To effectively determine what risk is associated with your contracts, you don’t just need a contract scoring plan. You need to automate it! Your contract scoring plan helps standardize your contracts and ensure that your business isn’t taking on more risk than anticipated. This step will also give your negotiators more effective guidelines that can help them set terms in each contract that benefit your business. Once you know what KPIs matter most to your business — our comprehensive guide to contract management KPIs can help — and what metrics you’re aiming for, it’s time to develop a contract scoring plan.
Step One: Set Your Risks
Each contract has some potential for risk for your business. If a customer doesn’t pay or if you fail to deliver on your customer’s expectations within the stated time frame, you may face significant consequences. The goal of your contract scoring plan, however, is to minimize those risks as much as possible. As you create your contract scoring plan, start by establishing what risks your company wants to evaluate. These may include:
- Cash flow
- Business liability
- Legal accountability, including breach of contract
- Potential warranty problems
- Termination concerns
- Loss of business integrity
- Failure to maintain goodwill
- Automatic rollover clauses (which can be both risky and beneficial)
- Intellectual property concerns
- Alleged confidentiality disclosures
Some risks cause more serious concern for your business than others. In some cases, risks that appear in a contract, especially clauses demanded by a customer, may not be worth taking. In other cases, you may be able to alleviate the risk in another way. Carefully define the risks that you want to score in your contracts before beginning your contract scoring system. Depending on your industry, your risks may look different — or you might not be worried about certain risks that another business might need to consider.
Step Two: Assign a Number to Those Risks
Each risk should be assigned a “point value.” Using analytics and hard numbers sets the stage for good decision-making. It makes it easier to compare contracts and describe risk in an easy-to-understand format so everyone’s on the same page. Generally, contract risks are scored on a 1-5 scale, with 1 being little to no risk and 5 being a substantial risk to the business. Once you add them up, you’ll get an average contract score. A high-risk contract needs to be revisited or avoided for your business altogether, while a low-risk contract could help point you toward success. For example, an SLA in which your company pays penalties for downtime might drop the whole contract score.
Once you’ve given a number to your risks, take the time to score some of your current contracts to get a better idea of what your average risk looks like. For example, if you have 20 data points, you should expect a risk score of 20 for a contract with no risk at all. However, the odds chances are that your business averages around 25-30 even if you take on little to no risk in your contracts. If your business is still in the startup stage, when you must build credibility, or you’re interested in pursuing innovation and opportunity, you might take on higher risks than an established business with a comfortable niche in your industry. Knowing the expected risks for your total business can also help inform your contract administration plan. In order for your contract scores to be effective, you need to know what your risk actually looks like and what risk the company is really willing to take.
High risk scores aren’t an automatic sign of failure; not knowing your risk score is the real danger.
Step Three: Use Your Contract Management Software Effectively
Your contract management software is your key to automating the contract scoring process. As soon as a contract enters your system, the contract management system has the potential to score it. Consider when you want your contract management system to create and highlight scores for your contracts.
You don’t just need a score when a contract is completed.
Ideally, you want your contract scored at several points throughout the negotiation process. This simple step can help identify potential risks and keep negotiations from getting bogged down, which could prevent your contract from being approved by the client.
Make sure your system flags the appropriate individuals at the right time.
A contract risk score does no good for your company if the right people don’t see it at the right time. Consider at what points the contract needs to be scored and when employees throughout the business need to be notified of that score.
For example, your negotiators might need to see contract risk scores at every stage of the negotiation process so that they can make needed changes before they present the next draft of the contract to the customers. Set the contract management software to automatically notify the team any time a contract risk rises over a certain score. The approval team may need to see the contract’s risk score before signing the final paperwork, especially if the contract has a high level of risk.
Take a look at your entire process and make sure that notifications are automatic. Your team shouldn’t have to go digging to find a contract risk assessment, especially once you make contract scoring an automated process. Automation frees your team up for negotiations and creative projects.
Contract risk management and assessment can change the shape of your business, allowing you to more effectively create contracts that minimize risk and maximize the benefit of each contract. By utilizing your contract management software effectively and prioritizing contract scoring through these methods, you can create a better system that will ultimately help your business better meet its goals.