The development and manufacturing of any given product has numerous suppliers and contracts associated with it. Supplier contracts for labor, equipment, materials, logistics and many other categories have complex and variable contractual elements. Labor agreements alone have many elements that make up “cost” – everything from statutory taxes to insurance to rising hourly fees. All variable components combined contribute to the cost of a product or service and can easily get out of hand.
It doesn’t have to be this way. A contract compliance audit can help consumer goods (CG) companies gain a clearer view into their contracts and how they are actually implemented. The goal is to proactively address root causes of contract issues by tightening contract language or changing processes to ensure they don’t continue, which leads to recoverable overcharges as well as future cost savings – and continued profit back to an organization’s pocket.
Controlling Costs and Improving Margins is Imperative For CG Companies to Remain Competitive
CG companies comprise one of the largest sectors in North America and are valued at close to $2 trillion. Competition among CG companies is strong as there is a continuous fight for shelf space as consumers frequently switch brands based on cost. As such, procurement teams must be on the lookout for ways to control costs and improve margins, while increasing their competitive advantage.
Typically, procurement teams and their suppliers negotiate contracts and lock them into place for two or three years, sometimes without a second thought. During that time, the parties behind the initial contracts may no longer be involved, and the way contracts are implemented can change significantly. This can all lead to unnecessary spending for the CG company.
One of the sessions that took place during the 2020 PRGXchange was entitled Managing Financial Complexity in a Dynamic Environment. During the discussion, a senior leader from a leading beverage company pointed out that contracts written up to three years ago may no longer meet the needs of the current operating environment, thereby creating gaps in supplier performance, and increasing risk and the need for flexibility. Take, for instance, changes in the market stemming from the pandemic.
The importance of governance and controls was readily apparent, even as flexibility was often needed to keep supply chains running. Due to changing circumstances, some suppliers wanted to be paid upfront or earlier than previously established payment terms. While concessions were likely made on both the supplier and customer sides during this unprecedented period, it will be necessary to re-examine the original terms, conditions and most importantly – intent – of standing agreements as business environments return to normal.
Discover Breakdowns to Recover Profit
Needs change during the life of most contracts, and a contract compliance audit can uncover root causes of lost profit. CG companies can use these insights to take a proactive approach to improving contract management and mitigating key risk factors through governance, while ensuring compliance to contract terms and conditions.
Several breakdowns were discovered during a recent facilities management contract compliance audit on behalf of a Fortune 100 company. The facilities management supplier miscalculated cost-based labor rates, billed labor that exceeded payroll costs, excessively marked-up travel expenses, billed for unauthorized charges and incorrectly charged for general liability insurance.
Over a three-year period, the audit identified corrective actions that exceeded $6 million and realized historical cash recoveries of $1.4 million. This might not seem like much against a supplier with annual billings of $160 million, but financial leakage eats into profits, period. Plus, the discovery of these issues enabled corrective action to ensure similar mistakes don’t reoccur.
Get Help from a Seasoned Contract Compliance Audit Provider
The aforementioned company, and many others, realize the vast number and variability of supplier contracts make it problematic to know whether agreed-upon terms are being met.
Since many procurement teams focus on contract negotiations, enforcement can become a distant priority, sometimes never getting a second look while things like rebates, interest and penalty payments go unnoticed. This can lead to lost revenue and processes that will ensure similar mistakes are made over and over.
To prevent this from happening, the best course of action is often finding a third-party audit provider that is both experienced and well-versed in contract compliance audits. The selected audit provider should specialize in contract compliance audits and demonstrate it has the experience to work with your strategic suppliers. It should not only know how to look for financial recovery opportunities but also know how to address underlying issues that include complex, conflicting or ambiguous contract language.
Look for a contract compliance audit provider that digs deep beyond the obvious mistakes. An experienced audit provider will be skilled in discovering hard-to-find issues and identifying the root causes of errors to help mitigate this type of leakage in the future. With supplier invoices being submitted by the thousands, a third-party review can help identify errors and noncompliance with contract terms and conditions.
A thorough contract compliance audit can help mitigate risk by identifying opportunities to improve contract language and finding the cause of profit leaks. This will lead to future cost savings, compliance and encourage an improved culture of audit oversight that benefits all parties involved.