IACCM’s 2019 Benchmark Report (issued in September) indicates the typical role of contract management and its measurement systems. This article illustrates many of the common challenges identified in the report - especially the issue of timely and appropriate use of contract management expertise and the importance of applying metrics that drive (and demonstrate) true value.
Sales, sales sales! How does this affect the bottom line? Keep inventory low. Keep the shareholders happy. We hear these phrases every day and we measure our performance in terms of sales, inventory and bottom line.
But why do we wait until a problem arises before we think to ask the most important question: “What does the contract say?”
Surprising that many business managers do not know the contract requirements before they start evaluating performance or success of a department using metrics and Key Performance Indicators (KPIs). More surprising is that they work with experts but when developing KPIs, they fail to use the contract managers’ (CM) knowledge of the company’s contractual obligations that are driven by the contract requirements. Contract managers’ knowledge and expertise is necessary from the start to provide guidance and insight when KPIs are first being developed.
Contract managers are critical to businesses when it comes to measuring performance. They are traditionally the first point of contact for customers. Their role is to act as the main facilitator for negotiations overseeing tasks such as recordkeeping, administrating the contract terms and conditions, overseeing change management, determining resolution for customer concerns, and so much more.
So, given the fact that no business is successful without satisfied customers, it is perplexing why businesses rarely engage contract managers in developing KPIs to measure the Service Level Agreements (SLAs) and evaluate the KPIs specified in every contract transaction between the company and the customer.
Unfortunately, when measuring customer satisfaction, too often companies use metrics tied to KPIs that do not have a direct impact to customer satisfaction. By contrast, developing KPIs to measure customer satisfaction will yield greater results than just using a number to evaluate an unsubstantiated goal.
That’s one major reason why many companies establish KPIs to build their businesses and increase profitability and resolve issues. By establishing KPIs, a company can measure performance tied to strategic goals and assess and drive organizational performance. A KPI measures performance of a specific activity. A metric is a number within a KPI that identifies how you are performing to that KPI.
Companies use KPIs at multiple levels to evaluate their success at achieving performance targets -- such as:
- overall business performance,
- financial performance,
- on-time delivery,
- inventory, and more.
So, what should the contract say and where does it fit into this KPI picture?
Just as we cannot put a puzzle together until we’ve examined the pieces and have studied the picture the puzzle will create when assembled -- we will not understand clearly what language the contract should contain until answers to questions, such as the following are well-defined:
- What is the contract manager’s role at your organization when it comes to measuring performance?
- When your company looks at top measurements of business success – sales, bottom line, low inventory -- what is the CM’s main challenge in guiding the contracting process toward success and how does that challenge apply to your KPIs?
- When should you measure KPIs?
- What measurable performance do you expect and when you know the answer, how might you correlate KPIs with metrics to determine contract requirements?
- When contract changes occur, how might you negotiate those?
- Where in that process do metrics come in? (Or are metrics and KPIs the same? The difference needs to be clarified early on and in the contract.)
- Why should customers care about KPIs?
The main KPIs our company reviews is Return on Sales and Inventory or Days Sales Inventory (DSI).1/2 Both are important to the success and profitability of a company. Our company also measures each department by metrics. Order accuracy is the metric we use to measure our contract managers and the metric each CM reports on each month; it tells us how well we input the customer purchase orders (put data into a computer). Order accuracy is also important from a sales perspective, because we want to ensure that the quantity and price is correctly recorded to avoid overstating the sales estimate.
But is this the right way to measure our contract managers?
We need to ask and answer…
- Are we successfully managing the contracts from the onset all the way to execution?
- How are the contracts managers overseeing the contracts throughout their lifecycle?
- Is the contract manager’s performance being measured by their negotiation skills and the results of their negotiation?
- How well does the contract manager evaluate risk? And can he or she recommend solutions to mitigate risk?
The all-important contract management role and the critical need for measuring performance cannot be overstated. For example, recently my organization implemented a new contract management tool and in our initial review of all the contracts, our organization discovered too many contracts with price escalation clauses that we were not enforcing.
This is only one example that illustrates why an organization needs to evaluate how well the contract manager negotiates contract changes. For example, a customer recently flowed down a contract change to the shipping policy. It appeared to be a simple change that our company could comply with, however, when the contract manager evaluated the costs with the additional steps that were required – such as additional cost and time for packaging differently and creating and applying bar codes – she could prove the true cost associated with accepting this change to the contract.
- DSI - Days Salesof Inventory is a ratio showing average time in days to turn inventory into sales. (How long does it take to turn inventory into sales.)
- Return on Sales definition - Return On Sales (ROS) Return on sales (ROS) is a ratio widely used to evaluate an entity's operating performance. It is also known as " operating profit margin " or " operating margin ". ROS indicates how much profit an entity makes after paying for variable costs of production such as wages, raw materials, etc. (but before interest and tax).
ABOUT THE AUTHOR
Tamara McMahon, IACCM certified as Contract and Commercial Management Expert (CCME), has been involved in several facets of contract administration and negotiation, including managing and facilitating the competitive contract negotiation process, statements of work, target deadlines and terms and conditions of contracts. She has supported contract efforts from receipt of Request for Quote (RFQ) and contract negotiation.