Contracts are the foundation of every commercial relationship and they need to be managed throughout their full life cycle. Without robust governance 30% of contract may get lost. This is why successful organizations don’t put the contract in the drawer after it’s signed. They actively manage the contract to stay responsive to changing business needs and they effectively direct and develop the supplier relationship. They achieve a strategic advantage by reducing value leakage and by reaping benefits from being their supplier’s customer of choice. If you believe you’re not getting the best out of your sourced service agreements this article is worth your while.
Establishing a contractual relationship is critical when sourcing services from an external service provider as a contract forms the legal and operational basis in every commercial relationship. When entering into an agreement, the parties typically assume that the outcome of the negotiation was the best result possible. In most negotiations however organizations don’t agree to their maximum ability but instead they agree to a level they are comfortable with. As a supplier you don’t what to run the risk of over promising on what you can deliver and as a customer you don’t want to overpay and undermine your business case. As a customer you typically try to maximize the service you get for the lowest cost and risk while as a supplier you aim for the opposite which is to minimize the service commitment and risk whilst maximizing revenue. Usually neither party fully gets its way and the result of the negotiation is that the parties agree on an outcome they both feel comfortable with.
Although agreed and captured in a signed contract,
there’s no guarantee that with robust governance the outcome will be delivered exactly as expected. It can actually go two ways; you can get less and you can get more than what is on paper. If you don’t monitor and manage risk and performance you’ll likely end up with less than what you bargained for, while on the other hand, if you build a strong productive relationship you may get additional value on top of what was contracted. In other words managing the value of sourced services relationships involves both risks and opportunities. The gap between the best and worst possible outcome is often referred to as the value gap. The value gap is the total value leaks from the contract due to ineffective governance. It is the delta of reduced value that not gets delivered and the potential added value that isn’t captured.
Research by global consultancy firms puts value leakage typically between 19 and 48 percent of contract value.
Based on practical experience with managing service contracts we at Leadmark consider 30 percent potential value loss as an initial indicator for the average organization. This is on average 23,75 percent which is at risk due to ineffective contract- and supplier management and 6,25 percent of value that can be realized on top of what is contractually agreed based on a strong and productive collaboration. Examples of sources of value loss due to ineffective governance are: contractual obligations not aligning to business needs, misinterpretation of what is agreed, poor monitoring of service performance, poor invoice validation and disputes on prices and volumes. Examples of sources of additional value due to a strong productive relationship are: higher productivity and less waist, lower transaction and coordination cost, improved planning and faster delivery / time to market, better support and faster problem solving, quick access to new technologies and ways of working.
So there are two factors that affect the value of your sourced services engagement post signature. One is effective contract and supplier management to get what you have contracted and the other is being treated as a customer of choice by the service provider to get additional value from the relationship. Clearly these factors are not isolated, they affect each other. If, as a service provider, you deliver substandard quality you can’t expect the customer to be lenient or offer additional work. If, as a customer, you try to dominate and win as opposed to being supportive and accomplish a result, you won’t be regarded a customer of choice that benefits from a preferential treatment.
Please contact Leadmark if you like to learn more about value leakage and how to optimize the value from your sourced services agreements through superior supplier management or by becoming a customer of choice.