Contract Economics is a relatively new term which has been coined to help businesses view their full range of contracting activities in a cohesive fashion, with a view to measuring the overall value and return on investment generated.
What does contract economics mean in practice?
In simple terms, it means looking at how on one side the costs of contracting can be reduced, and on the other whether additional value can be derived.
In more practical terms it will include:
- Examining the resource costs of creating, negotiating and finalising contracts. Asking whether the relevant human assets are being deployed as efficiently as possible and whether they’re being supported with optimal processes.
- Monitoring negotiations and in particular using clause analytics to understand which clauses regularly require revision and lead to delays in time-to-signature, and related costs.
- Developing a deeper understanding of contract risks and becoming better able to assess the probability of negative outcomes. Combining these learnings with better insights into clause language will lead to efficient contract revisions that don’t, in turn, lead to increases in risk.
Risks can be captured, measured and mitigated with greater confidence.
- Tighter management of contractual obligations to ensure agreed value and benefits are received.
Estimates of typical value-leakage from contracts vary from 5% up to 50%, depending on the source. Whatever the accurate figure, this means is that a significant proportion of the contract benefits secured during negotiation are never delivered.
According to the Faculty, a procurement consultancy, "More than 50% of contracted savings are not making their way to the bottom line" (Tweet to Share)
This can be down to a conscious changing of business priorities but is more likely due to a lack of oversight and ongoing contract management.
Focusing on obligations is one of the first steps to take to drive more favourable contract economics and in particular to avoid value erosion.
- Opportunity management: taking advantage of things like getting cheaper pricing for bulk orders, a discount for early payment or seeking classification as a preferred customer to obtain other tangible benefits.
These opportunities can often go begging if they’re not given the due care and attention required and they provide further opportunity for lowering costs or driving additional value.
- Effective renewal management so that unwanted contracts don’t auto-renew and favoured contracts are identified and addressed in good time so that their renewal is handled as efficiently as possible.
Having a clear timeline of renewals and supporting processes is another very good way to maximise contract value, allowing businesses to negotiate from a position of strength to get the optimal outcome.
Businesses without a focus on renewals can end up realising too late and are obliged to renew unfavourable contracts for business-continuity purposes or miss renewal dates altogether, leading to unnecessary spend.
A similar focus should also be extended to termination management so that any costs associated with the ending of contracts are minimised.
- Considering the role of technology to streamline all of the above. Deploying the right contract management software can have a transformative impact on the full contract lifecycle.
Centralising your contract data, automating key processes such as sign-offs & renewals and deploying artificial intelligence to make sense of vast amounts of contract data can all have a hugely favourable influence on contract economics.
AI and automation, in particular, have the scope to radically reduce costs by eliminating non-value-adding administrative work from the various contracting processes.
This, in turn, increases the potential for the existing staff numbers to handle a larger contract inventory and to support company growth.
- Focusing on information security. There is a multitude of risks associated with contracts but information security is one that’s fairly high profile at the moment.
If managed poorly, it carries the risk of significant financial penalties, as seen by Marriott and British Airways recently. Contracts contain large amounts of confidential and commercially sensitive information so controlling access and sharing them appropriately needs to be top of the agenda for those managing contracts.
This will minimise the risk of breaches or any other activity that could lead to fines or cost increases.
Contract economics is a useful term help get business stakeholders thinking not just about the content of contracts and whether they’re favourable or not but also whether the associated business processes around the contract are fit for purpose.
With the average simple contract costing in the region of $6,900 to produce (source: IACCM), it makes sense to examine every aspect of the contract lifecycle in order to make efficiency gains.
Lowering the costs of managing contracts while enhancing risk controls and driving more value from agreements will lead to a material impact on a business’s bottom line.
To find out how Gatekeeper can help you lower your cost of contracting while helping increase the value generated from existing and future agreements, contact us today.