Contract risk and valuation analysis-Laxmi’s snippets of wisdom

This is a guest post from Hariharan Laxminarayan

What are contract risk and valuation analysis? Can all contracts be managed in the same way?

A contract risk and value analysis establish the potential risk and reward for a contract. “Reward” is what can be considered as “added value” e.g. product innovation rather than just concentrating on price. It is very important to establish what type of contract you are dealing with so you can focus, look at the potential landscape for analytics, and allocate the correct resources to manage it. If you are not aware, then start spending time to review and identify what type of contract you are actually working on and what outcomes you want to achieve.

 You will deal with different types of contracts. Like a good painter (and not a typical doctor giving paracetamol for all cold patients and antibiotics for all allergic patients), you should not just manage all contracts in the same one common way. Know to paint well, a new sketch based on what the situation demands. A high-risk contract needs time and far greater attention than those for routine items. And when really have established what type of contract you are managing then you can treat it accordingly.

  Routine contract.

It is most likely that this will include “small services” and not major contracts or projects. For example, these contracts could be for stationery, fixings, consumables etc.etc. Routine contracts should be managed in the most efficient manner possible and devolving the responsibility to the end-users. A good idea would be to set up a call-off contract for stationery and consumables. Thus, the price and delivery times will have been negotiated in advance and the end-user can just order what they need when they need it. With routine contracts, it is beneficial to establish a long-term relationship with a supplier and have a minimum of formality which allows the supplier to offer extra “rewards” for his services. The supplier you choose for this service does not necessarily have to be small. Larger companies may offer economies of scale but may not be as flexible as a smaller one.

  Bottleneck contract.

Bottleneck items may not have a high purchase value but the key to managing this type of contract is to ensure the supply of the particular product or service. Negotiating price, delivery or quality, for example, will be restricted due to the limited availability of the product or service. The supplier does have a stronger position in this instance. If at all possible, try a multi-sourcing strategy to avoid the over-reliance of one supplier. The likelihood of “reward” from this type of contract may be minimal as the supplier does not have a real incentive to provide it. Solutions for managing this type of contract may be establish a long-term relationship, focus on a good relationship so your supplier has a mutual benefit and to try to develop different alternative requirements.

  Leverage contract.

The old views on leverage contracts were that the client could exploit their position as many suppliers could offer the products or services required and have a large spending budget. However, price should not be the only factor when selecting your supplier. Other factors should be considered such as delivery, quality, capacity for example if that is important. Strict contractual terms should be enforced so the supplier minimizes the risk to the client.

  Critical contract.

A critical contract will have a high spend with a limited number of suppliers who can provide the goods or services. It is a fine balance of power between the two parties who may be dependent on each other. A critical contract requires the most work to maintain and ensure the right outcomes. The investment of time and money and developing programs such as total cost modelling, value analysis and continuous improvement is essential.

 Developing a long-term relationship should reduce risk as the supplier is assured of long-term sales and is motivated to give extra “rewards”. Again, a robust contractual obligation should mitigate the risk to both parties. To summarize all contracts, have their own risks so the contracts officer must be complacent and manage each type of contract with the right resources and management...

 

Hariharan Laxminarayan is a procurement Professional with 25 years’ experience. He is an active member of the Chartered Institute of Procurement and Supply (CIPS), being a Chartered FCIPS, CIPS Global Congress Member and Chair at CIPS UAE - Northern Emirates. And a person I am happy to have as a friend and mentor for the past several years.