Agile contracts? What about Weighted Fixed Price?

October 14, 2013

MichaelangeloAgile contracts are tricky. In fact Software Development contracts are tricky. Software development is a non-deterministic creative endeavour, you’d be better off trying to nail down the acceptance criteria for one of Michelangelo‘s sculptures than a typical software project. Software is complex.

A few years ago I was involved in putting together a contract model called “Weighted Fixed Price” and recently it occurred to me that I’ve never blogged about it, so I’ve dragged myself away from the source to do so.

What’s wrong with the normal models?

So, fixed price is bad because it only works when you can really accurately define the requirements, acceptance criteria and the potential risk exposure is tiny. Otherwise you get schedule and cost over-runs, formal change control etc. etc. Of course supplier’s always build in their risk buffer into the fixed price so it tends to cost a little more than honest T&M would. Software work is rarely this predictable which is why there are so many high profile failures.

Time and Materials is bad because it’s hard to manage across commercial boundaries and customers can feel that they’re paying for nothing, endlessly. Even defining waypoints is difficult due to changes in requirements and over time. Unscrupulous suppliers could just sit back taking the money, delivering as little as possible to avoid gross negligence but nothing more. Scrupulous suppliers could be working hard but hit by the many and varied risks arising from such complexity and yet perceived by their customers as the unscrupulous.

Of course there’s variations like Capped T&M, Phased Fixed, Phased Capped T&M etc. but they all start getting a bit complicated and hard to manage, not to mention open to gaming.

Then there’s models like pay-per-point and other “incentive” schemes that raise over-complication, missing the point and gamability to an art form. Just say “no”.

Competition

The real incentive to suppliers to do a good job is follow on work. That means that as a customer you need your suppliers to be in a competitive market, being locked in to individual suppliers leads to captive market behaviours.

Weighted Fixed Price?

In an attempt to put something in the middle between Fixed Price for low risk exposure and T&M/internal for high exposure I put together “Weighted Fixed Price”. The idea here is to to basically use a Fixed Price model but have suppliers weighted by previous performance affecting whether they get the business or not.

So if a supplier 1 delivers 10% late on Project A then when we’re looking to place Project B for 500k and we’re looking at each supplier’s estimates then we’ll add 10% to supplier 1’s estimate.  That means all over things being equal we’ll choose the other supplier’s who typically come in closest to, or even under, their previous estimates. Weighting is transparent to each supplier but not across suppliers.

This provides the following pressures:

  • Suppliers don’t want to underestimate, they’ll come in over their initial estimates and adversely affect their weighting and therefore their chance for follow on work
  • Suppliers don’t want to overestimate to artificially lower their weighting or build in risk buffers, they won’t get the work because they’ll cost too much
  • Suppliers don’t want to take on complex, high risk work because they can’t predict the effect on their weighting (more below)

Out-sourcing doesn’t transfer risks to suppliers, because the customer is still the one needing the business benefit and paying for it, especially when things go wrong. The Weighted Fixed Price model is intended to genuinely transfer the complexity risk to suppliers, if they’re willing to take it.

What happens when the supplier finishes early?

They deliver early, watch their weighting affect their potential for winning future work increase massively and enjoy their fixed price money meaning that they’ve increased their profit margin on this job.

What happens when they deliver late?

They deliver late, their weighting increases and they’re less likely to win against other suppliers next time. However, if they could predict that they’re going to deliver late early in the project then they could renegotiate with the customer in light of what everyone’s learned about the work.

What happens when suppliers don’t want to bid for work because it’s too risky/complex?

Excellent, this means that they’re honestly telling us that the work is too risky to predict. This means we shouldn’t be out-sourcing it in the first place, time to stand up an internal team or supplement with some time-hire contracts if we need extra capacity.

Conclusion

The Weighted Fixed Price model is an evidence based contract model can be used in competitive supplier markets for reasonably well understood work with low risk exposure. It incentivises suppliers to estimate accurately and deliver to their estimates as that affects their opportunities for follow on work. It incentives customers not to out-source overly complex risky work.

It’s not perfect because we’re still trying to contractually define how a sculpture should make us feel but it’s something you can add to the mix of contract models you use.