Managing the risks and finances of contracts

From the October 2019 print edition

The art of business management lies in maximizing operational and financial performance while reducing risk. Contracting and contract management are key operational activities impacting how business is conducted.

Organizations must be agile and recognize the importance of incorporating specific planning and processes into their contract management activities to reduce risk and obtain best value.

Contract management involves looking at what the business requires, defining the need, developing the need into a plan to obtain it, tendering the requirement, awarding the contract, managing the contract and closing it out.

When a contract requirement is developed poorly, it can result in large financial loss over a technicality either not defined properly to overcharges on missing deliverables. The value of being proactive and linking management of contracts as a critical tool to operational needs will ensure stakeholders realize its importance.

To succeed in contract management, start at the pre-contract stage. Most of the upfront work will impact the contract’s value. Initial requests for requirements must focus on why the requirement is being established. Understanding what the organization needs is critical. Why do you need the contract? From this flows the other questions: What do I need? What is my budget? Who needs to be involved? When do I need it? What is the impact if I don’t get it?

These questions are critical in establishing the requirement and defining the risks, stakeholders, roles and responsibilities and the importance and methodology to source what is needed.

To get management commitment to move forward with contract requirements, establish the business case. By planning the outcomes, any critical elements, the risks, milestones, options and impacts will ensure clarity. Prepare the business case with the involvement of all stakeholders such as comptrollership, technical owners, procurement, risk, legal and management.

When the final contract requirement is identified, the technical authority/client must engage procurement to help. Contracting will review the contract requirement, incorporating appropriate terms and conditions into the solicitation documentation or contract. Contracting will consider what the requirement is and work with the client to process it into a strategy. This includes formulating the contract, stakeholder roles and responsibilities and contract administration.

Contract strategy is key. Consider issues like the nature, scale and significance of the requirement, it’s value, level of understanding and milestones, market capacity and attractiveness to industry. Evaluation criteria, success factors, business requirements and stakeholders will filter out suppliers that can’t meet the need.

Managing risk
Risk management is also critical. Risk mitigation tactics in each stage must consult, ask “what if” questions and address the risk with procedures/processes. Costs to control the risk, impacts on time/projects and the establishment of financial terms should be incorporated. Critical risks such as fraud, risk transfer and negative market share/reputation/supplier relationships must be front-and-centre when administering a contract. Terms such as contract exit strategies and financial requirements can mitigate risk.

Stuff happens, so a kickoff meeting with the supplier gives the chance to discuss how the contract will work. A discussion with the contractor on contract governance, expectations, milestones, performance measures, and roles and responsibilities is critical.

Changes and amendments to contracts are normal. Option periods and other administrative amendments form part of the approval of contract requirements at pre-contract award stage. Change is determined by a number of factors such as markets, technological developments, legislative changes and changing business needs (outcomes).

When changes are known, it’s easier to amend the contract and adjust the term. Negotiation between stakeholders is easier to manage and the amendment to the contract is simplified. Unexpected changes happen and should form part of the risk evaluation at the onset of the contract requirement (to consider the unexpected).

It is important that stakeholders in the contract management process understand their roles. Contract management monitoring, records retention and relationship management are key tasks organizations must manage. Formal amendment procedures should be set out in the contract and change control procedures initiated to allow for adjustments. Changes must include the justification or reason and allocate what is being requested.

Continuous risk analysis must be part of the contract management process. Lack of capacity by the supplier, reduction in demand leading to potentially higher per unit costs, deterioration in the supplier’s financial standing, supplier staff changes, delivery delays, market fluctuations and other issues may arise. If so, having an open and honest relationship with the supplier can alleviate some of the ambiguity. It is easier to mitigate risk and resolve issues if your relationship with the supplier is honest and transparent.
Risk can also result from poor contract management. Staff turnover, poor understanding of what the contract is about, unwillingness to engage the supplier and mismanagement of the contract can result in unexpected costs. Contract administration is the organization’s, not the supplier’s, responsibility. Poor internal contract management can result in overpayments, interest costs, default by the organization, court actions and reputation impacts.

Successful contract management is proactive. The aim is stakeholder consensus. Planning, risk managing the contract and establishing an honest relationship with the supplier will build a foundation for a successful contract that meets the organization’s needs.

Diane Daly , SCMP, CFSP II, is a senior advisor, Project Resource Management, Business Application Services Directorate, Canada Border Services Agency.