Blog - Management speak

The Contract Folder: Hidden Value or Ticking Bomb?

According to industry estimates, some 20 percent of litigation stems from contract disputes. To add insult to injury, it is not unusual that the original signed documentation cannot be found.

So why do so many organisations have this problem? It is our view that in many businesses the contract portfolio is the largest collection of unstructured data. The sheer volume of such data being created is reaching exorbitant heights. This in itself can make the cost of extraction and collation prohibitive. The uncertainty about how to best model the data to deliver real identifiable value often simply puts the challenge in the “too hard basket”. We have spent considerable time designing a methodology to find an answer to these challenges.

The value of legacy contracts

The information tied up in contracts is rich with data that can potentially drive commercial value and advantage. However, the very thought of having to tackle your existing legacy contracts either held centrally in a contract management system or at worst paper-based files, can be incredibly daunting and a mountain too big to climb. Many of our clients see contracts as “legal” but we believe that contracts are part of the commercial cycle that starts, for example, with a sale and leads to delivery. The intellectual property contained in them is a direct result of input from all parts of the organization: financial, procurement, the C-suite, sales, etc.

Every organization has this issue and in our experience, struggles with how best to tackle it. Some cite not having budget, while others procrastinate as the problem is perceived to be too big or perhaps not seen as mission critical.

At the most simplistic level the lack of a centralized repository only re-enforces a 'silo' mentality and inhibits the use of information in a consistent manner. Small wonder that there are inevitable disconnects.

Applying risk and audit techniques to increase visibility

We believe the answer is to change your approach and consider applying a risk and compliance based assessment to your contract portfolio. Doing this will avoid the need to deal with all your contracts and treat them all the same. Instead, you can prioritise and segment them based on the risk assessment and understanding which contracts give you the insight needed. By identifying the highest risk contracts, the size of the task drops drastically to more manageable levels.

We have developed a methodology that can be moulded to varying circumstances based upon international auditing techniques and statistical analysis. What does this practically mean and what are the key steps in the process?

The first is to break down risk into the key elements. Risk is not analogous. As an example there may be operational, financial and litigation risks in a contract; these are not equally likely to occur nor are they equal in terms of “impact” should the risk become reality.

Likewise, the body of contracts have differing impacts on a business, so it's helpful to break these down into categories. Using the Exigent methodology, we then have a risk weighting by contract type, overlaid with portfolio risk. You can then quantify the risk using the weighted risk factors and contract value. This then gives you an objective measure of how to prioritize the contracts from a risk perspective. Using this technique, you can then decide how many legacy contracts you wish to on-board and more importantly, understand why.

Identifying and prioritising the upside in contract portfolio

Of course, risk is only half the story. If you assume that not all contract obligations are enforced (as leading commentators believe and certainly we endorse), then there should be a significant payback on reviewing legacy information. The numbers are compelling: even if there is only 2% leakage on $100M of sales, this is significant.

Our clients are faced with the same problem; there is a lot of data and no absolute certainty as to the result. But using similar techniques in risk assessment, we apply commercial logic in conjunction with a systematic approach to understanding how to overcome this problem. Our analysts have identified some common traits that are likely to contribute to revenue leakage. It is a simple truth that the longer and more complex the contract, the more likely that obligations will not be accurately tracked or enforced. For example, there is a direct relationship between the number of sub-contractors in a relationship and the difficulty in enforcing the obligations in the contract.

Using statistical analysis, we can assess how many contracts will give us an informed view. Using sampling techniques, you can then delve into the portfolio and assess the extent of contract compliance. Extrapolating the results will help quantify the likely benefits at an early stage.

And there's more...

There are significant additional benefits from extracting information from the portfolio. We will not cover them in detail in this paper, but if the extraction process is done correctly then the following is possible for ongoing and new contracts:

Trend analysis and dynamic commercial analytics

Contract clause rationalization based upon the results of the risk assessment process

Of course organizations have differing levels of sophistication. In fact, there are different levels of sophistication within large organizations.

By using the risk and compliance assessment approach coupled with technology and methodology, the process lets you leave the data where it is, for example in legacy systems, but still interact with it to draw out value.

Contract management journey

To help our clients visualize where they sit in their “contract journey” we like to use the Contract Management Maturity Model (CMMM) as a roadmap. The model is progressive where 1 is the lowest and 5 the highest and you can only move from one level to another when you have satisfied all the requirements of the lower levels. Each level is achieved by performing certain agreed processes. While you may be tempted to jump levels or mix them up, it’s not recommended as you’ll get better results and benefits when the lower level processes are fully functional and embedded into the culture of the company.

The model needs to be viewed not as a rating mechanism but more as a continuous improvement tool.

Level 1 – Undefined and unpredictable

As the name suggests the contracts, as well as their process of management, are undefined and left to individuals in the organization to make decisions. There may be agreements, which commence without being written or well formed. At worse, they may not conform to industry standards or have not been reviewed by lawyers.

The immediate outcomes of this level are unpredictable client payments, failed vendor deliveries, various litigations, low value, low valuations and limited understanding of risk.

Level 2 – Locally managed

The contract management process really starts at this level. Basic processes are in place where contracts are drafted, reviewed, managed and stored locally. Individual contract owners may also be assigned to manage critical contracts but this will not always be consistently applied. Once contracts have expired they are then also archived locally in a manner that they are accessible to only key local personnel.

This level's key points are:

1. Contracts reduced to writing

2.Contracts reviewed by legal team

3. Contract ownership exists but may not be consistent

4. Active contracts stored locally, accessible by authorized personnel

5. Expired contracts archived locally

Level 3 – Defined and decisive

The process here needs to define certain parts of the contract to extract those key data points mentioned. At this level of maturity, the use of an integrated contract management tool at the very least is recommended.

Your list of tools now includes contract templates by type, review checklist, group reviewing, scorecard and a central repository. Tailoring guidelines for every contract strengthens you further. In cases where third party contracts are used, a gap analysis against the organizational templates needs to be performed and its impact documented.

Level 4 – Proactive and profitable

At this level the organization definitely needs a central repository. You can go a step further and ensure that the contracts can be tracked centrally, where possible at any time, anywhere and from any device - laptop or smartphone. This helps build a hierarchy of controls for the contract and reduces the risk of individual errors. It means that true risk management processes can be implemented from making a dictionary of risk, to rating them and from prioritization of risk to response plans for risk impact, probability and proximity. Alerts can be built ahead of time with agreed triggers. Similarly, compliance audits including cross-department plans can be made.

In addition to the above, this approach gets you in the position of advance business analytics on your legacy systems. You can start taking familiar contract terms and give them commercial value.

Level 5 – Continuous improvement, continuous benefits

Not many organizations make it to this level, however, it’s one of the easiest to sustain because of all the previous ground work done. Once maintained benefits are exponential. The need to have materialized risk analysis remains at this level to ensure further improvement of contract management process.

Self funding, better processes

Most of this will not be sustainable without commitment from the senior management. Initially, certain investments in terms of process definition, monitoring, mentoring and training teams, etc., will have to be made. However, the process should at the very least pay for itself. It reduces time to create new contracts for new relationships, focuses on clauses that really matter and therefore strengthens ability to negotiate and improve margins.

You may not have all the skills now and you can use external help to bring in that know-how. They can get things moving for you and drive it, however, it still means you need to look at internal processes and begin a culture change in the organization to sustain it.

Reap benefits now

An organization that does not have the capability to manage individual contracts, processes or understand the risk is doomed not to reap the true value of contracts. While you don’t have to be at level 4 or 5 of the CMMM to benefit, you can start applying simple analytics at level 1, 2 or 3 to solve problems in an intelligent and cost effective way.

The benefits of better contract management are unquestionable. As they are the most important part of the business, they need to be managed in a structured manner. Not only this, but the efforts from the entire organization need to be engaged to achieve desired results.

David Holme, CEO, Exigent Group Ltd.

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01 June 2016

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