PDF File: 

ASC5_wp_rafiq.pdf

Covigna

Organizations should immediately begin to evaluate their contract-management needs by auditing their current organizational capabilities to assess gaps and dependencies.

Overview

Enterprises have come to the realization that untold sources of value remain locked up in supplier relationships. A recent analyst study indicates that large enterprises can save more than 15 percent of total spend across their supply base by adopting emerging procurement strategies and best practices. To put this in perspective, the average Global 2000 enterprise would need to increase revenue by approximately 38 percent in order to match this magnitude of value creation potential (based on average operating margins of 20 percent and the fact that half of every revenue dollar is spent on external goods and services). To shed further light on the matter, consider that it would take nearly seven years of growth based on average rates over the last decade for such an enterprise to match the cost savings opportunity inherent within today's procurement function. Indeed, most enterprises would be challenged to identify potential channels for growing revenue at this clip in the midst of economic recession. Accordingly, the call to action surrounding the extraction of this value is being heard loud and clear, as evidenced by research indicating that more than two-thirds of Global 2000 companies have active investments in procurement best-practice initiatives.

This historic opportunity to create value is rooted in the implementation of complex procurement strategies. Whereas progressive thinking about purchasing practices has accelerated within the last five to 10 years, only recently has the procurement community seen the emergence of business models and frameworks that are mature enough in their completeness and practicality to embark on organizational initiatives of such magnitude. Indeed, many purchasing executives have been working diligently since the community was spurred into action by the advent of e-procurement to identify and understand all channels for value creation within their control. E-procurement was clearly only one component of a larger puzzle, involving both tactical and strategic opportunities.

The new profile of the procurement function within the enterprise — as evidenced by the emergence of the chief procurement officer — facilitated efforts to conceptualize the full spectrum of cost savings opportunities, each underlied by procurement strategies. Initiatives in strategic sourcing, e-procurement, supplier enablement, spend analysis, spend aggregation, and performance management are clearly an outgrowth of these efforts. Collectively, these initiatives hold the promise for billions of dollars in cost savings for large enterprises in the coming years.

Leading procurement organizations are clearly those that have developed a blueprint for where they are taking their business models incorporating many of these strategies.

Contract Management and Procurement Best Practices

One interesting characteristic of many emerging procurement strategies is their reliance on contracts and the process of managing these contracts. To illustrate the point, consider two emerging efforts within procurement organizations: strategic sourcing initiatives, and spend analysis and intelligence initiatives.

Strategic Sourcing

The goal of strategic sourcing is to efficiently meet the needs of enterprise stakeholders for goods and services by putting in place relationships with the highest-quality suppliers while simultaneously minimizing total cost. Clearly, contracts have a central role in this process since the terms of most purchasing relationships are negotiated and formalized in contractual documents. Because the average sourcing process can span three to four months, a significant amount of information is unearthed about the supplier, supplier landscape, product/service characteristics, and internal requirements that are ingredients into the contracting strategy. Without seamless interaction with the contracting process, it's quite possible that the relationship goals and objectives that surface during this period of time are not reflected in the negotiated terms. The key to realizing the value of effort during the sourcing process is the translation of the relationship strategy into an appropriate contract. After all, it's the contract and not the sourcing process that the parties inherit once a relationship has been formalized.

If the culmination of effective strategic sourcing is the execution of "good contracts" with suppliers, it becomes important to ask how well this goal is supported by current contract management practices.

During a contracting process, multiple stakeholders must come together to make decisions across a variety of matters including pricing, payments, product requirements, liability and risk allocation, product requirements and commitments, and so on. A diverse array of individuals — sourcing agents, risk analysts, corporate legal counsels, finance managers, contract managers, and internal customers from business units — must be able to come together during critical moments of the process to decide how the contractual terms that concern them will unfold through the contracting process. When buyers enter into contracts with inferior or suboptimal terms, this tends to occur for several reasons related to the complexity of organizing all the stakeholders.

Typical challenges related to these organizational issues include:

• Lack of clarity in roles and responsibilities. Questions that organizations should ask relate to identifying all the organizational skills sets and perspectives that need to be leveraged during the course of the contracting activity. For example, who are all the stakeholders that need to contribute? Who owns what aspects of which agreements? How does this division of labor get communicated among the contracting team?

• Lack of clarity on the business process. Questions that organizations should ask relate to how effort between the stakeholders should be organized into a set of repeatable business processes. For example, how is the need for a contract communicated? How is a contract draft generated for any given relationship? How do stakeholders of the contract communicate their feedback? How is an approval process structured when multiple people need to be involved?

• Lack of clarity on organizational standards. Questions that organizations should ask include what aspects of a contract are negotiable by whom? What aspects of a contract require special attention depending upon the characteristics of the supplier such as size, category, or risk profile? How are organizational goals and targets for contracts set? When are deviations from precedents and comparables acceptable?

Increasingly important to the objective of developing "good contracts" is a simultaneous desire to achieve efficiency in the overall contracting process. It's simply not good enough to organize all the stakeholders in a methodical process to figure out what constitutes a good contract and then to make sure the organization executes against these objectives. Because procurement departments increasingly view themselves as service providers to customers within their enterprise, they must pay attention to their responsiveness and service levels. This is because strategic sourcing is a practice that requires buy-in across all facets of an organization. In order for procurement professionals to be called upon for involvement as buying needs arise, business unit and line-of-business employees need to be comfortable with the effectiveness of the contracting process. In the absence of this comfort, natural barriers will arise that limit how much value procurement professionals can add to the activity of identifying, evaluating, and selecting suppliers.

The kinds of issues that procurement organizations should focus on are myriad. They include traditional measurements of effectiveness in the form of cycle times, output volumes, error rates, and the like. They also take into account resource planning metrics related to capacity requirements across different roles.

Progressive procurement organizations realize that a strategic sourcing initiative based on a "push model" (wherein the process is forced on the enterprise despite insufficient buy-in) significantly increases the risk factor of success. To reduce the risk profile of the initiative, they are looking to establish a "pull model" (wherein enterprise stakeholders proactively utilize procurement services and related processes because the benefits are clearly understood). To truly enable this pull model, procurement organizations need to address the twin issue of demonstrating their value-add to their internal customers as well as the effectiveness of the processes they employ to arrive at this value. Business practices around managing contracts are a very essential aspect of accomplishing these objectives.

Spend Analysis and Intelligence

The goal of spend analysis and intelligence initiatives is to harvest supplier relationships for value creation by continuously evaluating opportunities for purchase price reduction. At a fundamental level, enterprises have found that they know very little about their spending patterns and whether this spend is optimally allocated. Most see tremendous possibility to drive cost reductions by arming themselves with information related to how much they spend by category, product, supplier, or contract. The objective of initiatives in this area is to make the corpus of information available about corporate spending patterns, pending and future purchases, and the specific terms in place across supplier relationships work for the advantage of the purchaser. This is a challenging endeavor because the volume and complexity of the information is high and often beyond the scope of one system, corporate organization, and standard for the processing of information.

Contractual arrangements are a vital component of any spend analysis and intelligence initiative for two principal reasons. The first is that such initiatives are fundamentally concerned with the reduction of price, and contracts have significant influence on pricing. Naturally, it is the contracted price that matters in the course of a transaction. The second reason is that purchasing of most kinds is eventually transacted against a contract. Inevitably, any allocation of spend is made against a contract that covers the relevant good or service. As a result, to realize the savings from spend aggregation and consolidation, an organization must relate these strategies to contracts with the supply base.

To illustrate these points using scenarios, we can look at how the management of contracts and contractual information is required to support the low-hanging fruit of spend analysis and intelligence initiatives.

Transaction Analytics

Employees increasingly use e-procurement systems to assist in identifying relevant suppliers for their needs (for example, via the e-catalog component of such systems) and the execution of purchases with these suppliers. Consider a scenario where the need for a product or service can be supported identically by more than one supplier at similar service levels and responsiveness. Since the buyer is likely to be indifferent between the suppliers, the purchase should be made with the goal of minimizing cost, and the purchase order should be generated for the supplier whose contracted price is the least. However, this information may not be apparent from the catalog system for several reasons. First, the system may not indicate whether the various products or services are covered under the context of one or more contracts with the relevant suppliers. Second, should the contract coverage exist, each agreement may contain complex pricing rules related to discounting and incentives, which makes the calculation of the transaction price unclear. By closing this information gap, more guidance can be provided to buyers and more intelligent purchases transacted.

Spend Analysis

Two major cost-reduction strategies receiving significant attention involve the potential for aggregation and consolidation of spend. The purpose of these strategies is to remedy the fact that large companies still buy as if they were many smaller, unrelated companies. Since a majority of purchasing is made against a contract, when considering opportunities to consolidate spend, organizations should first ensure that their contracts support an aggregation strategy. This involves a review of the contract base to understand their implications in a number of respects. First, it's important to evaluate which products or services are covered by which contracts. For example, whether multiple contracts with a supplier could be used for the purchase of a given product or service. Second, it's critical to gain visibility into contracted price because the complexity of pricing terms can impact transaction pricing. Third, it's important to track spend by contract because this is the ultimate measure of whether spend is channeled in consolidated fashion. By addressing this information problem, a purchasing organization can be armed with tremendous tools for insight such as tracking purchasing patterns and forward-looking scenario analysis (running what-ifs, for example).

Purchasing Compliance

Enterprises spend considerable time structuring the pricing-related terms of contracts but are not always confident that they possess the capabilities to enforce these negotiated terms. In some cases, ensuring that terms such as volume-based discounts are being applied is complex. One approach to achieving compliance to negotiated terms is to reconcile invoices to contracted price. This would be accomplished by comparing contracted price (which can be dynamic) to invoices as they are being processed, so that exceptions can be flagged and remedied. It's clear that significant dollars are left on the table today because this practice is not common across many enterprises. Some estimates suggest that up to 2 percent of spend every year is noncompliant to negotiated price.

These scenarios illustrate that it is absolutely vital that contractual information be accessible to the systems and people executing transactions and planning spend strategies.

Contract Management and Organizational Transformation

There exists a large chasm between the promise of emerging procurement strategies and the organizational capabilities required to support these strategies in practice. There is arguably no better example of required organizational transformation to address this chasm than the means by which a large enterprise manages contracts.

Surprisingly, many organizations continue to maintain their contracts in filing cabinets. More worrisome is the lack of structure around how the contracting process unfolds and whether it takes real advantage of the sourcing process. In the event a contract is appropriately structured and designed, it is not clear organizations are set up to take advantage of the negotiated terms because contractual information is not enabled to work seamlessly with purchase decision-making, whether in line with transactions or in a planning context.

In attempting to bridge this gap, organizations need to review three core elements of their operational capabilities in contract management — people, process, and policy.

People, Process, and Policy

Enterprises should turn their attention first to a review of all the necessary processes involved in their contracting function. Some of these required processes will be readily ascertained and supported by current operating activities. This might include the process of approvals, which most organizations have standardized to some extent. Others will emerge as important processes that are currently incomplete or carried out in unstructured and diverse manners. This might include the process of creating a contract, which is often carried out in organizations based on individual discretion and the availability of templates, but no real guidance on how to use these templates.

In addition, new process requirements will reveal themselves after evaluation of anticipated procurement strategies and the support required from the contracting function. This would include many of the data management practices that would need to be established if contractual information is accessible to support spend analysis and intelligence initiatives. After taking inventory, an organization is likely to find a combination of known and unknown processes, which are being carried out at various levels of scalability, completeness, and maturity. Organizing these processes into one cohesive framework, a process map, is a key tool for organizational transformation.

A second critical ingredient is to organize a collection of people according to well-defined roles and relationships between these roles. To begin this activity, organizations should identify the skill sets required to make effective decisions during the contracting process. It is likely that some skills will emerge as critical gaps. For example, most organizations have underestimated the need for owners of contractual processes and standards. Is there a need for a centralized contract administrator who maintains the organizational best practices and standards? How many contract administrators would be required to support a given number of procurement professionals or categories of spend? These questions are critical to answer because sourcing agents, buyers, corporate counsels, and others cannot be effective in carrying out their responsibilities unless the contract support function is effective, scalable, and efficient.

Another step in the right direction is the formation of contract teams, with distinct roles and responsibilities allocated among the team members. The composition of a typical contract team should be communicated broadly in the form of policy so that stakeholders understand their expected contributions to the process. Participation outside procurement should be formalized so that there is sufficient commitment. Separately, measurement of resource requirements (planning purposes) and resource effectiveness (to govern feedback on individual performance) should be investigated.

Finally, it's important for managers to identify the policies they build into the contracting process to ensure that standards are achieved and exceptions can be handled. Maintaining a central collection of organizational policies, which come in the form of both guidelines and controls, contributes a layer of fine-tuning to the contracting process. Policies help guide decision-making as the contracting process unfolds, and if they can be put within the reach of people (and possibly systems) that carry out the contracting function, they provide an effective means for managerial guidance and control. Often simple policies, even in the form of a collection of do's and don'ts, are a sufficient starting point. Naturally, policies should be dynamic in nature and should learn from the collective experiences of the organization as new business situations arise and market environments shift.

A Call to Action

It's clear that business transformation initiatives within large purchasing organizations are being formed at increasing rates (67 percent of the Global 2000, according to one research effort). The competitive reality of today's marketplace and the potential cost savings at hand are two motivating factors behind the historic investment in a new wave of progressive business practices for the procurement function. For chief procurement officers and their partners in this endeavor, such as the CFO, CIO, or possibly the CEO, the stakes are clearly very high.

The contract management function plays an essential role in the realization of value stemming from next-generation sourcing, supplier management, and spend-management practices. At the same time, most large procurement departments face an alarming shortfall of organizational capabilities in the area of contract management, especially in terms of those on which the larger procurement strategies depend.

Large enterprises have awakened to the potential risk this chasm poses to their strategic business objectives and are taking steps to build required capabilities. They have begun to invest in efforts to consider how to organize their people, process, and policies into a proper foundation for contract management; and they realize it will take time to fine-tune. The primary challenges lie in rolling out these capabilities in a manner that is scalable and repeatable — a material task across large, global organizations with diverse objectives among its multiple stakeholders. To address the scale and scope of the initial and recurring challenges, it is quite likely that a high-level executive owner of the contract management competency will emerge in the form of a vice president of contract management, reporting directly to the CPO.

Leading enterprises have begun planning an organizational methodology around the management of contracts. At a minimum, organizations should immediately begin to evaluate their needs in this area by auditing their current organizational capabilities to assess gaps and dependencies. In the coming years, new initiatives in this area will accelerate, as they represent a major milestone toward the realization of the value and promise of the next-generation procurement practices.