Raising prices isn’t always the answer
Given this uncertain macro environment, using direct price increases to maintain or increase margins is losing effectiveness and businesses need to rely on alternative avenues for increasing their margins. This is where customer contract optimization can play a significant role as a source of margin upside that many businesses don’t even realize they have.
Customer contracts are a significant part of the business for most companies, and managing them profitably and efficiently can be very challenging. Contracting cycles are often long, arduous, and draining of organizational resources. Sales and contracting teams often do not spend enough time preparing for these contract negotiations and renewals.
Meanwhile, in the customer’s Procurement department, experienced teams know the value of negotiating every contract detail to achieve a lower acquisition cost over the contract’s term. These types of negotiations also wear out a supplier’s commercial team to the point that the customer gets more favorable contract terms.
The result? Businesses are leaving money that’s rightfully theirs on the negotiating table. Even if the amount is small on any given contract, they add up to significant revenues over time and across customers.
The causes of contract-based missed revenue opportunities
There are multiple root causes of sub-optimal contract management :
- Disjointed and disorganized contract storage that makes it nearly impossible for anyone to understand what’s in a single contract, much less get a big-picture view of what’s in all contracts.
- Limited (or no) visibility into what each contract, past, present, or future contains.
- No overarching strategy for keeping an optimal contract portfolio mix and contract performance targets.
- Inconsistent pricing across contracts due to one-off deals and case-by-case exceptions.
- No ability to see a baseline of contract terms and historical performance across a company’s entire contract portfolio leads to less negotiating power.
- Lack of best practice contract clauses and playbook for sales team to start from
- Sales teams aren’t armed with the knowledge to enforce compliance with company standards or push back against unreasonable requests from customers.
- Little or no investment in digital solutions, contract excellence processes, and operating models that would help companies achieve higher margins through contract optimization.
Each of these reasons contributes to the bigger picture of companies simply not getting paid the revenue they should be, because their contracts aren’t favorable, and they don’t have the visibility to recognize how they can make them better.
The entire idea behind contract optimization is to solve each of these root causes, equipping sales teams to negotiate contracts that bring in the revenue they should.
Filling the contract revenue gaps
In our experience, companies can achieve margin uplifts spanning from 400 to 1200 basis points by addressing the root causes of their contract optimization gaps. Realizing these gains requires two key elements. The first is a shift away from an administrative “contract management” mindset where the primary owners are typically legal teams to a “contracting excellence” approach driven by the commercial organization. The second is the implementation of systematic techniques, tools, and processes to extract more commercial value from contracting.
Our experience with clients across several industry sectors has allowed us to develop a significant perspective on designing, negotiating, and managing margin-healthy contracts. Leading firms deploy a consistent 4-step solution to improving contract effectiveness and profitability.
Step 1: Digitize contracts and extract terms
Today’s technology provides ample opportunities to take contracts from documents that live in filing cabinets, email inboxes, computer desktops, and shared drives to fully digitized repositories. Unlike simply scanning a paper contract, best-in-class technology uses advanced optical character recognition (OCR), machine learning, and generative AI to accurately extract contract terms, assign metadata, and organize contracts into document hierarchies, all to provide users the ability to search, analyze, and report on the contents of every contract.
One major difference in today’s leading contract lifecycle management software is their ability to use generative AI to do all of this in an intelligent way, based on context rather than searching for exact wording. Solutions such as Pramata have been trained for decades on millions of contracts to do everything from identify non-contract files, deduplicate vast numbers of contracts, prioritize contract versions and amendments, and identify variations in wording across clauses that mean the same thing.
Case study: MedTech Co: a provider of surgical products in the cardiovascular space, sought to improve financial performance. Contracts were stored in a shared drive without systematic organization and the ability to report or analyze these contracts effectively. The contract management team was doing its best to keep up with the volume and pace of new contracts, renewals, and quarterly business reviews. But without AI/Generative AI-driven efficiency, they were constantly behind. Historically, it took them over a month to generate compliance reports for a large group of customers. With a Contract Optimization system powered by AI and Generative AI capabilities, MedTech Co digitized its contract base and got unprecedented visibility into its renewal calendar, critical terms and conditions, and prices and rebates by commitment tiers. Their ability to produce complex compliance reports went down from more than a month to less than few hours, enabling them to prepare the commercial team for contract negotiations and freeing up time for the contracting team to focus on more strategic tasks.
Source: Bain & Co case study
Step 2: Analyze performance and margin opportunities
With its contracts digitized and organized, a company can now assess how well the contracts are serving its broader strategy goals.
There are three key areas we can use to gauge a contract’s health:
- Contract Economics: Compare how the contract has performed against similar ones and initial expectations by looking at metrics like average price, sales volume, profit margins, and product mix.
- Contract Compliance: Compare contracts to actual sales data to see if customers are meeting their contractual commitments like purchase volumes, minimum share of purchase, invoicing & delivery terms or order frequency.
- Contract Design: Evaluate how contract terms affect profitability, focusing on pricing, financial terms, service levels, and risk management. Creating a standard contract playbook and monitoring how each contract compares to your playbook standards is also part of contract design and re-design.
Step 3: Optimize contract strategy
Contract strategy starts with defining the optimal contract mix to drive performance improvements. Firms with both a solidly defined contract strategy and sophisticated contract management technology can ensure their contract strategy is aligned with their pricing and go-to-market strategy.
While the specifics of a company’s contract strategy will vary based on a variety of factors, including industry, we recommend segmenting contracts based on variables such as: how strategically significant a customer is; the customer’s risk profile, the cost to serve the customer; expected value delivery, length of contract; etc. Once segmented, a company can predict the total lifetime value of the contract using different variables and simulate different levels of performance, which they can use to further inform and refine their strategy.
Step 4: (Re)Design and (re)negotiate contracts to adhere to the new strategy
Having a strategy in place is great, but you won’t see results unless you adjust the realities of your contracts to align with it. That’s where this final, and critical, step comes in.
To do this, you must define essential terms, clauses, and commitment structures, and then arm the commercial team with the knowledge and skills needed to negotiate new contracts that reflect these essential terms. At this point it’s extremely useful to have a contract playbook and/or contract templates that allow the team to consistently implement your contract strategy.
If creating a contract playbook sounds daunting, Generative AI can help here as well. With Pramata, for example, a GenAI powered Contract Playbook Creator uses your ideal contract as a starting point to draw best practices from. It then asks the user questions about each term, clause, and provision so that it can later compare every contract in the company’s portfolio to the playbook, not just using exact wording but by understanding the meaning and context behind the words.
Don’t forget, with a strategy in place and a contract playbook in hand, the most important step is to enable your sales team so they can implement contract strategy as they close every deal.
Contracts optimization is a paradigm shift for revenue
Overall, contract price management and contract lifetime value optimization are often underdeveloped capabilities. However, companies can manage customer contracts profitably and efficiently with the proposed 4-step solution. Recent advancements with Generative-AI guided digital solutions like Pramata help expedite the maturity journey.
With solutions like Pramata, a small investment can produce significant returns by uncovering and plugging revenue leakage and capturing previously uncaptured revenue opportunities.
