I was reminded about this issue last week when one of my colleagues – an experienced chief engineer – laughed at a cost over run we had with some consultants working on a project.

Dear Colleagues,

I was reminded about this issue last week when one of my colleagues – an experienced chief engineer – laughed at a cost over run we had with some consultants working on a project. Rightly enough he said – you should have engaged them on a fixed price contract and defined precisely what you wanted. You would have got considerably more than with the hourly based contract where we ended up with the current significant cost overrun.

It is worth re-considering the different options here. Crudely and simplistically put, as a consultant or contractor, you can bid for work in three ways.

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

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

Two phase contract. In the first phase, you get paid on a time-and-materials basis to define the job to both your and the client’s satisfaction and then in the second phase you actually perform the contract on a fixed price (or sometimes time and materials basis).

Fixed price is a gamble (for the contractor, that is)

If you know exactly what has to be done, how long it will take and the project is actually achievable (many aren’t – particularly in software development – and I have been there a few times); then this is a great option. But if the outcomes are uncertain and the project is badly defined, you are playing with fire going for a fixed price contract. Sadly enough, many clients know exactly how difficult and risky a particular job will be and go for a fixed price and “lure” a contractor or consultant in to do the job so that the risk is removed from their bailiwick. They are simply after a rock bottom price.

Interestingly enough 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” when it comes to negotiating at the end of the job exactly what they will get paid. We had a particularly tough case recently here with an underground tunneling contract which was fixed price (no matter what the consistency of the earth and rock was); but the contractor 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 inability to use the tunnel for an extended length of time so after jumping around for a while, paid up.

If you are forced into going for a fixed price contract, and the definition of the job is still a bit uncertain, then ensure that you define exactly what you are going to provide in the contract  in terms of hours and materials and some rate of compensation for when 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 main part of the contract! A popular strategy followed by some control system vendors who bid a very low fixed price (and thus win the job against fierce competition) 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 defining all the terms and conditions and contemplating all eventualities otherwise you are up for considerably more money than originally anticipated.


Sometimes fixed price contracts don’t work too well in odd ways. On one particularly acrimonious job we were advising the client on (for building a Gas Turbine power station); we defined everything extraordinarily clearly and ended up with a fixed price job. Unfortunately the contractor didn’t factor in the risk for writing the control system software and the client had an awkward choice when the project should have been delivered. Either let the contractor go bankrupt and not finish the power station construction 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 but despite this, after a few months the contractor still went bust. Resulting 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 overly enthused with paying more. However just remember, when a variation to the contract comes up, at the earliest possible opportunity, you should bring this to the client’s attention and bill him. No matter how awkward and unpleasant this is. If you delay until the end of the contract, you will run the risk of not getting paid. 

And at worse case, as a contractor/consultant if you cannot see your way for getting paid for the additional work you are doing, and can’t get agreement from the client for the unreasonable variations that are being imposed on you, 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 considerably worse. At this point, you may find that the client can see that you are serious and is more accommodating.

Sometimes it helps to compromise

Clients naturally worry that with time-and-materials contracts that they will be “taken to the cleaners” as far as the ultimate price of the job. And this is a well deserved concern. I think often unproven contractors can get lazy and simply bill for every hour. Naturally this is a short term win; as they are unlikely to be invited back on site again.

I would suggest if both client and contractor are unsure that 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. And then a fixed price or well considered time-and-materials proposal can 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 both parties get a fair return on their investment. Not too much and not too little. But just right.

New Fangled approaches

I worry sometimes about these new fangled approaches of alliances and partnerships between clients and contractors, rather than using fixed price or hourly rates. A bit like a partnership between God and the Devil. With superb management on both sides, they can work out. But often they end up costing one of the parties far more.

And naturally remember that unless you are an altruistic person, that it is better to not get awarded 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,

Steve

 

Mackay’s Musings – 28th April’15 #562
125, 273 readers – www.idc-online.com/blogs/stevemackay