Contract life cycle management (CLM) applications help you manage the entire life cycle of customer and supplier contracts — starting from creating contracts to archiving them when they are no longer needed. There are two categories of these applications: buy-side CLM applications that manage supplier contracts and sell-side CLM applications that manage customer contracts. I focus on the following aspects of buy-side applications:

• The contract and contract life cycle
• Typical pain points of managing this life cycle
• How to develop a business case for a CLM application (i.e., identifying the areas in which an organization can expect benefits)
• The features a CLM application should have to manage the entire contract life cycle
• Three different contract management solutions that SAP offers

Understanding the Contract Life Cycle

There are different types of contracts, including purchasing, sales, service, partnership, loan, and insurance agreements. I focus on purchasing agreements. Typically, a contract has five stages in its life cycle:

• Contract authoring and creating: A typical contract can contain information such as trading partner information, contract value, contract time period, specific terms and conditions that must be met by each trading partner, and dated approval signatures of trading partners. An authoring contract is the first stage of the life cycle. Most companies have some form of a preapproved template for creating a legal contract and do not start from scratch. Authoring a contract is not completed alone; rather, the process can involve multiple stakeholders, including experts from the purchase (for buy-side contracts), legal, and finance departments.
• Contract negotiating: During contract negotiations, its value, terms, and conditions may be changed or reworded several times by one or both parties and their legal and finance departments. This stage needs strong internal and external collaboration between stakeholders.
• Contract approving and signing: After rounds of negotiation, when all stakeholders reach an agreement, relevant authorities from both parties approve and sign the contract. Once the contract is signed, it becomes active from a particular date and for the duration defined in the contract.
• Monitoring and administering the contract during the period it is active: This stage is typically the largest duration activity in the contract life cycle when the signed contract is stored in a central repository and has to be monitored efficiently. Contract monitoring means only authorized users can access the relevant contract. Users can quickly search the repository and can find the right contract. Contract monitoring ensures that the organization complies with the negotiated terms and conditions in the contract. For example, contract monitoring of buy-side contracts ensures that employees choose the right goods and services at the negotiated price mentioned in the contract when they place orders.
• Contract archiving or renewing: The contract is archived when it is no longer in use (for example, when a contract’s validity period has ended). Although the contract is no longer in use, contract records can be maintained for legal or fiscal requirements and for future analysis and reference. Contracts can also be renewed and renegotiated for price or a particular clause.

Typical Pain Points of Managing a Contract Life Cycle

Organizations face common challenges in managing a contract life cycle. Although there are company-specific challenges, the following challenges are universal:

• Labor-intensive and time-consuming processes having a high chance of error: Traditional contract management processes are mostly manual in terms of drafting a new contract, editing clauses, monitoring, and checking for adherence to all aspects of compliance in accordance with the terms of the contract.
• Contracts are often not renewed on time owing to lack of information.
• Contracts are not integrated with sourcing, operational procurement systems (these may be the Supplier Relationship Management [SRM] or SAP ERP systems), and payment systems for contract terms compliance and monitoring. For example, if a supplier contract is not integrated with the ERP system through which a purchase order or delivery schedule is generated, monitoring whether the purchase order is in accordance with the price and terms negotiated in a contract is difficult.
• Contracts are not visible throughout an organization: People needing access to contracts sometimes do not have access because physical paper contracts are spread across different locations and companies do not know who needs to access them (e.g., a new employee joins the procurement department). In this scenario, certain employees do not know what terms and conditions are mentioned in the contract. They are also not aware of when a change in any particular clause is made.
• Contract performance is not tracked by the business and there is no penalty for noncompliance: There is no way to track performance of thousands of contracts spread across different locations in hard copy or digital format. If a supplier is not compliant as per the contract (i.e., it supplies materials at a different price or delivery terms at a particular factory and does not obey the global contract that probably is done at the supplier’s head office), it is difficult to track this activity and penalize the supplier for violating the contract. Ensuring service-level agreement (SLA) compliance is always a challenge.
• A central repository for contract templates with preapproved legal clauses is not available: This pain point typically arises during contract creation when users face issues such as not having a template to not being sure if a template is current or if all clauses are proved. There is no control if someone modifies one of the approved clauses while creating the contact. A contract created using a wrong template or clauses can have serious legal implications for a company.
• No central repository for contracts: Some organizations do not have any central repository of digitized contracts. They can be hard-bound files spread across different locations of the organization such as desks or vaults, making them difficult to locate.
• No search capability within the contract: If an organization has thousands of contracts, finding the most appropriate contract for a particular vendor or item can be daunting.

Business Case for a CLM Application

An investment in a CLM application needs to be backed by potential proof of savings. Savings from some of these areas can be quantified, but there are also areas in which qualitative benefits are expected.

 You can expect quantitative benefits from the following:

• Improved compliance management in areas such as SLAs, delivery schedules, and contract clauses
• Improved rebates or discounts (ordering from selected suppliers as per the contract improves the chances of getting discounts)
• Improved renewal rates
• Shortened contracting cycle time (major savings are expected in creating a new contract as there is a predefined template and approved clauses — both of which are used as the starting point for drafting a contract)
• Reduced administrative costs (a major reduction is expected in administering contracts as contracts are created with less effort, all contracts are now maintained in a single central repository in digitized form, all updates are tracked automatically, and the overall manual effort to manage contracts is reduced)
• Improved supplier compliance vis-à-vis negotiated terms and conditions
• Reduced risks, such as legal or financial risks that are inherent in contracts
• Improved compliance and governance in regulatory requirements

Areas in which you can expect quantitative benefits from a CLM solution implementation include:

• Visibility into supplier performance
• Adoption of standard procedures, policies, clauses, and proper approvals throughout the organization
• Better analysis of contracts

An easy way to develop a business case for a CLM application is to ask the business a set of questions. If for a good number of questions the answer is no, you can use that to justify the investment. Here are 14 questions to use as check points:

1. Do you know where all your contracts are stored and in which format they are stored?
2. Do you know where a particular contract is stored?
3. Do you know whether all the contracts have the latest approved terms and conditions, clauses, and legal language (does it follow the latest template that the legal team finalized)?
4. Do you know how many of your contracts are expiring next month and in the next quarter?
5. Do you know how many contracts you have with supplier X or for material Y?
6. Do you know who reviews and approves your final contract at each location or for a particular material?
7. Do you know when the terms and conditions of a particular contract were changed and why?
8. Do you know how many of your suppliers met the agreed upon service levels as defined in your contract?
9. Do you know how many of your suppliers are sending invoices to you as per contract terms and how many are not (are you getting the right discounts, rebates, and incentives from your supplier)?
10. Do you know how to locate a particular term or clause within a 200-page contract?
11. Do you know who your high performers are as per the performance metrics you had established for your contract compliance?
12. Do you know when specific deliverables within a contract have been achieved or milestones have not been completed?
13. Do you know which of your contracts contains a particular clause (e.g., a price variation clause)?
14. Do you know how much you spent against a particular contract last year?

Features of a CLM Application

Organizations expect a CLM application to have a set of features to manage the entire contract life cycle. Table 1 lists these features. No one CLM application available in the market may have all these features, but solutions from CLM vendors, such as SAP CLM, meet most of them.

Table 1

Features that a CLM application is expected to have to manage the contract lifecycle

Contract Management Solutions from SAP

SAP offers three contract management solutions in its solution portfolio:

• A contract management solution in SAP ERP Central Component (ECC) — outline purchase agreement
• Contract management solutions in SRM — operational contracts and global outline agreements
• The CLM application

In the next section I discuss the pros and cons related to each solution plus information about which one is appropriate in what situation.

SAP ECC Outline Purchase Agreement

An outline purchase agreement is a longer term agreement between a purchasing organization and a vendor regarding the supply of materials or the performance of services within a certain period according to predefined terms and conditions.

An SAP ECC outline agreement is used for the following reasons:

• The purchasing department wants to set up a long-term relationship with a vendor for a specific group of materials or services.
• An organization wants to negotiate binding conditions for purchasing (e.g., price, quantity, or discounts) without actually releasing a PO
• An organization uses a pre-negotiated offer during day-to-day purchasing
• An organization wants to increase the speed of its purchasing process
• An organization wants to improve monitoring and control of the actual release of a purchase order against an offer

In the SAP system, such agreements are subdivided into:

• Contracts: Centrally agreed upon contracts or distributed contracts
• Scheduling agreements

Table 2 shows the major differences between contracts and scheduling agreements.

Table 2

How contracts and scheduling agreements differ

SAP ECC supports different contract types:

• Value contract: The contract is regarded as fulfilled when release orders totaling a given value are issued. Use this contract type when the total value of all release orders cannot exceed a certain amount.
• Quantity contract: The contract is regarded as fulfilled when release orders totaling a given quantity are issued. Use this contract type when the total quantity to order over the duration of the contract is known.

In SAP ECC a contract can also be for one location or for a central agreement. A centrally agreed upon contract allows a central purchasing organization to create a contract with a vendor that is not specific for just one plant. In this way, the purchasing organization can negotiate with a vendor by leveraging the whole company’s requirements for certain materials or services. A centrally agreed upon contract also allows the following:

• Contract items can relate to all plants covered by a purchasing organization
• All plants of a purchasing organization can order against a centrally agreed upon contract
• Using the plant conditions function, the centrally agreed upon contract enables a user to stipulate separate prices and conditions for each receiving plant. For example, transport costs can differ.

A contract can be created in one of the following ways:

• Manually: Enter all the contract data manually.
• Using the referencing technique: Create a contract by referencing purchase requisitions, request for quotations (RFQs), or other contracts

When you are working with SAP ECC outline agreements, consider the following points:

• Contracts are outline agreements. They do not contain details of the delivery dates for each of the items.
• To inform vendors of which quantity you need for which date, you enter contract release orders for a contract. A release order is a PO that refers to a contract.
• The release order documentation (i.e., the quantity released until now and the open quantity) is automatically updated when a contract release order is created. This documentation can be used for monitoring the contract.
• If a purchasing information record with conditions exists for the material and the vendor, the system automatically suggests the net price according to the conditions mentioned in the contract.
• The contract validity period is defined in the contract header as the validity period.

SRM Operational Contracts and Global Outline Agreements

A contract in SAP SRM is integrated with SAP SRM sourcing functionalities such as bidding and auctions. An SAP SRM system supports two types of contracts

• Operational contracts
• A global outline agreement

Operational contracts can be set in SAP Electronic-Based Procurement (EBP) for strategic purchases. The items covered in the contract can be published as a catalog that is available to all employees. The employees can pick and include items in their shopping carts.

A global outline agreement is similar to a centrally agreed upon contract in SAP ECC. The only difference is that it can talk with different procurement systems (SAP ECC in different versions and even other systems) at the back end. This contract is centrally negotiated by the central procurement department and can be used by all businesses in different locations and at factories across the company using different procurement systems. This global agreement created in SRM can be distributed to multiple SAP ECC back-end systems of the organization from where call-offs can be done. Such call-offs update the use of a global outline agreement.

SAP Contract Lifecycle Management

CLM is the application from SAP for managing end-to-end contract life cycles. The application comes with a contract repository, contract authoring, and advanced integration.

The contract repository stores clauses, templates, and legal contracts. It has these functionalities:

• Ability to upload legacy and third-party contracts
• Can search the contract repository easily
• Attribute and free text search capabilities
• Basic security
• Workflow
• Automated alert notification

Contract authoring includes:

• Microsoft Word integration
• Clause or template library
• Ability to collaborate with internal or external parties
• Advanced security
• Approval for clauses, templates, and legal contracts

Advanced integration provides:

• Integration between legal and operational contracts
• Advanced alert notification when operational contracts or business transactions deviate from the legal contract
• Legal compliance reporting
• Advanced reporting capability
• CLM Dashboard
• Integration with ERP
• Integration into esourcing or RFx functionality

The CLM solution adds value in the contract management process by quick contract creation, contract visibility, and compliance. As discussed earlier, the traditional contract creation process is lengthy and time-consuming. The CLM solution helps to expedite the contract creation process from the first draft through approval by a set of capabilities such as consistent, preapproved language from the legal department, the option to use workflow-based edits or approval of contracts, better version control, and integration with strategic sourcing and supplier management solutions. Some of the useful contract creation features are:

• Contract draft generation: Creating a draft contract from a library of clauses and templates, allowing for use of the latest approved legal language
• Integration with Microsoft Word: CLM creates a draft contract as a Word document for reviewing and editing by all stakeholders.
• Version control and change tracking: CLM offers capabilities to track changes and multiple versions of the contract.
• Workflow: Workflows in CLM ensure that key stakeholders can review and approve contract documents as and when required before final execution.
• Electronic signatures: CLM supports automated electronic signature capturing for approvals.

Once contracts have been signed, they need to be accessed easily. Providing this access is often a challenge. In CLM all corporate contracts can be maintained in a single repository, and you receive automatic reminders before contracts expire. CLM helps in contract visibility in number of ways:

• Data capture and reporting: Capture information for different contracts and generate reports for business and regulatory needs, including expiration alerts
• Contract search: Help in locating specific agreements by search
• Contract history capture: Document all activities that have taken place during the contract’s life cycle
• Detailed pricing and terms: Access the line-item details and terms information to support both internal and external compliance checks
• Contract administration: Support contract administration by setting retention and disposal dates, managing amendments, and proactively managing renewals

CLM contract compliance ensures that all contract stakeholders meet their obligations (i.e., suppliers deliver goods on time and at the right price). Contract use needs to be tracked diligently, and performance needs to be monitored. Integrating CLM with SAP ERP helps organizations control operating contracts in their ERP systems and increases the likelihood of employees choosing sanctioned goods and services at the negotiated price when placing orders. CLM also supports audit tracking to ensure that all parties maintain their obligations. Important features in CLM for better compliance management are:

• Contract audit management
• Contract performance management: Set and track specific KPIs for contracts and engage in proactive corrective measures if needed
• Standard integration with SAP ERP: Publish agreement header and line-item details to back-end SAP ERP agreements, to be referenced at times of transaction (e.g., an actual purchase order release) to help ensure compliance with agreed upon pricing and terms.

Rajesh Ray

Rajesh Ray currently leads the SAP SCM product area at IBM Global Business Services. He has worked with SAP SE and SAP India prior to joining IBM. He is the author of two books on ERP and retail supply chain published by McGraw-Hill, and has contributed more than 52 articles in 16 international journals. Rajesh is a frequent speaker at different SCM forums and is an honorary member of the CII Logistics Council, APICS India chapter and the SCOR Society. 

You may contact the author at rajesray@in.ibm.com.

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