After Carillion – Are Fixed-Price Contracts to Blame?
By Kimble VP Global Accounts Chris Mitchell In the wake of the collapse of the major UK construction firm, Carillion, some commentators have questioned the use of fixed-price contracts. But I would argue that they can be successful and effective even for complex projects. Customers like them because they know what they are paying for (read more…)
In the wake of the collapse of the major UK construction firm, Carillion, some commentators have questioned the use of fixed-price contracts. But I would argue that they can be successful and effective even for complex projects. Customers like them because they know what they are paying for and what they are going to get for that money. And if well-managed, they give the contracting business clarity about the scope and cost of what they have undertaken to provide.
Here are six steps to managing a fixed price contract successfully.
1 Do a thorough risk analysis.
Assess the risk areas: technical, legal, operational, customer relationship etc. If this process surfaces a particularly complex or difficult aspect, don’t be tempted to push it out into the future and hope for the best. Shine a light on it. Working in a competitive market means there will be pressure on price when proposing a contract. But if you can show, in a compelling and data-driven way, that the competition is ignoring or suppressing serious issues which you are highlighting, then the client will realize that going down the line, someone will have to pay for these. The collapse of Carillion, with building sites abandoned half-way through, is a powerful argument.
2 Ensure the scope of the contract is clear and limited.
Make sure there is clarity about what is outside the remit of what has been agreed, or add contingency for unexpected risks. For instance, to return to the field of construction, any building site could contain unexpected issues. From Roman remains to rare animals, it is possible that something might be turned up by the diggers. Has a full survey been carried out? If anything wildly unexpected appears, can the contractor go back to the customer? Have a “change mechanism” in place so that it is clear under what circumstances the customer may have to meet additional costs.
3 Focus on the Outcomes.
Exactly what has your firm signed up to deliver? It sounds obvious but everyone in the organization should know what the outcomes are and remain focused on them. That way these can be broken up into a series of deliverables and milestones which have to be met by a certain time in order to get to the finish line. Sometimes the client wants to change this or add to it. Any implications for the timing or the resourcing of the project have to be worked out and cost before agreeing to the change. And where there is clarity over what the outcomes are at every level, it means that if the project starts to veer away from what the proposal said, or the timing starts to slip, that will be obvious immediately and steps can be taken to deal with it.
4 Map the project against real-world resources
Many businesses plan proposals for projects in a purely theoretical way, often using spreadsheets. They take a hopeful view of what the costs will be rather than one grounded in data and experience. At Kimble, we facilitate the process of breaking down each individual aspect of a project and making it visible. For instance, we recommend assigning potential teams to specific projects when they are still at the proposal stage. This enables accurate forecasts of the real costs of recruiting, resourcing and meeting the expenses for each engagement.
5 Expose the profitability of each project
There should be an agreed and rigorous process in place that everyone in the organization adheres to for assessing the likely costs of projects at the proposal stage. This feeds into accurate forecasts based on the milestones that have to be completed. Having a clear idea of what the baseline this project was sold at and what the expected margin is, is key. Perhaps this project was sold at a very tight margin – that creates a risk that if the margin is diluted, it may make the company little or no money – it could even cost money. So a forensic eye will have to be kept on the progress of this engagement. Are milestones being reached on time? Is the number of hours worked creeping up against the proposal? But another thing to watch out for is – when you look at the data on this project, does it appear to be 100% on track? That is actually a warning sign because in the real world, that never happens!
6 Use accurate forecasts to steer towards more profitable projects
A business has to make a profit in order to survive, as the Carillion example demonstrates. Having accurate forecasts and a data-driven understanding of how much each project will cost to deliver allows managers to make better decisions. With this information at their fingertips, they should be better able to understand risk at an organizational level – for instance if too many projects are being sold at too low a margin. This should enable them to make better choices about what kind of work to pitch for going forward, and how to steer the business towards profitable projects.
This subject will be covered more fully in a forthcoming Best Practice Guide on the subject of Risk Management. Kimble Best Practice Guides, starting with “Creating a Forward-Looking Culture” can be found here.