Managing the obligations enshrined in contracts is central to controlling risk in an organization. Obligations are legally binding commitments made by one party to another, and missing these commitments can lead to adverse financial and regulatory consequences, revenue leakage and damaged business relationships.
Legal departments must take the lead in ensuring that their companies are being proactive in fulfilling their contractual commitments to avoid these risks.
Capabilities to discover, track and manage contractual obligations are necessary for companies to manage and reduce risk and get the most out of their contractual relationships. Yet like all things in business, such capabilities may be nonexistent or basic in some companies and very mature in others.
Here, we will discuss a model by which we can think about the maturity of obligation management. We summarize this obligation maturity model by its four steps: Ad-Hoc, Enabled, Regulated, and Optimized–or simply “AERO.”
With this model, legal departments can begin to think about how they can mature as an organization, and thus drive down risk and improve contract performance and relationships.
Why Adopt a Maturity Model like AERO
A business can improve only if it’s aware of where it stands and where it wishes to get to. A maturity model provides a framework for internal discussion and brainstorming. It also provides an opportunity to leverage the experience and expertise within the organization, and an impetus to prioritize change over the status quo. It helps the organization build toward its long-term goals.
Maturity models can at times be found wanting if they aren’t based on adequate evidence and weak analysis. So to come up with the AERO Obligation Maturity Model, we looked to harness our experience with millions of contracts and customers across every vertical to see how the best organizations evolve and enhance their obligations management capability. We have tried to distill that learning into a simple four-level maturity model that we hope will help organizations better manage their obligations, risks and opportunities.
Maturity Level 1: AD- HOC
The most basic level of obligation management is ad-hoc. At this maturity level companies are generally aware of their obligations but do not have an automated or comprehensive way to manage them.
Each contract requires special attention by highly skilled subject matter experts, making obligation management extremely expensive and inefficient. At the same time, there is no way for managers to gain a global view on how the organization as a whole is doing at managing obligations.
Indeed, we call this maturity level “ad hoc” because managers are left to reinvent their obligation management system with each new contract, with no shared best practices or procedures across the organization. The results are costly mistakes, damaged business relationships and poor use of time.
Maturity Level 2: Enabled
Companies that have matured to an Enabled level of obligation management have basic systems in place to identify and track contract obligations. For example, contract managers may pull obligations out of a contract and place them in a worksheet that helps them understand the milestones they have to meet to stay in compliance.
While this is a major improvement over the Ad-hoc stage, we still see many of the same problems. Extracting and tracking obligations is done on a contract-by-contract basis, which is extremely costly and time-intensive. While systems are in place to limit missed obligations, there is still no way for companies to gain a global view of outstanding obligations and model how well they are doing with fulfillment (cycle times, fulfillment rates, etc.) across the entire body of contracts.
Maturity Level 3: Regulated
At the Regulated stage of obligation management, we start to see companies taking advantage of automated processes to enforce consistency in how they handle contracts and thereby maximize value and drive down risk. Best practices and procedures are “built-in” to the process so that contract managers aren’t reinventing the wheel with each new contract.
We also see manual workloads decrease while compliance and visibility increase. With the help of contract management software, companies at this maturity can identify obligations and have a comprehensive view of their outstanding commitments and fulfilled obligations. Anomalies and at-risk obligations are flagged for review so companies can proactively intervene before damage is done.
The result is less risk and better outcomes, achieved with less manual contract management, enabling contract managers to focus on more strategic initiatives.
Maturity Level 4: Optimized
At the pinnacle of the AERO model is a state in which companies are extending their Regulated contract management process into other systems and are running advanced analytics over the data for deeper insights into obligation fulfillment and the transactions that affect them. Management of the obligation’s entire lifecycle is automated and fully visible.
These companies typically take advantage of software that connects obligations to transactional systems like the ERP, SCM or HR systems to track obligation fulfillment in real time. They also put an emphasis on dashboards that model workflows so managers can understand how obligations are being fulfilled and identify areas for improvement. Complex dependencies become visualized and thus manageable. And as the full lifecycle of the obligations are captured, improvements can be made to future contract language.
Organization with Optimized obligation management use AI/Machine Learning models trained on terabytes of contract data that can help discover obligations and their relationships, and managing them to fulfillment, ensuring that transactions off the contracts adhere to these obligations.
On the ground this leads to optimized relationships with customers, suppliers and partners, bringing various parts of the business together; at an executive level, we see contract data become a barometer of enterprise risk and performance monitored by the c-suite and the board.
The Promise of Optimized Obligation Management
When we step back and consider what the progression up the AERO framework from Ad-Hoc to Optimized means, it can be summed up as: In an Ad-hoc stage, the contract is a static document that you have to constantly go back to in order for any value to be derived from it; in reality we know that contracts are often entirely forgotten until problems arise. With Optimized obligation management, the contract becomes the nerve center of the enterprise, a living document that acts as a single source of truth for a company’s commitments, risks, opportunities and performance.
While contracts are nearly as old as civilization itself, the ability to extract and manage obligations as discreet entities that enable transactions within other systems is a fairly recent phenomenon enabled by AI and computer science. We are only beginning to see the full potential of what a contract can do for a company if managed and optimized on a digital platform.
To discuss where your company falls in the AERO framework, please contact an Icertis contract management platform specialists today.
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