Contracting is a common way to document agreed-upon elements between a vendor and a customer. Some key elements include pricing, term of contract, exit clauses, and renewal options. With effective monitoring and management of contracts, cost avoidance and even cost savings are possible.
Pricing
Pricing is often the key element of a contract. Once a contract is signed, it’s easy to assume that the correct price will be charged by the vendor and paid by the customer. However, it’s common for one or both sides to have information that is not timely and accurate. While vendors have many internal steps to implement after a new contract is signed, it is critical they remember to load the new prices and effective date into their system. At the same time, customers should be sure to update these variables in their purchasing systems.
One way to monitor this would be to implement a contract pricing validation process. This would include analyzing invoices at the time of the effective date by comparing invoices to the actual pricing in the contract. Recently, a small hospital experienced $50,000 of overcharges because a new contract pricing did not get entered timely into the vendor’s system, nor did the client enter the new pricing into its materials management system. This overcharge was discovered and appropriately corrected through a contract pricing validation analysis. The vendor subsequently credited its customer appropriately.
Term of Contract
In this case, “term” refers to length of time as contracts need to be time-bound for multiple reasons. Financially, prices change over time, and in many cases actually come down. Some examples of this include: new products, technology, and efficiency improvements.
As a new product comes to market, it is often in a higher price range, but as it matures or as competition to attract new customers increases among vendors, it’s then common to see the price go down. As a result, newer customers may get a better contract than your current one.
A best practice is to revisit pricing in contracts every two to three years and review competitive quotes from a broad range of vendors every three to five years.
Exit Clauses
It’s highly recommended that an exit clause be established to provide the way out of an unfavorable contract, other than breaching or pursuing breach. A no-cause, 90-day notice clause, or similar exit clause, allows a company to exit a bad deal or simply look for a better option. However, these no-cause outs work for the vendor too and can be frustrating, especially if your company is in a good arrangement. Reasonable time frames are good, but leave yourself an out that is not too burdensome.
Renewal Clauses
So, what happens when the original term is up? Do you want to renegotiate all effective contracts every two to three years? If not, auto-renewal options can be an alternative, but remember, auto-renewal should not be set it and forget it. Over time, pricing agreements get stale and sometimes current pricing is lower than your present agreement. Eventually, you’ll have to renew, and eight years into a three-year contract is not a good time to find out your prices are higher than the rest of the market. Time and again, we see contracts, eight or more years old, left on auto-renew while the current market is offering more favorable pricing. As a result, companies may incur hundreds of thousands more in costs that they can’t get back.
Summary
Contracts can be effective tools to preserve the terms of doing business with vendors. Failure to monitor them can be costly. Being proactive in monitoring, renegotiating, and seeking competitive bids is a best practice that can potentially lead to valuable savings.
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