Vendor Management: Fixed Price Contract for Risk Transfer? 4 Risks You Still Own in R&D Projects

We have heard this thousand times…

Outsourcing greatly helps in managing better. There are variety of ways to design the project contract between client and vendor organizations. Out of the contract types spectrum, two contract types stand out – T&M (Time and Material) where buyer (customer) bears all the risk. On the other extreme, in Fixed Price, vendor owns all the risk.

FixedPriceContract-Program-management

So, if you, as customer, could convince the vendor to accept Fixed Price agreement, it is a great deal. You will be a star in your organization for getting the best deal.

Right? Not quite – if you are in product R&D. Think of project context as below:

A. The ‘Client’ Organization: You are an organization with products and services. The philosophy of the organization is that you own the Intellectual Property and outsource maximum tasks. It believes that helps to control costs, reduce management effort etc.

There is brand new product initiative in your organization. You are the senior manager and is responsible for making it happen. Right from beginning you want to engage an outsourcing partner.

You have team which I call as ‘client’. This team has responsible to certify whatever is produced by ‘vendor’ (outsourcing partner explained below). Upon they accept mile stone delivery, you would release the payment.

B. The Project:

In very early stage, you have vague idea of the product. There is no roadmap, no complete buy-in from within the organization. Nothing is in place yet, which is very natural. But you want an outsourcing partner early because you want to give the maximum exposure and thereby reduce information blockage and lack of context. Your bosses are particular about Fixed Price model because they want no risk on the organization.

C. The Vendor: There is an outsourcing company ready to work with this client. Let us call this entity as ‘vendor’.

The vendor has

  • The sales manager – whose responsibility is get project and close the deal.
  • The delivery team – the technical team which actually works on the project. Once the project starts this team takes the center stage and works with client team.

D. Project Contract:

You, as client, have specified that it should be Fixed Price to the vendor sales manager. The sales person agrees after initial reluctance. He pushes the deal down the throat of the vendor delivery team. All these written in Statement of Work document printed and signed.

Vendor has accepted all the risks. You have done good negotiation. Haven’t you?

But what are your risks as customer?

1. Mindset of the vendor delivery team:

The nature of contract greatly influences the vendor behavior. The need in early stage of product planning is the depth and thoroughness of the analysis. Right from day 1, their focus is how to get the sign off. Less about the depth required. If there is any major miss, it will get detected very late, may be, even after project completion. As product owner, you will have to live with this risk.

2. Dynamics in your own organization:

In vague scenario, what is your internal team’s competency to certify a delivery from vendor? For vague scenario, the contract also would have vague acceptance criteria.

If you do not accept a deliverable, you need to convey what exactly is missing. Otherwise, vendor could escalate through your organization ranks. You can push back the vendor. But within your organization, you will still have explaining to do. Its outcome may not always be favorable.

If you accept the deliverable, you own the risk of any shortcomings from that moment. In early stages of product R&D, the chances are that the exact visualization of the deliverable does not exist. But still the deliverable may meet generic criteria defined in contract. The moment you accept the deliverable and clear the payment, you are vulnerable till product release and beyond.

If someone within your organization questions, will you be able to convince them that you have administered contract effectively?

This is the biggest risk for you. Fixed Price could increase management effort even for the client in some scenarios. And hence the client risks.

3. The options of vendor organization:

Since the agreement was signed, the vendor has to listen to you. No question on that. But is that enough? If the people involved feel that it is unworkable, they will find ways to get out of the project. For you, the project could make or break the career. But for the team members at vendor side, it may not be so. They may work their way out to different client account.

When things go wrong, sure, you can bring down the vendor side management team. But you also may go down with it.

4. Limitations with Enforcing the Contract:

Yes. The contract is binding. But will you ask your organization to take the legal route? This would mean multiple escalations from you to your bosses and other departments. Literally this means that you could not manage it and things are out of your hands. In the long run, the organization may bring the vendor to knees. But this is after few appraisal cycles of yours.  What about your own standing and career till then?

If the legal action is painful, the organization could write off the loss. And write off you too.

Do you see the risk ?

What is in Your Hands?

1. Standard Contracting Tasks:

All the relevant points B-schools and PMI teach.

2. Fairness:

Ensure that it is fair deal for both sides. The fairness is not for you to reserve a seat in heaven or to avoid sins. Just for better business gains. If deal is not fair, the members on either side will know. They will have ways to work their way out of the project in the future.

If things do not seem fair to vendor, convince your side for change of terms. It may include accepting more lenient contract type.

The bottom line:

Ensure fairness and right contract type for the context. With right contract, the relationship will be on right foundation.

There will still be issues. There are few things that can be done further down – once project starts. Those are for the future posts. Keep watching this page.

As always, comments, insights and questions – welcome !