on September 24th, 2009

Dear Colleagues

When you have a permanent job in a company, your income is pretty certain. In the real, but cruel world of consultant, contractor and contract, however, life can be considerably more complex and fraught with danger. If the contracts are not handled correctly you could end up considerably poorer, despite putting in an enormous number of working hours. It may be worth re-considering the different options as outlined below. (And at the end of this newsletter is an extract from our Project Management course – a bonus chapter on costs.)

Crudely and simplistically put, as a consultant or contractor, you can bid for work in three ways.

1. Fixed Price Contracts.
These arrangements lock you into a price. Generally, come hell or high water, this is the price you, as the consultant or contractor, get paid.

2. Time and Materials
You get paid for both your hours spent on the job as well as the materials supplied to the client.

3. Two-Phase Contract
The first phase – you get paid on a time-and-materials basis, during which time you define the job to both your satisfaction and the client’s.
The second phase – you actually perform the contract on a fixed price (or sometimes time-and-materials basis).

Fixed Price is a Gamble

If you know exactly what has to be done and how long it will take (and the project is actually achievable); then this is a great option. But if the outcomes are uncertain and the project is badly defined, this is a dangerous option. Sadly enough, many clients know exactly how difficult and risky a particular job will be, but go for a fixed price so that the risk is removed from their bailiwick. They are simply after a rock bottom price.

Interestingly though, on the other side of the coin, I see that many contractors go for fixed price contracts knowing full well that they will be able to “drive a bus through the contract”. There was a particularly tough case recently involving underground tunneling, with a fixed price contract. The consistency of the earth and rock had not even been established! The contractor, however, actually ended up getting compensated for his risk as he incurred substantial additional costs. The client wasn’t too enthused with the thought of lengthy litigation and the inability to use the tunnel for an extended length of time so after jumping around for a while, the money was paid.

In a situation where you are forced into going for a fixed price contract and the definition of the job is still a bit uncertain do the following: Ensure that you define exactly what you are going to provide in the contract in terms of hours and materials and the rate of compensation for a situation where the project specifications change. You may find that if you do this precisely enough, you will end up making more money from the variations to the contract than the actual fixed price part of the contract! This is a popular strategy followed by some control system vendors who bid very low fixed prices. Against fierce competition the jobs were won with the full knowledge that the variations would compensate them handsomely. If you, as the client, take on these fixed price jobs; you will have to spend an inordinate amount of time on the contract. You will need to define all the terms and conditions and contemplate all eventualities otherwise you are up for considerably more money than originally anticipated.

Sometimes fixed price contracts fail to work well for unexpected reasons. One particularly acrimonious job comes to mind. It involved the provision of advice to a client on a project to build a Gas Turbine power station. We defined everything extraordinarily clearly and ended up with a fixed price job. Unfortunately the contractor omitted the risk for writing the control system software and the client had an awkward choice at the end. Either let the contractor go bankrupt, but have an incomplete power station or pay more money for the unexpected variations the contractor hadn’t factored in (and thus keep him in business). The client ended up paying well above the fixed price. Despite this, a few months later, the contractor still went bust. This resulted in the client having to complete the job with the attendant risk now shifted onto her.

Theoretically, you can claim on variations to the contract, but this is always fraught with some negotiation and angst as the client is not often enthused with having to pay more. Remember, however, when a variation to the contract comes up bring this to the client’s attention and bill him at the earliest possible opportunity (no matter how awkward and unpleasant this is). If you delay until the end of the contract, you may run the risk of not getting paid.

And at worse case, as a contractor/consultant, if you cannot see your way to getting paid for the additional work you are doing, and can’t get agreement from the client, simply “up stumps” (as we say in cricketing lore) and leave site. It generally never gets better. It is best to face up to the reality of the situation and avoid your losses getting worse. At this point, you may find that the client can see that you are serious and may become more accommodating

Sometimes it helps to compromise

Clients naturally worry that, with time-and-materials contracts, they may be “taken to the cleaners” as far as the end price goes. This is a valid concern. Unproven contractors can get lazy and simply bill for every hour. Naturally this is a short term win – they are unlikely to be invited back on site again.

I would suggest that if both client and contractor are unsure then a two phase approach is always the best. Develop and agree on a good specification where the unknowns are clarified and defined for the first phase. A fixed price or well considered time-and-materials proposal can then be agreed on for the second phase. Let’s face it. At the end of the day, in the specialized world of engineering, it is important that we build up long-term, trusting relationships between client and contractor and that both parties get a fair return on their investment: Not too much. Not too little. Just fair.

New Fangled approaches

I worry sometimes about these new fangled approaches which involve alliances and partnerships between clients and contractors. They are a little like a partnership between God and the Devil. With superb management on both sides they can work out. Unfortunately, though, they often end up costing one of the parties far more.

Always remember that it is better to lose a contract if you are going to lose money on it. Finally, as Samuel Goldwyn wryly remarked: “A verbal contract isn’t worth the paper it’s written on”. Make sure all agreements are in writing, signed by the correct parties and can cope with project modifications.

Yours in engineering learning


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