Contracts are essential instruments for the company's activities and their execution crosses many of the organization's departments. An important question for all those who deal with the elaboration, negotiation, conclusion, and management of these agreements is: what is the expected value of that deal?
A simple answer would be to equate the value of the contract to the monetary cost of the service indicated therein. If it is a purchase agreement, for example, it would be the price paid for the item. If it is a service provision contract, it would be how much money was paid to that contractor.
The financial parameter is undoubtedly very important for the operation of the company. However, the value of well-managed contracts can also be measured from two other points of reference:
- Relational value: when the parties manage to reach a mutually satisfactory result, the contract becomes a partnership. This increases the reputation of those agents and reinforces the possibility of upsells, cross-sells, and favorable benchmarks;
- Organizational value: when contracts fulfill all the expectations of the parties, are reliable sources of information, and do not add costs or complexity to operations, the organization of companies becomes more fluid, like well-articulated gears;
However, contracts do not always reach their full potential for value creation, whether in the financial, reputational, or organizational dimensions. Therefore, the concept of “Contract Value Leakage” was created. Tackling this problem is one of the main challenges for managers of large companies.
The size and impacts of this reduction in value have already been documented in several surveys on the subject:
- Up to 9.2% of a company's revenue can be lost due to poor contract management, according to World Commerce and Contracting; e
- Between 12 and 40% of the value of contracts can be lost due to poor management, according to KPMG
In this text you will better understand how agreements lose value, in addition to discovering what to do to avoid this situation, extracting as much as possible from the agreements signed by your company.
How contracts lose value
You have already seen that it is possible to identify at least three types of value generated by contracts: financial value, relational value, and organizational value.
See below which are the main practices that cause losses in these three areas:
1. Loss of financial value
The loss of a contract's financial value is the easiest to visualize since it manifests itself in practices such as:
- Failure to collect installments
Due to disorganization or a high number of demands, it is possible that the financial sector fails to make an invoice, or even that it does not send them to the counterparty. This generates an automatic loss of financial value since the agreed payments are not being collected;
- Lack or delay in updating the value of installments
Without visibility, many companies fail to readjust the installments according to the index that was agreed upon or even delay the execution of this task, generating economic losses.
- Failure to collect contractual fines
It is common for contracts to structure fines in the event of default on installments or termination of the contract. For the party that was harmed by the lack or termination of the agreement, the non-enforcement of these clauses also reduces the financial value generated by the agreement;
- Triggering of contractual fines
From the perspective of the defaulting party, against which penalties are charged, this situation adds costs to the fulfillment of the contract, and, consequently, reduces the expected value of the agreement’s execution;
- Failure to charge additional fees provided for in the contract
It is also possible that contracts provide for the charging of additional amounts for services such as unforeseen revisions or changes in scope. If there is no visibility on these clauses, the charge will not be made and there will also be a reduction in the financial value that could be generated by the agreement;
This is the dimension in which losses to the company are most easily verified. However, it is also important to assess the loss of relational and organizational value that can affect a contractual relationship.
2. Loss of relational value
To transform the contract into a partnership, the parties must adopt a collaborative perspective both during negotiations and throughout the fulfillment of the agreement. This position needs to be translated into concrete behaviors that indicate the real consideration of the counterparty's interests and objectives, in addition to the search for a solution that fulfills them in the greatest possible dimension.
However, practices that distance themselves from this win-win approach transform the contract into an unbalanced relationship and imply a loss of relational value for those involved. Some of these situations include:
- Disorganized communication
From the beginning of negotiations, communication between the parties is chaotic, which usually lasts throughout the performance of the contract. Information is lost, requests are disregarded and not all responsible agents are properly engaged in the flow. Even if the installments are eventually fulfilled correctly, all the personal and emotional distress resulting from the constant disagreements undermines the partnership between the companies;
- Delays and unsatisfactory deliveries
When there is no visibility on the content and deadlines for fulfilling obligations, the company incurs delays and performs unsatisfactory deliveries. This can trigger the application of fines and other contractual penalties that, in addition to generating financial costs, also strain the partnership and can encourage terminations.
If one of the values that can be generated with a good agreement is the consolidation of successful partnerships, practices such as those listed above certainly reduce the chances of achieving this positive result. Therefore, they imply a clear leakage of the contract value.
3. Loss of organizational value
As you have already seen in the text “The value of connections: contracts as articulators between areas of the company”, agreements are the main link between company departments.
Take, for example, the case of deals concluded by the Sales team: they will be conducted by the salespeople, reviewed by the Legal department, perhaps even approved by the Board, fulfilled by the Product team, paid by the Finance area, and monitored by the Customer Service professionals. If this flow is well structured and efficiently conducted, the activities of all these agents will generate a positive result for the company.
Thus, one of the values that can be generated from good contract management is the optimization of the articulation between the company's areas. However, some common practices also undermine this objective, such as:
- Decentralized communication
There is no single communication channel between the company's departments so the transfer of the contract between the different sectors takes place without visibility on the status of activities or prediction in terms of deadlines for those involved;
- Incorrect or outdated documents
The templates used to prepare contracts may be incorrect or outdated. If the points of incorrectness are the clauses referring to the allocation of responsibility or compliance with applicable regulations, for example, this adds risk to the company's operations.
- Incorrect engagement of areas and people in charge
A contract’s life cycle may suffer relevant variations depending on the content of the services or the strategic nature of the agreement. It is frequent, however, that situations that deviate from the standard are not correctly identified. Thus, not all areas of the company or specific managers are engaged in all necessary cases, which also adds risks to operations.
- Lack of visibility on important information
Contracts are filed in repositories that are not accessible to everyone who needs to consult their information. It is also possible that they are not yet named to allow quick location. Thus, it becomes more complicated for the company's areas to play their roles in the management and fulfillment of the obligations indicated therein;
- Complete lack of data for management:
None of the areas gather information to monitor the stages of the contract’s life cycle, so it is not possible to identify points of inefficiency.
- Manual extraction of data for management:
There may be, in some areas, the initiative to extract data to follow the stages of the contract’s life cycle. However, this compilation is decentralized and done manually. This means that different areas of the company have spreadsheets with the same data, generating rework, and reducing the degree of reliability of that information since it is subject to manual errors in the transcription.
It is interesting to observe that each of the points that harm the organizational value of the contracts can also imply a loss of the financial value of the agreement. For example, the lack of visibility of important information can make it difficult for departments to comply with payments and eventually trigger an obligation to pay a fine.
How to avoid loss of contract value?
Now that you've understood how contracts lose value, both in the financial, relational, and organizational dimensions, the next important question is: how to avoid these losses?
The answer involves adopting Contract Lifecycle Management (CLM) practices. In general terms, the proposal is to understand that the administration of agreements involves several stages and that the best way to carry out the activities of each one of them is based on a full view of this flow.
Seven steps need to be considered by the manager: request, elaboration, negotiation, review, signature, management, and data extraction for intelligence generation. With the help of a document and workflow automation software, this approach makes contract management simpler and safer.
To better understand the perspective of CLM, see the text: CLM: what it is and how the technology can benefit your company
About the points mentioned in this text, CLM software can optimize operations in the following ways:
- Structure communication and keep full records
The parties can communicate through the platform, even in the negotiation and review stages. Everything is fully registered so that the information will not be lost and will be available to all those who need it.
- Ensures the use of up-to-date and complete templates
The CLM platform allows the automation of the most up-to-date and complete templates, ensuring the presence of all important clauses. This allows the management of operational risks and makes the contract an instrument for generating value in this area.
- It engages all the necessary areas considering the specificity of each document
The document's life cycle within the company is automated to guarantee that all areas and responsible parties will be properly engaged for each type of managed contract. This avoids rework costs and preserves the organizational value of the agreements;
- It guarantees full visibility of the agreement’s terms
All files are stored on the centralized platform, guaranteeing access to all areas that need to consult the terms of those documents. Thus, it is easier to maintain the financial value expected with the agreement, monitoring the fulfillment of all obligations in the way they were delimited.
- It generates alerts to help meet deadlines
It is possible to configure automatic alerts to notify those responsible for the deadlines of each contract. In this way, the payment of fines and other contractual penalties is avoided, in addition to preserving the relational value of that agreement.
- Automates data extraction for management
A CLM platform extracts data directly from documents and operations, reducing the manual work of employees and increasing the quality of data available to management for decision-making. This promotes the generation of organizational value from contracts.
Guarantee the full value of your contracts with netLex
Far beyond the financial value, contracts are instruments for generating relational and organizational value. When the full potential of these agreements is realized, they become true assets for the company.
However, many common practices in the corporate environment undermine the value generated by contracts. Now that you've seen some of them, you've certainly remembered situations in which these approaches generated very concrete losses for your operations.
The best way to avoid these negative outcomes is to invest in a CLM platform like netLex! Thus, it is possible to guarantee the full value of contracts, enhancing good practices while eliminating sources of inefficiency.
To learn more about how netLex can streamline your company's operations, contact our experts!