Contract value leakage costs companies 9 per cent of their bottom line on average. Find out what you can do to protect your business.
What is contract value leakage?
Contract value leakage describes a loss or reduction in the expected value of a contract. It occurs when the benefits or potential returns of a contract have diminished compared to what was originally anticipated or intended by the parties.
Another way to understand contract value leakage is to recognize how a contract loses value throughout its lifetime, comparing what a contract is worth at the point of inception, signature, and performance.
All businesses should be worried about contract value leakage, with research by WCC finding that it costs companies 9 per cent of their revenue on average.
What causes contract value leakage?
Organizations can experience contract value leakage for a number of reasons. However, there are a few common causes that your business should be aware of.
1. Weak contract terms and templates
Agreeing to contracts with unfavorable terms is one of the biggest causes of contract value leakage, with many companies settling on terms without negotiating and optimizing them.
Mistakes in the contract, such as missing clauses or incorrect terms, can also result in contract value leakage. This is because contracts with errors and omissions fail to protect parties from liabilities, making them more susceptible to financial losses.
This is more common in businesses without robust contract templates in place as individuals draft their own terms, rather than using terms pre-approved by legal teams.
2. Inefficient contract processes
Inefficient contract management processes can also diminish the expected value of a contract. This is because inefficiencies during the contract process can lead to increased operational costs and a lack of visibility into contracts throughout the lifecycle, which invites contractual risk.
For example, inefficient contract management processes can lead to drawn-out sales cycles, missed discounts, and a higher headcount. All of these things can make contracting more expensive, eroding the value of contracts as a result.
3. Scope creep
If the scope of work defined in the contract expands beyond its original boundaries, it can lead to increased costs and reduced value. This can occur due to changes in project requirements, additional deliverables, or unanticipated challenges.
Scope creep is a common cause of contract value leakage in construction contract management where the scope of work and associated costs can be challenging to accurately predict, resulting in unexpected costs.
4. Vendor or supplier performance
Contract value leakage can also occur when a supplier or vendor fails to meet the standards established for a product or service.
For example, if a company contracts with a supplier for specific high-quality materials, but the supplier delivers substandard, lower-value materials, this can have a knock-on effect for the buyer. It could mean that they have to sell them for less, or some of the materials won’t be used.
5. Market and economic fluctuations
External factors can also result in contract value leakage. For example, changes in market conditions or currency exchange rates can both impact the value of a contract. They can lead to unfavorable pricing, cost fluctuations, and reduced profits.
Although these fluctuations are difficult to predict and safeguard against, there are things you can do to futureproof your contracts. We’ll discuss these later in this article.
6. Lack of visibility into contracts
Poor contract visibility is another leading cause of contract value leakage. In particular, businesses often fall into the trap of missing upcoming contract renewal deadlines, or failing to perform their contractual obligations altogether.
This means that they can either find themselves trapped in contracts that have auto-renewed, or face the financial implications of a contract breach.
How to measure contract value leakage
The best way to measure contract value leakage is to subtract the actual contract value from the expected value of the contract.
Expected contract value - actual contract value = contract value leakage
The actual contract value is best measured post-execution, once the contract has been performed in full. The expected value of the contract is what you anticipate to gain from it when you first initiate the contract.
The difference between the two figures will give you the sum of contract value leakage.
6 tips to minimize contract value leakage
Fortunately, there are actionable steps you can take to minimize contract value leakage for your business, and most causes can be resolved using contract management software. Let's run through some tips to help you reduce contract value leakage in 2024.
1. Use automated contract templates to control contract terms
The first thing you can do to minimize contract value leakage is control the terms contracts are agreed on.
Rather than allowing your commercial teams to draft their own contract terms and edit templates freely, automated contract templates make sure teams only agree contracts on terms pre-approved and defined by legal teams.
This ensures that contracts are standardized throughout the organization to minimize risk and increase compliance.
2. Follow robust contract review and approval workflows
Businesses can also reduce contract value leakage by ensuring that contracts are reviewed and approved properly they are sent out for signing. This gives stakeholders a chance to flag any high-risk terms and replace them with more favourable ones. This is particularly important for more complex contracts, or contracts with a high contract value.
Automated approval workflows are a great way to make sure contracts are reviewed by the right people at the right time, and AI contract review software can make the process of conducting these reviews much faster and more efficient.
Juro's legal AI assistant makes it easy for teams to review contracts against their contract playbooks and flag key legal risks. To find out more, hit the button below to speak to one of our contract specialists.