The 5 Best Reasons for Contract Management
Management thinks contract management is, at best, a necessary evil. At worst, contract management is just an administrative cost center. If I’m busy is the best argument, then do not expect to get the support you need. There is a better way.
As a contract manager, lawyer, or compliance officer you can persuade management that contract management software delivers tangible financial benefits.
To persuade decision makers who are not as close to or passionate about the details as you are, make these statements the foundation of your presentation.
1. Contract management increases financial value
You must explain the financial benefits of contract management. Otherwise, contract management looks like expensive busywork. Arguments based on abstract ideas like “compliance is important” or “maintaining the contracting process is important” are too abstract when it comes to a specific number as line item in a budget.
Management wants to know what is the return on the investment in contract management ? Contract managers, lawyers, and compliance officers do not like this question, because it is a challenge to quantify legal benefits and risks. Despite the difficulty, it is imperative that you focus the discussion on quantitative, financial benefits of contract management.
Make a financial argument to get a financial result. There are specific lines of financial statements that contract management can affect.
2. Contract management “moves the needle”
When it comes to allocating budgets across the organization, executives hear demands from every quarter. It is rare for a manager to volunteer for a smaller budget or less staff. How do executives respond to conflicting demands for limited budgetary resources? Business leaders want to make investments that “move the needle (a budget after all is just a capital allocation).
Moving the needle means that the budget decision will have a meaningful effect on the financial performance of the organization. A meaningful effect varies among organizations and across departments. For example:
- 5% increase in sales revenue moves the needle for the sales team.
- 10% decrease in expenses moves the needle for the engineering department at a technology company.
- 10% increase in profitability moves the needle for the finance department.
The needle moving percentage is rarely explicit, but there is often a psychological number based on the financial statements of your organization. The point here is not about the percentage itself. We need to understand the scale of budget items.
If the management team needs to improve profit by $4,000,000, your request for modest contract management is more annoyance than a help. Don’t bring a $4,000 problem to a $4,000,000 fight. However, explain how $4,000 expense contributes to $4,000,000 in financial performance and you have a winning position.
3. Contract management controls risk in the contract portfolio
Later, we will cover direct financial benefits of contract management. Risk is an important element in the contract management equation. Risk deals with unexpected losses. While risk is not always quantifiable, it is measurable, as explained in How to Measure and Manage Legal Risk.
Risk is about uncertainty. If we cannot produce data like the following, then we probably have an unacceptable level of risk in our contract portfolio:
- Number of contracts with indemnification clauses
- Number of contracts with insurance obligations
- Percentage of expense contracts with auto-renewal provisions
- Number of contracts with unilateral termination provisions.
- Number of expired contracts
The data in any one of these lines might, on its own, justify investment in contract management.
4. Contract management software improves revenue
It is much easier to cut expenses than to grow revenue for most organizations. Revenue is precious and pays everyone’s salary, including the executive team’s compensation. It is a powerful argument to show how contract management benefits revenue.
To make the case for contract management based on revenue, ask these questions:
What percentage of revenue is contracted?
In retail, for example, the answer is “nearly 0%.” The public walks in the store and buys the product. Most industries, however, make sales under a contract. These contracts are often not counted as contracts because they are “standard” or “boilerplate.” But they are still contracts. If your organization has multi-year sales or service agreements, then those are clearly revenue related. Technology licenses, for example, are revenue related contracts for the licensor.
Do sales contracts contain price or quantity controls?
Identifying ways that better contract management allows your organization to increase prices or increase volumes from existing contracts is powerful. Many organizations load current prices and terms in the accounting system when a contract is signed, but often neglect contingent or delayed price escalators that might allow for “free” revenue growth during the contract lifecycle.
Only good contract management will find those opportunities. Contract managers can also remind Sales of opportunities for volume discounts or trade financing to increase revenue if those provisions exist.
Can contracts transform short-term revenue into long-term revenue?
Predictable revenue is almost as valuable as growing revenue. Effective contract management is critical to changing the business to a recurring revenue model. The structure, timing and renewal expectations all effect this change. Identify how much of next year’s revenue is tied to current contracts and then focus on growing that base.
5. Contract management software reduces expenses
For expense control, start with the biggest number on the page. Contract managers, lawyers and compliance officers lose credibility when they tout saving pennies when they could save dollars. Contract management can provide unique analysis for the organization, like:
- All contracts listed in order of annual spending rate,
- Expense related contracts with auto-renewal provisions, and
- Expense related contracts with contingent pricing or terms.
Contract managers have simple and complex techniques to help cut expenses for the organization. They are in the best position to alert the organization to purchasing options that will reduce prices.
You need to quantify the additional expense savings available with better contract management. Timing is everything.
Contract management gains visibility during budget cycles and when there is a problem with a large contract. These are not optimal moments to explain for the first time why contract management is important. If you wait for budget season, you are scrambling to justify the work of the last year. The budget season is an opportunity to underscore the value that everyone knows because you report the financial value of the contract portfolio continuously through the year.
A crisis is not a good time to point out the value of contract management either. Some contract managers, lawyers and compliance officers use those opportunities to say (politely or not), “If we had proper support, we could have prevented this problem.” Business leaders are not inclined to respond with, “Oh, if only I had approved their budget request fully last year,” because the justification sounds more like CYA.
Past contract losses are quite effective to justify contract management, provided that enough time has passed so tempers have cooled. It is also important to aggregate losses in financial terms to support a financial argument about the value of contract management.
Present solutions, not problems
Use these five techniques to justify investment in contract management software, processes, and people:
- Focus on financial value
- Move the needle
- Identify potential unexpected losses (legal risk)
- Increase revenue
- Decrease expenses
Transform the contract management function into a risk management function to elevate the contribution you make to the organization.