Why Month To Month Contracts Beat Long Term Contracts

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 Traditionally in service businesses, it’s the job of the sales person to get as many months contracted in for a client as possible. However, looking at my own data on month to month versus fixed term contracts (3 months, 6 months, 1 year) for the last 5 years, there doesn’t appear to be correlation between length of contract and lifetime retention of a client.  In fact, there seems to be quite a bit of evidence that month to month agreements last longer and have a higher sales close ratio.

The following of course only holds true if you are delivering on what you sell. If you are a company that provides little value and rely on enforcement of contracts as a means of survival, you may as well stop reading now.

There are several reasons why I believe month to month contracts are typically better to sell than fixed period contracts:

  1. 1. If a company is Non-public and not governmental, your recourse is often limited even if the client defaults or wants to cancel an agreement. How much money and time are you really going to spend enforcing contracts that have values of less than $100k? It would cost more to collect it than just let it go.
  2. 2. If a client does not like what you are producing in terms of work and want out of a contract early, and you don’t let them, you are going to open yourself to potential online reputation problems and negative reviews. Which in this day and age is very hard and costly to fight.
  3. 3. The sales close ratio on month to month contracts versus fixed term is much higher because the perception of it is “I can get out whenever I want if they don’t deliver”. Again, as long as you are not over selling your service, and are selling to the right audience, you should not have an issue retaining.
  4. 4. Fixed termed contracts have an end date, so the accounting department is usually imputing the PO as a fixed-time PO. Once the time is up, your point of contact is reminded of this by accounting, and you have to re-negotiate terms again and go through financial approval processes. If it’s a month-to-month agreement, the PO stays open ended and you don’t need to worry about re-selling it every year.
  5. 5. If a client does not have the finances to pay you, whether you have an iron clad contract or not, you won’t get the money. So what is the point of having it?

The only time that contracts may be important for the service industry is:

  1. 1. It’s a governmental or large public company that you are signing an agreement with. These can sometimes be sold to other companies.
  2. 3. You are getting financing against contracts (PO Factoring or Receivables Loans).
  3. 4. You are planning on selling your company in the near future. SOMETIMES, Acquirers find value in this, but I am seeing this as a factor less and less.