Stuff You Need to Know About Contracts

We mentioned earlier that contract knowledge is a key project management skill for procurement and vendor management. So, what exactly do we mean by contract knowledge? Although there is no substitution for actual experience, in-depth study, and formal training, here is a quick synopsis of the key contract facts that you need to understand to improve your effectiveness in this area of project management.

Conditions for Legal Contract

The four conditions that make a contract a legally binding agreement are

• It must be voluntarily entered into.
• It must contain mutual considerations.
• It must be created for legal purposes.
• It must be signed by authorized parties.

Key Contract Elements

Not every contract is the same, and not every contract will contain all of these sections (they may not apply), but the common contract components include the following:

• Scope statementIncluding deliverables, requirements, out-of-scope items, and assumptions
• Timetable and milestone dates
• Acceptance criteria
• Responsibilities of each party
• Financial arrangementsIncluding payment schedule, invoicing arrangements, and incentives
• Identification of the person authorized to make changes
• Change control procedures
• Issue resolution and escalation procedures
• Performance measurement and reporting
• Communications planStatus reporting, senior management meetings
• Procedures and/or penalties for ending the contract prematurely
• Liability for failure to perform
• Ownership and property rights of project deliverables
• Security agreements
• Non-disclosure agreements

Primary Contract Types

The three common contract types are as follows:

• Time and materials (T&M)
• Fixed price (FP)
• Cost reimbursable (CR)

The three variations of cost-reimbursable contracts are as follows:

• Cost Plus Fixed Fee (CPFF)
• Cost Plus Percent of Cost (CPPC)
• Cost Plus Incentive Fee

A common variation of T&M contracts is to cap the top end.

• T&M with a Cap

The Impact of Each Contract Type

In the previous section, we mentioned the three key contract types. In this section, we will review the points you need to understand about each type. The key categories include the following:

• Its advantages and disadvantages
• What situation is best for its use
• Who owns the risk
• The required project management tasks

Table 21.1 summarizes these key facts about each contract type.

Table 21.1. Summary of Contract Types

	T&M	FP	CR
Advantages	Quick to create. Brief duration. Good choice when hiring "people" to augment your staff.	Less work for buyer to manage. Seller has strong incentive to control costs. Buyer knows total project price. Companies are familiar with this type. Can include incentives.	Simpler scope of work. SOW is easier than an FP one. Lower cost than FP because the seller does not need to add as much for the risk.. Can include incentives.
Disadvantages	Profit in every hour billed. Seller has no incentive to control costs. Good only for small projects. Requires most day-to-day oversight by the buyer.	Seller may underquote and make up profits with change orders. Seller may reduce work scope if it is losing money. More work for the buyer to write the SOW. Can be more costly than CR if the SOW is incomplete. Seller will increase the price to cover risk	Must audit seller's invoices. More work for buyer to manage. Seller has only moderate incentive to control costs. Total project price is unknown.
Best to use when…	You need work to begin right away. You need to augment staff.	You know exactly what needs to be done. You don't have time to audit invoices.	You want to buy expertise in determining what needs to be done.
Who has the risk?	The buyer	The seller (cost), or both the buyer and seller if not well defined.	The buyer

Table 21.2 summarizes these key facts about each contract type.

Table 21.2. Summary of Contract Types

	T&M	FP	CR
Scope of work detail	Brief. Limited functional, performance, or design requirements.	Extremely complete. Seller needs to know all the work. "Do it."	Describes only performance or requirements. "How to do it."
Project management tasks	Providing daily direction to seller. Striving for concrete deliverables. Close monitoring of project schedule. Looking for a situation to switch the contract type.	Establish clear acceptance criteria of deliverables. Managing change requests. Monitoring project task dependencies. Managing risks. Monitoring project assumptions.	Auditing seller's costs. Monitoring seller work progress. Ensuring added resources add value to the project. Watching for shifting resources. Watching for un-planned seller charges. Rebudgeting.

The Absolute Minimum

At this point, you should have a solid understanding of the following:

• Solid project management is essential to reducing risk and improving quality on outsourced projects.
• Vendor management is composed of four distinct elements:
  • Evaluation and selection
  • Contract development
  • Relationship management
  • Delivery management
• Effective vendor management requires more formality in regard to communications and change control.
• Do not assume anything. If it is important to you or your organization, put it in the contract.
• Focus on "win-win" to build better vendor relationships.
• Make sure the vendor has the same goals that you do. Use incentives to align their goals with yours.
• Make sure the WBS (work breakdown) is appropriate for effective outsourcing.

The map in Figure 21.1 summarizes the main points we reviewed in this chapter.

Figure 21.1. Overview of managing vendors.