In 2006, the American investment bank JP Morgan Chase loaned General Motors $1.5 billion. In order to guarantee the loan, JP Morgan received a lien on GM’s assets.
Two years later, a contractual error meant that the lien was removed and when GM subsequently filed for bankruptcy in 2009, this became a very big problem for the bank.
Secured assets were protected through the bankruptcy, whereas unsecured ones were not, meaning JP Morgan was out of pocket for the full amount.
To a bank like JP Morgan, losing $1.5 billion is not a terminal blow, but the figure still represents somewhere between 1% and 3% of its annual revenues.
A simple contract mistake, albeit in a complex transaction, can have hugely significant financial consequences.
Which brings us to the IACCM and their estimate that poor contract management is costing businesses up to 9% of their annual revenue.
The kind of legal error described above would fall under their calculations, as would a host of further errors related to managing contracts through their lifecycle.
No business is immune from contract management issues but there are steps that can be taken to minimise the impact of them. We’ll get into those below.
But first you need to know where to look for them.
Where are the hidden costs of poor contract management?
The short answer is “everywhere”.
The reason for this is that contracts are ubiquitous. They govern the relationships between a business and its suppliers, its customers, its staff and its regulators.
Furthermore, everywhere that contracts are created, reviewed, negotiated, processed and stored provide opportunities for costs to be incurred or revenue to be lost
However, in order to narrow it down from “everywhere” to something a little more actionable, here is a list of six key areas where you can expect to find evidence of the negative impact of poor contract management:
1. Contract Renewals
As we’ve written about before, contract renewals are a huge opportunity to drive more value from your contracts and vendors.
When an initial contract is signed, commitments and obligations are agreed and the expectation is that the contract will deliver a certain amount of value to both sides.
At the point of first renewal, and each one thereafter, both sides have the benefit of real-world experience of the contract and can assess how closely that resembles what was originally agreed.
This can give them a much better understanding of the real value of the contract.
At renewal time, there is the opportunity to renegotiate the contract to better reflect the relative value that it’s providing to both parties. Contracts can be renegotiated to reduce costs, to drive additional benefits and concessions from vendors or to lock in commitments around innovation and compliance.
Taking the above into account, each renewal that passes without assessment or renegotiation represents lost value to the business.
And in some cases, there will also be a direct cost associated with renewals where an unnecessary contract auto-renews for a new term.
The bottom line is that renewals can only be capitalised on if the right people in your business are aware of them at the right time.
The key questions to ask:
- Does the business have a central record of all contracts and their associated renewal dates?
- Who is responsible for monitoring those dates?
- Is there a documented process for dealing with renewals?
- Is that process automated?
- Is it applied rigorously across all areas of the business?
- Which contracts are due to renew in the next three months and what is their combined value?
- Which live contracts are no longer required?
If this information isn’t easy to find, or is incomplete, then a review of your business’s technology and processes should be conducted.
2. Inadequate obligation tracking
Contracts and vendors shouldn’t just be appraised at renewal time, but rather should be subject to constant review and performance management.
Contracts lay out the expectations and obligations for each party over a set time period. The longer that time period is, the more likely it is that these obligations will fail to be delivered as agreed.
Now this can be down to changing circumstances and agreement from both sides to change their expectations.
However, it can also be attributable to poor contract management if there aren’t processes in place to monitor obligations, carry out regular reviews and conduct performance management.
Like any other business element, contracts can fall victim to changing priorities or personnel, meaning that they are not given the focus required.
Unfulfilled obligations usually mean that one party or the other is missing out on value that had been agreed.
Simply having the obligations for each contract easily accessible, such as stored as contract metadata, can make the world of difference when it comes to keeping a contract on track over its lifetime.
3. Specialist Resource Spending Time on Non-Specialist Work
In this context, specialist resource refers to departments such as legal, procurement and finance. Employees in these teams are paid for their specialist skills and to provide those expertise to the business.
While it’s impractical to think that for these roles there will literally be no non-specialist work required, every minute you’re paying specialist wages to people doing basic admin or other relatively menial tasks, there is money being wasted.
Consider the case of the in-house legal team, who are generally tasked with reviewing new contracts and ensuring the business is suitably protected.
Often their role will naturally extend to processing and storage of signed agreements, which, depending on their system for contract storage can be onerous and time-consuming or straightforward and seamless.
Once their role encompasses this part of the process, they then naturally become the gatekeepers for employees wanting to access or to query those existing agreements.
If they’re not able to delegate access to contracts, so that people can self-serve for these requests, your legal team can then be subject to constant interruption for manual checking of contracts. Sometimes, these queries can be as simple as “what’s the contract end date?” or “who signed this originally?”.
Finding the answers to these simple questions takes that team away from their core work.
A sensible course of action is to ask your legal team to monitor their workload over a period of time (two weeks would be suitable) and to record how much of it they spend doing avoidable non-specialist work.
This can then be extrapolated out and used to estimate the potential costs in terms of time and resource being wasted. Once that figure is calculated, it can form one of the strands of a business case for a contract management solution.
4. Loss of company intellectual property or confidential information due to poor access control
Many contracts will contain confidential information, and may be subject to NDA - whether it be terms negotiated with key suppliers, customer contract values or salary details for employees.
If your management of contracts is loose and poorly applied, you risk this information being handed to competitors or being spread to other parts of the business, perhaps with detrimental effects.
These outcomes have a potentially quantifiable cost if competitors are able to see the terms of your key agreements or get their hands on your customer list along with details of their contracts.
Controlling access to the documentation and being able to see an auditable record of who’s accessed the information contained within can save a significant amount of difficulty.
If your system for managing contracts permits, using features such as Role Based Access Control (RBAC) can significantly reduce the risks of confidential information being accessed illicitly.
5. Non-standard contract clauses
While there is nothing inherently bad with agreeing to non-standard clauses for particular contracts, the risks and implications need to be accurately assessed before they are signed off.
Non-standard clauses relating to things like indemnity, termination and payment terms in particular can have significant impacts down the line.
Clearly, contract management practices have a role to play in establishing precedent and process around where exceptions are to be made and who needs to agree to them.
However, the signing of contracts containing non-standard clauses can also be symptomatic of poor contract management process upstream in the contract lifecycle.
As we’ve written about above, well-run renewal processes provide the opportunity for objective assessment of vendor contracts and time for negotiation where appropriate.
Conversely, poorly-run processes can often lead to contracts having to be pushed through quicker than is ideal at the last minute. Rushing the process can not only lead to mistakes being made but can result in having to accept less-than-optimal terms in order to maintain a vital contract.
These less-than-optimal terms may include simply having to pay more for a service than previously because there wasn’t sufficient time to research alternatives in the market.
In this case, you can easily see where the cost is leaking from your business.
However, it may be less obvious where the original issue lay if a contract is later terminated unexpectedly by a counter-party, using a favourable termination clause to do so.
In both cases, a tighter contract management process improves the chances of a favourable outcome.
6. Inefficient sign-off processes
Signing a contract should trigger an exchange of value between the counter-parties. Whether it relates to goods and services, intellectual property or human resources, contracts are signed with an expectation of mutual benefit.
Delays to the signature process have the knock-on effect of delaying those mutual benefits from being realised.
While some delays can be unavoidable, there are plenty that can be of a business’s own making and which therefore equate to additional, unnecessary cost.
Poorly constructed approval processes can result in significant delays to a contract being signed and the value captured within it from being released.
Carefully consider who within your business needs to be included in a contract sign-off process. What order should they be involved in? Should it be different depending on things like the value of the contract or the jurisdiction that it falls under?
Consider who alternative signatories and review parties might need to be so that the process needn’t stop if certain people are out of the business on vacation or for other reasons.
Remember, while the impact on the business of this occurring on any individual contract might be minimal, when you combine this effect over multiple contracts and multiple departments, the unrealised value can soon add up.
The six areas highlighted here are only a sample of the places where unnecessary costs or lost revenue can occur as a result of poor contract management.
They represent good places to start if you’re looking to generate more value from your current agreements and optimise your internal processes to avoid unnecessary spend.
Whether a tighter focus on these six areas would have prevented JP Morgan Chase from their $1.5 billion error is still up for debate.
However, you can be confident that applying good contract management disciplines to any business will help ensure that more valued is realised from signed agreements