Contract Management Part Two Identifying Opportunities

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1 Contract Management Part Two Executive Summary This is the second paper in a series of three looking at how executives can make a compelling business case for investment to improve contract management performance in their organisations. By Peter Smith Managing Editor Spend Matters

2 The first paper covered an overview of contract management, why it is important for organisations generally and procurement functions specifically, and introduced the concept that contract management is basically underpinned by the need to manage opportunities and risks. If a contract contains no potential opportunity to deliver improved value, or inherent risks, then there would be no point applying contract management effort. In this second paper, we focus in more detail on the opportunities that can be generated from effective contact management. Those opportunity areas form a key element of the business case, along with risk management, which will be covered in the third paper. We look here at the different sort of opportunities that can be identified, ranging through compliance, direct value delivery, and other benefits from effective contract management. We also discuss how such opportunities can be presented as potential benefits in the most direct and tangible manner possible to form a compelling element of the business case. Introduction In the previous paper in this short series, we outlined why contract management should be a priority for procurement leadership, and gave some guidance in terms of putting together a business case for investment. That investment is likely to be in three areas - resource, training and development, and tools or systems to support contract management. In terms of those investment areas, cost may be incurred if additional staff will be required for delivering appropriate contract management activities. However, it s worth saying that often organisations are already putting resource and effort into contract management, but the issue is that effort is unfocused, not properly skilled or managed. The second investment area is therefore often training and development to ensure that staff involved in contract management understand their role and are equipped to deliver what is necessary. The final investment area relates to tools and / or technology. At the very basic level, some sort of record of contracts is essential if the organisation wishes to address this area seriously. As more is expected from contract management, then we need to consider more sophisticated technology that can add value from the contract drafting stage through the whole process - from administration, to performance management and improvement of the overall supplier contribution. We talked in the previous paper about why procurement should take some over-arching ownership of contract management, and the benefits generally to organisations that invest. Expressing that more directly, contract management is at its heart about two factors - managing opportunity and risk. If there was no risk inherent in a contract and no possibility for any opportunities to be derived from it, then we would not bother managing the contract. If I buy a lottery ticket, then from the point of contract, there is no risk or further opportunity available to me. Therefore contract management would be a waste of time and indeed a fairly meaningless concept in the context of that contract. But a long-term IT outsourcing contract sits at the other extreme. There are many risks inherent in the contract, from supplier failure (financial to performance) through to reputational risks if the supplier turns out to be exploiting 2

3 its workforce in some manner in far-off countries. There will almost inevitably also be opportunities to achieve more value from the contract than the original and exact words suggest. So those two factors are central to contract management, and therefore need to form the basis of the Business Case in terms for investment in the process. In the rest of this paper, we re going to focus on the opportunity side of the equation. Then in a further paper to be published later this year, we ll look in more detail at the risk side of the equation. Identifying the Opportunities We should make one distinction immediately. The business case may be at either a general level or for a particular contract. At a general level, the Procurement Director or other executive may be making the case for an organisationalwide investment in contract management, perhaps structured as a major project or perhaps as part of a wider procurement transformation programme. Or it may be that the business case is focused on one specific contract - how do we justify putting resource into managing a new outsourcing contract, for instance. Clearly, the opportunities identified can be much more specific in the latter case. Harder numbers may be available, or quite detailed examples can be provided, showing where the contract management activity will be focused and what the direct deliverables and benefits might be from that contract. If it is a wider programme and investment that is being sought, the opportunities may be expressed more generally, although it may still be possible and useful to highlight some direct examples of contracts where benefits are predicted. Inevitably, our descriptions and suggestions here will be reasonably general. So if you are applying them to a specific contract or set of contracts, then bear in mind the advantages of making that business case as specific as possible. Use the headings and examples here as a checklist for potential opportunities, but then aim to make your opportunities as tangible and directly applicable as possible. We have categorised opportunities here under five headings. i. Internal Compliance Internal compliance to the contract is often not considered strongly as a risk or opportunity factor, yet it can be either or both. We will focus on the risk aspect in our next paper - for instance, the risk of internal stakeholders not using the contract at all or not complying with the terms. But the closely related opportunity aspect may come about if for instance this is a beneficial contract that is not as yet fully utilised internally in the organisation. It may be that the contract is mandated, but we still need to actually make that uptake happen. That is what we traditionally think of as compliance, and the point can be made that most contracts will need contract management activity to drive that basic compliance, even if it has a theoretical mandate. The other relevant potential situation is a contract where there is no mandate, but with the right encouragement, the internal utilisation can be extended with beneficial consequences, such as cost savings compared to other contracts currently in use. That could apply in the case of anything from a contract for supply of branded marketing materials, to an IT outsource. 3

4 ii. Supplier compliance Supplier compliance to the terms and conditions of the contract is probably more often considered as a risk. That covers a whole series of risks around the supplier not actually doing what they say they will in the contract, and indeed we will feature this strongly in the third paper in this series. But we might also find that compliance can also generate opportunities; for instance, if the supplier has offered price reductions for volume growth, then effective contract management is needed to make sure that reduction actually happens if it is triggered. (There is some overlap here with the next section as well). Other compliance issues might include offers of free products, trials, or special deals made in the contract but which need focus to ensure the benefits are delivered. We ve seen, for example, in the legal services field, buyers asking for free workshops, access to intellectual property or similar in return for a legal firm becoming a preferred supplier. The providers generally agree, and this is included in the contract. But how often and how well do customer organisations take advantage of these terms once the contract or framework is up and running? iii. Direct cost improvement Contracts may contain the requirement for a supplier to provide cost reductions to the buyer over the contract period. That can take various forms, but (for example), it applies even if the contract simply does not allow for inflation linked cost adjustments over time, or has an inflation minus x% price adjustment clause. Such terms are very common of course in longer contracts. But making sure this happens does again require an element of contract management, to ensure that the supplier is actually doing what they have committed to do. Benchmarking or best value clauses are also common, particularly in more sophisticated contracts. They give the buyer the right to check market prices and ask for adjustments from the suppliers if they are found to be out of line. A best value clause may go further and require the supplier either to meet the lowest price in the market, and / or to ensure they are providing their own lowest price to the particular buyer. Clearly, all of this does not simply happen, and suppliers frankly will rarely volunteer to implement such processes without prompting, for obvious reasons! So it is usually up to the contract manager to drive this process, which can have very significant benefits and payback. There may also be more collaborative aspects to the contract, whereby the buyer and supplier commit to working together to reduce costs or make other improvements. These can of course prove to be effective mechanisms, but they do not simply happen. A key aspect of contract management is to drive and manage such initiatives, or at least oversee if it is users who actually do the detailed work. On a less positive note, benefitting from service credits or penalty clauses in a contract cuts across both risk and opportunity. We might rather not get into that territory, as it indicates a failure by the supplier, but if it does happen, it needs robust contract management to actually make sure the customer obtains those benefits. Certainly if the organisation has a history of being able to claim such money and perhaps failing to do so, then the contract management business case could treat that as an opportunity area. iv. Additional supplier value Under this heading, we have activities that deliver value through mechanisms other than simple price reductions or penalties. That s not to say they cannot contribute serious value, but it may not be obviously evidenced as a contribution to the bottom line. Many could fall under headings of change management or re-engineering, and cover how the delivery of the contract requirements might be improved through the contract period. There are many examples and they will differ depending on what the contract covers, but for example: Improving the logistics of the supply, in terms of delivery, stockholding, or materials handling. Quality or process improvement from suppliers that has a knock-on beneficial effect on the customer s performance or value proposition. Working to obtain mutually agreed changes in specification that provide benefits or savings to the customer. 4

5 Use of e-invoicing, supply chain finance or even dynamic discounting to deliver mutual improvements to the payments process Other than for the most straightforward contracts for routine goods, it is hard to think of a contract where opportunities of this sort do not exist. But they need to be identified, planned and executed successfully. That is a key role for the contract manager. v. Relationships and strategic activities Here we are moving into Supplier Relationship Management (SRM) territory. But there is an overlap or link with contract management. Whether the contract manager should also be the person who drives an SRM type relationship is a question for another day, and it is not always appropriate. But often it is the contract manager who will be driving or at least participating in more strategic activities with the supplier. Such initiatives are often hard to quantify for the business case, but they can include development of strong relationships that facilitate sharing of knowledge, developing partnerships with suppliers that might lead to top-line revenue growth, or capturing new and innovative supplier ideas. How do we quantify the opportunities? For a formal business case, all these opportunities ideally need to have estimates (at least) of benefits set against them. Now some of these may be purely subjective, and unquantifiable - better relationships with suppliers is a decent objective (and can be measured in some sense, by survey perhaps), but it is hard to put a cash value against it. But if serious investment in contract management is sought, then the opportunities will need to have some benefit numbers associated with them. This is not a precise science, and it is usually a case of looking for a credible estimate rather than an absolutely firm number. That is true of most business cases however, whether the organisation is estimating the benefit from an acquisition or investment in ERP software, so we are not alone in facing this dilemma. And we can use a number of approaches to establish that credibility. Where the potential benefits are clear and tangible, then they can be set out in the business case. For instance, if there are volume over-riders, rebates or discounts that are achievable but will need some management to ensure they actually happen, then they can be laid out clearly. It may also be relevant to link robust contract management with spend analysis opportunities. Understanding the contract population can help to drive compliance to contract terms and conditions, and can even facilitate spend recovery opportunities where over charging, duplicate invoices or similar have been occurring. (Using any relevant past experience here can be a powerful addition to the business case). Using benchmarking or external evidence can also be useful. If we can identify another organisation that is achieving better results from some aspect of supply, setting that as an aspiration with a benefit linked to that may be feasible. If there is no external guide, and where the contract management opportunity is aspirational, setting a measurable target can feed into the business case. Here are some examples where that sort of approach may be useful: We will target a cost reduction of 5% by working with the supplier on alternative specifications for this equipment / raw material / component. That potentially is worth 500,000. Improving delivery reliability and the process for scheduling deliveries will allow us to reduce material stocks by x%, reducing working capital requirements by 1 million. We will roll out this contract to 5 more countries where current prices are around 7% higher, saving 250,000. A further option here is to put probabilistic estimates against opportunities, in effect discounting them given the inevitable uncertainty around the numbers or even the likely delivery. We will talk about that in more detail in the next paper when we focus on risk. It is often even tougher to put numbers around the more innovative or strategic benefits that improved contract management might bring. A statement that says, we will obtain supplier innovation and ideas that will help us generate 5

6 an additional 1 million per annum in our own product sales may be the best that can be done. Quantifying and measuring the pay-off from such opportunities to support a business case is not easy. So it may be that it is useful to include such aspirations, but not relay on them as the core of the case. Another approach is to use past examples where effective contract management has paid off in the past and relate that to the current investment situation. Whilst past performance is no guarantee of future performance, as our financial advisers will tell us, using stories to illustrate the effect of good supplier and contract management can be surprisingly powerful. Here s an example of how we managed another contract similar to this one last year and saved a million can be a powerful addition to the business case. An investment in contract management should certainly not be purely a leap of faith, but including a few war stories can be very useful. And we ll have more on the use of case studies in the risk paper to follow. So, with a combination of predicted hard benefits, supported by credible targets and measurement, plus the use of narrative stories to illustrate other opportunities, the business case can take shape. (In part 3 we will look at the other key aspect of contract management; risk management and mitigation. Look out for the paper later in 2013). About the Author Peter Smith Managing Editor, Spend Matters UK / Europe Peter has 25 years experience in procurement and supply chain as a manager, procurement director, consultant, analyst and writer. He edits Spend Matters UK / Europe, and with Jason Busch, the founder of Spend Matters in the US, has developed it into a leading web-based resource for procurement and industry professionals. Peter is also Managing Director of Procurement Excellence Ltd, a leading specialist consulting firm, and is recognised as one of the UK s leading experts in public and private sector procurement performance improvement. Peter has an MA in Mathematics from Cambridge University, is a Fellow and was 2003 President of the Chartered Institute of Purchasing and Supply, and his first (co-authored) book, Buying Professional Services, was published by the Economist Books in June Before moving into consultancy, he was Procurement Director for the NatWest Group, the Department of Social Security (the DSS), and the Dun & Bradstreet Corporation, and held senior positions in the Mars Group. About BravoSolution Supply management executives are now, more than ever, under pressure to deliver more savings, develop and manage strategic supplier relationships, accelerate procurement cycles, and maintain process excellence. Confronted with these diverse yet consistent challenges, CPOs and sourcing professionals must seek tailored solutions that deliver rapid ROI to their business. BravoSolution offers leading software and services to fit the needs of today s sophisticated supply management organisations. Our services organisation, one of the world s largest teams of professionals dedicated exclusively to sourcing and procurement consulting, delivers lean, targeted services to support strategic sourcing and procurement initiatives. Our industry leading software toolkit supports the full supply management lifecycle across a myriad of industries, geographies and business models. As of today, over 50,000 procurement professionals in 60 different countries are benefiting from BravoSolution s technology and services, unlocking tangible benefits including increased process efficiency, decision support, cost reduction, improved process governance, greater quality relationships with vendors and the ability to share, understand and act upon the wealth of sourcing-related data held within their organisation. 6