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Contract compliance – managing your third-party costs

Robert Shaw Robert Shaw

Firms wanting to identify cost savings could look to contract assurance to reduce costs and maximise the value of third-party arrangements. Robert Shaw explains how.

Outsourcing and third-party arrangements are an integral part of the modern business landscape. But all too often, agreed contractual obligations aren’t met in full, leading to overpayment for services. The root cause is the fact that legal and procurement teams negotiate the contracts, but frontline staff are often unaware of the extent of the third party’s obligations. Perhaps they don’t have access to the contract in full, or there are complex legal clauses to untangle.

If people misconstrue the contract requirements on either side, it can be hard to reconcile initial contract spend with the final cost. If you are struggling to retain value from your third-party suppliers, here's how you can gain assurance over your existing contracts and manage compliance.

Identifying a contract compliance problem

One under-performing contract can have a significant financial impact, but in reality there may be multiple contracts, with a cumulative impact on your profit margin. That said, some contracts will be higher priorities than others due to high value, complexity, poor visibility with senior management, high-cost variance or a key event.

Starting with your highest priority contracts, collect data and business insights and review each contract in turn, to start identifying areas of non-compliance. This requires analysis of the data relationships – for example between contracts, invoices and payment history – to allow for reconciliation, and meetings with the frontline team to establish perceived contractual expectations.

How to analyse third-party contracts

Data analytics can make short work of contract reviews; it doesn’t have to be a drawn-out process. Machine learning can read contracts and transfer key information into a contract database. This helps you identify recurring themes, making it easier to spot discrepancies. It also lets you leverage powerful data visualisation and analytics tools, such as Tableau or Power BI, to view contract leakage data at a glance.

From there, you can review your transaction information. Reconciling all payments against core contract charges, invoices and rate tables will identify any immediate discrepancies or administrative errors. Key actions include:

  • reviewing individual transactions against the contract database
  • matching purchase-to-pay cycle data to ensure accurate flow of purchases through invoices to payment
  • detecting outliers using machine learning
  • interrogating VAT spend to make sure the right rates are charged and recovered.

The final step in analysing contract compliance is to interview the key staff members responsible for invoice spend in order to align payments to the services provided.

Issues with contract compliance are often people-driven, rather than system-driven, and arise from undocumented decisions or contested contract clauses. People working with the delivery teams can offer rationale for all payments made, reasoning behind it and help identify contract leakage.

Specialist input from subject matter experts, either within your business or via a third party, can also provide additional insight for each area under review.

Negotiation and settlement

Once you’ve identified areas of contract leakage, it’s important to prioritise them in terms of business and financial impact. This provides a good starting point for settlement negotiations to claim any credit or refunds owed, with a focus on the largest potential for recovery.

Looking beyond financial recovery, a contract compliance review will set a clearer compliance foundation for frontline teams. It demonstrates what the contractual obligations are in operational rather than legal terms and supports an improved control framework in the long term.

Lessons learned

Ideally, everyone wants to reduce risks before they crystallise. When it comes to contract assurance, this relies on effective training to make sure all parties understand contractual clauses and liabilities from the off. For frontline staff, contract compliance management processes also provide a much needed starting point to monitor and enforce compliance on an ongoing basis.

Contract leakage is fairly common. At a time when ongoing economic uncertainty is putting greater pressure on firms to make cost-savings, a robust contract review can make sure you’re only paying for the services you use and need, improving your business and reducing your costs in the process.

Contact Robert Shaw for further information on contract assurance.