Abstract
We have been told there is only one choice when it comes to contract options: either an irresponsible time and materials arrangement or a tyrannical fixed price arrangement. As a result, we are left with a big gap. Agile Project Management pays much attention to project execution and team values, but talks very little about how projects are initiated. This paper will discuss a variety of considerations and techniques for building contracts, which can be implemented right now.
Considerations
In the 2006 documentary Iraq For Sale (Greenwald, 2006), the faults of a cost-plus contract arrangement were highlighted in provocative detail. The government contractor, KBR, was asked to perform logistical fulfillment for the US military going into Iraq. In the documentary, we learned that KBR was incentivized to do some suspicious things. They instructed their truck drivers to drive to the destination, back to the port of origin, and then to the destination again, and charge the whole trip “at cost”. They were also incentivized to charge lavish lobster dinners for the truck drivers “at cost”.
At first glance, this is counter-intuitive. The cost-plus arrangement is designed to be a fair balance of financial risk between the contractor and the customer. However, most large cost-plus contracts try to be extra reasonable by adding an overhead margin for the contractor, plus a profit margin, and then a risk multiplier for working in a war zone. So, the higher the costs, the higher the financial reward. What we begin to see is that contracts are found not on instruments, but on relationships. In the KBR situation, the contracting relationship was founded on some suspicious conflicts of interest or quid pro quo. At least that is what the documentary asserts.
With some consideration, we begin to understand that there is a human process by which contracts are generated (see Error! Reference source not found.). In the beginning, there is some kind of collaboration, where two parties are exploring a business opportunity. These parties arrive at some kind of commitment saying, “This is what we are going to do”. And then, those parties want to hold each other accountable in some fashion to their commitments. That accountability needs to be enforced beyond the honor system, so we invent a legal system that uses an instrument called a contract.
Exhibit 1: The Human Process of Creating a Contract (Fewell, J. 2010)
Flexible Documents
Contracts are aggregations of several items, which break down into their more stable elements and their more changing elements. There are things about the engagement that are more stable and other things that are more changing.
Stable items might include the parties involved, such as the customer and the prime contractors. Also stable might be the terms and conditions, addressing how often invoices are sent and processed, and penalties for late payment.
On the other hand, less stable items might be what kind of services the buyer needs from the supplier. Initially, the engagement may only offer a telecommunications product. However, as the product moves into development, it becomes necessary to add some product support services. The parties have not changed, nor have the terms. With the additional broader scope, may come other changes. Telecom product development may cost more than support services, and therefore needs a different fee structure and different customer satisfaction criteria.
Finally, the least stable items are the detailed scope. In the beginning, we wanted a 3G mobile phone that delivered great web surfing. But now, we need to have fancy social media features. Initially, only product engineering support was needed, but now we need to offer customer support under the same service agreement. We need to change the detailed scope of one or more services. (Exhibit 2)
Exhibit 2: Flexible Contract Structure (Fewell, J. 2010)
With this in mind, it could make sense to have the contracting instruments reflect these varying degrees of stability:
Master Contracting Agreement (MCA): This would contain the most stable items, like the parties involved, as well as terms and conditions. One example of this would be the Indefinite Duration Indefinite Quantity (IDIQ) contracts prevalent in government contracts.
Schedule of Services: This would contain the fairly stable list of services and products to be offered under the MCA. A new version of this schedule of services is generated any time there is a change in the broad scope of the engagement. One example would be the multiple Task Orders (TO) that are issued under the IDIQ agreements.
Statement of Work (SOW): This describes the detailed scope items to be addressed in a given service. Short and lightweight, a SOW will describe a specific focus to be accomplished in a specific time. These documents are generated from pre-approved one or two page templates, or even a formal email.
Construct your contracting artifacts to embody the flexibility you need to do business.
Contracting Options
When it comes to cost we have been told, we can only choose between fixed price and time and materials. So, well-intentioned procurement specialists have been trying to find the idea balance, gave us the not-so-perfect solution of Cost Plus Award Fee. As we discussed earlier, this can also be manipulated. Here are some additional options coming from project managers on real projects:
Graduated Fixed Price
Thorup and Jensen (2009) explain in their paper the option of Graduated Fixed Price (see Exhibit3)
Exhibit 3: Graduated Time & Materials (Fewell, J. 2010)
If you deliver on time, you get paid for hours worked at the standard rate. If you deliver early, you get paid for fewer hours at a higher rate. The customer is happy because he pays less and gets his work accomplished sooner. The contractor is happy because his margin just doubled. However, if you deliver late, you get paid for more hours at a lower rate. This time both parties are unhappy. Every day that goes by, both parties lose money, but at a gradual manageable pace.
In example shown in Exhibit 3, late delivery rate represents a full 25% loss in hourly rate over early delivery, which is dramatic, but graduated.
Early Cancellation Clause
Many projects are planned with an iterative incremental delivery cycle, also called Agile Delivery. This has advantages over traditional “big-bang” delivery, such as time-to-market and early feedback and quality refinement. However, what if each incremental delivery offered a phase gate opportunity, where the customer says, “thank you, I am done now”. At that point the project could be cut off with early cancelation.
Sutherland (2008) shows us that with this clause, you have the option of canceling the remaining value of the contract, and pay a nominal cancelation fee.
Exhibit 4: Early Cancellation Clause (Fewell, J. 2010)
In the Exhibit above (Exhibit 4), the customer is a hero because he accomplishes the highest value for 12% less, and the contractor is happy because he gets paid not to do work and has a satisfied customer.
Fixed Price Work Packages
Traditional SOWs have a narrow, but fixed scope for a single price. In a case study at Marriott International (2009), one project successfully decomposed each SOW into individual work packages, each with its own fixed price. Then, as each work package is completed, the contractor is given the option to re-estimate the remaining work packages in the SOW, based on new information and new risks. This empowers the customer to make go / no-go decisions on the value of a work package relative to the cost. Often, because the risk is localized to such a detailed level, the cost variations are small where a customer can secure the additional funding. (Exhibit 5)
Exhibit 5: Fixed Price Work Packages (Fewell, J. 2010)
With this approach to a fixed-price arrangement, the customer retains control over cost and the contractor’s risk is localized to only the work package currently in progress.
Conclusion
Your Contract is Not Your Project Manager
Another consideration is the propensity to put every foreseeable issue into a contract. Granted, a contract enforces accountability on the human element, and as such a risk mitigation technique. Even if you have a several hundred-page agreement, you still need to a complete risk management solution. But you can’t put everything in the document, so don’t bother trying. Instead, leave all the minute details to the project management team, whether keeping a risk registry or having recurring discussions with the project team.
Summary
In summary, when it comes to contracts, it helps to consider that:
- Contracts arise from relationships
- Make sure you have flexible documents
- You have more options than you think
- Your contract is not your project manager
