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Selecting Contract Type for Outsourced Software Development Project John Constance MSc in Project Management, University of Liverpool

Abstract The best way to ensure a buyer receives the desired goods and services from the seller is through a contract agreement. Contract obligates the seller to provide specified procurement requirements to the buyer within described quality, cost and time. Yet while it is true contracts legally binds the parties to perform a particular set of obligations, the numerous uncertainties surrounding todays business environment can obstruct or reduce the parties ability to produce contract requirements. Changes in market conditions; and industrial regulations and standards can impact the criteria defined for the services to be provided. These uncertainties and numerous transactional risks demand the project manager to make sure to determine all the conditions surrounding the procurement and select the contract type best fit and suitable to eliminate or reduce associated risk to enable both parties to deliver their side of the contract terms. The project manager must ensure contract services not only make the seller to perform most effectively; but that through its terms and condition there is maintained shared client-contractor relationship and collaboration. Introduction While it is fair to say majority of day-to-day procurement transactions are conducted in straight forward one day activity in a stable and certain environment or arrangement; there are several other goods and service purchases that go beyond a days event and conducted in very harsh and uncertain business environment. To get a seller to provide particular services to a buyer, such conditions require a buyer-seller contract. Contracts are legally binding documents used by the project owner and the contractor to provide contract services. The contract all ensures all expected uncertainties and changes that may impact the sellers ability to legally fulfill its agreed performance are taken into consideration under the contract with provisions to manage such situation. There are several contract types that can be satisfactorily used to ensure all parties have the ability to perform their side of the arrangement. The project manager must determine condition surrounding the business market, industry, terrain and weather and the uncertainties associated with these conditions and select the contract type that will best manage to successfully procure the required project items and deliver of the goals of each party. This paper will examine the contract type required to manage a software development project that is within an unstable and changing business environment that can significantly impact the specifications and requirements of the project throughout its entire life. The various contract types will be briefly defined and the most appropriate and best-fit contract type for this project and business condition will be recommended. Reasons for the selection of this contract type will be provided and the conclusion will show this contract type is best fit to manage projects that will undergo drastic changes to its procurement specifications and requirements.

Software development Y.H. Kwak, J. Stoddard (2004) said projects involving software development is the collections of bigger programs that include numerous interactions and many dependencies that involves much of the same development processes of other project but creates something never done before. The authors reiterate that software development projects are implemented with gloomy profile of cost and schedule overruns and quality and fit-for-use problems. The outsourcing of software development or OSD, which is the focus of this paper, is about seeking a seller either in-country or buying look a seller abroad. According to Oleg Ishenko (2005) OSD can be divided into three components (in-country, near-shore and offshore). The author goes on to explain the problems encountered during OSD. Information confidentiality uncertainty provision of total security is difficult to foretell and prevent Staff proximity lacking constant and easy access to staff creates excessive management and technical overhead and decreases product quality Financial payback uncertainty - client uncertainty in product payback can due to bankruptcy, legislative changes, political instability, etc. Management complexity - a lack of firm control on operations Lack of control no control over the outsourced resources

Subhankar Dhar, Bindu Balakrishnan (2006) of San Jose State University in the USA identified several risks associated with OSD. These include people, knowledge, culture, politics, finance, quality standards, measurement, scope, cost, time, legal contracts, intellectual property, disaster recovery, contract management, geographic location, relationship and alliances and company specific risks. All these indicate that no matter the environment there is always the possibility that an OSD project is implemented under an ever changing and challenging environment. Contract type summary Sherrer (2009) defines a contract as a framework that legally binds one party to perform certain specified services or works and another party to pay for the provision of the specified services or works. It is the exchange of something of value for the performance of specified service. Contract involves the following: Identification of contract parties and their role and responsibilities Description of contract works, price, and duration Listings of documents that make up the entire contract Definition of governing laws, risk allocation, insurance, amendments and cancellations, process, procedures and consequences for failure, and other specific situations

PMBOK (2008) identifies three main contract types: Fixed-price contract: a contractor is paid a specified budget to complete the project works or services used when a reasonable and realistic price can be established at the start or works the buyer pays the contracted amount in spite of the contractors actual cost

it persuades the contractor to control costs there are three types of Fixed-price contract (PMBOK, 2008)

o Firm fixed price (FPP): precise, fixed price for a detailed described deliverable; good to use when the level of uncertainty is low o Fixed price incentive fee (FPIF): allows flexibility in performance deviation,
provides financial inducement for achievement of agreed requirements; used to negotiate a specified cost, and profit and maximum price for risk allocation; the risk is that the buyer will most of the time pay the seller for delivery of optimal project outcome

o Fixed price with economic price adjustment (FP-EPA): allows price adjustment based on agreed contingency factors not under the contractors control; and is
used to protect the parties against major economic unpredictables including costs for labor or material

Cost-reimbursable contracts According to Langford (2007) this contract type is more suitable where transactional uncertainties is expected to affect the contractors performance, delivery timetable, and total project costs Heldman (2009) said this contract as one that the buyer is charged to pay all contracted costs incurred by the seller there are three types cost-reimbursable contracts (PMBOK, 2008)

o Cost plus fixed fee (CPFF): allows the seller to recover actual costs; and when the
contract is completed the contractors receives an additional fee agreed by both parties; and used when uncertainties involved in the performance of the contract is sufficient to prevent the use of the fixed price contract

o Cost plus incentive fee (CPIF): allows the contractor to recover actual costs; and

when the contractor exceeds a specified performance a bonus fee agreed by both parties is paid to the contractor; and used to encourage the seller to improve cost savings and performance and achieve greater profits the payment of an award fee base solely on the judgment of the buyer; and used when additional incentive is required to ensure the seller achieves excellence in quality, time, techniques, and cost

o Cost plus award fee (CPAF): allows the contractor to receive all actual costs plus

Time and materials contracts payment made to the contractor based on actual cost of direct labor, materials and equipment usage, and a fixed add-on cost to cover overheads and profit used mostly in construction projects used when cost of materials and number of man-hours required is difficult to determine the contractor gets no incentive for cost control does not apply in this paper

Project condition and recommended contract type The project is to outsource software development. However the project environment predicts drastic changes in procurement specifications and requirements; and this is expected to happen throughout the life cycle of the project. The contract type recommended for this project situation is the Cost plus award fee (CPAF) contract. The reason why its best to use this contract type is as follows: the market is unstable thereby making market conditions requirements to change anytime during the project; and this change will impact the contractors ability to perform and complete the contract as termed and conditioned Langford (2007) defined cost reimbursable contracts best fit for condition where more likely transactional uncertainties would occur and these occurrences will have an effect on the sellers performance, agreed time for delivery, and the project total costs This contract gives the parties the option to cover only costs incurred; and because performance is done within a drastic changing business environment the contract gives the buyer the option to award a fee to the seller if satisfied with performance The completion of this contract in a changing environment is realistic and practical The CPAF is the framework for subjective evaluation of the sellers performance. Award fee at the discretion of the buyer encourages the seller to thrive to perform with excellence and high-level quality, and work is completed before schedule and cost is effective regardless of the several changes during the contract

Conclusion Most experts in outsourcing software development projects indicate that most contracts used are product contracts - license and warranties, contracts for the supply of products, contracts for the supply of services, contracts for the custom development service and supply of solutions and applications (Wei-lung Wang, 2008); and Peter Brooks considers the best contract types for software development are time and materials contract, fixed price contract, revenue shared contracts and hybrid contract, see (http://www.ehow.com/about_5572754_types-softwareoutsourcing-contracts.html ). However, Sollish, Semanik, Morris & Pinto (2011) advised that decision over contract type should be strategic and based on ways to influence payment conditions, risk allocation, and get optimal outcome. The authors emphasized the need for project manager to ensure all contracts terms and condition meet project plan including requirements and constraints. The project manager must scrutinize the various contract types including applicability, and legal and financial risks. In this way client-supplier relationships can be managed and lead to successful performance and completion of the contract. And all the condition of uncertainties and changes and challenges in outsourced software development projects can be managed effectively and satisfactorily using the Cost Plus Award Fee (CPAF) contract.

_____________________________________________________________________________________ References
Y.H. Kwak, J. Stoddard (2004) Project risk management: lessons learned from software development environment [Online] Available from: http://home.gwu.edu/~kwak/Project_Risk_Management.pdf Oleg Ishenko (2005) Outsourcing Of Software Development [Online] Available from: http://www.seoresearcher.com/research/Outsourcing-of-Software-Development.pdf Subhankar Dhar, Bindu Balakrishnan (2006) Risks, Benefits, and Challenges in Global IT Outsourcing: Perspectives and Practices [Online] Available from: http://www.isqa.unomaha.edu/dkhazanchi/Teaching/ISQA4590-8596/Readings/Supplemental %20Readings/week%2012/Risks-Benfits%20and%20Challenges%20in%20Global%20Outsourcing.pdf Sherrer, J.A. (2009) Project management road trip for the project management professional. 4th ed. J. Alex Sherrer. Project Management Institute (2008) A guide to the project management body of knowledge. 4th ed. Newton Square, PA: Project Management Institute. Langford, J.W. (2007) Logistics: principles and applications. 2nd ed. New York: McGraw-Hill. Sollish, F., Semanik, J., Morris, P.W.G. ed. & Pinto, J.K. ed. 2011. Planning and administering project contracts and procurement. Laureate Education, Inc., custom ed. Hoboken: John Wiley & Sons. Wei-lung Wang (2008) Common Types of IT Contracts [Online] Available from: http://softwarecontracts.net/ Peter Brooks, Types of Software Outsourcing Contracts [Online] Available from: http://www.ehow.com/about_5572754_types-software-outsourcing-contracts.html (Accessed 10 March 2012)