Last updated on November 19th, 2019 at 01:31 pm
Early in your business’s lifespan, you likely began a contract management system, whether electronically (for new, modern tech companies) or using an old-fashioned filing system. Thanks to modern technology, however, you have more opportunities than ever to make the most of your contract management efforts. That includes scoring your commercial contracts to better understand their risks and help prevent risks in the future.
Everyone has heard horror stories of companies that went under — or came close to it — due to a bad contract. Are you using the right KPIs to score your commercial contracts and reduce your risk?
What are KPIs for Commercial Contracts?
KPIs, or key performance indicators, are measurable values — either qualitative or quantitative — that define how effectively your contracts are meeting your business’s goals. Without the right KPIs, you leave many aspects of your contracts, and therefore your business’s performance, up to chance. Not only that, an inefficient contract management process can leave you missing out on many of the opportunities your business might experience.
By measuring the right KPIs and using them effectively, you can improve your contracts and better manage your business. KPIs help you control risk and choose the contracts that are right for your business.
The Most Important KPIs for Commercial Contract Management
In order to effectively manage the effectiveness of your contract management, you must isolate the most important KPIs. By narrowing them down, you can better understand which metrics will ultimately benefit your contracts and contract management most.
1. What is the length of your contract cycle?
Your contract cycle determines how long it takes, from contact to signature, to execute a contract. Often, the contract process becomes long, drawn-out, and inefficient. All too many negotiations fall through — or become bogged down by excessive features or information that isn’t necessary to the contract.
How long does it take your business, on average, to create and sign a contract?
You want to know the average length of your contract cycle, as well as how long it takes to complete specific types of contract cycles within your company. You may also want to break down the contract cycle and determine where the longest delays are — and, therefore, where you can institute changes to decrease those delays.
Separately, you may want to consider how long it takes for clients to renew their contracts with your company. Are companies spending an excessive amount of time looking back over the contract or considering loopholes, or do they generally renew automatically?
2. What is the average value of your corporate contracts?
Your company may have a handful of big corporate contracts, or you might prioritize corporate contracts and have only a handful of smaller contracts at your company. You need to know the average value of your contracts as a whole, as well as the average value of your big contracts.
Make sure to carefully examine any outliers that could impact the averages. Bigger contracts often take longer than smaller, more automatic deals. Measuring their value against the time taken to close them can let you know more about how valuable a bigger deal really is.
3. What is the average risk of your contracts?
When you take a look at your contracts, what’s the average value of the risk associated with them? Contracts generally have two types of risks: contract-related risks, or the risks that could occur within the lines or wording of the contract itself; and supplier-related risks.
What could happen, for example, if your suppliers fail to deliver the necessary materials for you to fulfill the contract?
What happens if you face financial difficulties during the process?
Could the contract itself create financial difficulty for your business — trying to take on too much when you lack the resources to fulfill the contract, for example?
Carefully evaluate the risks associated with each contract and assign them a value. Read our quick guide to setting up a contract scoring plan.
4. What degree of deviation exists in your contracts?
Your business probably has a standardized contract that allows you to easily sign new clients up without having to negotiate a new contract each time. When you work on a contract specifically for a new client, however, that client’s specific needs may cause you to deviate from your standard contract.
As you evaluate your contracts, consider how each one deviates from your standard contract, including what those deviations will mean for your company. Some minor deviations, like shortening a few deadlines for a rush order, can be easy to handle. More serious deviations, including a lower allowance for overhead and profit, could spell disaster for your business. Being forced to add termination for convenience clauses can be even more detrimental.
5. How many of your contracts expire and are not renewed?
Contract renewal is an important aspect of any business. Returning customers — those who will continue to use the services provided by your business — have a greater value for your business than brand new customers who may use you for only a single contract period. If you have a high customer churn rate, it’s time to investigate. You may find that something your business is doing does not fit the needs of your customers or that your current contract model fails to adequately reflect your customers’ needs. A solid contract does not just benefit your business. It also offers enough benefits for your customers that they come back for the services you provide.
You may find that something your business is doing does not fit the needs of your customers or that your current contract model fails to adequately reflect your customers’ needs. A solid contract does not just benefit your business. It also offers enough benefits for your customers that they come back for the services you provide.
Many of these KPIs will already be reflected in your contract administration plan, so implementing contract scoring won’t be as challenging as it may seem at the start. If you want to learn more about contract administration plans, read our recommendations for best practices.
The Benefits of Standardizing KPIs for Contract Scoring and Contract Creation
When you standardize your KPIs both for contract scoring and for contract creation, you develop a better understanding of exactly what makes an effective contract. Also, you can develop a strategy for making both your contracts themselves and the contract creation process more efficient in the future.
1. Understand what risks you’re taking with your contracts.
Do you have a high-dollar contract that represents a high level of risk for your company — a client, for example, who struggles to pay on time, or a job that has a high chance of failure?
When you standardize your KPIs, you’ll be able to quickly determine where those risks are and how they could impact your business in the future. Effective contract scoring can also help you prevent those risks in the future, along with these five contract management practices. It can even help you eliminate or pass on potential contracts that might not benefit your business.
2. Streamline your contract creation process.
If you find that your contracts take an excessive amount of time to create, you can isolate the problems that cause those delays. If some aspects of your contract creation process are consistently slowing down the whole, you can then take steps to streamline your content creation process. Scoring your boilerplate contract — and removing these hidden risks — can also improve your process.
When you understand where the potential challenges are along the way, you can break them down — and get them out of the way. Not only does that speed up your contract cycle, but it also makes your contracts’ scores healthier.
Another great way to streamline your contract creation process is to create standard contracts and standard operating procedures ahead of time. Learn more about how to build out those tools here.
3. Avoid contracts that pose too high a risk for your business.
In the client acquisition process, especially when it comes to corporate clients, it’s easy to let your excitement get ahead of you. You’re eager to sign a new client or to expand your business, so you might not take the time to clearly understand the risks involved. Your sales team may also be eager to close a deal without seeing the long-term ramifications.
By creating standardized KPIs to score your contracts, however, you can more effectively evaluate the risk posed by a potential client — and avoid contracts that might pose too high a risk for your business. Standardized scores also clearly communicate to other departments when potential contracts are good or bad. In fact, other departments should be part of the decision-making process when you’re setting KPIs to make sure there aren’t gaps in the score.
You may even choose not to renew current contracts that don’t offer as much potential gain for your business as you initially thought. For example, you may discover that you have a long-term client whose contract no longer delivers the value it did in that client’s early days with your business. In that case, you may want to reevaluate your contract with that customer or choose not to renew it.
4. Increase customer retention.
Customers who stick with your business have a much higher lifetime value than those that remain with your business for only a single contract term. When you score your contracts using the right key performance indicators, you can discover what elements your customers really need in their contracts — and, as a result, you can significantly increase your customer retention rates.
How to Use Your KPIs to Score Corporate Contracts
Once you have established your KPIs and started collecting the data you need to score your contracts, it’s time to get started. With these steps, you can score your corporate contracts. Not only can your team get a better idea of what risks your company might face as a result of existing contracts, but you can also determine how your company can more effectively acquire bigger contracts in the future.
Follow these steps to start scoring your contracts:
1. Evaluate the financial risk assigned to each contract compared to your average risk.
If an individual contract has a particularly high risk compared to your overall risk level, you may be better off letting that particular contract pass you by. It’s hard to skip an opportunity — the chance to expand to bigger and better corporations, for example. But if you have a corporate contract that will demand too much from your business, you may decide that the risk is not worth the potential gain. Your company’s finance department can weigh in to create standard evaluation metrics.
Of course, financial risks aren’t the only risks KPIs can help you measure. Read about these high-priority risk areas and how measuring related KPIs can help.
2. Take a look at the potential value of the contract compared to your averages.
In some cases, you may find that high value creates more potential risk. For example, taking on bigger jobs means a potentially bigger fallout if the contract falls through or your team is unable to deliver. If you discover that a contract fails to yield the appropriate value for your business in comparison to the risk, you can either reevaluate your terms or choose not to move forward with the contract.
Scoring all of your contracts across the board also allows your executive team to decide how many high-risk contracts your company can hold at once without either skipping too many growth opportunities or compromising the company.
3. Consider how long your business will bear risk as a result of the contract.
If you discover that a client drags their feet when the time comes to agree to the contract, you may have equal trouble trying to get them to uphold their end of the deal — including payment. Consider how long your business will bear risk as a result of the contract. A short-term risk, for example, might be reasonable, depending on what you stand to gain from it. A long-term risk, on the other hand, could hang over the head of your business, making it difficult for you to continue functioning normally.
4. Look at whether the contract is a new contract or a renewal.
Returning customers may be worth more than customers who are new to your business (even if their ACV — or annual contract value — is lower). As you evaluate your contract, consider the lifetime benefits of that customer to your business. A customer who is interested in expanding their use of your services, for example, maybe worth taking that extra risk, especially if you know the customer has been reliable in the past.
On the other hand, a customer who has failed to deliver on your expectations in the past might not be worth renewing the contract with. Don’t simply assign an automatic score based on whether or not the customer has worked with your company in the past; instead, take the time to consider the customer’s past behaviors and how they may impact your business in the future.
You may also want to consider customer longevity: for example, a customer who has been with your business for a long time may be worth maintaining or resigning a legacy contract. Other factors related to contract terms, such as automatic renewals or termination for convenience clauses, can raise or lower the total score.
Renewability factors are some of the most important KPIs for business, so learn more about how to make renewability a priority in your contract creation and management processes.
5. Consider how and why customers are falling away from your business.
Have you noticed any trends in customers who are choosing not to renew your contracts?
You might, for example, have noticed that customers no longer need certain services, or that customers within a certain price point are less likely to stick with your business. If so, you may want to more carefully evaluate contracts that fit those criteria to determine the likelihood of keeping those customers in the future. By evaluating the contract ahead of time, you can avoid potential clauses that could be a problem for either you or your customers — and improve your overall customer retention rates as a result.
If you already have a scoring system in place, read about how to streamline the process for faster scoring and simplified contract management.
As you learn to more effectively score your contracts, you’ll find that it’s much easier to determine what contracts are worth keeping and which ones will fail to offer the benefits you need for your business. Even better, all of this qualitative data can be easily measured and automatically scored with the right contract management software. An effective scoring system and careful attention to the right KPIs will allow you to create better contracts, evaluate risk, and choose clients that genuinely fit the needs of your business.