Strategy

Contract Automation: Digitizing the Party of the First Part

Companies turn to Web-based applications to better manage corporate contracts.
Jennifer CaplanOctober 17, 2001

Over the past decade, software designers have spent a good deal of time developing Web-based applications that automate just about every aspect of the buyer-seller relationship. But the creation of the agreements that bind those relationships — contracts — has largely been ignored by application vendors.

The result? Producing and storing legal documents remains as big a pain in the neck as it was 30 years ago. Indeed, you’d be hard-pressed to find a senior executive who isn’t familiar with the contract drill. Draft a proposal. Negotiate. Redraft. Negotiate some more. Dig through endless filing cabinets to unearth earlier versions of the contract. Insert riders. Express mail. Fax infinitum.

This paper trail of tears may soon be coming to an end, however. Over the past year or so, startups such as DiCarta, I-Many, MyContracts, Webango, and TradeAccess have launched browser-based applications that automate the creation and management of legal documents. What’s more, financial software heavyweights such as Oracle, SAP, and i2 Technologies have also come out with contract automation systems.

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While a number of these applications automate specific parts of legal document creation, others manage the entire contract lifecycle — from proposal and negotiation, through analysis, approval, and execution, to management and renewal. Some contract management programs go even further, tracking terms and conditions, as well as the relative profitability of different agreements. A few apps even prompt users through contract-negotiation steps and automatically issue checks to customers and suppliers when contracts go into effect.

This digitizing of corporate contracts makes a lot of sense in a digital economy. Mary Barth, Atholl McBean Professor at the Stanford University Graduate School of Business, notes that the increasing corporate reliance on outsourcers, application service providers, and electronic marketplaces has put a premium on the handling of contracts. ”Automation has become important because more and more relationships are being documented in contracts,” she says.

In addition, commercial documents have become more complex, as companies attempt to cram rebates, chargebacks, and refunds into service agreements. ”Managing contracts and breaking them down into pieces becomes more complicated,” asserts Barth. “It is inconceivable to me that managers at any reasonable-sized company try to do this by hand.”

Now Entering the Forgotten Land

They do. Surveys show that 99 percent of companies still don’t have electronic or automated contract management systems in place. While many companies use spreadsheets to track agreements, few have the technology to extract and compare the content of thousands of contracts. ”Most companies don’t have an early warning system, or the ability to compare contracts,” notes Michael Evans, a partner in Ernst & Young’s strategic investment division. ”It’s really the forgotten land.”

A trip to that land usually involves a tour of the Hanging Folders of Babble-On. Indeed, sifting through endless files to ensure contractual compliance remains a monumental task for many medium-to-large sized companies. This probably explains why most businesses simply let their contracts collect dust.

Not an ideal approach to managing information — which, after all, is what contracts are. Although a large percentage of companies deploy enterprise resource planning (ERP) software to automate back-office operations, most of those systems enable users to refer to a contract only as part of a sales or purchase order. As David Boulanger, an analyst at AMR Research, points out, ERP systems typically do not store contracts down to a line-item level ”The reason why some of these contract automation systems are so interesting is that they give each line item in a contract a life cycle,” he says. ”It gets negotiated, formalized, monitored, reviewed, and renewed.”

Users can then drill down into specific line items by going into an imaging program that produces the actual physical contract. That sort of zoom in, line-item view can help cut costs, says Ernst & Young’s Evans, whose company began rolling out a contract automation application in August. Evans believes the software, from MyContracts, will help the consulting giant reduce blunders. At the top of the list: avoiding missed deadlines. As important dates approach, the software automatically alerts the necessary employees to take action. ”When a renewal date for workman compensation insurance is coming up, for example, the right people need to know that so they can go out 60 days before the contract ends,” notes Evans. ”Otherwise you’ll be left without insurance.”

Remarkably, a lot of well-managed, technologically savvy companies make this type of mistake — mostly due to archaic contact management practices. And some of those mistakes can be costly. ”Many of our real estate contracts have options to take extra space at certain beneficial rates within a given window of time,” Evans says. ”If we don’t exercise those types of options, then we can lose out on multimillion-dollar opportunities.”

Another benefit of storing contracts in a browser-enabled database: All the parties who access a contract, including lawyers, procurement managers, and salespeople, have access to a uniform body of information. In a paper-based world, explains Evans, different people involved in the process might have different versions of a contract with attached amendments. By his lights, that’s a recipe for disaster.

Some contract automation software also helps managers distinguish between profitable contracts — and less-lucrative agreements. ”Whether we’re buying materials, benefits, or equipment, our managers need to know they’re buying at the lowest possible cost,” says Evans. “There is a function in MyContracts that allows us to bring in competitive bids before our contracts expire, which gives us some assurance that we’re not paying the absolute highest price.”

But What about the Sanity Clause?

While CFOs love saving money, they’re also keen to stay on the right side of regulators and shareholders. Toward that, some contract automation programs monitor revenue recognition practices and enforce compliance with generally accepted accounting principles. As CFO.com noted in “Revenue Recognition: The Subsidiary Made Me Do It,” the SEC has stepped up enforcement of revenue recognition regulations since releasing SAB 101 in 1999.

According to Scott Martin, CEO at contract automation application vendor DiCarta, software can make it easier for finance executives and internal auditors to assess whether the language in a contract has been properly translated into revenue schedules. He says many finance managers get into trouble when they use a revenue recognition method that conflicts with the intent of the original agreement.

DiCarta includes a revenue management application that automates the revenue scheduling process by extracting information directly from contracts. Once a month, after a company’s books are closed, employees in the finance department can use the system to determine the proper amount of revenue that should be recognized that month. The information, in turn, is fed directly into a company’s accounting system. ”Obviously, it’s much better to get things recognized properly in the first place than to rely on an internal auditor to find errors after the fact,” says Stanford’s Barth.

In addition, contract automation software generally affords senior managers better control over who has access to contracts — and what changes they can make. ”Controls can work more effectively and efficiently through a computerized system,” insists Barth, ”since it will not allow a clause to be changed, for example, until the people with the right password have said it’s OK.” What’s more, the digitizing of corporate contracts enables managers to look at the entire history of the document — a real plus for long-term contracts. ”Anyone along the way, given proper authority, can actually pull up the contract and the comments and the workflow that has gone into it,” says Boulanger of AMR. ”They can figure out what the thought process was behind the contract negotiation and formalization process.”

Several vendors are working on more-robust versions of their existing contract automation applications. Industry experts say that upcoming releases will include alert functions that are more full- featured. ”They will be able to alert you when something is misaligned,” says Boulanger, ”or when there are any irregularities.” That’s a big change. For the past 30 years, it’s been simpler to alert corporate managers when there hasn’t been an irregularity in a contract.