Variables Involved in Forming a Contract
As we've noted in previous articles, the notion of contracting
-- the acquisition of goods and services through contract -- is
a very flexible one. A contract can be devised to reflect requirements
of any number of variables, and the acquirer's contracting strategy
should be designed to optimize overall project results with regard
to associated risks.
To determine the best type of contract for your project, you will
want to consider the ten variables we discuss below. They are all
interdependent to a greater or lesser extent, and all can be depicted
on a continuum. In the figures below, the left side of the continuum
represents the best interests of the acquirer; the right side represents
the supplier's best interests.
Variable One: Product Type
As shown in Figure 1, the product type may
range from standard off-the-shelf software to off-the-shelf software
with some degree of customization (i.e., "COTS") to fully developed
software. Standard "off-the-shelf" software is normally obtained
by direct purchase order rather than through contract, since less
risk is involved. The more customized the software, the greater
the risk; this risk should be managed by adopting strategies recommended
in the Rational Unified Process® (RUP®).
Figure 1: Product Type
Variable Two: Product Scope of Work
Figure 2 shows the range of requirements definition,
which determines the degree of certainty for the scope of work and
the extent and timing of expected changes. The better defined the
requirements, the lower the risks to both acquirer and supplier,
and the greater the opportunity to establish fixed time and cost
Figure 2: Product Scope of Work
Variable Three: Product Safety and Liability
Figure 3 reflects the extent to which the software
product will be used in a safety-regulated environment and the liability
in case of failure. For example, an airplane traffic controller
system has a much higher safety requirement -- and therefore needs
more thorough testing -- than, say, a stock control system. The
higher the concern about risk of failure, the higher the level of
integrity required. This will be reflected in cost and schedule
Figure 3: Product Safety and Liability
Variable Four: Acquirer's Level of Control
Figure 4 shows the extent to which the acquirer
wishes to exercise control over the software development work. Typically,
for a fixed-price contract, the acquirer's control is minimal; if
they try to exert more control, they risk a contract claim on the
supplier's part for "interference." Fixed-price contracts place
the risk of software development on the shoulders of the supplier.
To mitigate this risk, the supplier must either ensure that the
requirements are well defined or insist upon a "time-and-materials"
basis for compensation. With progressive acquisition, you can begin
with a time-and- materials approach for early phases of the project
and then agree on progressively firmer terms for time and costs
as the project progresses. This represents an essential advantage
over traditional fixed-price contracts.
Figure 4: Acquirer's Level of Control
Variable Five: Supplier's Level of Control
Figure 5 displays the converse of Figure 4:
the extent to which the supplier has control over the development
process, and hence responsibility for the product's performance.
As we have noted, the supplier has primary control in a fixed-price
scenario; but the supplier's control (and desire for control) is
minimal in the case of a "cost-plus" or "time and material" form
of contract. These types of contracts place the risk and responsibility
on the acquirer's shoulders.
Figure 5: Supplier's Level of Control
Variable Six: Acquirer's Involvement in Quality Control
Figure 6 shows the range of options for the
acquirer's involvement in quality control. In a fixed-price contract,
quality control rests almost entirely with the supplier, although
inspection and testing may be conditions for interim progress payments.
Figure 6: Acquirer's Involvement in Quality Control
Variable Seven: Timing for Delivery and Pace of Work
Figure 7 shows the practical range of delivery
timing. If the target delivery date is earlier than the normal pace
of work would allow, then the work must be accelerated by some means
that incurs additional costs, such as overtime or extra resources.
This may also entail additional risk because it is more difficult
to coordinate the work.
Figure 7: Timing for Delivery and Pace of Work
Variable Eight: Form of Compensation
A fixed price, as suggested in Figure 8, appears
to be in the best interests of the acquirer. However, if the conditions
of such a contract are not met, then the contracted work may well
end up being more costly, taking longer, and even ending in failure.
The software industry is rife with examples of fixed-price contracts
that worked to the detriment of both acquirer and supplier. For
this reason, parties often adopt a modified form of fixed-price
contract with provision for scope variations and with or without
incentives. Time and materials compensation is most appropriate
if the extent of the requirements is either not yet known or highly
uncertain. As we noted in discussing Variable Four, Acquirer's Level
of Control, progressive acquisition allows you to use a time and
materials approach up front when there is great uncertainty, and
then firm up terms for time and cost later on, when the risk of
doing so is lower for both sides.
Figure 8: Form of Compensation
Variable Nine: Supplier's Cost-Risk Position
Figure 9 reflects the supplier's cost-risk
position vis a vis customization. Supplying standard, off-the-shelf
software provides the lowest-cost, safest, and quickest return to
the supplier. However, standard software may or may not meet the
acquirer's needs and typically requires some degree of customizing.
Even so, COTS is usually less risky to both parties than an all-custom
Figure 9: Supplier's Cost-Risk Position
Variable 10: Cost-Risk for Acquirer versus Supplier
Figure 10 broadly summarizes the respective
positions of acquirer and supplier for all nine variables we have
just discussed: The acquirer's cost-risk is inversely proportional
to the supplier's risk. As we have seen, the degree of technological
risk is the driving concern for both parties, especially in the
case of fully custom-built software. The best contractual relationship
should be heavily dependent upon the nature of the technology being
acquired, how much is known about the solution, and how the parties
want to allocate risk. In principle, each specific risk should be
allocated to the party best able to control that risk.
Figure 10: Cost-Risk for Acquirer versus Supplier