In today’s difficult and uncertain economic environment, organizations have placed cost savings high on their agendas. Obviously, procurement can play an important role in reducing costs by negotiating the best possible prices, terms and conditions in their contracts with suppliers. However, without an effective contract management program (including the right organization, processes and supporting technology) these savings will remain captured savings only, as opposed to realized savings. Some studies have even shown that organizations only save approximately 60% of the potential savings that they have captured (a phenomenon commonly known as savings leakage). But the benefits of effective contract management do not end with cost savings. Contract management can also play an important role in mitigating the supply chain risks that all companies face. In short, effective contract management can reduce savings leakage, mitigate supply chain risks and serve as a competitive advantage for companies.
However, although most companies are aware of what it takes to have a best-in-class contract management program, many companies lack the resources and/or the expertise to develop a program that can address the high number and complexity of the contracts that they maintain. This post presents two initial steps that any company can take, regardless of resources or expertise available, to move an organization towards an effective contract management program.
Classification of Contracts
The first step in implementing an effective contract management program is to identify the relative importance and type of each contract that the organization maintains. Undoubtedly, some contracts are more complex or more strategically important for the organization than others. It is important to know which contracts are key for the organization and where the highest potential savings are. Generally speaking, any contract can be classified as one of the four different types of contracts shown in the figure below.
Using this model, organizations can classify each of their contracts based on amount of spend and sensitivity, or complexity. Having this classification in hand, organizations will be able to develop a strategy and execution plan for each type (e.g., Frequent, Tough, Generic and Challenging) of contract that they maintain.
Development of a Contract Strategy and Execution Plan
In order to develop a strategy and execution plan it is important to understand the number of resources required and the best strategy to pursue for each different contract type. For example, a contract with low sensitivity and low spend (i.e., “Frequent” contracts) will require only basic contract management. This means that the organization’s focus for this contract should be on contract administration and supplier performance. On the other hand, if an organization has outsourced activities that are key to the organization’s daily operations (a “Tough” contract), then the organizations focus should include contract administration, relationship management, risk migration, strategy, innovation and development of the supplier. The below figure demonstrates this need for differing strategies and execution plans based on the type of contract.
Utilizing the framework presented here, any company can take the first steps towards realizing the benefits of effective contract management. However, it is important to understand that this is only the beginning. Implementing an effective contract management program requires processes that enable contract authoring, editing and storage – just to name a few. Finally, remember that the process is slow. It requires support from stakeholders within the organization, significant change management and coordination with suppliers. But if done correctly, the benefits are significant and well worth the investment in time and resources.