Five Contract Risks and How to Reduce Them

Five Contract Risks and How to Reduce Them

by admin
November 4, 2019

Risks are rarely black and white. When you sign contracts that are rife with risks for your business, the chances are that they will come to bite you in the back. It is always wise to assess the risk landscape you will be introducing your business to before signing any contract.

Typically, contract risks will come in many forms, from security risks to operational risks. If left unattended to, they can:

  • Make doing business negotiations tough
  • Increase the cost of fulfilling your end of the bargain
  • Ruin the reputation of your business

The complicated thing is that contracts come with a variety of obligations and clauses that make it easy for some issues to slip right through your fingers. To automate your system and identify the KPIs that can stop — or at least reduce — the risks before you sign onto them.


How Do KPIs Help Reduce Risks?

In a vacuum, KPIs, or Key Performance Indicators, can’t help your business become stronger. Your business needs to tie every KPI to an incentive or an action. If a discount is too substantial and makes a deal too weak, your finance department needs to decline the request and the salesperson needs to negotiate a different deal. If a contract has a large amount of risk but it’s worth the risk, the low-scoring KPI needs to trigger an alert to push the contract onto someone’s weekly or monthly review list. Start identifying KPIs at the core of your business. Then you can identify what ‘good’ and ‘bad’ metrics look like and how to start incentivizing higher performance according to the KPIs.

 Here are some common contract risks and how to reduce their chances of occurring:

1. Data Security Risks

Digital data is simply a double-edged sword, and it’s uniquely dangerous for small- and medium-sized businesses. While it improves the efficiency of business operations, it increases the chances of sensitive data falling in the wrong hands. What’s even worse is that you might have to share sensitive data with the other parties, from sales information to customer data. If the other parties fail to take data security seriously, you risk facing a data breach as well as losing consumer trust.

Don’t forget to account for data security clauses — they can go beyond what regulations cover. They can cater to issues like where the data is stored, how it can be accessed, and the best methods for reporting data breaches. For instance, a clause can require a vendor or business partner to use secure access control software to limit data access to a need to know basis.

2. Regulatory Compliance Risks

Regulatory compliance refers to rules set by the government to oversee how businesses interact with each other, with consumers, and the entire society. Most regulations have strict guidelines that you have to follow, or else risk hefty fines or even closing shop. For some, you might have to work with compliant business partners, or partners might have to meet specific regulations for you to be considered as compliant. HIPAA is a great example of this.

Ideally, your contract should include clauses that dictate the nitty-gritty details of remaining compliant to the different regulations. Your contract management software should reflect both in-contract commitments and regulatory requirements. This can include how to fulfill both internal and external compliance. A smart contract management system can monitor your company’s contract compliance levels and send automatic alerts to assigned parties if there are any red flags. You can detail whether partners/vendors will need to use compliance software or not to achieve compliance, too.

3. Profitability Risks

Discounts are among the best ways to win customers over. The fact that they bought a specific volume of your product, or have promised to stick to a specific order quantity, earns them some discount. The question is, will your business be profitable enough after the discount?

In some cases, offering a discount can eat too much into the profitability of your business. But it all depends on the math behind it. Before offering any discounts, you ought to calculate the profitability posture it will leave you in. This includes factoring in both overhead and direct costs. 

Fortunately, modern-day contract management software offers enough insight into how profitable a discount can be. It can allow setting the right discount terms on your contract while hanging on to your anticipated profit margin. Your company can have dynamic discount thresholds or hard percentages, and the KPIs should reflect adherence to ideal prices. Make sure you’re having these conversations with your company’s executives so your KPIs and contract scores have a consistent focus.

4. Scalability Risks of Vendor Contracts

A lot can happen between the onset of a contract and a year into it. Your business can grow exponentially, requiring even more resources. On the flip side, you might also require fewer resources due to dwindling business, meaning that you might have to pay for resources you aren’t using. This is where the flexibility of the contract comes in.

It pays to work with partners or vendors that will offer you the support you need, regardless of the position your business will be in. For instance, if you are signing a contract with a software vendor, they should offer you enough support for the anticipated peaks in demand. Take some time to evaluate the trend of your business and ensure that the contract you are signing factors in all aspects of your growth. Good contract management systems account for customer contracts, vendor contracts, and everything in between.

5. Operational Inefficiencies

There needs to be an alignment throughout the various operational aspects of your business. If there are inconsistencies in how each department gets things done, chances are that customers might be displeased or unduly inconvenienced. Your company partners can easily be the reason behind the inconsistency in service delivery, especially if you use subcontractors or third parties.

The trick is to ensure that your contract details everything that the other parties need to do to ensure consistency. This can include detailing specific product features as well as their delivery times.Setting and measuring contract KPIs can be a great way to ensure that a contract holds up. It gives you some level of control over the different features of the contract. If something looks amiss, you will know the root cause and can work on a way to solve it. Try out our contract management software to set and measure KPIs, as well as improve the success rate of your contracts.

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