Contract Management and Compliance

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Contract Management 101
A Total Value Management Introduction



Contents

Contract Management Defined

Basic contract management can be defined as the execution and monitoring of a contract for the purpose of maximizing financial and operational performance and minimizing risks. This involves tracking purchases against contracts to insure preferred suppliers are used, rates adhered to, and discounts and rebates collected. In addition, purchases should be distributed among suppliers as appropriate to mitigate risk. Contract management is important because it is the foundation of an organization’s procurement activities.

However, from an enterprise perspective, contract management takes on many more meanings. Although contract management is the process of tracking contracts to determine who the corporation should be ordering from, when, and at what price – and ensuring that the suppliers are adhering to the agreed upon terms – from procurement’s perspective; from a legal perspective, contract management is the process of ensuring that the corporation is using standard terms, that risks are mitigated, and that contracts are in place for all key relationships; and from a sales perspective, contract management is the process of dotting the i’s, crossing the t’s, and making sure payment terms and dates are clearly specified.

Thus, there’s simple sourcing and procurement contract management, and Enterprise Contract Management. Enterprise Contract Management is the holistic view of contract management that is formed when one looks at contract management from the enterprise perspective. Beyond the tracking, collaborative authoring, workflow, monitoring, alerting, reporting, template selection, and clause-selection capabilities in a standard contract management tool designed for sourcing and procurement, an Enterprise Contract Management Solution will enable an organization to do full Contract Information Management (CIM). Just like a true Supplier Information Management (SIM) solution will allow a corporation to capture, manage, query, and create initiatives around the corporation’s supplier information, a Contract Information Management solution will allow the corporation to capture, manage, query, and create initiatives – including contract optimization, leverage of intellectual property, and sustainability – around the corporation’s contracts and all of the information that pertains to them.

With a true Enterprise Contract (Lifecycle) Management (ECM or ELCM) solution, a corporation not only manages its contracts, but the information that is contained with the contracts and that is related to the contracts. A corporation can not only find the contract for a good or service in question, but share that information with their sourcing and procurement systems for automated compliance verification of invoices and spend analysis systems for compliance reviews and realized savings analysis. Thus, when selecting a contract management system, be sure to select one that allows for storage and query of all contracts, not just the ones that sourcing creates. It will deliver more value for the corporation’s dollar than a solution that only stores sourcing contracts.


Market Pressures

A number of significant market forces are converging that, when combined, will significantly increase an organization’s Cost of Goods Sold (COGS) unless advanced sourcing technologies, focused on Total Value Management, are brought to bear on the sourcing effort – a sourcing effort that must include contract management, tracking, and performance management. The major market forces are an uncertain global economic outlook, new regulations, globalization, outsourcing, decreasing returns from IT investments, and increasing costs.

Uncertain Global Economic Outlook

Rising and falling currencies, political instability, natural disasters, terrorism, rising fuel costs, supply shortages, changes in consumer spending habits, and an aging workforce are all putting increased pressures on business to reduce costs and improve financial and operational performance. The only way for an organization to reduce costs while improving financial and operational performance without increasing risk is to get a handle on what it is spending with which suppliers, where such suppliers are located, and which suppliers the organization should be spending with in the future. This necessitates a contract management system and the visibility that such a system affords.

New Regulations

New regulations are requiring companies to establish and document business controls, procedures for obtaining, tracking, and reporting material business information, and procedures and systems to ensure compliance and auditing. For example, the Sarbanes-Oxley Act (SOX) and the new FASB (Financial Accounting Standards Board) rules have made improved financial tracking and reporting an imperative. Thus, sourcing managers require e-sourcing tools that will allow them to gather and track all of the relevant information used in the e-sourcing process and that will allow them to implement standardized processes that will ensure their compliance with the new rules and regulations. Furthermore, they will need to get many agreements in iron-clad contracts, track, and enforce these agreements over time. This necessitates a good contract management system.

Globalization

Globalization is increasing the overall complexity of the supply chain. Logistics, lead-times, quality, import/export rules, and supplier relationships are all variables that need to be obtained, analyzed, and tracked in the strategic sourcing cycle. Managing a globalized supply base can be tough if the organization cannot identify whom it is sourcing from, from where, and when – which requires easy access to contract data, and, thus, a contract management system to put that data in.

Outsourcing

Gone are the days when strategic sourcing is as simple as running an reverse auction or putting a strategic item up for bid and selecting the bid with the overall best value according to a multi-variant ranking. One has to first determine whether or not the commodity should be included in internal spend management initiatives and if the projected cost savings are not sufficient to warrant inclusion in the spend management portfolio, the sourcing team will then have to decide whether or not to simply do catalogue buys or outsource the commodity to a managed procurement provider who might be able to obtain lower prices or better value through amalgamation with its other clients. Then someone needs to track the buys and the performance of the outsourced procurement commodities as well as the performance of the internal strategic sourcing buys. This will require a system for centralized contract management.

Decreasing Returns from IT Investments

Each year, the return from IT investments made in the organization’s enterprise resource planning (ERP), customer relationship management (CRM), and supplier relationship management (SRM) applications yield smaller and smaller returns. New applications, which builds on the data and knowledge in these existing systems, is required to extract additional value. A previous wiki-paper pointed out the essential nature of a spend analysis system to regain the initial value of investments of these systems, but a spend analysis system is most useful when it can compare actuals to contracted rates, which necessitates the existence of a central contract repository.

Increasing Costs

Steadily increasing raw material costs, energy costs, operational costs, and salaries are pressuring companies to streamline operations, reduce costs, and improve performance. A contract management system can streamline the procurement central and expose contracted rates to the organization, which can be enforced before invoices are paid.


Basic Requirements of a Contract Management System

Although a large number of differing contract management systems and solutions, described using different terminology and a focus on different features and functions, exist in the marketplace, the core capabilities of a contract management system should be distillable into a short and easily understandable list. After all, the ultimate goal of a contract management system is to insure that all negotiated savings hit the bottom line while streamlining processes and reducing risk.

When one begins to focus on the goals, the basic functionality starts to crystallize. Specifically, the organization needs visibility into its spend with respect to its contracts and associated purchases, monitors with respect to active contracts and upcoming renewals, appropriate access for all affected parties, and performance monitoring capabilities. This dictates the following basic capabilities: a centralized and searchable contract repository; collaborative contract creation and workflow; a template repository; monitoring and alerting against milestones; reporting and analytical tools; roles, permissions, and security; and data import and export capabilities.

Although many systems may, and often do, offer additional capabilities, they are not always critical and many of these capabilities are really just bells and whistles that do not offer significant value relative to the cost of the system when compared to the capabilities outlined above and explored below.

Searchable Centralized Repository

The most basic, and most critical, requirement of a contract management system is a searchable centralized repository that maintains and tracks all of an organization’s contracts. The repository should support and enforce (XML compatible) contract metadata that describes the contract. The metadata should be maintained in a global index to allow for quick and easy Boolean searches to support quick location of all contracts by supplier, commodity, and/or timeframe, for example. Finally, the repository should be very easy to navigate. If the system is clunky, users will not want any part of it and may try to circumvent the system whenever possible.

Collaborative Capabilities and Basic Workflow

The contract management system should allow multiple users to input, update, track, and create contracts and associated purchases and should track the status of a contract at any given point in time. It should allow users to mark contracts as proposed, modified, or accepted, define tasks (accept, review, reject, etc.) and associated users, and indicate whether the contract is current, expired, or pending.

In addition, it should also come with, and allow power users (and legal in particular) to create contract templates and standard clauses that can be re-used time after time in new sourcing projects. This greatly simplifies contract creation over time since it usually amounts to either selecting a standard contract and simply filling in quantities, delivery times, and shipping terms (as long as each procurement professional remembers to send out the standard contract, terms, and conditions in the RFP and indicate that suppliers must agree to participate in the eSourcing event) or, in special cases for a new or custom commodity or service, simply gluing together a contract from standard clauses (and then having legal do a cursory once-over for completeness).

Monitors and Alerts

The contract management system should allow the user to define monitors and automatic alerts to indicate upcoming contract expirations, automatic renewals, required approvals, and detected deviations. It should automatically alert a user of pending tasks, incomplete information, payments, and new routings. Furthermore, if it contains, or is integrated with, a compliance system, it should be configurable to automatically provide alerts when a transaction is identified that is either off contract or not at the contracted rates.

Reporting and Analytics

A good contract management solution should come with significant built in reporting and analytical capabilities that will allow the user to determine the number of contracts in the system, active, pending, expired, about to expire in the next 30 days, and so on. The user should also be able to run flexible ad-hoc queries to determine, for example, how many suppliers are in a particular region, how many suppliers have not agreed to confidentiality agreements, how many suppliers are associated with a category, and so on. This capability is crucial in the identification of savings, risk reduction, and supply base consolidation opportunities as well as for the support of compliance and spend analysis initiatives.

Import / Export Capabilities and Fixed Point Integration

A contract management system is worthless without data, or in our case, contracts. The last thing a sourcing organization will want to do is manually enter the hundreds, thousands, or tens of thousands, of contracts, that are currently in force. Therefore, import capabilities are absolutely critical. Also, since a good contract is a managed contract, the award particulars of a finalized contract need to be recorded in the purchasing and / or inventory tracking systems to insure that the contract terms are adhered to. Therefore, export capabilities are required as well. In addition, fixed point integration points to standard ERP and / or inventory systems as well as into the spend analysis and compliance tracking systems should be well defined.

Considering that many contracts in the organization might only exist on paper, the contract repository should have no problems accepting, indexing, searching, and converting standard OCR output formats as well, since a contract management system is only as good as the contracts in it that can be easily accessed and located.

Roles, Permissions, and Security

A good contract management solution needs to be accessible and usable by everyone in the organization who needs access to or is affected by a contract. However, not everyone should have the ability to create, alter, or approve contracts, and certainly no one should have the right to change a contract that’s been signed and finalized. (Adding an amendment or addendum is okay, but that’s different from changing the underlying contract, since it’s simply adding a new document and associating it with the contract.) Furthermore, only employees and cleared contractors should have access to the system, and only approved employees should have access to documents in the system of a confidential nature.

Thus, a good contract management system should have exceptional security, and the ability to define roles, assign them to users, and override default permissions on a user-by-user basis.

Template Repository

A good contract management solution should come with a repository where legal and procurement teams can create standard terms, clauses, and contracts for common categories and services to streamline the procurement and contracting cycles. It should also contain tools to quickly create new standard terms, clauses, and contracts as modifications or alterations of current terms, clauses, and contracts. Furthermore, it should allow the creation and storage of “contracting best practices” documents and tutorials to allow the organization to maximize its return on its investment.


Benefits

Contract Management systems offer a broad spectrum of valuable benefits. This section describes nine major benefits of contract management systems, many of which are unique to such systems.

Standardized Processes and Procedures

Contract Management systems enable standardized processes and procedures. This helps to decrease maverick buying and decrease supply risk while increasing spend leverage. The net effect is that buys as a whole become less costly and more valuable and a much greater percentage of negotiated savings are captured by the business, as opposed to the situation without a contract management system where every sourcing professional might user her own process to cut a contract.

Low Value Activity Automation & Cycle Time Reductions

Contract Management systems allow for automation of many low value activities including contract tracking, monitoring, and renewal alerting. This allows for cycle time reductions which in turn enables the procurement organization to place more spend under management per FTE. This is especially true if the contract management system comes equipped with standard templates and clauses which are then customized by the legal team for common commodity categories and services, since this allows for quick contract creation in most sourcing projects, especially if the standard contract, terms, and conditions are included in the RFX and suppliers must agree to them before they can be granted an award.

In addition, the centralization of contracts into a single repository allows for additional cycle time reductions since no time is wasted looking for contracts or gathering data to run regular performance or compliance reports. Not only does it take time to track down the individual who signed or last had possession of a contract, but also to eventually retrieve it from the appropriate filing cabinet. Moreover, studies have shown that at least 10% of contracts are lost in many organizations. With a contract management system, the contract is always there, at a few clicks of the mouse.

Spend Visibility

Probably the most valuable benefit of a contract management system with a centralized contract repository is visibility into global spend and the global supply base. This improves compliance and allows an organization to standardize on consistent contract terms. Furthermore, it allows for automatic identification of “evergreen” contracts, expiring contracts, and standard contracting cycles and the sourcing team to never miss a renewal or cancellation date again (providing that the appropriate alerts are defined and the system monitored regularly). It also allows for easy identification of contracts with suppliers in high risk zones due to natural disasters, political unrest, or economic uncertainty, which is critical to the development of appropriate organizational risk management strategies.

Improves Compliance

Contract management systems allow contracts to be tracked. This allows purchases against the contracts to be checked for compliance quickly, easily, and, if the contract management is integrated with the purchasing system, automatically. The net effect is that maverick buying is decreased, rebates are tracked and captured, and overpayments are reduced, if not eliminated. In fact, according to Aberdeen (Practical Approaches to Contract Management Deployment) compliance management is improved 55% with a contract management system.

Furthermore, just the simple fact that contracts are visible to each and every affected employee will increase compliance since purchasing rules will now be known and understood and easily enforced by diligent employees.

Solid Foundation for Spend and Performance Analysis

With all of the contract conditions and negotiated prices and fees in a central location, it’s a lot easier to compare actual purchases against contracted buys. This allows policy or regulation violations to be caught and dealt with immediately and insures that all spend is known and available to be appropriately leveraged in sourcing projects. It also simplifies invoice reconciliation immensely – either the organization is being billed the contracted price or it is not, and the system knows the right price. It also improves spend categorization, since the spend category can be selected or defined at contract creation time and prepopulated in the compliance tracking and performance monitoring system.

Centralized Repository

Without a contract management system, contracts are usually scattered across a company. This makes location difficult, and sometimes impossible. This also hinders compliance tracking and performance analysis. With a contract management system, contracts are always immediately locatable in a centralized repository. Moreover, this repository can be replicated and backed up on a regular basis to prevent data loss and used as a baseline for full spend accountability throughout the organization.

Rebate Management

Contract Management systems make it easy to track rebates and insure that all of the savings negotiated in a sourcing cycle are captured. Without a contract management system, a buyer might not even be aware of a rebate or be unable to locate the information necessary to obtain the rebate.

Reduced Maverick Spending

If a buyer is unable to locate a contract, or unaware that a contract exists, she is likely to order from whichever supplier she is more comfortable with or the supplier she ordered from last time at the best rate she thinks she can get. With a contract management system, a buyer can immediately determine if a contract exists, who the contracted suppliers are, and what the contracted prices are.

Evergreen Contract Elimination

Without a contract management system to automatically alert a buyer of contracts coming up for automatic renewal, many auto-renewing contracts are likely to go unnoticed and automatically renew, locking the buyer in for another buying cycle. If the market cost of the commodity is significantly less due to supply and demand, the buyer could end up paying a lot more then he or she needs to. Thus, the monitoring capabilities of a contract management system that insure no contract renews without warning are invaluable.

Statistics

According to Aberdeen (Practical Approaches to Contract Management Deployment), contract management systems bring the following benefits, which are hard to ignore:

Benefit Improvement
Compliance Management Increased 55%
Rebate Management Increased 25% to 30%
Material / Service Costs Reduced 2% to 7%
Contract Renewal Rates Increased 25%
Revenues Increased 1% to 2%
Evergreen Contracts Eliminated
Contracting Cycles Cut in Half!
Procedures & Terms Standardized
Contract Analysis Maximizes Performance
Administrative Costs Reduced 25% to 30%


Best Practices

As with every activity, there’s the auto-pilot way and the best practice way. This is particularly true in the initiation of a contract management project. This section outlines ten steps that will lead to a successful project.

Don’t Rush In

Before initiating a contract management project or select a contract management system, fully assess the situation. This should include a review of all organizational structures, processes, and system requirements. Review current contracting, compliance, and contract administration capabilities, their strengths, weaknesses, and the data available for migration into a contract management system. Holistically assess competencies from an organizational, process, knowledge, technology, and performance measurement perspective and determine a clear transition path.

Link the Business Case to a Pending Crisis

Contracts touch all areas of the business – not just purchasing. Legal, accounting, logistics, they all need to buy in to the system. Obtaining agreement across these disparate business units can be difficult, but much easier if the business case for the contract management system addresses an impending crisis such as SOX compliance or financial issues such as significant lost revenue or unnecessary incurred costs.

The business case must be compelling. It addition to defining and baseline the performance and associated costs of the current system and the expected improvements, it should detail the risk and potential costs of not implementing the proposed system (in terms of fines, lost revenues, etc.). It should also layout a project plan.

Obtain Senior Executive Support

Obtaining buy-in top-down is a lot easier then obtaining buy-in bottom-up. Furthermore, the senior management team can insure that processes, objectives, and goals are aligned with the contract management system. Obtaining executive support will help counter conflicting agendas, budgetary constraints, and aversion to change before they become issues. Considering that legal will be concerned about liability, finance with system costs and reporting capabilities, sales with impact to existing processes, and IT with how the CM system fits into the existing IT infrastructure, obtaining organizational buy-in could be difficult at first. Executive support will smooth the way.

Define Measurable Targets

As described in the last section, the implementation of a contract management system should be accompanied by significant benefits. Before the system is implemented, there should be objective, measurable targets for expected revenue, cost, and performance improvements such as unit cost savings, higher compliance percentages, improved service levels, reduced risks, or lower operational costs.

Start with the Basics

It’s the repository, contract creation, tracking, reporting, and alerting that often provides the biggest bang for an organizational buck – not the bells and whistles.

A phased approach to contract management demonstrates the quickest implementation and ROI. In particular, the following phases provide a good starting point for an implementation plan.

  1. Centralized Repository to support procurement and enhance compliance
  2. Process Workflows, Monitors, and Alerts
  3. Contract Creation and Collaboration Capabilities

In fact, Aberdeen (Practical Approaches to Contract Management Deployment) found that over 20% of the total value and ROI from even the most extensive contract lifecycle management systems was due to the centralized repository alone.


Define Detailed Functional Requirements and Stick To Them

Nothing can kill a project faster than scope creep, and this is especially true for a contract management solution. Start by auditing current processes, systems, and controls and locating the gaps. Then define what the basics of the process, system, and controls should be and uses this as the baseline for the functional requirements of the system.

This forms the basis of the project plan, which must be adhered to diligently in order to prevent scope creep and insure that the solution is implemented on-time and on-budget to deliver the ROI that was calculated.

Dedicate and Empower a Program Champion

A successful project is a managed project. However, a project manager is not enough to ensure success due to the nature of a contract management system project, the number of departments and individuals it touches, the number of different viewpoints, and the increased chances of at least some significant resistance. Someone intimately familiar with the objectives and goals of the project needs to be empowered to make hard decisions.

The program champion is responsible for communicating and ensuring alignment on program goals and milestones and ensuring that each affected user and stakeholder receives the proper training on protocols, governance, and systems.

Form a Contract Management Governance Council

Senior Executive Support and a Program Champion who can make hard decisions on a day-to-day basis are great, but at the end of the day the process needs to be owned, managed, controlled, and regularly improved. This should be done by a small oversight group that is representative of the different users and stakeholders, which will include, at the forefront, management, legal, and procurement.

Monitor, Measure, and Market Constantly

The project should be monitored and progress tracked and measured on a regular basis. This includes measurements of system adoption as well as process performance. Any derivations from the plan should be addressed immediately. Results should be reported to the governance council and key stakeholders on a regular basis along with recommendations for continuous improvements. In addition, great results should be marketed to the entire organization as an example of what good eSourcing systems and processes can bring to an organization.

Use Templates to Streamline the Contract Cycle

The contract management system selected should enable template support for standard contracts and standard clauses, and hopefully came with standard templates for different commodities and verticals that could be used to jump start the creation of custom templates and clauses for the specific categories, service, and vertical needs. Either way, one of the first efforts that should be undertaken, preferably in parallel with initial contract repository population, which can be handled by IT and procurement, is the creation of standard templates and clauses for common categories and services by the legal department, backed up by procurement, to streamline the contract cycle.

A Selected Bibliography

(The) 12 Days of X-emplification Day 4 - Contract Management by Michael Lamoureux, December 16, 2007

(The) 6 Days of X-asperation Day 5 - Questions to Ask Your Contract Management Vendor by Michael Lamoureux, February 7, 2008

Best Practices in Contract Management: Strategies for Optimizing Business Relationships by Tim Minahan of Aberdeen Group, September 2004

(The) Contract Management Benchmark Report Procurement Contracts: Maximizing Compliance and Supply Performance by Vishal Patel of Aberdeen Group, March 2006

Contract Management Helps Meet Sarbanes-Oxley Act Requirements by Upside Software Inc, October 2004

Contract Management in the Middle Market by David Bush, June 21, 2007

Disruptive Technology in the Contract and Proposal Management Marketplace by Vishal Patel of Aberdeen Group, July 2007

Enterprise Contract Management by Michael Lamoureux, July 17, 2007

(The) Forrester Wave: Contract Life-Cycle Management, Q1, 2006 by Andrew Bartels of Forrester Research, March 2006

From Research to Revenue: Optimizing IP Profits with Enterprise Contract Management by Ralf Vonsosen, July 2005

(The) Hackett Group Study on Contract Management: The DNA of Procurement, The Hackett Group, March 2006

Integrating Contract Management and Spend Analysis by Eric Strovink, October 17, 2007

Performance-Based Contracting Demands New Supply Chain Management Skills by Mark Hillman of AMR Research, October 2006

Practical Approaches to Contract Management Deployment: Accelerating and Optimizing Contract Value by Aberdeen, November 2005

Procurement Contract Risk Management by APICS & Protiviti, 2004

Authors

Michael G. Lamoureux, Ph.D. of Sourcing Innovation

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