Costing Out the Cost of the Contract

I’ve talked recently about the need for outsource contracting in a transparent and flexible Vested environment, but what about the actual cost of establishing a business contract?

While there is obviously no standard cost template for contract negotiation services—contracts can vary from the exceedingly short and simple to the immensely long and complex and you won’t find any BOGO contract specials at your local Best Buy—it is legitimate to consider how much it will cost to produce a contract.

The IACCM’s Tim Cummins addressed that question at some length in a recent Commitment Matters blog post. He dug into IACCM’s extensive benchmark database to extract some estimates.

He relates factors that impact the cost question, including:

  • Complexity – Is it a simple purchase order or a major outsourcing agreement?
  • What constitutes the actual contract – Does it include SOWs, schedules, SLAs?
  • Are Master Service Agreements, which represent core terms and conditions, part of the contracting process?
  • Time calculation definitions and whose time is part of the cost calculation. Are the parties using elapsed time (i.e. cycle time) or actual time (the number of hours spent on specific contract production activities)?

With respect to a simple purchase order, he says, “The actual production process in efficient organizations has been driven down to a cost of $10 or less.”

Things ratchet up quickly after that under other contract forms.

There are two key cost considerations, Cummins says. “One is the cost of producing and agreeing the contract; the other is the cost of having the wrong contract (inappropriate terms, poorly drafted SoW, unclear service levels).”

The latter point, it seems to me, is crucial. Wasting time, energy and money on poorly drafted, unclear contract terms accomplishes nothing and puts the entire outsourcing relationship at risk. The Vested Outsourcing Manual, which will be published in June by Palgrave Macmillan, provides a pathway to crafting the best possible Vested agreement and avoiding pitfalls.

Cummins notes that contracts can be put in place very quickly and at very low cost; the downside of that approach is that it can “create major risks and downstream costs in so doing,” for example renewing an expired agreement without review.

Another problem is too much rigidity, where procurement teams impose highly standardized agreement forms that are not adjusted for the nature of the goods or services they are acquiring, “for example, distinguishing between production materials, computer hardware or software licenses.”

Assuming companies are operating with an efficient contracting process, Cummins relates the following contract production cost estimates:

  1. Simple contracts (some negotiation and review (internal and / or external), low risk, relatively low value or spend commitment): Average cost $5,000 (lowest cost $3,500)
  2. Mid-complexity contracts (significant review, some external negotiation, significant – but not major – risk considerations,): Average cost $19,200 (lowest cost $12,000)
  3. High complexity contracts (major review and approval, extensive negotiation, high or unique risk factors and value): Lowest cost $40,000, upper cost may be $200,000+

A wide range of costs, but I would note that the upper end of the cost for a complex deal can well exceed Cummins’ estimate in complex outsourcing deals.  I have seen the cost of a retained advisory firm or legal fees amount to well over $500,000 just on the buyers side!

Companies that have excessive rigidity, no overall process discipline, or high levels of non-compliance  “may well produce contracts at much lower cost, but their actions will result in extensive downstream problems – for example, frequent claims and disputes, extensive cost overruns or project delays,” Cummins writes.

My recommendation? Get it right from the start with a Vested Outsourcing collaborative and flexible mind-set at the front end of the contract negotiation, the correct mix of experienced teams, and a clear vision of intent and Desired Outcomes. Following the Five Rules will get you the most bang for your contracting buck.

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