Week 8, 2019
Managing Risk: Fixed-Price, Time & Materials, and Agile Contracts
Each week I share three ideas for how to make work better. And this week, I look at different ways to govern work. Specifically, I look at three types of contracts and how they can be used to manage risk.
1. Fixed Price, Fixed Scope (FPFS)
I’m in the services business. Specifically, I’m in the digital services business. And here, the Fixed Price, Fixed Scope (FPFS) contract is the norm. Not surprising perhaps, given that most customers want to know what they’re buying. But there are two sides to this coin. And what works for the customer might not work for the vendor. FPFS contracts are decidedly one-sided; they place risk squarely on the side of the vendor. And most vendors are, consequently, apprehensive to sign such agreements. The one possible exception to this rule are productized services that manage risk by controlling processes (i.e., website starter pack with limited options for customization). For everything else, there are discovery projects — short and standalone engagements designed to discover enough scope so as to allow the vendor to sign the FPFS and still be able to sleep at night.
2. Time & Materials (T&M)
Before starting MAQE, I worked for a few years in the branding and advertising industry. And here, the Time & Materials (T&M) contract is the norm. Just like the FPFS variety, these contracts are decidedly one-sided. Only now the customer owns all of the risks. Uncapped T&M contracts mean that the vendor keeps billing until the work is done. Capped T&M means they keep on billing up to a certain point, regardless of whether the work is done or not. Neither makes much sense from a customer point of view unless they already know and trust the vendor or need to get started quickly on a project with emergent scope (i.e., a project for which scope is unknown and will emerge over time). Not surprisingly, this is the preferred contract type of most vendors regardless of industry. It’s quick and easy. And for long-term relationships, it leads to more work and less negotiation.
3. Money for Nothing, Changes for Free (MNCF)
FPFS and T&M contracts are, as mentioned, both decidedly one-sided — albeit in different directions. There are, however, alternatives designed to distribute risk more evenly between parties. Money for Nothing, Changes for Free (MNCF) is one such alternative. Here, a high-level estimate of the scope allows a target price to be agreed upon at the project start. Work is then governed according to two new clauses: “Changes for Free” and “Money for Nothing”. The former stipulates that the customer can change scope freely as long as the total scope does not change. The latter stipulates that the customer can terminate the contract early and save 80% of the remaining value. The idea is simple: to incentivize both customer and vendor to realize value as quickly as possible. The customers get most of the value at a lower cost, and the vendor gets 20% of the remaining budget as a performance bonus.
Contracts have one purpose: to manage risk. And risk should be born by the party best positioned to manage it. And that means that no one contract will work perfectly in all situations. You need to select the best one given the circumstances. But. You do need a contract. Likely you’ll never have to refer back to them. But if you do, you’ll be glad they’re there.
For a more in-depth look at the above contract types, I suggest “Agile and Commercial Contracts — an Overview” from Agile Innovation.
That’s all for this week.
Until next time: Make it matter.
PS. If you haven’t already, you need to watch Mike Montiero’s famous (or perhaps infamous) talk at CreativeMornings entitled “F*uk you, Pay Me”. You can thank me later.
