The Conduct of a Contract - Essay Example

Managing Contracts Introduction Contract management A contract is an agreement between two parties wherein the contractor renders a service to a party in lieu of the latter paying a sum of money to the former. The conduct of contract including its administration throughout the contract period falls under the purview of contract management. Contract management is the process whereby the buyer and seller meet their obligations to fulfil the objectives of the contract. For sound contract management, a contract need to have clearly defined deliverables and performance measures. Contract management requires a set of skills for defining deliverables, defining the requirements for achieving the deliverables, and managing the delivery of those requirements. Contract management is not an exact science (Gray and Larson, 412) and there is no perfect contract management system (412). An effective contract management system acts as an interface between the buyer’s and the supplier’s organization. Individuals or teams applying the contract management system should have requisite technical, contractual, and business knowledge to understand both sides of the arrangement. A contract is a legally binding instrument typically carried out with customers, vendors, partners or employees. It includes negotiating terms and conditions and ensuring their compliance. A contract results when each party, the contractor and the customer, promises the other a valuable benefit. The customer must have all the funds ready for the execution of a project and cannot expect any benefits until the completion of the project. Contract Contract or agreement is the document that enables the initiation and conduct of a project (Hill, 611). Contract is the confirmation of the customer’s request for the project and represents the contractor’s intent to achieve project deliverables and objectives (Hill, 611). Contract is more than a formal agreement between two parties and is a codification of the private law, which governs the relationship between the customer and the service provider (Gray and Larson, 413). Contract can be made with or within an organization. This usually means while one party promises to deliver certain goods, property or services by a specified date and the other party promises to accept the goods, property, or services and pay for them. Failure of one party to keep its promise may result in action by the other for breach of contract (Lock). Since contract management requires time and effort, adequate resources must be allocated to it. The conditions of the contract need to be clearly laid out, as an ambiguous or inconsistent contract, is difficult to comprehend and implement (Gray and Larson, 413). For the success of a contract both the parties need to understand the obligations of the contract. It also needs utmost cooperation and responsiveness on part of the customer and the service provider. An employee having a contract of employment is an example of a contract within an organization. Further down the line more contracts can exist between the main contractor and sub-contractor. . A contract has two principal organizations on each side. On one side is the customer, the organization that perceives the need for carrying out a project and musters motivation and money to carry it out. On the other side, is located the organization that is hired to carry out the work called the contractor (Lock, 84). These two principal actors are invariably present in every project. Often the identity of these two actors is shrouded in complexities. For example in IT and change management project, the customer and the main contractor may reside in the same company or the group of companies. In certain cases, there could be much larger number of smaller contractors rather than having one big contractor. A good contract states the obligations of the client and contractors clearly, completely, concisely and unambiguously. A sound business relationship can grow around the formal framework of the contract. A contract includes a clear statement of what is to be provided and what are the requirements that are to be met. Fixed Price Contract and Cost Plus Contract By their nature, contracts are of two kinds; the fixed price contract and the cost plus contract. The third type of contract, the time and material contract is a hybrid of the two. In the fixed price contract, one or more number of contractors make a bid, against the customer’s stated specifications, stating a total price for carrying out the project. The service fees of the contract are agreed upon in advance and remain fixed as long as no changes are made in the original provisions of the contract. Through competitive bidding a customer is able to get the minimum price. In case, the contractor lays a lower bid, there are chances that the contractor may not make adequate or no profit. On the other hand, if the contractor places a higher bid, there are chances that of the contractor losing the contract to some other low-cost bidder. The contractor has to be careful in estimating target costs and stipulated time schedule, because once they are agreed upon at the time of the award of the contract, it cannot be changed later on (Gray and Larson, 412). Fixed price contacts are preferred when the scope of the project is well-defined with predictable costs and low implementation risks. Fixed price contract is generally preferred by the contractors as there is less likelihood of changes being made after the award of the project. They are used when costs are fairly predictable and the time duration is long. The client is at minimum risk in the fixed price contract as the price is predetermined. The contractors tend to increase the price of the services to be delivered to mitigate their risk, keeping in mind that their prices remain competitive. The deadlines and deliverables in fixed price contract are well-defined and may include incentives for meeting or exceeding the objectives of the contract. There is lack of incentive for the contractors to finish the contract on time or control costs as they are reimbursed under any circumstance. Some fixed price contract may have incentive clauses attached to them. This helps in improving efficiency; control costs, and motivate the contractor (Gray and Larson, 412). Sealed bids are invited for competitive tendering of the contract and there is little chance of interaction between the contractor and the customer before the allotment of the contract. It is a reflection of the confidence of the contractor to complete a given project without spending more than its estimated costs. However, even in fixed-price contracts, there could be clauses that provide for limited price-negotiation or additional charges in the event of occurrence of events outside that may be out of the contractor’s control. Many fixed price contracts have an incentive clause that is designed to motivate contractors to reduce costs and improve efficiency. Consider the case where a contractor agrees to perform a given task at a target price based on target cost and a target profit. Likewise a maximum profit and maximum profit are also established. If the total cost ends up being less than the target cost, the contractor makes a higher profit up to the profit maximum. Similarly if there is a cost overrun the contractor absorbs some of the costs. Profit is determined on the basis of a cost-sharing ratio. A CSR of 75/25, for example, indicates that for every dollar spent above target costs the client pays 75 cents and the contractor pays 25 cents. This provision makes the contractor to keep the costs low since they pay 25 cents on every dollar spent above the expected cost and earn 25 cents more on every dollar saved below the expected cost (Gray and Larson). In the cost plus contract, some of the costs of the performance of the contract are reimbursed during the contract period (Gray and Larson, 412). These interim payments are also called interim payments or stage payments. Under these contracts, the customer agrees to repay the contractor for work done against a prearranged scale of charges. (Lock, 84). The contractor gets reimbursed for all costs and an additional fee is paid to cover overhead and profit. The fee for overheads and profits, negotiated in advance, is a percentage of the total costs. Generally, a penalty clause is added in order to limit failure in performance. The penalty payment is calculated according to the stated periods by which a contractor is late in successfully completing the project. In the cost plus contracts, though the contractors are supposed to make the best effort to fulfil their specific technical requirements, but they cannot be held responsible, if the work is not done in the estimated time and cost. Cost plus contracts face criticism as they hold little formal incentive for the contractors to control costs, or finish on time, because they get paid regardless of the final cost (Gray and Larson, 413). The major motivating factor for the contractors to contain costs is the negative effect cost overruns have on their reputation, and their ability to secure future business (Gray and Larson, 413). Cost-reimbursable contracts involve payment to the customer for the direct and indirect costs. Cost reimbursable projects can also include incentives for selected project objectives. In the cost reimbursable system the buyers absorb more risk associated with the contract. Time and Material Contract Time and material contracts are hybrid contracts of fixed price and cost reimbursable contracts. A time and material contract is used when the services that are needed cannot be specified and the total costs cannot be estimated in a contract. The contractor sends an invoice each week or month to the client listing the materials fee, the number of hours worked, and a description of work produced (Schwalbe, 190). The contract documents should unambiguously specify the exact role the contractor is required to perform. The customer and the client should both be clear on what is included, and what is excluded, in the quoted price. Contracts are of varied scope. At the lower end, they could be involving a sub-contractor for a minor involvement and on the other end; a contractor may be engaged for handling over of project to the customer only after completion and commissioning (Lock, 84). A contract is more than an agreement between parties; it is codification of the private law that governs the relationship between parties to it (Gray and Larson, 412). “It defines the responsibilities, spells out the conditions of its operations, defines the rights of the parties in relation to each other, and grants remedies to a party if other party breaches its obligations” (Gray and Larson, 412). The fee for the contract is calculated in advance and usually involves a percentage of total costs. The contractor is reimbursed for all direct allowable costs including that of material, labour and travel and an additional fee is paid to cover overheads and costs (Gray and Larson, 412). Unlike in the fixed price contracts, the risk burden shifts to the client or the customer (412). It is of primary importance that the work is finished on time and within the stipulated time frame. Though the contractors are supposed to put in their best effort to meet the technical requirements yet they cannot be held liable (412). The fees are based upon incentive formula and subject to additional provisions. Contract Management Activities Contract management activities are broadly classified into three categories: Service delivery management Relationship management Contract administration It is important that all these areas be addressed properly for the contract arrangement to be successful. All three areas needing different skill sets and professional expertise system should be managed proactively. Service delivery management ensures that service is being delivered as agreed, to the required level of performance and quality. It is the process of managing the performance provided to the customer as specified in the contractual performance metrics. It helps balance the cost and quality of services in order to provide the customer value for money. While some aspects of the service may be measurable by numerical means others may require subjective assessment. A contract is successfully carried out when both the customer and the management is when the success of the service delivery satisfies both the customer and the provider and the customer feels that the expected business benefits and value for money are realised. Relationship management keeps the relationship between the two parties open and constructive, aiming to resolve or ease tensions and identify problems early. For ensuring the relationship, feedback mechanism on the client performance is a must. Proper feedback from the supplier’s and the client’s perspective helps in prompt identification and handling of issues and problems. Relationship management requires formal mechanism, structures and processes, communication flows and peer to peer relationship between customer and the supplier. The communication between the contractor and the client should be peer to peer; that is operational problems are resolved by the staff at the operational level and not discussed with the business managers. Similarly, business issues should not percolate downwards at the operational or technical level. Contract administration handles the formal governance of the contract and changes to the contract administration (Office of Government Commerce, 1-58). Contract administration ensures that all contractual obligations are fulfilled by the parties to the contract. As there are number of uncertainties involved in contract work, no contract can fully address the issues that emerge. Contract administration is concerned with the mechanics of relationship between the buying agency and the supplier. Successful management of a contract requires good contract administration. Contract administration forms the last stage of contract cycle and is inclusive of all duties associated with a contract. Contract administration also includes contract review and contract transition. Contract administration is the formal governance of the contract and includes such areas as contract maintenance, change control, charges, cost monitoring, ordering and payment procedures, management reporting and so on. (Office of Government Commerce, 1-58). It concerns with the mechanics of the relationship between customer and the provider. Clear administrative procedures describes clearly as to who does what, when and how. Contract maintenance is indispensable to contract administration. It helps in keeping contract documentation up to date and relevant to what is happening ‘on the ground’. Contract administration also requires creating appropriate structures with representatives of both customer and the contractor for reviewing and authorising change. Specification and change control is central to the contract administration procedures. Contract administration involves overlooking the activities following the award of the contract till its completion. There is no need for the contractor to indicate the cost of the project till the end of the project. Managing the service delivery is of foremost concern to the contractor as well as the client. It ensures that all that is agreed upon is delivered to standards of quality and specifications mentioned. A well documented contract addresses the question of service levels and terms and conditions of the contract. In addition to the contractual and commercial aspects, the management of relationship between the contractor and the client, based upon right attitude and behaviours is vital to the successful execution of the contract. The three key factors responsible for the relationship to work are trust, communication and recognition of shared aims. Smooth information flow channels, sound management structures, involvement of staff at all levels are necessary for successful completion of the project. Sound information flow is managed at three staff levels, the operational, business and strategic. The operational staff consists of the end users and the technical support staff. The business level includes contract manager and relationship manager on both sides. The strategic level is that of the management and the board of directors. The contract administration is the formal governance of the contract through contract maintenance and change control, charges and cost monitoring, ordering and payment procedures, management reporting, etc. It ensures proper procedures demarcating the responsibilities of the parties in the contract. Contract administration plays a vital role in the successful completion of a contract. All procedural details including that of making changes are documented well in the contract administration. The contract should also include means to measure performance. Changes in the Contract Contract change control system provides the mechanism whereby a contract can be modified. A contract may need to be changed under conditions where the customer wishes to alter the original design or scope of the project is initiated. A contract may be modified through a contract change control system that includes necessary paperwork, tracking systems, dispute resolution procedures, and approvals (Gray and Larson, 413). There are a variety of reasons due to which the client may wish to make changes in a contract. The change could be need based as the project moves from the drawing board to reality. Market changes may also necessitate adding new features or increasing the performance requirements of the equipment. Also, decline in financial resources may dictate that the owner cut back on the scope of the project. Changes in the contract could also be forced due to arising of unexpected but legitimate problems or development of unforeseen circumstances. There need to be formal, agreed upon procedures for making changes in the initial contract (Gray and Larson, 413). Conclusion It is impossible to erect a foolproof contract management system. Authorities in different countries are always earnestly trying to develop effective contract management and administration system. However, despite their best effort to evolve a fool proof system the news of the abuse of the system are not uncommon. No amount of theoretical deliberation or practical application can address all the issues concerning a sound contract management system. In addition to the formal contractual obligations the parties also need to develop working relationships between parties involved that are based on mutual goals, trust and cooperation. It forms a productive relationship based upon mutual trust and cooperation. References Gray, Clifford, F, and Erik W. Larson. Project Management. 2nd Edition New York: McGraw-Hill Professional, 2002 Lock, Dennis. Project Management. 8th ed. London: Gower Publishing Company, 2007 Hill, Gerard, M. The Complete Project Management Office Handbook London: CRC Press, 2004 Schwalbe, Kathy, Introduction to Project Management, London: Cengage Learning, 2008 Office of Government Commerce, Contract Management Guidelines 2009 The UK Government 31 May 2009 Read More