What is the Cost of Poor Contract Management?

Contracts are an essential part of a successful business. In order to make purchases for your business or sell goods/services to others, formal written contracts must be used for most agreements.  It is extremely important for these contracts to be managed efficiently throughout the contract lifecycle.

Contracts can prove to be a great benefit for companies. However, most of the focus on contracts comes on the front end of negotiations. After that, many contracts are not looked at until it’s time for their renewal.

This can be a mistake and one that can cost businesses the equivalent of 9% of their total income, according to research by the International Association for Contract and Commercial Management. Mismanaging a contract also can lead to poor performance from the contractor, who may not live up to the deliverables promised in the original agreement.

How It Happens

Poor contract management is defined as not monitoring a contract once it is signed. This often happens when those in leadership or managerial roles negotiate contracts and then turn over the process to those at the operations level.

Caught up in the day-to-day workings of an organization, professionals at this level may not have the time or authority to monitor a contract.

If contracts are completed through a procurement department (often the case in public agencies), they are tasked as more of a process-oriented unit rather than an area of long-term strategy. A lack of resources to monitor contracts is a frequent issue across all organizations.

The Impact of Poor Contract Management

Losses occur in a variety of ways from poor contract management practices. Managing contracts throughout their full lifecycle will help reduce losses. Efficient contract management will result in stronger long-term relationships with customers and vendors and more success in your business overall.

Underperforming Projects

Some contractors do not deliver the contracted work as promised. While most contractors follow the rules, some take advantage of long-term contract situations. This frustrates other potential contractors, who find it unfair that contracts are awarded to “another supplier based on the value-added promises, which are then never monitored,” wrote University of Liverpool Management School lecturer Laura Menzies in a 2016 article for Public Finance titled, “The Cost of Poor Contract Management.”

Missing Renewals

In some extreme cases, no one realizes when a contract is expiring. This can lead to disruption in service or delivery of products that are fundamental to a business and cost them revenue. More frequently, companies do not renew contracts within a time frame that allows for discounts or a lower rate – something many contractors include when they first negotiate a contract in hopes of establishing a long-term relationship. However, those discounts are often available 30 to 60 days before the contract ends. That deadline is often missed without contract management.

Breach of Contract

Contracts can be breached for a variety of reasons, but sometimes it can happen because contracts are mis-managed. Breach of contract can destroy business relationships and add costs to a project, including damages and attorney’s fees. Breaches are commonly the result of poor communication with contractors on benchmarks and goals which can lead to issues down the road.

Opportunity Cost

The money that goes to underperforming contractors is money wasted. But this issue goes beyond the loss of the money spent. There is also the opportunity cost – loss of money and time that could have been spent on a contractor who completed the job satisfactorily the first time on budget and  within the scheduled timeframe.

Scope Creep

Contractors can overwhelm a company with additional costs by increasing the scope of projects. Sometimes these additions come from unforeseen circumstances and other times there are simply additional costs a contract allows them to charge. Scope creep can negatively impact project delivery deadlines as well as drive up costs.

How to Avoid the Risks

Contract management is a complex task. The first step for a company that wants to better manage contracts is appointing someone within the company to oversee them as the main focus of their job. This could even involve creating a new position.

The following are other possible steps to take.

Review the Process

This is where methodologies like Agile and Lean Six Sigma can be implemented to remove unnecessary waste and improve process efficiency. For example, Agile calls for a continuous feedback loop on the status of contract deliverables to ensure frequent collaboration between negotiating parties. Reviewing the current process, as in Lean Six Sigma, can help determine if a contract issue lies in the original negotiation, the renewal process or if processes were poorly defined.

Define Scope in Detail

Scope creep often occurs when a project’s parameters are poorly-defined. Clear, specific definitions on project scope need to be included in a contract at the beginning, with both parties acknowledging and agreeing to them.

While not usually a priority, it’s wise to evaluate the contract management process and adjust where necessary. The benefits for a company in terms of both money and opportunity are worth the investment.