In the world of contracts management two trends are running parallel, however a meaningful common solution is not in sight yet.

On the one hand, business transactions are increasingly becoming complex due to many factors including globalization, variety of products & services, geographic locations, local & international laws etc. On the other, the number of such deals and contracts are also increasing due to increased business activities, number of players, new products & services etc. Overall, the management of contracts from writing a strong contract to monitoring the performance over the contract life cycle is becoming a daunting task for the companies.

While there are many tools & technologies today that provide solution to the second problem i.e., monitoring the performance of the large number of contracts over the life cycle (CLM or Contract Life cycle Management), the first problem is largely left to the organizations themselves to deal with.

Also, while most contract management tools can monitor the contracts and help reduce inefficiencies and leakages in the process, the real business risks lie in the contract language itself.

A big question then would be – are the organizations setup or equipped with contract specialists that thoroughly understand the business environment of the company including the internal & external risks and help negotiate a robust contract. While most large and medium size organizations have such a setup, many others struggle.

General understanding in many organizations is that the legal department is the expert and once legal team reviews a contract, the job is done. While this is true partially, legal department can only review the legal terms & conditions related to the laws such as liability, indemnification, intellectual property, and other potential law-suits. What about the risks associated with the factors such as pricing (competition, exchange rate etc.), consumption (demand changes), product obsolescence (new technology, substitutes etc.), and other similar factors?

Below two recent examples should highlight the point above –

A mid-sized US based IT company got into a contract for contingent workforce wherein the user department negotiated the contract. By the time procurement team got involved, it was late to do any changes to the contract. Apparently, the business unit (end user) had the contract reviewed by the legal department.

Fast forward 9 months……. The contract was needed to be terminated due to lack of demand for the services. Although the contract had an exit clause, it was negotiated such that there was a commitment on the annual spend and the shortfall of over half a million dollars had to be paid to the service provider to break the contract. Could this loss have been avoided or minimized? Absolutely, if the contract was reviewed for potential future risks. Yes, this clause could have been negotiated to be flexible.

In another similar company, a software license agreement of a million dollars was negotiated for a three years term. The agreement however was structured such that full payment was done in advance and there was no refund on the cancellation or changes. Again, in this case as well, the contract was negotiated by the user department.

Murphy’s law played in this case too. Over the term, only one third of the licenses were consumed, thereby losing a large chunk of value. Interestingly this fact became known only at the time of contract renewal at the end of the term.

So why do companies find it difficult to have control over this aspect? There are various reasons, but the one that stands out is a general lack of awareness among the business functions about the contract language and its criticality towards managing business risks. Due to the speed at which business needs to run today, general tendency is to focus on technical & cost factors first and then wrap up larger contract discussions quickly to move on with running the business.

Here are a few things companies can do to avoid this trap –

• 1. Involve procurement or contracts team well ahead in the supplier selection and contracts negotiations.
  2. Have procurement team understand the business functions, their needs and analyze business risks ahead of the negotiations.
  3. Include key contract terms in the RFP document and negotiate these alongside the techno-commercial factors, rather than afterwards.
  4. Create general awareness across the organization of the criticality of contracts and various terms.