• Companies report that linking material costs; inventory write-ups and write-downs that carry costs and capacity requirements; and material liability to the income statement and balance sheet not only deliver value, but align customer relationships to the internal organization and also extends into supplier relationships.
• Linking material, costs and availability with properly used contract management (CM) and other business-process-related technologies, mitigates potential risk areas by exposing the elements that are not in alignment or that create gaps.
• The business functions that contribute to and gain the most from CM technologies are sales, supply management, and legal services.
• CM technology provides an integrated, collaborative platform for ensuring reliable supply and reduction of risk for the customer, enterprise and supplier. The value is obvious in two measures: risk mitigation — use technology to reduce or remove factors that increase risk; return on investment (ROI) is the point of reference for the technology adoption and enablement across the enterprise and the cornerstone for the measurement of success.
AMR Research finds the average business has contracts for 85 per cent of their total customers and 55 per cent of their total suppliers. Most of these business contracts are stored in filing cabinets, compact disks, and personal hard drives located in sales, legal or procurement departments. The results of this highly fragmented business process are duplicate contracts at various prices, too much or too little inventory and wrong completion dates. The organizational risk posed by a decentralized, multi-functional and disparate CM process often goes ignored by companies. This article articulates an organization’s CM value, CM business process requirements, technologies that assist in closing the gap, and the calculation of the technology return on investment.
Income statement and balance sheet value
CM is the business process associated with a documented agreement of two or more parties. CM typically resides in the three functions of sales, legal and procurement. The management of contracts includes a contract repository, contract authoring and approval work flows, contract language and standardized terms, and the identification and tracking of the risk and liability of each contract. Risk-aware, performance-driven organizations understand the immediate value that comes from using CM technologies to improve product and service availability, reduce costs, and lower risks through a more holistic view of CM that spans the balance sheet and income statement.
Our research indicates that organizations are sharpening their focus on the availability and costs of materials that support revenue and working capital in three major areas (see Figure 1):
• material costs;
• inventory write-ups and write-downs that carry costs and capacity requirements; and
• material liability.
Companies report that linking these three areas to the income statement and balance sheet not only delivers value, but aligns customer relationships to the internal organization and extends into supplier relationships. The linked value is displayed in terms of pure numbers: the revenue, costs, inventory, and risk factors that come from aligning the contractual elements. The success in alignment is based on the current and future economic value derived. When done properly using CM and other business-process-related technologies the entire CM process mitigates potential risk areas by exposing the elements that are not in alignment or that create gaps.
A $7 billion discrete manufacturer found it had multiple contracts for the same customer based on different sales regions across one country. The customer did not know it had three different contracts and was charged three different prices for the same product and service. The discrete manufacturer consolidated the three contracts to one thereby reducing inventories and reducing their potential liabilities by 78 per cent. The VP of Sales noted, ‘Without an automated workflow provided by our CM vendor we were at risk of $1.4 million of excess inventory. ’
Business functions gain
The business functions that contribute to and gain the most from CM technologies are sales, supply management, and legal services.
Sales gains value by providing customer contracts with tangible, flexible requirements for revenue recognition. When some terms of the contract are not met, the customer can hold off payment or even walk away from the agreement. For these reasons, it’s in the sales organization’s best interests to not only use CM technologies, but also drive the requirements through service-level agreements (SLAs) to the rest of the organization and its suppliers. A tightly-knit contract cycle from revenue to supply enhances the ability to make the right decisions.
Example: A $2 billion discrete manufacturer introduced a CM product into its sales organization to improve the contract cycle time and standardize customer contracts. The organization mapped out its business process to the new CM technology resulting in immediate work flow improvements. Once effective training was implemented for users, the organization improved margins by 3 per cent and reduced the time to client signature by nine weeks. This resulted in an immediate enhancement to revenue and margin.
A recent AMR Research study shows that CM will be one of the largest areas of technology spending for supply management in 2008. This makes sense as companies, now more than ever, need a way to track their customer requirements via flow-down clauses, ensure compliance, and mitigate risk in their supply base. Supply management needs not only a repository, but authoring, workflow and compliance monitoring to ensure success.
CM technology is an engine that provides supply management efforts with the following:
• immediate visibility into the revenue flow-down requirements;
• the supplier’s requirements for inventory and capacity;
• cost of procured items over time;
• liabilities based on business requirements;
• collaboration across the enterprise; and
• a full financial impact of the supply side.
Example: A $5 billion high-tech company’s supply management organization used its CM technology to stop an insistent supplier’s proposed cost increase. The commodity manager segmented the contract by forecast, current and future contracted costs, inventory liabilities and capacity requirements. When the totals were calculated, the supplier was put on notice it had not fulfilled half of the contract obligations, including carrying inventory as well as the reduction of costs based on completed innovative process changes. The commodity manager not only stopped a proposed cost increase, but also reduced them because of the unmet contractual requirements.
Legal services is the contract engine within many organizations, touching all contracts from sales to supply. It is also the sanity check and final approver, protecting the assets of the firm if litigation is ever required. Verifying that risk mitigation is identified within contract clauses, it also serves as the checkpoint for finance. All aspects of authoring, repository, compliance and workflow in contract lifecycle management are required by legal.
Example: With its CM application, a US health insurance company found it could tie its contracts with customers directly into its network of employees and doctors in full compliance with all requirements across its ecosystem. This connection allowed the health insurance provider to offer the services required by its customers and employees as well as capture and analyze the costs and assist in liability planning across the ecosystem of payers, providers and patients.
Technologies that close the gaps
Technology vendors that provide CM products are AEC Soft, Ariba, Bravo Solution, CMA Contiki, Ecteon, Emptoris, Finetooth, Iasta, I-many, Lawson, Nextance (Versata), Oracle, SAP, Selectica, SpringCM, Symfact, and Upside Software. Although they all offer CM products, each company provides technology that is slightly different in approach. Still, their products provide visibility into trading-partner requirements and the risk and exposure for each enterprise.
Each provider has expertise that can be validated by current customer use. Companies considering CM products should speak to the reference customers and ask the reference about the value derived from the product including partnership risk reduction, improved visibility and ROI.
Consider a $24 billion discrete manufacturer’s experience:
‘Prior to using a CM product, we were in yearly litigation disputes, held our contracts in hundreds of filing cabinets around the world, and had no concrete idea of our contract value—whether or not we were over-exposed or going to run into a problem. We had no clue about the extension of our business to our partners.’
The company was experiencing strategic risk by not optimizing CM across its internal stakeholders. But after it implemented a CM application globally over 18 months, the manufacturer achieved 220 per cent ROI across the company, while improving contract cycle time by 68 per cent and reducing litigation cases by 80 per cent.
ROI of CM technology
CM technology provides an integrated, collaborative platform for ensuring reliable supply and reduction of risk for the customer, enterprise and supplier. The value is obvious in two measures: risk mitigation and ROI.
For CM, handling risk is straightforward: use the technology to reduce or remove factors that increase its effects. Without CM technology, risk factors can multiply.
Risk value can be calculated by multiplying the probability of risk and its impact (see Figure 2). This model can also be useful for communicating the value of contract lifecycle management to stakeholders, with company contracts reviewed against it to expose gaps.
As part of the selling process, the technology vendor typically calculates ROI. This then becomes the point of reference for the technology adoption and enablement across the enterprise. It’s also the cornerstone for measurement of success. Enterprises should ensure key elements are included in the ROI analysis (see Table 1). If the elements are not known, they should be estimated.
Example: An $8 billion High Tech chief purchasing office (CPO) needed CM technology because, as he put it, ‘My business process was fragmented and not under management. I knew that technology would provide a consistent work flow and repository. It was just up to my team and me to choose the right technology and achieve an immediate ROI.’ The CPO and his team chose a buy-side only technology product that was: quick and easy to install; streamlined their process by removing 31 days in the contract review process; implemented standard contracts based on supplier, product and business requirements; and reduced product risk exposure by 48 per cent.
Can you risk NOT using CM Technology?
Clearly, the advantages brought by CM functionality are numerous and spread across the organization and ecosystem of customers and suppliers. An organization’s financials are critical to success, but so is mitigating the risk of higher costs, too much inventory and unknown long-term financial liabilities. Do you know where your company’s liabilities are headed, short- and long-term? Do you know what is happening with your customers and suppliers? Contracts are an excellent way to monitor the availability, cost and liabilities of your trading partnerships. Can your organization risk NOT using CM technology?
Mickey North Rizza is a key member of the supply chain team and communicates effective supply chain, procurement, sourcing, and financial spend management strategies to AMR Research’s clients.
Prior to joining AMR Research, Mickey held the positions of vice president of global supply base management and director of procurement and sourcing At Moduslink Corporation, where she was responsible for implementing strategic sourcing programs, driving strategic positioning of materials in Europe and the Americas, and introducing new procurement technology. And prior to that was materials manager at M/A-Com, Inc., a division of Tyco International.
During her career, Mickey has aided many companies as they built their supply chain strategies, including the role of purchasing manager of Advanced Techcom Inc., Innova Corporation, and Motorola.