A contract is not a point in time event. It has a lifecycle --- it must govern a relationship over a period of time despite the fact that it is by definition a static document. Over time, a lot of things can change. This change, or variation from an expected outcome, is risk, and is why effective contract risk management becomes so important to corporate counsel, e-procurement and contract management project teams in organizations.
The usual tendency is to see risk negatively, or as the likelihood that returns will be less than expected. This in turn leads to an almost automatic desire to minimize or suppress risk rather than manage it. Exacerbating this is the fact that time does actually increase risk (because the longer your time frame, the more stuff that can happen.)
Avoiding Risk is a Good Thing Right?
What’s wrong with minimizing risk? Sounds like a good thing, right? Not necessarily. Suppressing risk can be very expensive to organizations and produces lower returns. A simple example would be a biotech procurement manager ensuring supply of a key input by contracting for twice the required quantity. In this instance, the risk of production line being shut down for supply shortage is minimized, but cost is doubled, and margins are reduced.
Effective contract management embeds risk assessment so that corporate counsel, procurement and contract administrators can move from just monitoring compliance to protecting the organization from substandard returns.
We Recognize the Usual Suspects but Miss the Real Culprits
Each function in an organization can lay out a litany of risks based on their frame of reference. Identifying and then assessing the risks outside of one’s department, however, is much more difficult. In addition, we tend to see the demons we know best more clearly and more frequently. So while the finance team can provide a complete analysis of the effect of interest rate changes corporate investments during the life of the contract, they might not catch the impact a strike at supplier’s plant might have on production, costs and margins.
Managing Risk Cannot be Done in a Vacuum
Dynamic contract management constantly pushes the firm to recognize a wider range of external factors with blindsiding potential. This cannot be done effectively in a silo or a vacuum. In our procurement example, while the finance group might be pleased with volume discounts gained from buying larger quantities, the production team might reveal storage and spoilage risks associated with the key input, making the “buy double” risk minimization strategy an even poorer business decision.
Good business process underlies dynamic contract management by:
-Bridging functional walls within organizations
-Enabling informed collaboration by tearing down information siloes
-Removing blinders to full scope risk analysis
BPM and Supply Chain Risk
The most effective contract management systems ensure that risks are accurately and systematically identified and assessed. They do this by pulling business intelligence real-time from different systems within the organization for cross-functional, collaborative analysis. If your contract management system doesn’t do this, the default is probably risk minimization, with all the inherent costs, duplications and inefficiencies that come along with it. And right around the corner is the event you never saw coming…