Contracting for Agile

The Status Quo

Traditional contracting methods
  • Time and Materials (T&M)
  • Fixed Price (which also fix Scope)
Optimal contracting position

The End — almost

1. Time and Materials (T&M)

T&M
  • Low risk for supplier
  • Clarity over what is being contracted for (i.e. labour)
  • Ultimate flexibility
  • Limited scope for supplier to differentiate from competition
  • Supplier becomes a body shop — customer can get attached to specific supplier employees
  • Customer focused attention on day rate rather than value delivered
  • Most of risk retained with customer (Preferred supplier lists/frameworks can help here. With these there is the ever present prospect of a future re-compete at which point the supplier will have to demonstrate value — hence, in theory, incentivising the supplier to perform assuming they value the relationship).

2. Capped Time and Material

Capped T&M
  • As per T&M
  • Fixed financial liability for customer (can’t overspend by acident)
  • More incentive on supplier (some transfer of risk) to ensure benefit is realised before cap is reached
  • Supplier knows they don’t have a blank cheque
  • As per T&M

3. Capped Time and Material, define outcome

Capped T&M, define outcome
  • Low customer risk, customer benefits if either the project is delivered early or late.
  • Supplier is incentivised to deliver on time
  • Supplier is not incentivised to deliver early
  • Risk is not shared equally
  • Quality likely to suffer in the result of overrun

4. Incremental Delivery

Incremental Delivery
  • Outcomes can be regularly changed
  • Total Risk can be better understood by biting the problem off in smaller chunks
  • Supplier is incentivised to delivery
  • No confirmed upfront price for customer
  • Long term pipeline of work not guaranteed for supplier

5. Two(+) Phase, Discover then Fixed Price and Scope

Two(+) Discover then Fixed Price and Scope
  • Promotes derisking early (think UP Inception/Elaboration)
  • Shared risk between customer and supplier
  • Works towards customer having a defined costs and deadlines after small initial outlay
  • Incentives supplier to work effectively in both phases
  • No confirmed upfront price for customer may cause issues getting business cases signed off
  • Temptation for supplier to use derisk phase to produce detailed specification to reduce risk of change later (V model)

6. Fixed Price and Scope

Fixed Price and Scope
  • Lower risk for customer
  • Supplier drives the deliver and manages resources
  • Change is handled explicitly
  • Opportunity for increased profit/cheaper solutions if economies of scale leveraged
  • Provides an opportunity to break into new markets / earn the trust of a new customer
  • Does not foster a collaborative relationship
  • “Change”, cost and what is considered change likely to become highly contentious
  • Risk mostly with supplier
  • Quality likely to be traded in the event of overruns

7. Price Target

Price Target
  • Risk is shared (generally in proportion to the size different between customer and supplier — bigger party taking on more risk)
  • Both sides are incentivised to deliver
  • Agreeing “what” the price target is for (i.e. scope)
  • Change needs to be handled carefully.
  • Need to negotiate sharing proportions

8. Fixed Profit

Fixed profit
  • Risk is split between parties
  • Supplier is incentivised to deliver early and has costs covered in the event of an overrun
  • Customer retains control of backlog and has freedom to request change
  • Quality is controlled in the event of an overrun
  • Money for Nothing Customer can terminate (if value proposition no longer makes sense) by paying remaining profit
  • Change for Free If the customer remains engaged, they can replace items (of equal value) in the backlog with anything they choose.
  • Careful attention is required to define the outcomes to the satisfaction of both parties (which is now the central commercial agreement)
  • Likely to get some disagreements around if a change is part of the core contract — as the supplier will be incentivised to up sell to increase profit (or to prevent dilution of profit)
  • Follow on work after the delivery date will need recontracted
  • Customer does not have a fixed price for the work (but will benefit through “cost price” on additional effort resulting through other runs)

9. Fixed Price, Shared Risk Budget

Fixed Price, Shared Risk Budget
  • Formal arrangement for customer and supplier to share risk
  • Allows customer to cap exposure to delivery risk, but supplier also has some protection for unforeseen circumstances
  • Both parties incentivised not to raid risk pot
  • Additional formality, complexity and cost of setting up contract
  • Customer may be reluctant to share risk funds

10. KPI Driven

KPI Driven
  • Highly flexible and KPIs can be targeted to specific customer value measures
  • Allows for change, scope not predefined
  • Delivery expectations clearly understood — less scope for ambiguity
  • KPIs can be assessed at regular intervals (e.g. Sprint, Program increments) — so risk can be managed and shared
  • Goodhart’s law — “When a measure becomes a target, it ceases to be a good measure.”
  • Extreme care is required to pick the right metrics. Picking the wrong metrics may cause significant issues — drive the wrong behaviours
  • Many Agile metrics make poor KPIs (e.g. Velocity) — hence this approach is recommended only if customer and supplier has appropriate SMEs who understand what they are doing
  • Unstable output likely at start of contract or with new/changed team — best results with stable team with a track record

Other Useful resources:

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