Insights -- June 2004
Companies accept contract compliance breakdowns as a fact of life and have done so for years. However, the Sarbanes-Oxley Act of 2002 (SOA) and other regulatory risks create mounting pressure to get this process under control. Across all industries, recent additions to 8-K requirements under the Sarbanes-Oxley Act indicate that contract compliance is affected by two of the eight material events that must be reported (termination of agreement and termination/reduction in business relationship with customer that constitutes specific amount of revenue). While definitions are still evolving, companies must have processes and tools that allow them to measure the impact of being out of compliance, losing a contract, or both.
Food and Drug Administration (FDA) audits are a reality in the Pharmaceutical, Biomedical Device, and Consumer Products (CP) industries. A fear of warning letters and/or fines is increasing the heat in contract compliance for these industries.
Defining the problem
Two problems make contract management difficult to control:
> Companies set up unprofitable contracts because of a lack of visibility into actual costs. Cost of service is a poorly understood metric at most companies today. Activity-based costing projects do not typically take costs down to the specific customer level. Even at the macro level, determining how much it costs to process an order is beyond the grasp of many accounting departments today. Without this visibility, salespeople typically base new contracts on last year's deal plus a small percentage increase rather than looking at actual profitability.
Track record
> Compliance with contract terms is not tracked. Volume discount pricing is awarded to customers in the hope that they will live up to volume commitments. Today, compliance is often tracked manually, or even worse, companies rely on customers to police contracts, assuming that customers will let them know when they are out of compliance. However, most customers do not wave the red flag when they are being undercharged for products and services or overpaid on incentives. Further, customers often have multiple contracts in force at the same time. When an order comes in, salespeople have to decide what contract to use. This typically involves pulling out a thick binder of various hard copy contract terms while salespeople make their best guess.
What Can Help?
Enterprise Resource Planning (ERP) and Customer Relationship Management (CRM) applications cannot help with contract compliance. While most ERP and CRM suites have contract management modules, they only track the contract start and end date, key prices, volume, and attachments. They lack the functionality required to perform analytics on the right contract prices and terms, manage conflicts, assess compliance, or all of the above. To address this problem, companies have looked to best-of-breed vendors. Many tools perform this capability for buy-side/procurement contracts, but only a handful of best-of-breed tools support the needs of sell-side/sales contracts. Model N (Life Sciences only) and I-many (mostly Life Sciences, but includes other industries) specialize in contract and revenue management. Other vendors57; tools deal with price management with contract compliance as an offshoot. These include Revenue Technologies, Zilliant, and PROS Revenue Management.
Recommendations
Take control of contract compliance; do not rely on customers for enforcement.
Assess current contract compliance processes to uncover areas of improvement to build the business case, including: percentage of contracts out of compliance (such as did not live up to volume commitment); services delivered that are not included in the contract; overpayment of incentives; customers with multiple, conflicting contracts in place; and inability for salespeople to find the right contract against which to price orders.
Look at tools to help with the contract compliance process. This is an emerging space that requires a best-of-breed product today. ERP and CRM vendors will catch up in the next three to five years, but many companies cannot wait that long.
If more than 50 percent of corporate revenue is contract-based, invest in contract compliance technology today. If more than 25 percent of revenue is through government deals, contract compliance must be a high priority.