Friday Rant: Treat Contracting as a Business and Sourcing Process, Not Just a Legal One

In last Friday's first rant, I shared some thoughts and anecdotes about the role contracting can play in helping companies more quickly realize identified savings. In this rant, I’ll focus on some of the roles contracting can play in identifying additional savings and risk-reduction opportunities from a business perspective versus just a legal one. Perhaps the biggest mistake companies make with contracting is that they treat it as a process separate from supplier negotiations. In my view, the two should be intrinsically linked. Consider the following examples of how companies can apply contracting approaches in the context of the sourcing and negotiating process to improve results:

  • By integrating price escalation and de-escalation clauses into the sourcing and contracting process, companies can tailor a category management strategy to optimize for savings potential or commodity price opportunity/upside/risk (or a balanced savings and commodity price risk strategy that falls somewhere between the two extremes).
  • Organizations that are more advanced (from a sourcing perspective) can begin to explore how suppliers’ price and value contracts are based on individual underlying elements (e.g., lesser vs. greater indemnification clauses, liability limits, etc.).
  • Companies can introduce potential third-party vehicles (e.g., direct hedging, ETFs, tailored financial derivatives such as swaps, and insurance contracts) to minimize or maximize potential savings and risk upside/downside.
  • Companies can limit potential competitors from working with strategic suppliers … but the key question to ask here is: At what cost relative to rewards?
  • By introducing new entities and elements into contract structures in certain types of cross-border transactions that may include third-party organizations as part of a structure -- potentially wholly-owned by either or both of the contracting parties -- it is possible to reduce import duties, tax and related obligations.
  • Through tying payment (either direct or incentive/rebate based) more directly to actual performance and having a means to track and measure compliance, organizations can structure relationships and contracts based on aligning the goals of both parties while also reducing total cost elements.

Without question, contract management software and approaches are gaining more adherents by the day. I can’t help but see that the more we begin to treat sourcing and contracting as an integral process, the more we’ll be able to efficiently and effectively save money while reducing risk for our companies -- not to mention creating more transparent and stronger supplier relations along the way.

-Jason Busch

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