How Contract Management Reduces Costs and Risks

Pop quiz time: How many supplier contracts does your organization have? Where are your contracts located? When do those supplier contracts expire? Which of the contracts will automatically renew? If you don’t know the answers to these questions, you are not alone.

Many organizations that operate under a decentralized purchasing environment cannot answer these questions.

This begs another question: what is so important about managing supplier contracts?

Today, I’ll answer that question so you can answer any question about your purchasing.

Contract Management 101

As we all know, contracts are binding agreements between the buyer and seller. In decentralized purchasing environments, most contracts are written by the seller(supplier) and are typically written to benefit the seller and agreed to by the buyer.

Sometimes legal counsel is involved in rationalizing the contracts in a positive way. If the contracts are not actively managed however, problems and additional costs can occur.

Contract management risks include:

• Automatic renewal clauses – contract renews for new terms if notice is not given
• Automatic price escalators – pricing increases based on certain anniversary dates
• Market price escalators – pricing increases based on certain market events (fuel surcharges)
• New supplies and services not covered by the contract – added after original contract
• Price Advantages – market conditions may have changed, new competitors may have arrived on the scene, so managing contracts through their due date is important

Expense Categories That Typically Involve Contracts

All suppliers are different and may or may not require a contract before they engage in business with your organization. Based on our experience you will likely have contracts for the following expense categories:

Managing Contracts with Centralization

Whether you have a single point organization or own multiple locations, the best strategy to manage your contracts and mitigate risk is to centralize all contracts and agreements in one location. Ideally, the CFO or Controller would be the best point to centralize all agreements. The CFO/Controller should develop the following management processes:

• Original agreements or copies of same for all supplier commitments acquired
• Agreements scanned and stored on a local drive or web-portal
• All hard copies stored in a file with CFO/Controller or the A/P Dept.
  
  

1. Create a Management Tool for Contracts-Agreements

Once all contracts are collected from various management staff, and stored in a central location as described above, the contract management process begins. A simple contract management tool (database or Excel) should be developed that includes the following information:

• Supplier name
• Expense category
• Contract origination date
• Contract end date
• Supplier notice requirement (varies by contract, but may require 90 day notice to prevent auto renewal)
• Internal Category Owner – individual inside the organization who manages the agreement and will be responsible for the renewal or quoting process.

2. Establish the Contract Management Process 

Once the tool is developed, all contracts need to be reviewed and entered into this document. Once all information is completed, the process is set for active management.

A sort of the “Contract List” by due date will now identify all obligations for either new quotes to be accomplished or a renegotiation with plenty of time to avoid an auto renewal.

Executive management (President, CFO, or Controller) should be responsible for the active management of this important management process.

3. Review the Commitment Process 

While you are gaining control of the contract management process, it might be a good time to review and improve your commitment approval process. Organizations usually commit company funds for services and supplies through three accepted methods:

• Contracts
• Purchase Orders
• Invoice Approvals

Setting up a simple approval matrix similar to that below, with only key management allowed to commit company funds, will prevent surprises and increase your controls. Amounts will vary according to your internal needs and processes, but the general concept remains valid.

The best place to incorporate an approval matrix is in your company purchasing policy document. One this policy is defined, all personnel should be appraised of the new policy including the new process to centralize contracts and agreements.

Organizations have many supplier contracts to manage within their organizations. Identifying those contracts, collecting the contracts, centralizing the documents and then creating a management process to manage the expiration process will reduce risks to the organization and ultimately lead to more competitive pricing in the marketplace.

Developing an approval or commitment process will also reduce or restrict the personnel within an organization authorized to commit company funds.

The combination of both strategies will result in less risk and a more predictable and stable business environment.

If you are planning to undertake this effort to get your spend management function set up and running correctly, you do not have to go it alone. StrategicSource’s Profit Improvement program help you identify areas for improvement long-term.