What is Contract Leakage and How Can I Fix It?

No matter what kind of business you’re in, your business relies on contracts. They are the basis of almost all our relationships – from suppliers to customers, partners, contractors, and staff. It’s essential these business contracts are watertight but the fact is, many are not. Businesses are losing hundreds of thousands of dollars through what is called contract leakage – the difference between the value expected from a contract and the real value created in production.

That difference can be enormous. According to the International Association for Contract & Commercial Management (IACCM), poor contract management costs companies up to 9% of their revenue. That’s a huge hit on the bottom line! But there is a solution.

poor contract management

What Are the Causes of Contract Leakage?

Often, it is contract technicalities that create contract leakage. These are clauses governing how a product or service should be produced that were never cleared with the appropriate internal department, supplier, or contractor. In some cases – for example, if a customer has a non-negotiable part specification for a factory that cannot produce it – the technicality is big enough to grind an entire project to a halt and jeopardize the contract and the business relationship.

These are some common examples of contract leakage, from the IACCM:

  • Invoicing errors: If the correct contract terms or pricing don’t make it to the invoices sent, creating a difference in the value your company expected to bill and the actual billing price. This frequently happens when finance staff come across unexpected terms or complicated contracts they don’t know how to bill for.
  • Unrealized pricing adjustments: This is the difference in the price of something now compared with at some point in the past. Generally, it impacts companies that buy components or products to improve or onsell them later. Having a handle on the actual value of your inventory means you will always know what a contract is worth at a certain time.
  • Non-compliant work: If the work provided for in the contract was done in part or wholly outside the scope of the contract. A simple example is a construction contract that requires a redevelopment to be done according to a number of building codes. If the redevelopment is done in any other way, it would be considered non-compliant. In order to be compliant, your business must communicate the requirements of your contracts to the teams fulfilling them.
  • Delivery failures: Contracts also stipulate how and when a product or service will be delivered, and failures to live up to expectations are a business relationship-killer.

Any of these contract leakage types can result in poor customer experiences, lost renewal opportunities, and lost business. Here are some warning signs that you might have contract leakage:

  • Disagreement over contract scope
  • Weaknesses in contract change management
  • Performance failures due to over-commitment
  • Performance issues due to disagreement over what was committed
  • Inappropriate contract structures
  • Disputes about pricing
  • Issues with subcontractors

In Practice: Poor Contract Management Jeopardized FDA Approval

A Fortune 500 company discovered its contract leakage was not only killing its business but also endangering its ability to sell to the multi-billion-dollar US market. Procurement research company SpendEdge evaluated a food and beverage company and discovered their contract management processes made it impossible for the company to follow FDA and EPA regulations.

The found the company:

  • Had a lack of scope understanding and visibility, meaning it was hard to see and track what is going on, especially in aggregate.
  • Could not easily generate important data. It was attempting to correlate email threads with spreadsheets to manage contract fulfillment.
  • Was struggling to remain compliant with new rules from the FDA and EPA.
  • Did not have business rules for contracts, which meant there were often contracting errors and time-consuming runarounds.

The solution was the implementation of a contract lifecycle management platform, which streamlined its contracting processes, allowed for dynamic communications across teams, and increased its profitability while reducing spend on contract management overall.

Contract Lifecycle Management: The Solution to Contract Leakage

The IACCM says contract leakage can be solved by standardizing the contracting process. It recommends the use of quality, tailored agreement templates, tools for negotiation including click accepts and playbooks, and clear service-level agreements (SLAs) and remedies.

Contract management software like anapact supports the entire process – from request through review and redlining, approval, execution, storage, renewal, and disposition. Here’s how it can help:

  • Clause libraries allow staff to create contracts only from clauses that have been approved by the relevant teams, meaning potential issues with fulfillment or compliance will be flagged before the contract is signed.
  • Managed workflows mean that teams are always working from a single source of truth, leading to fewer invoicing errors.
  • Automatic reporting takes care of compliance, naturally.
  • Integrations with other tools reduce the risk of unrealized price adjustments and delivery failures, by connecting the contract terms with individual fulfillment and compliance parameters.

How is contract leakage impacting your bottom line? With huge benefits to profitability and new regulations in the mix, there is no better time to invest in your contract lifecycle management process.

anapact is a best-in-class platform developed by contract managers for businesses like yours. Get a demo today.