Contract Management: How It Operates & its Current Problems

  • Post by:
  • November 22, 2018
  • Comments off

Throughout history, agreements have formed the basis of human interactions, ranging from a handshake all the way to “a 500-pages service agreement”. In a fast paced and globalized business environment, contracts set particular norms and rules in conducting business, providing safety for the insecurity that a lack of trust and familiarity creates. Lack of trust between business partners continues to drive the contract management evolution process.

Contracts form the Basis of Commerce

Nowadays, every company regardless of its size deals with contracts between different parties such as customers, vendors, distributors, contractors, and employees. Contract management has become a daily routine, especially for large corporates. Imagine a huge international company with thousands of employees. On a daily basis, this enterprise communicates with clients and suppliers on topics such as contract execution, termination or expansion alongside checking the compliance and reconciling any terms and actual execution. From a practical point of view, manual contract management is impossible here unless hundreds or even thousands of employee are dedicated to the process. The development of technology and computing have streamlined many of the contract management work streams, however, until recently, the process has remained complex and cumbersome.

IT Managed Services is a Growing Market

Let’s overview the snapshot of the current market state. The market size of managed IT services continues to grow every year. With a market size of $229.59 billion worldwide in 2020, overall IT spending in 2018 is approximately $900 billion. More specifically, the global enterprise contract management market is expected to grow from US$1.09 billion in 2016 to US$4.01 billion by the end of 2024, with a CAGR of 17.75%.

The Essentiality of Efficient Contract Lifecycle Management

Market trends are forcing recognition that Contract Lifecycle Management is no longer an optional capability. It’s a priority. These trends include:

  • An increase in global business velocity requiring faster execution of the contracting process
  • Increased demands on governance, risk and compliance (GRC) management
  • A push for legal self-service to reduce operational costs and handle increased volumes
  • Digitization of paper contracts, embracing e-signature
  • The move toward more diverse sales and licensing models
  • Companies’ expansion into new markets (including mergers and acquisition activity)
  • Increased personalization of customer requirements

All in all, every business interacts with another from a buy-sell perspective. The Client-Supplier is the most widely spread interaction, but managing this relationship consumes much time and effort. Both parties have their own contract management systems and this fact makes it even more painful to reconcile and execute contracts. To cope with this challenge, parties usually agree on which contract management system to consider as the single source of truth. Nevertheless, the problem isn’t solved entirely.

Generations of Contract Management

We are evolving from two generations of contract management:

The 1st generation entails the Supplier having the single-source of truth for contracts. The Client’s records play a secondary role in this case. A lengthy manual process ensues for the reconciliation of records and is expensive for both parties. A variety of departments are required to be involved with the process such as sales, procurement, legal and IT.

The 2nd generation tackles it in the opposite way. Here, the Client has a managed single-source of truth solution. The Client therefore has an upper hand in the contract relationship. However, the problems in reconciliation and costs stay the same. The ownership of the single source of truth is the only thing that has changed.

Moreover, both generations of contract management don’t solve these challenges present in the execution of contracts. After a Client or Supplier make a step in execution in their own contract management system, each step has a considerable response delay in internal contract system of another party.

Apply this to 3+ parties contracts, and management becomes a whole other nightmare…

The Contract Lifecycle Stages

Client-Supplier perspective

Each of the stages of the Contract Life Cycle has its own bag of problems:

1. Request

Representatives of Client and Supplier negotiate a common agreement. Then the Supplier side requests its internal legal department to prepare the contract.

2. Generate

Commonly the Supplier’s legal department creates every single contract, whether it’s standard or specific. It demands preparation of a contract and any other additional agreements (e.g., Non-Disclosure Agreement, service agreements, licensing).

3. Negotiate

Negotiations between Client and Supplier take place to determine the final terms and conditions.

4. Approval

Depending on the size of a contract, it can require approval from multiple stakeholders, including legal, controlling, risk management and other departments/executives.

5. Execute

Contracts are signed and then placed in a storage on an internal or external database. Meanwhile, the Supplier delivers goods or services and the Client pays according to the contract terms.

6. Search/Report

After execution, contracts are manually searched for in order to prepare a report for top-management. Both versions of truth exist.

7. Compliance

When a contract requires long-term and continuous delivery of services or goods, then both parties continually check the compliance of the contract according to their own versions of the truth. Disputes may arise due to non-compliance of delivered services or goods and the payment received. The situation may worsen due to different versions of truth between Client and Supplier.

8. Amend/Review

Most contracts have an end date along with an opportunity to review and prolong. At this stage, the whole contract lifecycle is usually required to be repeated.

Problems in Contract Management Systems

Altogether, contract management software has found its place in the international market by helping companies grow and maintain the sustainability of their contracts. After a decade of evolution, current contract management systems are beginning to stagnate and face the following problems:

  • Silo mentality

Contract management requires the participation of many people across various departments within the company. Inter-departmental interactions often suffer from this silo mentality, which makes it particularly difficult to efficiently manage contracts.

  • Multiple versions of the truth

Both the Client and Supplier need to reconcile their separate database systems, due to individual records displaying discrepancies between services consumed (client) and services delivered (supplier).

  • Duplication, tampering, data corruption

A Configuration Management Database (CMDB) used for records of services consumed/delivered is susceptible to a myriad of data cleansing issues, including duplication, tampering, data corruption and lack of auditability.

  • Lack of process enforcement

Fuzzy processes (calls, emails) and lack of process enforcement leads to faulty record keeping.

  • Manual process for value settlement

High reconciliation and legal costs are incurred by clients and suppliers, due to long, costly, manual processes for value settlement.

  • Lack of a real-time view

Management suffers from inefficiency as predictive and analytical budgeting and financial tools are hampered with bad data and a lack of a real-time view.

  • Risk regarding disputes and litigation

Time- and money-consuming disputes degrade client-supplier trust relationships.

Conclusion

Managed services contracts are critical for the Global Fortune 2000. For competitive advantage, global corporates need to focus on innovation and all enabling activities are usually outsourced and out-tasked. Technology services are critical in R&D, customer acquisition and retention. These services commonly cost corporates hundreds of millions over the course of a contract every year.

It is in no doubt that contract management systems have improved company operations globally. Hours of paperwork have been removed and billions saved in company expenditure. However, current contract management systems have drawbacks. Real-time updating features, time wastage in legal/contract management departments and reconciliation and value proposition processes should all be improved upon in the upcoming generations of contract management systems.

Read Also: Contract Management: The KCS Solution & How Blockchain will change Contract Management