Contracts are an essential feature of modern commerce. According to the International Association for Contract & Commercial Management (IACCM), the average cost of processing a routine contract is $6,900, while the cost for complex contracts run much higher. This only includes operational costs. What also needs consideration is the impact on the bottom line associated with vendors and customers not adhering to the terms of contracts.
Add security and regulatory compliance risk to the mix and the potential costs really start to add up. Many companies have little idea how much time and effort they spend on managing contracts and associated documents let alone the P&L and risk exposure.
To discuss these issues, Digital Journal spoke with Colin Earl, CEO of [url=https://www.agiloft.com/ t=_blank]Agiloft, to examine how businesses can quantify the return-on-investment of commerce lifecycle management with key performance indicators for business operations, risk, and compliance.
Digital Journal: What are the costs to businesses associated with contracts?
Colin Earl: According to the International Association for Contract and Commercial Management (IACCM), the average cost of processing a routine contract is $6,900, while the cost for complex contracts run much higher. But that’s just the cost of administering a contract, which includes the time it takes for lawyers to draft and review and for approvers to approve and so on. It does not account for the costs associated with vendors and customers fulfilling the terms of contracts, the risks of failing to comply with regulatory mandates, or even security considerations.
A lot of companies have no idea how much time and effort they spend managing contracts and associated documents, let alone the P&L and risk exposure. According to Gartner, more than 85 percent of organizations don’t have an enterprise contract and commerce lifecycle management (CCLM) system. Many organizations have multiple departmental systems that do not communicate, while others rely on flat files and spreadsheets.
But this is changing. Gartner expects in the next four years 90 percent of global enterprise and 50 percent of mid-size companies will have a CCLM system in place. In fact, it was the top subject for Gartner analyst inquiries in 2018.
DJ: What are the additional costs and challenges when contracts are not adhered to?
Earl: Revenue leakage, most commonly due to unauthorized discounts and overpayments, can also include lost revenue due to errors and inefficiencies in contract processes. This is a major risk to companies as it is effectively sending profits down the drain. According to IACCM, companies lose 9.2 percent of their annual revenue due to poor contract management practices. When typical profit margins hover around 10 percent, even halving this loss can increase profit margins by 50 percent. That is a huge potential for any organization, and when you consider that revenue leakage often spills over into other business processes, it is imperative that businesses utilize automation to eliminate leakage.
In addition to managing compliance, automated CCLM software reduces revenue leakage by streamlining operations. For example, if you don’t use standardized contract templates and language, you’re going to end up with long lead times and longer negotiation cycles, which will lead to stalled projects and missed opportunities. Automation also ensures a standard workflow with well-defined protocols and procedures for approvals. This alone can speed up business operations and greatly reduce the time and effort required for audits.
DJ: Are there other risks connected with the contract process?
Earl: A huge risk is data security. Security risks related to digital data are among the most difficult to police and contracts contain all kinds of sensitive information. Whether it’s valuable IP, pricing information, or confidential customer and employee data, not keeping contracts in a secure, access-controlled system is a recipe for disaster.
The second major risk involves managing compliance, specifically regulatory compliance. Regulatory compliance refers to government mandates such as HIPPA or Sarbanes Oxley. These complex requirements are generally included in contract documents with each party’s obligations clearly spelled out. When managing large volumes of contracts, the challenge is to ensure that the appropriate clauses are included and to monitor internal and external compliance. And if you are attempting to monitor compliance manually, you are exposing your company to tremendous risk of compliance failure.
Operational compliance risk relates to the terms and conditions of your contracts. For most companies, most of the operational risk revolves around revenues and expenses. As a basic best practice, contracts should clearly define performance obligations that your contract management system can track and manage. Performance obligations refer to whether the customer or vendor is meeting the terms and conditions in the contract. For example, contracts that involve rebates and discounts need to be tracked and managed. Trying to keep track of these without CCLM results in lots of inefficiencies that end up costing real money to buyers and sellers.
Another common example is contract renewals. Managing renewals consistently shows up as big pain point when we talk to prospects. When renewals are not properly monitored, they can lead to underpayments from customers and overpayments to vendors. An added advantage is the data you get from a CCLM system allows you to adjust your terms to maximize contract value.
DJ: What metrics can be used to help businesses assess the contract process?
Earl: Most companies have no idea how much time, effort, and money are spent on processing contracts. The first step to reducing these costs is to get an understanding of your current state. Some metrics you may want to look at include:
Average time spent processing a contract
Average contracts executed per team member
Average response time for each workflow member
Average legal spend per contract
Average contract turnaround time
At Agiloft, we benchmarked metrics from research conducted by industry experts like IACCM, Goldman Sachs, and others. We created a value model that quantified specific measures, vetted it against real-world numbers provided by our customers, and followed up with an open discussion at an advisory council meeting.
One of our larger customers did a financial analysis of the time the legal department spent manually routing contracts and the time executives spent approving contracts and related documents. The company found that the cost per contract came in at just under $5K, not far from IACCM’s estimate of $7K and big chunk of the legal budget. That was before implementing a CCLM strategy.
After, it was just $2,500 and they are processing thousands of contracts per year. Automation also provided a number of interesting insights. For example, what everyone thought was the busy season for contracts was, in fact, a relatively light time. The conventional wisdom on where the workflow bottlenecks were occurring was also completely inaccurate. Automation provided the executive team with a dashboard that showed:
How many contracts are currently under review in different categories – sales, purchasing, etc.
Flag contracts that were risky or not compliant with company policies
Flag contracts that were up for renewal or required executive action
DJ: Are digital contracts making things easier?
Earl: Yes, a CCLM system that manages digital contracts include the following benefits:
Well-defined permissions in a system that manages access is critical to ensuring data security. Leading CCLM software allows organizations to configure access permissions down to the document field level and apply varying levels of permissions based on location, group, or individual user. In addition to standard CCLM features like two-factor authentication and data encryption, these features can ensure your most valuable IP, customer data, and contracts do not end up in the wrong hands.
A dynamic repository that automates compliance and includes a full audit trail. A leading solution will enable you to easily audit current contracts to ensure they have the appropriate clauses related to data privacy, arbitration, confidentiality, or other regulations that affect your business.
Once you’ve identified the gaps, your legal team can update the contracts with the appropriate language and contact any third-party signatories. A CCLM system also includes a central digital repository for all your contracts, which helps track other types of compliance and allows advanced systems to trigger business process automation to aid future operations.
Rule-based approval workflows and automatic notifications allow you to track operational compliance, or the terms and conditions of your contracts. A capable CCLM system can track contract expirations and renewals associated with hundreds of vendors in addition to accounting for discounts and other contract obligations. And on the revenue side, it can match insurance payments against the services delivered.
That way you get up-to-date cost and renewal information, eliminate overpayments, and provide visibility into its revenue cycle. The result is cost savings and better use of resources. It also enables better business insights that help companies make better strategic decisions.