The Dangers of Inadequate Contract Management
Costs of Bad Contract Management
Effective contract management underpins both profit and long-term growth and success. It’s therefore unsurprising that the potential for financial loss that results from poor contracting processes and contract management is significant.
When an organization fails to adequately manage its contractual relationships it becomes vulnerable to overpayment, lost revenues and regulatory penalties.
Overpayments
Without the use of a contract lifecycle management system, purchases from suppliers are often made without a clear understanding of agreement with those suppliers. As a result, businesses can and do end up paying more than they should for goods and services. Inadequate contract management processes can, for example, lead to a failure to apply quantity or early payment purchase discounts. Yet although these kinds of discounts may seem small on an item by item basis , when exercised across the range of goods and services purchased by a business it is easy to see how a business can quickly overpay by hundreds or even thousands of dollars.
Revenue Leakage
Weak contract management processes can also lead to revenue leakage. Revenues are lost where an organization fails to manage sales and distribution contracts and as a result, does not receive agreements to distribute first or exclusive rights to sell their goods and/or services. In other words, internal lapses in contract management lead to missed sales opportunities.
Non-Compliance Penalties
Failure to adequately manage contracts can also lead to severe penalties and fines for non-compliance. Where agreements are entered into for large-scale construction projects, for example, businesses can be hit with late delivery charges or penalties for failure to complete projects on time.
Legal and Regulatory Risk
Effective contract management is not just about operational efficiency; it can also mean the difference between compliance and non-compliance. Legal risks lurk behind every poorly written or managed contract, and companies that do not take their contracts seriously are courting serious trouble.
When a business enters into an agreement with another party, all of the terms and conditions included in that agreement become enforceable in a court of law. When one party fails to fulfill its responsibilities under such an agreement, it can be on the hook for costly legal damages. A contract may go bad for many reasons: the other party may breach the agreement, or it may become impossible or impractical for you to carry out your responsibilities.
A business that entrusts its agreement to someone who doesn’t have a clear understanding of the terms and conditions, never updates the document after a reorganization, or continually makes ad hoc agreements with others in the company will end up with a collection of contracts that are not fit for modern business use. Such contracts cannot be relied upon as enforceable agreements if and when things go wrong.
Poor contract management, including failing to monitor agreements, also has legal consequences when third-party parties decide to challenge the agreement. Such challenges could come from competitors, former employees, customers, and even shareholders. Wording that was once considered favorable may become unfavorable over time. Or a third-party may subjectively interpret of some of the contractual language as unfair.
Such legal challenges can lead to costly and unnecessary litigation regardless of whether or not your organization wins or loses. Even if your company is successful in defending itself against the claims, the legal fees and related costs of litigation can be enormous, not to mention the time loss related to defending the company.
The bottom line: If your business isn’t managing its contracts, it is opening itself up to serious legal consequences.
Impact on the Company’s Operations
Perhaps more than any other form of indirect cost, the cost of poor contract management, and the corresponding ripple effect, is operational inefficiency. Some of the most manifest consequences of unused or unused contract entitlements, delayed efforts to support contract compliance, and duplicative spending include not only excessive risk management but also missed deadlines, improper resource allocation, and fractious workflows – which in turn compounds these expenses. For example, failure to make timely use of a recently negotiated price discount can result in penalties for late payment – or with an empty value that is followed by a new round of negotiation to recover that same value.
Operational efficiency also suffers when contract disputes create bottlenecks in contract fulfillment. Disputes regarding the quality of goods or services under a contract can be operationally debilitating. Complicating the operational risk of contract disputes is ineffective change control. Poorly managed amendments, modifications, or contract change orders introduce potential points of conflict; when conflicts do arise, time lost as operations are halted and scrambling over how to move forward begins to add up quickly.
Impact on Relationships
The poor management of contracts can have a direct impact serious negative impact on relationships with clients, suppliers and other partners. The damage is done because misunderstandings arise due to imprecise or erroneous record-keeping relating to the terms of the contract. Expectations are not met because contractual compliance has not been properly monitored. Trust is eroded through one party’s failure to confirm that the other has complied with the terms.
The cumulative effect on contractual relationships can be catastrophic, especially for contracting parties who are involved in long-term supply chain or commercial delivery relationships. Repairing and rebuilding trust in contractual dealings is a complex challenge that takes time and costs money. What is more , failing to manage contracts properly can create significant exposure. If a service or supply contract has been poorly managed it may allow a terminating counterparty to escape liability for damages or an aggrieved customer to claim a reduction in the price payable or refuse to make payment altogether.
The implication of a failure to manage contracts is that any approach to contract formulation and negotiation that does not contemplate the need to document contractual changes and conceptually prepare for the management of the implementation phase is irresponsible. A business should not give its IT department the task of formulating, drafting and negotiating a major new services contract without requiring the output of all that activity to be properly translated into an operationally implementable form of contract by its legal department.
Impact on Reputation and Loss of Customers
If the work isn’t handled properly, the client will leave and so will its ability to compete in its marketplace. They will probably lose money — especially if they didn’t get paid for the original service — but they will also lose market confidence or share their brand identity, and the costs of that can be astronomical. With the world becoming more digitalised, and things are becoming more and more online, companies are becoming more accessible to the wider world, so anything like this becomes very public.
Being based in London, I have Sky News on in the office quite a bit, so I hear a lot — and it always comes up that "a director or senior manager has resigned after allegations of [insert issue]". For example, a data breach within their organisation, someone swindling money from them or even an employee or director embezzling funds — there’s always a televised acknowledgement of that by the firm. People see that and remember it. That creates serious reputational damage in their sector.
Whenever something bad happens, your customers only see that as a very bad thing. For example, if the airline industry was to be in a head-to-head market share competition, and one airline has lost lots of bags, handled lots of complaints badly, that airline obviously gets bad PR and customers will avoid that airline. The damage is more than just that; the people making those decisions are paid more and usually hold shares in the business. Their stock is going to drop, and they’re going to be out of a job. The company could even go out of business. It causes a ripple effect, and these ripples will soon turn into tidal waves if you don’t deal with them properly.
Strategies for Successful Contract Management
Contract management is an ongoing process extending from pre-award to closeout and release of claims. Contract management is a business process and must be integrated with financial, procurement, subcontracting, property management, and other business processes containing common data and a series of related tasks. Development of policies and procedures to manage contract requirements and the data supporting these requirements should reflect that the contract management function includes all of these business processes and the data supporting them. This includes the consolidation of separate business processes (procurement, imports, R&D, etc.) with a series of business processes that interact with each other in a deliberate, coherent manner that may generate additional business processes and data requirements as a product of the interaction.
One of the best ways to improve contract management processes is to utilize contract lifecycle management tools. Many organizations still maintain "paper-based" contract management handling processes, these are often the result of general indifference within the organization to develop tools and policies and procedures necessary to compete in the global contract environment. Such processes and operating procedures will leave the company ill equipped to perform in the global marketplace.
With an effective contract management tool, contract management becomes a two-way street where the contract manager is now in a proactive management role demanding compliance with contract and other business requirements rather than relying passively on data flowing upstream (i . e., verify then record). The ability to identify discrepancies, non-compliances, and potential issues before the regulatory compliance officials gets involved can be invaluable in protecting the company’s overall interests.
A second critical strategy for effective contract management is regular audits. Although audits are often viewed as being more responsive, audit results can still prove extremely useful in improving organizational business processes. Although audits have their own set of limitations, in the proper hands they can serve as a valuable tool for improving contract management processes.
One of the frequently overlooked strategies for effective contract management is staff training. Organizational staff members must be fully aware of the organization’s contract management policies and procedures, as well as the business area’s specific contract management policies and procedures. Staff training should include education regarding the process for initiating a revision to the contract management processes. Policies and procedures are of limited value (having the "form" but not the "substance") if personnel are not made "aware" of their existence. This means that training sessions, supervisory and disciplinary actions must be made in the context of the contract management policies and procedures. Organizations must take the time and effort to ensure that all staff members understand and abide by the contract management policies and procedures of the organization.