Contract Compliance — The Hidden Underbelly of Sourcing Under-performance

Spend Matters welcomes a guest post from Michael Eckstut, Principal, Strategy and Operations Practice at Archstone Consulting.

Procurement groups are generally measured by the value contribution they generate for their organizations, most often based on realized savings. As a result, most procurement organizations devote a time and effort to various forms of strategic sourcing -- identifying savings opportunities in specific categories, developing plans and conducting "transactions" to try to get to those savings.

The sourcing process is now well understood and established. Most leading organization select vendors and negotiate good prices and terms for products and services. They sign contracts (often after a torturous contract negotiation) and then, really high performing organizations will develop a transition plan, especially if a new vendor has been selected. Then they move on to the next category and the sourcing event, feeling good about what they just accomplished.

But let's dial back for a second. The sourcing landscape is, in reality, much more complex. Procurement has been driving their organizations' compliance efforts for some time -- ensuring preferred/targeted suppliers are being used, that contract prices are actually being charged, any rebates or discounts are getting credited and that the sourcing processes are being followed. So clearly, contract compliance is more than just pricing, supplier and process compliance. Contract terms are becoming more complex; specific terms can place requirements on service levels, T&C's, financial terms, upgrades, services rate cards and intellectual property ownership. Statutory reporting requirements are becoming increasingly stringent and often require contract compliance assurance and ongoing validation. Finance organizations are asking for more tangible proof that promised savings and other benefits are actually being realized, while simultaneously facing increasing legal and regulatory compliance issues and reporting requirements themselves. And now, more than ever, key strategic suppliers are playing a critical role in a company's ability to execute on its business model as suppliers are being asked to do more and to work in a more partner-like environment. With all of this complexity, a few questions should be asked:

  • What happens after the contract that was so painfully and carefully negotiated is signed and the supplier transitioned into an active role?
  • How is ongoing progress measured in achieving the goals of the particular sourcing activity?
  • How can organizations leverage all that hard work, and actually manage and track the outcomes to achieve strategic advantage beyond simple initial savings?
  • Where is the real, long-term competitive advantage to be found from working with the supplier?

To account for all these variables and achieve visibility, compliance and accountability, the supplier contract should not be seen as the end of the sourcing process, but more strategically, the beginning of the broader relationship or the Supplier Relationship Management (SRM) process. Contracts can serve to drive SRM efforts more explicitly and formally, as they can provide KPIs and a relationship governance structure for ongoing relationship management, performance measurement and be the bridge for long-term relationships and renewals.

SRM can deliver strong value in several ways, including providing capabilities to address challenges with increasingly complex supply chains, growing exposure to risk, poor or non-existent processes and unclear accountability. SRM also provides an answer to the limitations of a sourcing-focused strategy, which all companies that carry out sourcing programs will eventually face: diminishing sourcing returns. Once a company has thoroughly executed on the low-hanging fruit of each category of spend via classic sourcing initiatives, finding the next frontier of efficiency requires real and close collaboration with strategic supplier-partners. SRM processes become vital to defining and managing that next frontier.

The Hackett Group uses a model (illustrated in Figure 3, below) that defines how relationships with key suppliers are established, managed and measured over time. Our model describes the key components of an SRM program as well as the linkages between overall SRM strategy and the supporting business processes, organizational governance and systems to make it work.

Figure 3: The Hackett Group -- SRM Model

Key elements of a successful SRM program include:

  • SRM effectiveness comes mostly from going deep, in the right way, with strategic suppliers. Ensure success by starting with a small number of suppliers before extending enterprise-wide
  • Obtaining stakeholder alignment, proper resources, and top management commitment, along with establishing clear operating models in processes, roles, metrics, etc. is key (and also one of the biggest challenges)
  • Gaining agreement between both internal stakeholders AND suppliers around the metrics, measures, and goals is vital
  • Measuring value beyond cost reductions -- i.e., value of innovation, risk reduction, quality improvement -- is key to real performance improvement, and can be challenging
  • SRM efficiency challenges are compounded by the lack of strong technology tools and adopting proper tools is a requirement

Finally, what is the ROI, both hard and soft, of really paying attention to SRM and contract compliance? Although Hackett reveals that even top performers have more work to do, the potential rewards are highly compelling.

In summary, sourcing is only the beginning part of the value capture process. The leaders, those that actually realize the full benefits (and more) of their hard fought sourcing gains, focus on the rest of the steps -- contract management and supplier relationship management. Effectively managing supplier relationships, and the contracts put into place with them, is the key to seeing real returns and a true competitive advantage.

-- Michael Eckstut, Principal, Strategy and Operations Practice at Archstone Consulting

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