The purchasing professionals at Kingsport, Tenn.-based Eastman Chemical Co., the $5.3 billion chemical and plastics manufacturer, handle an average of about 350 contracts per year, ranging in duration from one to five years, and in value from $10,000 to many tens of millions of dollars. With a company pedigree that extends back to the 19th Century, before Eastman Kodak spun off its chemicals division in 1994, it's safe to assume that the 30 or so purchasing practitioners who manage the company's contracts have been doing a pretty good job so far.
Why then is Eastman Chemical evaluating an online, automated contract-management system, if the current processes are working just fine? Put that complex question to Larry Bailey, group leader for global e-information systems procurement services at Eastman, and he'll give you a simple answer: Walking and biking work, but cars work much better.
Too Much PAPER
Eastman is not alone in automating the way it handles contracts. The chemical company's initiative is part of a broader trend toward streamlining this component of the supply chain, as companies seek both to eliminate the inefficiencies of current manual processes and to be more strategic in their purchasing. The need for automated contract management has become more pressing in recent years, as large corporations have increasingly outsourced non-core functions. In fact, while Eastman Chemical is managing relationships with about 6,000 suppliers at any given time, the National Association of Purchasing Management (NAPM) has reported that the average Fortune 1000 company actually has between 20,000 and 40,000 suppliers. Moreover, estimates are that about 80 percent of B2B purchases involve some sort of contract, and that makes for a great deal of paper floating back and forth between buyers and suppliers.
But not only have contracts grown in number recently, they have also grown in their complexity, according to a report from investment research firm Goldman Sachs entitled Time To Manage Those Contracts! First, the authors write, agreement terms have become more sophisticated to include items such as rebates and chargebacks, as well as conditional agreements. It has become increasingly common for contracts to encompass thousands of products, prices, incentives, compliance levels and other variables. In addition, companies are requiring greater amounts of information to manage their contracts. Never mind the fact that much of that information resides in various systems across a single enterprise, from enterprise resource planning (ERP) to accounts payable; much of it, such as rate information or sales data, must frequently come from business partners.
The proliferation and elaboration of contracts has had both tactical and strategic implications for companies such as Eastman Chemical. On the tactical side, the business pain has been the inefficiencies inherent in managing vast amounts of paper. As Debbie Davis-Waltermire, director for worldwide indirect materials and services at Eastman, says, The real pain is the iterations you have to go through between yourself and the suppliers. Under the manual process the company has been using, Eastman's procurement staff would prepare contracts using word processing applications, starting with standard templates, sending the draft documents by e-mail to suppliers and awaiting revisions. The revised contracts would then be further redlined and marked up, going back and forth between the buyer and supplier until a final document emerged. This system worked fine, so long as the supplier on the other end of the e-mail was using compatible word processing software that would allow for the tracking of changes. If not, Eastman's staff might have difficulty identifying changes in a draft contract received back from a supplier. We've got this issue of, where were we last in our negotiation?' explains Bailey.
Once the parties had agreed to all the terms and conditions, one side or the other would print two hardcopies for signatures. Eastman would then file four copies of the final document: one working hardcopy and one fingerprint, DNA hardcopy (Bailey's term for the copy stored in the fireproof safe), as well as an electronic text document and a scanned version of the hardcopy that could be used to verify annotations or signatures. The purchasing staff would also log the contract in a database system that included a tickler feature to remind the contract's custodian when a particular milestone passed or renegotiations were due.
The Price of MANUAL PROCESSES
The cost of such redundant manual processes can be enormous. Goldman Sachs estimates that companies incur between $25 billion and $30 billion in hard costs every year from managing their contracts. In addition, on the strategic side, the multiplicity of processes and software applications required by a company of Eastman's complexity to shepherd a contract from start to finish can divert the purchasers from their primary focus, negotiating better deals for the company. Right now when I have to train a new procurement person to work in this environment, I have to train them on four different tools sets, says Bailey. I'd rather not have them get tangled up in the tool and instead be more focused on how best to negotiate this business transaction.
On the back end, contracts provide little benefit to the enterprise if they are locked away in a filing cabinet or forgotten in an electronic folder on the hard drive of an employee who left the company six months ago. The problem in both those cases is that visibility into those contracts is very poor, says John Proverbs, director of product marketing at Santa Clara, Calif.-based Diligent, (formerly Webango) an e-sourcing platform provider that offers the online contracts management solution that Eastman Chemical is implementing. The ability to do analysis on those contracts is low, and the ability to do active contract management is not there. As an example of the consequences of this lack of visibility, Proverbs suggests that a company might have 10 different contracts with a single telecommunications provider at the firm's 10 locations. All those contracts could have different pricing, terms and conditions, even if the agreements cover the same products or services. Alternatively, the company could have separate contracts with 10 different providers. With those contracts sitting in a drawer - or in several drawers - the company's purchasing managers would be unable to discern the firm's total exposure and would therefore be unable to consolidate the spend or negotiate a better discount rate.
Issues of compliance arise, too, according to Joseph Hnilo, a vice president at Menerva Technologies (Redwood City, Calif.), which provides a sourcing solution that includes a contract management component. Besides the obvious risk of not complying with the terms of an agreement, a company that does not have the means to understand how suppliers are performing against a contract might be missing out on opportunities to make better use of its best business partners. Compliance measurement is important because companies want to be able to identify their best suppliers so that they can shift more spend toward those suppliers and be able to negotiate better discounts, says Hnilo. To do that, a company must have the ability to pull relevant data from contracts, as well as back-end systems, and compare obligations versus actual performance.
Perhaps most important, contracts are the embodiment of the relationship that a company forms with its suppliers and customers. Contract management is the proverbial area where the buy side meets the sell side, says Pierre Mitchell, analyst with Boston-based technology consultancy AMR Research. That's where the relationship comes together and gets instantiated. It's not just legal terms and conditions that show up in a written contract. It's really all the performance measures surrounding the relationship that you have with the supplier or the customer. In other words, without a comprehensive understanding of a supplier's performance, a company is in a weak position to assess the true state of its relationship with that supplier.
The POTENTIAL ROI
Given the various business pains associated with manual contract management processes, it should come as no surprise that the potential return on investment from moving to an automated contract management system falls into several categories. In its report, Goldman Sachs cautions that the ROI likely will vary by industry, but the authors go on to suggest optimistically that contract automation could accelerate negotiation cycles by 50 percent, reduce erroneous payments by 75 to 90 percent, cut operating and processing costs associated with managing contracts by 10 to 30 percent, and result in a 10 to 20 percent headcount reduction.
Those ROI categories jibe with the view of Scott Martin, president and CEO of Redwood City, Calif.-based diCarta, one of the so-called pure-play software companies devoted to offering a contract-management solution. Martin points to potential hard-dollar savings from improving the business processes associated with managing contracts and potential soft-dollar savings to be gained by saving purchasing staff time and letting purchasing departments handle more contracts with fewer staff. Further, Martin continues, contract automation can add value by allowing a company to better manage its risks. Most companies do a really good job of measuring how much risk they are willing to take on a deal-by-deal basis when they are buying or selling something, he says. Where they have not done an effective job, because they haven't had the tools in place, is measuring in aggregate their total position. For example, a company may deviate from its standard warranty for specific transactions, and that may make sense on a deal-by-deal basis. But without the right tools, the company might not have a perspective on its aggregate exposure should there be a warranty issue.
Mitchell agrees that automation has the potential value to increase the efficiency with which a company handles contracts, but he emphasizes the benefits to be gained from greater visibility into one's contracts, that is, the ability to analyze contracts in a strategic manner. Ultimately, the analytics that surround the contract strategy - which is really a sourcing strategy - is where there is a huge amount of value to be added, he says.
The SOLUTION PROVIDERS
Mitchell goes on to say that the analytics are also the most difficult component of contract management to actually automate. Not that solution providers aren't trying. In fact, a number of software companies have begun attacking the contract management problem from several different angles. In addition to Diligent and Menerva, other e-sourcing players offering contract management capabilities include Frictionless Commerce, enterprise resource planning (ERP) suppliers such as Oracle and SAP, and J.D. Edwards, which offers a solution for the pharmaceutical and health care industries through a partnership with I-many, another pure-play contract software provider. diCarta, mentioned above, is considered another early mover in contract management, having launched its product in February 2000.
So many players make for a crowded lineup of potential solutions, but the market may be large enough to support multiple providers: Goldman Sachs has estimated that the market for contract management software could reach $3.1 billion by 2005, while Credit Suisse First Boston's technology group has pegged the market at $3 billion to $5 billion by 2006.
CONTRACT AUTOMATION at Eastman Chemical
Of course, while the future of automated contract management may indeed prove bright, at the moment it is difficult to find enterprises that have had much experience using the solutions, let alone one with a track record long enough to speak of a solid ROI. Eastman Chemical is evaluating using Webango's contract management tool in the third quarter of 2001. Davis-Waltermire estimated the company would eventually be handling between 200 and 500 contracts per year through the system.
The Diligent tool, accessed through a hosted Web site, allows Eastman procurement staff to assemble contracts from reusable clauses, or objects, within the documents created with the tool. Each object has a particular set of attributes attached to it. For example, a termination clause would have date and fee attributes, which would let the company set up alerts and notifications related to the clause or perform analyses to determine the conditions under which that clause could be invoked. The objects can be stored in a shared library, a feature that in general allows enterprises to standardize their contract language, although Davis-Waltermire says that her department has worked together with Eastman's legal department over several years to develop approved language for contract clauses. In any case, Bailey says the standardization built into the system keeps contract managers focused on the key content in the agreement - price, quantity, delivery dates, quality and so on - rather than on the legal boilerplate.
Once an Eastman procurement staffer has prepared a draft contract, the supplier in question can access the document through the same hosted site to review the agreement and provide any necessary feedback. The supplier just needs a computer with access to the Internet. The two sides can bounce versions of the agreement back and forth during the negotiation process, and the system will maintain an audit trail so that Eastman can track changes in the terms over the various iterations. In addition, the tool gives the parties the flexibility to negotiate clause-by-clause and close each object as agreement is reached on that clause. It allows you to keep the supplier from coming back and trying to renegotiate something that has been closed, Davis-Waltermire says.
Neither of the two Eastman practitioners would discuss the cost of the system to their company, and moreover they both admit that their ROI expectations were less than concrete. Bailey says the company would like the system to pay for itself in 12 months, but he acknowledges that the return will be more subjective than for other technology systems. He will be looking for improvements in business processes and for an assessment from purchasing staff as to whether the Webango tool is better than the system they had before. It's a fuzzy number, Bailey says. You can't measure it. You can't put a gauge or a meter on it.
Nevertheless, Davis-Waltermire is confident that the system will prove its value, saying, The investment is well worth it when we start to look at the pain of not having a good contract [audit] trail. She notes in particular that as Eastman Chemical goes through the process of splitting into two companies - a chemicals and plastics company to be called Eastman, and a polyethylene terephthalate (PET) and fibers company to be called Voridian - the contracts repository will prove an invaluable tool for sorting out the legal obligations and supplier relationships of the new firms.
Nor did the absence of a concrete ROI stop Distributor Market Advantage (DMA) from undertaking an online contracts management initiative. ISource has covered the I-many's project with DMA, which is a $1 billion sales and marketing organization wholly owned by 14 independent food service distributors (see When the Contract Is King, the Links column in the August 2001 issue of iSource). In brief, DMA co-developed with I-many a contract management portal to link more than 200 manufacturers with the 14 distributors and a total of 25 food service operators that DMA serves. One need only multiply 200 by 14 by 25 to get a feel for how many thousands of agreements the DMA portal will handle once it is fully deployed, and a sense of the potential efficiencies that all the involved parties could achieve by moving away from using fax and e-mail to exchange contracts.
However, Tom Stewart, vice president of business development for DMA, says the company did not have set-in-stone expectations for the return on its investment in the portal: Our thinking was that we were simply going to reduce our operating costs by streamlining the [contract management process]. Did we do an exhaustive ROI? Not really. It was more or less a feeling that everyone had that it would definitely keep people happier in the supply chain at this point.
At the same time, Malcolm McAlpine, product director for food service at I-many and a veteran of the food service industry, says the solution provider will be working to define the hard-dollar savings achieved through the use of the portal. For example, with manufacturers, distributors and operators having access to the same information at the same time, all parties should see savings from reduced paperwork, less time spent chasing down contractual details and fewer errors.
Best Practices STILL EVOLVING
An additional consequence of the relative newness of contract management solutions is that the best practices associated with their application are still evolving. Naturally, as with any major software implementation, the first challenge is what AMR's Mitchell terms Change Management 101. McAlpine, for example, says that with contract staff straining to keep up with the ongoing flow of work, they have little time to devote to learning a new system.
For this reason, diCarta's Martin emphasizes the importance of selecting software that provides a usable interface, and he also says that organizations must realize that the new level of visibility the new applications bring to contract processes can entail a new level of responsibility, as well. For example, with the approval process online for everyone to see, bottlenecks in the approval process will become evident. In the past, that information was sitting on someone's desk, and it was not necessarily visible how long it sat on one person's desk versus another person's desk before it got approved, Martin says. With an automated contracts management system, it is instantly clear who is holding up the process. Is that good for the organization? Sure, but it's a cultural shift that must be managed, too.
Finally, trust could be an issue in cases when trading partners are being asked to put confidential contracts online. McAlpine says that the software providers must address this issue by demonstrating the security features built into their solutions to control access to privileged information.
Breaking the CONTRACTS BOTTLENECK
Will all purchasing eventually be done based on contracts negotiated and stored online? Probably not, or at least not for every company. For one thing, not every company will buy everything based on contracts. Eastman Chemical, for instance, expects to have about 1,000 of its suppliers working through its online contract management portal, out of a total supply base of more than 6,000 suppliers. On the other hand, DMA's Stewart is certain that eventually all his company's contracts will be online.
It also seems likely that the solution providers will move toward offering greater capabilities for analyzing a company's contracts, including by drawing greater information from financial, ERP, accounts payable and other back-end systems. As part of this trend, Mitchell foresees the emergence of a common datamart that will sit on top of multiple back-end systems, holding shared data from all those systems and allowing a company to perform spend analysis and supplier monitoring in conjunction with contract management.
Similarly, Martin, of diCarta, sees a convergence of buy- and sell-side contracts, as well as other agreements. We want to be the repository for all contacts, whether they are buy, sell, partner or employee agreements, he says. The theory is that all an enterprise's agreements contain information that could impact buying decisions, so the purchasing department should have visibility into sales contracts to ensure that procurement contracts align with sell-side obligations with regard to quality, delivery schedules and so on. This type of visibility would ensure that obligations filter back up the supply chain to the enterprise's suppliers.
Finally, Hnilo, of Menerva, believes that increased use of automation solutions will fuel a move toward standardization of contracts as companies work to remove the inefficiencies inherent in past practices and processes. If the ability to source, negotiate and do contract-based deals - either on the buy side or the sell side - is a bottleneck, companies aren't going to tolerate that because it will be too costly, he says, adding, Contracts can't be a bottleneck for doing business.
SIDEBAR: Conversation With a Contracts Pro
With more than 20 years experience in contract and procurement management, Linda Collins, CPCM, C.P.M., can rightfully be called a contracts pro. Currently, she is manager of contracts for Raytheon Systems Co., in Fort Wayne, Ind., supervising a group of contract managers and coordinating contract management training for her business unit. In addition, Collins is national vice president for membership of the National Contract Management Association. iSource spoke with her recently about contract management in the e-Business Age.
iSource: How has e-business changed the field of contract management?
Collins: It used to be that you would TWX [TeletypeWriter eXchange] something to someone, and they could respond a little more quickly than if you connected with them over the phone. Then we got into faxing, and now we're into corresponding by e-mail, which accelerates things more. With e-business, I see everything picking up. Everyone expects that, because our technology is so fast, everyone should be able to respond to requests just as quickly as they get them.
iSource: Are these new tools making the process of managing contracts more efficient, as opposed to just speedier?
Collins: It has made us more efficient. One thing I have seen over the past 10 years is that because we are taking up less time on administrative matters, we are able to get involved with more real business issues, the business of managing a program or managing a contract, versus just administering it. So we're getting away from the paper pushing and we're able to get involved more with the meat of the contract. And that is very positive for the profession.
iSource: And is that reflected in a change in the skill set required for people in the profession?
Collins: Yes, we're doing more strategic planning. In the past, we were lucky to have any time to plan at all. We were much more reactive, rather than being able to think about the strategies behind what we're doing. I see the profession moving more toward total business management skills rather than the perhaps more narrowly defined skills that you think of with a contracts administrator.
iSource: Where do you think the software won't be able to replace current contract management practices?
Collins: One of the things that you work on is developing a relationship with your counterparts. Whether you're getting together face-to-face or talking over the phone, you have a little bit more effective means of communicating and understanding the underlying meaning of the words. If you're doing that strictly electronically, you lose some of the flavor. I can see transmitting letters electronically and doing the general correspondence that way. But there is so much that still needs to be done person-to-person, because you can't work through - or it's more difficult to work through - the critical problems if you haven't taken the time to get to know the person and really establish a rapport with them.
iSource: Do you see the e-business solutions eventually being integrated into every organization?
Collins: I see us continually moving in this direction. Some organizations and companies are able to move a little more speedily than others, but I think that we will continue evolving in that direction. Everyone is trying to do business smarter, faster, cheaper, and certainly doing more business electronically helps with all that. My concern is that we don't lose the personal touch in our business dealings.