Contract Compliance
Contract Compliance is a KPI (key performance indicator). Having many vendors under contract has several benefits, such as cost savings and risk management, making agreements about invoice efficiency and ensuring deliveries. The position of a commodity in the Kraljic Matrix and the size of the commodity (ABC Analysis) determines the type of contract or agreements desired for a commodity. In this blog these subjects will be discussed and a new way of analysing, the 'contract compliance efficiency matrix', is presented.
Definition
Contract compliance in ISPnext is defined as 'all expenses within a contract' and is expressed as a percentage of total spend. On the market there are companies with contract compliance up to 80%. More important than a single value for contract compliance is the contract compliance over time (figure 1). Per company or industry it can be discussed if that 80% is feasible. Another point of discussion is whether non-influenceable commodities should be part of contract compliance as a KPI. And finally, there might be commodities where the purchaser should have more freedom to go for the best price. Government organisations which have to comply with tender laws have less freedom when it comes to contract compliance. It can be concluded that many nuances can be made when it comes to contract compliance and that a choice should be made per industry, company and commodity.
Contract compliance efficiency
To have insight into the contract compliance per commodity, in ISPnext, there is a chart called 'contract compliance efficiency'. In this chart the commodities are plotted with on the x-axis the 'contract compliance' and on the y-axis the 'relative number of vendors with a contract'. When analysing this chart it is clearly visible if contracts with vendors are effectively used. The matrix is divided into four quadrants, and per quadrant the use of the contracts per commodity is evaluated.
Efficient (High realisation within contract, low percentage of vendors with contract)
The contracts are used well and this is efficient. This is the quadrant for most companies to have the highest numbers of commodities. It is good to do business with several vendors to spread risk, but to still have the majority of the spend inside contract which is the case for the commodities in this quadrant.
Super Optimal (High realisation within contract, high percentage of vendors with contract)
At first this might look like a goal to pursue but it is questionable if this is necessary. To do business with several vendors is good to spread risk but it is not efficient to have a contract with each and every vendor. Only for companies with a very large underlying risk would this be the desired quadrant to have the majority of the commodities. An example could be a company which operates a nuclear power plant, where national security is an issue.
Inefficient (low realisation within contract, high percentage of vendors with contract)
There is a large percentage of contracted vendors. It looks like the organisation is doing well, but there isn't that much spend inside contract. This is inefficient purchasing. There can be several causes for this problem. It can be the case that contracts are unknown within the organisation, the contracted vendors cannot supply the goods needed
or there is a lot of 'maverick buying' within the organisation. There are probably many opportunities to improve.
Potential (low realisation within contract, low percentage of vendors with contract)
There are only few contracts for the commodities within this quadrant. There is a lot to gain considering contract compliance.
With the contract compliance efficiency matrix an organisation will have insight into the current situation. To determine whether or not there should be a high contract compliance within the commodity the Kraljic Matrix is a useful methodology.
The influence of the Kraljic Matrix and ABC analysis on contract compliance
ABC analysis
The ABC analysis can help to select the vendors to have contracts with when enhancing total contract compliance is a goal. When all A vendors are under contract, there is spend of 80% under contract.
Kraljic Matrix
By looking at the position of the commodity in the Kraljic matrix, it can be determined what the importance of having a contract is and what kind of contract it should be; what will be the important contract agreements. Per quadrant of the Kraljic matrix the effect on contract compliance is discussed.
Non-critical items
Non-critical items are easy to purchase and have no large influence on the company result, there shouldn't be too much hassle. Combining vendors is a goal as is making contract agreements on the performance of the vendor like delivery reliability and invoice efficiency.
Strategic and bottleneck products.
Because there is a large purchase risk for these commodities the insuring of volumes by making contract agreements is important. For these commodities a high level of contract compliance should be aimed for.
Leverage products
These are important commodities for the company, but are also easy to purchase. It is questionable if closing contracts is always necessary. Purchasers may have more space to use their buying power when they are not restricted to contracts.