The cost of poor contract management – are you using all tools at your disposal?
Contract managers face decisions daily which cost organisations millions of pounds. These decisions are often made in good faith and with justification – but sometimes, due to a lack of awareness of the tools at their disposal, value for their company is lost.
Contract managers managing large supplier contracts will have many commercial levers at their disposal to make sure they’re getting the best value for the organisation from contracts. But sometimes decisions are made that mean these commercial levers are not fully utilised, leading to the cost of those contracts being notably higher than forecast at contract signature. This ignorance can lead to a significant cost implication for companies, with the IACCM putting the average loss through value leakage due to poor contract management at 9% of annual turnover. For example: decisions not to obtain information demonstrating the supplier has met an important KPI which has associated service credits; decisions not to discuss with the supplier the innovation savings they promised would be delivered; or even decisions not to recover a rebate that has been triggered by annual spend volume.
Two reasons are often given for making a decision not to use their commercial levers – potential damage to the relationship with the supplier, and delay to the project schedule. But rarely, when used in the right way, do we see evidence that decisions to use these commercial levers damages the relationship or disrupts the schedule. Where this has happened it’s only in cases where a poor relationship already exists. Looking at it from the other side, contract managers typically don’t appear to feel the relationship is damaged when the supplier makes use of their own commercial levers, for example by applying for a scope variation for increased costs. So why the hesitancy on the organisation side?
The delegation of authority paradox
When decisions are made to spend money, a well-recognised delegation of authority would, typically, require senior sign-off to be sought dependent on value. When decisions are made not to recover an unpaid rebate or apply for liquidated damages however, rarely is senior approval sought. And the paradox is that the financial impact of both decisions on total cost, and therefore to the organisation’s bottom line, is the same.
There are two potential explanations for this. Firstly, it’s simply that because the decision and its effects are usually not fully understood or reported, it falls beneath the radar of such financial controls. Second, is the well-known cognitive psychology of loss aversion - we tend to strongly prefer avoiding losses to acquiring equivalent gains. Or in this case, we make sure there are controls on making payments (the loss of money) but don’t when deciding whether to recover costs through use of commercial levers (acquiring gains), even though the values and effect to total contract cost may be exactly the same.
These same two explanations may provide an answer as to why the CFO may not pay closer attention to the Contract Management function. And yet the result of such decisions in the Contract Management function on an organisation’s bottom line could be profound.
Redressing the imbalance
PwC’s Commercial Assurance team specialise in identifying the commercial levers available to Contract Management. We pair this with our expertise in audit, financial analysis and supplier negotiation, and work together with our clients to effectively use those commercial levers to recover costs and reduce value leakage.
Get in touch below to find out more.
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