significant improvements, most have not. Suddenly, the reticence is disappearing; there is a real belief that a focus on ‘relationship resource planning’ can yield the next big wave of savings – and that the IACCM community, with its ‘collaboration across boundaries’, will be at the heart of the movement that drives these benefits.
The field of Procurement has been undergoing rapid and significant change. All the experts predict that the era of change is not over – indeed, quite the opposite – it is speeding up.
How successful has Procurement been in making the adjustments expected of it? IACCM has been undertaking research – ‘Procurement Present & Future’ – to find the answer and to discover priorities for further improvement. While input from the function itself has been welcomed, our particular focus has been on those who interact with Procurement – other internal functions and stakeholders, plus suppliers.
What’s the verdict?
There is widespread agreement that Procurement has become more influential. This has been especially noticeable in its focus on compliance and allocating greater risk to suppliers. Around 70% have also noted the relentless pursuit of lower prices, with around a third noting a shift towards the broader measurement of ‘cost of ownership’.
Given these observations, it is not surprising that few perceive Procurement becoming better at building collaborative relationships. In fact, internal colleagues actually think that Procurement has gone backwards in this regard; supplier personnel are a little more generous, but still only give a rating of 6 out of 10 for this capability.
SRM is a bright spot; technology gets mixed reviews
Supplier Relationship Management (SRM) receives positive reviews for the contribution it makes to improved results. Category management is also seen as helpful. In organizations where they have been introduced, both of these initiatives link to perceptions of increased professionalism.
Technology has been an area of major investment for many Procurement groups, so has this generated a positive return? Views are mixed. There is consensus that systems are generating better data, supporting improved conversations and performance management. However, outside Procurement, there is no great feeling that automation has streamlined procedures, nor has it resulted in fairer rewards. Indeed, suppliers identify procure to pay systems in particular as overall damaging to business results and the ‘fairness’ associated with contract award.
So does it add up to greater value?
Overall, the results support the view that change has been occurring. Certainly Procurement appears to have been increasing its control and making its presence felt – and it is not surprising that these characteristics are not popular with everyone. But of course the real question is whether those increased controls are starting to deliver real business benefit. That is where the jury appears still to be out. Scores in areas such as business judgment, delivering innovation and operating flexibly are on average negative – and this sums up to very mixed views on whether Procurement has actually increased its business value contribution in the last five years. By a small margin, suppliers feel that value has increased; by a slightly larger margin, internal colleagues feel that it has not. Clearly, there is still progress to be made – and the pressures for rapid change will only increase.
To participate in the IACCM survey and receive a full copy of the ‘Procurement Present & Future’ report, visit https://www.research.net/r/Procurementpresentandfuture
New research will be presented at the IACCM Americas conference next week. It shows that levels of trust in outsourcing relationships are often weak or non-existent. Not surprisingly, where trust is low, disappointing or failed results are not far behind.
Without giving away the details (further in-depth reports will be published later this year), a couple of points jump out at me from the findings. First, in spite of all the talk about strategic advantage and innovation, the overwhelming majority of buyers continue to focus on cost reduction as their primary goal and measurement of success when outsourcing. This aligns with previous research which shows that, at least in early years, reduced costs are the main determinant of a ‘good’ project. Only over time do other characteristics, such as innovation or continuous improvement, start to have extensive influence on the relationship.
What I found especially interesting in the results was that the number one reason that buyers give for their unhappiness is that they perceive suppliers ‘under-scope’. This, presumably, leads to regular battles over fee versus free and, in many cases, to additional costs or under-performing services.
These issues of cost reduction and under-scoping appear to me inextricably linked (and were discussed in my recent blog on opportunism). If buyers focus on cost reduction – and therefore base supplier selection on low prices – they can hardly complain if the provider minimizes scope in order to win. This syndrome is evident in industry after industry and, sadly, suppliers who try to warn buyers about the consequences of this approach simply do not win business. All the evidence we have is that honesty and integrity do not pay.
So if your outsourcing agreement – or indeed any other signficant project – is failing, you should look at the success criteria you established and see whether these drove subsequent behavior. If you want to achieve lower costs, a low-trust and adversarial relationship is the last way you will achieve it. Successful results typically accompany open and honest relationships where the parties are not punished for speaking the truth.
One of my colleagues recently met a marketing executive from Uber at an airport. While talking, my colleague observed:’Uber is really a giant contract management company’. His comment was met with a puzzled look, followed by the reply: ‘I’ve never really thought about contracts’.
Ten years ago, there was the financial collapse. Before that, Enron; and since then, a multitude of highly publicized cases of major public sector waste and, in some cases, corruption. The common factor in each of these? All of them were running operations that relied on integrity in their contracts and contracting practices, yet with senior management that either didn’t know or didn’t care about the underlying lack of visibility and operational discipline.
So what about Uber?
Contracts – and the way they are formed and managed – is the core of Uber’s business. They establish contracts with their drivers; users of the Uber app accept its terms and conditions; regulators require contracts as part of the license to operate. It is the commercial design and interconnections between these contracts that should provide the source of the company’s overall integrity.
So what should Uber be doing differently? I’m certainly not suggesting that there has been any form of corruption. The issue is more to do with alignment. Good contracts and effective contract management are based on thorough stakeholder analysis and reconciliation of different (sometimes conflicting) stakeholder interests. In its race for growth, Uber appears too often to ignore or disregard key stakeholders, or to ensure compatibility between the various relationships it establishes. It has operated with an arrogance or ignorance – I don’t know which – that is now bringing inevitable repercussions, in particular massive damage to its brand.
Uber is not alone in failing to use a disciplined contracting process to drive operational performance and standards. In a recent IACCM survey, the role of contracts in supporting corporate values and brand image came in bottom place. Yet in my view, it should always be top. Contracts should test, validate and reflect the brand. You cannot, in an age of growing transparency and heightened consumer expectations, get away with marketing one thing and contracting for another.
The fact that a senior marketing executive could be so dismissive perhaps offers a further clue to the problems Uber faces – but also suggests a path through which it might find redemption. Analyse your contracts, understand their interdependencies, test their integrity and alignment with corporate goals and values. Through this approach, businesses can rapidly identify and address many of their commercial weaknesses and failings. It is something IACCM member companies are fast recognizing and is one of the core values the Association provides through its annual process reviews and benchmarks.
It’s time for Uber to take a corporate membership!
Many of the jobs in procurement and sales contracting are squeezed into the middle of the process – that is, the part that starts with preparing or responding to bids and tenders, ensuring compliance, preparing and perhaps negotiating the contract. While these are important activities, they are also highly replicable and therefore threatened by automation, standardization and outsourcing. IACCM estimates that job roles focused on these activities will reduce by some 80% over the next five years.
This means that many of today’s practitioners need to focus their efforts somewhere else, providing support or leadership in areas that either are not so impacted by automation, or alternatively are new roles being created as a result of automation. The good news is that such roles not only exist, but also they are increasingly a focus for management attention.
To prepare for these changes, IACCM recommends that its members think about the performance and integrity of trading relationships. The inefficiencies in managing across organizational boundaries offer remarkable opportunities to generate improvements and measurable business value, in both pre-award and post-award management. To achieve this, we need far more focus on the market, an understanding of new suppliers, new forms and sources of competiton, trends in delivering customer value. Building commercial capability requires not just understanding, but also coordination of internal resources to ensure that these sources of value and differentiation have been developed. Such changes will drive new contract models, alternative approaches to pricing or charging and closer integration across organizations.
A holistic view of commercial performance is something that almost all organizations currently lack. Fragmented investments in technology have not helped the situation. But the new wave of analytical software tools is starting to offer very different insights and the ability to prioritize and tackle key sources of value loss and opportunity erosion.
IACCM will shortly release a series of podcasts with advice on how today’s practitioners can make the shift in their role. Alternatively, discover the answers at IACCM’s forthcoming conferences – see http://www.iaccm.com for details.
This week I have been overwhelmed by messages of congratulation for IACCM’s 18th birthday. It is a stark contrast to 1999, when I recall one of the more encouraging comments was: “It’s been tried before. It’ll never work.” Today, with over 40,000 members, from more than 16,000 organizations in 165 countries, I think we can confidently conclude that the pessimists were wrong. Indeed, it seems safe to say that commercial and contract management are flourishing.
Eighteen years ago, the formation of IACCM was indeed a leap of faith, but that faith was based on an evident shift in business need. The forces of globalization – and in particular the spread of networked technology – had created conditions that demanded greater standardization and simplification of commercial policies, practices and procedures. The contracting process – and contracts themselves – stood out as a major barrier for global business, with traditional multi-national companies operating through relatively independent country subsidiaries and unable to enter into multi-country commitments.
Those conditions also revealed the fragmented and inconsistent nature of contract and commercial skills. There was no consistent training, no underlying body of knowledge. The jobs and skill sets – if they existed at all – were largely undefined, except within a single company.
It took 3 years to gather more than 1,000 members. It was 5 years before IACCM had any paid staff. Still the overwhelming view was that the organization could not survive. Yet steadily, with the strong support and enthusiasm of a dedicated band of believers, the pace of growth accelerated.
Today, the conviction that got us started continues to shine through. Indeed, I believe that we are entering a second and even more fundamental phase of relevance, not only to business, but to society as a whole. This time it is the digital world that is the transforming force. User-based systems, social media, advanced analytics – these are forces that demand a new wave of fundamental simplification in commercial practices and in contract formation. Trust in business, trust in institutions is at a premium. To respond to social and political demands, both public and private sector must operate with increased commercial transparency and using methods – such as contracts – that engender confidence and understanding, rather than distrust and confusion.
Who will lead this new wave of change? For me, the answer is clear. Just as in 1999 a small band of believers led fundamental change in contract and commercial practices, so the next few years will see an expanded band leading the way in creating a framework for successful trading relationships. While many traditional roles may be challenged by the emerging global forces, those in contract and commercial management will adapt and prosper as those agents of change.
My thanks and gratitude go to all those who have been on the journey with us over the last 18 years. Today, the Association is strong, with a dedicated and talented staff, a focused and enthusiastic Board and a myriad of ambassadors among its members. I look forward to welcoming many more over the years ahead, because the journey has only just begun. At 18, IACCM has just come of age – the best is yet to be!
Join us today – become part of the IACCM family at http://www.iaccm.com
An article in Inside Counsel poses the question “Why would company executives want the General Counsel to report to the CFO”? It highlights the following as potential reasons:
• The CEO travels extensively or has too many reports. Hence, the CEO wouldn’t be a good manager and there would be a lack of connection—which would be a detriment to the GC and the legal function.
• The CEO has an extremely difficult personality so the GC needs a buffer, which is best served by the CFO.
• The CFO is a more active manager and would be more effective in maintaining a stronger relationship with the GC. There is a dotted line to the CEO.
• The CFO wants the added report for his own professional development.
• The structure of the company has many other core functions reporting to the CFO.
• Because the CFO and GC work so closely together, that reporting structure is a more logical one.
• The CEO doesn’t like lawyers and wants to engage with the legal function “only as necessary.”
• The nature of the company’s legal matters does not merit a CEO report at this time.
As with any organizational debate, these points are all interesting. But it seems to me they miss a fundamental issue – and that is, the scale to which a business’s financial performance links to the General Counsel and the legal staff.
Should the Legal function grasp financial opportunity?
In IACCM’s recent ‘Purpose of a Contract’ survey, respondents were asked whether a contract should be ‘an instrument for generating financial benefit’. They ranked this purpose in tenth place – out of eleven. Arguably, this should be first on the list. Businesses enter into contracts to secure economic gains or to protect economic assets. Similarly, they care about things like regulatory compliance not for their own sake, but to avoid the financial consequences of non-compliance. Hence there is potentially a powerful argument for the GC to report to the CFO, if only to increase legal department appreciation of the key impact their role has on corporate financial performance.
My counter-argument to this position is that the GC – and legal department – is needed as a moral compass. In my experience, companies with an over-powerful finance function are the most likely to lack balanced commercial judgment. Their focus on profitability and growth can lead to decisions that damage business reputation. A strong legal function, properly integrated into the business and with significant authority, should operate as a counter-balance. But to do that, they certainly must appreciate the extent to which their work has an economic and financial impact – so we need lawyers who are truly commercially aware.
Commitment Matters 