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IACCM - International Association for Contract & Commercial Management Contracting Excellence Magazine
 

Contracting Excellence Magazine - Jul 2009

 
 

 

The Top Negotiated Terms: Negotiators Admit They Are On Wrong Agenda

 
This is the 8th year that IACCM has conducted its annual survey of the ‘most frequently negotiated terms and conditions’. The study attracted a record input from more than 4,000 qualified participants from legal, procurement, contract and commercial management groups worldwide. Almost 1,000 corporations and organizations were represented.
 
 
Negotiators tell us that they remain entrenched in fighting traditional battles. The top negotiated terms remain largely unchanged. If anything, the focus has become more protective and risk averse. For example, the biggest mover (up 5 places to number 5) is Confidentiality / Non-disclosure – in a sense oddly symbolic in an era when public pressure is for increased openness and transparency.
 
And in the end, that is the startling thing about this year’s survey. It has become increasingly apparent that what we negotiate is out of step with business needs. This year, we have confirmed that many of the negotiators themselves believe they are negotiating the wrong things.
 
A New Environment Needs New Contracting Practices
 
In a series of surveys and follow-on discussion groups, it has become clear that the commitments and obligations required to compete in today’s highly competitive and fast-changing environment have changed. Yet the rules and the procedures by which contracts are governed have not. External influences such as regulation have combined with the traditionalism and parochialism of the law to stifle adaptation.
 
Specifically, the global economy has swung increasingly towards services. Most major manufacturers have sought to avoid the pressures of ‘commoditization’ by moving towards packaged solutions and services. In addition, new forms of contract relationship – such as outsourcing – have become common. All these relationship types demand outcome-based commitments, weakening the traditional principle of caveat emptor and making the ability to bear and manage risk into a source of competitive advantage.
 
As if this shift in value propositions were not enough, we have also witnessed an era in which the speed of change has augmented the role and purpose of contracting. Successful deals that deliver economic value require lifetime management. The contract and the process through which it is created and managed become key instruments for relationship governance. Traditional contract standards and the focal areas for negotiation help little in providing such a framework. Liabilities, Indemnities, IP rights, Liquidated Damages are all topics that prepare for failure and disagreement. They are at best negative incentives and in general, imbalance in the negotiated allocation of risk results in an environment of self-protection, constrained information flows and a culture of blame.
 
So if today’s contracts are focused on protection, is that really a bad thing? After all, lawyers and contract negotiators are charged with protecting the company or organization from risk.
 
The reason today’s focus is wrong is because it is lop-sided. It concentrates on assumed failure and does little to establish the framework for success. Therefore it does not manage risk because it fails to enable opportunities, growth, mutual benefit. The focus of negotiation today stifles collaboration and results in many contracts being dangerously incomplete when they are signed. This is because battles over the allocation of risk frequently prolong negotiations and divert attention from the real issues, which are what the parties want to achieve and how best they can do it. 
 
The Negotiators’ View
 
How do we know that negotiators themselves sense this weakness? Because this year we asked them whether they believed the terms that receive greatest focus today are resulting in optimised business outcomes. And 75% said no.
 
 

©IACCM 2009. All rights reserved.

 

When asked where negotiating time should be focused, the Top Ten list was transformed to reflect the business reality of a world where agreements are more complex, subject to faster and more regular change, and increasingly focused on services, solutions and outcomes. The ‘new’ top terms are dominated by the need to ensure certainty over the basic intentions of the deal and then to ensure it remains on track and is adjusted in the face of changed conditions or requirements. This revised focus for negotiations presumes that the parties will establish procedures for more open information flows and greater transparency – implying their intent to collaborate and to work together to manage risks and optimise results. Terms such as liability and indemnities occupy the place they should – as last-resort fall-backs in the event that well-crafted intentions become derailed.
 
So what is preventing the change?
 
Since both buy-side and sell-side negotiators feel similar shifts are desirable, it is perhaps surprising that the current Top Ten shows no sign of movement. But in fact, it seems that few are translating their belief into action – and that is because they feel they are alone in their belief. Two thirds say that they could not achieve this change because the other side would not support it. Large numbers also blame internal forces – term and policy stakeholders who would not allow such a move. Yet our interviews suggest that none have actually tested their hypothesis – they simply assume no one else would be willing to change.
 
A shift of this sort is not easy. It demands different involvement in the negotiation and probably – for many – much earlier introduction to the team. There are a range of obstacles to this change, but that does not mean they could not be overcome – and the rewards in doing so could be very significant.
 
In subsequent articles, IACCM will lay out the steps needed for change and will also describe the projects it is undertaking to make this shift possible.
 
Our first chart reflects the terms most frequently negotiated today (as at Dec 2008 / Jan 2009).
 
 

 ©IACCM 2009. All rights reserved.

 

This second chart shows the views of negotiators worldwide regarding the areas that should receive greater focus in order to derive better business outcomes. This consolidated view disguises the variations between buyers and sellers, between functional groups, between jurisdictions and industries. It is those differences and their implications that we will describe in subsequent reports.

 

 

 

©IACCM 2009. All rights reserved.

 
 

Enabling Customer-Centric Solutions: An Update

 
It is two years since we last interviewed M.C. McBain, IBM's Vice President Global Alliances & Contract Development . Since then, IBM was the inaugural winner of our ‘Most Admired Companies for Contract Management’ and has undergone significant evolution in the way it handles terms and conditions development and negotiation. This interview offers an update to the IBM approach to contracting – both in terms of supporting product and service solutions and in ensuring that the contracts themselves represent solutions to customer and market needs.
 
 
IBM aims to become a premier globally integrated enterprise, where work flows to wherever it can be done best and where open environments allow powerful innovation. This strategy means that new product and service solutions are being launched all the time and there is continuous expectation that all employees will contribute by  generating higher value.
It is two years since we last interviewed M.C. McBain, Vice President Global Alliances & Contract Development . Since then, IBM was the inaugural winner of our ‘Most Admired Companies for Contract Management’ and has undergone significant evolution in the way it handles terms and conditions development and negotiation. This interview offers an update to the IBM approach to contracting – both in terms of supporting product and service solutions and in ensuring that the contracts themselves represent solutions to customer and market needs.
 
­­­­­­­­­­­­­­­­­­­­­­­­­­IACCM: When we last spoke, I recall being especially impressed by the way that IBM had devoted contracts expertise to the product lifecycle. This yielded a range of benefits, but especially that products and services came to market clothed with appropriate terms and contract structures – and that there were resources in place to ensure continuing alignment over time. Has anything changed?
MC McBain: Since we last spoke, we have seen the consolidation of the Contracts & Negotiations function with the Legal department. This has allowed the legal standard agreements team – the group that designs and maintains IBM’s core contracts – to be integrated with the team that oversees broader policies and practices for the product and service divisions. This has enabled increased speed and responsiveness to the needs of the business and external changes. It also ensures that IBM’s agreements and terms are flexible to the needs of solution packages.
IACCM: I know that one of your goals is to stay ahead of the game – to anticipate shifts in the market, rather than find yourself always reacting. Does that remain a key objective?
MC McBain: Absolutely – and there are two examples which I would like to use. First, we are focused as a group on ‘the next big thing’ – or, given the scope of IBM, I should perhaps say ‘the next big things’. This means we are focusing work on solution initiatives and technologies that have high impact. Current examples are Cloud Computing and IBM’s ‘Smarter Planet’ initiatives, programs such as new models for electric grid management, water management, and healthcare . Working in leading-edge areas like this is very exciting and rewarding for contract professionals.
The second example is the need for ever-increasing sophistication in understanding customer expectations. You may recall when we last spoke that we had developed a market management model, laying out eight key relationship types which facilitate businesses in shaping their customer or partner offerings and ensuring timely involvement of the right support resources. We try hard to stay on top of changes to these models and to develop contract terms and practices that are appropriate for different relationship segments.
Through our client value initiative, we seek to monitor differences in buying patterns and values and to adjust contract offerings accordingly, as we bring new solutions to market or learn from shifts in market needs. Sometimes that is hard; for example, we know that customers who are interested in Cloud Computing typically prefer a fully electronic service – click and accept contracts, electronic invoices etc. But such approaches may not be legally acceptable everywhere, some countries simply do not allow the advanced techniques our customers would like. So we must monitor, adapt and adjust to come up with the best solutions.
IACCM: ‘Ease of doing business’ is viewed as an important issue for many of our members – facilitating better internal and external relationships. As we know, that can be tough to achieve in an environment of continuous and rapid change – especially reconciling old business models with the needs created by new solution offerings. Is this an issue that features in your work?
MC McBain: We learned long ago that ease of doing business requires a ‘one company’ approach. Customers and business partners are doing business with IBM Corporation, not its individual divisions or product groups. So we must ensure consistent ‘look and feel’ and the contract must have solution characteristics. In more recent times, we have been further extending this philosophy. We have focused on designing systems that deliver integrated ingredients, often from an extended supply network or ‘eco-system’ that goes beyond IBM.
We have a massive advantage over companies where contracts and legal groups are fragmented. On my team, we work with everyone and this offers unique insights and opportunities for cross-fertilization of needs and ideas. It means that we are not only better at innovating, but that when we innovate we have the potential to do it consistently across the enterprise. If you like, you could say that when it comes to contracts and contract practices, we operate as a center of excellence for the enterprise.
But of course having the vision and the information is only one part of the story. As your question implies, the challenge is often to ensure that new commitments can be matched by execution capabilities. Enterprise modeling has allowed better and faster understanding of the downstream connections. We have a strong belief in ‘ Get it right rather than fix it’ – so that is why we have invested so much in having a proactive front-end contracts and legal organization. We get involved right at the outset of product and service ideas and concepts, we ask questions early to be sure that the terms and commitments can be shaped as part of the planning, not as some after-thought.
IACCM: Despite ever-tougher global competition, IBM remains one of the most successful brands. We know from past experience – and recent results – that the Corporation understands the importance of contract terms and contract management discipline in demonstrating and delivering value. What are some of the key lessons for those in contracts and legal groups? 
MC McNeill: You have to be ready to make a cultural shift – perhaps on a regular basis. We operate in a global economy and business conditions are often tough. The business demands that we deliver innovation, yet with models that can be replicated and which we are confident about delivering.
I would say that businesses must get the front end right. The contracts and terms – and the associated resources - that support solutions must be right at the outset, they must be affordable and they must be responsive to on-going needs. You must build market confidence in your ability to deliver against your promises.
Business analytics is also important and another indicator of the cultural shift that I mentioned earlier. Traditionally, contracts and legal groups both tended to work at specific deals and attempts to capture and learn from experience were limited. That has changed; we must capture and analyze data so that we are aligned with the market and customer needs from the outset.
Finding and developing the right people for today’s contracts groups can be tough. In a solutions market, you need knowledge workers with critical skills who know what it will take to compete effectively. You need expertise and professionalism – people who will not compromise on quality and reputation. This really is key in a solutions market, where customers rely on the outcomes you have promised.
 IACCM’s Tim Cummins interviewed M.C. McBain  on May 29th, 2009.
 
 

Public Sector Contracting: In Need Of Urgent Repair

 
Initiatives in the United States to reform public sector contracting are to be welcomed - and IACCM is preparing a major input to this debate. The US is not the only Government that understands the urgent need to drive improved contract outcomes. But this will not be achieved by traditional procurement attitudes and behaviors, often treating suppliers as 'the enemy'. As a recent blog in 'Commitment Matters' highlights, we need a more holistic revision to contracting models and the skills deployed to negotiate and manage contract relationships.
 
 

So far as I know, the memorandum issued by President Obama on March 16th calling for improved contract management was a first. I am not aware that any other head of state ever highlighted the importance of contract management discipline in the effective and proper application of public sector funds.

Recent incidents demonstrate the urgency of this need. For example, Sherry Gordon reported yet more problems for the UK's National Health Service when she wrote recently on Spend Matters. And the US press has been full of the contention in Virginia, where Northrop Grumman won a major IT outsourcing contract that is now riddled with questions. A further variant arose earlier this month, once again affecting the UK health service, when the press questioned the competence of procurement in its use of reverse auctions to select and deliver outsourced care services – and its failure to oversee the results (see Reverse Auctions).

It can be tempting to blame the suppliers. For example, it is suggested that Northrop Grumman lacked the skills and experience to undertake the outsourced work in Virginia and the media in the UK is pointing at BT as the culprit for missed deadlines and service level failures. But in the end, projects like these depend upon a high degree of collaboration and honesty between the parties. They also require robust governance and rigorous performance management. And that has to be a mutual commitment and capability. Blame is rarely all on one side; and certainly not when, as these incidents suggest, the problems and issues go back over a number of years.

Today's complex, service-based deals demand selection and post-award management procedures that are far more robust than most public sector agencies are equipped to provide. Traditional procurement training is inadequate – and in many cases makes the problem worse. The tendency for public procurement policy to focus on price alone is reinforced by training programs that treat suppliers as untrustworthy and to be held at arm's length (see for example my recent blog on A Simple Way To Undermine Procurement Success). In many cases, delivery personnel have little training in supplier relationship and performance management, there is little or no continuity of staff and fragmented responsibility for outcomes.

President Obama's concern was echoed in a recent report by the UK's National Audit Office, which focused on the challenges in post-award contract management and highlighted deficiencies in current practice. Last year, a Rand Corporation report on EU Public Procurement Policy (based on research by IACCM) was scathing in its observations of contracting policy and practice. The report highlighted the distorting effects of risk-averse terms and conditions, often compounded by the use of external consultants and law firms. Overall, it found that the lack of robust and transparent contracting principles not only sets the seeds for potential failure of many projects, but also leads to higher pricing due to the levels of risk that suppliers must bear.

All the evidence suggests that the need for improved contracting competence is urgent. It is refreshing that President Obama's advisers have understood the need (and IACCM members are invited to respond to that initiative); and there are similar steps afoot in the UK and Australia. However, given the scale of today's public sector expenditure, combined with the need to ensure greater efficiency and (shortly) savings, the pace of change must be faster.

This article is taken from the Commitment Matters blog. IACCM members are invited to send their views on changes needed in public procurement to info@iaccm.com.

 
 

A Man With A Vision: Changing The Image Of Contracts

 
In this interview with Jason Anderman, CEO of WhichDraft.com, we explore a new ‘self-directed legal resource’ that enables the creation of free legal forms and contracts.
 
 
Jason Anderman is on a mission. In common with a growing number of IACCM members, he is frustrated by the repetitive and unproductive nature of many contract negotiations, which he describes as ‘boring’. He is convinced there must be a new way, so that time and resources are expended on shaping deals and relationships to deliver better results. But as many have experienced, resistance to change is strong; the agenda for negotiations remains stubbornly fixed on traditional, legally dominated topics (see previous article on ‘The Most Frequently Negotiated Terms’).
The difference with Jason is that he has decided to do something about it. Abandoning his work as a senior in-house counsel with a top medical technology company, he built and launched WhichDraft.com, a free on-line resource for simplified contracting. In Jason’s words: “WhichDraft.com aims to be a company that brings sophisticated understanding of contracts to those who cannot afford traditional advice or expensive software”.

To an extent, this definition downplays the extent of the task, because to deliver this service requires investment in the creation of contract standards or models, at both a term and a document level. The core templates that Jason is producing have the potential for much wider application than just ‘those who cannot afford traditional advice’. Indeed, his work may ultimately complement and draw from a number of current IACCM projects, in which we are working on global standards for contracting and contract principles.

Avoiding Repetition

“During my career, I have observed how contracts seem to be getting longer and taking more and more time,” observes Jason. “Can you imagine anything more boring than writing – and rewriting – a contract? The interest, the intellectual engagement is in shaping the deal. That is where – as a lawyer and adviser – I want to be spending my time”.
According to Jason, many lawyers exhibit limited interest in the business terms within a contract – yet they house most of the risk. His dream is that we can move towards a set of global principles and standards for these business terms – for example, provisions such as exclusivity, forecasting and change control. He sees the IACCM community as the body uniquely equipped to address these areas of contract. 
The WhichDraft.com web site has been developed using the latest programming language and protocols, which enable changes to flow automatically to other affected areas. This is important because it massively reduces the workload behind maintenance and updates of content and ensures accuracy - a critical characteristic in something as sensitive as a contract.  “In many ways contract language is like software code”, comments Jason. “You are creating function by putting words together.”

A Basis For Negotiation

Jason shares the philosophy that underlies each of the current IACCM standardization projects. He believes that a standard template will often do no more than provide a basis for negotiation, through terms that are mutually agreed as balanced. “Many of today’s standard forms of contract are complex and inflexible. They impose rigid rules which may be inappropriate or outdated and often represent the views of one side – so we often start working around them or resisting them. This is not the way standards have to be.”

Today WhichDraft.com still offers ‘buy-side’ and ‘sell-side’ forms of agreement, yet already narrowing the degree of imbalance between them. Over time, Jason hopes that we can move towards using an agreed and common base. This would allow discussions to focus on principles, rather than coming from polar opposite positions, as they do with the traditional ‘battle of the forms’. He refers to a recent Contracting Excellence article by Ashif Mawji, CEO of Upside Software, which highlights the benefits of such templates within advanced contract management applications.  (See “Why integrating your buy-side and sell-side agreements in one contract management system is advantageous")
Overall, these efforts should reduce the potential for misunderstanding, shorten cycle times, reduce the costs of contracting and ensure time is spent on shaping the deal and its related business terms. Yet it is of course these very benefits that create strong aversion from many legal and contract negotiation professionals. Standards undermine their traditional work. “There is a fear of change, technology is seen as a threat.”

Overcoming Resistance: A Dynamic New Approach

Jason agrees with an analogy between this resistance to modern technology and the way that the legal profession in Europe clung to the use of Latin in court and legal systems. For centuries, lawyers refused to use the language of the common people in order to maintain the mystique of their profession and its standing. In some respects, we face a similar challenge today, with a community that is resistant to use of the latest communication and efficiency tools. But with cycle times ever shorter, such resistance is bound to crumble and Jason wants to be sure that he is at the forefront of the change. That is perhaps why his web site draws unconsciously on another mediaeval term and carries the by-line ‘Contract Alchemy’.

So what progress has Jason made with his grand vision? WhichDraft.com has gone live and already boasts an impressive array of content and functionality (see http://www.WhichDraft.com):
  • Templates for common business agreements
  •  A question and answer wizard that shows clause permutations
  • Software that writes clauses and assembles a contract
  • Contract assembly tool to create your own personalized Q&A wizard and templates
  • Multiple version tracking and red line comparisons
  • Free, provided at no charge 
The content is proving useful worldwide, though of course some provisions should be tested for local validity (they are based on US and Common Law principles). There is also need to develop content for different industry environments. But all of this is work in progress and by partnering with groups like IACCM and similarly enthusiastic individuals, Jason is confident that his vision will continue to become a reality – and that we can indeed take the boring parts out of contract development and drafting!
Jason Mark Anderman is President and Co-Founder of WhichDraft.com. He graduated in 1992 from Washington University in St. Louis and received his J.D. and M.A. degrees from Duke University School of Law and Graduate School. Following a period in private practice with law firms  Paul, Hastings, Janofsky & Walker (New York, NY) and Goodwin Procter (Roseland, NJ), Jason served as counsel at Becton, Dickinson and Company, a Fortune 500 medical technology company. He is a certified Six Sigma Green Belt and has led projects to drive efficiency in legal services.
 
 

Project Risk In IT Application Development Contracts

 
This paper by Mike Tremblay, a Contract Consultant at HP Services, reviews some of the contract elements encountered in Information Technology application development contracts and provides both Customer and Supplier perspectives so that each party’s respective interests and motivation are considered.
 
 

This paper reviews certain contract elements encountered in Information Technology application development contracts. The contract provisions are (1) deliverable milestone billing structure, (2) holdback, (3) warranty, and (4) critical deliverables. 

1.       Payment Milestones

a)       Background:
 
The deliverable milestone billing structure is quite common in contracts that require a contractor to construct something tangible for a Customer. The Building Construction industry has a long history of receiving payments based on percentage of completion or pre-determined construction stages subject to Customer acceptance. Under this type of billing arrangement, the Customer approves periodic payments or “draws” against the total contract price based upon the Supplier’s completion of certain construction phases and satisfactory inspection by an independent government building official. In some construction contracts, the Supplier is not allowed to build profit into these periodic draws with all of the projected profit for the entire project being built into the final draw due. Construction type draws might include the following major phases of a new building construction project: foundation, framing, rough carpentry, rough electrical, rough plumbing and others.
 
In the automotive industry, tooling Suppliers often are paid on a percentage of completion basis with final payment due after the tooling has been proven to meet the production specifications. This is known as Production Part Approval Process” or “PPAP”.   PPAP is a process where the Customer verifies that the engineering design record and specification requirements are properly understood by the Supplier and the resulting tooling and processes meet these requirements in an actual production run at the manufacturing facility of the Customer over a pre-determined period of time (typically 3 – 6 months).
 
In the software application development process, payment milestones might include such things as:
 
Project Schedule
System Design document
Code Build
Test Cases Complete
Unit Testing
Integration Testing
User Acceptance Testing
Deployment
Warranty Acceptance
 
These examples of deliverable milestones are not intended to be all inclusive, but are representative of the major application development project stages that can be quantitatively measured as being complete. 

b)       Customer Perspective:

In an application development project, the Customer’s expectation of the Supplier is to develop a product that meets the Customer specifications within a desired time-frame.   The Customer value is not fully realized until the final work product can be used in production so the Customer motivation is to place the highest value on the final work product.   For longer term engagements, the Customer may be willing to pay for interim deliverables but still desires to place the greatest weight on the finished product.
 
c)       Supplier Perspective:
 
With development projects that could span multiple months, the Supplier desires to obtain payment on a percentage of completion basis. A fair compromise to this is to base the payment on mutually agreed to interim milestone deliverables or phases in the development cycle, such as the ones mentioned earlier. Once the Supplier provides the Customer with the deliverable and it is accepted by the Customer (usually using some pre-determined acceptance criteria or testing results), payment is made to the Supplier. The Supplier should price each interim deliverable in line with the estimated effort required in relation to the total project in order to match price with effort.   In addition, it is advisable that the Supplier negotiate a number of milestone payments throughout the development project life so as to have a steady stream of billable events. 
 
The risk to Supplier is that if any milestone is late or does not meet the acceptance criteria, payment is delayed until the deliverable is completed and accepted.   When a project is running late, the Supplier may also have to invest additional resources to get the project back on track, further worsening the performance to the Supplier’s point-of-sale model.
 
The project schedule should have some pre-determined, time-limited Customer review and feedback period so as to avoid the Supplier milestone payment being held in limbo for an indeterminable period of time.
 
 
2.       Holdback Provisions
 
a)       Background:
 
Holdback is a contract mechanism that allows the Customer to hold back some percentage of the total contract price from the Supplier until a pre-determined period of time or event following delivery of the work product. Holdback in the construction industry and manufacturing industry is not a new concept but it is a relatively new provision in computer application development projects.   There are three main components to holdback provisions.  
 
a.        The time period that the holdback amount is held by the Customer

b.       The amount of the total price that is being held back by the Customer

c.        The criteria used to release the holdback amount

1) Time Period:

Typically the time period is between 30 and 90 days but it could be longer. Some contracts hold back until the warranty period has expired while still others may specify a time period to prove that the work product functions as specified over a pre-determined use period in the Customer production environment.

2) Amount:
 
The second component in the holdback provision is the amount of the holdback. Typically one can expect anywhere from 5 to 25% of the total contract price to be held back.  
 
3) Criteria for Release:
 
The third main component is the Holdback release criteria. This can be from the very simple, like a pre-determined period of time after delivery or it can be based on more stringent exit criteria (warranty, pre-determined production performance over some pre-agreed to period of time).
 
b)       Customer Perspective:
 
The Customer’s motivation to utilize a holdback provision is to retain part of the total price of the project until the Supplier demonstrates that the deliverable has met the requirements over some pre-defined period of time.  This provides an incentive to the Supplier to deliver a quality product.  This approach maintains a Supplier interest beyond just the delivery of the final work product and prevents a Supplier from pulling a dump and run, with full payment in hand.
 
c)       Supplier Perspective:
 
If the holdback period is for some extended period of time and/or is a large percentage of the total price, the Supplier may consider a time value of money cost element when developing the price of the project. Typically, if it is expected that the hold back period will be longer than 30 days or the holdback amount is larger than 15%, one may consider pricing in this lost time value of money. The Supplier should insist on a holdback release criteria that is objective and consistent with the application development requirements.   During times of tight credit or where a Customer is under financial duress, the Supplier may want to cap the holdback amount or eliminate it entirely to reduce cash exposure. Projects that exceed some pre-determined threshold should require the Supplier to obtain internal leadership approval prior to submitting a pricing response to the Customer.
 
 
3.       Warranty
 
a)     Background:
 
Warranty has been a staple in the consumer hard goods industry for years. However it is relatively new in the Application Development space. The warranty concept is relatively the same for both consumer hard goods and Business to Business IT application development. That is, that the product is warranted to run as advertised or according to specifications for some period of time after delivery.
 
b)        Customer Perspective:
 
The Customer’s desire is to seek remediation in the form of corrective actions by the Supplier in the event that significant defects or non-conformities to the requirements exist in the final product. The length of the warranty period should be of a sufficient duration to detect any non-conformities over the normal cyclical use of the applications. Typically this can be done in a 30 day period for applications with monthly cycles and 90 days for those applications that run on quarterly cycles. Even though the Supplier may have run a variety of tests (unit testing, integrated testing, user acceptance testing, load testing, performance testing, etc.) on the application to make sure it performed to the specifications, some things may not get discovered until it runs in the actual production environment.
 
When the application development project (i) is complex, (ii) utilizes leading edge or unproven technologies, (iii) is of a nature that the test cases may not capture the variety of conditions that may exist in the production environment, or (iv) will not have access to an integration testing environment that mirrors the production environment, the application may encounter problems that may not surface until the application is running in the Customer’s actual production environment.   Thus there is a need for the Customer to have some recourse with the Supplier after the application is put into production use.
 
c)   Supplier Perspective:
 
The Customer expects and Supplier strives to develop an application that performs to the Customer specifications. The warranty objective for the Supplier is to limit the warranty period to a reasonable time-frame. Since application development is not a precise science, the defects or non-conformities required to be corrected during the warranty period should be material in nature and related to the actual functional requirements but not minor issues related to look and feel. For example, font size or screen colors should not constitute a warranty item. However, missing a key end user function should be a warranty item.
 
Warranties should be limited to 30 to 90 days after being placed into production use.   If the resulting developed application will not be put into production use until sometime after delivery of the final work product, the Supplier should consider negotiating the removal of the warranty coverage or changing the warranty period to some fixed time-frame following delivery of the work product. The Supplier does not want to be in a position of having to provide support for an undeterminable, unquantifiable warranty time-frame.  That would require the Supplier to maintain some level of expertise to be on hand to respond to the “just-in-case” and undefined warranty situation. 
 
 
4.       Critical Deliverables
 
a) Background:
 
1)       Critical Deliverables are those deliverables that the Customer deems key milestones or activities during the system development lifecycle.   Failure of the Supplier to deliver these on time will cost the Supplier in the form of Critical Deliverable credits to be paid to the Customer. Critical Deliverables are the Customer’s financial motivator to the Supplier to keep the project on track so that the Customer can realize the benefits associated with the enhanced functionality.  
 
2)       At this point, it makes sense to discuss the relationship between Critical Deliverable Credits and liquidated damages as Critical Deliverable Credits are often viewed as liquidated damages.   Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance). In order for a liquidated damages clause to be upheld in a legal ruling, two conditions must be met. First, the amount of the damages identified must roughly approximate the damages likely to fall upon the party seeking the benefit of the term. Second, the damages must be sufficiently uncertain at the time the contract is made that such a clause will likely save both parties the future difficulty of estimating damages.
 
The use of the terms Critical Deliverable Credit is used instead of the term “penalty” because based on legal principles “damages for breach by either party may be liquidated damages in the agreement but only at an amount that is reasonable in light of the anticipated or actual loss caused by the breach. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.” Further, “when a sum is stipulated in a contract as a punishment for default, not as the measure of compensation for breach of contract, the stipulation is a penalty and is invalid and non-enforceable.” Critical Deliverable credits are allowable because each party know what is in their own best interest to include or exclude from the contract. Each party knows their own situation and the surrounding circumstances better than any third party (including an arbitrator or a court).
 
Key Definitions:
 
Critical Deliverables mean those deliverables performed on a one-time or periodic basis, for which a Deliverable Credit may be payable.
 
Critical Deliverable Credits means the monetary amount(s) that the Supplier shall pay to the client (or apply against Monthly Charges) in the event of a failure to achieve a Critical Deliverable.
 
Typical Critical Deliverables associated with IT Application Development projects are as follows:
 
Supplier Project Team Fully Staffed and Equipment/Software Available for On-Time Project Start
Detailed Integrated Project Schedule (WBS) Signoff Obtained
Construct Tollgate
Test Tollgate
Deploy Tollgate
Close Tollgate (including warranty period completed)
Requirements Signoff Obtained
Design Signoff Obtained
User Acceptance Test Signoff Obtained

3)       Critical Deliverable TBD Credit amounts in RFPs: If a Customer issues a request for proposal which has Critical Deliverables and the associated credits that indicate a “to-be-determined” (TBD) amount, then the requirements are incomplete. Some Customer do this as a practice, with the belief that Suppliers should not price any additional risk or harden the solution based on the size of the Critical Deliverable credit. This is not only a bad contracting practice, but it also brushes past business realities that risk is not an element that influences solutioning and pricing. Certainly if the Critical Deliverable Credit due the Customer for failing to meet a particular milestone was $100,000 versus $1,000 per week late, the Supplier has to either (i) design a hardened and resilient solution to significantly reduce the chance of failure to meet them and/or (ii) add a price premium to allow for the risk of experiencing a Critical Deliverable failure and then having to pay the Customer the resulting large credit.   The economic risk is 100 times higher with the $100,000 per week Critical Deliverable credit versus the $1,000 per week late credit. In either case, the price to the Customer for the same work effort would be impacted.   Although this example is a bit extreme, it does illustrate the point of how the size of the Critical Deliverable Credit can influence the risk to the Supplier and thus the resulting price to the Customer. 

If the Supplier accepts the “TBD” amount without a qualifying statement, the Customer could later insert some amount much larger than that anticipated by the Supplier, thus increasing the risk profile to the Supplier.   Leaving the “TBD” amount in a Supplier response implies that the amount of the critical deliverable credits has no bearing on the risk profile of the engagement. The Supplier is advised to qualify the response by providing the Customer with those critical deliverable credit amounts that fit the Supplier’s risk tolerance and making the response contingent on Customer acceptance of the proposed Critical Deliverable Credits. The Supplier should develop the solution and price to meet these proposed Critical Deliverables. Other alternatives are (i) the Supplier could request the Customer to provide complete requirements by including the critical deliverable credit amounts prior to the Supplier responding to the RFP or (ii) the Supplier could always opt to no bid the opportunity.

4)       Critical Deliverable due dates: The Customer includes the due dates for the Critical Deliverable (for example, “in accordance with the Baseline Project Schedule” or “XX weeks after some project event”), along with the lateness allowance of that Critical Deliverable (one week late, then a credit is paid). Early service level methodologies, used the Critical Deliverable Credit as a one time payment for missing a Critical Deliverable Due Date. Today, it is not uncommon to find Critical Deliverable schedules designed to have the vendor pay a repeating credit until the Supplier provides, and the Customer accepts, the deliverable.  A Critical Deliverable with a Critical Deliverable Credit based on a per-week-late basis, would require the Supplier to pay the Customer the Critical Deliverable Credit for each week that the Critical Deliverable is late until it is delivered. For example, if the Critical Deliverable is based on a “per week late” Critical Deliverable Credit and the Critical Deliverable is 4 weeks late, then the Supplier will pay the Customer 4 times the Critical Deliverable Credit amount. Critical Deliverables that are late may also cause subsequent dependent Critical Deliverables to be late thus increasing the Supplier’s Critical Deliverable Credit exposure. One can see how the Critical Deliverable Credit can snowball to become quite onerous to the Supplier if the project falls behind schedule early in the project time-line.

5)       Progressive Critical Deliverable credits: A recent new, more onerous twist to the Critical Deliverable is the progressive credit. In this scenario, the Critical Deliverable Credit increases in size as the deliverable continues to fail meeting the Due Date.

 
EXAMPLE:
 

 
Critical Deliverable Credit based on Number of Weeks late
 
1 Week late
2 weeks late
3 weeks late
4 weeks late
Transition Plan
$1,000
$2,000
$3,000
$5,000

 
 
a)     Customer Perspective:
 
The Customer interest is keeping the project on time. By including Critical Deliverables and the associated critical deliverable credits in the contract for the application development project, the Customer provides a financial motivator to the Supplier to stay on time.
 
Critical Deliverable Credits should be viewed in light of the entire damages picture that is drawn from the performance failure. Taking into consideration the contract’s direct damages cap - the Critical Deliverable Credits should be viewed as an additional remedy over and above the direct damages cap. 
 
b)    Supplier Perspective:
 
The Supplier’s objective is to develop a solution and align its internal incentives with the Customers requirements and emphasis as described in the Critical Deliverable Due Dates in the proposed project schedule and the Critical Deliverable Credits. For interim Critical Deliverables, the Supplier should try to negotiate a waiver of any interim Critical Deliverable Credits if the final Deliverable is delivered on time.  Another risk mitigation action is to negotiate lower Critical Deliverable Credits for these interim deliverables with a larger Critical Deliverable Credit attached to the final work product deliverable.
 
For projects with a milestone billing structure, the Supplier should push for milestone payments for each Critical Deliverable. The rationale is that if the deliverables are critical to the Customer then these deliverables must also provide value in the form of a milestone payment.
 
Removing the subjectivity out of Customer acceptance is another way to mitigate risk.   The Supplier should propose objective acceptance criteria and if the deliverable meets these objective criteria than the Critical Deliverable is met.
 
Conclusion:
 
Information Technology Application Development projects are bound to have one or more of the following types of contract elements:
 
·         deliverable milestone billing structure
·         holdback
·         warranty
·         critical deliverables
 
The key point to remember is that these contract elements all should involve some level of risk assessment to be done by both the Customer and Supplier. All development projects will have some level of inherent risk just by the nature of the work. The contract elements listed above are a way to shift some of the risk from the Customer to the Supplier.  Given that certain information technology consulting groups cite that the failure rate of “large” IT application development projects ranges from 50 to 80%, it is important to understand the impact of the risk re-allocation presented by these contract elements.
 
Taken to an extreme, let’s take the example of a long term, complex, high dollar value project with one milestone payment due at completion of the work product, a high percentage (15% or higher) holdback amount with an extended warranty and holdback period and multiple progressive critical deliverables with excessive critical deliverable credit amounts. In this situation, the Supplier may add additional resources and “over solution” in order to provide additional assurances of timely delivery against unknown risks and may also add a price premium to cover the time value of money and contingencies for critical deliverable credit payments.    This will translate into a higher price to the Customer. An overly high risk profile will cause potential Suppliers to price in the additional risk resulting in an unacceptable price point for the Customer or even worse could influence some capable Suppliers from even bidding on the work.
 
The key is to balance the Customer desire for timely execution to the project schedule with the Supplier’s risk tolerance. By striking a balance to the risk allocation of these contract elements between Customer and Supplier the resulting agreement should increase value to the Customer and provide a tolerable risk profile to the Supplier.           
 
The author is employed as a Contract Consultant in the Legal Affairs office of HP Services, a division of Hewlett Packard (Mike worked for EDS, prior to HP’s acquisition of EDS in August, 2008). Mike has over 15 years of Information Technology contracting experience on both the Buy and Sell side. In addition, Mike has taught graduate level MBA courses as an adjunct faculty member for Davenport University in Warren, Michigan. Thank yous go to Jason Cole and Doug Peters (also an IACCM member) for their editorial comments to prior drafts of this paper.
 

 
 

Commercial Management Delivers for Charity

 
Catch22 is a charity that works with young people in the UK who find themselves in difficult situations. Last year, it helped more than 34,000 youngsters who were struggling to find their way in life, through problems with learning, domestic circumstances, exposure to drugs and other personal or social pressures.
 
 
Catch22 is a charity that works with young people in the UK who find themselves in difficult situations. Last year, it helped more than 34,000 youngsters who were struggling to find their way in life, through problems with learning, domestic circumstances, exposure to drugs and other personal or social pressures.

At a glance, it scarcely appears to be the sort of organization that would much care about contracts and commercial management. So Tiffany Kemp, Managing Director at Devant Ltd., was understandably surprised when she received an on-line enquiry about commercial contract training. However, she quickly came to understand why Catch22 depends on its contract and commercial skills – and also to appreciate the extent to which they needed bolstering.

As a charity dealing primarily with public sector clients, commercial discipline was not intrinsic to the Catch22 organization. Its dedicated staff was far more proficient in understanding its young clients’ needs than it was at negotiating contracts. And for many, these long, complex documents seemed to have little bearing on their day-to-day work, so they were reluctant even to read them.

“There was little scrutiny of contracts,” comments Tiffany. “But by taking the step of making their enquiry through our website, Catch22 was one of the first organizations in this sector to really understand the importance of commercial / contractual relationships. Our task was to help their field workers appreciate how commercial understanding was a good thing for their organization and for the young people they are working to assist.”

The key breakthrough was to help staff understand that contracts offer a mechanism not only to operate within budget, but to generate a surplus to fund other projects. “Before (the training), contracts were seen as legal instruments to manage what most saw as theoretical risks. They were typically signed without any real review and certainly no one used them as a tool to manage the relationship or to generate income,” explains Tiffany.

The initial targets for training were the Regional Directors, who were in charge of projects within their geography and signed off on each contract. By focusing on this senior group, the program not only emphasized the importance of better commercial understanding, but also ensured that top management started to demand more from their staff – and to explain the benefits. Training is now extending to lower levels in the organization. In the words of Chris Wright, National Director of Operations at Catch22: “Managers are being more proactive about commercial issues. They are raising more questions about proposed contract terms from commissioners and are able to enter contract negotiations with their eyes wide open. In addition, they are now more confident about setting appropriate expectations with commissioners which is improving the risk profile of projects and, hence, the operational and financial outcomes for Catch22.”

In Chris’s view, the success of the program is because it avoided “dry as dust legalese” and focused on “pragmatic, business-oriented principles that made it very easy for us to relate important commercial and contractual issues to our everyday activities”. Tiffany echoes those sentiments. As an enthusiastic supporter of IACCM, she ensures that Devant’s work as consultants and trainers emphasizes the role of commercial management in delivering good financial results through sustainable and well-structured business relationships.

Catch22 is a great example of the spreading awareness of the role that contract and commercial management play in today’s business and economic environment. They offer the control and disciplines that enable improved management decisions and create a platform for change and innovation. Fran Pollard, Catch22’s Director of New Business Development, added:  “As Government relies more and more heavily on the voluntary sector to deliver services in support of its social policies, the potential for delivering significant benefits to young people has increased – but so have the risks to providers, both commercial and operational. It is essential that the voluntary sector is equipped to negotiate a fair balance between the risk taken by commissioners and that taken by themselves. Catch22, with help from Devant, is at the very forefront of this drive.”

Successful training has proven to be the first important step. Now that they understand the benefits of commercial management, and feel equipped to enter into contract negotiations with commissioners, the internal teams are pushing for improved procedures and tools, to assist in handling some of the common issues and opportunities.  “Now we have helped the commissioners recognize that they too could benefit from improved commercial skills,” laughs Tiffany, as she prepares Devant to tackle what may be a future opportunity.

Devant (www.devant.co.uk) was created in 2003 to provide Contractual and Commercial Management services. The company works with the belief that contracts should be a tool for managing business relationships, rather than just an 'insurance policy'. This means that they need to “reflect how you do business - how you sell and deliver your products or services, your company's culture and your tactical and strategic objectives”.
 
 
GAIN STATUS, SKILLS AND SECURITY FROM WORLD-LEADING DEVELOPMENT PROGRAMS
 
Executives in industry and government have woken up to the critical role that contracting plays in delivering sustainable business results. There are growing demands for robust skills and predictable methods in the selection, negotiation and management of trading relationships.
 
This means it is a time of great opportunity for those charged with responsibility for contracts and commercial management - yet also a time when skills and knowledge must not be found wanting or techniques not up to the task.
 
That is why your peers around the world are taking steps to refresh and update their know-how and to obtain professional credentials. Whether as individuals or teams, participants in IACCM programs benefit from unique learning approaches that combine a structured syllabus with flexible mentoring and networked discussion groups. It is the only program that offers an integration of buy-side and sell-side interests with a global perspective, assisting students of all levels to grasp the latest ideas in collaborative, market-aligned bid, contract and relationship practices. And to emerge with a benchmarked skills profile and a formal professional certification. 

TAKE STEPS TO JOIN THE GLOBAL PROFESSION TODAY! Contact Paul Mallory at pmallory@iaccm.com or Jim Bergman at jbergman@iaccm.com or sign up for one of our forthcoming webcasts (dates to be announced shortly on our homepage -  www.iaccm.com) and hear from managers and practitioners from the world of contracting and commercial management. Discover how, through this low cost, versatile program, participants gain:

  • New understanding and insight to risk and its management
  • Appreciation of the strategic and operational impacts of contracting and the delivery of economic value throughout the relationship lifecycle
  • Ability to apply standardized techniques and methods of good commercial practice
  • Influence over key stakeholders and increased status with sponsors and management

 

 
 
 
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