How to check your return on contracts

As a general rule, every contract that an organisation executes is expected to deliver some level of positive, monetary or non-monetary benefits.

These can be tangible, like bankable savings or reduced processing time, or intangible, like improved staff satisfaction or enhanced capacity for innovation.

Achievement of the expected benefits can be described as return on contracts or value delivery.

Key to determining the return or the value delivery is that wherever possible, achievement of these benefits should be clearly measurable rather than anecdotal.

Furthermore, not all benefits are created equal. If fully delivered, some expected contract benefits will potentially have more value than others.

These specific benefits should be identified as key or important as their delivery warrants close attention.

The organisation should periodically check that at least the key benefits are actually being delivered as expected. Non-key benefits can be checked if and when desired, bearing in mind the law of diminishing returns.

The prudent organisation will go one step further and check if the benefits received are worth the cost, to see if they are getting value for money.

In this article we’ll discuss how to check if and to what extent any specific contract is delivering the expected benefits and providing value for money.

Normally, only the most important contracts need to be regularly checked in this way, but any other contracts that make up the top 20% of spend should ideally be checked no less than annually.

Are you getting the expected benefits?

Why is this important?

Checking if the expected benefits are actually being received allows remedial action to be taken sooner rather than later if progress is too little or too late.

Either scenario might introduce an element of risk in terms of supplier capability, organisational readiness and so on that might not have been planned for and now needs to be addressed.

It could also be an indicator of optimism bias in the form of overestimation of benefit sizing or timing.

Whether or not there is an issue with benefits delivery, the check can also test if the expected benefits are still relevant, rightsized and consistent with the latest organisational goals and strategies.

The outcomes of the check form a key input into the value for money check.

The Benefits Management process

Because benefits can and do come in all shapes and forms depending on the purpose of the associated contract, a fairly standardised Benefits Management process is useful. This process should cover:

1. Documentation of the expected benefits of the contract, including importance and ballpark delivery timing
2. Capturing the baseline measurements of the initial situation in respect of those benefits
3. Determination of what information needs to be collected about the delivery of each benefit, and how, to allow comparison against the relevant baseline and any immediately prior delivery check
4. Development of a comparison approach for each type of expected benefit. Over time, sufficient approaches will be developed to form a library that can be used to allow rapid completion of this step
5. Establishment of the timetable for conducting the comparison exercises, taking account of ballpark delivery timing
6. Performance of the comparison exercises and documentation of the results
7. Analysis of the results to allow derivation of recommendations to cover situations like:
1. Taking advantage of the benefits delivered to date
2. Changing the benefit delivery approach to get a better outcome
3. Resizing or recasting the expected level of benefits
4. Realigning the benefits with current organisational strategies or external circumstances
5. Terminating the contract due to lack of any benefits delivery.
8. Presentation of the results, showing the extent of benefit delivery versus expectation, trending over time towards target, ongoing benefit feasibility and relevance and any recommendations
9. Assignment of responsibility for ownership and performance of the process.

Benefit measurement guidelines

Measurement can take many forms: direct, inferred, guesstimate. It is driven by the nature of the benefit being measured. Bearing in mind the quantity and complexity of the contracts involved and the associated expected benefits, the key principles are:

1. Keep measurement systems simple to use and understand
2. Where practical, use existing information sources or performance measurement systems
3. Alternatively, adapt or add to existing systems
4. As a last resort, build new measurement systems
5. Document and revisit working assumptions
6. Concentrate on monetary benefits and establish Key Performance Indicators for them.

Are you getting value for money (VfM)?

What is Value for Money?

VfM is a simple concept: you are getting what you expected for the monetary or non-monetary price you paid, no hidden charges, no unpleasant surprises, no gotchas.

Here’s a straightforward example. You buy a cinema card for $250, allowing you to see 25 movies in a 12-month period. This means the price per visit is $10 if you see 25 movies. If the actual admission price for any particular movie ranges from $10 to $20, depending on time and day of the week, then the card could deliver a maximum of $250 in savings.

Even though the card has to be paid for up-front, the perception of value for money can be induced whenever the actual but unpaid cost of admission for a particular movie exceeds the nominal $10 paid via the card purchase.

However actual value for money is achieved only when the cumulative actual admission price applicable at the time each movie is seen reaches or exceeds the $250 price of the card.

At that point, if the card has been used less than 25 times and its term hasn’t expired, there will be no cost for the remaining number of attendances.

Things aren’t usually as straightforward as this in the contract-driven business world because business transactions are rarely that simple.

VfM in the business context

VfM has often been viewed as either:

• Getting the lowest pricing or a result that delivers the lowest cost, or
• The difference between the total benefit obtained under a contract and its total cost.

These views fail to take account of a wide range of financial and non-financial factors necessary to deliver a more comprehensive and realistic view of VfM, such as:

1. The quality of the goods and services obtained
2. The fitness for purpose of the goods and services, in terms of:
1. Consistency with procurement policies
2. Delivery of no more than the capability required to meet the identified need
3. Compliance with designated specifications and standards
4. The supplier’s capacity to deliver the goods and services to required service levels
5. The supplier’s flexibility to adapt the goods and services to meet changing needs.
3. The supplier’s relevant experience and performance history
4. The total cost of ownership (TCO) of the goods and services including where applicable:
1. Acquisition costs like pricing, freight, legal fees, training
2. Operating costs like utilities, safety monitoring, cleaning
3. Maintenance costs like consumables, spare parts, repair labour, downtime
4. Transition in / out costs like implementation planning, disengagement planning
5. Licensing costs like software, information, IP rights
6. Alteration costs like additions, upgrades, retraining
7. Consumables costs like paper, toner, fuel
8. Support costs like insurance, rates and taxes, management fees
9. Disposal costs like inspection, decommissioning, remediation / make-good, transport.
   
   

In practice, consideration of TCO is neither required nor warranted for the bulk of an organisation’s contracts. Even when TCO could be used, it isn’t always possible or practical to identify, qualify or even estimate all the associated benefits and costs.

This is particularly the case for contracts that are complex, long-term, dynamic in terms of change, and/or require significant management.

Due to its complexity and the uniqueness of each situation where it is applicable, using TCO to calculate VfM will not be covered in this article.

How can VfM be achieved?

Value for money can be achieved in many ways, for example by:

1. Getting an increased level or quality of goods and service without increasing the cost
2. Avoiding unnecessary purchases
3. Ensuring that user needs are met but not exceeded
4. Specifying the requirement in output terms allowing suppliers to propose cost-effective and innovative solutions
5. Optimising the cost of delivering goods and services over the full life of the contract rather than only minimising the initial price
6. Ensuring continuous cost and quality improvements are contracted obligations on the supplier
7. Managing demand and aggregating transactions to obtain volume discounts
8. Developing a more effective working relationship with key suppliers to allow both the organisation and the suppliers to get maximum value from the contract by identifying opportunities to reduce costs and adopt innovative approaches
9. Optimising processes to reduce the time and cost of acquiring goods and services
10. Ensuring that key people have the personal characteristics needed for success in their roles
11. Training key people specifically in the arts of negotiation, contract management, supplier relationship management and project management as required
12. Establishing a payment plan to smooth out cash outlays.

How can achievement of VfM be determined?

A simple indicative check can be used for determining if VfM is being achieved for a specific contract. It involves a review of the behaviour of both the supplier and the organisation with respect to the operation and use of the contract, and consideration of the outcomes of the Benefits Management process with respect to benefit delivery.

This check is generally applicable for any type of straightforward procurement contract regardless of complexity, term, change velocity and so on. It should require minimal data collection if the contract is being actively managed but obviously more otherwise.

Some level of discussion with various stakeholders is likely to be needed.

The check provides a simple indicator of the likelihood that VfM is being achieved, based on an assessment of the level of agreement with the validity of two sets of value indicators.

A comparison of the sum of the agreement scores against a set of threshold values shows the indicative VfM achievement level.

The value indicators used are:

1. Supplier value indicators
1. Pricing is market competitive
2. Price reviews are conducted on time
3. Price increases are held at or below the inflation rate
4. Invoicing is consistently correct
5. Opportunities for obtaining discounts are available
6. Agreed quality levels for goods and services are consistently met
7. Compliance with contract obligations is consistently good
8. Delivery dates are consistently met
9. Support Service Level Agreements are consistently met
10. Service performance levels are relevant and set appropriately
11. Self-reported performance figures are consistently trustable
12. Market, technological and regulatory change is consistently handled well
13. Innovation / continuous improvement is being provided
14. Issue management is consistently well handled
15. The supplier relationship is working well
16. Expected benefits are being acceptably delivered.
    
    
2. Organisational value indicators
1. Order aggregation is in place to maximise opportunities for obtaining discounts
2. The contract owner and the end-user community are happy with supplier performance
3. Contract changes that result in cost increases are always justified and approved
4. All parts of the organisation can readily obtain goods and services under the contract
5. Compliance with contract obligations is consistently good
6. Recognised good practice in contract lifecycle management is consistently used
7. Supplier and contract risk are well understood and adequately mitigated.

A modifiable template for scoring the indicative VfM check is available to download here.

Indicative VfM check assessment approach

The score range used (0 - 5) provides a general indication of the level of agreement with a value indicator, namely:

Note that a score of zero (N/A) means that the specific behaviour in the generalised list is not applicable, ie not exhibited by the applicable party.

As an example, if a supplier does not offer any discount opportunities, a score of zero would be assigned for indicator 1.e above.

The overall indicator of VfM being achieved by a contract is based on the total score assigned across all value indicators as a proportion of the maximum score possible across the value indicators. Note that the maximum possible score doesn’t include an allowance for any indicator designated as N/A.

The VfM achievement level score thresholds are:

What does the indicative VfM check reveal?

Every score in the range 1-3 indicates an obstacle preventing maximum achievement of VfM. These obstacles can generally be dismissed if the VfM achievement level is at least Satisfactory, and almost certainly dismissed for Good and Excellent.

Because the check looks at supplier and organisational behaviour as a driver for VfM, reordering the lists of supplier and organisation behaviour from lowest score to highest (ignoring scores of zero) superficially and non-judgementally prioritises the behaviours that need attention.

If this is not the first indicative VfM check conducted, the scores can be compared against the previous check to determine if anything has changed in the intervening period, and the trend direction.

What should happen next?

Any action to address discovered issues and trends will depend on the current check’s determination of the VfM achievement level, the criticality of those issues and the cost and effort of remediation.

Because judgement is needed to determine what is possible, practical and achievable with respect to behavioural change, discussions with the supplier should be held to apply an agreed ranking to each low-scored behaviour, irrespective of which side is responsible for those behaviours.

Potential payback and ease of remediation should influence the ranking.

Each side should then assess the remediation feasibility of, say, the five top ranking behavioural issues and determine the likely cost. Further discussion should take place to agree on an action plan for improving achievement of VfM.

The plan should be presented to each side’s senior management for approval. Presuming eventual approval, possibly after some rework, the plan should be implemented in accordance with its timetable.

Summary

A crucial Contract Lifecycle Management activity is ensuring return on contracts. This involves:

1. Understanding how the organisation expects to benefit from the receipt of goods and services via a contract with a supplier
2. Testing the level and trajectory of benefits delivery from the contract on a regular basis, and taking any remedial action necessary to achieve better alignment with expectations
3. Analysing both the supplier’s and the organisation’s behavioural contributions to achieving value for money from the contract, and taking any remedial action necessary to improve the situation.
   
   

Ensuring a positive return on contracts is a risk management activity that can be critical to an organisation’s health.

Regularly checking that at least key contracts are delivering benefits to expectation and simultaneously providing value for money is analogous to a dairy farmer testing the productivity of individual cows in the herd.

In both cases, if output can’t be upped despite trying various approaches, the outcome for the underperformers can be grim.

If you would like more information on how to improve your return on contracts and how to embed the right disciplines and contract management tools in your business then contact Gatekeeper today for a free consultation.