Victorian Rail Track (VicTrack)
Author: Andrew Sanford, Senior Solution Engineer, Revitas Inc.
OK, let's say your company does everything right when it comes to contract lifecycle management (CLM). Even then, you may not know all the hidden risks if your contracting processes are isolated from the greater enterprise. Would you like to spot the red flags before they catch you by surprise?
Although contracts are the foundation of any business, many companies lack tools and strategies to limit liabilities and extract maximum value from every agreement. Shockingly, in many cases, companies rely on Excel to track millions or even billions of dollars of annual transactions to bridge the gap between CLM and the other systems …
A problem with two sides …
Most large organizations maintain contracts on two sides of the business: the buy side and the sell side. Here's just one common sell-side scenario.
It's another great day in XYZ company's contracting department. The sales team has just closed another big deal with a customer after a tough negotiation. Joe, the contract administrator, is feeling good. The customer demanded some alterations to the agreement terms and conditions, and Joe did a great job tracking the changes through the authoring and review processes, and expediting legal review and all required approvals.
It looks like an example of contracting best practices in action, but is it? The final version of the agreement stipulates a number of volume-based pricing discounts. In other words, the customer is receiving a discount in return for promising to purchase a certain amount of product from XYZ. The contract is signed and active, but …
Within most companies, the answer is a resounding “no.”
The fact is that most companies do not have an automated sell-side contracting solution in place to effectively manage contracting processes. But many of these same companies do have at least an entry-level system in place for managing buy-side contracts. So why are sell-side teams slower to adapt?
According to Tim Cummins, CEO of the International Association for Contract and Commercial Management (IACCM), the difference is that while buy-side teams have been “strongly focused on cost reduction, risk avoidance and compliance, their sell-side colleagues have to learn to balance a much wider set of factors in developing sustainable contracts and relationships.”1
One of the key problems of implementing effective sell-side contract management lies with the historically siloed nature of contracting, with contract information tending to be stored in its own insular system. For example, the terms of an agreement often reside with the contracting team in department-exclusive files, drives or repositories, but execution of the payment lies within the enterprise resource planning (ERP) system. This segregated approach creates a disconnect between the two processes (Figure 1).
Figure 1. Traditionally, ERP and CM systems operate independently—and inefficiently—in silos, unable to share pertinent data about contract terms and execution.
When departments are hindered from sharing critical information, the company is at increased risk of committing errors that can have lasting impacts. For example, if an amendment is made to the contract but the ERP system is not updated, the accounts payable department could end up inadvertently paying ineligible incentives.
The same applies to every related function. When contracting information is siloed, key stakeholders in legal or finance struggle to get the visibility they require into critical contract information, such as key milestones, pricing terms and conditions, legal obligations or amendments. These employees are limited in their ability to perform their jobs effectively.
True CLM must span the entire period that a contract is active. The only way to achieve this comprehensive and well-rounded approach is by implementing an integrated CLM solution that unites contracting with each related function throughout the entire lifecycle.
Powerful impact of integrated CLM on volume-based pricing calculations
An industrial gas manufacturer and distributor provides a classic example of the power of an integrated CLM and ERP solution. This company forms rigorous agreements with its customers, leasing equipment to them for storing their industrial gas products and stipulating the monthly volumes to be delivered. The company's sales contracts are complex, specifying volume thresholds and even the means for ensuring contract compliance.
Customer compliance with contract terms and conditions holds serious value for the gas company. In fact, a recent manual audit of customer compliance indicated that more than $10 million in pricing concessions and penalties were at stake. So the client took significant action to improve and standardize its CLM business processes, hoping that improved contracting would yield improved contract compliance from customers. These business process improvements accelerated contract cycle time by 80%. Yet the issue of contract compliance remained unresolved.
As a result, the industrial gas supplier implemented a purpose-built CLM software solution to simplify and automate its contract-creation process, institutionalize standard terms and conditions and establish a connection between siloed processes. In particular, the gas company's new CLM system captures customer volumetric commitments as contract metadata —ie data that is explicitly identified within the CLM system. Explicitly identifying key contract terms as metadata allows the company to use those terms to run calculations and analytics. Improvements in analysis enable the company to easily gauge the performance of its customer agreements and leverage that insight to continually enhance the development of new contracts.
Finally, the new CLM system integrates with the gas company's existing ERP system, enabling the company to more easily enforce terms and conditions of the agreement. For example, the CLM system contrasts actual shipment volumes and dates in the ERP system with the terms from the contract, assesses compliance, and generates a notification to the relevant parties if a customer is in danger of missing the volumes required by the contract.
Disconnects can be seriously problematic
Volume-based pricing is just one example of a business strategy that requires integration between CLM and ERP. Integration has benefits across many areas, including the management and execution of channel sales incentives. Many manufacturers stipulate the terms of incentive programs in their contracts. These agreements tend to exude complexity, often specifying complex volume-based tiers, brand eligibility, customer eligibility, bundles, rebates and billbacks.
Distributors' and resellers' incentive calculations are based on the sales that each partner achieves; matching those sales to the terms set out in the incentive agreement determines eligibility. For many large manufacturers that leverage indirect sales channels, the processing of incentive calculations is the single largest revenue-related calcuation that occurs outside of the ERP system (Figure 2).
Figure 2. In channel sales scenarios, incentive agreement terms are captured by the CLM system, while channel sales data is housed in other enterprise systems, breaking down communication and placing corporate revenue at risk.
Because of the significant revenue tied to channel sales incentives, the negative impacts from siloed processes and information become seriously problematic. Rebate and other incentive terms are locked within the contract, but compliance is processed via customer claims, point-of-sale system data or ERP sales data. Many companies attempt to unify these processes and outcomes through a series of data extracts, Excel spreadsheets, manual calculations, merges, and other non-automated, error-prone tools.
Shockingly, in many cases, companies rely on Excel to track millions or even billions of dollars of annual transactions to bridge the gap between CLM and the other systems. These types of manual entry processes can be cumbersome and inaccurate, leading to error-prone results. The risks are incalculable. One small keystroke error can have devastating consequences throughout an entire spreadsheet. Without a proper, integrated system in place, companies put signficant amounts of revenue at risk.
In fact, a typical pharmaceutical manufacturer might spend more than $800 million a year on chargebacks and incentives, of which 5- 10% is at risk of overpayment if contractual terms and customer sales data is not linked. That is upward of $80 million!
The next big thing in CLM is enterprise-wide integration. A recent study backed by the IACCM2 found that the real contracting risks for organizations are scope and goal changes, party responsibilities and pricing scenarios. Together, these are cited as frequent problems in more than half of all contracts.
For years, contracting departments have been enhancing their business processes and systems, aiming for standardized terms and conditions, better visibility, clear approval workflows, and faster agreement cycles. Those are worthy goals. But achieving the next level of contracting business value means breaking through the traditional concerns of legal departments and contracting administrators, and integrating contracting with the greater enterprise.
The author hosted with IACCM a video presentation, ATE “Beyond Traditional Contract Management: Measuring Post-Execution Contract Performance” (August 6 2014)
1. The Revitas Blog: “Buy-side versus sell-side contracting: Who's got it right?” Interview with Tim Cummins. May 16, 2012.
2. IACCM presentation by Tim Cummins from July 2014, titled: “Are your contracts fit for purpose? Driving improved contract outcomes.”
ABOUT THE AUTHOR
Andrew Sanford is a Senior Solution Engineer with Revitas specializing in contract management and revenue management solutions. Andrew has 25 years of manufacturing experience with an emphasis on supply chain and manufacturing optimization. He has implemented enterprise software solutions in the life sciences, refining and marketing, chemicals, food and beverage, and consumer packaged goods industries. Andrew has a degree in industrial and operations engineering from the University of Michigan.
Revitas accelerates revenue by delivering comprehensive, integrated solutions for contract, revenue, and compliance management. Revitas enables channel-driven companies to create, execute, and manage complex contracts and incentives effectively and profitably, both on premises and in the cloud. For more information, visit http://www.revitasinc.com.