Connection between Contract Management, Risk mitigation & Cost reduction

Today, almost 75% of the procurement globally is based on contracts/agreements with their life term ranging from 6 months to 10-15 years. Once the procurement contract is established with the vendor, purchase orders are created and released as the need arises for product/services during the year with some exceptions in the process when purchase orders are not created owing to confidentiality/strategic reasons. Process of ‘goods/services receipt’ and ‘payment making’ follows as per contractual terms. Timely monitoring of performance of vendors based on quality/cost/delivery time/service support to leverage the best amongst available opportunities forms the next step in contract management.

Due to involvement of numeral complexities and given their long term/inherent nature, contracts expose organizations to multi level risks. Ever surging complexities, regulatory requirements, involvement of huge sums and many other business requirements( cost reduction/vendor alliances/responsiveness etc.) make activities ;negotiations (multi level), collaborative authoring from business stakeholders, procurement experts, and legal professionals, multiple approvals, adherence to compliances and monitoring vendor’s performances ; critical and all the more important in a growing organizations. Now challenge remains in executing these activities to have an efficient and effective contract management system. Current systems used are manual and lack integration in above mentioned activities and thereby poses a risk to supply chain of any organization.    

    

Functional requirements:

·         Reduction in ‘Time to contract’

·         Efficient tracking/monitoring of vendor’s performance

·         Proper governance and efficient /effective version management

·         Spend visibility

·         Security of confidential contracts/documents

·         Collaboration and high user adaption among key stakeholders

·         Adherence to regulations and compliances

·         Lesser risks and thereby disputes through greater transparency

·         Better business relationships

·         Effective financial management

System requirements:

Above mentioned functional requirements can be achieved through a contract management application which will help in:

·         Contracts standardization

·         Flexible work flow expediting necessary approvals

·         Streamlined amendment process

·         Central Contract repository providing full visibility

·         Integrated and automated system to track vendor’s performance vis-à-vis contractual terms

·         Parallel Negotiation of Commercial & legal terms reducing redlining & cycle time

·         Compliance tracking

·         Reduced manual processes and contract administration workload

·         Automate standard processes

·         Involves business partners (Interactive management)

·         Shorten Contracting Cycle (Time consumed in establishing  a contract and administrative activities during the life span of a contract)

Listed below are the benefits, financial as well as process centric that any organization will gain after the implementation of Contract management module.

#	ROI Potential	Potential benefits in first year itself *
1	Streamlined operations (faster processing, headcount reduction)	75-100%
2	Performance Management	10-30%
3	Risk mitigation	40-50%
4	Improved financial management	50-75%
	Total potential benefit in first year	175-255%

Burlinton Northern and Santa Fe Railway Company (BSNF), Interpolis Verzekeringen and Hewlett-Packard (HP) have reaped benefits on similar lines and have reached break even within 6 months time.

Detailed Justification of factors contributing to ROI

1)    Streamlined Operations

o   Reduced time to create and administer contracts: Time and effort to track and administer contracts can be greatly reduced. Standard templates and clauses based on requirement can be utilized. Auto reminders based on expiry date can also be set.

o   Improve process efficiency throughout the contract life-cycle: Optimizing processes related to creating business contracts

o   Reduce manual processes and contract administration workload: Manual intervention reduces directly impacting work load on buyers

o   Streamlined amendment process

o   Consolidate contract databases/repositories: Contract administrators can access the complete record of purchase documents and interactions related to a contract. They can also tracks deliverables and drill into all relevant documents

o   Leverage standard templates

o   Eliminate duplicate entry

o   Eliminate ‘shadow’ systems and tracking mechanisms: Excel sheets and other mechanisms being used can totally be eliminated

o   Support unique processes in different business units: Standardization across regions

o   Improve reporting: Accuracy improved and MIS reporting time reduces

2)    Performance Management

o   Identify and ensure delivery of contract benefits: Tracking deliverables timelines/quality/quantity including completion of services

o   Monitor and manage compliance and performance: Performance metrics may be designed based on actual and forecasted deliverables

o   Penalty clauses clarity and accountability: Based on vendor performance and user’s remarks penalty clauses can be focused

3)    Risk Mitigation

o   Identify and manage risks: Allows users  to monitor the factors when it exceed a threshold ex. dollar value

o   Ensure proper controls of standard templates: Automatically insert a  required approval whenever specified template text has been altered

o   Provide audit trails: Any contract modification, review approval, rejections, renewals including  who and when information is tracked

o   Ensure strong security: Read only, update, delete etc rights may be used

o   Enforce policies: Workflow processes as per rules/policies

o   Monitor compliance of contracted parties: Ensures notifications are automatically sent out in a timely manner and identifies when compliance items represent a risk

o   Identify and manage sensitive contracts:  Special business rules can be applied based on sensitivity ex. high spend contract, high profile contract

4)    Improved Financial Management

o   Eliminate renewal of contracts for unwanted goods and services: Visibility enhancement can help in removing “unwanted contracts”

o   Improve financial tracking of contract-based transactions

o   Identify and prevent overcharges: Transparency and close vigil can prevent overcharges across the system on contract based payments

o   Realistic picture of forecasts and budgets relating to expenditures

o   Improved cash flow projections

PricewaterhouseCoopers:  Companies could realize savings that equate to 2% of total annual costs by eliminating inaccuracies and noncompliance through contract automation.  Therefore, a company spending $1 billion could save $20 million annually

Goldman Sachs: A typical Fortune 1000 organization has between 20,000 and 40,000 contracts and spends as much as 100 basis points of their revenue to manage buy-side contracts, and 25 basis points of their revenue to manage sell-side contracts. They estimate that these enterprises could experience a potential reduction of 40 basis points in hard and soft costs by using contract management software. Contract automation could accelerate negotiation cycles by 50 percent; reduce erroneous payments by 75 to 90 percent, cut operating and processing costs associated with managing contracts by 10 to 30 percent, and result in a 10 to 20 percent headcount reduction.

Aberdeen Group:   Ineffective control and management of supplier contracts cost businesses    $153 billion per year in missed savings opportunities.

Supply chain / Logistics parameters and Financial statements

It's an eye opener to note how every decision made in supply chain, no matter small or big, impacts the financial statements which play a humongous role in the mind of shareholders/analysts/auditors while making decisions and determine the fate of any organization. Do click on the below given mind map for more details. 


Do share your views an suggestions. Happy reading!

Electronic Data Interchange- Making life easier!

Communication in Supply Chain

Organizations, today, maintain relationships with numerous other organizations as suppliers, customers, service providers, channel partners etc. and communication plays a pivotal role in growth and sustenance of any organization.

Organizations may be at any level of the supply chain and perhaps can be part of many supply chains, seamless and efficient information flow remains a challenge for all and slowly but surely organizations are realizing and waking up to impact of communication in this fast paced world.

Organization deal in number of products and most of the times, each product require number of raw materials which increases the complexity of the supply chain.

With the advent of ERP systems, organizations have been able to achieve seamless information flow within the organization but communication with external parties largely remains a grey area. This challenge is mainly due to different organizations using different legacy systems for their internal information needs.

Question that arises is whether it is possible to integrate the internal and external systems in such a way that it becomes easy to interact with partners and customers?

In other words, is it possible that we release purchase orders from our ERP systems and it is readily accepted by the legacy system of our supplier i.e. no need to manually feed the data in their legacy system from our POs? Similarly, is it possible that we receive invoice from the suppliers in their format and it is readily accepted by our ERP system?

The types and level of integration determines the extent to which data from customers and suppliers are visible and usable.

Standardization, exchanges of information and decisions and synergies will be byproduct of the integration between internal and external IT systems.

EDI:  Electronic data interchange is a set of standards that collectively provide a common protocol or syntax for transacting business documents electronically.

Just as a group of individuals with diverse backgrounds can use a common language (such as English) to converse with each other, EDI provides a common “language” that enables businesses with dissimilar computer-based business systems to communicate with each other.

 EDI is not a standard but has myriad variations and versions. In this regard EDI is much like English with its many regional dialects and colloquialisms.

Companies that are EDI enabled can send and receive business documents electronically with their trading partners. In simple terms, EDI enables the computer system of one company to “talk” to the computer system of another company and digitally exchange data.

Without the use of EDI, companies either mail or fax to exchange information. In this scenario, a company enters data in the system, prints it and mails/faxes it to the trading partner (customer or vendor). Then, trading partner after receiving the document must then feed the data into their applications. Waiting time and errors results in inefficiency in the way organizations operate. This inefficiency may be linked to the revenue loss, added expenditures, delays and damage to the reputation of organizations.

This system involves your data to be translated /coded into a transactional language which can then be transmitted to the trading partner via internet or some dedicated data network. These translated documents can then be readily accepted by the trading partner’s system. It is supported by syntax or protocols which are shared with the trading partners before transmitting the data. It is akin to providing the specifications of the material you are going to deliver to your partners.

Well, times will surely bring such innovations in the industry which will change the life of people for better.

Performance based logistics- Changing the way we contract!

Performance based logistics

Abstract:
This discusses what Performance based logistics (PBL) is, how it came into being and how it has brought a paradigm shift in the way companies operate. H ow it mitigates the risk in entire supply chain and creates a win-win business model for all stakeholders. No matter whether these are manufacturing organizations or service providers, PBL, a concept and a practice is very much executable in all kinds of industries, provided organizations are willing to accept their suppliers/ service providers/ customers as their partners.

Problem:
A company Dusing Ltd. has outsourced the fulfillment and call center services of their product to Idetel 3PL and agreed to pay on the following basis:
• $1 per minute for each call
• $3 for each order fulfilled
• $2 for each expedited order
• $15 a month for each pallet of inventory
• $2 to manage each return
• $1 to scrap and destroy damaged goods
Under these terms and conditions, more the Idetal gets paid, worse the supply chain operates.
Puzzled? Startled? Read on…
Let’s see how!
If Dusing Ltd. forecasts too much and unable to sell, then Idetel gets more money due to high inventory and moreover, it gets paid a scrap fee to destroy the product when it becomes obsolete.
Even when its products return from the market, Idetel gets paid more.
What is resulting is a transaction based logistics wherein service provider gets incentives to abide by the contract, and not necessarily by doing well for Dusing Ltd.

Second example: A software giant, just like other software firms, struggled with frequent excess inventories and huge write-offs due to mismatches between supply and demand. It sells its products through retail stores and it is almost impossible to know the demand of a new product in a market. Driven by the philosophy of hitting the shelf in no time compounded with high profit margins, it holds huge inventory.
To minimize the loss, software firm shrinks the profit of the supplier, leading to unhappy supplier and quality problems. But the problem of high inventory persists.
Where did the business model go wrong if at all and is there a way of doing it differently and efficiently?

Another example is about a company which pays it logistics service provider on the basis of number of trips it makes to supply the material to its various site locations. More the trips, more the money/incentives transporter gets.
Does the company want the transporter to make as many trips to the sites as it can? Or it wants the transporter to make as less number of trips as it can? Or it doesn’t matter to the company how many trips it makes as long as it is providing the material at the right time with minimum number of damaged goods?

How PBL helps and who has adopted it?
DoD (United States department of defense) has adopted a creative approach for procuring logistics support for its weapon system christened as performance based logistics which has been a key driver in helping the DoD to deliver higher performance and lower costs in procuring logistics support for its weapon systems.

At its core, PBL is a new collaborative business model designed to align the interests of both the client (e.g., the DoD) and the logistics service provider.

Under a PBL agreement, the client specifies his goals or desired performance outcomes, and the logistics service provider then gets paid according to how well it succeeds in delivering those performance outcomes.

Under this arrangement, the client does not pay for unit transactions of such support services as warehousing, transportation, spare parts, repairs, or hours of technical service.

In the example of software giant which was discussed earlier, PBL contract can contain
• Maximize revenue from its retail sales by ensuring 98% in-stock rates for retail fulfillment with a 48 hour service level.
• Reduce its costs by holding a minimum amount of inventory needed to achieve the high in-stock rates-thereby reducing obsolescence.
• Reduce overall total costs of operations by reducing non-value added activities.

Under the new PBL arrangement, the software company still gives the supplier a forecast. However, the supplier is accountable for production at optimum levels that are just high enough to meet demand. Rather than simply setting production levels to meet the forecast, the supplier is rewarded with incentives for producing less provided that it can hit the targeted stock rates.

For the supplier, the PBL agreement required it to assume a more proactive and accountable role in managing the customer’s supply chain. Toward this end, the supplier had to switch its production model from traditional push-based approach, where production levels were set equal to the customer’s forecast, to a demand-pull system

Similarly in the last example of transporter getting paid based on number of trips, contract should contain clauses such as availability of goods at 98% times with less than 1% damaged goods.

The PBL business model should be considered by any company that out sources services as a way to align supply chain partners to a set of common goals. And in so far as the partners succeed in aligning their performance goals, they will also have reduced risk across the entire supply chain.
Understanding the core competencies, aligning the goals and treating the service provider as a partner, remain the important pillars of PBL.