Are fixed price contracts deceiving us?

Fixed price contracts, the easiest way to ensure control over spending and to avoid blowing an allocated budget, right?

Wrong.

Fixed price contracts are just that. Fixed price against a fixed scope. This does not mean they are a “fixed total cost”. In fact, quite the contrary, they are littered with assumptions, obligations/dependencies and other variables, all of which will likely affect the total cost of the contract.

I’m asked to investigate this contract option by so many customers however, more often than not, once I explain all the commercial risk involved, the request is usually deemed unfeasible, but not for the supplier, for the actual customer! Why is this? Well, the thought process tends to be that by going fixed price, all the risk is passed over to the supplier, hence the traditional application of an uplift (for acceptance of risk) to the overall value of the contract.

This is a false hope and the reality is much, much different. If you’ve told a supplier a piece of infrastructure is in a certain state and they’ve contracted based on that information, it’s very likely that should you have been wrong, the cost may increase, and who carries that commercial burden? Yes, you guessed it, you the customer. That uplift tends to cover items they may have got wrong or under scoped by being forced to forecast costs from the start, not elements outside of their control. Fixed price contracts will not allow you any flexibility and are tough to get right in dynamic organisations with regular operational change.

Now it’s far more common in the public sector than the private one, and the trend doesn’t show any signs of slowing. Too many public sector departments blindly jump into fixed price contracts with complete naivety and no consideration for their ability to manage them. They should really be asking themselves the following questions:

  • Are you sure the information you’re providing the supplier is accurate?
  • Are you able to manage your obligations, or the contractual dependencies allocated against your resources?
  • Are you able to manage your other suppliers and contracts and ensure they do not impact the fixed price contract? Are you in a contractual position to gain reimbursement from them if they do?
  • Are you confident that there aren’t other events likely to occur internally that may be outside of the suppliers control, which impact their ability to deliver against the contract?

Taking from the last bullet first, it’s very sensible to ensure the total budget exceeds the value of the fixed price contract. Whilst more and more planning can drive greater accuracy in the contract, there are still some events which will incur extra cost. Ones which the supplier is not likely to cover.

From personal experience, I remember managing a multi-£m project around 8 years ago and coming in one day to find there had been a major leak in the server room caused by an air conditioning unit, one which destroyed multiple on-premises physical servers and caused huge disruption to the customers day to day operations. This was a fixed price contract and you can rest assured that the cost to replace all the hardware we had just put in (along with the professional services to rebuild, configure, test etc.) was not one incurred by my employer!

Now regarding the bullet referencing other suppliers, it’s not something to take lightly. Again, far too often suppliers will struggle to work together, not provide suitable or sufficient information or delay project decisions and activities. Sometimes it’s down to the power struggle and the competition for revenue in the account, whilst sometimes it’s actually quite sensible for an incumbent supplier to push back (I mean if you’re paid to support an infrastructure or application, you’re not going to be happy to continue supporting it if an unknown entity rocks up and implements a load of change to it right?).

It’s important that when entering into a fixed price contract, a deep understanding of obligations and dependencies is established across the full supplier ecosystem, with commitment to what is being agreed from all. I can’t stress how often I’ve worked with customers or business leaders, shouting to no avail as they commit to obligations in a contract that need to be delivered by their other suppliers… without actually involving them in the process and securing their commitment! Not only do they need to buy into what is being done, but commercial arrangements need to be made. Accountability also needs to be established against their stake in ensuring the customer can realise the outcomes detailed within the contract.

Now there are some better ways to try and fix the cost, although a lot of the commercial risks highlighted above still remain. The difference with some of the alternatives is that the knock-on effect doesn’t necessarily mean there is a requirement to increase the contract value (and push up total cost).

Fixing the cost is actually one of the benefits Agile projects provide us (although many seem to think Agile means no control over budget, this is not the case). Now if you think back to the traditional time/cost/quality triangle, one is often compromised (to differing extents). Now in an Agile project, by going fixed price, you can fix the cost, as well as fixing the duration through well-defined sprints. In order to engage fixed price however, locking down cost and time will mean quality, or in this case the volume of overall scope, is likely compromised and every requirement perhaps not met.PROJECT MANAGEMENT TRIANGLE (scope time quality cost)With an Agile approach, you can fix a duration and an amount of resource/cost to deliver against a contract scope in that period. Usually a minimum viable product (MVP) can be produced under this fixed cost, although the volume of iteration, refinement and quality improvements being made in the project may be limited as once the budget and time available is exhausted, whatever is left is left, and this more often than not may not match the original expectations and full contract scope, instead often being a workable solution (provided for that fixed cost) but limited in additional, non-essential features or requirements.

So back to the purpose of this blog. I’m hoping this is helpful to anyone reading, enabling you to maybe help organisations, whether these be ones you are delivering work for as a supplier or one you work for internally. Helping to articulate the risks, responsibilities and expectations of engaging a fixed price contract is of huge importance right now, especially in times of ever increasing commercial and budget scrutiny. If we can work together to help refine contracts and the delivery approaches within them, I’m sure over time we can gradually reduce overspend on these contracts and improve the outcomes delivered. Fixed price may still be the right option for some, if they’re more diligently and accurately engaged, although if a Time & Materials contract is managed properly and any variations to baseline activities actioned hastily, these can quite often be delivered for less total cost than the fixed price alternative. Just know what you’re truly committing to before you sign!

Contract spend is something I’m particularly passionate about, considering the number of public sector customers I’ve worked with in my career. There’s nothing more frustrating that seeing budgets blown, contracts under-delivered etc. when the source of the spend is from tax payers themselves. Please don’t hesitate to get in contact with me if you or anyone in your network of contacts is ever in an uncertain position with scoping out this sort of thing 😊 I’m always happy to provide free advice (time permitting!).

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s