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World Wide Technology
2020-07-06 22:55:33

How to show value of contract scoring

Our contracting team has developed a scoring model to rate the overall compliance of a potential contract with standard contract language guidelines provided by our legal department. By scoring a contract before and after negotiations, we can show the improvements our professional negotiators have achieved in the contract.

What I am looking for is a way to show the monetary value of those improvements. Can anyone recommend any ideas on this subject?
 
 •  IACCM  •   2020-07-07 07:07:43
Hi Stephen
I'll be happy to speak with you on this, but at a simple level we recommend dividing terns between those that are 'passive' (no direct impact on process - an example is indemnities) and 'active' (direct impact on process).

When a passive clause changes, the economic benefit will typically be through a trade-off - eg a compensatory discount for reduced risk. An active clause change is likely to have a direct impact - eg on resources required, time to cash etc.
 
 
 •  World Wide Technology  •   2020-07-08 13:43:36
Hi Tim,

Thank you for your response. I am not sure I understand your reply. I will try to be more specific about what I am looking for. Our legal has developed a set of 33 contract requirements they would like to see in our contracts (we mostly use the supplier's paper). For each of the 33 requirements, legal has provided an ideal position, as well as fallback 1 and 2 positions.

Working with our legal, we developed a spreadsheet with points for a contract from 0 to 100. Each requirement is assigned a point value percentage, which represents its percentage of the overall contract score. Percentages of that overall point value are assigned to each position (Ideal, Fallback 1, and Fallback 2. Using this spreadsheet, we are able to come up with an overall contract score for each contract, showing how well a contract conforms to what legal requires.

By scoring each contract prior to negotiation, and after negotiation, we are able to show which contract requirements were improved by negotiation and the increase in the overall contract score. For example, we can show a stakeholder that over negotiations improved the contract score from 60 to 70.

What I am struggling with is how to show the stakeholder what that improvement represents to him or the organization in actual dollar value. I know there is a soft benefit to, say, for example, improving our indemnification language to include all third party IP infringement, not just U.S patent infringement, but how do I translate that improvement to a dollar value? Thanks in advance for your help.
 
 
 •  IACCM  •   2020-07-08 14:30:02
Hi Stephen
Thanks for clarifying!

So based on your description, the score you have created is essentially a risk score - which in itself is valuable (and if you are not already doing so, you may want to think about ways to consolidate the results so that you can identify scores by segments, such as different categories, different parts of the business etc. This is great for management reporting, to show how risk levels may vary).

Unfortunately, 'risk' does not in general translate to a $ value, unless you can show that you managed to gain a trade off. For example, maybe you conceded a level 2 position on third party indemnity (because actually you decided the risk here was low), but in return the supplier conceded an improved service level or an extension of payment terms (both of which would have a $ value).

My original point was that many of the traditional legal terms don't directly translate to a monetary gain - they are more focused on avoiding loss or obtaining compensation for failure. But the business terms will represent financial costs or benefits - for example, speed of delivery, service level performance, the right to adjust volumes or usage. Your negotiators should be looking at opportunities to off-set agreement in one area with beneficial terms from the supplier in another.

I guess your challenge here may be that the 33 terms agreed with Legal are not in fact those which represent real economic value - but in that case, maybe you need two indices, one for risk level and the other for economic benefits. Your negotiators should be equipped to understand the right balance in any given situation - how real is the risk versus the opportunity for a gain.

I hope this makes sense, but if not, let's arrange to speak.
 
 
 •  JHensley Consulting  •   2020-07-14 19:21:06
I agree with everything Tim wrote.

Re: two indices ("I guess your challenge here may be that the 33 terms agreed with Legal are not in fact those which represent real economic value - but in that case, maybe you need two indices, one for risk level and the other for economic benefits. Your negotiators should be equipped to understand the right balance in any given situation - how real is the risk versus the opportunity for a gain.")

As Tim said, a risk score for revised terms does not necessarily translate into economic value - so much of this math would be "informed speculation" so to speak. As you mentioned, "there is a soft benefit to, say improving our indemnification language to include all third party IP infringement, not just U.S patent infringement."

Since each situation is unique, the economic value would be a sliding scale based on the size of the contract. For buy-side sourcing and procurement, your monetary scale would need to be informed by an estimated value of the "typical" procurement order anticipated with the vendor. You may want to include a third index that provides you with anticipated volume. (Again, all of this is educated guesswork without knowing more about your business.)

For example:

Say the terms initially were at 100 in terms of risk, but then were reduced through negotiation to 50 based on your scale. Here's the fuzzy math part: we assign this particular clause a value of $10,000 per order if risk is at 100 (full risk = full expense to your company). The anticipated volume of orders impacted by this clause is 20 per year.

So the amount of monetary risk reduced (with guesswork disclaimers above) = (50/100) * 10,000 * 20 per year = $100k annually.

Is that what you're driving toward?

Personally, I'd recommend embracing the risk scoring as the key metric without adding in the monetary value (unless it's a tangible asset with value you can trace). With the subjectivity involved, adding in more assumptions to extrapolate out to "hard numbers" could potentially confuse leadership if they aren't aware of the guesswork behind them. If they can better understand the risk rating, then they will be able to see trends for the legal team - and negotiators - who are adept at lowering their risk without needing a dollar amount. Dollar amounts using the formula above could be gamed or skewed more easily than looking at the average risk score reduction achieved by a negotiator.

Finally, there are also CLM systems that will automate all of the above for you and your end users if you're looking to move out of Excel. You may be using one already that could have these indices added into it and do the calculations for you.

Furthermore, depending on the tool used, you can leverage AI to read third-party paper, compare it to your legal baseline for the 33 terms, and have it assign a risk rating automatically to be reviewed/confirmed by legal. That would require training the AI for your use case, which is often only accessible/affordable for large enterprise implementations.

Please let me know if this was helpful or if I'm off-base! Happy to discuss further.
 
 
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