When was the last time you reviewed the profitability of a particular customer contract? When it’s time for renewal, have you reviewed individual line items and adjusted pricing beyond a rollover or flat percentage increase? Companies often have blind spots when it comes to contract management. It can be challenging to create a monitoring and review process, update products and adjust pricing. Sometimes, it can even be difficult to track the revenue a particular contract brings.
Out-of-control contract business can be a significant drain to profitability, with underperforming and low-margin price points getting rolled over year after year. Effective contract management requires a change in mindset, the right process, and the right tools. The key is to continuously monitor and keep focus on lowering the percentage of un-managed contract pricing every month. Give your company a monthly, quarterly, or annual contract improvement margin goal.
Monitor the Performance of Contracts
Most enterprise software systems have visibility into contract business through built-in reports, sometimes referred to as exception reports. The first critical step to taking control of your contract business is to have clear reporting on the volume of sales on contract, customers using contracts, and the specific line items that are included on contract. Once you have clean visibility, look for patterns involving individual sales representatives, customer types, and product families.
Address three critical questions as you work to monitor contracts more closely.
Do Your Contracts Account for Individual Product Price Sensitivity?
Companies often apply wide-ranging discounts to entire catalogs of products. Too often, the chosen discount rate that is applied across the board is based on how competitive the most visible and competitive items need to be in order to win the business. It’s rarely necessary to discount low-sensitivity products much, if at all, but many contracts don’t capitalize on margin opportunities on these long-tail items.
Have You Adjusted Your Contract Pricing to Keep Up with Cost Increases?
Costs go up over time, but the prices on a given contract are often static. As a result, profitability erodes for your company overtime as contracts mature.
Are You Reviewing Contracts When They Renew?
The administrative burden of managing countless line items causes companies to renew and roll over underpriced contracts with minimal increases (or none at all).
Taking control of your contracts can seem like a daunting task. Fortunately, with the right process and tools, your company can recover profitability on existing contracts and break the cycle of unprofitable contract extensions.
Create a Contract Review System
The key to managing contracts is to create a regular review process. Drive the review process by expiration dates of the contracts or SPAs, which are your opportunity to review the performance of the contract and proactively chart the course for improving your margins. During the review process, determine if it makes sense to continue the contract with existing pricing, terminate the contract, or to adjust the pricing and extend it. Create a team or committee of individuals that will review the contracts and SPAs on a regular basis. Ensure that your contracts strike a balance by delivering profit to your business and meeting your customer needs.
Does the Contract Generate Expected Sales?
The key measure of a contract’s performance is whether it generated the amount of sales as intended. When the sales volume is less than expected, determine whether the contract deserves a renewal or expiration. If sales volume is as expected or greater, continue the contract.
Recommend Adjusted Pricing to Your Sales Team
For contract business you decide to renew, evaluate the profitability of the contract as well as any cost increases to consider. Take this opportunity to also apply appropriate margin premiums to low-sensitivity, low-volume products that are on the contract. Once you create the new, adjusted price schedule for the contract, communicate it to the sales team with ample time for them to review it with the customer, 60 days prior to the renewal date. This provides the necessary time for the customer to adjust pricing in their ERP and be ready for the contract renewal date. Pre-notification reduces the probability of your customer continuing to pay outdated pricing and create debit memos.
Work to Reduce Costs of Contract Items
Improving contract profitability involves more than just strategic pricing. For contracts you decide to renew, work with your procurement team to receive the same or lower cost from your vendor where possible. Additionally, push for a time approval longer than 12 months at fixed costs. This will assist your business in increasing the profitability of the contract. In the event you receive a price increase from a vendor after the contract has been renewed, you’re able to fend off the negative impact on margins.
The Contract Management Playbook
Put the effort and structure in place to slice through the complexity in your contract business. Instead of simply rolling over contracts from one year to the next, it’s possible to take control of this critical part of your business and uncover profit improvement opportunities.
We use a proven playbook with clients to put a better contract process in place and guide them to better decisions that correct costly mistakes. The goal is to build a disciplined process to manage contract and special price agreements to drive margin improvement.
Often, a critical piece of the puzzle is having the right tool. ContractGPS™ is a comprehensive solution that combines intelligent pricing recommendations with a cloud-based, ERP-agnostic workflow tool that allows you to effectively manage and optimize existing contracts.
Do you need some help improving the profitability of your contracts and SPAs? Reach out. We’d be happy to chat.
Take control of your customer-specific pricing.
ContractGPS™ gives manufacturers and distributors the visibility and control required to maintain and optimize contract pricing. Capture margin opportunities within your contracts.