Contractor motivations, constraints and decision-making patterns

implications for project management

University of Kentucky

Technical, cost, and schedule uncertainties in high-technology projects typically require a high degree of client-contractor cooperation if project success is to be achieved. In particular: mutually acceptable and feasible goals must be defined; planning and control systems which foster joint communication and problem-solving must be established; achievable and motivating performance incentives must be developed.

However, the ability to accomplish these project management tasks depends on the responsiveness of the contractor. For instance, to be truly effective a performance incentive must be consistent with the contractor’s primary motivations in bidding on the contract — and these motivations are frequently more complex than simple profit maximization. Additionally, such incentives should be matched to the contractor’s ability to be responsive. The project manager’s authority, the nature and style of his organization, and his ability to command needed resources will shape and limit his ability to achieve the performance standards required to obtain incentives.

Accordingly, contractor evaluation systems must be designed based on an understanding of those constraints and motivations which influence those contractor decisions and activities related to performance goals and incentives. Similarly, an understanding of these factors is also important in designing and maintaining effective planning, control systems. That is, the success of a given cost-schedule control system depends (at least in part) on the contractor’s motivation to make it operationally effective and on the organizational and managerial constraints which may limit its effectiveness.

The objective of this paper is to identify those factors which influence contractor motivations and which constrain contractor actions regarding performance goals, incentives, and planning and control systems. By understanding how such motivations and constraints influence contractor decision making patterns, the client will be better able to select project management tools which will achieve the responsiveness and coordination needed to attain project goals.

In order to understand and predict the primary motivating factors for a given client and to become aware of other forces influencing contractor decisionmaking patterns (especially, the ability to be responsive), several important dimensions of the contractor/project environment must be analyzed, such as:

Contractor Motivations and Objectives

The Contractor’s Financial Environment

The Contractor’s Organization

“Other Business” Constraints

Constraints on Cooperative Interaction

Project-specific Constraints

Contractor Motivations and Objectives

Contractor motivations represent the long-term requirements imposed on a firm by managers, employees, clients, and stockholders. Such requirements are met through undertaking a number of contracts of various types over time.

Past research on contracting leads to the following list of possible kinds of motivations: [See (1), (8)].

• Organizational survival;

• Organizational growth and development;

• Maintaining present and future sales volume;

• Minimizing working capital requirements;

• Protection of corporate reputation;

• Maintaining and developing personnnel and technical capabilities;

• Advancing organization’s level of technology;

• Covering independent R&D expenses;

• Obtaining technical spin-offs for other business.

These have been summarized as motives which reflect the desire for effective control or “mastery” of contractor operations and environments (1). This mastery is comprised of two basic elements:

• Avoidance of risk and uncertainty;

• Maintaining the ability of the organization to control its own fate and facilitate expression of the technical interests of its personnel.

A fundamental result of this research is the notion that the specific objectives which a contractor attempts to attain on a given project will be influenced by extra-contractual motivations. Essentially, this concept suggests that contractor managers and personnel are often motivated by factors other than profit. Further, the rate of profit obtained on a given contract is viewed as subservient to other objectives as long as the economic viability of the firm is maintained. Finally, the concept suggests that when confronted with the option of achieving profit from either higher technical performance or lower cost, the former path will be selected.

One illustration of the specific contractor objectives which may develop is provided by Hunt, Rubin and Perry (3). In investigating the NASA acquisition process, these researchers attempted to determine contractors’ views on what the contract should accomplish. A summary of contractor importance ratings yielded the following rank order:

1. Foster quality performance;

2. Reduce contractor risk;

3. Safeguard proprietary interests;

4. Offer operational flexibility;

5. Stimulate government-contractor communications and work relationships;

6. Motivate cost control;

7. Yield a high profit;

8. Reduce government technical direction or surveillance;

9. Foster program discipline on methods and procedures.

While few firms showed significant deviations, this ordering tended to hold across large and small contractors.

Accordingly, it can be suggested that the basic motivation faced by a specific contractor will influence the determination of the specific objectives a contractor will pursue on a given project.

In turn, the contractor’s primary objectives will influence his decision-making patterns regarding responsiveness to client goals; to contractual incentives on various performance criteria; and to any client-imposed control systems.

The Contractor Financial Environment

The analysis of a contractor’s financial capability of completing a project is frequently a formal part of the contractor selection process. However, in addition to analyzing the financial environment to consider financial stability of a contractor, such analyses are useful in understanding contractor motivations and decision-making patterns.

At any point in time, a contractor has some set of financial goals and constraints which will exert some influence on strategy. These may include the following:

• A contractor needs to generate increased return-on-investment (Net Profit ÷ Net Equity) in order to obtain capital funds in outside money markets;

• A contractor needs to generate increased cash flow in order to meet upcoming debt maturities;

• A contractor operating below capacity needs increased sales to more fully utilize personnel and equipment and in order to cover fixed costs.

Contractors may behave differently in terms of their reaction to incentives depending upon the particular financial constraints they face. Specific considerations which warrant attention in this regard are presented below:

  1. Return-on-investment — The current “Profit ‘76” studies in the Defense Department are based on the presumption that aerospace industry investment needs to be stimulated to improve efficiency. Some current procedures for procurement of technical items provide for establishing target fees on a percentage of cost basis and then tying overhead rates to direct labor hours, thus reducing industry incentives to invest in labor saving equipment. To the extent that a contractor has a need for improved return-on-investment, then incentives which facilitate such improvements may be effective.
  2. Financial Reporting — One of the limitations of return-on-investment analysis is the fact that some contractors typically represent only one division of large, often diversified corporations. Such divisions typically do not report information beyond total sales and net profit to net sales ratios — if that. (Although return on capital employed may be estimated at the contract or at the divisional levels (4).) Further, corporate financial strategy may incorporate separate objectives for each division. That is, a corporation may rely on one division for cash flow, and another for a high profit to sales ratio to support a third division which is capital intensive.
  3. Leverage — The size of a return on equity may not present a full picture of a corporation’s financial position. Leverage (the ratio of long term debt to net worth) has risen sharply in the past decade in many industries. Contractors with high return-on-investment ratios may be in serious trouble if such ratios reflect very high leveraging using debt which is about to mature.
  4. Divisional Goals — The smaller the contract, the less likely it will even be amenable to return-on-investment analysis, as facilities will increasingly be shared with other contracts. In short, this concept — while important to the corporation is unlikely to be established as a specific contract goal. However, awareness of the financial leverage constraints and other fixed costs, of cash flow needs, or of net profit needs may improve awareness of specific contract goals to the extent that a given contract is expected to contribute to such requirements.
  5. Net Profit Goals — Hunt, Rubin, and Perry (3, pp. 267-268) found that large contractors tended to have lower percentage profit goals — probably due to better cash flow and to the larger value of their contracts (and thus higher absolute profits). For large contractors, minimum acceptable profit ranged from 3%-7%, while the range for small contractors was 5%-8%. Where “reasonable” profits are expected to be achieved, there is a tendency to have a declining marginal utility of profit. That is, contractors who will clearly reach profit goals are likely to be less motivated to pursue cost saving investments, will avoid layoffs of key personnel, and will focus on assuring reliability through increased confidence testing.
  6. Contribution to Fixed Costs — Primary sources of fixed costs facing the contractor are debt payments, general and administrative expense, depreciation and maintenance, and some indirect labor (assuming that the bulk of engineering, supervisory, and technical personnel will be retained even at excess capacity). A contractor operating well below capacity is likely to consider the financial attractiveness of a contract not merely in terms of accounting profit but in terms of the expected net contribution to fixed overhead. If a contract covers all variable costs and a portion of truly fixed overhead, such a contractor will be better off than he would by not having the contract even if an accounting loss is incurred on the contract, since total divisional loss is still reduced. Even on cost plus incentive fee contracts, overruns which reduce profit may still yield improved divisional performance if the incentive share lost per dollar of overrun is less than the contribution to fixed overhead gained from the client reimbursed share.
    (For instance, a 20%-80% share ratio saves a contractor $.20 in profit on each cost dollar saved. Failure to save the dollar gives net revenue of $.80 ($1.00 in sales — $.20 contractor share). If over $.20 of the $.80 represents fixed cost to a contractor below capacity, the net contribution to divisional fixed overhead and profit will be greater with the overrun dollar being spent.)
  7. Cash Flow — Increasing the contribution to fixed overhead, even at an (accounting) loss leads to greater availability of cash for purposes of meeting current obligations (payroll, debt, materials purchases) to assure continuity of business. Since certain fixed costs (e.g. depreciation) are only paper costs and others (e.g. G&A) can be delayed in payment, increasing the fixed costs charged to a project will also lead to improved cash flow where a firm is below capacity. While cash flow problems can frequently be assessed by analysis of the ratio of current assets to current liabilities, it should be recognized that the “inventory” portion of current assets claimed by some high technology contractors may be considerably less liquid than for other types of businesses due to the limited market for items such as airframes, spacecraft components, custom production equipment, etc. Further corporate levels of current assets and liabilities may not reflect the proportionate breakdown for the division under review. Depending on the profit center organization of the corporation, such measures of working capital may or may not indicate the level of cashflow pressure on the division.

The Contractor Organizational Environment

The contractor’s organizational structure will impact the acquisition effort to the extent it enhances or restricts the contractor project manager’s authority.

Where the contractor is organized along strong functional lines, a project manager has little authority over the personnel and financial resources allocated to his project. This may restrict his ability to:

• alter work rates to change schedules;

• develop cost-performance trade-offs;

• influence overhead charged to his program;

• stimulate technical personnel to respond to incentives;

• modify policies.

In addition, the project manager’s ability to motivate low cost performance from the project team may be limited by individual attitudes and preferences. As Perrow points out, organizations engaged in non-routine technologies have focused on goals of quality, innovation, and reliability (6). Such situations are more consistent with the technology development interests of project team members than cost control.

Under such conditions, the ability to respond to changes in client needs is more limited than in a more dedicated program organization where all workers are responsible to the program manager.

Additionally, contractors generally need to maintain a viable labor mix and bidding capability simultaneously. Consequently, top design engineers may be removed from projects once a contract is signed. Thus the contractor may be constrained by the technical qualifications of his personnel.

Due to these constraints, it can be expected that evaluations of the contractor project manager operating in a strong functional organization will be more a function of technical performance and total revenue than of profit percentage. However, financial criteria will probably increase in importance for dedicated organizations attached to very large projects.

Also of concern is the constraint of disutilities (8). Contractors operating below capacity tend to avoid layoffs which could reduce costs due to consideration of the skills needed for future projects and proposals (as well as due to empire-building in functional divisions). Consequently, contractor objectives may shift away from profit maximization to a combination of profit satisfaction plus broader manpower utilization.

Other Business Constraints

Opportunity costs reflect the costs of lost profit and overhead contribution incurred because a contractor approaching full capacity foregoes an alternative contract. Consequently, if larger, more profitable or more technically important projects are competing for contractor resources, the contractor program manager may be constrained in responding to the needs of a given project due to the absence of resources and the lack of top management attention.

The existence of other business may pose constraints for other reasons as well. If the “other business” is primarily with longterm regular customers the client’s project may be a low priority set-aside for a manpower pool. Further, the requirements of other, larger contracts may restrict the availability of high quality manpower for managing subcontractors — thus reducing the contractor’s ability to control a major amount of the contract outcome.

Constraints on Cooperative Interaction

Contractor-client interaction can occur either through formal or informal reporting systems. With regard to formal financial reporting systems for monitoring cost and schedule progress, several kinds of problems have been experienced.

• Such reports may overload the system (especially on large projects where PERT is being used) with an unmanageable volume of information.

• Required reporting formats may be incompatible with contractors’ internal systems, thus adding to the cost of reports and perhaps reducing their accuracy.

• In complex systems acquisitions, such reports may be prepared two or three levels away from the working level, resulting in a large time lag.

• Such reports may not reflect technical problems currently being encountered which, if unsolved, will lead to cost and schedule problems later.

As a consequence, frequent face-to-face reviews at the management and technical working level are often required to identify technical problems at an early point in time. Such reviews often lead to technical intervention and direction from clients, a condition which may conflict with the contractor’s desire to maintain a “mastery” over his technical operations. Accordingly, if such formal reviews are perceived by the contractor as unwarranted interference, the effectiveness of such interactions will be reduced. However, formal reviews may be successful if an atmosphere of cooperation has been developed through informal interactions.

Informal interactions include contractor marketing activities, informal negotiation of disputes, and shared decision-making on contract implementation procedures. Such personal communications activities (which are educational or propagandizing in nature) may assist in developing inter-organizational awareness of joint problems. Further, interactions among technical personnel may lead to the development of professional group pressures for cooperation in achieving the formal standards of performance (7). Obtaining insight into the needs and styles of the other organization and increasing inter-organizational identification are direct consequences of informal interactions and facilitate decision-making and coordination (2).

Key questions which should be investigated in order to understand potential problems regarding such interactions include the following:

  1. Marketing Activities — Does the company have a sufficient, well-experienced, well-known marketing staff to keep company management abreast of the overall aspects of the program?
  2. Contractor Involvement — Is your contract of significant value or importance that the company feels identified with the product? Does the company even know how important the contract is to the client?
  3. Patterns of Coordination with Clients — Is the company used to working in this environment? Will they help the project along by providing required inputs on a timely basis? Have they been known to help plan or just take direction? Are they willing to seek technical advice when needed?
  4. Role Compatibility and Communications — Does the contractor project manager have a single client counterpart, or rather over-lapping contacts with a number of personnel thus reducing the efficiency of inter-organizational communications.
  5. Subcontractor Relationships — The contractor project manager must also act as middle man with subcontractors in many cases, so he has more outside interfaces, restricting his ability to maintain interaction with the client.

Project-Specific Constraints

Earlier, we suggested that contractors may have a variety of contract objectives. The contractor’s ability to achieve these goals and simultaneously satisfy the client will be limited by project-specific constraints over which the contractor has limited control.

These constraints include:

• clarity and precision of performance objectives;

• magnitude of required technological advances;

• level of cost uncertainty;

• extremely inflexible schedule requirements;

• statutory limitations on client (testing levels, funding rates, use of specified parts or equipment, etc.)

Such constraints pose limitations to the contractor in terms of restricting the options he may select in meeting financial goals and in terms of restricting his “mastery” over his operations. Accordingly, if such constraints are excessive or inappropriate, they may reduce the contractor’s motivation to be responsive and to interact with the client in problem-solving.

Conclusion

In sum, the client’s success in achieving his project goals depends on his ability to select and develop project management practices which improve the contractor’s responsiveness to client needs. However, this requires the client to be aware of the contractor’s needs as well. All contractors are not alike and their motivation and constraints may change over time or across projects. This article was designed to demonstrate the variation that exists in these motivations and constraints and to describe the impact of such variations on project performance.

In order to increase the probability of project success on high-technology projects, the client should perform a continuing audit of the contractor’s financial and organizational environment and of the other factors influencing the contractor’s ability and willingness to be responsive (See Table 1). In turn, this should provide clues regarding the specific contractor decision-making patterns which can be expected (See Table 2). This type of analysis can be of real value in establishing and implementing the kinds of goals, plans, controls, and incentives needed to assure a high level of client-contractor cooperation and to achieve the client’s goals (See Table 3).

REFERENCES

1. A. Cirone, “Extra-Contractual Influences in Government Contracting” National Contract Management Journal, Vol. 5, Fall 1971, pp. 53-66.

2. R. Hunt and I. Rubin, “Approaches to Managerial Control In Interpenetrating Systems: The Case of Government-Industry Relations” Academy of Management Journal, Vol. 16, June 1973, pp. 296-311.

3. R. Hunt, I. Rubin, and F. Perry, “Federal Procurement: A Study of Some Pertinent Properties, Policies and Practices of a Group of Business Organizations” National Contract Management Journal, Vol. 4, Fall 1970, pp. 245-299.

4. L. Goodhue, “Fair Profits from Defense Business” Harvard Business Review, Vol. 50, March-April 1972, pp. 97-107.

5. D. Murphy, B. Baker, and D. Fisher, Determinants of Project Success. (Washington: NASA NGR 22-003-028, 1974).

6. C. Perrow, “A Framework for the Comparative Analysis of Organizations” American Sociological Review, Vol. 32, 1967, pp 194-208.

7. L. Sayles and M. Chandler, Managing Large Systems: Organizations for the Future (New York: Harper and Row, 1971).

8. F. Scherer. The Weapons Acquisition Process: Economic Incentives (Boston: Harvard University, Division of Research, 1964).

Table 1

The Client’s Checklist: Analyzing Contractor Motivations and Constraints

Which Extra-contractual Motives Must Be Considered?
  • Develop new technology for alternative business
  • Utilize manpower
  • High technical performance
  • Minimize risk
  • Maintain control over selection of technical options
  • Preserve bidding capabilities
  • Develop reputation
What Organizational Factors Are Important?
  • Profit-center organization
  • Project manager authority
  • Employee motivations
  • Functional vs. projectized organization
  • Key technical personnel
  • Visibility of project to top management
  • Contractor internal reporting systems
  • Willingness to engage in joint problem-solving
  • Patterns of communication with client
  • Ability to control subcontractors
What Financial Factors Are Important?
  • Dollar profit to corporation
  • Divisional sales
  • Divisional return-on-assets
  • Contribution to fixed costs
  • Cash flow
What Project-specific Factors Are Important?
  • Schedule flexibility
  • Cost uncertainty
  • Technical uncertainty
  • Statutory or client policy constraints

Table 2

The Client’s Checklist: Analyzing Contractor Decision-making

What Contractor Decision-making Patterns Can Be Expected?
  • Assignment and retention of top engineers?
  • Modification of manpower loading schedules to achieve efficiency; to achieve technical performance; to achieve progress payments?
  • Selection of cost-performance trade-offs favoring performance?
  • Stress incentives to personnel?
  • Control of overhead charges?
  • Receive top management attention?
  • Prepare timely and clear cost/schedule reports?
  • Maintain high level of interpersonal communications in planning and problem solving?
  • Place little vs. great emphasis on cost control?
  • Show commitment to meeting the client’s needs?

Table 3

The Client’s Checklist: Analyzing Client Options

What Client Decisions Require Review
  • Selection or modification of profit incentives
  • Plan milestones and progress payments to improve cash flow incentives
  • Attempt to gain contractor top management attention
  • Modify cost/schedule formal reporting system
  • Modify client-contractor interfaces to improve communication for problem-solving
  • Monitor or establish procedures for monitoring subcontractors
  • Clarify performance goals
  • Modify weighting of performance criteria to reflect current problems (e.g. award fee type contracting)
  • Use fixed price contracts
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