Set up your Contracts for Active Management

Set up your Contracts for active Management.

Contracts are an often overlooked asset in an organisation. In fact they are frequently not even regarded as an asset.

The proper setting out of contracts, management and storage of them is however a fundamental activity in business. Each contract represents the relationship with the respective supplier, so it’s value is the sum of the purchase value from that supplier plus all the value added through your own processes. In short, your contract portfolio would have roughly the same value as your balance sheet!

In this article we cover the basic elements that form best practice in setting out a contract to be properly managed. In an upcoming article we will also cover systems and technologies in the market to help

Avoid Restrictions, build in flexibility

Beware of exclusive agreements, limits on future vendors or customers. These limits are put in place to protect the vendors, and remove your ability to walk away from the deal once performance falls.

Favour short term contracts with formalised review and renewal phases rather than long term agreements. This includes auto-renewal contracts. Research by Aberdeen group shows that companies miss out on 5% of savings opportunities because of these rolling renewal contracts.

Set KPI’s

It’s an oft quoted truism by Peter Drucker, “what gets measured gets improved” so making sure that you measure the delivery of the service is critical enough to be included in the contract.

Ensure definitive KPI’s for measuring performance are agreed upon, this can include lead times, order fill rates, response times, and quality indicators such as rejection rates, production line complaints.

Monitor performance

Frequently with large contracts, you get a veritable barrage of sales people, consultants, sales engineers and market experts before and during contract negotiation, but once signed, before the ink is dried it can be a struggle to get hold of someone or get the vendor to deliver to the terms agreed.

To avoid this, set up an initial “bedding in” phase with constant monitoring of the agreed KPI’s, the expectation should be that it would take a little while to reach the level that’s expected however during this period the constant monitoring should tell both you and the supplier where attention is needed and you would have an early get out clause if they fail to reach the level expected by the end of this period.

After they’ve managed to fill your expectations, don’t assume that everything will continue to be smooth running. Business and people change over time, use the regular review and renew points you agreed earlier to make sure the KPI’s are still being hit.

Standardized templates

The process of drawing up contracts is usually lengthy, costly and generally frustrating for everyone involved. The most annoying part is that you know you have to do it all again next time.

Having standard templates that include all of your key elements, KPI’s, measurement cycles etc. will not only speed up the process but also ensure that you can manage all of your contracts in the same way. The first objection to templates is usually that business is too varied to be able to be templated effectively.

Three strategies are used to avoid this:

  1. Establish mandatory and non-mandatory clauses
  2. Define the templates based on geography and industry
  3. Always update the templates using 1 and 2 above, rather than modify a specific instance of the contract.

Communicate, communicate, communicate

Ensuring that there is constant and open discussion between vendor and customer is key to avoiding many of the pitfalls inherent in managing supplier relationships. Make sure that there are well established lines of communication on at least three levels:

  • C-level for addressing serious issues and setting strategic goals
  • A formal channel between the suppliers fulfilment and your purchasing group
  • A back channel between your supplier management organisation or lacking a formal organisation at the mid-level exec responsible for your internal service levels into a supervisor, ideally VP, level at the supplier to head off any issues before they hit C-level and go nuclear.

Most day-to-day communication happens through the formal channel, that’s where orders are placed and notices are given. The most important channel though is the back-channel, that’s where early signs of problems are spotted and a true partnership is built to improve the relationship and the value it brings to your organisation.

Both parties that operate on the back channel need to have vested interest in making sure that the relationship improves over time.

Contracts are an Asset

Ensure that you manage your contracts like any other asset. Would you have your inventory split between HR, Marketing, Legal and Procurement? Most likely not. Keep all your contracts in a central repository. Not only does this help ensure a standardized process and convergence in contract forms it also helps to avoid having multiple agreements with the same supplier.

Where exactly this asset should be kept is always a point for debate. The default position is usually that since it’s a “contract” it goes to legal. However aside from the initial wording Legal actually have very little to contribute to the contract management process. Rather, if the contract is treated as part of the supplier relationship it makes sense to keep it in your supply chain organisation, but with this comes the responsibility to actively manage the contract.