If organisations can’t keep on top of the volume and diverse terms in their supplier contracts, they are making themselves vulnerable to risk and value leakage that could impact their success.
In today’s global marketplace, organisations are juggling countless local and international supplier contracts, with the number, diversity and complexity of terms often proving difficult to manage.
“Organisations are engaging a lot more external partners to deliver services,” says Michael Smart, Partner, Shared Services & Outsourcing Advisory, KPMG. “Part of the problem is the sheer volume of relationships, the types of services now available including managed services, along with services being delivered from multiple geographies.”
Add to this that many organisations are becoming complacent with their supplier management frameworks, often passing on risk and accountability to the supplier. Adrian Gibby, Partner, Contract & Compliance Advisory, KPMG, says a failure to manage supply contracts well can present serious issues, such as a drop in service standards, ‘value leakage’, duplicated effort, increased risk, lapsed agreements and non-compliance. He says to solve this, companies need to look at their supply chain from a “broader governance perspective”.
“It is looking at how to manage supply chains more effectively across both performance and risk management,” Gibby says.
Many organisations could have hundreds, or in the case of large organisations, thousands of active supplier contracts in operation. Smart says they are overwhelmed with managing contracts and relationships, and have no time for personal contact with the suppliers.
“You can’t continue to view supplier management as a secondary function after the outsourcing deals are done,” he says.
Carly Richards, Director, Contract & Compliance, KPMG, says that when the challenge of managing a supply chain exceeds capacity, companies can lose track of key terms within supplier agreements.
“The focus tends to be on those suppliers who they spend the most with, or who are delivering high priority products,” she says.
If contracts are not managed closely, relationships with suppliers can deteriorate.
“A combination of out of date and rolling contracts can weaken control over your supplier base,” Richards says.
Peter Liddell, Partner, ASPAC Head of Supply Chain & Operations, KPMG, adds that suppliers could “up their fees or even change their terms because they’re still supplying, but out of the contract terms”.
This leads to the common issue of ‘value leakage’, which KPMG estimates can typically be 17 to 40 percent of a contract’s value.
“Even though they have contracts, purchase orders and delivery dates, they miss them and that has huge implications for certain industries such as automotive and other ‘just in time’ manufacturing industries. They have production lines running based upon the fact that raw materials and goods will arrive at certain times,” Liddell says.
Gibby adds that within each supplier, ‘verbal agreements’ or ‘side order agreements’ can blur the lines of what is acceptable service and what isn’t.
“The safeguards that ensure you’re getting what you paid for fall away. There are interpretations from the supplier that may not be in line with the original contract and result in loss of significant value,” he says.
With the threats of risk and loss of contract value, it is clear that organisations need a disciplined approach to managing contractual exposure. To begin, Richards advocates establishing a “supplier contract database”.
“Setting up an accurate contract database is an extremely valuable exercise. It enables an organisation to review agreements, establish supplier scorecards to maximise value, and consider what steps need to be taken to rationalise,” she says.
Once databases are refined, establishing an ongoing contract management framework is vital. Continual financial and operational auditing, along with stringent risk identification processes are key. Liddell says cloud-based technology tools can help this process.
“A simple example would be if I need a new laptop, and procurement has contracts with preferred suppliers that it has built into a system. The system becomes like a ‘menu’ where I log in, it recognises me, gives me the options through the preferred suppliers, and I place my order. The system then manages the entire source-to-pay tasks,” he says.
This approach helps to centralise supplier governance and spend control, minimises the freedom for teams to source goods and services outside of supplier contracts, and enhances the traceability of business spend and delivery.
Smart offers other tips, such as setting automated reminders for key dates in contract deliverables, tracking of key performance indicators, and contract renewal dates.
Richards says focusing effort and resources on managing supply chain contracts all comes back to mitigating risk and gaining full value of out of agreements.
“Being prepared will allow you to make better use of your working capital, but also make sure you’re spending your money with the right suppliers and getting better value from those contracts,” she says.
Once supplier management is running smoothly, time can be spent fostering relationships with suppliers that lead to better working scenarios, shared knowledge and even innovation, Liddell suggests.
“Working closer with suppliers allows you to leverage the innovation that they’re building into their products. It could help reduce your research and development spend or give you a much better product.”
The further companies reach around the world with their supply chains, the greater the risk that they could be exposed to poor ethical practices. Find our more in Ethical supply chains – investigation and risk prevention.