Contract Management – it’s all about Risk and Opportunity

We laid off the subject last week with all the excitement (?) around John Collington leaving his role and so on, but let’s get back to Contract Management, how procurement can play a worthwhile role in it, and what it is all about.

We argued last time that procurement must play a role in contract management, because it is so important to the successful delivery of the contracts that procurement  put in place. But before we get back into what that role might be, let’s address a related point. How do we work out which contracts need managing, and what sort of resource needs to go into that activity?

Over the years, I’ve heard different numbers mentioned – a benchmark that said you should spend 2% of the contract value on contract management. Another that said 5%. But intuitively, those flat rate approaches can’t be right. For a start, there must be economies of scale in management – so a contract with a value of £10 million a year shouldn’t take 10 times as much contract management cost as a similar one worth £1 million.

But also, different types of contract must require different types of contract management activity and varying levels of resource. I managed some pretty large contracts for supply of skimmed milk powder back in my procurement youth . But frankly, they didn’t need much managing.  Give the supplier a schedule of deliveries, and meet them once a quarter to check everything was OK.

So it is not simply related to the size of contract. Neither is it purely complexity. We could argue that a stationery supply contract is pretty complex, with many delivery points, stakeholders and different line terms. But no-one would expect to see huge resources going into contract management of the corporate Banner or Office Depot agreement.

The work I did for National Audit Office and Treasury in the UK some time ago around this issue took my thinking in the following direction. If we could be absolutely certain that the supplier was going to meet precisely the terms and conditions of the contract, for the whole period, then why would we bother with any contract management activity at all (whatever the size or nature of the contract)?

So the risk of the supplier not meeting the contract requirements must be a factor that drives the need for contract management effort and input.  But if there was none of that risk, the only reason for contract management would be the potential for added value over and above the original contract terms. That could make it worth putting some effort into the management.

I don't claim my thinking was totally original, but the conclusion I reached was this.

The purpose of Contract Management is to manage the risk and opportunity inherent in the contract, and the resource and effort put into it should  be proportionate to that risk and opportunity.

We’ll leave you to mull that over, and expand on it in our next post.

Voices (2)

  1. Ian Heptinstall:

    Hi Peter, fully agree wtih your conclusion, though I would make your added-value point stronger.

    Unless you have selected the perfect supplier (..?…), you should always have improvement targets. Similarly for any longer-term agreement, you should expect performance and value to improve over the duration. Long-term deals that freeze the value at the time of contract are risky, and I suggest should ony be considered by those with 20:20 foresight.

    Another angle, even on a shorter deal where you only want what was agreed, is that suppliers are usually busy people, and if you only put your time into the riskiest/weakest ones, there is a real risk that the good supplier’s performance doesnt increase in line with their potential – either because you fail to guide them in the areas you want them to improve, or just due to the lack of attention shown. After all suppliers are just a collection of human beings, and we humans can easily become less energised if we get no feedback, or dont see the human side of an organisation.

    Do you think Usain Bolt doesnt see his coach for months on end, just because he won a race by a country mile? I bet they are down at training straight away thinking “that was great, now what can we do to get better”. Good purchasing is as much about motivating suppliers as anything else.

    To adapt your quote from David A the other day: Procurement…”trusted adviser to colleagues, coach to suppliers”

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