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Analyzing the Cost of Poor Contracting

    

Poor contracting can take many forms. It may relate to imbalanced negotiating power, hasty and careless drafting, or inadequate oversight during performance. Regardless of when or why a contracting relationship deteriorates, there are going to be negative consequences for both parties, and this impact is always detrimental to the companies' bottom line. According to the International Association for Contract and Commercial Management (IACCM) “the average cost of poor contracting is 9.2% of an organisation's annual income - and even higher for large capital projects, up to 15% of the contract value.” Here are some of the costs associated with poor contracting and ways to avoid them:

Supply Overruns

If a company does not pay close attention to its supply contracts, there is a good chance that it will end up over ordering and/or overpaying for the goods and services that it needs. Supply overruns are rather common in the manufacturing industry, and especially for those engaged in high volume contracting or those utilizing a lot of parts to create a product. These redundancies tend to occur during the performance phase, particularly if the contract management team loses track of renewal and cancellation provisions and does not routinely analyze its supply line contracts. Of course, by utilizing dynamic contract management software that notifies users of important dates, these costly mistakes are easily avoided.

Withheld Payments

For companies trying to keep a handle on hundreds or thousands of contracts, it is not terribly surprising when contractually required actions are delayed or altogether forgotten. Unfortunately, many contracts correlate payments with performance, and thus failing to perform any step, irrespective of how trivial it may seem, will likely result in withheld payments. For smaller operations, this may be extremely problematic if it disrupts their cash flow and can cause a ripple effect across the entire business process. But, this is another example of an avoidable issue, simply requiring an investment in a solution that facilitates contractual oversight. There are plenty of affordable services available, and it is worth it to make the monthly payments to avoid a much larger loss associated with failing to perform.

Personnel Increases and Additional Professional Services

In the unfortunate event that a contract goes sour, the parties to the agreement will likely have to pay existing personnel overtime or hire additional personnel in order to get things sorted in a timely fashion. And, there may be other human capital expenses, such as legal services, financial and tax planning, or auditing. However, rather than react to this sort of occurrence, it is always better to do whatever it takes to avoid it, which clearly means being extremely proactive throughout the contract life cycle. This requires diligence and a keen attention to detail during every phase of the contracting process. 

 

For example, during contract negotiations, a company can evaluate the business mindset and approach of its counterpart, and perhaps pull the plug if it is evident that the other side’s approach is adversarial and combative. And, during contract drafting, it may become apparent that there is not a true meeting of the minds, an essential element in a contractual agreement, and thus this may indicate that services should be sought elsewhere. Ultimately, every member of the contracting team must be vigilant, proactive, and communicative to decrease the likelihood of entering into weak contracts and mitigate the potential effects of any contracts that do have deficiencies.

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