How Contracts, and Contract Intelligence, Can Help Manufacturers Weather Inflation

August 18, 2022

Inflation is hitting every industry, threatening margins in all sectors and countries. In the United States alone, the Consumer Price Index (CPI) climbed by an annualized 9.1% in June 2022, the highest rate seen in a generation.

For manufacturers, the pain is felt acutely on multiple fronts. In a recent PwC Pulse Survey, 68% of manufacturers believed inflation would remain high through the end of 2022, and 73% expected to raise prices to protect both gross and profit margins from the increasing costs of everything from raw materials to parts, components, and energy.

The good news, however, is that manufacturers have a way to protect themselves against inflation: contracts.

Contracts must be understood as a risk management tool critical to manufacturers’ response to inflation. Manufacturers can defend themselves from the worst effects of inflation by building in proper protectionary language and clauses from the outset and by realizing the intent of those clauses after execution.

Contracts are critical in responding to inflationary pressures

Inflation hits manufacturers on the buy side via more expensive raw goods; often, these goods are tied to commodity price indexes, making them hypersensitive to price adjustments. In other words, they are unavoidable. So, the question becomes: How can you manage this risk to your margins by adjusting suppliers or prices?

The answer to these questions is likely in your contracts. Many companies have language in their contracts regarding price adjustments—both around how much adjustment is allowed and at what frequency (annually, quarterly, etc.).

Yet having this language in the contract isn't enough. Companies must operationalize them to ensure their intent is fully realized—a challenging prospect when you have tens of thousands or even hundreds of thousands of contracts in play. Without visibility into which contracts say what, manufacturers may struggle to take advantage of the inflation protections they contain. This is money they are entitled to but is leaking from the business.

As inflation has become a crucial concern for businesses, most manufacturers will look at their standard contract language to ensure they adequately address inflation risks. Contract managers may arrive at the ideal language only to struggle to ensure that it is used in all new contracts. In other words, the risk has been identified but not managed.

Get insight into contracts to leverage their power

For these reasons, in today's marketplace, manufacturers must have systems and processes in place to ensure that the full intent of every contract—including clauses pertaining to inflation—is first correctly captured in the contract language and then fully realized in practice.

At Icertis, we call this Contract Intelligence.

With Contract Intelligence, companies gain a complete view of what's happening across their contract portfolios before and after signatures. Contracts essentially become another enterprise data pool that can be centrally managed and analyzed.

For example, standard price adjustment clauses—reflecting the latest strategy devised by leadership—can be instantly deployed across the company, along with fallback clauses in case counterparties push back during negotiations. Whatever language is used, a Contract Intelligence platform can track it and the associated risk, so nothing comes as a surprise.

Post-signature, manufacturers can push contract information into other enterprise systems. As a business operates, front-line users can be sure their actions (purchase prices, price adjustments, etc.) write back to the letter of the contract, driving compliance and eliminating leakage.

Most importantly, Contract Intelligence paints a complete picture of a company's commercial operations – every dollar in and every dollar out. If a supplier increases prices, manufacturers can quickly see what products are impacted and what rights they have in their sales contracts to share the price increases with customers.

Understand what's in your contracts and the steps to take

On paper, this may sound simple enough. But it is far from standard practice. For example, Icertis recently did a proof of concept around inflationary clauses for a European legal service firm.

Executives at the company came to Icertis because they were losing margin to increased wages in their workforce, but they couldn't effectively operationalize the effort of reflecting wage increases in their client pricing. This came down to contract visibility: The company had legacy contracts spread across its systems—from SharePoint folders to people’s hard drives.

By digitizing all these contracts with AI, Icertis analyzed more than 20,000 contracts to discovering inflation-related clauses. This gave executives a single view of their rights to adjust their rates with customers to reflect higher wage costs. What was once hidden leakage was transformed into a value lever.

Conclusion

Contracts are a risk management tool critical to how manufacturers respond to inflation.

Yet effectively using these tools doesn't just take good contract language but a system that allows you to understand what contracts say and how they operate in the enterprise.

By transforming contracts into structured, connected, and on-demand data, manufacturers can gain unprecedented levels of agility to respond to the current crisis – and whatever one comes next.