The term contract management is typically used in procurement or purchasing departments. As part of the procurement department’s responsibilities, the manager negotiates, accepts, and signs contracts with suppliers of goods and services to the organization. Contract management is the process of ensuring that the supplier honors their negotiated contract terms. Although the role of procurement in the negotiation process is an essential part of a cost management process, contract management is where the actual savings are either achieved or missed.
Effective contract management practices result in lower operating costs, efficient services, and a stronger bargaining position during the next round of negotiations. Contract management includes ensuring contract compliance, acting as the primary contact for issues related to service and dispute resolution, as well as managing any payments or clauses negotiated into the contract. In general, contract management can be broken down into three main areas: thresholds, rebates, and performance clauses.
Threshold is a term used to define specific targets of dollar spending, transactions, or units purchased. These thresholds are usually tied to dollar discounts on the purchase price and are often based on number of orders received within a specific time period. As part of the negotiation process, thresholds are often used to demand even deeper discounts than the supplier would normally provide. As the volume increases, the supplier has the motivation and the capacity to reduce the price, as its costs decrease.
Rebates are used as a reward or incentive to the supplier to meet specific targets. For example, a bakery may negotiate to purchase a specific quantity of flour over a set time period. Any additional, non-scheduled requests that are completed within a specific time period are eligible for a rebate to the supplier. The invoice is for the standard amount, but the rebate is calculated and paid back to the supplier as a reward for meeting an immediate need. This flexibility is often found in time-sensitive environments, where the contract is for a standard delivery schedule, but additional flexibility is needed to meet the business requirements.
Performance clauses are based on measurable items that are critical to the operation of the business. Common clauses are based on delivery within a specific time frame, invoicing within a set date range, meeting benchmark delivery dates, and percentage of completion for construction projects. The purpose of a performance clause is to set up an accepted measurement method between the supplier and the customer. These clauses are often tied to penalties or rewards, depending on the industry.
Effective contract management involves daily activity tracking, performance management, and follow-up with the supplier. Only through an active contract management process can the company claim any benefits included in the contract. These benefits may include early release clauses, additional payment reductions, and other penalties.