This article provides useful information about contract risk management for SMEs. It will help you manage your risks like big companies do!
Give a contract to anyone to read and see what they comment afterwards…
Most of us will find this a boring exercise, not sure what to look for. About half of us will find the contract conditions “quite OK” and the other half “absolutely unacceptable”. This has more to do with the personality of the reader than the actual contract conditions:
- optimist vs pessimist;
- combative vs accommodating;
- more trustful or rather suspicious; etc.
Unless you are a contract expert with a solid experience and capacity to compare, in your head, against benchmark contracts, you will have a hard time to give a solid opinion and identify risk areas after a first reading. And, how many of us go for a second reading…?
How big companies work
Big companies have lots of staff to analyze contracts. The commercial manager will look at the overall picture and will be supported by the legal department and several specialists (fiscal/tax, finance, insurance).
They will systematically set-up a risk review process. The team shall identify (probability & impact), quantify (risk provisions), track and mitigate risks. And, last but not least, validate the risks that have to be taken by the company in order to secure a good deal.
Contract Risk Management for SMEs
Step 1. Set-up a Contract Risk Scoring tool
What can you do as a small or medium sized company (SME)? … Certainly not recruitment, like big companies do! Then, how can contract risk management for SMEs be done without additional resources?
Having commercial managers with a broad enough spectrum is the objective, but also a challenge. A good start is to have your commercial manager fill-out a questionnaire to score the contract risks. As an example, you can look at TRaCRs, an on-line free-of-charge tool, accessible at the following link:
The best is to set-up your own tool. With twenty questions, you can typically cover the whole spectrum of commercial and contract risk. The person analyzing the contract in your SME just has to select the most representative answer from 6 multiple choices, corresponding to risk levels from 0 to 5. You will also be able to establish the Contract Risk Score for the overall project.
Step 2. With the Contract Risk Scoring report, you can hold Contract Risk Management Meetings where decisions are taken
Based on the report you get from Contract Risk Scoring, good practice is to set-up a review board including the managers that will execute the contract and that are capable of judging the overall risk.
During this meeting, you will typically start with “red flag” issues. These are the ones with a rating of 4 and 5. The team then tries to mitigate the risks, working down the list towards the lower ratings (that naturally need less attention). You can:
- while still in tender stage, consider to include a deviation to the contract in your offer.
- look for mitigation measures (e.g. establish an action plan to avoid that the risk materializes; find measures that will keep the consequences of a risk event under control; sometimes insurance can be considered).
- provision a sum to cover the (non-mitigated) risks based on their probability of occurrence and impact.
- build a consensus within your team on risk-taking, which is a good foundation for successful project execution.
Step 3. Use the project’s Contract Risk Score for bench-marking
The Contract Risk Score for the whole project is a very valuable metric:
A score of below 30 means the contract has low risk. An example of this are projects with World Bank conditions. Between 30 and 50, we find the projects with moderate contract risk. Above 50, we can speak of a high risk project that should be followed-up with special care.
With the Contract Risk Score, you can compare all projects in your portfolio on an objective basis and manage the portfolio accordingly (e.g. for the establishment of priorities and the allocation of the resources).
Next steps & conclusion
If you find that the above-mentioned questionnaire doesn’t match with the risks your company is facing, you can write to us (firstname.lastname@example.org) and ask for a more adapted version. You can also set-up a workshop with your team to brainstorm on your specific SME project risks and establish your Contract Risk Scoring questionnaire as an outcome on common grounds.
Sooner or later, contract risk management will be a MUST for all SMEs to show good governance (for example when raising funds / borrowing money from banks). To be a successful company in the-long-run, pro-actively managing your risks is essential. So, better to start asap and not miss the boat!
AfiTAC.com is the blog on commercial and contractual subjects for the Project Businesses (Construction, Infrastructure, Oil & Gas, Power & Renewable, Water Supply & Sanitation, etc). Its objective is to stimulate reflection, learning, convergence to balanced contracts and positive dispute resolution. You can subscribe to our newsletter by writing to “email@example.com”. You can also connect to our LinkedIn page. Engagement with the readers is what keeps us going. So, don’t hesitate to exchange with us by commenting here below, liking our publications on LinkedIn and writing to us ” firstname.lastname@example.org “.