Transferred Costs

Badly drafted or inappropriate contracts produce unnecessary costs for a business. But the worst of these is transferred costs.

Imagine you are running the procurement department of a large company.

The company’s law department produces the contract templates that procurement uses, but that is the extent of the law department’s involvement. Negotiating those contracts is carried out by procurement with just about zero involvement of the law department.

And that’s where the problem starts.

Lawyers are risk averse, and the law department will typically populate the contract with clauses that are intended to protect the company in every conceivable circumstance. This approach saves the law department time and money (they don’t have to think about real, likely risks), and it saves them from having to make a judgment call on what risks to address and which ones to ignore.

But this approach just pushes the problems further downstream. Those unnecessary clauses wind up the people you are trying to buy from, and you and your procurement colleagues spend a lot of time defending them.

The procurement team – typically smart people and expensively trained – are now spending their time arguing unimportant contract clauses on typically low-value contracts. Why typically? Because there are always more low-value contracts than high-value ones, and arguing over a low-value contract is just as time-consuming as arguing over a high-volume one.

The opportunity cost to the business is huge. The time spent on low-value contracts means those contracts which are really significant to the business – and where procurement’s involvement would really add value – are neglected.

Poor contracts produce cost. But of all these costs, the most pernicious is the transferred cost.

3 December 2024