Profit Maximization in the Contract Lifecycle

The goal of contract lifecycle management is in essence profit maximization.

From the moment you create the value proposition to writing the proposal, drafting, negotiating, and signing the contract up to contract execution, renewing and closing out after all products and services have been delivered, there are opportunities to enhance your revenues, mitigate risks and reduce costs.

On the flip side, there are continuous threats that may reduce contract revenues or increase costs and risks.

In this post I will show you where in the contract lifecycle your margins may be under attack.

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Do you Monitor Contract Performance and Contract Value Leakage?

The companies I have worked for, especially in aerospace and high-tech, and often high-value, equipment, system information technology industries, often had tools in place to measure the win-rate of proposals and contracts and of course, they all tracked final order intake. But there they stopped.

The companies were completely in the dark about what the costs were of people working on proposals, contracts, negotiations, changes, renewals, and so forth (transaction costs).

And even if the total contract value was known, after signing nobody checked whether that value remained intact. Which of course it didn’t.

A lot of focus in such industries is on risks and compliance but they overall lacked business and cost control. In summary, they had no idea how much value was destroyed in the complete contract lifecycle.

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Profit Maximization and Contract Value

Only a few companies like software-as-service (‘SAAS’) providers seem to really track and know what happens with the contract value over the whole contract lifecycle of sales cases. From the start, with the request for proposal, through the proposal, negotiation, contract signature, execution, change, renewal up to the endgame when the contract finally will be closed out.

In all contract lifecycle phases, you can be losing a lot of contract value. Revenues by missing renewal dates and cross-and upsell opportunities. And bottom line costs by running into higher (transaction and other) costs due to delays, inefficiencies, and many more reasons

Contract Value Leakage and Profit Erosion

Contract value leakage can hurt both your top line and bottom line. Do you ever compare your sales forecasts with what actually, in the end, was realized? Probably not, if you are like most other companies.

Contracts once in a while can go terribly wrong, and cost you millions, destroy your profitability, and on top of that harm your reputation. And even when you are not chased by customers throwing claims at you and you think everything is under control, you may still be losing a lot of money without you even knowing it.

In a very simplified form and theoretically it looks like this:

So along the line, you will lose about 10% of your gross margin compared to what you think you should get out of the deal. But – as described above- you most probably don’t know exactly where and when.

Does this scenario sound familiar to you?

Well, maybe not if you are only responsible for Sales and only feel responsible for closing the deal’ (the top line). You only lost 2% in negotiation in this example. Which you already put in your price most probably. But what about the other 2% lost in the proposal and negotiation phase?

Also, you will not know if you are the program manager responsible for delivering the product and service. You ‘inherited’ the deal from Sales but ‘unfortunately’ lost 2% during the execution of your program. Mainly due to penalties and liquidated damages. But what about the other 4% lost in the post-signature phases? Where does that come from?

If you are the owner, CEO, or CFO, you should have the right overview and data. And you should be able to see there was an extra 6% loss of value/revenue over time.

Unfortunately, most companies are often flying blind and don’t have a complete picture. Is yours? In most companies I have worked for, the most important reason is that they are hindered by the fact that important customer and financial data are spread across the organization and fragmented over multiple internal systems.

Value erosion can go up to over 10% loss of revenue

In the different phases of the contract lifecycle, value is lost. 10% is not just a fictitious number. It is on average 9.2% for all industries (source: World Commerce & Contracting). But for example in aerospace & defense, it is around 10%. For Oil & Gas, it is even higher.

So what happened with your margin? And how do you know your contract value is eroding There are many tell-signs that indicate issues with your contract value leaking? So what are the signs your value is eroding? You may hear them every day.

In mega-projects involving the expenditure of over 500 million euros, it is even worse. Studies (2013) of the European Commission show that 65% fail or severely underperform, with an average cost overrun of 80%, Much of this failure could be avoided through better commercial and contract practices, processes, and tools. On both sides of the equation: buy-side and sell-side.

And it may be giving you a worse position compared to your competition who is saving much more money than you to re-invest in the company or give a return to the shareholders.

And continuing to invest in traditional business systems and processes will not help you to eliminate value leakage. You need to start looking at legal tech or CLM applications if you are really serious about improving your contract value, profit margins, and in the end also reputation.

In the remainder of the article, I will sum up what I have seen over the past 30 years in small to large companies as the main causes of contract value leakage. And it’s only getting worse: more customers, more products and services, more jurisdictions, business models, etc.

Here below the main causes of value erosion per phase in the contract life cycle.

Value leakage in the contract life cycle

Here below I have made a graphical representation of what can happen with contract value during the contract lifecycle. I advise you to download it and use it as a reading guide for the rest of this article.

The contract lifecycle management process includes the following steps:

1. Preparation and Proposals. The contract lifecycle management process begins by identifying the needs and requirements of your customers, the value propositions of the products and services you want to offer, and the types of terms and conditions and related documents you need for what in the end will become the contract.
   
2. Drafting contracts and Negotiation. Writing a contract by hand is a time-consuming activity, but through the use of automated contract management systems, the process can become quite streamlined. Upon completion of drafting the contract, it nearly always is negotiation time! Not much to be automated here, so here you really need skills!
   
3. Execution and Manage. The phase in which most bottlenecks occur is getting management approval and signatures. This can be prevented by creating and automating tailored approval workflows. Obligation management is then the most important activity to ensure deliverables are being met by the parties and the value of the contract isn’t deteriorating already in the early phases of the duration period. 
   
4. Changes and Renewals. Reverting back to all documents relevant to the contract’s initial drafting is needed when changes to the contract have to be made. Renewal dates have to be monitored to make sure the contract remains in place and business revenue isn’t lost. Automating the process allows an organization to identify renewal opportunities and create new contracts.
   
5. Close-out and Exit. Contract management also means managing the termination of a contract or closing it out as soon as all obligations have been fulfilled.

Ad 1. Preparation and Proposal Phase

Value erosion at the start of the contract lifecycle

Maximizing your value or eroding it already starts before the first offer is put out to the customer by:

• Marketing and sales organization issues: lack of clarity in roles, responsibilities or authorities, slow onboarding new managers or reps, not having a marketing or sales department at all, or leaving sales to program or technically trained managers with poor commercial skills
• Not knowing your customer is going to send out an RFP, which often, in a B2B environment, is evidence that your customer relationship is poor
• It being unclear which business unit is responsible for treating the RFP; or multiple focal points between your company and the customer who does not know who to send RFPs to
• Not having the right or enough resources to fulfill the customer’s requirements and activities requested
• Requests for Proposal arriving on the wrong desk, taking too long to respond to, or even getting lost
• Having no 360-degree or a fragmented view on the customer due to weak research into existing customer relationship; what have we done in the past, products sold, documentation, terms & conditions used, operational commitments, entitlements, contracted pricing, competition
• Customer relationship data and contracts hidden in documents, departments, heads of people, and fragmented across the organization in filing systems, on hard drives in other systems (ERP, CLM, CPQ, Billing, e-Portals, etc.) and elsewhere, leading to loss of time on hunting for documents and data
• Not having proposal (configuration) or contract life cycle management tools with clause libraries templates, and approval workflows, which increases risks of using wrong forms, search issues, extending lead times,
• Not listening to the customer or even contacting the customer to get a better understanding of their requirements and needs and which leads to weak or wrong value propositions
• Talking to the ‘wrong’ people in customer, for example, only talking with the engineers, and not with the departments that actually need to approve and fund your project

The negative impact of issues in the proposal phase on profit maximization

Developing the proposal and value proposition is the phase in which you have the best and only shot to set the ceiling to maximize profit over the lifetime of the contract that may come out of this. However, also here there are huge risks of leakage of the total contract value occurs due to:

• Not having people skilled in writing winning proposals in your organization
• Too quickly rushing into the offer phase whereas customer needs and requirements are still not completely clear or under discussion leading to weak value propositions
• Lack of pricing strategies, non-competitive pricing or pricing not based on value but ‘cost plus’ considerations, missed price opportunities, leading to overpricing or underpricing
• Not identifying upselling and cross-sell opportunities related to the proposal
• Lack of templates and standard clauses libraries, and terms and condition sets for the business to work with
• Not being clear in the proposal and poor visibility on what you already agreed to in the past, like contracted pricing, pre-negotiated discounts, previously negotiated MSAs, best-price guarantees
• The specification or statement of work to the proposal not being clear as for what you are selling (lack of clarity of scope and goals)
• The statement of work containing implicit performance obligations, legal commitments due to poor tech writing skills
• Committing to multiple performance obligations, or milestones, and deliverables dates, which are not achievable
• Low maturity IT and/or proposal (configuration) or contract lifecycle management technology causing you to work mainly manual with obsolete tools
• Lack of deal approval procedures (bid-no-bid) which may lead to you losing bids or winning bids but nor being able to deliver on time due to lack of resources, other commitments
• Failure to engage the customer and other stakeholders resulting in wrong contract forms, misaligned interests, issues/opposition in this and future phases of the contract life cycle, and extended lead times.
• Multiple versions of T&Cs leading to confusion, and wrong wording ending up in the proposal
• Forgetting to identify cost and risk pass-through opportunities to subcontractors and vendors

Ad 2. Contract Drafting and Negotiation Phase

Margin erosion due to poor contract drafting and negotiation

After submitting the proposal there is another chance you are further degrading your contract value in the contract drafting and especially the negotiation phases due to:

• Poor contract drafting skills in your organization and creating contracts that are unclear, difficult to understand, and miss clarity (especially in the specification and SOW)
• Using non-standard terms or customer (‘third-party’) paper
• Having no contract life cycle management tools with existing masters or templates and clause libraries or prenegotiated terms to speed up the deal
• Missing out on essential terms or conditions, like liability caps, liquidated damages clauses, sole remedies, warranties, dispute resolution, leading to potentially devastating claims
• Designing contracts designed to support internal processes and practice and not reflecting the trading relationship with your customer
• Not spending enough time on understanding how the contract will work once signed
• Focusing too much on risks and the avoidance of loss, rather than maximization of benefit and performance in a wider portfolio context, leading to disbalances in the commercial relationship with the customer
• Not involving the legal/contract team and other stakeholders involved early enough, especially in the specification or SOW drafting and discussions with the customer, resulting in wrong contract form, extended lead times, and misaligned interests and issues/opposition and disputes in the future
• Protracted negotiations allowing the competition to influence or take over, leading to delayed revenues
• Negotiations focussing on the wrong terms and risks and inflexibility leading to performance management dominated by blame/fault, leading to loss of economic benefit
• Poor negotiation skills leading to unnecessary price discounts and risk exposure and essential clauses preventing value leakage (like liability cap) being weakened
• Contract duration being too long leading to unforeseeable costs further on in the lifetime of the contracts not accounted for in the contract

Ad 3. The Contract Execution and Manage Phase

Contract value leakage are now more and more becoming apparent

There are several issues which make a contract more likely to suffer from value erosion after signature. Profit margin destroyers created in all former phases now come to the surface and new issues created in this phase further reduce the margins once expected at the start by:

• Poor handovers from the deal team and delayed contract routing to the implementation team, resulting in commitments and obligations being missed and misunderstood in the execution of the contracts
• Poor post-award processes and governance resulting in repetitive issues and errors causing value loss
• Subcontracting not in place on time, leading to delayed flow-downs of obligations and subcontractors starting work too late
• Slow booking and delayed receipts of payment caused by lengthy paper signing or acceptance protocols, delayed order entries and bookings
• Lack of clarity on scope and goals and inflexible terms and conditions in the Contract now to over-servicing, causing lengthy discussions, interpretation issues, claims, and blame/fault disputes
• Missed performance obligations or guarantees, on-time delivery issues, wrong KPIs, quality issues (warranties, service level agreements) leading to price reductions or penalties
• Contracts being incomplete and lacking mechanisms to deal with it
• Users seeing contracts as irrelevant to business needs because they are difficult to use or understand, and full of ‘legalese’
• Too many different or non-standard terms & conditions between this and other contracts so the program and delivery responsible managers lose the overview of the obligations
• Not monitoring or missing product/service renewal information (dates)
• Poor change management leading to higher costs
• On-going risk management not in place, obligations or service level agreement commitments, and service level/regulatory compliance not met, leading to penalties, liquidated damages
• Missed cost pass-through opportunities leading you you taking all the risks
• Billing and invoice errors, failed audits, leading to delayed revenue recognition (gaps)
• Missed performance guarantees leading to penalties or price reductions
• Missing or poor contract close-out protocols leading to liabilities provisions still needing to be registered on your balance
• Limited or no use of contract technology resulting in poor contract visibility, inefficiencies and loss of quality in performance and analysis and complete, timely, accurate information not getting to the people who need it

Ad 4. The Contract Change and Renewal Phase

Contract value leakage caused by forgetting contract changes and missing opportunities

There are several issues which make a contract more likely to suffer from value erosion after signature. Profit margin destroyers created in all former phases now come to the surface and new issues created in this phase further reduce the margins once expected at the start by:

• Changes in (market) regulations missed and therefore service level/regulatory compliance not met, leading to penalties, liquidated damages
• Unrealized upsell/cross-sell (missed revenue increases)
• Missed price increases like yearly price revision/escalation
• Poor change management and renewal processes leading to missing amendments, price increase, and renewal terms improvement opportunities

Ad 4. The Contract Termination Phase

Contract value leakage caused by not clesing out contracts correctly

• Missing or poor contract close-out protocols leading to liabilities provisions still needing to be registered on your balance

Contract value at stake

Revenue assurance

So revenue value leakage ‘triggers’ are:

• Renewal Dates
• Pricing
• Discounts & Rebates
• Payment Terms
• Invoice
• Revenue Recognition Factors
• Price Increases
• Cost Pass-Throughs
• Recurring Revenue

So what are some of the measures you can take to assure prevention of loss of revenue moments?

• Improved operating margins by better capturing of price increases, purchase commitments, and cost-pass throughs go straight to the bottom line.
• Eliminating incorrect billings and invoice issues and setting up correct and updated payment schedules you ensure that negotiated fees and payments correlate with actual invoicing.
• Providing historical customer data, including contract risk and revenue information, that you can give the negotiation team the right data to improve their negotiation strategy.

Operational impact

Triggers causing value loss in operations are:

• Products Sold
• Payment Terms
• Effective Date
• Purchase History
• Purchase Actuals
• Purchasing Vehicles
• Non-standard Ts&Cs
• Service Level Agreements
• Discounts & Rebates

Risk impact

• Non-standard Commitments
• Region
• Non-standard Ts & Cs
• Entitlements
• Discounts & Rebates
• Pricing
• Cost Pass-through
• Price Increases
• Payment Terms

• Global visibility into non-standard terms and business risk
• Reduce customer wrong billings and improve satisfaction
• Improve management of non-standard contractual commitments
• Improve visibility into internal control and revenue recognition effectiveness

Customer retention increases because your teams have global visibility into customer commitments. You can respond more quickly to new customer commitments and be proactive in addressing their needs and contracted requirements and regulatory changes.