Research has shown that companies on average lose 9% of their annual revenue because of substandard contract management practices. That is a crippling amount for many small and medium-sized enterprises that are already facing rising overhead and shrinking margins.
Having poorly constructed contracts, or those that are not managed and monitored can result in several costly consequences. For example, you may end up paying for services that were never rendered, be charged for penalties because of late payments, or be bound by terms that are unfavorable to your company.
To avoid these potential pitfalls, it is important to have a contract management strategy in place. This will help you to centralize and keep track of all your contracts, as well as ensure that they are properly written and executed.
But what exactly is contract management, and how does it work?
Let’s dive in!
What is contract management?
In simple terms, contract management is the process of creating, executing, and monitoring contracts. This includes everything from negotiating the terms of a contract to ensuring that both parties are upholding their end of the bargain.
It is important to have a clear understanding of the contract management process as it can help you to avoid common mistakes, save time and money, and protect your interests.
Here are the key steps involved in contract management:
This is the process of agreeing to the terms of a contract. It is important to have a clear understanding of your company’s needs and objectives before entering into negotiations.
- What are the key deliverables that need to be met?
- What is the budget for this project?
- What are the timeline constraints?
Answering these questions will help you to develop negotiation strategies and objectives. It is also important to understand the other party’s interests and objectives. This will help you to find common ground and come to an agreement that is beneficial for both parties.
This is when the contract is signed and both parties are legally bound to uphold their end of the deal. Importantly,
- The contract should be reviewed by a lawyer to ensure that it is legally binding.
- Both parties should keep copies of the signed contract.
- The terms of the contract should be clearly understood by both parties.
If there are any changes to the contract, for example, if one party wants to make an amendment, then this must be done in writing and agreed upon by both parties.
Once a contract is in place, it is important to monitor it closely to ensure that both parties are upholding their obligations. This includes keeping track of deadlines, payments, and any changes or modifications to the contract. If there are any issues, they should be addressed immediately.
Regular check-ins with the other party can help to identify potential problems and address them before they become serious. It is also important to have a concrete system in place for tracking and managing contracts; one that employees are fully trained on.
Most contracts have a set term and will need to be renewed once they expire. This process typically involves renegotiating the terms of the contract to ensure that they are still favorable for your company.
It is important to start the renewal process early so that you have time to negotiate any changes to the contract. If the other party is not willing to renew the contract, then you may need to start the process of finding a new supplier or service provider.
There may come a time when you need to terminate a contract before it expires. This could be for several reasons, such as if the other party is not upholding their end of the deal or if your company’s needs have changed.
The contract management process can seem daunting, but it is important to have a clear understanding of each stage to protect your interests.
Contract lifecycle management
Sometimes, this can be called contract life cycle management, or CLM. This is the process of managing a contract from beginning to end. While contract management can be discussed in more broad terms, there are eight specific steps for CLM.
- Requests: Identifying a business need and determining if a contract is the best way to meet that need.
- Authoring: Creating the contract itself. This includes everything from drafting the terms to getting sign-off from all parties involved.
- Negotiations: Agreeing to the terms of the contract.
- Approvals: Ensuring that all parties involved have approved the contract.
- Signature: Putting the contract into effect by having all parties sign it.
- Obligation: Ensuring that all parties involved are fulfilling their obligations under the contract.
- Compliance: Confirm that the contract is being followed and that all parties are adhering to its terms.
- Renewal: Renewing the contract (or negotiating a new one) before it expires.
Each of these steps is important in its own right, but they are also interdependent. For example, you cannot have a signature without first having a negotiation. Likewise, you cannot have a renewal without first having an obligation.
The key to successful contract management is understanding these steps and how they work together.
Contract risk management
Importantly, there are checks and balances to contract management as well.
Risk management is the process of identifying, assessing, and mitigating risks. This is important in contracts as there is always the potential for something to go wrong. For example, a supplier may not be able to meet their obligations, or there may be a change in market conditions that impacts the contract.
By identifying risks early on, you can take steps to mitigate them. This may involve setting aside money in case of unforeseen circumstances or putting clauses in the contract that protect your interests. Here are some things to consider.
- Potential threats: What are the things that could go wrong?
- Probability: How likely is it that these things will happen?
- Impact: What would be the consequences if these things did happen?
- Mitigation strategies: What can be done to reduce the probability or impact of these risks?
Some of the ways that you can mitigate this risk are through things like:
- Indemnification: This is a clause in the contract that states that one party will be held harmless in the event of any loss, damage, or liability.
- Insurance: This protects against any potential losses that may occur as a result of the contract.
- Force majeure: This is a clause that excuses one or both parties from their obligations if an unforeseen event occurs (e.g., natural disaster, pandemic).
- Limitation of liability: This caps the number of damages that can be awarded in the event of a breach of contract.
- Waiver of subrogation: This clause protects the other party from any claims that may arise as a result of the contract.
- Escrow: This is a deposit of money or property that is held in trust until the conditions of the contract are met.
Any of these things must be agreed to by both parties and negotiated in good faith.
Contract management challenges
Even with a good understanding of contract management, there are still some common mistakes and challenges that creep up. Here are some of the most common challenges faced by businesses when it comes to contract management.
- Inconsistent procedures: This can happen when different departments or teams are responsible for managing contracts, and each has its way of doing things. This can lead to confusion and errors, which can be costly.
- Lack of visibility: Another common challenge is the lack of visibility into the contract management process. This can happen when contracts are spread out across different departments or team members, making it difficult to get a clear picture of what is going on.
- Inefficient processes: Inefficient contract management processes can lead to wasted time and money. This often happens when there is duplication of effort, manual tasks that could be automated, or a lack of standardization.
- Poor leadership: If the contract management team lacks leadership or direction, it can be difficult to achieve objectives. This often leads to a lack of motivation and poor performance from team members.
- Unexpected change: This can happen when key team members leave, and their knowledge and experience go with them. This can disrupt the flow of work and make it difficult to meet deadlines.
- Complex contracts: Contracts that are too long or complex can be difficult to understand and manage. This can lead to mistakes being made, and it can be hard to keep track of all the different clauses.
If you can relate to any of these challenges, don’t worry — you are not alone! These are common problems faced by businesses of all sizes. Luckily, there are some things that you can do to overcome them.
- Develop clear and consistent procedures: This will help to ensure that everyone is on the same page and doing things the same way.
- Increase visibility: Make sure that contracts are stored in a central location and that they are easily accessible by all team members.
- Streamline processes: Look for ways to automate tasks, eliminate duplication of effort, and standardize procedures.
- Provide leadership: Clearly define roles and responsibilities, set objectives, and provide support to team members.
- Minimize turnover: Try to retain key team members by providing training and development opportunities.
- Keep it simple: When creating contracts, try to use clear and concise language, and break down complex clauses into manageable chunks.
By following these tips, you can overcome some of the most common contract management challenges, and avoid losing any of that precious revenue.