Robaxin uk “If you think that a fixed price contract is going to solve all your previously experienced project issues, think twice”
A fixed price contract appears to be the magic bullet to a number of project management issues, but that may only be superficial. At the end of the day, all of the project management routines still need to be flawlessly executed including the financial aspects, regardless what contract vehicle has been selected.
With a fixed priced contract the customer is making an attempt to transfer the financial risk to the vendor. The transfer is at a cost to the customer and wouldn’t exist, if the parties decided to sign a time and materials contract. The additional cost is a risk premium (cost contingency) that the vendor is adding to the base estimate that if done properly already has an effort contingency. It is quite common to see a risk premium in the 10 – 30% range on top of the base estimate and effort contingency together. So long story short, customers are paying a lot extra when they sign a fixed price contract. Is that worth the money; is that worth the delivery risk? Now, there are customers that want to know what the actual project cost to the vendor is and based on the outcome recoup part of that risk premium. Unfortunately that’s not how it woks, because the customer did not bear the delivery risk and also would not chip in extra dollars if the vendor would experience a cost overrun.
Alongside the risk premium (additional cost), the customer bears the risk that the vendor is not delivering the contracted scope with the expected quality (less business benefits). When a vendor is exposed to a fixed price deal, they are managing the project scope very tight. When the project scope is not well defined in the contract and therefore the level of ambiguity (see previous post ‘Ambiguity’) is relatively high, the project is set up for failure. Oftentimes the expectation gap cannot be closed without a project change request, which most customers do not account for in their budget when they have signed a fixed price contract. It is very likely that the gap is significant; therefore the vendor is raising many change requests over time. The relationship stress that manifests between the customer and the vendor, because of the conflict, can be detrimental to the overall trustworthiness of the parties, and when trust goes down, cost goes up, and speed goes down (see Stephen M.R.Covey, “The Speed of Trust”). As a result, the project slides into a downwards spiral triggering all different kind of consequences.
Managing a fixed price contract is asking for a different mindset from the parties than any other contract vehicle. Scope and schedule must be perceived as equally important for both parties. If not, the project is doomed to fail. There are cases where a vendor managed a fixed price contract as it was a time and materials contract. For quite awhile there was an abundance of resources and everything seemed possible (exaggerating here a little bit), but overtime when the project actuals came in and the scope verification check was completed, the vendor realized that the burn rate was way out of line, and that the only way out was raising change requests (extra dollars or scope reduction). At that point, frantic behavior should not be a surprise to anybody. It is possible that the vendor tells the customer that for certain deliverables they have exceeded the number of hours, and the customer has to pay extra. Or that rigorous testing is not required, because best practices and development standards have been followed consistently, and therefore the risk of failure is low. A customer would instinctively think: “But I have a fixed price contract for that deliverable, the requirements are clearly articulated in the contract, blueprint and specifications. We agreed to the delivery approach, what’s the problem?”
These are just a few examples of situations where a customer might end up with, if they make a fixed price deal. They need to be aware of the buyers risk of paying more (risk premium), for potentially less quality (business benefits), and potentially damage to a good relationship with the vendor, whom they may have been successful with before at other projects. What is then the alternative?
There is actually a few. Customers can simply go for a time and materials contract. There is nothing wrong with that if they manage it well. Or customers can decide to go for a hybrid model, where the basis of the contract is time and materials, with fixed price for specific, well-defined scope items. They can also consider performance-based contracts with time and materials as basis. If the intention is to transfer delivery risk to the vendor (which is a great idea and something a customer must consider), embedding performance-based incentives in the contract is a perfect alternative. More and more vendors are willing to demonstrate skin in the game.
The success of any contract vehicle comes down to the accuracy of the scope definition. Customers need to know WHAT they want (see my post ‘Continuity of Vision’) throughout the project lifecycle. They need to clearly articulate it to the vendor, and collaboratively document it meticulously in the contract. When customers are locked into a fixed price contract, discrepancies seem to be much harder to resolve than with any other contract vehicle. Customers must be mindful of the pros and cons of a fixed price contract when they consider it. Customers should not run into it, because they think they have frozen their financial baseline and they therefore only need to focus on scope and schedule. That’s an act of shortsightedness, which at a certain point in time will be proven to be wrong.
Bas de Baat
Program Manager Enterprise Applications, PMP©