Today a new report on contract value leakage – Tackling Erosion: Restoring Value to your Contracts – has been published by World Commerce & Contracting.
It is based on a survey conducted in October 2020 and received input from 475 organizations and I also participated.
In this post, I will also refer to some of the main conclusions of this report.
This is the link and you can also download it here below.
Contract Value Leakage and the Contract Lifecycle
What is your potential profit from a contract and how does contract value leakage affect your top and bottom line?
Over the lifespan of a contract your contracts often lose value.
You may recognize the following scenario if you belong to the (only!) less than 50% of companies that monitor the financial performance of their contracts on their total lifecycle.
The original business case you created showed huge potential (and a great margin!).
However, in the end, after you delivered the goods or services and you closed out the contract, there was a negative difference between the end-result and the original assumptions.
You had lost money down the road.
This difference is what we call ‘contract value leakage’.
Contracts nearly always lose value. And it starts already in the preparation and proposal phases.
Preventing contract value leakage is one of the most important opportunities for you to improve your topline and bottom-line.
Commercial Management Issues
Value leakage already starts long before the signature of the contract in the preparation and proposal phases.
And commercial issues are the most important factor in value leakage.
Some of the most important reasons are:
- Poor Statements of Work and technical (performance) specifications or unclear scope and commitments about the product or service. In the survey performed for the Tackling Erosion report, this came up as number one. This manifests itself later in the lifecycle when conflicts arise, customers submit claims, or even terminate the agreement.
- Lack of effective marketing and sales strategies or processes
- Weak or no value proposition creation (including defining uniques selling points)
- Lack of pricing strategies and pricing too high or too low
- The complexity of products, services, organizations (e.g. multiple decisionmakers, personnel changes)
- Overcommitting (early deliveries, higher performance), leading after contract signature to penalties and the customers executing performance guarantees.
This leads to suboptimal proposals where already the value potential takes its first big hit.
The negotiation phase is the next phase in which contract value further erodes if your people negotiating don’t have the right skills or mandates (for instance to cross- and upsell extra products and services which would lead to an increase in value potential):
- Agreeing in negotiation to sell your service to a customer at a price point that is lower than what your other customers have agreed is an acceptable price.
- Accepting unreasonable penalties for performance failures or uncapped or too high liability commitments.
All this leads to suboptimal contracts (poor proposal and contract quality).
You may have lost an average of about 6% of the total value potential even before you signed the contract due to commercial issues (source: DocuSign).
Contract Management Issues
After signing and executing the contract and in the delivery phase, your contract value can further decrease due to:
- Poor program or project management in managing multiple performance obligations
- The Tackling Erosion survey shows that issues with milestones and deliverables are the second most significant factor related to value leakage
- Performance issues (on-time, on-spec, on-budget performance) leading to penalties and claims
- Poor contract management (invoice issues, late payment)
- Multiple stakeholders and interfaces involved
- Long planning and delivery horizons
- Low awareness in the organization of the contract (poor visibility) leading to unenforced obligations and higher ongoing costs
- Inability to execute contract terms or act upon them or failure to enforce rights when needed (renewals, extensions, chargeable changes, price escalation) is also high on the report’s list of causes for value leakage.
- Regulation or compliance changes not acted upon
- Missing opportunities for upselling and cross-selling to increase revenues
So, in addition to the on average 6% value leakage before contract signature, further value erosion can go up to about 12% of the total revenue over the lifespan of a contract after the contract is signed due to contractual issues (source: IACCM).
Total Contract Value Leakage
This example leads to a loss of an average of up to 20% of the total contract value!
Now the percentages I mention above are averages and I use them only to illustrate contract value leakage in general.
Because in some industries they can be much higher.
In the Tackling Erosion report, the authors show that for specific types of sell-side contract (long-term services, SAAS, subcontracts, capital projects, but also consulting and professional services) in specific industries (engineering, manufacturing, aerospace, telecoms, business services, capital projects in oil and gas, construction) contract value leakage can go up to respectively 30% and 60% (!) of contract value and higher!
The report refers to a study performed by the European Commission that for megaprojects cost overruns can be near to 80%!
The software and health industries score much lower and seem to suffer less from contract value erosion.
The Solution Starts with People and Processes and Then Technology
The issue of total contract value leakage has all to do with (weak) resources and skills (people), (fragmented) processes, (disparate or no) systems use across the contract lifecycle.
The contract lifecycle management software providers will all claim that your contract value leakage issues will disappear by implementing their tools.
And of course they will certainly improve a lot of stuff as described above:
- having a central repository for all your proposal, contracts, and related documents and communication
- clause libraries and pre-approved templates for standardized contract generation
- the ability to search and analyze agreements quickly and receive alerts on contract terms (renewal)
- and connect critical business tools to take action on contract terms.
- electronic approval workflows and signatures
- and so on.
However, in the end – and more importantly – all improvements start with you and your people.
Because: a fool with a tool, is still a fool!
You need to have the right people doing the right job.
Your people need to manage the contract value during the lifecycle of a contract – from beginning to end.
Having the right processes in place helps your people to do their work, to adapt to their goals and their needs (and not the other way round).
To slightly adapt the expression I used before: a fool following a process, is still a fool.
And in the third place, today’s technology and the choice of the right legal tech or CLM tools can help them be much more efficient and effective.
ContractExec Can Help You Optimize Total Contract Value
To help customers in high-tech industries manage and optimize contract value, ContractExec has developed the Contract Value Lifecycle Management℠ process.
And to end this post with some unashamed self-promotion,
ContractExec can help you with training your people, defining the processes and technology for setting up monitoring of your lifecycle contract value.
By doing that you can obtain timely and reliable performance data to identify the sources of problems and manage risk better.
DO OUR CONTRACT VALUE QUICK SCAN
In a 30-minute phone call you will get some first advice how to reduce contract value leakage and what our contract value quick scan can do for you.