Nearly every vendor purchase or customer sale involves a contract. The contract will include legal conditions of a purchase or sale, such as the price paid and the goods or services to be received. Some contracts are more extensive than others, particularly those that involve high-value items or extend over lengthy periods.
All kinds of organizations use contracts in their business operations. However, it can be quite the task to manage contracts, especially if yours are complex or you have a small team that oversees them. Fortunately, you can leverage contract performance metrics to increase efficiency, streamline operations, and reduce potential risks of non-adherence to contractual obligations.
How Contract Metrics Drive Better Business Outcomes
Many organizations use key performance indicators (KPIs) to set business goals and measure performance. KPIs are helpful in every department, including marketing, finance, and sales. Managers and stakeholders can establish specific objectives and hold responsible parties accountable for achieving them.
Contract management key performance indicators follow the same concept as other metrics. Essentially, the contract manager sets a specific goal and deadline. They assign someone (or a team) responsible for achieving contract management KPIs, then measure performance using data or some other resource. This makes the contract process much smoother and success more measurable.
An organization can implement a solid contract performance management system to focus on optimizing revenue and expenses to align with desired business outcomes. Since the goals are identified and employees understand the expectations, they're prepared to make informed decisions. If you're on the hunt for contract management tips, KPIs are a great way to measure success.
Key Contract Performance Metrics
Selecting a KPI for contract management starts with understanding the content of your business contracts. Collaborate with everyone involved in contract management processes, including:
Contract managers
Legal teams
FP&A (Financial planning and analysis)
Revenue managers
Each team member can provide valuable insights about existing contracts to help you decide on effective contract management KPIs. Here are a few common KPIs that may apply to your business.
1. Contract Compliance Rate
The contract compliance rate evaluates how frequently the parties involved adhere to its terms. A high contract compliance rate reduces legal risk since parties are less likely to take legal action if all contract conditions are met. If the contract is between a business and a client, fulfilling all the contract terms can go a long way to strengthening ties and developing trust.
To calculate the contract compliance rate, use this formula:
[(Total number of contracts - Non-compliant contracts) / (Total contracts)] x 100
Say you have 500 contracts and 10 cases of non-compliance. Your contract compliance rate formula would be:
[(500 - 10) / (500)] x 100 = 98%
If your contract compliance rate falls below your expectations, set a target goal and identify ways to achieve it.
2. Time to Contract Closure
Some businesses have complex sales contracts that require time to close. If that's the case for your organization, consider tracking the time to contract closure metric, and tracking contract cycle times. Essentially, this monitors how long it takes (on average) to close a new sales deal. The shorter your time to close, the more efficient your sales team is — and the faster you'll start seeing the revenues from a new deal.
To measure the time to contract closure, implement a two-step formula.
Calculate the days required to close each deal within a period, such as a quarter. The formula is simply Close Date - Open Date. The close date reflects the day you received a signed customer contract, while the open date is when you began negotiations or obtained the sales lead.
Determine the average contract closure during the period. Tally up all the contract close times, then divide by the number of contracts closed.
Say your sales team closed three deals last month. The first and second deal took 15 days to close, while the third deal was finalized in five days.
The average time to contract closure is:
(15+15+5) / 3 = 11 days
3. Contract Renewal Rate
Measuring your organization's contract renewal rate sheds light on the effectiveness of your renewal strategies and the loyalty of your customers. The higher your renewal rate, the more likely future customers are to stick with you for the long term. If your renewal rate is lower than you'd like, determine where your organization falls short of customer expectations and work to improve them.
The formula for the contract renewal rate is:
[(Number of customer renewals) / (Total potential contract renewals)] x 100
As an example, assume you renew 80 contracts from a pool of 100 eligible renewals. Your percentage of contracts renewed rate is:
[(80) / (100)] x 100 = 80%
This gives you an idea of how effective your contract lifecycle is and how likely customers are to remain with your business.
4. Spend Under Management
Most businesses set a budget for their expenses. However, spending can exceed designated amounts if not managed carefully, adversely impacting financial performance and future business operations. To keep control of your organization's spending, designate approvers to manage costs and avoid going over budget. The spend under management metric can tell you how much business spending is done through the approval process and how much isn't. The higher your spend under management, the more control you have over procurement.
To calculate spend under management, use this formula:
(Total procurement-managed company spending / Total organizational spend) x 100
Say you have $800,000 in spending designated to procurement managers but $950,000 in total expenditures for the period. The calculation would be:
(800,000 / 950,000) x 100 = 84.2
Your spend under management is 84.2%.
5. Vendor Performance and Satisfaction
Vendor performance metrics measure how well your vendors fulfill their end of a contract and whether they meet your expectations. High vendor performance and satisfaction ratings indicate a positive partnership for your organization. Lower ratings indicate it may be time to look for a new vendor.
There is no single metric to evaluate vendor performance and satisfaction. Instead, you can establish metrics based on the type of contract you have with the vendor and what they provide. Some example measurements you might consider include:
Vendor responsiveness
On-time delivery rates
Profitability margins
Leverage Technology to Track Performance Metrics
While it's possible to establish a contract performance system and evaluate metrics using basic spreadsheet software, it's inefficient. Complex and lengthy contracts can hinder the process, and time constraints can make it impractical for your team to stay on top of their contract performance evaluations. Instead, consider investing in a dedicated contract analysis tool like Terzo.
Terzo is an AI-powered contract management software that extracts key contract data and visualizes it in a simple, easy-to-follow format. It includes a robust analytics platform you can customize with your most vital contract metrics. To learn more about Terzo and how it can enhance business goals, speak with our sales team today.
