The Guide to Contract Management – Benefits, Stages and Best Practices
Irrespective of the type of business you have, one aspect that is unequivocally central to the organization’s functioning are contracts. On a daily basis, contracts form the backbone of every relationship that an organization has with stakeholders like its suppliers, partners, and customers. Given its utmost importance for business performance, it is crucial to have effective contract management in place that will not only drive long-term value for your organization but will also help establish powerful stakeholder relationships. A contract management process that will guide the entire lifecycle of the contracts will ultimately make or break the organization.
What is Contract Management?
Contract management refers to the business processes that manage the creation, implementation, and evaluation of contracts to maximize business performance and minimize risk.
Contract management is pivotal for your business – Contracts, being legally binding, determine a business’s stakeholder relationships, pricing structures, the scope of work, rights and obligations, timelines for projects, warranty provisions, etc. Given how critical contracts are, effective contract management can dramatically improve the performance of the organizations. Similarly, if your contract management is not structured well, it might expose the business to various operational and financial risks and affect the ultimate bottom line.
The role played by contract management is also evolving. It’s not just filing documents anymore; contract management entails understanding every aspect of a contract’s lifecycle to extract meaningful data insights. Businesses are engaging in contract lifecycle management to drive their performance and know how they can better achieve their objectives. A Gartner Report has mentioned that ‘CLM is evolving from an operational record-keeping system to an enterprise-level core system addressing business risk, costs and the pursuit of revenue maximization.’
Benefits of Contract Management
Let’s look at some of the significant benefits of contract management:
- Aids Business Functioning
Efficient contract management will help simplify how an organization functions – it structures business expectations, the mechanisms needed for their fulfillment and allows you to analyze how the organizational objectives meet. The insights from contract management can also help identify areas for revenue optimization and cost minimization.
- Improves Functional Efficiency
Best-in-class contract management techniques involve the use of various software or tools that automate the process of managing contracts. By reducing manual efforts, it improves business efficiency and the scope of errors. The personnel can focus on more strategic aspects of contract management like evaluating contract performance, identifying areas for improvement, etc.
- Improves Spend Visibility and Minimizes Maverick Spending
By structuring the engagement of an organization with its stakeholders, especially its suppliers, contract management simplifies transactional and performance tracking. It increases spend visibility and improves transparency of where exactly your money is going. Maverick spend is one of the critical issues that plague businesses and higher spend visibility will help you curb undocumented expenditures. By increase spend visibility, contract management can also help you identify higher cost savings opportunities for your organization.
- Increases Visibility of Suppliers
Suppliers form a crucial part of most business today as the majority of the organizations involve suppliers for the provision of goods/services for facilitating their performance. Contract management helps in tracking the suppliers, assessing their performance based on the criteria mentioned in the contracts and evaluating supplier risk. Furthermore, it also acts as a mechanism for building long-term, collaborative relationships with the suppliers resulting in valuable synergies.
- Enforces and Improves Compliance
Having a contract management system that dictates terms and conditions and procedures followed implements and enhances the level of compliance amongst the relevant stakeholders. Increase in compliance invariable helps in mitigating a large number of risks within the organization.
It is crucial as Zycus’ annual report, Pulse of Procurement 2018, has identified contract risks and lack of compliance as one of the significant procurement pain points in 2018.
Stages of Contract Management
To ensure effective contract management, it is essential to identify the steps of contract management which can be used to put a contract management system in place. The phases and cycles of contract management might differ based on the type of organizations and how they function; however a basic framework design is possible.
- Identify Business Objectives and Goals and Define Risk Appetite
Before a contract gets drafted, it is essential to identify the business objectives and goals for which the contract is necessary. It will help set appropriate expectations for both parties and will also enable effective evaluation of how the contract was able to fulfill the organization’s requirements.
Additionally, it is crucial to understand and define the stakeholders’ risk appetite to set appropriate performance expectations and to minimize the probability of risk occurrence throughout the lifecycle of the contract.
- Draft the Contract
Once the business objectives and expectations get identified, defined and communicated correctly, the drafting process of the contract starts.
Gather all supporting information and documents required and if the organization maintains any, take help of standardized templates that are updated and adhere to all regulatory/legal and organizational requirements. Drafting a contract is an extremely critical process as any level of ambiguity might result in business losses.
- Negotiate the contract with involved stakeholders
One the contract gets drafted, the negotiation between the interested parties commences. This process takes into consideration what each party expects from the contracts concerning the pricing structure, terms, and conditions, rights and obligations, warranty provisions, renewals, and termination, etc. Ensure that all proposed changes in the negotiation process are effectively tracked for incorporation.
The negotiation process should ideally be conducted in a way that all involved parties communicate with transparency and mutual trust. An added benefit of this is that the organization can build long-term, collaborative relationships and leverage the resultant synergies for improved performance.
- Finalize and execute the contract
Once the negotiation phase concludes, and the contract is amended to incorporate any appropriate changes, the contract goes out for approval to all relevant teams. It is essential for the organization to have a proper workflow of the approval process for various types of contracts to ensure that approvals do not impede the contract cycle. Once the contract is approved and finalized, the execution by all relevant stakeholders starts based on all the specifications mentioned in the contract.
- Manage contract obligations and audits
The contract management doesn’t end when the contract gets executed. Post-execution, it is essential to ensure all involved stakeholders meet their obligations regarding their performance, timelines, payments, etc. Managing obligations enables compliance to all the contract specifications and provides that contract performance meets the business requirements.
Additionally, it is vital to periodically audit all contracts to measure performance and to identify any exposure to risks. Regular contract audits will help you identify and establish risk mitigation mechanisms.
- Manage contract termination and renewals
As the contract cycle arrives its closing date, it is essential to keep track of termination or renewals. Missing contract renewals can result in significant losses regarding the loss of long-term relationship building and synergies, missed revenue maximization opportunities, etc. Additionally, it implies the organization has to execute a new process for the same contract requirement.
Best Practices for Contract Management
To make the contract management system more useful, you can implement certain best practices that will ensure that you reap the maximum benefits from your contracts:
- Centralize a repository for all contracts
Ensure that your organization is storing all contracts in a centralized repository that can be accessed by all relevant stakeholders. It will help track contracts and all related information on terms and conditions, renewals, etc. and prevent loss of crucial, sensitive data.
- Ensure team collaboration throughout the lifecycle of contracts
In a majority of the business cases, the contract management process is overseen only by the legal department. Make sure there are procedures or communication channels in place so that the contract represents the requirements and goals of the relevant stakeholders. By ensuring collaboration and communication between the legal and other business units, a contract is more likely to produce desired performance results with minimal risks. It also prevents complete dependency of the other business units on the legal team and unnecessary ‘back-and-forth’ which might impede effective contract management by producing inefficiencies and long cycle periods.
- Enable compliance throughout the lifecycle of contracts
Ensuring effective compliance management through the lifecycle of contracts is crucial. Ensure all regulatory/legal and corporate requirements are met at every step of contract management to avoid tracking down the legal department at the later stages. Compliance to contracts by all relevant stakeholders will go a long way in preventing financial or operational loss and in mitigating various risks for the organization in the long term.
- Standardize contract management processes without mandating rigidity
Standardizing various stages of contract management will reduce cycle times and related inefficiencies. The organization can have standardized templates or frameworks for the contracts as a majority of the contracts have common agreement types. Ensure that the templates are pre-approved and updated periodically and that they adhere to regulatory/legal requirements. Every organization should have a contract management procedure that fit their needs and is known by all the business units so that they can follow a standardized method of managing their contracts.
Why is a Contract Management Software important?
An important question for the organizations to ask is – ‘Is investing in contract management software important for an organization?’ Agreed, researching and on-boarding a contract management software that suits your organization’s requirements might prove to be a complicated and time-consuming task. However, investing in software will make contract management more effective, efficient and productive in the long-run. Here’s how:
Once contract management software automates the lifecycle of the organization’s contract, manual efforts that go into tactical tasks will significantly reduce; and so will the probability of human errors.
Contract management software will also enable higher efficiency at every stage of contract management and thus, reduce contract cycles. For example, while drafting a contract, if the legal team were to prepare every contract the organization requires manually, it will expose the contract management process too long and expensive cycles: contract management software and tools store templates that can be filled automatically with minimal manual intervention.
Contract management software will help centralize a repository for the contracts in a cloud system while simultaneously enabling more comfortable access to critical contract information by all relevant stakeholders. Thus, finding, tracking and evaluating contracts will be a few clicks away.
Contract management software will also contribute to contract risk mitigation and performance maximization. It will ensure all relevant stakeholders get necessary notifications on time, especially when it concerns contract renewals, payments, deadlines, etc. If that isn’t enough, contract management software will link your contracts to compliance management to ensure the respective stakeholders meet all relevant obligations.
Additionally, with the help of artificial intelligence that comes with contract management automation, you get the power of data analytics and its predictive capabilities in your hands. You can derive crucial insights from your contract management system, forecast costs and revenues from contract data and identify how you can further drive your performance.
In a Nutshell
IACCM research has found that 70-75% of failing projects occur due to contracting and commercial issues, resulting in an average 9.2% of annual revenue leakage.
With this in the backdrop, this blog post attempted to cover crucial aspects of contract management – its benefits, stages and best practices that can drive contract management processes to be more effective and productive. Contracts are embedded into the very foundation of any business and hence, ensuring your contract management meets business requirements accurately is critical.
Organizations realize the strategic importance of contract management in achieving enterprise objectives and are transforming their existing processes with AI, software, and digitization to harness maximum benefits.
What about you?