Updated: Aug 8
The difference between the potential value of an agreement and the value that is captured is commonly defined as ‘Contract value leakage’.
Over a contract’s entire lifecycle, the negotiation of sub-optimal contracts and the lack of contract management are two of the largest factors that can heavily influence the value of the contract and in extreme cases - will generate a loss.
The IACCM estimates that companies on average lose 9% bottom line due to contract value leakage.
We gathered 7 challenges leading to value leakages that sales departments commonly face. Understanding these is a good start to ensure you are not one of the companies loosing 9% or more at the bottom line.
It is clear that challenges causing value leakage do not only appear in the negotiation phase, but over the whole contract period and often thereafter as well.
Successful companies understand and manage these challenges by ensuring a clear contract management process. Using a tool like Legly is the first step ensuring that your organisation get onboard and consistently get the support needed to avoid risk of contract value leakage - the whole contract value life-cycle.
7 challenges leading to contract value leakage
Over a contract’s entire lifecycle… "Companies lose on average 6.2% – 12.4% of their annual revenue due to contract value.”
That is totally unnecessary.
Here are 7 challenges that sales departments commonly face when it comes to the quality of the contracts and the contract management.
1. Lack of clarity on scope and goals
A lack of clarity on the contractual scope and goals are generally one of the largest defining factors in whether or not a company can fully take advantage of the value of a contract.
A huge example of the lack of clarity and goals is the absence of contractual playbooks or contractual guidelines in place.
Fundamental questions when defining a contractual playbook are:
What can and cannot be accepted without management approval?
What should be excluded, and what are we missing?
What is the deal-breakers in any given contract?
A good contractual playbook will generally clearly state the responsibilities, obligations and remedies that each party has. Statements of time frames, alternative clauses and the limits of what can be accepted should all be included.
Without these defined boundaries in the form of a playbook, this can lead into more complicated questions of who has responsibility for late or delayed deliveries? What remedies are available?
2. Contract team not involved early enough
Within day-to-day business, there is a clear separation between sales and legal. This is shown through the function of lawyers and how they need to deal with complex and dense contracts while sales departments focus more on the outcome of finalizing the deal.
The biggest culprits when it comes to inefficiencies and low-quality contracts are when legal teams are not involved early enough and a lack of integration between legal and sales.
Overly complex legal terms can prove to be a barrier for sales departments, therefore it is important for the legal team to review the contracts as soon as possible and to get rid of deal breakers early.
Ideally this should be done before the negotiation process moves too far forward, and steps backwards need to be taken. In worst case scenarios, there are no legal teams to support and double-check these drawn-out contractual negotiations which more often than not become a problem later down the line.
As for any other team in a company, Legal teams are required to do more with less resources. They are taking on a more strategic role in, for example, market analyses or acquisitions.
Simultaneously, the rest of the organisation demands more support with, among others, reviewing customer contracts, NDA and Data processing agreements. All of which are central to keeping the organisation afloat. Many Legal teams are thus discovering they can barely keep up with their growing and escalating list of day-to-day tasks. Somehow a balance needs to be struck, where enough time is allocated to both the tasks that need to be done to stay afloat and those that concern long-term strategic interests.
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3. Protracted negotiations
Protracted Negotiations may arise out of the difficult legal language used in contracts and the complexity of contract terms, which isolates the lawyers from the business negotiators.
This isolation happens when business negotiators have higher barriers to fully participate in creating the legal agreements that should reflect the negotiations that occurred between the parties.
Such disconnects can often lead to contracts that are either overwritten, with too many self-protective clauses, or underwritten, resulting in a lack of sufficient attention to the core terms of the negotiation.
Sales and legal teams also face challenges regarding protracted negotiations as contract review is not always immediate priority of the legal teams. It is often overlooked in favor of other high value tasks, which poses a problem for sales teams that want to quickly finalize deals.
Similarly, Sales departments without any legal guidance can find themselves in a difficult position translating legal terms into practical commercial terms.
4. Negotiation focus on the wrong terms and risks
A common pitfall when it comes to negotiations is when focus is placed on utilizing a combative contractual framework instead of trying to avoid clauses that will make a large difference on the bottom line.
For example, an excessive focus on terms such as 'who has liability for what' or 'remedies for defects' can take attention away from smaller aspects that affect the bottom line more, such as price adjustments.
These less obvious, but equally important, aspects of the contract are more focused on preventing loss of economic benefits and on ensuring the full value you negotiated for is actually accounted for in your contract. Negotiations therefore need to shift their focus away from failure, disputes and remedies to self-protective clauses that are aiming to lock down the value negotiated for in the first place.
Another pitfall that occurs is when sales departments only focus on what they understand, largely concerning volume and price. In these instances, the front page of the contract receives the most attention and the more complex clauses relating to damages and liabilities get largely neglected.
5. Contracts lack flexibility
The typical things that come to mind when you hear the word ‘contract’ are usually long and rigid, as contracts are known to be extremely long and dense descriptions of legal agreements and boundaries.
As a result, contracts lack flexibility and cannot be changed easily to the detriment of all parties. Clauses such as fluctuating prices of raw materials, inflation, currency fluctuations and interest rates are all external factors that can heavily weigh down the bottom line and in extreme cases, result in a loss.
To account for the unexpected, flexibility needs to be accounted for while the contract is being written and negotiated. Both parties can agree on benchmarks and prices but allowing for this flexibility is extremely relevant to both suppliers and customers. Whether the price of raw materials increase or decrease effecting the profitability of either side, both parties should implement this flexible approach in contractual clauses in order to hedge bets and protect themselves from the downside of fluctuating prices.
6. Contracts are difficult to use or understand
Contracts that have difficult and complex legal jargon can also be a huge problem to those who work with them, especially sales departments that do not specialize in dealing with legal language.
This problem is normally perpetrated by legal and contract teams that have yet to fully adapt to a shifting legal landscape and still struggle to find that middle ground between legal robustness and readability.
A large emphasis needs to be placed on using language in the contract that can be easily understood, while still being relevant, since this will have a large impact on the value in the contractual lifecycle.
It is important that sales departments are empowered with contractual knowledge and knowhow, since a more empowered sales department that knows the contractual risks in front of them is also better prepared to take advantage of what can be gained.
7. Limited use of contract technology
Nowadays there are DIY tools that assist and streamline the process of reviewing contracts. These tools are more relevant today than ever, as legal teams also have more tasks to deal with than reviewing contracts.
Considerations such as Mergers and Acquisitions and other more strategic tasks can dominate the already busy schedule of internal legal teams. This poses a large problem for both sales and legal departments, as a large aspect of the revenue of a company is determined by this legal agreement and how value is captured in the clauses.
A solution to alleviate the increasing demands that legal teams face is to integrate Legal technology into the contract review process. Tools that directly assist the process of managing large volumes of contracts or the actual process of reviewing the contract can greatly benefit both sales and legal.
Please note that this document is not legal advice. Legly, and its representatives, are not responsible for the content herein or the suitability for your company’s business. We recommend you use this in conjunction with legal advice and not as a substitute.